Cato Policy Analysis No. 143 November 20, 1990

Policy Analysis

Why Trade Retaliation Closes Markets and Impoverishes People

by Jim Powell

Jim Powell is the author of The Gnomes of Tokyo: Why Foreign Investment Is Good for Us (Amacom Books, 1989). He has written for The New York Times, The Wall Street Journal, Barron's, Money, and other publications.


Executive Summary

This analysis challenges the prevailing fashion in U.S. trade policy, the so-called crowbar theory that predicts that foreign markets will open if we close our markets, or at least threaten to. The crowbar theory is enshrined in the "super-301" section of the 1988 trade law.

The primary target now, of course, is Japan. James Fallows, Atlantic Washington editor, attracted international attention with a May 1989 article contending that the United States must "contain Japan."[1] Fallows's cold war language, of course, suggested that Japanese companies pose a threat comparable to that of Soviet weapons. He made it clear that Japanese containment called for "outside pressure" from a nation "unchallengeably strong," such as the United States was when it occupied postwar Japan.

In The Enigma of Japanese Power, Dutch journalist Karel Van Wolferen insisted that the Japanese play by fundamentally different rules than we do. He concluded that only "therapeutic economic sanctions" are likely to bring significant changes in Japanese trade policy.[2] In Tradinq Places, former Commerce Department trade negotiator Clyde V. Prestowitz promoted the idea of "managed" trade: the United States should close its market if Japan does not give us a satisfactory share of its market.[3]

Yet despite frequently repeated claims, it is hard to find a single significant case in which trade retaliation or retaliatory threats have forced open a foreign market. Examination of a large number of recent and historical cases of trade retaliation reveals that when retaliation-related market openings did occur, they were small. In many cases, countries responded to retaliation by further closing their markets--surely the opposite of what crowbar theorists intend. Consequently, the history of trade retaliation looks like a bad investment portfolio: small gains dwarfed by huge losses.

The crowbar theory has backfired so many times that a study of it, like the study of warfare, inevitably becomes a study of failure. Trade retaliation has failed to produce significant market openings for five principal reasons.

First, retaliation tends to inspire nationalism and xenophobia in the target country. "The theory of economic sanctions is that they will cause a split within the leadership and the masses of people," says political scientist Robert Gilpin of Princeton University. "But in almost all cases, it's been the opposite. What you have is really a rally-around-the-flag response in these countries."[4]

Second, retaliation forces a country to reorient its economy toward alternative suppliers and markets. Sometimes that means expanding business with previously unimportant trading partners. The target country may develop brand-new trading partners. It may raise crops or produce goods that other countries want so much that they will disregard retaliatory sanctions. The target country may pay premiums for its imports. One way or another, it is almost sure to get along.

Third, retaliation commonly expands the role of government in the target country, much as warfare does. The target government may increase its use of price controls, import quotas, exchange controls, "administrative guidance," and other restrictions, which become very hard to get rid of because they are defended by local lobbyists. That is why, in more than one case, retaliation has had the presumably unintended consequence of promoting fascism. Thus, retaliation may indeed hurt the people in the target country without helping the country that imposed the sanctions.

Fourth, the "tougher" the sanctions, the more they harm people in the retaliating country. Import restrictions trigger shortages and higher prices for consumers, and export restrictions wipe out business for exporters. Sanctions probably inflict as much harm at home as they do on the target country. That is why tough sanctions are seldom adopted, despite continuing objectionable practices in a target country. When such measures are adopted, they lead to losses, black markets, and corruption.

Fifth, retaliation cannot do anything about the worst cases, nations whose economies are already closed. Since there is little trade with such countries, threats to cut off trade are meaningless.

To be sure, retaliation may inflict considerable harm on a target country with whom a lot of trade is taking place, but such retaliation rarely causes the target country to change its policies. In many cases, people have patriotically endured hardship rather than do the bidding of a hostile foreign government. If Washington prevented American consumers from buying any Japanese products, Japanese companies as well as American consumers would lose, but past experience suggests that it is unlikely that the Japanese government would respond with a significant market opening.

Since the crowbar theory has failed in practice, we should not be surprised to discover that its underlying premises are false. Crowbar theorists assume that it is somehow easier for Washington to get other governments, thousands of miles away, to make significant policy changes than it is to achieve changes, such as abolishing agricultural import restrictions, here at home. Also false is the premise that markets open only when subjected to external pressure such as trade retaliation. That is as false as the ancient delusion that genuine reforms can be imposed by conquest.

As is shown below, significant market openings tend to occur for domestic, not external, reasons, and the precondition is almost always an economic crisis. When enough people in a stagnant, closed society fear falling behind prosperous open-market economies, it becomes politically possible to overcome entrenched interests and abolish border restrictions. Equally important, there must be prosperous open-market economies in the world--standard-bearers if you will--so people in closed societies can see for themselves that they will really be better off after they go through the short-term pain of allowing long-protected, backward enterprises to close and make their resources available to new entrepreneurs.

The most dramatic way we can promote more open markets abroad is to unilaterally repeal our own border restrictions. Although that is a formidable task, it is far more likely to succeed than is a policy of bludgeoning foreigners thousands of miles away. By repealing our border restrictions, we will make it possible for our people to get what they need more easily and cheaply. Companies will become more competitive, and living standards will go up. We will provide a much-needed affirmation that peaceful contact with the outside world is perhaps the most powerful, persistent stimulus for human progress.

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