1970s Déjà Vu

This article appeared in the Wall Street Journal on November 27, 2008.

World leaders have sounded alarm bells against a repeat of the1930s, when tit-for-tat protectionism followed hard on the heels ofthe Wall Street crash. But they are fighting the wrong enemy.Current events suggest a different, but still vexing, scenario: thecreeping protectionism of the 1970s, rather than the spiralingprotectionism of the 1930s.

In the 1970s, oil-price hikes and other shocks triggeredinward-looking, mercantilist policies, including in Europe and theUnited States. Immediate policy responses were not overlyprotectionist: There was no equivalent of America's 1930Smoot-Hawley tariff. But escalating domestic interventions on bothsides of the Atlantic exacerbated economic stress and prolongedstagnation. Not least, they spawned protectionist pressures.Industry after industry, coddled by government subsidies at home,sought protection from foreign competition. The result was the "newprotectionism" of the 1970s and 1980s.

Then, as now, manufacturers of gas-guzzling cars facedbankruptcy. Congress bailed out Chrysler in 1979. The Britishgovernment bailed out Rolls Royce and British Leyland, and Renaultwas saved by French taxpayers. Several other sectors -- timber,energy, minerals, railways, airlines, shipbuilding -- receivedgovernment subsidies in the 1970s, in both Europe and the U.S. Manycompanies were nationalized.

On both sides of the Atlantic, "voluntary export restraints" andother nontariff barriers were also deployed to "manage trade." Thesectors that received subsidies at home were also protected fromforeign competition. Through the 1980s, American car manufacturerswere protected by VERs that restricted the number of Japanese carsexported to the U.S. Europe negotiated a similar agreement withJapan in 1983. Many other sectors, such as semiconductors and VCRs,were also protected. The French government even demanded that allJapanese VCR imports enter France via Poitiers, a small townhundreds of miles from the nearest shipping port.

Now, as in the 1970s, there is a big global push to expanddomestic regulations which "manage" the market. Most new regulatoryproposals are not directly protectionist, but they do have subtleand indirect consequences for global economic integration. Newfinancial-market regulations are brewing in OECD countries as wellas in emerging markets. They concern everything from a globalcollege of financial regulators and stricter capitalizationrequirements to limits on executive pay and directions to lend tosmall enterprises. Unless current regulatory ambitions are scaleddown, they run the risk of stifling market signals and emasculatingthe entire global economy.

Regulatory agendas are also becoming cluttered with governmentsubsidies. These measures comprise bailouts for ailing corporatebehemoths (such as the U.S. car industry), and funds to protect"national champions" in "strategic" sectors from foreign takeover(as President Nicolas Sarkozy has proposed for France and the EU).Such measures inevitably distort global commerce and triggerretaliatory responses: If one country subsidizes, others follow; ifone sector gets subsidized, others will demand like treatment. Thatwill in turn lead to a clamor for other forms of protection againstforeign competition, such as antidumping and safeguard duties,export subsidies, and discriminatory product standards.

Where will this creeping protectionism lead next? Financialservices remain first in the line of fire. Tighter prudentialregulations may be called for in some cases, but they should bedistinguished from the rules that underpin market access forfinancial services firms, whether domestic or foreign. Thisdistinction is now being ignored. Politicians and regulators --including those in China and India -- will likely use the financialcrisis as cover to block further market opening to foreignfinancial-services providers. Indian commerce minister Kamal Nathsaid after the EU-India summit in September that the financialcrisis has vindicated his government's policy of avoiding acomprehensive liberalization of the country's banking system.

Creeping protectionism will not be restricted to finance: It canalso be directed at specific countries and other economic sectors.Much Western protectionism in the 1970s and 80s was directed atblocking imports from Japan and other East Asian Tigers. Now, on amuch grander scale, there is a protectionist backlash against theglobal integration of China and India. In the U.S. and EU,allegations against China of "unfair trade" linked to "currencymanipulation," bilateral trade deficits, hidden subsidies, and lowlabor and environmental standards are resurfacing.

Investment nationalism, often combined with energy nationalism,is also on the rise. The United Nations Conference on Trade andDevelopment has recorded an increase in the number of new lawsunfavorable to foreign direct investment. Since 2005, a quarter ofall new FDI laws are considered to be unfavorable to FDI, comparedwith an average of 7.5% from 1992 to 2004. These restrictions arebunched in energy-related sectors, but they are spreading to othersectors. Congress, for instance, blocked a bid by China NationalOffshore Oil Company for Unocal, and it scuppered Dubai Port'sattempt to take over the management of six U.S. ports. Meanwhile,the Chinese government has recently tightened foreign-investmentrestrictions to protect national champions in a range ofindustrial, energy and service sectors.

Last but not least, the climate-change agenda appears set tobecome the Trojan horse of "standards protectionism" in the 21stcentury. Technical standards have long been a popular form ofprotectionism because they aren't as obvious as tariffs or quotas,and can be disguised politically as matters of "safety" or"quality." The EU has an emissions-trading scheme in operation.Congress will probably pass a similar cap-and-trade scheme nextyear. Because such schemes will impose substantial compliance costson energy-intensive sectors at home, the EU and the U.S. will seekto impose similar costs on cheaper, carbon-intensive productionelsewhere that is not subject to carbon-reduction policies. Hencethe threat of trade sanctions on "free riders" -- China inparticular.

Because we've been down this road before in the 1970s, we cansee where it is leading. Giving way to protectionism will deepenand prolong the global recession. Containing protectionism, andextending open markets, will facilitate flexibility and adaptation.It will speed up recovery and lay the foundations for futureprosperity.

Razeen Sally

Messrs. Erixon and Sally are co-directors of the European Centre for International Political Economy in Brussels. Razeen Sally is on the Center for Trade Policy Studies board of advisers and author of the Cato book, New Frontiers in Free Trade.