A Protectionism Fling: Why Tariff Hikes and Other Trade Barriers Will Be Short‐​Lived

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Introduction

During the past six months governments have intervened massivelyin the financial and real sectors of their economies, revivingdebate over policies long considered vanquished. Some governmentshave turned to protectionism, raising tariffs and other barriers totrade. Others are subsidizing industries or more quietly finessingregulatory policies to advantage domestic “champions.” Surely, thetemptation to placate powerful domestic interests will lead othergovernments toward protectionism in the months ahead.

A sense of foreboding seems to have enveloped the trade policycommunity, where a common view among scholars, economists, andjournalists is that a resurgence of protectionism is inevitable,and that it will cause serious economic damage. In the newspapercolumns and in the think tank reports, there is little evidence ofany faith that the rules‐​based system of trade‐​established in partfor the purpose of containing and defusing protectionistoutbursts‐​is equipped to rise to what is arguably the first majorchallenge in its 62‐​year existence.

But that view does not adequately reflect the fact that mostgovernments prefer policies that keep their economies open to tradeand investment. Despite some episodes of backsliding, the world isunlikely to witness a significant departure from the trend towardtrade and investment liberalization that has been evident since theend of World War II. An increasing number of governments have cometo recognize that optimal economic outcomes arise under conditionswhere policies enhance‐​rather than limit‐​the freedom of people totransact with others, including foreigners. Protectionism limitschoices and thereby undermines human liberty and economicefficiency.

Reasonably well‐​respected trade rules and the reality of aglobal economic system that renders trade openness an imperativefor success are some of the reasons to believe that anyprotectionist outbreak will be fleeting. Indeed, policymakers wouldbe advised to respond to the downturn by reducing theirtrade and investment barriers unilaterally because doing so expandschoices, reduces costs, and spurs the kinds of structural reformsthat facilitate economic growth.

A System to Bend but Not Break

One of the reasons for the creation of the rules‐​based system oftrade was to ensure that the scenario of spiraling, retaliatoryprotectionism of the 1930s never played out again. Starting withthe General Agreement on Tariffs an Trade in 1947, through sevensubsequent multilateral rounds of trade liberalization culminatingin the establishment of the World Trade Organization in 1995, andinto the present, that objective has been upheld.

The WTO/GATT rules encourage trade liberalization, but alsogrant governments some flexibility to manage their own paces ofliberalization and to re‐​impose or raise barriers under certaincircumstances. The rules distinguish between “Bound” and “Applied“tariff rates. The bound rate is the maximum rate of duty (perproduct category) that a member can assess against imports, and theapplied rate is the prevailing rate of duty (per product category).Generally, the bound rates of developed countries are significantlylower than the bound rates of developing countries. That is, thehighest allowable tariffs in richer countries are much lower thanthe highest allowable tariffs in poorer countries.1

Within the rules, developing country economies are consideredmore vulnerable to potentially disruptive effects of rapid changesbrought about by increased trade and investment. Accordingly,governments of developing countries are afforded greater latitudeto respond to those changes. How much latitude depends, to someextent, on the differences between each country’s bound and appliedrates. If the applied rate relative to the bound rate is low, thenthere may be vast room for backsliding and raising tariffs inresponse to a perceived crisis. For many developing countries, thedifferences are vast.

India’s simple average bound tariff rate is 50.2 percent, butits simple average applied rate is 14.5 percent. Thus, the Indiangovernment could almost quadruple its tariffs without violating itsWTO obligations. Likewise, Brazil has a lot of “overhang” with anaverage bound rate of 31.4 percent and an average applied rate of12.2 percent. By contrast, China has far less latitude forbacksliding. Its average bound rate is 10.0 percent, and itsaverage applied rate is 9.9 percent. The institutional restraint onChina’s backsliding is similar to that on developed countries. Thebound and applied rates of the United States are both 3.5 percent,and for the European Union (27) the bound rate is 5.4 percent andthe applied is 5.2 percent.2 Many factors affect a member’s bound rates,including its level of development, its duration as a member of theWTO/​GATT, and its past negotiating positions, to name afew.3

Other forms of temporary backsliding also are permitted withinthe system. Members can raise tariffs in excess of their boundrates, impose quotas, and even ban imports altogether under variousWTO agreements. The Agreement on Safeguards permits members toimpose duties or quotas in response to unforeseen import surges,which seriously injure a domestic industry. Under the Anti‐​dumpingAgreement, duties can be imposed when a domestic industry ismaterially injured by reason of imports that have been sold atprices below “normal value.“4 The Agreement on Subsidies and CountervailingMeasures permits members to impose duties to offset the injuriouseffects on a domestic industry from imports that benefit fromforeign government subsidies.

Under the rules, imports also can be banned in the interest ofpublic health or safety. Some member countries have used theseprovisions to exclude imports of beef that were suspected ofcontamination from “mad cow” disease. Others have bannedgenetically modified agricultural products on the grounds that therisks of consumption are presently unknown.

Protectionism on the Rise?

C. Fred Bergsten of the Peterson Institute for InternationalEconomics finds that “The WTO rules are very porous. If you simplysay live up to your rules, you still have massive scope for what Icall legal protectionism.“5 But Bergsten sees the glass as half empty.Sure, there is scope for backsliding, but without that scope in thefirst place the WTO/GATT system likely never would have come tosucceed as it has. Governments would have been less willing toformalize commitments and the scope of rules coverage would havebeen smaller in terms of products and countries involved.

Still even more importantly, the trade rules are not sorestrictive that governments obsess over finding ways around them​.It is not the existence of the rules that compels countries toliberalize trade. Governments typically are not looking for excusesto raise trade barriers. If compliance were the primary motivationfor countries to liberalize trade, we would not observe appliedtariff rates that are so much lower than the maximum allowablerates. And we would likely observe much greater use of the varioustrade remedies across industries and more invocation ofrestrictions in the name of health and other technical barriers totrade.

Trade liberalization is motivated by self‐​interest, and thedisparities between bound and applied rates are explained by thefact that most members have a preference for openness. There arereal benefits, beyond the reciprocal openings of others’ markets,to keeping one’s own trade barriers low. Nevertheless, governmentshave been invoking protectionist measures over the past severalmonths. Here are just a few examples:6

  • In India, tariffs and other restrictions have been raised onsome steel products;
  • Ecuador raised tariffs on 940 different products by a range of5 to 20 percentage points;
  • Indonesia limited the number of points of entry into domesticcommerce for imported products and is requiring its civil servantsto buy only Indonesianmade products; and
  • Argentina made licensing requirements more onerous forso‐​called sensitive products, such as auto parts, textiles, TVs,and shoes.

And here is how a top‐​circulation American daily newspaperdescribed the global flirtation with trade barriers inDecember:

Moving to shield battered domestic manufacturers fromforeign imports, Indonesia is slapping restrictions on atleast 500 products this month, demanding special licenses and newfees on imports. Russia is hiking tariffs on imported cars, poultryand pork. France is launching a state fund to protect Frenchcompanies from foreign takeovers. Officials in Argentina and Brazilare seeking to raise tariffs on products from imported wine andtextiles to leather goods and peaches.7

There may be nothing necessarily incorrect about the factsreported. But the tone and implications are possibly misleading. Itis hard to accept the otherwise marginally significant factswithout also accepting the provocative metaphors and sense ofimpending doom. Those actions have less antagonistic explanationsand more benign interpretations.

The actions of Indonesia, Argentina, and Brazil are consistentwith their rights under the WTO agreements and will have anegligible collective impact on world trade. Russia is not even amember of the WTO and frequently behaves outside of internationalnorms, so its actions have very limited representative value. AndFrance has intervened to block foreign takeovers of Frenchcompanies on other occasions this decade, so its actions are notparticularly noteworthy. The popular media usually lacks nuance inits accounting of trade policy events and often intones that thepresent will be a replay of the 1930s.

A Little Perspective, Please

Although some governments will dabble in some degree ofprotectionism, the combination of a sturdy rules‐​based system oftrade and the economic self interest in being open to participationin the global economy will limit the risk of a protectionistpandemic. According to recent estimates from the International FoodPolicy Research Institute, if all WTO members were toraise all of their applied tariffs to the maximum boundrates, the average global rate of duty would double and the valueof global trade would decline by 7.7 percent over fiveyears.8 That wouldbe a substantial decline relative to the 5.5 percent annual rate oftrade growth experienced this decade.9

But, to put that 7.7 percent decline in historical perspective,the value of global trade declined by 66 percent between 1929 and1934, a period mostly in the wake of Smoot Hawley’s passage in1930.10 So thepotential downside today from what Bergsten calls “legalprotectionism” is actually not that “massive,” even if allWTO members raised all of their tariffs to thehighest permissible rates.

If most developing countries raised their tariffs to their boundrates, there would be an adverse impact on the countries that raisebarriers and on their most important trade partners. But mostdeveloping countries that have room to backslide (i.e., not China)are not major importers, and thus the impact on global trade flowswould not be that significant. OECD countries and China account forthe top twothirds of global import value.11 Backsliding from India, Indonesia,and Argentina (who collectively account for 2.4 percent of globalimports) is not going to be the spark that ignites a global tradewar. Nevertheless, governments are keenly aware of the events thattranspired in the 1930s, and have made various pledges to avoidprotectionist measures in combating the current economicsituation.

In the United States, after President Obama publicly registeredhis concern that the “Buy American” provision in the AmericanRecovery and Reinvestment Act might be perceived as protectionistor could incite a trade war, Congress agreed to revise thelegislation to stipulate that the Buy American provision “beapplied in a manner consistent with United States obligations underinternational agreements.” In early February, China’s vice commerceminister, Jiang Zengwei, announced that China would not include“Buy China” provisions in its own $586 billion stimulusbill.12

But even more promising than pledges to avoid trade provocationsare actions taken to reduce existing trade barriers. In aneffort to “reduce business operating costs, attract and retainforeign investment, raise business productivity, and provideconsumers a greater variety and better quality of goods andservices at competitive prices,” the Mexican government initiated aplan in January to unilaterally reduce tariffs on about 70 percentof the items on its tariff schedule. Those 8,000 items, comprising20 different industrial sectors, accounted for about half of allMexican import value in 2007. When the final phase of the plan isimplemented on January 1, 2013, the average industrial tariff ratein Mexico will have fallen from 10.4 percent to 4.3percent.13

And Mexico is not alone. In February, the Brazilian governmentsuspended tariffs entirely on some capital goods imports andreduced to 2 percent duties on a wide variety of machinery andother capital equipment, and on communications and informationtechnology products.14 That decision came on the heels oflate‐​January decision in Brazil to scrap plans for an importlicensing program that would have affected 60 percent of thecounty’s imports.15

Meanwhile, on February 27, a new free trade agreement was signedbetween Australia, New Zealand, and the 10 member countries of theAssociation of Southeast Asian Nations to reduce and ultimatelyeliminate tariffs on 96 percent of all goods by 2020.

While the media and members of the trade policy community fixateon how various protectionist measures around the world mightforeshadow a plunge into the abyss, there is plenty of evidencethat governments remain interested in removing barriers to trade.Despite the occasional temptation to indulge discredited policies,there is a growing body of institutional knowledge that when peopleare free to engage in commerce with one another as they choose,regardless of the nationality or location of the other parties,they can leverage that freedom to accomplish economic outcomes farmore impressive than when governments attempt to limit choicesthrough policy constraints.

A Growing Constituency for Freer Trade

The WTO/GATT system was created in the first place to deter aprotectionist pandemic triggered by global economic contraction. Itwas created to deal with the very situation that is at hand. But intoday’s integrated global economy, those rules are not the onlyincentives to keep trade barriers in check. With the advent andproliferation of transnational supply chains, cross‐​border directinvestment, multinational joint ventures, and equity tie‐​ups, the“Us versus Them” characterization of world commerce no longerapplies.

Most WTO members are happy to lower tariffs because importsprovide consumers with lower prices and greater variety, whichincentivizes local business to improve quality and productivity,which is crucial to increasing living standards. Moreover, manylocal economies now rely upon access to imported raw materials,components, and capital equipment for their own value‐​addedactivities. To improve chances to attract investment and talent ina world where capital (physical, financial, and human) isincreasingly mobile, countries must maintain policies that create astable business climate with limited administrative, logistical,and physical obstacles.

The experience of India is instructive. Prior to reformsbeginning in the 1990s, India’s economy was virtually closed. Theaverage tariff rate on intermediate goods in 1985 was nearly 150percent. By 1997 the rate had been reduced to 30 percent. As tradebarriers were reduced, imports of intermediate goods more thandoubled. The tariff reductions caused prices to fall and Indianindustry suddenly had access to components and materials it couldnot import previously. That access enabled Indian manufacturers tocut costs and use the savings to invest in new product lines, whichwas a process that played a crucial role in the overall growth ofthe Indian economy.16

India’s approach has been common in the developing world, wheremost comprehensive trade reforms during the past quarter centuryhave been undertaken unilaterally, without any external pressure,because governments recognized that structural reforms were intheir country’s interest. According to the World Bank, between 1983and 2003, developing countries reduced their weighted averagetariffs by almost 21 percentage points (from 29.9 percent to 9.3percent) and unilateral reforms accounted for 66 percent of thosecuts.17

The Indispensible Nation

The United States accounts for the highest percentage of worldtrade and has the world’s largest economy. The WTO/GATT system is aU.S.-inspired and U.S.-shaped institution. Recession in the UnitedStates has triggered a cascade of economic contractions around theworld, particularly in export‐​dependent economies. Needless to say,U.S. trade policy is closely and nervously observed in othercountries.

But despite the occasional anti‐​trade rhetoric of the DemocraticCongress and the protectionist‐​sounding campaign pledges ofPresident Obama, the United States is unlikely to alter its strongcommitment to the global trading system. There is simply too muchat stake. Like businesses in other countries, U.S. businesses havebecome increasingly reliant on transnational supply chains. Over 55percent of U.S. import value in 2007 was of intermediate goods,which indicates that U.S. producers depend highly on importedmaterials, components, and capital equipment. And there is also thefact that 95 percent of the world’s population lives outside of theUnited States, so an open trade policy is an example to uphold.

Finally, the President has made it a priority to restoresquandered U.S. credibility with the international community. Thatobjective cannot be fulfilled by acting in a multilateral,internationalist manner on foreign policy, while acting in aprovocative or unilateralist manner on trade policy because, formost countries, U.S. trade openness and engagement is the form ofdiplomacy that matters most. Accordingly, the president will haveto thwart the Congress’s sometimes combative, unilateralisttendencies on trade policy if he hopes to restore U.S. foreignpolicy credibility.

Conclusion

Despite the global economic contraction and the occasionalprotectionist indulgence, there is reason to be hopefulthatretrogressive policies will be marginal, short‐​lived, andultimately rejected. The absence of trade rules in the 1930s meantthat there were no proffered courses of action, no sources ofadjudication or remediation, and no generally accepted limits tothe actions governments could take in response to external economicpolicies. And there were far fewer domestic constituencies of anypolitical consequence advocating against protectionism in the ’30s.Consequently, there were no proven stopgaps to prevent the pandemicof spiraling protectionism that erupted and exacerbated the globalrecession.

Today we have the benefit of understanding the consequences ofthe actions taken in the 1930s. Although that understanding doesnot guarantee avoidance of past mistakes, we also have solidinstitutions and incentives to help steer policymakers away fromthe abyss. The rules governing more than 60 years of tradeliberalization have fostered greater certainty and stability, andthus more investment, trade, and economic growth. And today, thecommercial and political appeal of protectionism is considerablydiminished because most countries have established domesticconstituencies that depend on a trade and investment environmentthat is open in both directions.

Notes


1 WorldTariff Profiles 2008, World Trade Organization (Switzerland:2008).

2 Ibid.

3 See ibid. forreferences to tariff rates. China’s relatively rigid situationstems from the fact of its late accession to the WTO, in 2001. Ithad to appease the wishes of many more established members to winapproval for its own membership, whereas India’s relativelyflexible situation owes to its longer standing membership and itsparticipation in previous negotiating rounds.

4 For a detailedanalysis of antidumping rules, see Brink Lindsey and Dan Ikenson,“Antidumping 101: The Devilish Details of ‘Unfair Trade’ Law,” CatoInstitute Trade Policy Analysis no. 20, November 26, 2002.

5 Steven Mufson,“WTO Seeks to Curtail Protectionist Measures,” WashingtonPost, February 6, 2009, p. D03.

6 “Report to theTrade Policy Review Board from the Director‐​General on theFinancial and Economic Crisis and Trade‐​Related Developments,“World Trade Organization, Document no. JOB(09)/2, January 26,2009.

7 Anthony Faiolaand Glenn Kessler, “Trade Barriers Toughen with Global Slump,“Washington Post, December 22, 2008, p. 1. Emphasisadded.

8 Antoine Bouetand David Laborde, “The Potential Cost of a Failed Doha Round,“International Food Policy Research Institute Issue Brief 56,December 2008, http://​www​.ifpri​.org/​p​u​b​s​/​i​b​/​i​b​5​6.pdf.

9 World TradeOrganization statistics,http://​www​.wto​.org/​e​n​g​l​i​s​h​/​r​e​s​_​e​/​s​t​a​t​i​s​_​e​/​i​t​s​2​0​0​8​_​e​/​s​e​c​t​i​o​n​1​_​e​/​i​0​1.xls.

10 U.S.Department of State, “Smoot‐​Hawley Tariff,” description provided athttp://​future​.state​.gov/​w​h​e​n​/​t​i​m​e​l​i​n​e​/​1​9​2​1​_​t​i​m​e​l​i​n​e​/​s​m​o​o​t​_​t​a​r​i​f​f​.html.

11 WorldTrade Organization, International Trade Statistics, 2008,data downloaded from http://​stat​.wto​.org/​H​o​m​e​/​W​S​D​B​H​o​m​e​.​a​s​p​x​?​L​a​n​g​u​age=E.

12 UnitedPress International, “China Rejects ‘Buy China’ Policy,” February9, 2009.

13 Governmentof Mexico, Economic Secretary, “Mexico Launches a Phase Down Planto Reduce Import Rates,” NAFTA Works (A Monthly Newsletter onNAFTA and Related Issues),http://​www​.naf​tamex​i​co​.net/​n​a​f​t​a​w​o​r​k​s​/​n​w​2​0​0​9​/​J​a​n​0​9.pdf.

14 Governmentof Brazil, Brazilian Foreign Trade Chamber (CAMEX), OfficialGazette, Resolution nos. 4 and 5, February 4, 2009.

15 “InResponse to International Pressure, Brazil Cuts ImportRestrictions,” Latin American Herald Tribune, January 30,2009.

16 VidyaMahambare, “Trade Protectionism Cannot Fight Economic Crisis,“Rediff.Com, December 12, 2008.

17 WorldBank, “Global Economic Prospects: Trade, Regionalism, andDevelopment,” 2005, p. 42.