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     May 14, '13

Into a protectionist world
By Martin Hutchinson

The choice of Brazil's Roberto Azevedo to lead the World Trade Organization (WTO), over the reported opposition of both the European Union and the United States, is an indication that protectionism, which had appeared thankfully quiescent in the early years of the current recession, is now a major global danger.

Since a renewed downturn is inevitable when the current global bubble bursts, the long-term outlook for the world economy is thus much darker than before.

Brazil is the most protectionist and economically irresponsible of the BRIC countries (the others being Russia, India and China), and Azevedo, otherwise undistinguished, has spent the last 15

years upholding Brazil's protectionist position in the halls of the WTO, as well as helping corral the more foolish emerging markets into blocking trade deals such as the Doha round.

With the EU (all 27 countries) the US, Japan and South Korea backing his Mexican opponent, who on the face of it was better qualified, it took a massive lobbying of the less developed members of the 155-strong WTO by China, Brazil itself and probably India for Azevedo to win.

Brazil itself is a champion of retaliatory "anti-dumping" actions and has blocked foreign inflows into the country the real for fear of a so-called "currency war" being waged by the major industrial nations. The direction in which Azevedo will lead the WTO is thus clear.

This is a pity. Of all the world's bloated crop of international organizations, the WTO is the only one that has a useful function. The World Bank makes loans to the Third World that, being directed through government, mostly end up in ministers' pockets. The International Monetary Fund provides some of the worst financial advice ever, taking bread out of the mouths of honest private sector merchant bankers. And the United Nations' principal purpose is to hamstring the attempts of the United States and other powers to preserve world peace and reduce the number of countries ruled by dictators and kleptocrats.

But the WTO has a genuine free-market purpose. Given that we live in a Westphalian world with many independent governments, we need an organization that will push those governments toward reducing trade barriers of all kinds, not erecting them.

The British tried moral suasion in the 19th century, running a free trade policy unilaterally following the 1846 repeal of the Corn Laws. It didn't work. Britain's principal economic rivals, France, Germany and the US, built up massive industrial bases behind high tariff walls, dumping their surplus products on the free-trading British Empire and third parties as a whole. The result was the gradual decline of the peaceful 19th century world into an arms race and two world wars.

The US, itself highly protectionist during most of its history, tried to lead the world in the general direction of free trade after 1945, but the hypocrisy of its agricultural protectionism and the gradual decline of free trade support among the American people made it less and less effective in this role.

The Uruguay Round of trade talks, which ended in 1994, was the last gasp of this post-World War II drive to free trade, and the creation of the WTO was the greatest achievement of that round.

The WTO worked reasonably well until 2008. However, even in the halcyon days of the late 1990s, the 1999 Seattle protests and, more important, the feeble and equivocal reaction to them of the Bill Clinton administration, demonstrated that there was no longer a strong constituency even in Western countries for trade liberalization. The 9-11 attacks allowed the George W Bush administration to kick-start the Doha talks in 2001, but the rapid erosion of the Bush administration's global position caused the Doha Round to become a dead letter well before the final admissions of failure in 2008 and 2011.

After the 2008 crash and the global downturn, protectionism rapidly reared its head, but for the next few years the WTO itself played a useful role in making it difficult for all-out protectionists in rich countries to advance their agenda.

When "anti-dumping" actions were undertaken, such as that by the US on Chinese tires, the aggrieved party referred them to the WTO, and there was at least some hope that the WTO would condemn them and impose retaliatory sanctions. Numerous bilateral trade treaties were signed, both before and after 2008, but on close examination they were mostly mere expressions of goodwill, with very little true trade liberalization beyond what was already agreed.

This election thus marked a choice. Mexico's Herminio Blanco was an admirable candidate, well qualified and with a genuine free-trading achievement on his resume, the negotiation for Mexico of the North American Free Trade Agreement in 1991-94. He therefore represented a road not taken with the choice of Azevedo. With the WTO bizarrely headed by a protectionist, the world is headed off in a different direction.

There will be little effect in the first year or two, while we remain in this funny-money bubble, fueled by crazed global monetary policies. However this bubble will burst, as bubbles do, probably in the latter half of 2014. At that point, with the world in a recession without either monetary stimulus (which will already have wreaked destruction) or fiscal stimulus (with most of the rich world saddled with impossibly large budget deficits and staggering government bond markets) protectionism will appear, government by government, to be truly an attractive option.

Just as successful movements to free trade are normally multilateral, so the movement to protectionism will be unilateral, consisting of a large number of initially minor "retaliatory" actions against imports which compete against domestic interests suffering in the recession.

It is unlikely initially that any major country will pass a broad-based tariff like the infamous 1930 Smoot-Hawley Act, which has made itself notorious (not entirely justly - the real damage was done by the 1862 Morrill Tariff sponsored by the sainted president Lincoln) even among those with little economic knowledge.

However, each petty act of protectionism will raise demands for retaliation by the interests whose exports have been blocked. The recession will also bring about a further round of political instability, caused by disgruntled electorates who rightly question the economic competence of a political class that has burdened them with debt and rotted away their savings, all for no long-term benefit.

At some point either a new populist-protectionist government will arise in a major economy or, equally likely, the existing political class will adopt protectionism as a weapon to prevent the arrival of such a government.

Either way, within a year or two of the downturn, one of the major economies will introduce broad-based protective legislation, including not only a substantial hike in tariffs across the board but also a mass of non-tariff barriers to trade. My best guess as to the first introducer of such legislation would be the EU, which may regard it as a carrot to prevent recalcitrant members seeking independence and/or a stick to punish them if they do.

Once one of the major economies introduces tariff legislation, it will quickly spread. The occasional eccentric, perhaps Britain if the David Cameron government is still in power (not under Ed Miliband's "Even Newer Labor" however), may rise above the temptation, but the developed countries will be in too much recessionary trouble and the emerging markets are mostly protectionist anyway, as witnessed by their support for Azevedo. The WTO will be powerless to stop the trend, since it will be conflicted at the top.

Apart from everybody's living standards, which will be sharply hit by unexpected inflation as protection eliminates the flow of cheap imports, the most badly affected companies will be those with global supply chains.

Global communications and the Internet, which have produced immeasurable economic benefits by allowing goods and services to be sourced efficiently in cheap labor economies, are powerless to overcome a world in which each movement of goods across a border attracts a massive tariff bill, together with the inevitable delays and costs involved in clearing a protection-minded Customs service.

Companies like Walmart, massive beneficiary of the sourcing possibilities from China, will be forced to reorient their entire logistics operation. They will probably succeed in doing so, but the additional costs imposed on US consumers will be gigantic and the damage to Walmart's own profits will be severe. Apple also will no longer be able to outsource all its manufacturing problems to Taiwan's Foxconn and its massive Chinese plants; instead it will be forced to manufacture in the United States, or at best in Mexico, because other options will have been ruled out.

Needless to say, Apple's spectacular profit margins will then be history, if they have not already been eroded by normal competitive forces - and Apple products will become the equivalent of Tesla electric cars, fancy low-volume toys for the ultra-rich.

The return of high tariffs to the world economy will undoubtedly be accompanied by the return of exchange controls. Global trade imbalances will become much more severe, while the tariffs themselves and the collapse of global trading networks will bring inflation and make the inevitable state budget deficits impossible to finance. (The tariffs themselves will provide extra revenue, but this will be counteracted by the general economic decline, with lower state revenues and higher benefits payments, that accompanies them.)

Consequently even rich countries will resort to exchange controls, in an effort to prevent capital flight and force domestic savers to finance the government's deficits. The impoverishment of the middle classes, so important a feature of British life after World War II even with the extravagant global growth of that era, will become a universal feature of a global economy in decline.

The impoverishing effect of global protectionism will be spectacular. The Great Depression was exceptionally severe, far more so than should reasonably have been expected, because of the 65% collapse in the volume of world trade, which in turn was cause by the erection of tariff and currency barriers. Only Britain, which had a protected market in its empire, was able to lessen the Depression's effect with the aid of ultra-sound economic policies and a modest 10% external tariff, ending the unilateral trade disarmament of 1846-1932. More typical was Argentina, which remembers its rather sound and benign governments of 1930-43 under the rubric of the "Infamous Decade".

If the next global downturn leads to an upsurge in protectionism and a prolonged economic collapse, we will indeed remember its politicians as "infamous." But I wouldn't put money on anything much better.

Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.

(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)




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