January 18, 2011

In a nutshell, protectionism is when a government restricts the flow of goods in or out of the country – either through tariffs, quotas or outright bans – in order to protect either local producers or consumers of the good in question.

Yet, since 1929, the world’s economists have, by and large, agreed that protectionism is damaging to both the country that engages in it as well as the rest of the world. This is because protectionism was the leading cause of the Great Depression.

By Farooq Tirmizi

If government officials believe they can restrict foreign trade without any negative consequences, India’s recent move to bar vegetable exports to Pakistan should serve a sobering reminder of the folly of protectionism. No country can expect to block access to its markets and products to other countries without retaliation.

Earlier this month, the Pakistan government announced a ban on exports of onions to India, in part due to concerns over an increase in local prices. India then retaliated by banning exports of all vegetables to Pakistan.

 

This case, and many others that precede it, are proof of what has become a truism amongst economists: restricting free trade does far more harm than good to any country. In order to appreciate this argument, one first needs to understand the compulsions of protectionism and the damage it is capable of, benefits of the World Trade Organisation (WTO) system as it currently stands, and then finally the many reasons why free trade is more beneficial for Pakistan.

In a nutshell, protectionism is when a government restricts the flow of goods in or out of the country – either through tariffs, quotas or outright bans – in order to protect either local producers or consumers of the good in question.

Yet, since 1929, the world’s economists have, by and large, agreed that protectionism is damaging to both the country that engages in it as well as the rest of the world. This is because protectionism was the leading cause of the Great Depression.

On October 24, 1929, the New York Stock Exchange experienced one of its worst crashes, heralding the beginning of a deep recession. Yet, what turned a severe recession into the Great Depression – a period of prolonged economic malaise that lasted a decade – was something that happened on June 17 of the following year: the United States Congress passed a law known as the Smoot-Hawley Act which raised US tariffs on 20,000 goods to record levels.

This was done ostensibly to protect industries at home from foreign competition (does that argument sound familiar?). The move provoked massive retaliatory tariffs from the rest of the world, causing American exports to plummet by 50 per cent, resulting in massive layoffs at many factories and outright shutdowns and bankruptcies at thousands of others. Global trade as a whole plunged, causing the economic slowdown to spread to the rest of the world.

The economic hardship faced by many European countries in the aftermath of these trade wars is identified by many historians as the leading cause for the Second World War breaking out on the continent.

After the war, there was a consensus that trade protectionism was never a worthwhile effort and that it almost invariably resulted in more harm. This lesson appears to be lost on Pakistani policymakers, who routinely use arguments similar to those that preceded the disastrous experiment of the Smoot-Hawley tariffs in order to justify their protectionism.

They would do well to realise that the WTO-led system of global trade is, despite its flaws, in the economic interest of the country.

The World Trade Organisation (WTO) is a global institution that, by the consent of its members, regulates global trade in goods and services. It emerged from a series of negotiations that trace back to the Breton-Woods conference in 1944 and culminated in the Uruguay Round of global trade negotiations that created the WTO in 1995.

The WTO has accomplished something that many had thought impossible: bringing a relative degree of calm to the international economic order. Through a series of rules on non-discrimination and dispute settlement, it has created a set of global laws that are enforceable. This is best illustrated with an example.

Suppose Bangladesh believes that the US is discriminating against Bangladeshi goods in violation of WTO rules, it can sue the US in a WTO dispute settlement arbitration panel. Suppose the panel finds that the claim is correct and the US is in fact discriminating unfairly against Bangladesh, the WTO will order the US to remove the discriminatory rules under its treaty obligations to the WTO.

If it fails to do so, Bangladesh and all other countries in the world, will be allowed to place trade sanctions against the US. The US may not care about trade sanctions from Bangladesh, but it will care very much about any such moves by the European Union, Japan and other large economies. And these countries will not hesitate to use the Bangladesh ruling against the US, which means that the US is likely to abide by the ruling in favour of Bangladesh.

All of this translates to one thing: even one of the smallest economies in the world can force the largest economy to follow the rules.

The system, of course, has its flaws. It permits protectionism in a few key sectors, most notably agriculture. But there is a mechanism to change those rules, through global trade talks – the most recent round of which started in Doha in 2001.

While liberalising global agricultural trade has evaded success thus far, the WTO nevertheless has some very useful components that make trade in the world freer and fairer than it otherwise might be.

No country can survive without trade with the outside world, nor should it try. Economists argue that countries should play to their comparative advantage: focus on producing goods and services in which they have a relative advantage and trade for the rest. Pakistan has benefited tremendously from access to the markets of other countries, most notably in textiles, rice and other products. Yet that market access is based on the premise of reciprocity: in order to have access to the markets and goods of other countries, Pakistan must open up access to its goods and markets.

In the current case involving onions and other vegetables, Pakistan imports far more foodstuff from India than the other way round. Were it not for the import of lentils and spices from India, the prices of these goods would have risen a lot faster, hurting consumers even more.

In an attempt to keep down the price of onions, the government may end up causing a hike in the prices of many other goods. Who will it be protecting then? Will cheaper onions be worth the cost? It seems unlikely.