Saturday, January 12, 2013

Trade collapse and protectionism - An NBER analysis

The global economic downturn in 2008-09 has been commented upon and analyzed extensively. Did it also lead to a growing trend of protectionism during this period? Since economies floundered and international trade fell drastically, one would expect that protectionist measures played a key role during this time.

The National Bureau of Economic Research (NBER) in a recent report interestingly downplays the role protectionist measures had in causing the economic slowdown. Analysing tariffs and non-tariff barriers imposed during this time, the report titled  "The Great Trade Collapse"  comes to the conclusion that protectionist measures were not the main reason for the slowdown of the global economy.
"During the early stages of the trade collapse, many worried that the macroeconomic crisis would provoke a repeat of the destructive spiral of protectionism that broke out during the Great Depression. With this backdrop in mind, we review evidence on changes in protection during the crisis in this section. By and large, there was not a significant shift toward protectionism during the trade collapse. We close this section describing several explanations regarding why protectionism may have been muted."
Detailing out the possible reasons as to why protectionism did not rise to the extent it probably should have due to the economic crisis the report explains:
"The resilience of the open trading system was a victory for both the political consensus and institutions that underpin the global economy. The fact that there was no strong protectionist response to the crisis begs the question: why was protectionism contained? There are several lines of work that suggest answers, though more work is certainly needed to answer this question. 
First, the institutional architecture of international trade – including the WTO and regional preferential agreements – may have served to manage protectionist pressures. For example, the ability of countries to adopt WTO-legal temporary trade barriers may placate the most injured or politically powerful industries, alleviating pressure to adopt more comprehensive or permanent barriers. Moreover, though WTO tariff bindings exceed applied tariffs in many cases, preferential agreements shrink the genuine discretion that countries have in adjusting tariffs after a crisis.49 More generally, the role of the WTO as a forum for monitoring trade policy and exerting moral suasion in discouraging protectionism is also likely important, though extremely difficult to quantify.

Second, some have argued that the political economy of trade policy has changed with the rise of cross-border foreign direct investment and supply chain fragmentation. For example, use of imported inputs likely induces firms to lobby for freer trade, offsetting traditional lobbying for import-substituting protection. Gawande et al. present suggestive evidence that vertical specialization in production at the sector level is negatively correlated with the level of tariffs across sectors and changes in tariffs during the 2008-2009 crisis in some important emerging markets (e.g., China). 
Third, one way in which the 2008-2009 crisis differed from the Great Depression was that most countries had flexible exchange rates, and hence the ability to respond to the crisis using macroeconomic policy rather than trade policy. Looking at the Depression episode, Eichengreen and Irwin (2010) point out that countries that stayed on the Gold Standard were significantly more protectionist than countries that floated their exchange rates. They argue that countries that stayed on gold resorted to trade policy as a second-best form macro-policy, rather than due to protectionist pressures per se."
The growth of protectionism in the last few years have been criticized for denting the multilateral system. Are we overstating the threat of protectionism? Is world trade still largely based on a rule-based system with exceptions of protectionism or are we moving towards a more protectionist world? Is the international legal framework robust enough to address the issue of inward looking measures that are inconsistent with multilateral trade rule principles? With the definition of "protectionist" itself being contested (see this piece that states that neo-protectionism in a varied form will rise), could we see new interpretations of trade rules to justify seemingly protectionist behavior?

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