Seductive inward turn of protectionism

We all knew from the campaign speeches that President Donald Trump was going to support protectionism. But we were willing to discount some of those early speeches as campaign rhetoric. We hoped that after the election it would be more normal. America as a country has always stood for open markets, minimum trade barriers, free movement of goods and services and people across the seas, across nations. Of course, it has also fought unfair tactics like currency manipulation or hidden subsidies by other countries. But all that was to basically ensure free markets, and more importantly free access to its own domestic market.

All that is about to change. In his inaugural speech, Trump said, “Protection will lead to great prosperity and strength”. So now there is no ambiguity. It is no longer campaign rhetoric. The policy will be based on “buy American, hire American”. He also said, “We must protect our borders from the ravages of other countries making our products, stealing our companies and destroying our jobs.” Never mind that even a simple product like a mobile phone is “made” across several countries and value chains that cross several borders.

This is the language of economic patriotism, and cannot be easily rebuffed.  Trump’s words have already caused companies like Ford to cancel plans of new investment in Mexico. Other auto companies are also looking to relocate new plants within the USA. The prospective presidential candidate in France is using similar language, threatening French companies and asking them to come back home. Elections in Netherlands are throwing up similar sentiments of economic nationalism. When the flag is wrapped around economic policy (such as it is), it is difficult to argue.

It is now strange to find the President of China, Xi Jinping cautioning against the ills of protectionism. He compared it to sitting in a dark room with all doors and windows closed. China is becoming the champion of free trade. The resurgence of policies championed by Trump is a backlash to long stagnation in wages, productivity and industrial jobs in America and Western Europe. Stable blue-collar factory jobs have been migrating to developing countries like China and India and other East Asian economies for more than 40 years.  

The gap between earnings of high school educated workers (the erstwhile blue collar ones who used to work in factories) and college educated workers (who are mostly in services) have steadily widened in USA. Meanwhile college education has become prohibitively expensive. So middle class America (those blue collar workers and their families) finds itself stuck between a rock and a hard place. Older workers can neither upskill themselves (because college is expensive) nor can they get well-paying jobs.

This is a deep structural problem that requires improving the education and skilling infrastructure, getting workers into the frontier industries (which require higher skills) and climbing the value ladder. But instead of doing this hard work, it is easy to blame foreigners who steal American jobs.  

Even Obama used this in his 2008 campaign. He is the one who popularised the word “Bangalored” to describe American jobs that had been outsourced.  But unlike the present president, Obama quickly disavowed that rhetoric once he assumed office. In fact, his inauguration speech was the opposite of isolationism. It spoke of how America would work with and help every country in its quest for peace and development.   Trump now talks of every country’s right to pursue its own self-interest, even if that means shutting down its borders.

In many ways, Trump’s election itself is validation of the instinct of protectionism spreading across the world. It won’t do for economists to cry from rooftops of how it will eventually hurt everybody. The advantage of free trade was first well-articulated by David Ricardo back in 1817. Nothing much has changed from his original hypothesis and insight. The advantages of free trade however do not accrue uniformly to all, and while most people are winners, there are some losers as well.

Thus by offshoring IT services to Indian companies, the American economy benefits immensely for after all their banking, finance and manufacturing services become leaner and more efficient. But in that process, some American jobs are surely lost. If the vested interests have a much louder voice then protectionism will reign as is happening now.

Compounding the problem of stagnant productivity in America is the build-up of excess capacity in China. This has happened in a variety of sectors like steel, cement, chemicals, textiles, aluminium, other metals, garments, electronics and others. Ever since the economic crisis of 2008, world GDP and hence demand has slowed down. So the excess capacity is not getting used up. Hence those products are unleashed on world markets at very low prices i.e. “dumped”.  So we are seeing protectionism in the form of anti-dumping duties (justified) and higher import duty barriers.

In India, too, we are likely to see action against cheap Chinese imports to protect domestic jobs and industry. Last year, duties were announced for steel products, and this might be expanded this year. China may retaliate by weakening their currency further. So protectionism in the form of import duties can result in currency wars, and further competitive devaluation. As currencies weaken, imports become expensive leading to inflation. That will surely end badly as was seen in the East Asian crisis of 1997 that began with severe devaluation by China in 1994.

No country can unilaterally oppose the fever of protectionism sweeping across the world. It would be unwise not to heed the surge of cheap imports caused by dumping. India too should be pragmatic about protecting the interests of domestic jobs and industry. But along with China, it should take up the cause of keeping trade more free and to ensure that protectionism doesn’t get out of hand.

Strange times these are then, when developing countries take the lead in persuading the West to lower its trade barriers.  

(The author is a senior economist based in Mumbai)