The current crisis is twofold: it affects Wall Street and Main Street — that is, both finance and the real economy. It has also been accompanied by a sharp decline in trade. The reasons for this decline — manifested not only in absolute trade volumes but also in the decline of trade to national income (GNP) — involve factors other than protectionism, which has been held at bay in several ways. This fact makes Niall Ferguson’s pessimism seem alarmist.
Given that the ratio of trade to GNP rose strikingly in the decades of growing incomes prior to the crisis, one might expect that it would decrease during a recession in which incomes and consumers demand are on the decline. There are two reasons that explain this reverse phenomenon. First, product components increasingly are outsourced to other parts of the world and then assembled in one place. Thus, even if the value of the final product changes little, the trade in components needed to manufacture that product will rise.
Second, a statistical complication can impact such components trade. Exports are measured by their gross value, that is, the price at which a product is sold. But GNP is a measure of value added. For instance, imagine that a car is sent to several countries to have different features added in each. The main body and engine of the car might be produced in the United States, before it is exported to Germany to have leather seats installed, then sent to Poland for windshield wipers, and so on. The value of the U.S. body and engine will be counted as an export value by each country that supplied a part or feature. But the value added is counted only once; GNP does not count the same item multiple times. Hence, statistically, the ratio of trade (gross value) will rise relative to GNP (value added in different countries).
These factors are in part a function of how globalization has changed the structure of the world economy. But there are two additional trends that have undermined trade volumes since the onset of the crisis. First, falling incomes (the Main Street side of the crisis) have caused trade to decline as people buy fewer imports. Second, on Wall Street, the financial crisis means that the working capital necessary to finance trade is unavailable. The latter phenomenon has been studied in Japan, where firms have close alliances, or keiretsu relationships, with banks. My colleague, economist David Weinstein, has studied this phenomenon for Japanese exporters and estimates that as much as 30 percent of decline in Japanese exports may be attributed to the collapse of banks, and hence the lack of working capital for trade.
It appears that the outbreak of protectionism is not at the heart of the trade collapse during the crisis. Rather, the three I’s — ideas, institutions, and interests — have combined to keep protectionism in check.
Ideas. No policy-maker today believes that a recession should be addressed by raising trade barriers. A country can impose barriers to divert world demand to its own goods; however, other countries can do the same with their own tariffs. The result, then, would be to burden the world with trade barriers without addressing the real problem: the insufficiency of world demand. Thus, increasing world demand is the correct Keynesian answer.
Notably, tariffs were not raised significantly during the East Asian financial crisis, and G20 leaders have also continually argued (with a few lapses) against protectionism.
Institutions. Whereas trade barriers spread during the 1930s after the United States passed the Smoot-Hawley Tariff Act in 1930, the architects of the postwar world economy built roadblocks to such a freewheeling spread of tariff barriers in the General Agreement on Tariffs and Trade of 1947. Although successive changes have strengthened these anti-protectionist disciplines, the task remains unfinished.
Interests. The world economy is more interdependent than ever before. In many firms, jobs and profits depend on foreign markets. Thus, when companies that compete with imports want protection, they are countervailed by firms that fear retaliation. When steel and construction sectors advanced Buy American provisions, firms such as General Electric, Caterpillar, and Boeing rushed to Washington to point out that this would be a “penny wise, pound foolish” move.
Consequently, protectionism has been held at bay. This reality does not mean that we can be complacent. We could hit from the side, as with impatience with global imbalances leads otherwise sane economists, such as Paul Krugman and Martin Wolf, to endorse trade retaliation against China! Or when outsourcing is decried because it is convenient to do so, as in the 2010 Senate race, when California Senator Barbara Boxer accused opponent Carly Fiorina, the former CEO of Hewlett-Packard, of outsourcing thirty thousand jobs. What Boxer failed to mention is that if those jobs had not been outsourced, Hewlett-Packard would have become uncompetitive and would have lost perhaps one hundred thousand jobs instead. In the fight against protectionism, we must remain vigilant.
This article will appear in Challenges to Business in the Twenty-First Century, a paper published by the American Academy of Arts & Sciences.