Does the world economy face a danger from rising protectionism?

The Covid-19 pandemic is forecast to reduce global economic output and world trade in 2020. This raises the question of how trade policy will respond to the challenges posed by the economic crisis. In the past, recessions were loosely associated with increases in protectionist trade policies. But the challenges for the current era are more likely to be export restrictions and trade-distorting domestic subsidy programmes.

The association of import restrictions with recessions originates in the example of the Smoot-Hawley Tariff Act of 1930, when the United States imposed highly restrictive import tariffs in an attempt to mitigate the damage of the Great Depression to domestic producers and workers. This triggered retaliatory tariffs by US trading partners and led many to associate recessions with trade protection.

Evidence from recent decades is far more mixed. From the 1980s until the late 2000s, the use of special import restrictions increased during recessions in many high- and middle-income countries. But other forms of import restrictions did not systematically move with the business cycle during this period. Most recently, during the 2008/09 global financial crisis, the Group of 20 (G20) nations pledged to refrain from raising import tariffs and other protectionist measures, and they largely abided by these pledges.

What does evidence from economic research tell us?

• The record of using trade policy during recessions is mixed. A clear pattern emerges in some periods and among some countries, but there is no broad empirical regularity across the twentieth and twenty-first centuries.
• Imposition of the Smoot-Hawley tariffs was followed by a 40% decline in US imports, but a quantitative assessment finds that only 10% of the 40% decline was associated with an increase in the effective rate of protection (Irwin, 1998). The retaliatory trade policy responses by US trading partners varied considerably, with some imposing high tariffs while others raised import barriers only modestly (Eichengreen and Irwin, 2010).
• More recent studies of protectionism over the business cycle are divided between those that examine the cyclicality of temporary trade barriers allowed by the World Trade Organization (WTO) – Knetter and Prusa, 2003; Bown and Crowley, 2013; Bown and Crowley, 2014 – and cross-country studies that examine the cyclicality of a wide range of different types of trade policies (Rose, 2013; Lake and Linask, 2016).
• Studies examining these temporary trade barriers find a clear counter-cyclical relationship during the 1980s through the early 2000s (Knetter and Prusa, 2003; Bown and Crowley, 2013; Bown and Crowley, 2014). But during the Great Recession, major economies abstained from imposing new import restrictions at the rate that would have been expected given the severity of the crisis (Bown and Crowley, 2013). This is suggestive evidence of a change in policy-makers’ behaviour relative to previous economic downturns.
• An analysis of a large range of trade policies in 180 countries concludes that most measures of trade policy were not counter-cyclical over the period after the Second World War (Rose, 2013). This finding is consistent with the fact that under the rules of the WTO and its predecessor, the General Agreement on Tariffs and Trade, countries could not raise import tariffs and impose import quotas except in ‘exceptional circumstances’.
• An analysis of 72 countries over the period from 2000 to 2011 finds a pro-cyclicality of tariffs, driven by the policies of developing countries, which are generally less constrained by WTO rules (Lake and Linask, 2016).

How reliable is the evidence?

The big picture that emerges from the numerous empirical studies cited above is that the trade policy responses to recessions vary across time periods and countries. The most recent studies (Bown and Crowley, 2013; Lake and Linask, 2016) suggest that weak macroeconomic performance no longer triggers protectionist responses.

The US-China trade war (Crowley, 2019), which began in 2018 when the world’s two largest economies were enjoying economic expansions, serves as an important counter-example to the idea that trade policy is counter-cyclical.

The reason why policy-makers might be concerned about rising import restrictions during a recession is that such measures reduce economic wellbeing. Goldberg and Pavcnik (2016) provide a comprehensive discussion of the effects of trade policy on prices, trade volumes and social wellbeing.

Recent empirical studies document substantial social costs to the US economy from the import restrictions imposed during the US-China trade war of around 0.08% of GDP (Amiti et al, 2019) or 0.04% of GDP (Fajgelbaum et al, 2020). These empirical estimates are considerably smaller than counter-factual estimates from quantitative trade analysis such as Ossa (2019), which finds that a full-fledged trade war between the United States and China would lead to real GDP losses of -0.4% and -0.7%, respectively.

The difference between the empirical studies and the quantitative trade analysis is that the former estimates the costs from the tariffs actually imposed during the trade war whereas the latter estimates the costs from a trade war in which all tariffs on both sides are raised to 60% ad valorem on both sides.

What new policy concerns about trade policy are raised by the Covid-19 crisis?

The Covid-19 crisis raises new concerns about trade and trade policy in three areas:

• The use of export restrictions on medical supplies.
• The possible use of export restrictions on food.
• The use of domestic stimulus policies to aid industries and businesses, which can distort trade flows.

This suggests that past experiences with trade policy and business cycles are not directly applicable to current challenges.

Export restrictions 

There are far fewer examples of countries using export restrictions or export taxes than there are of import restrictions (Karapinar, 2010; Bown and Crowley, 2016).

The use of export restrictions during the Covid-19 crisis is being tracked and reported by Global Trade Alert, working with the European University Institute and the World Bank.

• The WTO rules on export restrictions are relatively lax; export taxes are permitted and prohibitions are permitted temporarily on food and ‘essential’ products (GATT Art. XI, 1994). This means that there is no global rule or norm requiring countries to refrain from using export restrictions on medical products or food, especially during a crisis.
• A notable exception is that China agreed to abstain from using export restrictions as part of its 2001 WTO accession agreement.
• Imposition of export restrictions on ‘rare earth’ metals by China (Mancheri, 2015) led to a WTO dispute and the eventual removal of the Chinese export restrictions. An interesting feature of the rare earth dispute is that it drew attention to the asymmetry in obligations by different WTO members: the United States or the European Union (EU) have greater unilateral discretion to impose export controls.

Medical devices, testing equipment/medications and personal protective equipment. 

One of the main policy concerns during the Covid-19 crisis has been the imposition of export restrictions by countries trying to ensure a domestic supply of difficult-to-source medical devices and personal protective equipment (Bown, 2020).

After several European countries imposed export restrictions on medical equipment, the European Commission stepped in with an agreement that EU member states would only impose European-level export restrictions to non-EU members. In early June 2020, these EU restrictions had been placed on hold. (See Global Trade Alert for an up-do-late list of global measures).

The small body of research on export controls has focused on quantifying the losses due to export restrictions in oligopolistic markets with few producers, such as cars (Feenstra, 1984; Goldberg, 1995). Lessons from these studies would be most applicable to medical devices produced in such markets.

Food

During the world food crisis of 2008/09, the prices of many cereal crops rose 40% above the level in January 2007 (Food and Agriculture Organization, 2011). The brunt of this price surge was felt in low-income countries.

Many low and middle-income cereal-producing countries managed to stabilise domestic prices through the use of export restrictions or export taxes. While these export restrictions stabilised domestic prices in some countries, they also increased price volatility in world markets and, hence, had negative effects on countries that imported food.

Food riots related to price spikes and shortages took place in a large number of developing countries (World Bank).

An enormous body of research examines the consequences of the global food crisis. Economic analyses tend to split into country-specific studies examining the consequences of the crisis for the wellbeing of consumers and/or farmers, and model-based analyses of export policies and price dynamics in global commodity markets (for example, Bouet and Debucquet, 2012).

Domestic stimulus policies that aid industries and businesses

Governments typically implement substantial domestic stimulus packages to aid businesses and industries during economic downturns. A subsidy to consumption that does not distinguish between domestic and foreign goods would not generally distort trade flows.

Related question: What is the size of the fiscal multiplier?

But government aid to domestic producers can ‘crowd-out’ (unsubsidised) foreign imports, stimulate exports, or both. The implied distortion to global trade flows is regarded by many as unfair effort by one country’s government to benefit its own economy at the expense of those of other countries. The Global Trade Alert project led by Simon Evenett has collated data on economic policy measures that potentially affect or distort trade flows since 2008.

There is an active academic and policy debate about whether anything can or should be done to restrict domestic policies with significant international spillovers. In the ‘laissez-faire’ or ‘do nothing’ camp, Rodrik (2011) famously argued that the ‘globalisation trilemma’ means that countries can have only two of the three options of deep global integration, national sovereignty and democracy. The implication is that global rules restricting domestic policy options, such as industrial subsidies, come with substantial non-economic costs.

Sykes (2010) argues that the economic case for regulating domestic subsidies through international agreements is weak, suggesting that a laissez-faire policy may be the best option. In contrast, Evenett and Fritz (2018) argue that domestic policies that promote exports and discourage imports have larger effects on trade flows than tariffs and quotas and should be discouraged.

Where can I find out more?

Chad Bown provides policy recommendations for the G20 to ensure continued access to critical medical supplies during the crisis.

The Food and Agriculture Organization report – The State of Food Insecurity in the World, 2011 – includes a chapter examining lessons from the world food crisis of 2008/09.

The Global Trade Alert provides regular updates on which food and medical products are coming under new export restrictions.

Who are experts on this question?

• Meredith Crowley, University of Cambridge, works on import protection and business cycles.
• Simon Evenett, University of St. Gallen, directs the Global Trade Alert project.
• Alan Winters, University of Sussex, directs the UK Trade Policy Observatory and has written extensively on how trade policy affects developing countries.
• Paul Collier, University of Oxford, works on poverty in Africa and the 2008 global food crisis.

Author: Meredith Crowley