Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Protectionism Does Not Work

Written by johnleemk on 6:09:17 am Apr 19, 2008.

As the economic downturn facing America spreads across the world, it is becoming increasingly fashionable to bash free trade and free markets. Rising food prices and foolhardy investment bankers make the case for protectionism and mercantilism seem even more common sensical than they already are. Unfortunately, the apparent logic behind protectionism does not hold up. Free trade has its flaws; it is no cure-all. However, protectionism is a worse solution to the problems of development.

Not too long ago, the free market was making progress in the public imagination. Despite sporadic protests against an apparent corporatisation of the world's resources, or supposed exploitation of the world's poor, it seemed clear that free trade was benefiting the world. Exuberance — some might say irrational exuberance — dominated our vision of the world that lay before us.

In the wake of the recent global economic downturn, anti-trade opinions have begun picking up new adherents. Many historians and economists have published pieces suggesting that too much free trade has been unhealthy for the world's economy, blaming it for everything from families losing their homes to people starving in developing countries.

The presidential campaign in the United States has reemphasised the importance of trade as a political issue. Some of the most important states in terms of electoral power have been hard hit by outsourcing, offshoring, and more recently, the subprime crisis. The people of the United States demand to know what those vying for the presidency plan to do to tackle these problems.

Reading the public mood, practically all the leading candidates adopted anti-market policies. Both Barack Obama and Hillary Clinton proposed measures that would hamper the workings of the market system; Clinton earned mockery in some circles for her proposal to freeze interest rates. Even Republican John McCain, who professes to not know much about the economy, has released economic proposals that do not support trade or markets — McCain has actually floated the idea of freezing interest rates at 0%. It also goes without saying that to capture a powerful electoral base, all candidates have endorsed massive government protection of certain industries, such as the ethanol farming industry. Both Obama and Clinton have suffered scandals where they wound up sacking key advisors after it turned out both men were supporters of free trade.

Meanwhile, some claim to have found support for protectionism and mercantilism in the annals of history. An oft-repeated claim is that present day developed countries protected their own homegrown industries initially, and opened up to trade only after successfully building up their "infant industries". The theory behind this is not new; the infant industry argument is one economists are familiar with and often skeptical of.

I will only briefly address the theory side of the arguments against trade. The fact is, trade makes the world more efficient. It is all but impossible to deny this; if one country has more fertile soil than another, that country is better off growing crops than the other. That is why the infant industry argument has gained in credence recently — it is the only one that makes a modicum of common sense.

The argument that the world is being taken over by corporations which exploit the poor has limited applicability. A truly free market is not one where the government favours corporations; a free market gives consumers the power to spend their money as they see fit, to buy the products and services they think serve them best. When corporations monopolise the market, or terrorise the people, then this is a failure of both government and the market; it no more justifies getting rid of trade than it does getting rid of the government. The government must step up to enforce laws that give consumers freedom of choice and information, while allowing competing firms to enter new markets.

The argument that rampant consumerism will destroy the world is likewise misplaced. I don't think it is up to governments to tell people how they should spend their money. Those who are anti-consumerism must convince the consumers themselves that they are making a mistake in how they currently spend their incomes. Any attempt to limit people's options in the guise of protecting them must be recognised for what it is: an undemocratic attempt to enforce the will of a vocal few over the many. If consumers would rather eat McDonald's and watch television than live in some idealised vision of what a quaint developing country should look like, it is up to those who argue against this to convince those consumers that they have a mistake; anything else is undemocratic.

Now, for the historical and practical arguments. It is indisputable that all countries have, at one time or another, practiced protectionist policies. But to conclude that a country which practiced protectionism can somehow trace its future economic success to said protectionist policies, we must establish a clear chain of causation. I don't see anything other than an interesting apparent correlation; there is no study I know of which actually compares presently developed countries with more free trade to those with less and looks at the economic impact.

In fact, the wrong question is whether a country practicing protectionism can thrive. Of course it can. The right question is whether, all other things being equal, a country with more free trade will be more successful than one with more protectionism, or alternatively, the precise opposite of that. I do not yet know of an economic study which has proven either hypothesis.

My contention is that all the facts we possess at the moment compel us to support trade as a useful tool to promote economic development. Historically, why did the British Empire prosper? There are obviously many reasons, but might not one be the simple fact that they had more free trade amongst their territories than any other colonial power? Economic historians often ponder the English legal system, which has proven to be a bedrock for stable and free markets, with the rule of law rather than the rule of arbitrary tyranny; more than a few firmly think that this contributed significantly to the British Empire's economic progress.

In more recent times, it is easy to think of countries which foundered under free trade and free markets. Russia has not gone anywhere. Neither have many Latin American or African countries. India is still very poor, in spite of all the progress it has made. But let us look at countries which take the two policy alternatives we have offered here to their very logical extremes. It is clear that trade serves to build up the economy, even if it is starting up from scratch.

Let's look at this more closely in detail. Ireland, Hong Kong, and Chile are the poster children for the free market. All of them were not particularly known for economic prowess a mere fifty years ago. Ireland was the sick man of Europe till well into the 1970s, and maybe even 1980s. Hong Kong was not more than a British-owned rock in the South China Sea. Chile was just another Latin American country.

But all three countries pursued extreme free market policies, without even a significant breather to adopt protectionist policies. Only Chile really tried the protectionist, socialist approach; the brutal dictatorship of Augusto Pinochet toppled the elected socialist government in a coup, and while murdering thousands of its own people, implemented some of the stoutest free markets in the world. Today, Chile bears the scars of Pinochet's murderous rule, but it also is perhaps the most vibrant economy in Latin America.

Now take the opposite end of the spectrum. Every country which has tried protectionism eventually had to abandon it as a failure; clinging on only made life harder. Both Koreas experimented with protectionism. North Korea's extreme version means thousands have starved to death and today live in poverty unimaginable to almost anyone reading this. South Korea had no choice but to dismantle its chaebols and pursue a more free market after the 1997 Asian economic crisis proved they were not viable business entities. Japan also took a protectionist tack early on, but it was helped significantly by its own consumers, who generally refused to buy foreign-made goods; they did not need a government to really pursue protectionism, and businesses which decided to move into the global markets had no choice but to compete. Until they had competition, the Japanese could not produce quality goods; it is easy to forget that their first exports were complete crap. Those which never ventured into a real free market have never flowered; there is a reason hardly any of us are depositing our money into Japanese bank accounts.

Of course you can screw up development despite having a free market. Usually what actually happens is that governments mistake pro-business policies for pro-market policies. A true free market is one open to new competitors, and one where consumers are free to choose. Anything otherwise will not work. Look at Russia, Latin America, Africa — any poster child for the supposed failure of trade. How much do their economies actually resemble free markets, where the government protects the freedom of firms to enter the market and compete, and the freedom of consumers to choose? These are little more than protectionist economies in themselves, except that the protectionism is more subtle than subsidies and tariffs.

Nevertheless, it is still far easier to screw up pure protectionism than it is to screw up the market. To assume that the infant industry hypothesis is true, you must in the first place assume that protectionist barriers will easily fall once the industry is ready to compete, and that the industry will ready itself, rather than assuming it will be under protection forever. Neither assumption appears truly justified. In the United States and the European Union, two supposed bastions of the ostensibly multinational corporation-biased free market, protectionist barriers to agricultural imports have been incredibly hard to bring down. Ethanol subsidies in the United States and elsewhere are actually literally starving the developing world — rather than growing food to feed the poor, we are growing food to feed the automobiles of the rich and their green consciences.

As for the assumption that these infant industries will of their own volition mature, look at Japan and China. In neither economy did their infant industries mature till they had to compete internationally. The first Japanese cars were horrible, as were their first cheap knockoff electronics. But they learned from their competition once they moved overseas — a brave step that many corporations are reluctant to take. In communist China, you had the epitome of protectionist policies, but we did not witness the "Great Leap Forward" Mao Zedong envisioned. Rather, the country was marked by stagnant and backward factories that did not contribute to any meaningful economic progress until Deng Xiaoping opened up China to the world.

Trade is not the perfect panacea. It will not guarantee development. It will not guarantee prosperity. But it is a far better bet than protectionism, which has yet to make a convincing case for itself, either on the theories or on the facts. Even left-leaning economists, like the late Joan Robinson of the Cambridge School of economic thought — a woman who some believe lost the Nobel Prize for her praise of communist China's Cultural Revolution — went as far to state: "The misery of being exploited by capitalists is nothing compared to the misery of not being exploited at all." In more recent times, the poster child for hatred from the right-wing pro-marketeers has been Paul Krugman, who actually gained notoriety in the 1990s for his incredible defence of free trade. There might conceivably be a good case for protectionist policies; if there is one, however, it has yet to be made.

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