Will the financial crisis lead to more protectionism?

In opening the WTO’s Public Forum for 2008, which is taking place in Geneva at the moment, Pascal Lamy, director-general or the WTO referred to newspaper headlines heralding a potential Great Depression Two. He noted that policy-makers in the United States and across the globe, are desperately seeking to avoid the series of mis-steps that accentuated the financial crisis of the 1930s. Lamy then added:

“They are all stressing that lessons from the Great Depression have been learned, and that the many policy mistakes that were associated with it will be avoided. But one of the important lessons of the Great Depression, which we must not forget, is that “protectionism” and economic isolationism do not work. They are policies of the past, which should have no place in our future” (here).

I suppose that quite a few economists who are concerned about the current financial crisis have recently revisited what Milton Friedman had to say about the origins of the great depression. My conclusion after re-reading the relevant chapter of “Capitalism and Freedom”, is that the policy mistakes that led to the great depression are unlikely to be repeated. I am less sure that the U.S. will avoid the policy mistakes that Japan made at the beginning of the 1990’s - but that is not what I want to write about at the moment.

After I had read what Friedman had to say about the origins of the great depression I then found myself reading his comments on trade liberalisation in the following chapter about international finance and trade. If Pascal Lamy has good cause to be concerned about a rise in protectionism in the current environment – as I think he has - it seems to me that the best way to defend against it would be to revive efforts toward trade liberalisation. The following comments by Friedman on approaches to trade liberalization seem to me to be particularly relevant in the light of the recent failure of international trade negotiations:

“Given that we should move to free trade, how should we do so? The method we have tried to adopt is reciprocal negotiation of tariff reductions with other countries. This seems to me a wrong procedure. In the first place, it ensures a slow pace. He moves fastest who moves alone. In the second place, it fosters an erroneous view of the basic problem. It makes it appear as if tariffs help the country imposing them but hurt other countries , as if when we reduce a tariff we give up something good and should get something in return in the form of a reduction in the tariffs imposed by other countries. In truth the situation is quite different. Our tariffs hurt us as well as other countries. We would be benefited by dispensing with our tariffs even if other countries did not. We would of course be benefited more if they reduced theirs but our benefiting does not require that they reduce theirs. Self-interests coincide and do not conflict” (Friedman, 1982: 73).

Friedman made it clear in the following paragraphs that he was using “tariff” to cover non-tariff impediments to trade as well as tariffs.

It is difficult for those who share Friedman’s views about trade liberalization not to view WTO negotiations as vaudeville. The negotiation process seems to exist to allow politicians to clown around on the world stage keeping their domestic audiences amused, while behind the scenes they continue to pander to narrow interest groups favouring high protection.

Does this mean that the WTO is worse than useless? Not necessarily. The WTO has potential value as a forum that can help member countries to resist the pressures of domestic interests seeking to retain or even increase trade barriers. It seems to me that it is not beyond hope that WTO processes could be used to help individual countries to develop trade negotiation strategies that would achieve the benefits potentially available to them through unilateral reductions in protection. If many countries can induce each other to do this simultaneously, all can also obtain the benefits flowing from reductions in trade barriers of other countries.

How this could happen? The best ideas I have seen are in a contribution to the WTO Public Forum by Bill Carmichael, former chairman of Australia’s Industries Assistance Commission (here).