World Recession and Protectionism

A recession is usually defined as a sustained slowdown in economic activity over a period of time. This usually refers to negative growth in Real Gross Domestic Product within two consecutive quarters in a year.  An Economics’ dictionary defines a recessions as, “slow economy, period characterized by a decline in the gross domestic product during two or more consecutive quarters; ebb, decline; withdrawal, act of receding.”[1]  A world recession is simple a recession in a wider context, thus a world recession crosses borders and affects everyone on the globe. Definition for what a “world recession” is still difficult to determine.  Moving to the subject of protectionism, a website on globalization run by Emory University defines protectionism as an, “Effort to shield domestic producers against foreign competition”[2]   Protectionism may come in many faces, but it is usually done using the following instruments; tariffs, quotas, administrative barriers, direct and export subsidies and manipulation of the exchange rate market.  In some cases protectionism is disguised in certain legislation that it will take only trade experts to detect it.  Of important analysis in this article is the relation between a world recession and protectionism.   This article will seek to determine if there is some correlation between these two economic situations.  Special reference will be made to an article by Alan Beattie entitled, “Crucial Cargoes.”   This article tries to ascertain if whether during the current world recession we will witness a spate of economic trade barriers being imposed by countries against each other.  It the article draws reference from the events during the great depression of the 1930’s and the world recession that occurred in 1982 and tries to speculate if the same will happen now.

Recessions are usually characterised by a plunge in economic activity in areas such as manufacturing, finance, real estate, services etc.  Demand for goods and services decreases. This translates to less revenue for companies.  In some cases, some companies go bankrupt and close shop.  To mitigate the effects of the recession on their business operations, most companies will react by embarking on massive cost cutting exercises.  These mostly include streamlining down operations, which involve laying off workers, halting production in some business units and postponing any planned business expansions or investments.  Depending on the severity of the recession, job losses can be really huge.  History has shown that during periods of high unemployment social unrest is very likely and people can easily fall prey to extremist leftist or rightist parties which are a threat to general peace and stability. The great depression of the 1930s led to the rise of radical leaders such as Hitler and Mussolini, who plunged the world into one of the most costly and most destructive war in human history.

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It is with the above in mind that politicians and major decision makers in a country are tempted to resort to protectionism during periods of recessions.  The major reasons normally given to defend policies of protectionism normally include:

Ø    Protects local businesses from foreign competition

Ø    Helps infant industries develop until they can withstand market forces

Ø    Helps protects jobs

Ø     Prevents dumping

Ø    Helps to restrict import of harmful goods

During a global recession the main goal is to protect local industries and save jobs.  One of the major psychological driving forces behind a recession is “fear”.  According to a psychological research group based in Indiana, USA, this feeling is described in detail as “Fearful of perceived major losses, businesses and everyday people will postpone major purchases and stop buying overpriced cups of coffee.”[3]   Politicians and economic policy makers are no spared from this either, however their fear is based more on them being forced to resign by the general public due to perceived underperformance.  Thus they will resort to protectionism so as to be seen by the general public to be doing something to mitigate the effects of the recession. Alan Beattie, emphasizes this in a line in his article where he writes protectionism is, “a reaction to an economic downturn” rather than a cause.  The general decrease in the economic activity during a recession means companies are competing for a shrinking customer base with less spending power. Thus protectionism gives the domestic companies an advantage by simple eliminating foreign competition.

 

Anti-dumping and Countervailing actions

An important area to look into in this discussion is dumping and how governments deal with them. Dumping is defined as the, “practice of selling goods abroad below cost or at a price below that charged in the domestic market in order to eliminate a surplus or to gain an  unfair edge on foreign competition, or when goods are unacceptable for the domestic market.”[4]  In recent years there has been a long drawn out wrangle between the United States and China, over China’s alleged dumping of goods in the United States market.  This highlights how controversial the subject dumping can be.  Dumping of goods in a foreign country is not only an economic issue but a political one as well.  Alan Bettie in his article portrays how some top United States politicians are championing protectionism over free trade to score political points.  Governments respond to, “alleged dumping” by using anti-dumping and countervailing duty actions.  These normally include using tariffs and quotas.  The former seeks to eliminate the advantages of the unfair low price by adding a tax on the product, making it more expensive thus reducing the unfair advantage it has on local products.  A quota on the other hand limits the amount of the unfair priced product imported into the country. This decreases the overall profit margin for that good, and the limit on the quantity imported into the country, reduces the effect it has on the domestic market. The quantity will be too low to have a major impact on the domestic market.  The diagram below illustrates how a tariff works to reduce the effects of dumping:

 

The tariff imposed by the government causes the price of the dumped good to increase from P1 to P2.  Demand for this good in the domestic market decreases from Q4 to Q3 as indicated by the diagram.  The quantity of imports is reduced to, (Q2-Q3), thus favouring the domestic market.  Due to the tariff there is a loss in consumer welfare due to higher prices. The area (a,b,c,d) represent this.

Another method that can be used against dumping is quotas. An import quota as it is often called is a measure by the government to limit or restrict the quantity of a good imported into a country.  A quota works by reducing the supply of the good imported into the country and thus creating an artificial shortage, which leads to a rise in the price of that good.  In some instances, the revenues gained from the tariffs are disbursed to domestic industries who are suffering the effects of dumping.  The two words, quotas and tariffs are somehow interrelated; they are both used as anti-dumping and counter-availing actions. In some cases however, these instruments may be abused, and be used as a disguise for protectionism, in order to surreptitiously evade the world trade organizations rules on anti-protectionism.

Protectionism impossible and ineffective in the 21st century

With the world currently facing its worst recession in decades, some speculators will think this will mean a return to the high protectionism culture of the 1930s. This means agreeing to the assertion raised by Alan Beattie, in his article, “Crucial Cargoes”, were he says, that, “Would global recession bring thirty’s style curb on trade.” Theoretically and based on the previous recessions the world has seen, this may be true. Especially if one is to use the recession of the 1930s as a reference. A fact to note however is that today’s world economy is far much more diverse, complex and advanced to be compared to the pre-world war two scenario.  The technological advances the world has made in the last fifty to sixty years, together with other factors, will render protectionism difficult of if imposed at all, ineffective.

In modern times, capital moves easily across many borders.  Most takes place through the internet and other ways which make it difficult for the government to control.  Most importantly is the existence of the world trade organization that did not exist in the 1930s. About 80% of all the countries in the world are members of the world trade organization and they are all bound by its rulings.  The World Trade Organization has a clause which restricts member states from engaging in protectionist measures or measures having similar effect.  Members who breach these rules are subject to punitive measure being imposed on them by the body. Last but not the least, countries of the world have hindsight experience of what protectionism can do.  The protectionist methods of the 1930s worsened the effects of the depression and led to world war two. Former United States FDR secretary Cordell Hull once said, “If goods can’t cross borders, he said, armies will.”  Just as that statement was true in the 1930s it remains as true now.