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Protectionism: “Fairness” Is the New “Freedom”

Protectionism: “Fairness” Is the New “Freedom”

No. 2, Nov.-Dec. 2016 » TheFILEstarters

Lately, the media and the Parliament have triggered debates on adopting protectionist measures: granting subsidies, “51% Romanian goods” quotas in supermarkets, restricting the selling of land to foreigners, closing large shops during the weekend, etc. The arguments rely on the need to support domestic capital, to secure food and/or energy, bailing out even loss making companies and avoiding unemployment. Though presented as strategically important, these measures would harm the Romanian economy, jeopardising the already stagnating structural reforms meant to modernise it. Moreover, these decisions ignore the provisions of international treaties Romania is part of (GATT/WTO, EU, FAO, IMF, etc.).

Trade: a history of ups, downs and offs

Protectionism is an economic policy meant to limit the access of foreign goods in the national markets. Its aim is to favour the domestic market, without discouraging exports. Irrespective of its forms, the general principle of protectionism remains the same: creating obstacles for the entry of foreign goods, thus limiting the access of the consumers to these products and shifting them towards domestic goods.

The history of protectionism is strictly linked to international trade. At the beginning of modern trading, during the first decades of the XIXth century, the great nations promoted protectionism on a large sale. After abolishing the Corn Law in 1846, that forbade the import of grains and other cereals, thus maintaining the high prices in favour of the British landowners, a gradual liberalisation of international exchanges began.

This trend was also triggered by the 1860 Franco-British Treaty that eliminated the restrictions concerning the trade among the two countries, diminished duty fees and led for the first time to the most favoured nations’ (MFN) clause, i.e., a country that has been accorded MFN status may not be treated less advantageously than any other country with MFN status by the promising country.

The liberalisation process was interrupted at the end of the 1870s when, at that time, developed countries returned to protectionism leading to numerous wars and commercial retaliation.

The climax was reached during 1929-1930, when protectionism seemed to be the best possible answer for the crises. Confronted with economic difficulties and a hostile international policy, induced by the peril of a new war, economies around the world tried to protect themselves, not by closing new treaties, but acting on their own and limiting imports and exporting at dumping prices, devaluating their national currencies and creating monetary blocks.

Interwar inwardness and post-war openness

At the same time, Romania led a counter foreign trade policy. During 1922-1928, the liberal governments favoured the domestic economy and semi-autarchy (“Through ourselves!”) when all the other nations made efforts to restore free trading. During 1928-1931, when the Romanian economy was hit by the crises and the European economies were heading towards protectionism, The National Peasant Party’s government tried to liberalise the foreign trade (“Open gates policy”). Shifting the trade policy from liberalism during the crises to restricting the economic relations at the dawn of the Second World War was delayed compared to other European countries that have undertaken similar measures.

After the War, multilateral agreements were generalised (as opposed to the 1846-1945 era, when bilateral agreements were favoured) and international organisations were entrusted with their management.

According to the preamble of the respective official documents, the aim of the agreements is to set up a genuine international cooperation based on free, durable trade. During 1947-1994, this cooperation was known as GATT (General Agreement on Tariffs and Trade). In 1964 the WTO (World Trade Organisation) was established and endowed with disciplinary powers. The fundamental objective of the WTO taken over from GATT (1965), is the gradual reduction of protectionist barriers to favour economic growth without putting at risk emerging industries of those in distress. After the failure of the Seattle conference (1999), the WTO launched a new negotiation cycle (Doha 2001).

Presently, a new institutional framework of international trade has been launched: the EU-USA free trade TTIP (Transatlantic Trade and Investment Partnership). The aim of this partnership is to abolish trade barriers (duty fees, useless regulations, restrictions on investments, etc.) for a vast category of economic sectors and to facilitate the purchase and selling of goods and services between EU and USA.

Romania’s socialist “freedom” to trade

Concerning the Romanian economy, it was rebuilt after the war following the Stalinist pattern. The model was based on state or collective ownership of the means of production and on centrally-based decisions that pursued the planning of most of the economic variables: prices, salaries, the allocation of the national income for consumption and accumulation, imports, exports, etc.

Under these circumstances, during the last stages of the Communist regime, imports were drastically restricted and exporting was favoured to gain the necessary foreign currencies to repay the foreign debt and to diminish the dependency on external funding.

In the Communist economy, duty fees were in place, but only to offer reciprocity to other countries that diminished import fees for Romanian goods, but not to protect the Romanian economy.

The Romanian economy was a closed one and completely isolated, and for this autarchy means other than duty fees were used: the state monopoly over the foreign trade, the planning of the volume and structure of imports and exports, administrative prices for exchanged goods, travel restrictions, etc.

After the fall of communism, the state monopoly of the foreign trade was abolished and Romania re-established relations with the multilateral international institutions mentioned above. Consequently, the duty regime was revisited according to the assumed obligations.

The commerce and the well-being of nations

The fact that the free trade affects the economy has been well known for a long time. The idea is as old as time. In his celebrated book, The Wealth of Nations, Adam Smith argues in favour of international free trade, showing that, by specialising in the production of certain goods, all nations benefit from the trade liberalisation. As within the domestic market the division of labour, specialisation and free trade lead to increased productivity and welfare, at the level of the global economy, free trade leads to a generalised welfare of all nations. Nevertheless, Smith admits duty fees in two circumstances: when industries have a strategic importance for the national economy and as a response to the duty fees imposed by other countries for imports from that country. According to Smith, protectionism is an exceptional measure that hinders the proper functioning of the economy.

Following this line of thought, one can separate the efficiency of free trade at domestic level and the efficiency of free trade at international level (cosmopolitan-efficiency argument – J. Bhagwati).

Both approaches assume that prices are freely set by the market that is not touched by mal-functionalities.

It is, though, well known that markets are often disturbed, because of externalities, for example. The market distortions may also manifest under government interventions. Thus, governments may distort prices by subsidising production in certain areas or because they do not properly protect intellectual property, hindering the emergence of knowledge or, on the contrary, over-protect the domestic know how, licences, trademarks, etc., thus hindering foreign competition. In such cases, the production and exchanges based on distorted prices are ineffective.

The analysis of free trade at domestic level is at the core of national trade policies. And, basically, this is the main objective considered by Adam Smith. Concerning the analysis of the free trade effects on the world economy (cosmopolitan-efficiency argument), it is relevant for the drafting of international trade regimes. For example, starting from the conclusions of specific research, the WTO was established as a discussion and negotiation forum for new trade regulations, but also for the existing ones and to grant solutions in case of litigations among member states. The IMF was created following the Bretton Woods Agreement (1944) and had, as its initial objective, the surveillance of foreign exchange policies of member states, to avoid devaluation for competitive reasons. Further on, the IMF evolved, becoming more of an administrative body of the international monetary system to ensure its stability. During globalisation, the importance of research concerning the role of free trade increased as a determinant of sustainable world economic development, of increased living standard and poverty reduction.

Protection levied against… protectionists

In this case, widely analysed by modern economists, two situations in which free trade can contribute to the welfare of nations are envisaged.

Firstly, as Adam Smith shows, a country may adopt protectionism as a reaction to the restrictions enforced by other countries upon imports from that particular country (i.e., protectionism may be used as a means to force the opening of closed foreign markets. Instead of “opium wars” between Britain and France on one side and China on the other side (1839-1842, 1856-1860) or instead of threatening the bombing the Yokohama harbours by the American war ships (1859), a country can threaten to introduce trade restrictions, and in case this strategy is successful, the gain is doubled: out of its own trade that remains free and the trade of foreign countries that has become free. Nevertheless, Smith and other economists as well doubted that such a policy may have a positive outcome. They have discovered that threats of dire repercussions do not necessarily induce a country to reduce its own trade barriers and retaliatory measures tend to be amplified and to remain permanent.

Still, this strategy is used at present. A surprising example is the USA, which, despite declaring itself in favour of international free trade, considers that the American market should stay closed to make other countries open their own markets. The American legislation Omnibus Foreign Trade and Competitiveness Act allows and sometimes obliges the American government to force other countries to accept new trade obligations, threatening with duty repercussions in case of non-compliance. In addition, voluntary quotas can be set concerning exports to the USA. The USA simply forces other nations to redirect exports according to the American interest, thus violating the principle stating that international exchanges should be guided by market prices.

Protection levied against… monopolists

The second case in which protectionism can contribute to the welfare of a nation is the one in which that nation has a monopolistic stance in producing a certain good.

Ever since R. Torrens and J.S. Mill – who lived in the first half of the XIXth century –economists have considered that a country which has an important position in international trade can use the optimum price to take advantage of its monopolistic position, thus gaining more from the trade with other nations. It is equivalent to saying that a monopolistic producer can maximise its profits by increasing the price and reducing the production.

Presently, a kind of selective protectionism known as strategic commercial policy is recommended by some economists (B. Spencer, J. Brander) in case the market is under the control of a company (for example a foreign one), that is monopolistic (imperfect competition), and the entry costs of a new domestic company are high. In this case, it is necessary that the state grant subsidies to increase competition.

Thus, the advantages of a monopolistic company are limited, and the new company, by becoming competitive, following public aid, will gain part of the market. The similarity of this argument and M. Manoilescu’s plea for protectionism as a means to sustain Romania’s industrialisation between the two wars is obvious.

Presently, the most cited example (P. Krugman) is of aeronautics, characterised by a duopoly (Boeing – old and well established producer and Airbus – new, fragile and having initial technological setbacks): the subsidies granted by the French state to Airbus allowed the reduction of costs (mainly the research and development ones) for the new aircraft, thus becoming the leader on the market.

The second case raises at least two objections. Firstly, with rare exceptions, such as the member states of The Organization of Petroleum Exporting Countries (OPEC), few countries seem to hold a significant monopolistic stance for a sufficiently large number of goods to confer a practical meaning to the exceptions from the free trade rule. Secondly, the other countries may enact repercussions against the “optimum” price.

Consequently, the ability to use the monopolistic stance to improve welfare is questionable. Even contemporary economists (P. Krugman, A. Dixit, G. Grosman etc.), who have built their academic reputation by identifying the theoretical cases in which oligopolistic markets that allow governments to use import duty fees to increase the national income, are against protectionism. The main argument they rely on is that government rarely disposes of enough information to identify the situations for which duty fees are appropriate.

Protectionism and the imperfect competition

One could wrongly understand that any market imperfections are a good reason to adopt protective measures. Indeed, economists have fallen in this trap for more than two centuries: as shown above, from the beginning of modern international trade, in the first decades of the XXth century until the 1950s, the solution of protectionism was often used. Presently, the majority of economists support the idea that protectionism is an inadequate and insufficient way to correct the internal market deficiencies.

For example, in case salaries do not adjust quickly enough to the decrease of demand for certain goods, a decrease that is the result of external competition, modern economists show that the adequate governmental policy is intervention, or ceasing intervention, on the labour market, where the appropriate measures to treat the cause of problems may be taken.

A relevant example is that concerning the member states of a monetary union (for example the Eurozone) that have renounced their national currency and the foreign exchange mechanism. According to the optimum monetary union theory, in this case the regulating functions of foreign exchange must be replaced with cross border labour and financial flows that exclude any form of protectionism.

Or, in the case of the Eurozone member states where the labour market is rather inflexible, affecting the domestic and cross border labour flow, abolishing this rigidity is an adequate solution to the economic problems these countries must deal with. In the above-mentioned free trade agreement negotiated by the EU and US, it seems that this conclusion is being considered.

Protectionism and the interest groups’ coup

Economists also support the idea that even if protectionism is theoretically adequate, its levers would actually be captured by interest groups (rent seekers) that would use the respective measures for their own narrow interests and not for the national interest.

The main cost of protectionism is to force consumers to give up cheap imported goods. For instance, consider a certain good and its P0 market price corresponding to a free competitive market in an open economy. As the figure bellow shows, the market equilibrium is in A where the demand DD’ equals supply SS’. Q0 is the quantity consumers buy at the equilibrium point.

Consider now that some domestic producers are discontent with the existing market price P0 that is too low. Consequently, they will rally to form a pressure group forcing the authorities to adopt protectionist measures.

If the lobbying is effective and the government introduces, for example, a duty fee, the domestic prise will tend to go up to P1, and the new equilibrium point will be in B with a corresponding demand Q1. A percentage of the reduced quantity that belongs to consumers (P1BAQ0O), is now transferred to producers as rent (P1BEP0). It actually means that rent is the increase of producers’ income and thus part of goods as part of the overall social production given that those who buy the goods they produce are paid at a higher price and consequently they themselves acquire a lower quantity of goods.

The drop in consumer welfare, because of limited competition induced by protectionism, is represented by the ABE triangle (“Herberger’s triangle”).

This decrease is induced by the fact that, because of protectionism, consumers cannot choose among the similar domestic or imported goods, but must accept the highest price P1, of domestic goods. And, in case these goods are not only more expensive but also of lower quality, the losses suffered by consumers is even more significant (that is not shown by the graph). Actually, the decrease of consumer welfare is embedded in an additional cost they support, cost that translates into an additional income, i.e., rent, (P1-P0), enjoyed by the producers that have asked for protectionist measures.

An important cost of protectionism is the cost of lobbying, supported by those who seek protection. This cost is the source of rent that goes to those who grant protection (politicians, bureaucrats, technocrats, etc.) and to the media (journalists, analysts, spokesmen, etc.)

Presently, all these activities are extensively studied by economists describing them as rent-seeking or Directly Unproductive Profits seeking activities. They are unproductive because they bear profit or income for those who develop those activities without creating added value for society.

The too many shades of “grey protectionism”

The main characteristic of modern international trade theory is the significant downsizing of arguments in favour of protectionism and the emphasis on the advantages of free trade vs. protectionism.

Still, protectionism takes ingenious, various forms. When the supporters of free trade succeed in eliminating it from an area it appears in another: the supporters of protectionism seem to be ahead of free trade supporters in pioneering new means for protectionism against foreign competitors.

The main forms of protectionisms are:
  1. tariff measures, mainly duty fees – levied as a percentage that increases the price of imported goods, which becomes higher than the price of domestic goods; consumers are forced to buy mainly domestic products, thus favouring domestic producers and contributing to the development of particular economic sectors and the reduction of unemployment; as already shown, the cost of the entire process is supported by the consumers;
  2. non-tariff measures such as contingencies quotas to limit the quantities that can be imported or the increase of these quantities;
  3. grey or disguised protectionism, thus called because it is less visible and bureaucratic; an example is the enforcement of various norms: technique, hygiene, security, consumers’ protection, environmental protection.

In the past, governments have implemented tariff measures (duty fees) and non-tariff measures. Presently, various forms of grey or disguised protectionism are in use.

A particular form of grey or disguised protectionism is the so called voluntary export restraint; voluntary export restriction or the orderly marketing arrangement. Instead of restricting imports by installing duty fees or contingencies, the exporting country restricts exports but the protecting effect remains the same. The main difference is that exporting countries prefer export restrictions, instead of import restrictions on partner countries, allowing exporters to obtain higher prices and higher profits induced by protectionism.

An example is that of voluntary quotas introduced in Japan for automobile exports to the USA. Obviously, USA could have limited the import of Japanese automobiles by levying duty fees. But, this measure might have increased the prices and the reduction of automobiles acquired by American citizens. Consequently, the Japanese government voluntarily limited the number of cars exported to USA.

Because the supply was reduced, the Japanese car producers could increase the prices and continue to export to the USA. Ironically, the additional profits generated by the voluntary limitations of exports, probably helped the Japanese producers to increase investments and thus to become more competitive. In the 1980s the number of voluntary restrictions increased, becoming a disruptive factor for yet another reason. These types of agreements are an advantage for selective exporters, instead of allowing the market to determine the exporters that will lose following limitations in international trades.

In the above example, the alternative would have been for the US to protect its own car producers by introducing contingencies of duty fees applicable to all the foreign car imports, allowing the American buyers to decide whether they want to buy less Japanese or European cars. By applying voluntary export restrictions, the efficiency criteria are replaced by political ones.

Protectionism embraces nowadays an even more insidious form called administered protection. This type of protection results from applying those rules meant to meet market conditions or specific events determined by legislative bodies or administrative authorities. Thus, in almost all developed countries there are regulations concerning fair trade laws, that seek, on one hand, to prevent other countries from subsidising their exports that would distort the stimulus created by the market and would affect the international division of labour and, one the other hand, to avoid dumping level pricing for export goods.

Some governments promote countervailing duties or antidumping duty policies to neutralize the effects of those policies. These mechanisms of so called equitable policies are meant to support free trade.

Trade trends: from free to fair and to fair(y)

Actually, fair trade is used instead of or to support free trade. It regards those cases in which mechanisms are obviously used against competing foreign companies to force them to accept voluntary restrictions. Such trading mechanisms are, normally, allowed for domestic companies (sales during Holidays) and are forbidden to foreign companies.

Literature shows that in the 1980s many fair trade mechanisms shifted to genuine protection used against foreign competition. Consequently, proposals were made to prevent the capture of the respective mechanisms by rent-seekers. The essence of these proposals is to create bilateral procedures to solve litigation and ensure more objectivity than the national procedures. Such solutions are provisioned, for example in the Canadian-American Free Trade Agreement and in The North American Free Trade Agreement (with Mexico). Another possibility is to extensively use the procedures prescribed by the WTO to solve litigations.

Recent research concerning protectionism concentrates on two big problems. Firstly, the possibilities of eliminating agricultural protectionism, agricultural subsidies and the selling of agricultural products in developed countries exempted in 1965 from the GATT rules are intensely studied. Secondly, economists are concerned with the proliferation of bilateral free trade agreements which are, basically, preferential ones. They show that because of the massive extension of preferential treatment to developing countries, as an exception from the most favoured nation clause, the GATT principles are strongly eroded jeopardising the free international trade.

With all these ideas and efforts having been institutionalised, there are many producers stating that certain countries engage in unfair trade. Thus, the opponents of free trade with certain countries argue that in their respective cases, free trade is impossible because of environmental, quality, wages and other standards. The list of objections against free trade with certain countries in which unfair trade exists is infinite. And here we also find the main sources of inspiration for the arguments against free trade.

 
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OEconomica No. 1, 2016