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Protectionism: To Worry or Not to Worry?

by and Martin Kessler | July 11th, 2013 | 03:00 pm
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This post elaborates on the July 11 piece in the Financial Times about the puzzling lack of protectionism in recent years.

Pascal Lamy, director general of the World Trade Organization (WTO), has rung some low-sounding alarm bells, noting in mid-June that more than 100 trade-restrictive measures were implemented by G-20 economies over the previous seven months. His concern follows recent work by Simon Evenett, a trade expert at the University of St. Gallen, Switzerland, whose 12th Global Trade Report documents a slow rise in protectionism, and a separate study by Gary Hufbauer et al. (2013) on local content requirements.

Contrary observations have been made by Paul Krugman and Tyler Cowen, who noted the “protectionist non-surge” after the recent financial crises, especially compared with the protectionist explosion during the Great Depression (see also Eichengreen and Irwin 2009 and Baldwin and Evenett 2009).

Should we worry about the return of a protectionist flood? In a forthcoming paper (Subramanian and Kessler 2013), we examine the case of the United States from a long-term perspective, which provides some reassurance.

The real puzzle relates not to the cyclical shock of the Great Recession but the massive structural trade shock experienced by the United States especially embodied in the two-decade surge in imports from China. Why did this unprecedented episode not lead to serious recourse to protectionism? As the figure below shows, merchandise imports from China surged from half a percent of US domestic demand in 1990 to 5.2 percent by 2010.

Moreover, the domestic uproar against China did not match the backlash over the North American Free Trade Agreement (NAFTA) in the early 1990s, and the actual protectionist actions against Japan in the 1980s. (The first Reagan administration presided over the greatest upsurge in trade barriers in the postwar period, in the form of voluntary export restraints (VERs) by Japan and anti-dumping and countervailing action by the United States against Japanese imports (Destler 1992).) Figure 1 illustrates the magnitude of the changes in imports for these countries.

In other words, why did the protectionist dog in the United States merely whimper (China) when it barked loudly (Mexico) and bit hard (Japan)?

Figure 1 US Merchandise imports from China, Mexico, and Japan, 1962–2011



Note: Domestic absorption is GDP minus trade balance.

Source: Direction of Trade Statistics (DOTS) and International Financial Statistics (IFS), IMF.

Whether measured as the level of imports or change in imports, and whether measured relative to absorption or working-age population, we find that the China shock is much greater. For example, in terms of average levels of imports, the China shock was 2.5 to 3 times as large as Mexico’s, and about twice as large as Japan’s. And if we take account of China’s relative level of development—6 percent that of the United States compared to 42 and 70 percent for Mexico and Japan, respectively, see table 1—the differential in the trade shock is magnified considerably.

     
  Table 1 Three import shocks to the US compared  
 
 
  Country Period Real imports by working-age inhabitants (in 2005 dollars) Import absorption (as percent of domestic consumption) GDP per capita (PPP dollars)
(initial year)
 
  Average Change Average Change As percent of US GDP  
 
 
 
  Japan 1970–1990 374 355 6.8 6.2 68.9  
  Mexico 1980–2000 197 542 2.9 5.5 42.0  
  China 1990–2010 672 1259 8.5 14.9 5.7  
 
 
  PPP = purchasing power parity  
  Sources: IMF, Census Bureau, Penn World Tables 7.1.  
     

Why did the protectionist dog merely whimper (China) when it barked loudly (Mexico) and bit hard (Japan)? Several factors might explain the differential response to the China shock.

Measurement error: Conventionally recorded imports could exaggerate the China trade shock. Chinese exports embody less value added than the exports of many other countries because of the large volume of intermediate inputs it imports and transforms into exports. Even making allowance for this distinction between gross and value-added imports, however—and the problem was arguably as acute in relation to Mexican maquiladora exports to the United States—does not change the numbers presented above.1

Focal point for protectionist reaction: A second explanation could be that in the case of Mexico, the uproar was exaggerated because there was a focal point: a trade agreement—NAFTA—that had to be passed by the US Congress. Rallying around preemptive action is easier than around ex post action, according to this explanation. But in the case of China, there has also been an identifiable target and identifiable policies: currency manipulation. Moreover, Mexico was an ally, whereas China is a potential adversary and competitor to big power status, which should have increased the outcry and concerns in domestic US politics. In the case of Japan, there was also no focal or rallying point, as with NAFTA, but that did not prevent a protectionist upsurge.

Complete specialization: A third explanation is that by the time the China trade shock arrived, the United States had specialized so much away from unskilled labor, there was less to disturb domestically. For example, the number of workers employed in the US clothing sector declined from 900,000 in 1990 to 150,000 in 2013. In technical terms, the United States is no longer in the cone of diversification (Edwards and Lawrence 2013). However, the estimates of employment disruption by Autor, Dorn, and Hanson (2013) question this explanation. They show that rising exposure to Chinese imports increased unemployment, lowered labor force participation, and reduced wages in local labor markets. They estimate that the exogenous component of the China shock explains one-quarter of the contemporaneous aggregate decline in US manufacturing employment over the 2000–07 period. Moreover, the lack of opposition while the manufacturing sector was shrinking remains a puzzle.

Nature of trade and a too-big China: A fourth argument relates to the combination of the nature of trade and the power balance relative to the trading partner. From a US perspective, trade with Japan was very different from trade with China. The former represented head-to-head competition in some specific industries (steel, cars, and semiconductors) whereas trade with China was based on differences in endowments, with China exporting relatively low-skilled goods to the United States. If, (arguably) capital is more influential in the US trade policy process, then the protectionist response in the Japan episode is explicable: Facing a decline in profits from Japanese competition, US manufacturers fought back, and did so successfully. In contrast, China defanged or co-opted US industry through its strategy of openness to other US exports. As a result, trade actions against China were opposed by US firms with a large stake in the Chinese market. This explains, in part, the failure of successive legislative initiatives against Chinese currency policy.

While this may explain the difference between the Chinese and Japanese experiences, it does not explain the difference between the Chinese and Mexican experience, which produced demands for action. In both cases, the trade shock was of the Hecksher-Ohlin type—imports being sourced from much poorer countries than the United States, affecting the fortunes of relatively unskilled labor in the United States—and yet the protectionist outrage from labor was relatively muted in the Chinese case despite the large magnitude of shock. In contrast, labor groups were in the forefront of the anti-NAFTA campaign.

Social safety net: Rodrik (1998) has argued that sustaining trade requires social insurance mechanisms to cushion the adjustment costs from liberalization. Direct evidence of the importance of social insurance in relation to the Chinese experience comes from Autor, Dorn, and Hanson (2013). They show that rising exposure to Chinese imports and the attendant labor market impacts led to almost $15 billion of transfer payments (unemployment, disability, retirement, and health care) in the 2000s.

But while one could argue those hurt by imports from China were somehow placated by social benefits, this explanation would not apply to the Mexican shock. Social insurance was available for those disadvantaged by Mexican imports, but that did not prevent an uproar against Mexican imports.

Macroeconomy: Finally, it is possible that the underlying macroeconomic situation was better during the period of the Chinese export surge. Unemployment rates were declining, and the average unemployment rate was lower than in the two previous episodes (5.8 percent vs. 6.4 percent (1980–2000) vs. 6.7 percent (1970–1990)). But average growth was slower during the Chinese episode and the situation of the middle class not any better. A rising and highly overvalued dollar in the mid-1980s played a role in the clamor for protectionism in the United States against Japan. But the dollar was not a major factor in the run-up to the NAFTA debate.

One conclusion from all this is that if US domestic politics could survive a shock as great as that from China, there may be an underlying resilience (assisted by government insurance mechanisms) that should not be underestimated. Moreover, structural shocks similar to China’s are unlikely to repeat themselves, which should temper unremitting pessimism about the future of trade integration.

References

Autor, D., D. Dorn, and G.H. Hanson. 2013. The China Syndrome: Local Labor Market Effects of Import Competition in the United States. American Economic Review, forthcoming.

Baldwin, R. and S. Evenett. 2009. The collapse of global trade, murky protectionism and the crisis: Recommendations for the G20. Ebook. London: CEPR

Destler, I.M. 1992. American Trade Politics, 4th. ed. New York: New York University Press.

Edwards, L., and R.Z. Lawrence. 2013. Rising Tide: Is Growth in Emerging Economies Good for the United States? Washington: Peterson Institute for International Economics.

Eichengreen, B., and D. Irwin. 2009. The Protectionist Temptation: Lessons from the Great Depression for Today. Vox-EU, May 17.

Hufbauer, Gary Clyde, Jeffrey J. Schott, Cathleen Cimino, Martin Vieiro, and Erika Wada. 2013. Local Content Requirements: Report on a Global Problem. Policy Analysis, forthcoming. Washington: Peterson Institute for International Economics.

Rodrik, D. 1998. Why Do More Open Economies Have Bigger Governments? Journal of Political Economy 106, no. 5: 997–1032.

Subramanian A., and M. Kessler. 2013. The Hyperglobalization of Trade and Its Future. In Towards a Better Global Economy, eds., Shahrokh Fardost, Jere Behrman, and Dani Rodrik. Geneva: Global Citizens Foundation. Available at http://www.gcf.ch/?page_id=5838 (accessed July 11, 2013).

Notes

1. We re-computed Chinese value-added imports and while the size of the Chinese shock declines, it remains orders of magnitude larger than the earlier shocks from Japan and Mexico.