Depression, Not Protectionism, Is What’s Killing Trade

The downturn in global trade is stunning — a sure sign that this is no garden-variety slowdown we are experiencing.  And in Canada’s case, the cyclical downturn in trade lies on top of a deeper structural change: our increased reliance on resource exports, which produced (via Dutch Disease mechanisms) a corresponding shift of output and employment into non-tradeables, and a substantial decline in the trade-intensity of our entire economy.

This puts the lie to the grand, pompous myth that protectionism is the greatest single danger we face in the world today.  Depression is the much bigger danger — including the biggest danger to world trade.  And emphasizing reflation initiatives, even if they are tied to efforts to address trade imbalances (which, after all, clearly contributed to the financial instability that is now dragging us all down), is more important than staying true to free trade principles.

Wynne Godley et al have some interesting arguments on this point in their current “Stategic Analysis” commentary for the Levy Institute (titled “Prospects for the United States and the World”).  They argue that helping the US address its long-standing, crippling trade deficit through trade policy intervetnions will be essential to helping the US economy recover; the fiscal stimulus, no matter how large, will not be enough.  And revitalizing the US economy, by the way, will be good (not bad) for world trade.

Here is my own take on this same point from my column in yesterday’s (Feb. 19) Globe and Mail:

Global trade flows are collapsing. But it’s not because protectionism is raising its ugly head – contrary to the wringing of hands and gnashing of teeth in free trade circles these days. Rather, it’s the meltdown of the market economy, not anti-market intrusions by governments, that’s behind the meltdown of world trade. This is an important distinction to keep in mind, because it runs headlong against the long-standing myth that so-called “protectionism” caused the Great Depression (rather than the other way around).

Statistical evidence points to a shocking slump in global trade. In the U.S. (until now the dumping ground for excess output from around the world), monthly merchandise trade fell almost 30 percent from July to December. Japan’s exports plunged by 14 percent in the last quarter of 2008 – sparking a frightening 12.7 percent annualized decline in GDP. China’s imports declined an incredible 21 percent in the year ending in December, dashing once and for all the dim hope that Chinese consumers might pick up where debt-burdened U.S. consumers left off.

The Canadian numbers are not much better. Our international trade (counting both exports and imports) declined 15 percent in just the last two months of 2008. But exports fell a lot faster than imports, producing Canada’s first trade deficit since 1976 – a shocking come-down for a country that thought it could ride the global commodities wave to never-ending prosperity. Lulled by overheated prices for oil and other commodities, we allowed our value-added export industries (especially manufacturing, but also mobile services industries like tourism and film-making) to wither away. Turns out that commodity prices were no more reliable than sub-prime mortgages and asset-backed paper, and now our national trade balance is teetering.

In fact, Canada’s trade has been flagging for years. As a share of our total economy, exports have declined steadily from 45 percent of GDP in 2000 to just 30 percent by the end of last year. Again, far from being the result of protectionism, this dramatic decline in trade is actually an unintended result of free trade itself. NAFTA pigeon-holes us as a continental supplier of energy and other resources. Those industries boomed – for a while. But non-resource industries were squeezed out, and an increasing share of output and employment was shifted to non-traded domestic industries (donut shops, department stores, and the like).

By the same logic, free trade contributed to the financial catastrophe in the U.S. that is now dragging down the whole global economy – and hammering world trade. The U.S. incurred massive trade deficits for years, as U.S. corporations moved away in search of lower wages and more compliant homes. Americans kept borrowing and spending despite their industrial decline, creating the financial overhang that is now collapsing.

In short, allowing key industries to crumble, and handcuffing governments from pro-active economic strategies (whether aimed at particular sectors or the economy as a whole), doesn’t help trade – it hurts trade. If we really want to boost trade, we should focus first on re-igniting growth and employment. And in this context, we should simply ignore the high-and-mighty denunciations of protectionism emanating from those who still worship free markets.

For example, President Obama’s stimulus package, by putting our biggest customer back to work, would boost Canada-U.S. trade, far more than his long-standing Buy American proposals would limit it. The over-the-top outrage directed against those provisions by our government seems more intended to distract attention from their own (weak) efforts to support Canadian industry.

Similarly, rescuing the beleaguered North American auto industry will inevitably require addressing the huge trade imbalances that have weakened domestic producers so badly. Governments won’t invest billions of dollars in the industry, and then sit back to watch imports continue to conquer the market. On the other hand, imagine a managed-trade approach: a new North American Auto Pact, to assist the recovery of domestic producers and encourage more investment in North America from offshore. That would foster more trade and investment, not less. The alternative is a continued meltdown in production and employment that would turn recession into depression, suppressing trade in the process. After all, Canada’s auto exports have plunged almost 40 percent since 2000. So it’s clear that the “hands-off” approach has not exactly boosted trade in this key sector.

Free-market nonsense about how private markets are always efficient, got us into this mess in the first place – by intellectually justifying financial market practices that were both immoral and destructive. Free-trade nonsense about how unrestrained global markets must be allowed to dominate our industrial recovery, no matter how unbalanced trade flows become, will only make matters worse.