The Washington Consensus may be dead, but its legacy of free trade is alive; albeit gasping for breath. In the wake of the economic crisis, governments around the world are contradicting themselves as they propose squarely protectionist measures, while at the same time singing the praises of free trade.
Whatever the global leaders' rationale, the world we live in today is built on liberalised trade. Starting from the launch of the General Agreement on Tariffs and Trade (Gatt) in 1947, global trade flows have increased to $28.2 trillion in 2007 from just $120 billion in 1948. That growth would not have been possible without the half century of work to reduce trade barriers from Gatt, and efforts by the World Trade Organisation.
A new wave of protectionism could effectively put an end to the globalised world as we know it. This end would be coupled with numerous negative implications for the companies and banks that have built their success on the growth of world trade. "Trade has become another casualty of the recession," says Pascal Lamy, WTO director-general. "In these times of serious economic crisis, our biggest challenge today is to ensure trade is part of the solution and not part of the problem."
The history of protectionism is varied. The Smoot-Hawley Tariff Act in the US, widely agreed to have caused a bad recession to turn into the Great Depression, is likely the darkest symbol of protectionism. The other is the astounding growth of countries that encouraged exports while protecting domestic industries, notably Japan and South Korea.
Smoot-Hawley precipitated one of the largest drops in global trade ever recorded. After its passage in 1930, the total volume of world trade dropped 66% by 1934. Total US-Europe trade fell to $1.2 billion by 1932 after peaking at nearly $3.7 billion in 1929.
"The Smoot-Hawley Tariff Act brought about economic ruin," said Nayan Chanda, Brookings Institution senior fellow on foreign policy at the Centre for Northeast Asian Studies. "The world has become so much more integrated that a trade war could cause incalculable social unrest and political convulsions."
Recent protests in Europe and elsewhere, attest to the potential of the economic crisis to create social discontent.
Conversely, countries that pursued export-oriented development coupled with domestic protection have been some of the most successful in the world. In the 1950s, South Korea was a country with per capita income on par with Bolivia and Senegal today. Now, the country is a developed nation and the world's 11th-largest exporter. This rapid economic growth took place under a deliberate government policy that protected the country's chaebol -- business conglomerates -- from foreign competition while encouraging innovation and exports.
Unfortunately, the South Korean example of protectionism to promote growth only works when applied in isolation. Had the US and Europe increased trade barriers as South Korea encouraged its domestic industries to export, the country would be nowhere near where it is today.
"Within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services," said the Group of Twenty (G20) after their meeting in Washington last November. While agreeing not to raise explicit trade barriers their statement left a lot of room for indirect protectionism.
Despite the G20's statement, protectionist measures have started cropping up. The US economic stimulus package's now infamous "Buy American" clause, though watered down, restricts stimulus funded infrastructure projects -- one-third of the $789 billion package -- to buying only American made iron and steel. France's proposed auto industry bailout includes the stipulation that car companies not close domestic manufacturing plants.
In Asia, Singapore's stimulus package gives incentives to companies to hire local labour and the United Arab Emirates' labour ministry has issued rules making it all but impossible to layoff Emirati staff. Grandiose government and international organisation statements are good but do not concretely address the very real pressure local citizens are placing on their politicians to protect jobs and livelihoods.
Out of politicians reaction a new protectionism is emerging -- financial protectionism. The world's banks and trading companies are already reporting a drop in trade as a result of difficult financing conditions. Last November, a WTO panel of financial industry leaders estimated the world faced a $25 billion shortfall in available trade financing.
Whether explicit or implied, national government bank bailouts are creating preferences among lenders to focus on their home markets. In Greece, central bank governor George Provopoulos has reportedly warned banks receiving bailout funds against using the money to support overseas operations.
All in all by the time the G20 met this month, the World Bank reported 17 of the 20 nations had implemented some form of protectionist measure.
"Protectionism, whether in the form of restricting imports or indirectly through making capital infusions contingent on retaining home-country employment, would inevitably limit any recovery in global trade flows," says Richard Brown, Bank of New York Mellon's Asia-Pacific regional head.
Can the actions be stopped?
Coordinated international resistance to the economic crisis and the growing protectionist sentiments is the only way forward. At least that's what the WTO, International Chamber of Commerce and other multilateral organisations say.
"If it's a job for a job, then we will have massive unemployment," says Lamy, paraphrasing Mahatma Gandhi. Accordingly, he proposes concluding the stalled Doha Round trade talks, cooperation between countries to resist trade barriers and increasing the amount of government-backed trade finance guarantees.
What Lamy forgets is the very real pressure leaders from China to Iceland are feeling as their constituents are increasingly faced with job losses, lack of credit and the general social malaise that accompanies a recession. This is the straw that will break leaders' backs when it comes to supporting free trade.
"We, the proponents of free trade, have tended to talk from the head," said Scott Davis, UPS's chief executive, in a speech. "The antitrade forces talk from the heart about lost jobs, lost homes, lost hope. In the court of public opinion, the heart wins."
Not everyone agrees with those calling on countries to resist protectionism. "Toyota would have made a profit this year if the yen had not strengthened so much against the dollar. In order to avoid such a terrible currency mismatch, Toyota should build its cars in the markets where it is selling them, in the US and Europe. Factories outside Japan should therefore be expanded at the cost of factories inside Japan," says CLSA Japan auto analyst Christopher Richter, echoing 1930s-era autarkic sentiments.
The way forward on protectionism and economic recovery has yet to be determined. During the last 50 years countries have made a dramatic shift towards focusing on their economic competitive advantages for growth -- a shift that makes a return to local production potentially difficult and painful for banks, businesses and citizens alike.
"If we were to focus only on the US market, we would be ignoring some very significant opportunities," says Petros Sakkis, vice president of international operations for Wessco International, a global hospitality industry supply company. "If we were to focus only on sourcing products and buying our goods from the US we would have no business. If we didn't buy in Europe, Asia and where things are manufactured, we would very quickly see our company's revenues decline to low numbers. The crux of our business is global trade."
This story first appeared in the Asian Trade Finance Yearbook 2009 that was published as a supplement to the April issue of FinanceAsia magazine.