Friday, February 20, 2009

Protectionism In Recessions

When a great number of jobs are lost, as they often are during recessions, the public often cries out for protectionist measures (i.e. "Buy American") in order to keep more money inside the country. Unfortunately, policies encouraging such behaviour force individuals and businesses to buy more expensive goods/services than they otherwise would, resulting in further losses. Furthermore, when one country decides to implement such measures, other countries retaliate with their own protectionist policies, resulting in a race to the bottom which increases costs (everyone must pay more for their goods) at a time when profits are already under pressure.

In fact, this is exactly what happened in the Great Depression. Below is a chart depicting the average import tariff rate in the US over the last two centuries:

Notice a spike in 1930 with the passage of the Smoot-Hawley Act, a protectionist measure that economists credit with deepening the Great Depression. Trading partners of the US retaliated with protectionist measures of their own and it didn't help matters. In the mid-1930s Congress began to relax protectionist laws, and the next decade saw several notable bi-lateral trade agreements that were the impetus for the strong economic growth that followed.

Since the year 2000, tariffs have continued to fall as more and more governments have recognized that economic studies continue to show that trade benefits both partners. However, the latest US stimulus bill risks going against the spirit of free trade. As jobs in certain industries are being lost and special interest groups (those that are hurt in the short-term by the flight of jobs) clamour for protectionist measures, it's important that the government, and its constituents, the voters, pay attention to history by noting that free trade has helped us achieve the level of wealth which we are at now, and more trade, not less, will help get us out of this cyclical downturn.

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