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05/28/2009

Tariff Race in the 1930s - Subsidy Race Today?

Tim Sprissler, Deutsche Bank, Frankfurt.

This article appeared in the May 2009 issue of Current Economics with permission of the author.

Key Concepts: Protectionism |Tariffs | Subsidies |

Key Economies: Euro zone|

As the economic crisis unfolds, some argue that customs duties are much less likely to be increased today than was the case during the Great Depression of 1929-1933. The general environment is said to be different today and so the crisis is correspondingly unlikely to be exacerbated by protectionism. Back then, global trade collapsed by two-thirds and the closing-off of markets turned a recession into a full-fledged depression. Even though one can largely concur with the first argument, this does not mean that a worsening of the crisis to similar proportions can be ruled out entirely. Protectionism has many faces. Today, a subsidy competition could occur instead of the tariff-raising contest which materialized back then.

But let’s take one thing at a time: at present, tariff hikes really do appear to be much less attractive than they were in the Great Depression. Today, some 72.5% of import trade takes place either within customs unions or free trade zones, such as the EU and NAFTA, or between OECD countries. In the former, the tariff restrictions have been lifted completely, while in the latter they are at the level set by the World Trade Organization. Therefore, for just under 75% of global trade, tariffs can only be increased by violating the respective trade rules and are thus only possible “illegally”. Moreover, the agreements often enable the countries involved to impose “legal” punitive tariffs and other countermeasures if such violations occur. This further diminishes their attractiveness.

It follows that a risk of protectionism exists “only” for slightly more than 25% of world trade. This is primarily due to the “binding overhang” of the emerging markets which, since the Uruguay Round, have unilaterally reduced their tariffs below the level agreed at that time. Tariffs can be hiked here within the framework of the agreement; among others, Turkey and India have already taken advantage of this possibility. In any case, such measures could result in the impairment of global trade to the tune of as much as €400bn (European Commission estimate). Notwithstanding, in times of strong intra-industrial trade it appears there is less risk of further major tariff increases. The explanation is that exporters are often simultaneously importers of production inputs and thus have little interest in tariff increases or currency devaluations since this would make their imports more expensive. For all of the reasons stated, the lobby for direct trade barriers appears to be much smaller than it used to: companies integrated into international value-added chains will be less eager to urge their governments to boost tariffs.

So does this mean the risk of protectionism is smaller today from the outset? No, it does not. For just because the conventional protectionism channel is blocked does not mean that countries and companies will not continue to resort to measures to boost the competitiveness of their products during slumps in demand like in the 1930s. The measures simply become more oblique in the shape of non-tariff barriers to trade. Among non-tariff barriers, no doubt the greatest danger lurks in the trade-impairing effects triggered by national subsidies – if for no other reason than the scale to which they are being planned or have already been implemented.

Most tariffs are bound in trade agreements
Intra-zone imports as % of world imports 2006

Intra zone Chart Image

Source: UNCTAD Handbook of Statistics

Subsidies worth US$43bn have already been earmarked in the industrial nations for the automotive sector. So far, the US has transferred a total of US$17.4bn to American automakers – and a definitive solution has still not been found. To bail out their auto industries and forestall any discrimination, other countries – including Japan, France, the United Kingdom, Sweden and Brazil – have followed suit with direct aid totaling around US$20bn.

In the agricultural sector, in fact, subsidies sometimes kick in automatically if prices of farm products fall below a certain level. According to World Bank estimates, US farm subsidies will rise by 22% this year, to US$9.9bn. For its part, the EU re-introduced export refunds for butter, cheese, and whole and skimmed-milk powder in January. The emerging markets of China, Brazil and Argentina are attempting to stem the tide with subsidies of their own totaling roughly US$5bn.

A subsidy battle looms large. It seems that the practice of protectionism is shifting away from discrimination against foreign competitors by imposing tariffs towards actively providing preferential treatment to domestic companies via subsidies. And in this case the logic of intra-industrial trade cannot be used as a counter argument, since subsidies place no limits on the domestic companies in their intra-industrial trade. As a consequence, there is even a sizeable lobby that actually favours measures in this gray area of protectionism.

Unquestionably, government has no choice during the current crisis but to prop up the economy; however, support measures for allegedly “systemically important” sectors and suppliers will always be tantamount to preferential treatment for them vis-à-vis competitors from abroad. Overcapacities will be protected and adjustment processes and/or market exits will be hampered. And the ones that have to foot the bill will be foreign suppliers that are perhaps more competitive as well as domestic consumers. The fact that budget restrictions put certain limits on such a subsidy battle does nothing to reduce its contentiousness. For the more the spirit of free trade is violated, the sooner protectionist tendencies are likely to escalate. For example, there would probably be retaliatory measures in the emerging markets.

It thus seems legitimate to ask whether the subsidy competition of today might not lead to a closing-off of markets in much the same way as the tariff contest did in the 1930s, and whether the results might not be similar. Sounding the all-clear on protectionist tendencies prematurely would – in any event – be fatal.




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