Protectionism

It is only natural that democratically elected governments should yield to populist protectionism at the slightest risk, real or imagined, of rising unemployment. This has happened time and again in the past. The current global economic slowdown has yet again given rise to a debate on whether developed economies will go down that path, and some observers expect the worst.

Ownership of businesses and assets is dispersed across borders: production is domiciled in countries that make it cost-competitive and efficient (frequently, far away from centres of consumption); and capital is truly fungible, chasing the best risk-adjusted returns. Global trade has increased the productivity of all participants, be they developed countries or developing ones.
Thus it is no surprise that exports’ share of world GDP has more than tripled, from ~9% in the 1960s to ~32% today. Over 1992-2007, cross-border capital flows have galloped, with FX contracts alone quadrupling. Emerging markets have benefited from surging growth on the back of a 20-fold jump in private capital flows (to a meaningful US$500bn) in the past three decades—and many large developed economies are in no small measure dependent on savings of less-developed countries. The world is too interdependent for any large-scale attempts at protectionism to endure.

The political class will always have the temptation to reanimate the protectionism bogey, though economic compulsions will circumscribe such attempts. One thorny issue is export of jobs through outsourcing or allowing foreigners into the job market through issuance of work permits (such as H1B visas in the US). Policy responses to such issues will continue to be dictated by political expediencies. Barriers to influx of skilled labour will rise, as illustrated by the recent condition contemplated by the UK government to restrict it to those with master’s degrees.
Such measures pose a serious threat to the Indian IT industry, which is among the largest users of visas for skilled workers. Similarly, sectors like steel or auto manufacturing, which employ large labour forces, could see trade barriers getting erected. However, such moves will necessarily be limited by availability of local capacities; take for instance textiles, in which the US is so dependent on imports that it can make barely one-third of its needs domestically, even at full capacity utilisation. Outside services (especially IT-related), metals and auto manufacturing, we see limited risk of any of the larger economies adopting a protectionist stance.

The impact of any protectionist stance will be very different on India and China. India’s trade balance is still negative, so the world needs India as much as India needs the world (to export to). The potential impact on China, a far bigger exporter, would be far greater—though few developed economies would venture to upset the apple cart, given their dependence on Chinese savings to finance their ballooning federal and corporate debts. Furthermore, nearly 58% of China’s exports are from foreign invested enterprises, rendering any protectionist stance an even more complicated issue. What is certain, though, is that a slowdown in FDI will hurt both, as it has been a substantial driver of growth in capital formation in the past.

In sum, the fear of protectionism is overdone; no large economy can afford to erect barriers to trade or capital, as the costs and pain from such a stance are too onerous to bear. The political leaders of the largest economies realise this and the recent G20 meeting in London—though it was more symbolic than substantive—corroborates this. A few pockets of protectionism are unlikely to have any meaningful impact on the world economy, though some industries and countries will be affected more than others.