May 4, 2008

Recent stories of rises in tariffs on food have caught our attention, as several countries try to protect their citizens’ interests. While we generally applaud governments protecting their citizens’ interests (that’s what they’re supposed to do after all), this type of action is dangerous and short-sighted. Firstly, the law of unintended consequences says that this can cause prices not to fall, but to rise (which, it turns out, it looks like they’re doing, due to either others also hiking tariffs, or to farmers responding to price signals by, say, planting wheat instead of rice). Secondly, protectionism tends to spread like a virus, and the results are just as painful.

Across the world, there have been rising protectionist feelings, and this latest outburst is but another example. The apathy towards the apparent failure of the Doha Round of trade talks for the WTO, the appalling rhetoric coming out of the Democratic convention in the US (who would have thought that Hillary Clinton would spend so much time and effort denigrating NAFTA, one of her husband’s most famous legacies ), the current food tariff issue, there are many signs that the global political mood has turned sharply against free trade.

It is difficult to say if free trade is unreservedly good, beneficial for all at all times. Perhaps there is a case to be made for protecting infant industries. Perhaps some countries at some stages of development need temporary protection. Perhaps. But there is also great danger here. This is a slippery slope, far too often going on for longer or going farther than originally expected, and distorting the efficient functioning of the market. Protectionist measures are contagious – one action most often triggers more, be it cries for increased domestic protection or tit-for-tat foreign retaliation. Like drugs for a heroin addict, it is very hard to stick to one small dose.

Right or not for small developing countries and industries, wide-spread global protectionism would cause wide-spread malaise. Why? It is because protectionism is the equivalent of an increased and regressive tax on the consumer. It is similar to creating a cartel, allowing less efficient, cartel-like domestic producers to win out over more efficient foreigners. To understate the case, cartels are not known for their efficiency or their responsiveness to the consumer. If foreigners can make clothes at a fraction of the cost that America can, let them, buy from them, and focus on design, research and development, software, and other areas of the economy where the value added is much higher than sewing. Both sides win by this: the domestic consumer and the producer and employees in the foreign country.

Efficient cartels/monopolies can exist. It’s simply that, over the course of economic history, they have been very, very rare. Like a benign autocrat, this should be a benefit in terms of efficiency, but the reality is far too often a dictator.

Unobstructed competition is the challenge that separates the good from the great. The great companies and economies of the world didn’t thrive because they were protected – they grew because they were more efficient than everyone else. The market economy’s strength is that it opens up to all the chance to solve complex problems, and then brings those solutions to the world.

There has been a lot of talk that this financial crisis is the worst one since the Great Depression. Looking back to that time, we know that there were mistakes made by the Federal Reserve and there were troubles with the banking system, but the situation was made worse by the infamous Smoot Hawley Tariff Act of 1930.* Stirring protectionism, throwing sand in the workings of the global economy, isn’t something we should wish on our economies right now, especially as they try to digest the outcome of the present financial turmoil. It’s going to be tough enough out there for the next little while. Let’s not make it harder for ourselves.

* This piece of misguided legislation raised tariffs on over 20,000 imported goods, which triggered increased tariffs around the world as other countries retaliated. American imports and exports both plummeted, and the US economy went through as rough a patch as it ever has.

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