G20 Protectionism in the Wake of the Great Recession

Gary Clyde HUFBAUER
My starting point is that the officials are much too complacent about the world trading system. I will single out, perhaps unfairly, Director-General Pascal Lamy of the World Trade Organization (WTO). Basically, his message is that we met the protectionist beast and we conquered it. I want to correct that impression. In the wake of this Great Recession of the last two years, the world had a flurry of protectionist episodes which are now distracting political leaders. So let me tell you what we found in our research.

We used the Global Trade Alert (GTA), which provides the best record of what has happened. My colleagues and I scaled the GTA record of protectionist measures according to three different indexes: number of trading partners affected; number of tariff lines affected; and number of measures implemented. If you look at the chart of G-20 implementation of final protectionist policies, you might think that things look pretty good by the third quarter of 2010, because all three indices are going down. That is true. But, we have another chart that reflects "pipeline" measures. What do we mean by "pipeline"? What we mean is protection that is being considered by legislators and government leaders. The three indices of pipeline measures are not so optimistic.

Let me give an example of a pipeline measure. There is a bill in the U.S. Congress to require that all manufactured goods be imported by a firm which has a registered agent, i.e., an agent who can be sued in case the manufactured goods cause health or safety problems. This bill arises out of defective drywall that was imported from China and caused illness, but there was no agent who could be sued. Well, in light of this experience, the bill sounds reasonable. However, if you think about small countries, or small exporters of manufactured goods, it will often happen that they cannot afford to appoint a registered agent. A registered agent means a firm that is prepared to defend a law suit. The agent will want to be insured against potential damages, perhaps to the extent of several million dollars. Does the proposed bill violate WTO provisions? Probably not. Like this measure, most of the protection in the pipeline does not clearly violate WTO rules. Indeed, most of the implemented measures do not violate the letter of the WTO, but they are protection, and they do contradict the spirit of the WTO.

I will just cite one other "clever" US pipeline measure. There is a proposal to put more border guards on the Mexican border, and the reason for that is to deter illegal immigration and illicit drugs. Congress has proposed to pay for the guards by requiring firms that use the H1-B visa (a visa for specialized workers coming to the U.S.) to pay an extra fee. But not all H1-B employers would have to pay this extra fee, only employers who employ a large number of H1-B workers relative to the native workforce. What does that mean in practice? It means that Indian software firms operating in the U.S. will pay the fee. It does not mean that Microsoft will pay, because its number of H1-B workers is small compared to the overall level of Microsoft employment. The bill is discriminatory, but it is not discriminatory on its face. It does not violate any WTO rules because the WTO has nothing to say about immigration. So there you go. This is the kind of protection we are seeing rather often. Looking ahead, currency wars could lead to more new trade protection.

The WTO reports what we call "virtuous acts", in which a country actually withdraws its past protection. We examined these virtuous acts and classified them according to high virtue, medium virtue, and low virtue. A high virtue act is illustrated by the case of soybean oil imported by India. India imposed a 20% tariff, probably to protect domestic vegetable oil manufacturers. That is a pretty high tariff, but within India's bound tariff schedule, and it had an indefinite duration. But India actually withdrew the tariff about six months after it was imposed. We regard this move as a high virtue act. Medium virtue acts cover measures which were put in place with a definite expiration date and countries actually allowed the expiration to occur without renewing the measure. Low virtue, by our scaling, includes all the anti-dumping measures, countervailing duty measures, and safeguard measures which, according to WTO rules, have a natural life. A country is supposed to impose, for example, anti-dumping restrictions for a period of time, and when the time period expires, the country is supposed to go through a new hearing for any renewal. It takes little energy by the minister of trade to let an anti-dumping measure expire because it has a natural life. Same with countervailing duties, same with safeguard measures. They all have natural lives. Many of these trade remedies have in fact expired and that is why the WTO says things are great. In contrast, my co-authors and I say these expirations are deeds of low virtues.

Let me now say something about the scale of protectionist episodes. I know the World Bank claims that less than 1% of trade has been reduced by protection. The GTA uses a different arithmetic and is more alarmist than the World Bank. The GTA suggests that about 8% of total world imports have been affected by "jumbo" measures imposed by G-20 countries. Jumbo measures include, for example, the rare earths quota imposed by China. Jumbo measures erode the spirit of liberalization. At this point in commercial history, virtually every G-20 country has serious complaints about the jumbo measures of other G-20 countries. These complaints are going to occupy ministerial time and energy, and distract ministers from thinking about new liberalization. That is the real cost of the protectionist outbreak. It is not so much that a lot of trade has been curtailed, but rather the diversion of ministerial attention.

The biggest reasons to be somewhat pessimistic going forward are the prospects of fairly high unemployment and fairly slow growth in the advanced OECD countries. Carmen Reinhart and Vincent Reinhart have examined all financial crises going back a couple hundred years. The trajectory after the financial crisis was generally pretty gloomy. According to the Reinharts, it takes five or ten years to get back to the normal pace of growth after a country recovers from a financial crisis. Based on this record, the prospects for brisk growth and sharply falling unemployment are not bright. High unemployment puts pressure on politicians to resort to other policy measures. One of those policy measures is protection, in one form or another. The longer that unemployment lasts at high levels, and the longer we have slow growth, the greater the pressure is going to be on politicians to implement protection.

Let me say something about the unemployment differences between the U.S., Europe, and Japan. We examined the average number of hours worked. In all countries, the number of hours worked dropped in the Great Recession. But the differences are very interesting. In the U.S., the number of hours worked dropped because people were laid off. This is a very different story than in Europe. Japan is at a position between the U.S. and Europe. In Europe, although the number of hours worked has dropped, the amount of unemployment has not increased very much. In fact, in Germany it has hardly increased at all. What has happened? Everybody works a few hours less. Moreover, in Europe, if you are unemployed, you get rent subsidy, child support, and income maintenance. All in all, government payments may replace 60%, 70%, or even 80% of the previous wage. There is nothing like that in the U.S. You are lucky if public safety nets give you 50% of your previous wage. Many people get nothing. Therefore, the political pressure coming from unemployment is much harder on the trading system in the U.S. than in the other industrialized countries.

Everybody has been watching action in the currency arena and the big U.S. effort at quantitative easing (QE). The broad facts are as follows: the Federal Reserve tripled the size of its balance sheet from about US$800 billion to about US$2.4 trillion in the early months of the Great Recession. That means the Fed bought an additional US$1.6 trillion of assets in its first installment of QE. It did that in the early days of the crisis, and the Bank of England did almost as much QE in percentage terms. The European Central Bank (ECB) has done less; it has increased its assets by about 50%. We are now in the second phase of QE, since world growth seems to be slowing down. In September and October 2010, Chairman Bernanke laid the groundwork for another installment of QE right after the November elections. (Note: At that meeting the Fed committed to another $600 billion of QE.) Of course there is a lot of criticism of what QE is doing to the currency markets. But what seems to be fairly certain is that the industrial countries as a whole have run out of fiscal stimulus. The U.S. already did fiscal stimulus, and it is not going to do more. The public does not like it. In fact, the mood against fiscal stimulus is strong politically in all advanced countries. However, if you look at the data, the picture on fiscal stimulus differs from the rhetoric. The U.S., despite the dispute at the Toronto Summit, will actually reduce its fiscal stimulus pretty dramatically in 2011 because the 2009 stimulus program is running out of money. The numbers could be even more dramatic if the so-called Bush tax cuts of 2001 and 2003 are not extended - but it seems likely they will be extended.

Right now, as I say, general fiscal stimulus in terms of big new spending seems to be off the table. So what else can be done? One thing I am promoting in the U.S. and I would also like to promote in Japan, is much more business-friendly tax systems in both countries. Our two countries have the worst business tax systems in the OECD. We have the highest tax rates. Japan has the further feature that it has a very short net operating loss carry forward period of just seven years, one of the shortest in the OECD. The carry forward period is 20 years in the U.S.; the Japanese system means that a lot of companies lose the tax benefit of their losses after seven years. Japan could cut its tax rates a lot and could enact a longer net operating loss carry forward period, and these steps would not necessarily reduce tax revenue. Like other scholars, my colleagues and I have run the regressions. What the regression evidence shows is that high corporate tax rates shrink the corporate tax base. Business firms shift their activity to non-corporate forms, they reduce investment, and they license technology abroad, so the tax base at home shrinks. Our analysis shows that the effect of reducing the statutory rate on corporate tax revenue, expressed as a percent of GDP, is close to zero. I know that is not what ministries of finance estimate. But they are wrong. The ministries consistently stick to a position that, if the rates are cut, that will reduce tax revenue collected. Historical evidence says otherwise.

Let me talk a little about exchange rates. It is true that the QE by the U.S. has resulted in a general devaluation of the dollar against the floating currencies in the world - namely all the important currencies except the RMB. The question is, can a country double its exports by devaluation? Devaluation will boost U.S. exports but probably not double them. Probably the only way we can double U.S. exports, especially when many countries now have a similar goal of increasing their exports, is to liberalize trade generally. If a big country like the U.S. reduces the value of its currency, that action will find echoes in other countries. So I do not think that devaluation can be the central feature of an expansion of U.S. exports on the scale that President Obama said he wanted in January 2010, namely doubling in five years.

What I would like to see coming out of the G-20 summit is a big push for the Doha Round. It will take U.S.-China cooperation to revive the Round. I would go so far as to urge the G-20 trade ministers to meet in a remote island, not take any aides with them, not take their cell phones, and complete the deal. They need to be cut off from special interests who are telling them not to cut a deal. I would say lock the ministers in a room, and if they do not come out with a deal, fire them. Get another set of ministers. I think the Doha Round is important enough that the world needs a make or break meeting.

Two other things I would like to see happen out of the G-20 summit. One, I would like to see the leaders appoint a council of wise men and wise women - former trade ministers, people with some distinction, people like Peter Sutherland, to call out and name and shame new instances of gray-area protection. My other recommendation is that trade ministers really ought to feature as prominently in G-20 Summits as finance ministers. So far, they have not been given the same role. They need to interact with their own leaders to get the trade ball going.

Let me just make a few remarks about U.S. trade sentiment. I am sorry to say that it is downhill. Pro-trade voices are definitely a minority. Unfortunately, anti-liberalization sentiments are creeping into the middle-classes, which was not true ten years ago. The fear of outsourcing is a big cause - losing jobs to India, losing jobs to China. The reason for fear are: 1) High unemployment; and 2) Flat median household income over the past 20 years. Those factors are also coupled with two other factors, one with respect to Mexico and one with respect to China.

With respect to Mexico, NAFTA is commonly confused with illegal immigration and illicit drugs. A violent, guerilla war is going on in Mexico. The news is widely reported in the U.S., and the violence is wrongly associated with NAFTA. The same thing happens with illegal immigration. Mexico is getting a bad rap on grounds which have nothing to do with NAFTA or the trade agenda.

Regarding China, well, there is a lot of anti-Chinese feeling in the U.S., associated with China's big trade surplus and China's rise as a great power. It's hard to foretell when better trade relations will emerge.

I am hopeful that, after the November elections, President Obama will give some attention to trade issues which have essentially been buried for two years. The Obama brand, if there is going to be an Obama brand, will be the Trans-Pacific Partnership (TPP) agreement. Asia is the future in terms of economic growth and that is recognized by the Obama team. The biggest opposition right now to TPP is the dairy industry, which is highly protected in the U.S. The industry is very concerned about competition from New Zealand. If President Obama cannot get the Korea-U.S. FTA ratified early on, then I suppose TPP will be pushed way off to the distance. The game plan is to get the Korea-U.S. FTA ratified, then to move on Colombia and Panama, possibly energize the Doha Round, and put a lot of effort in TPP.

Finally, a note of optimism. If you look at the gravity models, and assume moderate growth in world income, you can project a big increase in trade relative to GDP. The potential is there. A lot of trade potential could be unleashed with forward-looking policies. That is reflected in the last few tables of my presentation.

Thank you very much.

TAMURA Akihiko
You said that currency is irrelevant to reducing the trade deficit. You also seem relatively optimistic about TPP, even after you said that the U.S. public sentiment to trade policy is quite negative. I find this a little bit inconsistent.

Also, there is a risk with analyzing protectionist measures in terms of number of trading partners, number of measures, and number of tariff lines, because the impact on trade volume is missing. How are you going to address this point?

Gary Clyde HUFBAUER
On the exchange rate effect, I am not saying it has no importance. Obviously the internal savings and investment balance and government spending are critical. However, I do not agree that there exists a magical set of exchange rates which will reduce global deficits and surpluses to a tolerable level. I do not see that even big changes in exchange rates can generate the necessary changes in the internal savings and investment balance to reduce current account deficits and surpluses to under 3% of GDP.

On TPP, my answer is part hope. President Obama has enormous power to galvanize the country on issues that he cares about, as was shown in the health care debate. It is my hope that President Obama will put his stamp on TPP in the next two years and more generally on trade policy.

Regarding the impact of protection on trade volumes, on the whole the impact has not been large. My estimate would be that we have reduced trade by only about 1%, not more than 2% of what it otherwise would have been. Remember in 2009, trade dropped by about 12%, and up to the third quarter of 2010, trade just about recovered. However, a lot of people are angry about what another country has done to limit trade. Look at this rare earth issue. Everybody thinks the Chinese are cheating on that one, and I am sure the Chinese think we are cheating on other trade issues. It has really poisoned the atmosphere, in terms of trade policy, to have all of this stuff going on, even though the volumes affected are so far small.

Q: My question is about the currency war. It seems that the question still remains whether an undervalued currency is a countervailing subsidy or not. What is the state of the debate in Washington right now? Also, some seek a multilateral solution, while others seek a bilateral solution in light of concerns of unemployment or job creation. What is your view? Thirdly, how will the currency issue affect the long-term trade policy?

Gary Clyde HUFBAUER
I think a countervailing duty against China or any other country, because it has an undervalued currency, would be found to be inconsistent with the WTO. I also do not think an Article 15 GATT case against China will prevail. In either event, the U.S. would probably lose legally. However, long before that happens, China would, in some shape or form, retaliate. If you read what Secretary Geithner said when he did not publish the so-called manipulation report, he laid down a soft marker of about 1% RMB appreciation a month. He did not explicitly say it is a marker, but the way his statement is phrased, you can read it as a marker. If China's currency continues to appreciate at 1% a month, I think the Obama administration will do its best to deflect the currency bill. If China does not appreciate in the next few months at this rate, I think the bill will pass very easily. That could just be the start of a truly difficult currency battle which impacts trade in a major way.

I will tell you my favorite solution, but it has not gotten any traction in Washington. By custom, and in the U.S. by statute and treaty, we do not tax interest earned by a foreign government on holdings of U.S. financial assets, e.g., Treasury bonds and corporate bonds. My solution is to give notice of termination of the treaty with China, citing the undervalued RMB and the huge store of Chinese foreign exchange reserves. If we give notice before June 30, 2011, the treaty could then be terminated on January 1, 2012. That would give Chinese leaders time to think, and consider the possibility that the U.S. will impose a tax on the interest earned by official Chinese agencies. I am not thinking the U.S. would actually collect this tax, but it would be a way of saying to China please do not accumulate still more foreign exchange. Instead, please change your policies and stimulate domestic demand.

In terms of how a currency compact should be worked out, yes, it should be multilateral, but limited to the big powers, i.e., Japan, China, the U.S., and the EU. Those four countries can sit down and work out commitments on all sides. Maybe this suggestion is too hopeful, but bilateral currency agreements are pretty difficult, for the reasons underlined in your question.

Finally coming back to the trade policy, I think if we see an FTA between the U.S. and Korea, then in the wake of that we can also ratify the U.S.-Columbia, U.S.-Panama agreements. And then fresh energy can turn to TPP and Doha simultaneously. But that vision means that President Obama truly decides that trade policy is important, and there has been no sign of that through September 2010.

Q: Some in the business community are concerned about the increased costs of trade, including the increase in shipment costs, mainly for security reasons like container scanning. Did you consider these measures as sort of protectionist measures? What do you think about the effects of those measures?

Gary Clyde HUFBAUER
Yes, you have touched on a very important concern. The distribution of firms that participate in international trade is highly skewed towards large firms. Why? Fixed costs. Fixed costs are very high in entering the business of international trade. As a result of tighter security measures, small firms will find it that much harder to participate in international markets.

We have another bill in Congress called the 100% cargo screening initiative. When this bill goes into full effect, about 150 of the approximately 700 ports in the world that ship items to the U.S. will be able to meet the standards. What about Guatemala? Jakarta? Vietnam? Absolutely not. There is going to be a sharp increase in fixed costs for shippers in these countries trying to participate in international trade.

Another question that could spark new protection in the decade ahead is climate change and measures to foster the green economy, including voluntary labeling by corporations and mandatory labeling by governments.

Q: You mentioned U.S.-Korea FTA. Do you think an FTA between the U.S. and Japan is possible?

Gary Clyde HUFBAUER
As for an FTA between the U.S. and Japan, my vision is that this will occur through the mechanism of the TPP if we move forward on the TPP over the next five years, rather than a bilateral U.S.-Japan FTA. I think fears can be addressed and negotiated, but incrementally, in the context of the TPP.

Q: You indicate short-term pessimism and long-term optimism. I am curious, where is the source of your medium-term optimism?

Gary Clyde HUFBAUER
A lot of leaders in the G-20 would see it in their own self-interest to promote a positive agenda to improve economic growth. This is a way of staying in office. The political-economic cycle is well documented: bad economics make it hard to get reelected. Open markets can promote growth in all countries. That is my best case for medium-term optimism, fear of the alternative.