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Protectionism a barrier to recovery

The current global economic crisis, along with protectionist murmurs around the world, have raised fears of a new wave of trade protectionism. A report by DFAIT’s Office of the Chief Economist warns that the cost of such protectionist policies are greater now than they were even in the 1930s.

The report, written by Erik Ens, notes that the years of the Great Depression, which gave rise to protectionist policies referred to as “beggar they neighbour”, led to a retaliatory cycle that deepened the depression of the 1930s. Ens says that a repeat of this policy failure would be even more damaging now.

Higher trade barriers in the 1930s reduced real trade by an estimated 19%. Today, World merchandise exports constitute 25% of world GDP and Global Insight predicts that the value of world trade will drop 28% in 2009. And the World Trade Organization predicts a 9% drop in volumes in 2009.

Given that the world economy is more deeply integrated through trade and investment linkages, and imports are more likely to be inputs in the production processes of domestic industries as part of global value chains, new trade barriers would have the unintended consequence of increasing costs for already struggling domestic industries.

For example, many sectors are integrated at the firm and industry level in North America, and the global competitiveness of these firms is contingent on an integrated continental market.

Such is the case with intermediate products, which are goods or services that are supplied to other companies to be used in the production of final goods, like Canadian auto parts exports to U.S. manufacturers. Between 1995 and 2005,U.S. intermediate product imports grew at more than twice the speed of domestic inputs.

Ens says that this is partly the result of Canada’s increasing role as a U.S. supplier after the Canada-U.S. Free Trade Agreement and NAFTA. The Conference Board of Canada estimates that Canada’s intermediate goods exports in North America rose 115% during the 1990s, with 60% of Canada's top 25 merchandise exports being intermediate.

The report also notes that 28.7% of Canada-U.S. trade is intra-firm. Most Canada-U.S. intra-firm trade is led by U.S. firms: three-quarters of Canada to U.S. intra-firm exports originate from the affiliate of a U.S. company back to its parent, and 94.4% of Canada-U.S. intra-firm imports are from U.S. parents. Trade barriers would therefore have a disproportionate impact on the internal value chains of U.S. firms, raising their costs of production while they face shrinking markets.

Many value chain products also cross the Canada-U.S. border more than once, so the added costs of trade barriers could be multiplied at each stage of production. Ens says that given the higher costs of protectionist policies, economic recovery strategies should take into account the importance of value chain trade.

In this regard, Canada has set an example with the unilateral elimination of import tariffs on a wide range of machinery and equipment in Budget 2009, reflecting that open trade not only helps Canada’s trade partners, but enhances the competitiveness of Canada’s industries.

For more information, visit the website of the Office of the Chief Economist.

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