Protectionism by Another Name?

One thing you can probably get 99% of economists to agree on is that a global trade war in the middle of a global recession is a bad idea. If every country increases import tariffs, hoping to protect its domestic industry from foreign competition, global trade will fall in all directions, hurting everybody. Put another way, increased tariffs are a negative-sum game.

To date, we haven’t seen much in the way of higher trade barriers during this crisis, although you could argue that some bailouts constitute subsidies favoring local over foreign companies. Instead, however, we are seeing friction over currency valuations. If you want to boost your net exports but don’t want to do the obviously unfriendly thing and increase tariffs, the other option is to devalue your currency: a weaker currency increases the price of imported goods and reduces the price of exported goods, hence reducing imports and increasing exports.

Yesterday, Tim Geithner accused China of “manipulating its currency,” something we’ve heard periodically over the last several years but not in much in the last few months. (Of course, Geithner then said that “a strong dollar is in America’s national interest,” whatever that means.)  Switzerland threatened to intervene on foreign exchange markets to suppress the value of the Swiss franc. And the French finance minister criticized the U.K. for letting the pound depreciate. (Hat tip Macro Man for the last two.)

Theoretically, devaluing your currency is not as bad as import tariffs. If every country tries to devalue its currency at the same time, exchange rates will remain the same; this is a zero-sum game in that sense. It’s a little more complicated, because there are at least two ways of devaluing your currency. One is for the central government to sell its own currency and buy everyone else’s currency on the foreign exchange market. The other, however, is to run an expansionary monetary policy (lower interest rates, more money creation, etc.), which is inflationary. So one possible outcome is that every country runs an expansionary monetary policy, exchange rates remain the same, but commodity prices go up because there is more money floating around. In today’s environment of low or negative inflation expectations, however, that might not be such a terrible thing.

But the other side of competitive currency devaluations is that not all countries are equally well armed. In particular, countries that use the euro cannot devalue their currencies, because they don’t control their monetary policy and they don’t have the scale to intervene significantly on the market for euros. In short, other countries can devalue their currencies at the expense of Eurozone members. This is one of the reasons why, as we (and Martin Feldstein) have warned, the economic crisis will increase tensions within the Eurozone. The New York Times just ran an article on this exact topic:

Germany, France and the Scandinavian countries are mounting billion-dollar stimulus plans and erecting fences to protect their banks. But the peripheral economies are being left to twist in the market winds.

This is a good indicator that fears about the Eurozone are going mainstream.

4 thoughts on “Protectionism by Another Name?

  1. Are restrictions countries impose on the movement of capital or labor also forms of protectionism?
    Also, during the 19th century, the tariffs imposed by the US on British imports aided the industrialization of the US. These tariffs allowed the shoe and textile industries to develop here in New England.

  2. How about taking this one step further and discussing how US national interest intersects the Euro system?

    Geithner’s use of the “m” word set some people on edge, but I see it as a very positive engagement with reality. What other cannons might be fired leading up to G20 in April?

    Cheers & thanks for blogging,

  3. “Theoretically, devaluing your currency is not as bad as import tariffs.”

    This statement is not clear, and seems to be wrong. The devaluing of a nation’s currency merely acts as a recallibration of nominal prices; an import tarriff accomplishes a simllar goal although only domestically.

    I think you may be talking about the potenital international implications of raising tarriffs, and even about the welfare distorting effects of such actions.

    Under this analytical framework, a devaluation of a currency affects far more stakeholders as all product prices change. There is a (theoretical) possibility that the “zero-sum” game you describe happens; that is, all countries competitively devalue leading all nations back to square one. Although possible in theory, it’s never happened in practice. China’s monetary conundrum, and the US’ baffling insistence to bring it up during this critical time (most likely to give rhetorical support for Union support) will be a key variable down the road.

  4. JK, please read Geithner’s statements carefully for he did not accuse China of currency manipulation. He merely reiterated his boss’s opinion on the matter which he does not necessarily share.

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