Dec

Beggar thy neighbor - trade protectionism (part 1)

Brian Butler on December 4th, 2008

GloboTrends columnist Bio: Brian Butler is a specialist in “global-macro” economic analysis. As a global-macro analyst, Brian founded “GloboTrends“, an online site for macro-economic trend analysis, with a focus on providing this analysis to global investors. The highly popular “GloboTrends blog” is prominently displayed on Thunderbird’s MBA website , and has been featured as syndicated content on Nouriel Roubini’s RGE Monitor, Emerginvest.com, Business Week Exchange, Wikinvest.com, and other reputable news outlets.

With slowing economies globally, there is the real threat that individual countries might choose to look out for their own economic growth by trying to boost exports. If just one country does this, its ok. But, if all countries all try to engineer lower exchange rates to boost exports, then we could be in for serious trouble. This is a classic “prisoners dilemma” scenario.

Beggar-thy-neighbor trade policies (or competitive devaluations of currencies), is basically what turned the 1929 stock market crash into the 1930’s economic depression. It wast until after trade protectionism became entrenched with “beggar thy neighbor” policies of the Smoot Hawley act in the US (in which the US raised import barriers on a wide variety of products) that sparked a global race to the bottom, eventually feeding the fire that led to Nazism and Fascism in Europe.

Example in Latin America

The real danger of the latest financial crisis is that it could lead countries to try and boost local production (and jobs) by engineering lower foreign exchange rates, and boosting exports. Back in November, we saw the first real hint of raising protectionism when Mercosur (Latin American trade bloc) raised its common external tariff on a variety of items.

Example in China (maybe):

China represents the latest example of a nation trying to boost internal production (and jobs) by depreciating its currency against the US dollar. The benefit to China is that a lower value of the currency benefits Chinese exports, making them cheaper on world markets. This is good for China as it boosts demand for their products (if purchasing nations choose to substitute Chinese goods for others).

But the trouble with competitive devaluations of currencies is that in order for one country to benefit, another must loose. This is the trouble with seeing the world as a Zero-Sum game (in which my gain is someone else’s loss).

But during this crisis…if you assume that global demand is shrinking, then the only way for China to increase its exports would be to take away exports from someone else.

This must be true unless lower prices from China would be significant enough to spur additional demand from consumers than would otherwise exist. This is possible, and welcome…but the more likely scenario is that consumer demand around the globe is going to contract in 2009, and that in order for China to boost its exports would be to take away share from someone else.

This is the essence of a “beggar thy neighbor” strategy. Only time will tell if this is really happening, or if the sudden depreciation in the Chinese currency was organic and not state mandated. Lets hope it was the former. Keep tuned in to GloboTrends as we will track this trend (of rising protectionism)…