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The problem with protectionism... and what’s Trump got to do with it?

In Depth: what is protectionism and how does it affect global trade?

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Donald Trump is by no means the first US president to put “America First”. It was one of the nation’s Founding Fathers, James Madison, who introduced the first truly protectionist tariffs in order to shield and encourage America’s nascent manufacturing industry in the early 19th century. By that time, mercantilism had long been common practice in Europe, as monarchs sought to enrich their nations at their neighbours’ expense.

What is protectionism?

Protectionism refers to any defensive policy designed to protect a nation’s manufacturers, producers and workers from foreign competition. The main measures taken to achieve these goals are tariffs on imported goods, import quotas, and subsidies - although there are plenty of less overt ways to stymie competition, such as anti-dumping legislation, exchange rate controls and administrative barriers. China recently banned a host of imported cheeses for containing “too much bacteria”. The problem with these initiatives is that they risk sparking retaliatory measures that can rapidly escalate into all-out trade wars.

Historical lessons

Historically, protectionism tends to wane during times of prosperity and peace, and to creep back in during times of war and economic recession. Since the end of the Second World War, it has been the stated policy of most developed countries to eliminate protectionism through free trade policies enforced by international treaties.

The General Agreement on Tariffs and Trade was signed by 23 nations in 1947 and remained in effect until the establishment of the World Trade Organisation (WTO) in 1995. Today the WTO has 164 member states. There are hundreds of other regional, multilateral and bilateral trade agreements in operation, from the North American Free Trade Agreement (Nafta) to the Trans-Pacific Partnership (TPP), and more are being negotiated.

By the early 21st century, after a long period of trade expansion and growing prosperity, the consensus seemed to be that protectionism was a bad thing. At the G20 summit in 2009, leaders pledged: “We will not repeat the historic mistakes of protectionism of previous eras.” Nonetheless, as the effects of globalisation and recession have begun to bite, many developed countries have started to introduce restrictive trade measures. During difficult economic times, protectionist policies are an easy sell. Populist politicians focus on retaining jobs. They tend not to mention the higher costs of goods, and shrinking consumer choice; nor the fact that, in the long-term, such policies kill innovation and lead to inefficiency.

The election of an isolationist American president in 2016 may have profound consequences. Donald Trump withdrew from the TPP, has threatened to pull out of Nafta (which he described as “the worst trade deal maybe ever signed anywhere”) and has goaded China with accusations of currency manipulation and of stealing American jobs. A trade spat between the US and Canada has put thousands of jobs in Northern Ireland at risk, after Trump proposed a punitive import tariff of some 300% on Bombardier’s latest plane (the wings are made in Northern Ireland). A rattled Theresa May called for world leaders to stand up and defend free trade to its disillusioned citizens.

Make the connection

Free trade is not a zero-sum game. In our interconnected world, about 80% of global trade is made up of international supply chains, with materials produced, goods processed and value added in lots of different countries. In this context, protectionist measures by one country are potentially an act of self-sabotage. Trump may be angered by the fact that the US exports less to China than vice versa – but while electronic gadgets shipped from China to America contribute to the Chinese trade surplus, they also provide American consumers with cheap goods and boost American shareholders’ bank balances.

Lower prices and greater consumer choice do hurt employees in various industries – that’s the capitalist trade-off. But to protect countries from each other makes as little sense as protecting any industry from the lower costs delivered through greater efficiencies, including automation. The alternative to viewing global trade as a zero-sum game is to see it as a potential win for all, and to focus instead on ways to encourage innovation and dynamism at home while using antitrust legislation to ensure fair competition.

Much of the world sees Brexit as a protectionist move. Is it?

The main point for many people who voted in favour of Brexit was to regain control of the UK’s borders and thereby protect the interests of UK citizens, particularly regarding jobs and employment. The vote in favour of Brexit, therefore, was clearly protectionist.

Will it be difficult for Britain to make a trade deal with the US under Trump?

As long as the proposed EU (Withdrawal) Bill is passed without too many amendments – which is far from a done deal, given the amount of amendments and changes being proposed by MPs – existing EU legislation will be copied across to UK law, meaning it will be easy to make trade deals with other nations. The passing of this legislation is essential and will make it simpler to negotiate future trade deals even with protectionist foreign governments. Donald Trump’s administration has previously said it would be keen to strike a deal with the UK – although claims that this could be completed in 90 days seem overly optimistic.

What might rising protectionism mean for currency markets?

Those economies dependent on exports may be tempted to lower interest rates, to keep their currency weak (and, therefore, exports cheap). A more extreme measure that could materialise is central bank interference in the foreign exchange (FX) markets, selling currency in an effort to drive down its value. It has been seen previously - for example, in Switzerland, during the worst of the eurozone crisis. With its status as a safe haven, investors flocked to the Swiss franc, dramatically pushing up its value and forcing the central bank to intervene. FX currency experts, such as OFX, offer products such as forward contracts so that clients can lock in rates for delivery at a later date. This makes market volatility easier to navigate and plan for, should unforeseen events arise.

Does the pound have further to fall, or is worst-case Brexit factored in?

The pound could definitely fall further should the UK fail to make progress on a free trade agreement with the European Union, with talks between Britain and EU leaders due to start in December. Sterling has been boosted recently by claims that EU nations are to begin discussions among themselves about how a future trading arrangement with the UK would work. Provided sufficient progress has been made in negotiating the exit  “divorce bill” for the UK to partake in the December discussions, these talks should further firm up confidence and support for sterling. A “no deal” and default to the WTO’s rules would see sterling dramatically drop. Recently we saw moves in GBP/USD to around 1.35, leading a flurry of clients to lock in dollars by way of a forward contract, which can be used to exchange funds over the next 12 months.

How important is it to strike a good trade deal with Europe?

Vitally important. Europe accounts for around 50% of the UK’s current trade, so it is essential that a comprehensive trade deal is reached, to protect UK interests. OFX clients worried by the thought of a “no deal” scenario are looking to use forward contracts to lock in the current rate of exchange, to protect against further depreciation of the pound.

Does China deserve to be called a “currency manipulator”?

By controlling the trading range of the renminbi each day, China manipulates its currency to ensure that it doesn’t appreciate (or depreciate) too much. It uses far more control than the majority of Western governments, and given its status as the world’s largest exporter of goods, ensuring an artificially weak exchange rate is hugely beneficial to the domestic economy. The last time China substantially devalued its currency was August 2015. The move saw a huge sell-off in equity markets around the world as concerns grew that the economy was in a worse state than previously thought, rattling investors.

Isn’t the desire to protect your own industries completely normal?

Yes, but recent moves have been seen as more extreme than before. For example, America’s exit from the Trans-Pacific Partnership (TPP), and efforts to reform Nafta, highlight some of the more extreme measures taken recently.

Is the idea of each nation having its own currency inherently protectionist?

It could be perceived as being protectionist. However, having a domestic currency has been a way of trading and growing an economy for millennia. A domestic currency combined with monetary policy tools is an effective way of nurturing economic growth, ensuring price stability and assisting employment.

Could the rise of e-commerce help limit the effect of protectionism?

The rise of e-commerce, and the opportunities that accompany it, could well limit the effect of protectionism. Opening up to foreign markets via online selling may offset the potentially damaging effects of import tariffs being imposed. OFX offers online sellers foreign currency accounts that can be used to collect revenues generated in EUR, USD and several other currencies, which can then be converted, allowing online sellers the flexibility to exchange their funds at an optimum time and rate.

What is the practical impact of protectionism for small businesses?

Protectionism limits access and increases costs to small businesses trading internationally. Drastic protectionist moves have the potential to dramatically decrease the value of a currency, as seen with sterling following the vote to leave the EU. Importers should consider using a forward contract, to lock in the current rate of exchange in order to mitigate the risk of protectionism to their day-to-day business.

Are British businesses worried about protectionism after Brexit?

The protectionist move has already occurred, with the Brexit vote. UK businesses should be far more concerned about the UK’s future trading relationship with the EU. Once the UK leaves the bloc and sees out any transition period that may be implemented, a “no deal” result could cause significant damage to the UK economy - the effects of which could be felt for several years.

For more information from OFX on currency exchange and other matters, please click here 

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