The Rise of Protectionism: The Contagiousness of
Protectionism in a Global Cooperative
World Order
Program: The New Protectionism and the End of Multilateral Cooperation Assignment: Master thesis
Date: August 31st, 2018 Words: 19334 Supervisor: Dhr. dr. S. Krapohl 2nd reader: Dhr. dr. J. G. W. Blom
Student: Eline Kuijs #10536019
eline.kuijs@student.uva.nl
Abstract
Fear exists that the recent developments towards protectionism coming from the United States might be a repetition of what happened in the 1930’s. There has already been conducted research comparing the situation of the 1930’s to the global financial crisis that the world has endured and this thesis aims to add to the debate by conducting comparative historical analysis that fills this gap up until the current situation. The empirical process on protectionism in its current form is ongoing, and it might not be possible to ‘predict the future’ in any way but it is possible to reflect on the situation in the 1930’s and take those lessons into the present. By combining Milner’s (1988) argument that strong economic interdependence prevents the spread of protectionism and Baccini and Kim’s (2012) argument that strong international institutions prevent the spread of protectionism, this research deems the spread of protectionism in the current context to be unlikely.
Table of contents Abstract 3 1 Introduction 6 1.1 Societal relevance 8 1.2 Scientific relevance 10 2 Literature review 12 2.1 Understanding protectionism 12 2.2 Why protectionism? 13
2.3 The prisoner’s dilemma of international trade 14
3 Theoretical framework 17
3.1 Economic interdependence 17
3.2 Resisting protectionism through strong economic interdependence 18
3.4 International institutions 22
3.5 Resisting protectionism through strong international institutions 23
4 Methodology 26
4.1 Comparative historical analysis 26
4.2 Variables, operationalization and data collection for H1 27 4.3 Variables, operationalization and data collection for H2 29
4.4 Case selection 31
5 Analysis 32
5.1 Results for economic interdependence 32
5.1.1 Trade openness 32
5.1.2 Current account balance 36
5.2 Results for international institutions 42
5.2.1 Growth of intergovernmental organizations 42 5.2.1 Cross membership within intergovernmental organizations 43
5.2.3 Lock-in mechanisms 46
5.3 Contextual comparison 50
5.3.2 The Trump Tariffs 53
6 Conclusion 55
1. Introduction
Advocating protectionism is a highly atypical move for a Republican presidential candidate. The classic Republican vision has tended to consider free trade and individual achievements to be the most important factors behind economic prosperity (Appelbaum 2017, Johnson 2012); thus, Republicans believe in minimalistic government interference and advocate personal financial responsibility (Appelbaum 2017, Johnson 2012). This firm classical Republican standpoint on free trade has taken a hit since the candidacy of Donald Trump and his constant promotion of “fair” trade (protectionism) and railing against “free” trade. This protectionist vision is sharply at odds with the classic Republican vision of free trade orthodoxy but nevertheless managed to push aside other Republican candidates such as Ted Cruz and Marco Rubio (de Rugy, 2018) and gain support from the electorate.
When the Trump administration came into effect in 2016, President Trump immediately set his campaign promises to put “America First” when it comes to international trade into action. With the so-called Trump Tariffs, the President imposed tax increases on the import of solar panels, washing machines, steel, and aluminum in order to support and favor domestic produced products. Other highly protectionist stands Trump has taken include withdrawing from the Trans Pacific Partnership (TPP), leaving the negotiations on the Transatlantic Trade and Investment Partnership (TTIP), and demanding renegotiations on the terms of the North American Free Trade Agreement (NAFTA). By imposing tariffs and backing out of preferential trade agreements, Trump has delivered on his campaign promise—but this will have its impact on the global trade order (Ikenberry, 2017).
The fact that Trump won the presidential election forced the U.S., and therefore the world’s leading economy, to follow a protectionist path. In March 2018, President Trump ordered import tariffs on imported steel (25%) and aluminum (10%). As the world’s largest steel export country, China has been hit the hardest and has threatened with counter measures (The Economist, 2018). At first, exceptions were made for neighboring countries Canada (the largest supplier of imported steel to the U.S.) and Mexico. After carefully shaped negotiations, the E.U. was also granted a temporary exception to the tariffs; however, on the 1st of June 2018, the import tariffs for Canada, Mexico, the E.U., and the other countries all came into effect. All of the countries have expressed that these measures will greatly disrupt trade relations between them and the U.S. and that they will not shy away from counter measures such as import tariffs on American products (The Guardian, 2018).
Many economists warn that the protectionist trade policies of the U.S. will have devastating effects when the situation develops into a trade war. Protectionism functions as a
catalyzer for retaliation measures, when spinning out of control eventually resulting in a trade war and disrupting the economic cooperative global trade order. Economists note that the world has experienced this before, during the 1920s-30s. The Smoot-Hawley Tariff Act and the retaliatory trade war that followed are the historical precedents that most economists fear. In the run-up to the Great Depression, there was a trend towards protectionism. This move towards protectionism was not the sole contributor, but, according to Douglas (2017), definitely worsened the scope and depth of the Depression. After the stock market crash in 1929, the Smoot-Hawley Tariff Act was signed into effect, aiming to protect American jobs by imposing tariffs on foreign products to promote the sale of domestic products. However, the rest of the world reacted by imposing retaliatory measures which crippled the U.S. and international economies even further. This marked the end of the cooperative era and ushered in a wave of protectionism on the economic world order. Many scholars agree that this protectionist act was a great contributor to the extent of the collapse of the global economy during the Great Depression that followed (Madsen 2001, Whaples 1995, Schattschneider 1935).
Although economic scholars warn for the possibility of a 1930s-style trade war following the Trump Tariffs (Woolf, 2018); it is not safe to simply say that history is doomed to repeat itself. But it is important, as Galbriath (1954) points out to obtain good knowledge of what happened in order to use that knowledge as a safeguard against recurrence. The effects of the trade war and the Great Depression that followed in the 1930s had a gravely negative impact on the cooperative economic order and could be felt all over the world. Because of its significance to international trade history, it is wise to take lessons from that history into account when assessing the current Trump Tariffs and their possible impact on the world. However, it would be overly simplistic to argue that in the current cooperative world order the Trump Tariffs will have the same impact, since there is no possibility of predicting whether the effects of the protectionist wave from today will have the same impact as the protectionist wave of the 1920s-30s. This is mainly because the differences in (economic) context between the 1920s-30s and the current time period must be taken into account.
In addition to the economists, there are also voices that argue that due to this difference between the historical context and the current context, it is not very likely that a trade war will unfold as a result of the Trump Tariffs. The main arguments against the possibility of the spread of protectionism include the importance of the growth of international economic interdependence. According to Milner (1988), countries will refrain from protectionist retaliation because of the growth of international economic ties, which reduces interest in protectionism by increasing its costs. Another strong argument is made by Baccini and Kim
(2012), who state that due to the growing importance and strength of international institutions, protectionism is less likely to spread across countries. The numerous international institutions present in the international system serve as conveyors of information and mechanisms of commitment (Baccini & Kim, 2012, p. 369).
Since protectionism has been shown to spread from the U.S. across other countries in the 1920s-30s, and the unfolding protectionist measures of the Trump administration have been taking a more serious form every day, it seems important to contribute to the existing research on the matter and identify under which circumstances protectionism is likely to spread across countries in today’s cooperative society. After the global trade order recovered from the protectionist wave and the Great Depression, the cooperative era that followed seems now to be in serious danger. The question that arises is whether the protectionist trade policies of the U.S. are contagious in the current environment of global trade cooperation or whether protectionism could be contained. Thus, the research question that is posed in this thesis is as follows:
To what extent will it be likely for protectionism to spread across countries in the current global cooperative world order?
This thesis will proceed to answer this question by elaborating systematically on the situation of the 1920s-30s and the current situation. Firstly, here follows a carefully developed literature review that shines light on the political economic debate on protectionism and trade liberalization. Secondly, this research includes a theoretical framework that shows theories that oppose the contagiousness of protectionism in the current cooperative global order. Thirdly, the analysis will be presented, and finally, the conclusion will summarize these findings and discuss the weaknesses of the thesis.
1.1 Societal relevance
This thesis derives its societal relevance from the fact that trade wars affect the world economy and in case of crisis ultimately affect people (financially) at the individual level. Trump propagates his protectionist measures as “fair trade” and beneficial for American workers by promising that the policies will create more jobs and boost the national economy. Scholars of many different disciplines are interested in the effects of these protectionist policies and began monitoring them as soon as Trump ran for office; not only scientific researchers are interested, however, as the phenomenon has been widely broadcast by mainstream media and journalists
are closely watching Trump’s every move on the topic. Many offer their views in opinion pieces, keeping alive the societal debate on the matter.
An interesting factor that contributes to this widespread societal involvement is President Trump himself. Trump can be described as a controversial individual who became president quite unexpectedly and came from a non-political background. As the president of one of the largest economic powers in the world, he is bound to receive attention with every policy he imposes. Furthermore, with social media now a commonly used medium for news distribution, Trump is able to personally state his views and intentions on a daily basis. His social media participation, primarily through Twitter, makes it possible for him to interact closely with people and promote his views (whether or not his following agrees or disagrees), therefore encouraging the debate.
These are all reasons that the debate is very lively. The societal importance is that many scholars argue that protectionism will end in disaster and that companies and eventually individuals will bear the burden. Many studies have shown that protectionism is never the best option for the workers, both in America and abroad (Davis 2017, Surugiu & Surugiu 2015). Since his inauguration, Trump has followed through with his extensive protectionist agenda, thereby threatening foreign states with a multi-front trade war (The Economist, 2018). According to Trump, it is “easy” for the U.S. to win this war (The Economist, 2018). Trump justifies his protectionist measures by claiming that import tariffs will shield the American steel and aluminum industry and that without these measures, free trade will threaten to impair national security (The Economist, 2018). He thus fails to acknowledge that six of the top 10 countries that provide steel to the U.S. are NATO allies.
Some scholars argue that Trump is misleading the American people by claiming that imposing tariffs will be an effective way to win a trade war and will persuade other countries to lower their tariffs. This is mostly because the U.S. has in the past been able to stimulate international free trade by being positively pro-trade; leading with protectionism will likely only lead to more protectionism. Another important impact that is likely to follow from Trump’s “America First” strategy is that instead of punishing foreign governments for their protectionism and protecting national security, the tariffs will drive up the price of everyday products that are made from steel within the U.S. This will, in turn, make it more difficult for American manufacturers to compete with international manufacturers, who will have the option of using steel without added tariff costs. Further reasoning expects that U.S. manufacturers will lose their jobs over their non-compatible position and Trump’s protectionism backfiring on both an international and individual level.
1.2 Scientific relevance
The gap that this thesis aims to fill lies in the fact that there is a great deal of literature about the 1920s-30s but there is not sufficient knowledge about the current situation and the threats that the world faces through the possible spread of protectionism. Since the world has developed and changed since the recovery of the Great Depression, it is important to discover whether or not protectionism is likely to spread across countries under the current circumstances. Since the end of the Great Depression and the emergence of the international cooperative era, the literature on trade wars has not been extended to today’s society. The aim is to develop a theoretical understanding of the circumstances that enable protectionism to spread, and under which circumstances protectionism can be contained to one area of the world in the current situation.
The typical argument in the trade liberalization-protectionism debate is game theory-related; when a large economic power such as the U.S. begins to impose protectionist measures, other countries will be likely to answer with protectionist measure to protect their own economy. This causes protectionism to spread across countries. If this logic is followed, protectionism will be a domino effect that spreads through the international system until cooperation falls apart. This logic could be followed when looking at the spreading of protectionism in the 1930s, but new questions arise regarding the current wave of protectionism. The major question that arises due to the changed globalized economic world order is: what kind of factors are now in place that could stop this domino effect? One factor that is important to take into consideration is the growing economic interdependence in the international global trade order. Helen Milner (1988) found in her research that the protectionist spiral of the 1920s-30s did not reappear in the 1970s, even though there were strikingly similar economic and political trends. She argues that governments will refrain from protectionist retaliation due to the growth of international economic ties, which reduces the interest in protectionism by increasing its costs. Because of international economic development and integration, international production networks and interdependence on trade markets make that there are an excessive number of economic actors that would be disadvantaged by protectionist measures.
Another important factor that could contribute to preventing the spreading of protectionism is the growing existence and importance of international institutions. This assumption is based on the importance of international institutions such as the World Trade Organization (WTO) and the mechanisms that are in place to steer international trade in a cooperative direction such as dispute settlement and lock-in mechanisms. Baccini and Kim
(2012) have researched the impact of international institutions on the possible rise of protectionist policies during the global financial crisis. They argue that with international institutions becoming stronger with stronger mechanisms for upholding liberal trade policies, they contribute to the prevention of the spread of protectionism (Baccini & Kim, 2012, p. 369). Combining these two major arguments that advocate for preventing the spread of protectionism will arguably fill the gap in the literature and add to the debate that mainly contains arguments accepting the spread of protectionism. These two major arguments against the spread of protectionism were developed during the energy and oil crises of the 1970s and the global financial crisis that started in 2007. Therefore, it will be interesting to see if these arguments can be upheld in the current situation concerning the Trump Tariffs. The global economic order has, since its recovery from the Great Depression in the 1930s, undergone change and development to stimulate cooperation between countries and to counteract protectionism. This thesis aims to fill a gap in the literature by comparing circumstances in the 1930s and now to see whether or not it is likely that the rising protectionist measures taken by the U.S. and the counter threats from the rest of the world will in fact lead to the spread of protectionism and, eventually, a trade war. This means that it is important to compare what happened in the 1930s to what is happening today. How are the institutions today? Are these institutions stronger so that we can expect that they are a more effective rescue line than they were in the 1930s? Also, how deeply integrated was the economic interdependence in the 1930s compared to now? Might this be a factor that will prevent protectionism from spreading across countries?
The empirical process on protectionism in its current form is ongoing, and it may not be possible to “predict the future” in any way; however, it is possible to reflect on the situation in the 1930s and take those lessons into the present. We certainly should not dismiss the important lessons from the crisis in the 1930s and the importance of the crisis to the global trade cooperation that came with it. It should also be stated that this thesis does not imply that history is doomed to repeat itself, but similarities between the 1930s and now in certain areas are striking and therefore pose a possible threat to the environment of global trade cooperation that need to be studied.
2. Literature review
Protective measures that governments of countries can take to protect their domestic markets against trade competition from import products are referred to as “protectionism”. This section focuses on the main means that countries can exercise to influence international trade and protect their national markets (taking protectionist measures). First, the question of what protectionism is will be explored to obtain a better understanding of the concept. Then the most important forms of protectionism and the major theory about protectionism and trade liberalization will be explained.
2.1 Understanding protectionism
Free trade, or trade liberalization, and protectionism are opposites: one is not possible in the same sector in combination with the other. A system of free trade is in theory a system in which traders can trade money and products without restrictions through national borders worldwide. This situation can only be realized if there are few legal trade restrictions (Lang & Hines, 1993, p. 6). Proponents of free trade believe that the market should be able to take its course and that it is not the task of governments to create obstacles to the functioning of the market. They therefore warn against economic measures that restrict free trade. In other words, they often warn against (the threat of) protectionist measures.
The term “protectionism” is linked to the concept of “economic nationalism”. This includes the entire policy and actions of the government that emphasize the national control of the economy (and capital and labor). Economic nationalism is an “opponent” of globalization and free international trade. According to economic nationalists, the state must have a dominant role in the (national) economy. This can be expressed, for example, through protectionism, which is central to this thesis, but also, for example, in colonialism (Johnson, 1968, p. 17). There are many different types of measures that are considered to be protectionist. Their common link is that they involve measures of the government to protect national industry and agriculture and to protect products against cheaper and/or better products from abroad. This description will be used in the remainder of this thesis as a definition for protectionism. Broadly, according to Lang and Hines (1993), a distinction can be made between four types of protectionist measures:
- Tariffs: an (additional) tax is imposed on foreign products. This makes the products more expensive and therefore less attractive to buy;
- Embargoes: this applies when it is forbidden to import certain foreign products or products from specific countries;
- Quotas: the import of a certain type of foreign product or products from a certain country is limited by a specific set amount or value;
- Technical requirements: setting (qualitative) conditions for products, as a result of which adjustment is necessary to make input possible. This causes delays and higher production costs, which disadvantage foreign producers.
After careful evaluation of the existing theory on protectionist measures and the current events, it seems important to add a fifth variant:
- Subsidy for companies and other support measures to domestic companies whereby the (international) competition is deliberately disadvantaged.
2.2 Why protectionism?
Opponents of protectionism believe that any government intervention adversely affects global economic prosperity. Only if the government refrains from intervening in the market can the economic principle of comparative advantages exist (Brakman, 2004, p. 14). It is not surprising that the proponents of protectionism disagree with this. Various arguments have traditionally been made to argue that protectionism can be rational from the point of view of a particular country. Five prominent arguments often recur (Brakman & Jepma, 1995, pp. 14-20):
- Protection of the growing industry: an industry receives temporary government support during the construction phase in order to grow without foreign barriers.
- Striving for self-sufficiency: international trade leads to specialization in production. As a result, it is conceivable that the national production level of a strategically considered product may, in the eyes of a government, become too low, as a result of which it will become dependent on a particular country for that product. If a conflict arises, it can be overly easy for foreign countries to enforce certain behavior by means of sanctions. Countries can prevent this from happening by enforcing protectionist measures.
- Reducing the balance of payments deficit: countries with a long-term balance of payments deficit can try to rectify this deficit by limiting imports through import restrictions. In that case, the protectionist measures are not industry-specific.
- Economic redistribution: there is intervention in the market by the government to allow certain economic agents to move forward and others to decline. This can be done through a levy or additional tax on imported goods. As a result, the imported products become more expensive, while those of the domestic producer become relatively cheaper. This increases the income of domestic producers.
- Creating an optimal rate: the idea behind this motivation for protectionism is that by raising an import tariff, the price of the import products increases and they are therefore reduced by the other party. The intention is that, if a country is an important enough trade partner, the foreign country will lower the price of the goods in order to increase sales again. In this way, a country can try to negotiate the optimal price.
In identifying the motivations and backgrounds of protectionist measures, the scientific literature regularly distinguishes between “old” and “'new” protectionism. “Old” protectionism focuses on taking measures that pursue the interests of the established order, including those of states. “New” protectionism centers on protecting broad public interests, such as the health and safety of residents and the reduction of poverty. An example of a measure that falls under “new” protectionism is a levy on products that are bad for the environment. The levy attempts to make the purchase of the product in question less attractive (Lang & Hines, 1993, p. 7).
2.3 The prisoner’s dilemma of international trade
The most common theory used in the political economy to understand why protectionism would spread across countries is the prisoner’s dilemma of international trade (Haggard & Simmons 1987, Keohane 1986, Rodrik 1998). The prisoner's dilemma is a concept in game theory. The core of the dilemma is that all players do not have enough information to make an informed decision and therefore will choose the safest option, which, in the end, is never the most profitable (Grieco, pp. 602-604, 1988). The most advantageous option for all parties would be if they acted in the same way (in game theory this is called “cooperation,” in this case, facilitating a free market). When there is a chance, however, that other parties are acting differently (taken into account the uncertainty of the other party’s policy choices) (in game theory, “defection,” in this case: taking protectionist measures) it becomes less advantageous to act cooperatively and parties will choose to defect in order to protect themselves (2/2) (see figure 1). The most beneficial outcome for all parties would be if all countries were to use a cooperative strategy (3/3) (see figure 1).
Figure 1: Trade liberalization/protectionism prisoner’s dilemma.
Source: Krapohl, 2017, p. 38
The most profitable outcome for each country individually would be to be able to profit from international trade and open markets without giving up the protection of their domestic economies (Krapohl, 2017, p. 38). This means that a country would ideally protect their own market from imports and thereby competition but would still be able to export their products internationally. The worst possible outcome would be the exact opposite, when a country liberalizes their market and all other countries close their markets, because then the first country would have no markets to export its products to but would have many foreign products imported into its own market, creating a deficit. Following the line of reasoning of the classic prisoner’s dilemma, a country would likely choose to avoid this worst possible outcome for themselves by also protecting their markets, making complete trade liberalization impossible.
Trump’s justification for the tariffs is to minimize the U.S. trade deficit, which means that the value of imported products is much higher than the value of their exports to certain countries (Tuerck et al 2016, Celik 2018). By imposing tariffs on imported products from certain trading partners Trump seeks to reduce the import and improve the U.S. trade balance. But the government of these trading partners, such as China, can also reciprocate by imposing its own tariffs on American products. Because China is committed to respond by imposing their own tariffs on American products, there is not much reason to assume that the Trump Tariffs will bring down the U.S. trade deficit (Celik, 2018). In this case both the United States and China will be better off without tariffs. This is exactly a prisoner’s dilemma like situation where all countries are choosing the best option for their own, protectionism, and thereby the outcome is the least favorable for everyone.
This prisoner’s dilemma of trade liberalization, however, is not a one-off game, but can be viewed as an ongoing game with multiple rounds and multiple players. Krapohl (2017) defines it as a continuous cooperation project whereby players must decide on multiple
occasions whether or not to protect or liberalize their markets. This could be explained as an iterated prisoner’s dilemma in which players can achieve cooperation by playing tit-for-tat (an eye for an eye; Axelrod, 1984), because of the repeated nature of the game and the possibility for players to react to each other’s previous moves (Krapohl, 2017, p. 39). Tit-for-tat essentially means that country A defects against country B, if country B has defected before. This would then be a provoked defection. However, country A would still cooperate with the other countries (C, D, E and so on). The question is whether country A may be forced to give up tit-for-tat to protect its market and defect against other countries, which have not provoked its defection in the previous round. Then, country A would become an unconditional defector and protectionism would spread across countries.
When the U.S. imposes tariffs against China, and China would retaliate by also imposing tariffs against the U.S. this could be considered tit-for-tat. But the effect of these tariffs is not contained between those two countries, its effects will also be felt by other countries. Because, when the U.S. and China close off their markets to each other, their product surplus must be exported to other countries, for example to the European Union, which creates an excessive pressure on the E.U. market. The E.U. would then be forced to impose tariffs of their own to protect its economy. In this case it would not be tit-for-tat and protectionism spreads across countries. Game theory would expect that cooperation becomes stabilized by playing tit-for-tat (Lipson, 1984, pp. 5-6), but tit-for-tat alone is not a good stabilizer because tit-for-tat could also mean that everybody will retaliate against everybody and then international cooperation is going down.
It may be reasonable to assume from the game theory argument the possibility of the current protectionist measures contributing to the outbreak of a trade war. Thus, there are factors needed to uphold cooperation and prevent this from occurring (Belke & Cui, 2010). There are two main factors that uphold cooperation in the current cooperative economic order, namely international economic interdependence, which means that the economy and multinational businesses are so internationally integrated that it is far too costly to apply protectionism (Milner, 1988) and the existence of international institutions such as intergovernmental organizations and preferential trade agreements that promote cooperation by providing information and setting the rules of the game (Baccini & Kim, 2012). Organizations such as the World Trade Organization (WTO) exist to safeguard basic principles of international trade (Celik, 2018). These principles include reciprocity, transparency and no discrimination. Moreover, the WTO provides a dispute settlement mechanism in case of a conflict (Celik, 2018).
3. Theoretical framework
This chapter will provide the theoretical framework used to develop the hypotheses on the two factors that may uphold international cooperation.
3.1 Economic interdependence
Interdependence, or coherence, occurs when people are dependent on one another in social interdependence. With states, there is interdependence if they are mutually dependent on one another at the same time. However, this degree of dependence does not need to be equal at all times. Interdependence is a social, economic, emotional, cognitive, and political phenomenon. States that engage in trade together are at the same time dependent on each other's political decision-making or legislation (Tomz, 2007). Gaining economic welfare and benefits are therefore often dependent on political decision-making and legislation of the trading partner.
Interdependence refers less often to bilateral dependency in international relations, in which only two states are dependent on one another. In reality, there is usually a multilateral dependency due to globalization. The degree of political cooperation indicates to what extent market forces will work efficiently. The trade of most states will therefore depend on the world market and not specifically on only one trading partner.
Some scholars believe that interdependence leads to peace. After all, a healthy relationship between states is better for the economy. In theory, states would prefer to avoid conflicts as much as possible so that economic blockages do not arise. On the other hand, interdependence creates distorted relationships between states. For example, if a state imports more goods than exports, there will be a deficit in the balance of payments. The welfare of the population within a state then depends excessively on the trade that drives a state. A state can become more powerful, while the standard of living of the population goes down. Basic government strategy to avoid economic dependence on other countries are protectionism and autarky.
Rusek (1990) takes a (government) policy approach to testing economic interdependence between the U.S. and Canada. He finds that Canada and the U.S. are so economically intertwined that their policy approaches towards economics and trade are also interdependent (Rusek, 1990, p. 92). Economic interdependence within member states of the E.U. has also been studied. Morselli (2014) finds that member states in the E.U. as well as the European Monetary Union (EMU) experience a higher level of economic interdependence with one another compared to countries outside of the Union.
While Rusek (1990) focusses on neighboring countries, the U.S. and Canada and Morselli (2014) on the E.U., Belke and Cui (2010) study the economic policy interdependence of the U.S. and the overseas E.U. Belke and Cui (2010) examine whether the monetary policies of the Federal Reserve (Fed) and the European Central Bank (ECB) are economically interdependent. Their results show that the two central banks have an interdependent policy relationship but with a clear leader-follower tendency (Belke & Cui, 2010, pp. 796-5). These results indicate that the U.S. and the E.U. are economically interdependent as well, but that the U.S. is the leading indicator of policy.
Gomez et al. (2013) have, in accordance with the above-mentioned scholars, underlined the existence and growth of economic interdependence after the Great Depression due to the globalization that developed after the crisis. They argue that increasing economic interdependence between different countries stimulates synchronization in the “world economic cycle” by analyzing business cycle co-movement (Gomez et al., 2013). Their approach is a hierarchical network approach, which is based on the perception that globalization increases trans-planetary integration and economic world interdependence.
Gomez et al. (2013) analyze similarities in global patterns of economic growth in the world economic order by identifying cross-country cooperation and growth clusters from the development of economic interdependence over the last decades (Gomez et al., 2013, p. 1633). Their primary findings reflect economic globalization as a regional rather than a global process, meaning that economic interdependence is driven by cultural, geographical, economic, and political regional clubs (Gomez et al., 2013, p. 1644). The synchronization of business cycles is related to regional integration arrangements such as between the E.U. and the ASEAN (Gomez et al., 2013, p. 1644). Another interesting finding they note is that global crisis highly affects the degree of output integration in regional clubs and economic distress ensures greater output synchronization (Gomez et al., 2013, p. 1645).
3.2 Resisting protectionism through strong economic interdependence
The most important theory for this thesis to help learn which factors are currently in place to prevent protectionism from spreading is explicated in the book Resisting Protectionism: Global Industries and the Politics of International Trade by Helen Milner (1988). She questions why the protectionist wave of the 1920s-30s did not reappear in the 1970s, despite its similar economic and political factors. By investigating the growth of economic interdependence between countries and analyzing its effect on trade policy, with a focus on the U.S. and France, Milner (1988) argues that countries did not react with protectionism in the 1970s due to the
growth and strengthening of companies’ international economic ties. The firms that benefit from international trade and the availability of the world market reduce the firm’s interest in protectionist measures by increasing its cost.
In her extensive research, Milner (1988) has demonstrated that economic interdependencies between countries have much to do with the policy preferences of large, internationally operating companies. According to Milner (1988), companies that have greater international ties, such as multinationals that benefit from global intra-firm trade, will be less protectionist-minded than nationally oriented companies. To prove this claim, Milner (1988) first examines export dependence, global intra-firm trade, and multi-nationality in the U.S. and goes on to examine these variables in France to see whether in spite of differences in ideological, historical, and political contexts, France’s response to increased interdependence was also to oppose protectionism.
An important similarity between the 1920s and the 1970s was the declining hegemony and high levels of economic distress (Milner, 1988, p. 245); the question then remains why the 1970s did not show the levels of protectionism that occurred in the run-up to the Great Depression. The systemic and business cycle theories (see Gomez et al., 2013), as previously described in this chapter, that had prevailed earlier do not satisfactorily show an answer to this question. Milner (1988) examines how and why companies form their preferences and how these preferences translate into government trade policy by taking companies themselves as the starting point, or unit of analysis.
The companies’ trade (policy) preference is in this research the dependent variable and is determined by independent variables; levels of multi-nationality, and export dependence. Export dependence captures the importance of these exports in comparison with domestic production for the state and represents the vulnerability of the company to import competition (Milner, 1988, p. 20). The amount of export dependence indicates how vulnerable companies are to losing sales in foreign markets. By multi-nationality, Milner (1988) means the extent of companies’ production capacity and profits in foreign countries relative to capacity and profits in their homeland. The level of multi-nationality therefore captures companies’ vulnerability to (policy) changes in these foreign countries. A large degree of direct foreign investment and intra-firm trade, or the level of integration of the company internationally, indicates a significant attachment to the international economy (Milner, 1988, p. 21).
Linking export dependence and multi-nationality to trade policy preferences can be derived from a cost-benefit analysis of a company when the company is further opening or closing its home market given the significance of integration in the international economy
(Milner, 1988, p. 21). Policy changes may be followed by counter reactions that may entail disruption of foreign investments and companies’ international trade flows. The further opening or closing of foreign markets has economic effects on the price and supply of products in both the foreign and home markets. In addition to international threats caused by policy changes, the domestic competitive position of multinational companies is also not assured (Milner, 1988, p. 21). The impact of a policy change upon the companies in an international industry can alter their domestic competitive position and is likely to harm them economically.
When protectionism comes into play, Milner (1988) also assumes the possibility of retaliation with counter protective measures by foreign countries. When other countries begin to protect their markets, it poses a threat to export-dependent companies’ exports and ultimately their profitability (Milner, 1988, p. 22). Moreover, the exporting company may face rising economic costs due to a reduction in available supplies. Protectionist measures such as closing the home market tend to drive up production costs and make their products less competitive in foreign markets (Milner, 1988, p. 22). Additionally, the amount of competition will rise, since the availability of open markets decreases and more companies will move toward the few open markets that remain. The closure of a country's market has a negative effect on foreign-exchange earnings and leads them to be less able to buy export products (Milner, 1988, p. 22). Besides the international challenges, the competitive position of export-dependent companies will likely diminish, since less export-dependent companies will benefit more from protectionism (Milner, 1988, p. 22). These economic costs of protectionism promote resistance to protective trade policy preferences by export-dependent companies.
The more internationally integrated a company’s foreign investments are, the more likely they are to prefer open markets as opposed to protectionism, even if that means more competition from imports (Milner, 1988, p. 22). For a multinational company with substantial global intra-firm trade, the costs of protecting the home market outweigh the benefits that protectionism brings. The economic costs of protectionism for companies with a high level of multi-nationality also arise from fear of retaliation or counter protective measures. By implementing protectionist trade policy, retaliation from foreign countries might disrupt the integrated world trade flow and lead to foreign production becoming more expensive (Milner, 1988, p. 23). Foreign governments might impose new and stricter rules upon companies and companies’ foreign property may be in jeopardy. A highly integrated company might be disadvantaged by closing its home market because they can no longer export from their production site. Multinationals’ domestic competitive position is therefore also weakened because protectionism may strengthen the multinationals’ domestic rivals (Milner, 1988, p. 23).
The costs and benefits of protectionism are unequally distributed between highly integrated companies and less internationally integrated companies. Therefore, companies with high levels of multi-nationality prefer open markets. Milner (1988) identifies four types of companies and their trade policy preference.
Figure 2: Types of companies and their trade policy preferences according to Milner (1988):
Source: Milner, 1988, p. 25
Milner’s book establishes a microeconomic understanding of a macro political outcome, the system-wide persistence for free trade in the 1970s. Milner (1988) analyzes 18 companies that suffered import competition over time and makes a convincing case that the structure of a company determines its preferences in trade policy in times of economic difficulty. Milner finds that the trade policy preferences of individual company’s shape governments’ trade policies, which means that it gives a great understanding of the system-wide absence or presence of protectionism or free trade. The empirical evidence that Milner (1988) presents supports the argument that there was more resistance towards protectionism and protectionism was therefore more contained in the 1970s than in the 1920s-30s. Companies in the U.S. were more export-dependent and multinational then they had been before.
These findings demonstrate the strong state/weak state distinction for protectionism that has dominated the political economy for the past decade, since Milner (1988) compares the trade policy preferences of the U.S. (which qualifies as a prototypical weak state) and France (which qualifies as a strong state) to find that their preference formation functions similarly (Milner, 1988, pp. 254-65). The key argument to extract from Milner’s (1988) analysis is that
the growth of export-dependent multinational companies with international production networks prefers open markets and that this will prevent protectionism from spreading through the economic world order. There are too many actors within countries that would be disadvantaged by protectionist measures, and the structure of the world economy has only globalized more since the 1970s. This means that when the wave of protectionism in the 1970s was contained it might be even more likely that the global economy is able to contain it in the current situation. Since Milner (1988) has already proven that this is the case with the 1920s versus the 1970s, it is important to also make this distinction for the current situation. To see if economic interdependence is a factor that could prevent protectionism from spreading from one country to another, the first hypothesis of this thesis is:
Hypothesis 1: If the global economic order has strong economic interdependence then the likelihood that protectionism will spread is limited.
3.3 International institutions
As the aforementioned prisoner’s dilemma of trade liberalization and defection has proven, without taking a wider context into account, governments would be safest off by intervening in their national economies and imposing protectionist measures. Krugman (1987) reflects on the European telecommunication equipment industry as a sector that has many government-owned companies, which makes it possible for countries to pursue protectionist policies in the industry without violating the international trade agreements that are already in place. Such policies are, in the long run, harmful to all players involved. The structure of the prisoner's dilemma means that not only in the telecommunication equipment sector but also in other sectors, each player is better off imposing government interference to prevent them from being the only ones who do not; the best possible outcome, however, would be if no one intervened (Krugman, 1987, p. 142). Krugman (1987) notes that in order to avoid such a trap in this dilemma and to promote cooperation, establishment of the rules of the game are necessary. Setting and abiding rules the of the economic policy game keep mutually disadvantageous actions to a minimum (Krugman 1987, p. 142). When rules are established, they can restrict governments from protectionist intervention in the international market and implement sanctions on those who undermine the rules. If the gains of protectionist intervention by governments are limited because of these possible sanctions, then there is an incentive for continuing the use of free trade to prevent trade wars. As international institutions are the framework of these rules of the economic policy game and international trade agreements are the embodiment, they could function as incentives for free trade policy choices.
Baldwin (2009) studies the trade policy choices that several countries have made during times of crisis. The countries that are analyzed are integrated in the global trade order and economically interdependent but have, according to Baldwin (2009), changed their policy preferences away from free trade and towards protectionism. The reason for these changes in trade policy preference were to soften the blow from the global financial crisis that occurred in 2007. These protectionist policies undermine the liberal global trade order. Although it is assumed that many countries would appeal to protectionist measures in times of crisis, not all have acted on them, according to Baccini and Kim (2012). This raises questions how to explain government trade policy choices when facing economic despair (Baccini & Kim, 2012, p. 370). 3.4 Resisting protectionism through strong international institutions
The existing theories on trade policy preferences and the reasons why governments choose protectionism demonstrates the importance of development of international institutions and preferential trade agreements (Baldwin & Evenett 2009, Cali 2009, Dreher & Voigt 2011, Henisz 2000, Ingram et al 2005). Major international economic institutions are, for instance, the World Trade Organization (WTO; previously the General Agreement on Tariffs and Trade, or GATT), the International Monetary Fund (IMF), the Organization for Economic Co-operation and Development (OECD), and the United Nations Conference on Trade and Development (UNCTAD). The WTO and preferential trade agreements (PTAs) are international institutions devoted to trade and the promotion of trade liberalization. Important functions provided by international institutions specializing in international trade include the monitoring and enforcing tasks. The main objective of the WTO, for instance, is to aid countries and global organizations in conducting business internationally. The WTO’s main functions consist of creating a framework for trade policy, monitoring and reviewing the trade policies of its member countries, providing (technical, economic) cooperation to developing countries, and dispute settlement between countries (WTO, 2018). These types of international institutions have gained importance due to the growth of globalization (Belke & Cui, 2010).
In light of their objective of monitoring and reviewing the trade policies of different countries, the various international institutions offer reports on a regular basis. A report of the WTO from 2009 shows that none of its member countries have engaged in widespread protectionism and trade restrictions and that the global trade order remained as liberalized and open as it was prior to the crisis (WTO report, 2009). Another report by the OECD strengthens this claim by stating that member countries had successfully refused the allure of protectionist policy choices during the global financial crisis that started in 2007 and emphasized the need
to maintain multilateral trade liberalization (OECD report, 2011). These outlets of information and research provide an interesting twist on the classic prisoner’s dilemma of trade liberalization. The international institutions provide information on the behavioral choices of different countries, which eliminates the risk of not knowing the policy intentions of a possible trading partner (Tomz, 2007, p. 239).
International institutions reduce the uncertainty in the trade liberalization prisoner's dilemma by providing information. According to Keohane (1984), this is the most important function that these institutions bring to the table, as it creates transparency in preferred policy choices by different countries. Exposing this information has another advantage, according to Oye (1986): it forces governments to play by the rules because cheating will be easily detected and has consequences. It can therefore be safe for member countries to have strong expectations about another country’s trade policy behavior for future reference. Along with the important function of information distribution fulfilled by international institutions, Baccini and Kim (2012) add the significance of “lock-in” mechanisms. In addition to monitoring and enforcing, these institutions and trade agreements also have the power to lock down commitments to liberal trade from its members and make defections or taking a protectionist policy course difficult and costlier by attaching legal obligations (Baccini & Kim, 2012, p. 370).
Baccini and Kim (2012) support the importance of the information function and the lock-in mechanism of international institutions in their article “Preventing protectionism: International institutions and trade policy”. They analyze the role of international institutions and PTAs in preventing the spread of protectionism across countries during the global economic crisis that began in 2007. Times of crisis are, according to Baccini and Kim (2012), higher-risk periods for the rise of protectionism due to an uncertainty in the conduct of international economic relations that pushes countries towards protectionist policies. The main argument in their article is that international institutions are a buffer for the rise of protectionism. They describe international institutions as “conveyors of information and mechanisms of commitment and socialization” in the international system (Baccini & Kim, 2012, p. 369). These economic international organizations can mitigate the uncertainty that exists in the prisoner's dilemma of trade liberalization and defection because they increase the flow of information about trade policy preferences between their members. Baccini and Kim (2012) also touch upon non-economic international institutions, which have been proven to increase the flow of socialization between its members.
The results of Baccini and Kim’s analysis are reassuring. They reach a consensus that a rise in protectionism due to the global financial crisis has been avoided (Baccini & Kim, 2012,
p. 395). The claim that the existence of international institutions in the global trade order decreases risk and uncertainty among countries trade policy choices is supported (Baccini & Kim, 2012, p. 395). Economic institutions help to tackle trade cooperation issues, particularly those that arise during times of crisis. By giving member countries the reassurance that other members will not opt for defection, the incentive to implement protectionist measures is minimized. The presence of an extensive network of international institutions in the global trade order decreases waves of protectionism by increasing availability of information to member countries. Baccini and Kim (2012) also find empirical support for the institutions’ functions as mechanisms of information and the signing of PTAs.
The article also shows significant support for the aforementioned lock-in mechanisms, which “locks in” member countries’ commitments to maintaining free trade policy (Baccini & Kim, 2012, p. 396). When applying this finding of Baccini and Kim (2012) to the currently unfolding trade wars between China and the U.S. and the U.S. and the E.U.—which were sparked due to the Trump Tariffs on aluminum and steel—it may be noted that Trump does not shy away from violation of the legislative rules and obligations that come with membership in international organizations and the economic and political costs such violations can inflict upon his country. This lack of fear may be rooted in the fact that there are certain loopholes in the rules to avoid such costs. The WTO allows tariffs if the national security of a member country is at risk. Trump is not able to prove his claim and is thereby plainly neglecting the rules (The Economist, 2018).
Baccini and Kim (2012) developed their theory and tested its results during the global financial crisis, which has now ended. The development of international economic institutions has been a distinct feature of the global economic order since the Great Depression, and the network of international institutions has continued to grow since their article was published. The importance of understanding the modes of international economic governance in this globalized era remains. Drawing from the reviewed literature on international trade (policies), the argument of the impact of international economic institutions is highly relevant, especially since international institutions eliminate risk and uncertainty in the international trade liberalization prisoner’s dilemma, challenging a widely adopted theory. Therefore, it is absolutely vital to include the importance of international institutions into this thesis. The second hypothesis is thus as follows:
Hypothesis 2: If the global economic order has strong international institutions then the likelihood that protectionism will spread is limited.
4. Methodology
4.1 Comparative historical analysis
Comparative historical analysis is a commonly applied method in social sciences and has been used for a considerable amount of time. It can be defined in the broader sense as a methodology utilized to uncover historical patterns across cases (Mahoney & Rueschemeyer, 2003, p. 10). A common point for all research that uses comparative historical analysis, although not unified by any hard rule on theory or method, is that the focus must be on a process over time and the use of contextualized comparison (Mahoney & Rueschemeyer, 2003, p. 10).
The comparative historical analysis method consists of three main features which must be taken into account. The first is that comparative historical exploration is fundamentally concerned with the identification and explanation of causal mechanisms that produce the outcomes of interest for the study (Mahoney & Rueschemeyer, 2003, p. 11). Second, comparative historical research explicitly and extensively analyzes historical proceedings and carefully takes the unfolding of the process over time into consideration (Mahoney & Rueschemeyer, 2003, p. 12). It is important to keep in mind that events as the subject of research, such as the formation of states, revolutions or globalization, are processes that unfold over time and are not static occurrences that take place at one fixed moment (Mahoney & Rueschemeyer, 2003, p. 12). Accordingly, because those events that are the object of a comparative study are located in a time and context, the contextual effects of these time periods should be addressed relative to one another (Mahoney & Rueschemeyer, 2003, p. 12).
The last main feature of comparative historical analysis is that systematic and contextualized comparisons of either similar or contrasting cases can take place (Mahoney & Rueschemeyer, 2003, p. 13). In this way, practitioners usually focus on a small number of cases in order to find explanations for important consequences within historical outcomes (Mahoney & Rueschemeyer, 2003, p. 13). It must be noted that the comparative historical analysis method does not directly aim for universally generalizable knowledge, because it is complicated by history and context which could never be generalized over a large number of cases. Rather, this methodology makes it possible for a study to create a comparative understanding of what might lie ahead, taking into account the context of history. For this reason, comparative historical analysis can be considered as a distinctive method for this particular research.
To answer the research question “To what extent will it be likely for protectionism to spread across countries in the current global cooperative world order?” comparative historical analysis has been identified as a suitable research method. The aim of this thesis is to make an
educated assumption of what might follow from Trump's protectionist policies today. Therefore, a historical case must be identified that is analogous to a current situation. Accordingly, the Great Depression of the 1930s, including the run-up to the event, has been selected as a historical analogy for comparison with the present situation. Hence, this past pattern of historical events will be used to provide an indication of the future of a possible new protectionist wave and the contagiousness of protectionism, thus fulfilling the purpose of this research.
4.2 Variables, operationalization and data collection for H1
Regarding the first hypothesis, “If the global economic order has strong economic interdependence then the likelihood that protectionism will spread is limited,” the assumption is that more economic interdependence is present between countries now than in the 1920-30s. Accordingly, this is a factor that should prevent the spread of protectionism across countries anno 2018. To measure the strength of economic interdependence, two variables have been identified: trade openness and current account balance. Trade openness (TO) is the most obvious variable to measure international interdependence, since it implies the economic integration of a country (Berthier et al, 2017, p. 19). It could be argued that the meaning of “trade openness” is similar to the idea of “free trade,” a system where all trade restrictions are eradicated. Pritchett (1996) offers a simple definition of trade openness as an economy’s international trade intensity, but Stensnes (2006) argues that trade openness must also be defined in relation to trade barriers against international integration imposed by national governments. Openness to international trade increases the size of the market that is available to domestic firms. Moreover, it drives potential global value chains with which firms could link their own production. Trade openness thus drives innovation and productivity by exposing firms to international expertise, technology and competition. It is argued that trade openness yields many economic benefits, including economic growth and development (Jackson, 2015). Trade openness is operationalized as the sum of imports and exports as share of Gross Domestic Product (GDP), or TO = (X + M) / GDP (Ortiz-Ospina & Roser, 2018).
To further analyze the strength of international economic interdependence the Organization for Economic Co-operation and Development (OECD) identifies certain major indicators that explain the status of international trade. One important indicator described by the OECD for international trade is the current account balance (OECD, 2018). The current account balance (of payments) is operationalized as a record of a country’s international transactions with the rest of the world. These include all transactions (other than those in
financial terms) that involve economic values and occur between domestic and non-domestic entities (OECD, 2018). The current account is the sum of the balance of trade (export minus import), net income (from abroad) and the net current transfers, or CA = (X - M) + NY + NCT. As far as possible this indicator is measured in millions of U.S. dollars, as the historical data does not provide the current account balance in U.S. dollars but rather in the domestic currency of each country at that time. The 30 largest trading partners of the United States in 2017 represent around 87.9 percent of U.S. exports and 87.4 percent of U.S. imports (U.S. Department of Commerce, 2018). The average current account balance for 2016 was 1.1 billion U.S. dollars. The lowest value at that time was in the United States, at -451.69 billion U.S. dollars, while the highest value was in Germany, at 286.84 billion U.S. dollars (World Bank, 2017).
In order to measure economic interdependence through these three variables, this thesis will make use of international trade data. Trade data from the 1920s to 1930s will be analyzed and systematically compared with current trade data. For the trade openness variable, Ortiz-Ospina and Roser (2018) provide trade openness data on Western European countries for the 1920s to 1930s based on historical trade data by Brian Mitchell (1998). As this data does not cover the United States, the online International Historical Statistics database, namely the volume on the Americas by Brian Mitchell (1998), was consulted to acquire the necessary data. Ortiz-Ospina and Roser (2018) also provide accurate current data on trade openness for both the United States and Europe.
The International Historical Statistics database comprises trade data dating back to 1750, and provides the most reliable and accurate figures on historical international trade. Therefore, this thesis also relies on this database for historical data on the current account balance. The historical international trade data obtained from the Brian Mitchell (1998) database will be compared with relevant accurate international trade data provided by the OECD (2018). The OECD is an intergovernmental organization that aims to promote policies to improve the economic and social well-being of individuals around the world, and provides reliable data on productivity and international trade. Furthermore, all of the countries taken into consideration in this thesis are member states (please see section 4.4 “Case selection”). For this current account balance variable, it must be taken into account that historical trade data is measured in current values; consequently, for every Western European country a different currency is displayed against U.S. dollars for the United States.
Milner (1988) measures economic interdependence multinationality and export dependence. In this thesis the focus lies on the national level, and therefore the multinationality
of individual companies will not be taken into consideration. Rather, only the export dependence of a country as a whole will be used. The decision to use international trade data in this thesis to determine the increase or decrease of international economic interdependence between the 1920-30s and present day is a choice made due to the lack of historical data in many areas for the 1920s-30s. Most data extends back to as early as the 1960s, or more often the 1970s, which leaves little room for selectivity. This also applies to the variables identified to measure interdependence. To measure the economic interdependence between countries and also over time it would be very interesting to be able to include, for instance, foreign direct investment; however, concessions had to be made due to the lack of availability of such data.
4.3 Variables, operationalization and data collection for H2
Concerning the second hypothesis, “If the global economic order has strong international institutions then the likelihood that protectionism will spread is limited,” the assumption is that international institutions are stronger now than they were in the 1920s-30s. Accordingly, this could be a factor preventing the spread of protectionism across countries anno 2018. To measure the strength of international institutions, three variables have been identified: intergovernmental organizations, cross-membership and lock-in mechanisms. International institutions are a central focus of international relations scholarship, as well as of policy-making efforts around the world (Duffield, 2007, p.1). In this thesis, the focus will lie on intergovernmental organizations (IGOs) to define the strength of international institutions.
A non-governmental organization (NGO) is an organization that seeks to achieve societal, public or social good and whose activities are not subjected to government control (Hsui, 2018). In contrast, IGOs are organizations created on the basis of agreement of three or more states under international law (Hsui, 2018). Because NGOs are generally concerned with social poverty and climate issues, while this thesis examines trade on the international level, NGOs are not taken into consideration for this research. In an IGO the member states are bound by the treaty of the international organization if they have explicitly agreed to it. Hence the power of decision in an IGO lies in the hands of the delegates or representatives of the member states. In this respect, member states do not transfer authority or sovereignty (or a limited amount) to the international organization.
As a variable, IGOs are operationalized as organizations where decisions are taken exclusively by national governments. To measure the strength of international institutions it is interesting to consider whether there are more IGOs in place now than in the 1920s-30s. In addition, the second variable provides clarity on cross-membership of countries within these
