An Aide Memoire on the Perils of Protectionism

Shakespeare once said: “That which we call economic patriotism by any other words would smell as sweet.” Perhaps those were not his exact words but irrespective, his premise was correct. Protectionist policies employed by European countries as of recent do indeed smell although sweet is probably not the best adjective that could be used to describe the smell.

In Europe, particularly in the energy sector, economic nationalism (read protectionism) seems to be on the rise. For example, the recent EUR 72 billion merger between the French energy companies Gaz de France and Suez has brought criticism allegations of government interference from the Italian government. The Italians argue that the union between the French companies was designed to hinder a potential hostile takeover on behalf of the Italian firm Enel SpA. The French government, which now owns approximately 35% of the new company, argues that they are not endorsing protectionist policies but rather promoting ‘economic patriotism'.

Further examples of such policies can be found in Spain and Luxembourg, among other places. In Spain, the power company Endesa rejected a EUR 29.1 billion bid by German firm E.ON suggesting that the bid did not ‘adequately reflect the true value of Endesa.' [1] The bid proved to be disconcerting to the Spanish government who sought to obstruct the merger via the invocation of a 1999 Spanish law that gives authorities the right to block companies in which a public body has an interest from taking a stake exceeding 3.0 percent in a Spanish energy company. [2] The European Commission has proposed that Spain be brought before the European Court of Justice for its' actions.

Protectionism again reared its ugly head when Indian steel company [3] Mittal Steel, the world's largest steel producer, attempted to takeover Arcelor with a EUR 18.6 billion bid. The government of Luxembourg, who owns a 5.6 percent share in Arcelor, responded by asserting that the ‘hostile bid by Mittal Steel calls for a reaction that is at least as hostile.' [4] The reaction consisted of passing legislation which would make it easier to fend off unwanted takeovers. In response India's commerce minister, Kamal Nath, has argued that opposition to the takeover is the result of racial discrimination and has gone out of his way to remind E.U. members of their WTO obligations.

I could go on and discuss how the government of Poland sought to disrupt a merger involving Italian banking leviathan Unicredit and Germany's HVB bank but the point has been made relatively clear:  Europe is witnessing a resurgence in protectionist policies.

While one could make the argument that efforts to protect national interests are carried out in concern for the state and its people, the bottom line is that such behavior is diametric to the E.U. notion of a free and open market and counter-productive in the context of international trade. Economic nationalism is not in the best interest of governments or consumers as it has the potential to:

          Diminish the potential value of firms. The Economist [5] reported increased deal activity (roughly 50%) in all major European markets in 2005. In the form of mergers and acquisitions, this increased activity is, at least in part, a function of corporate profits. Government intervention retards the economic growth of corporations and devalues stocks owned by shareholders.

          Lead to sub-optimal performance. By barring productive firms from acquiring those that are less productive, economic nationalism leads to sub-optimal corporate performance. Efficient firms are efficient because they eliminate stagnant and unproductive components of the firms they acquire.

          Diminish foreign direct investment. When national governments interfere in private business deals, foreign companies become reluctant to invest. Undoubtedly, situations such as the ones in Spain and in Luxembourg will push firms to look toward more liberal markets for investment opportunities.

          Inadvertently lead to increased unemployment. For example, in the early 1980's the United States placed import quotas on the auto industry. As a result, the average price of an automobile rose almost 41% over 4 years. [6] Although the goal was to save American jobs, the higher prices of automobiles led to significantly decreased sales and consequently, numerous job cuts in the auto industry.

          Distort prices. Tariffs, subsidies, and non-tariff barriers ultimately result in higher prices for goods and services. One need only look to the Common Agricultural Policy (CAP) for an example as E.U. consumers are paying roughly twice as much for their food as they would without the CAP. [7]

After delineating some of the negative aspects of economic nationalism, it seems judicious to reiterate some of the advantages associated with free trade. In this context the term free trade is used to identify trade policies free of any form of government interference.

The most obvious advantage of free trade can be seen in the form of economic growth. Data from developing nations  (between 1970 and 1990) shows that countries with open trade policies registered a 4.5% growth rate while those with closed borders registered a growth rate of only 1%. During the same period, the GDP of the open countries grew by an average of 2.3% while the GDP of the “closed” countries grew by only 0.7%. [8] To use the United States as an example, a University of Michigan study shows lowering global trade barriers on all products and services by even one-third could boost the U.S. economy by $177 billion, thereby raising living standards for the average family by $2,500 annually. [9]

Another advantage of free trade is that it creates jobs. While some might argue that such policies result in the loss of American jobs, evidence from the North American Free Trade Agreement (NAFTA) suggests otherwise. Opponents of free trade argued that the implementation of NAFTA would result in the massive loss of blue-collar jobs in America however since its inception more than 14 million new American jobs have been created, unemployment has fallen from 6% to 3.9%, and the number of manufacturing jobs in the U.S. has remained stable at roughly 18.4 million. [10]

As well, free trade promotes innovation and competition. By encouraging competition, free trade of goods and services forces companies to be innovative and create better products for lower prices in order to retain their market share. One example of the benefits of competition can be seen in the airline industry. In 1975, the airline industry carried about 200 million passengers where as currently the industry carries almost 600 million passengers a year. [11]

Free trade also fosters the strengthening of infrastructure while helping to develop of a variety of institutions. Infrastructure development comes via the construction and maintenance of ports, airports, and highways while institutional growth can be seen in the expansion of the banking, financial, and insurance sectors. Free trade also reinforces the rule of law as in order to enforce contracts and protect transport vessels, trading countries must have stable police forces as well as strong judicial systems.

Some analysts and scholars argue that free trade promotes peace. Erich Weede, of the University of Bonn, contends that a number of quantitative studies provide evidence of a causal chain running from free trade via prosperity and democracy to the avoidance of military conflict. Citing research by prominent political scientists such as Susan Stokes, Carles Boix, and Seymour Lipset, Weede argues that ‘trade underwrites democracy and thereby the democratic peace where it prevails.' [12] One cannot extricate free trade from democracy and it would be remiss to completely ignore the relationship between free trade, democracy, and peace.

These are just a few of the obvious benefits resulting from free and open trade practices. Most industrialized nations engage in protectionist policies at one point or another however the recent upsurge in economic nationalism in Europe is cause for concern as it has the potential to become self-perpetuating.

The appropriate course of action would be to recognize and accept the fact that, in an economic context, the world is shrinking quite rapidly and ‘economic patriotism' ultimately does more harm than good. There is no longer room in the global economy for countries such as France to endorse takeovers when French companies like Vivendi Universal buy out foreign firms such as Seagram and Houghton Mifflin and then later reverse their position when a foreign firm such as PepsiCo seeks to takeover Danone. The pitfalls of protectionist policies are well known however it has become quite apparent that they can sometimes be forgotten. Thus I give to you this brief reminder.

 

 

 


[1] www.uk.biz.yahoo.com

[2] “EU to sue Spain over ‘illegal' energy merger blocking law – www.zeenews.com.

[3] Although Mittal Steel is an Indian owned firm, it is registered in the Netherlands and is therefore bound by E.U. regulations. 

[4] “India reminds EU of WTO obligations in steel battle.” – www.euobserver.com.

[5] “Europe's nascent merger boom” – 9/3/2005

[6] “The Myths and Realities of Trade Protectionism.” – www.heritage.org.

[7] “A New Agenda for European Agriculture: A Radical Proposal.” – www.timbro.se.

[8] “The Benefits of Free Trade.” – www.ncpa.org. 

[9]   “International Trade.” – www.whitehouse.gov.

[10]   “The Benefits of Free Trade: A Guide for Policymakers.” – www.heritage.org.

[11] “Why America Needs to Support Free Trade.” – www.heritage.org.

[12] “The Diffusion of Prosperity and Peace by Globalization.” – www.independent.org. 


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