Drezner: How Economic Recovery Plans Could Go Awry

When debates about trade are raging in policy circles, the free traders' A-bomb is the 1930 Smoot-Hawley tariff. In response to the 1929 financial crisis, Congress raised U.S. tariffs to their highest level in history. Within a year of its passage, 26 countries had imposed quotas on U.S. imports. Countries resorted to "beggar thy neighbor" policies, devaluing their currency or restricting imports in order to improve their balance of trade. The overall effect was to deepen the Great Depression and lay the groundwork for the second world war. So the message of Smoot-Hawley is clear; ratcheting up protectionism too much is a recipe for depression, distrust and war. (Story continued below...)

In the current global economic crisis—the worst since the Depression—leaders have been making the right noises about avoiding Smoot-Hawley II. The G20 communiqué in November declared: "Within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports." President Bush stressed the importance of jump-starting the Doha round of trade talks. Surely, the lessons of the '30s will convince countries not to take this path again.

The problem is that many G20 economies have honored that statement only in the breach. Two days after the G20 summit, Russia's government announced that it would increase tariffs on imported cars and began allowing the ruble to depreciate against the dollar and the euro. A day after that, India slapped a 5 percent duty on several iron and steel products. Argentina and Brazil recently approved the idea of raising tariffs on a number of goods, including textiles and wine. Prior to the G20 meeting, China increased export-tax rebates on more than 3,700 goods; since the summit, officials have signaled that it would take additional steps to boost exports.

None of these measures will immediately imperil the open trading system, but they do undercut adherence to other G20 pledges. They also retard any effort at jump-starting the Doha round of trade talks. Further protectionism is also possible. While the advanced industrialized democracies have not retaliated, there is growing sentiment for a protectionist response in both the United States and Europe.

Beyond old-fashioned tariffs, there are other ways in which beggar-thy-neighbor policies can creep up. Russia has begun to let the ruble slide against major currencies, and China has reversed its three-year-old policy of allowing the yuan to slowly appreciate against the dollar. The Financial Times reported that multiple Pacific Rim exporters have started buying up dollars in order to keep their currencies undervalued. The activity was worrisome enough for the Asian Development Bank to warn its member this month that "we need to avoid unnecessary and excessive interventions in the foreign currency markets, especially to depreciate domestic currencies."

What is truly worrisome, however, is that a lack of cooperation on trade could spill over into a lack of coordination on fiscal policy. Coordination on these two issues are linked. States running trade deficits worry that export engines like Germany and China will free ride off of their own fiscal expansions, boosting the growth prospects of these exporters without any serious fiscal expenditures on their part. Already, other Europeans are upset over Germany's inaction on the fiscal front. German Finance Minister Peer Steinbruck's warning against "crass Keynesianism" to NEWSWEEK's Stefan Theil has merely stoked these concerns even more.

If this fear persists, there is a danger that any Keynesian boost will come attached with protectionist provisions to ensure that the benefits remain within national borders. Some reputable economists are already advocating this kind of action in the absence of global policy coordination. As the global downturn persists, these political pressures will become harder to ignore. What has been a mild backlash against trade liberalization could quickly turn into a tsunami. If trade wars break out in the wake of the global financial crisis, they will not take the form of Smoot-Hawley—but they will be equally dangerous.