Mutually Assured Depression

Protectionist moves in the midst of a worldwide economic contraction threaten to provoke massive retalitation.

During the Cold War, a favorite acronym of Defense Department planners was MAD, which stood for mutually assured destruction.  The logic of MAD was straight forward: if the Soviets fired their nuclear weapons, and we could launch ours before theirs hit us, thereby ensuring that we would all be destroyed, nobody would ever be crazy enough to launch their warheads.  Interestingly, at this moment of profound economic crisis, the 'MAD logic' is once again applicable, though today it means something slightly different: mutually assured depression. 

If, in a misguided effort to stimulate the American economy, we raise barriers to trade, which would be akin to a first strike, our trading partners will do the same, and this crisis will be prolonged and severely deepened.  Yet unlike the Cold War period, where our leaders were typically very careful not to be too provocative in their public pronouncements, leaders today keep publicly toying with this idea of launching our economic nuclear weapons. 

As our domestic purchasing power continues to fall, reliable access to global markets, where some demand for American goods and services remains, is critical to preventing the further collapse of our domestic economy.  Yet in the recently-passed stimulus bill, Congress inserted a broad ‘Buy American' provision, and its virtues continue to be touted by its supporters.  The superficial appeal of such a provision is clear, but in the current economic environment, America can ill-afford the kind of retaliation that will result from adherence to such a measure.  

Perhaps what is most shocking about this continuing debate over protectionism in a time of crisis is its familiarity.  The United States tried raising barriers to commerce to get us out of a depression once.  It didn't work.  In 1930, as the country was entering the throes of the Great Depression, Congress passed the Tariff Act of 1930, which is more commonly known today as the Smoot-Hawley tariff.  Economists disagree over whether the Tariff Act turned a depression into the Great Depression, but they widely agree that the wave of retaliatory protectionist measures and 'beggar-thy-neighbor' policies in response to the Act lengthened and intensified the global depression.  Yet that lesson, which made it clear that global economic crises demand the removal of barriers to commerce, rather than their imposition, appears to have been forgotten by many. 

In order for an economy to thrive without vibrant international trade, it must have a domestic market large enough to support a nation's merchants and manufacturers.  In boom times, the United States could theoretically generate enough overall demand to sustain our economy, at least for a period of time.  In bad times, however, shriveled domestic markets are simply incapable of providing enough demand to sustain our domestic producers, and at the moment, the United States is facing a situation marked by, among other things, an astonishing slowdown in domestic demand. 

Though the entire global economy is enduring a sharp contraction in demand, access to overseas markets offer American producers opportunities that currently do not exist at home.  As the economy's collapse has continued, the purchasing power of U.S. businesses and consumers has dropped precipitously.  Businesses are struggling to invest and consumers are struggling to buy.  In early February, the Commerce Department announced what may have seemed like a nugget of good news amidst all the economic doom and gloom.  Unfortunately, it was not.  The Department announced that the U.S. trade deficit had dropped 4% in December 2008, to $39.9 billion, a 6-year low.  Considering all of the ink that has been spilled in recent years decrying our ballooning trade deficit, one could be forgiven for thinking that this was a positive development.  Certainly, restoring balance to our trade deficit -- by selling more goods in foreign markets and buying more from domestic markets -- is a worthy long-term policy goal, but that is not what actually happened in those final weeks of 2008 when the deficit fell.  Rather, our trade deficit fell because neither businesses nor consumers could afford to invest or buy, so as domestic demand plunged, the amount we imported dropped relative to the amount we exported. 

Since consumer demand, unlike trade policy, does not discriminate based on product origin, if American consumers and businesses lack the capital to purchase goods and services from abroad, they also lack the capital to purchase goods and services at home.  In fact, when money is tight, it is often demand for the American-made version of a good that falls first.  A manufacturer who imports textiles from, say, India, does so because they are cheaper.  If buyers cannot afford as much of the Indian textiles -- hence, the decline in imports -- they certainly cannot afford to fill the gap in their supply with the more expensive American version.  But, for the American seller of textiles that operates in a global marketplace, all is not lost when domestic customers cannot afford to buy.  They have access to a much greater volume of market participants, and they can look beyond American borders for customers that may still have sufficient purchasing power. 

If, on the other hand, demand for American-made goods and services were limited to American consumers -- meaning that U.S. producers had no alternative but to exclusively shop their wares in our withered domestic markets -- those producers would be in grave trouble and the country would now be in an even deeper economic hole.  Yet in the global economy, the sheer size of the marketplace means opportunity for American producers, particularly when our domestic marketplace is so constricted.  
 
Notwithstanding these facts, arguments favoring protectionism as a policy response to our current crisis keep cropping up in our national debate.  Those that favor raising barriers to trade argue that it is a means of stemming this devastating economic spiral.  If the government raises tariffs on imports, they argue, Americans will buy American products rather than their foreign counterparts, thereby jump-starting the domestic economy.  This argument, however, ignores the fundamental reality that any gains that accompany increased tariffs will be more than offset by a loss of access to the very markets that are currently keeping the U.S. economy from drowning and that will be critical to our eventual recovery.

Perhaps it is unfortunate, but barriers do not usually operate in only one direction.  If we want American producers to serve as the engines of recovery -- as job-creators and as investors -- then their access to global markets must be protected, but if we raise economic barriers our trading partners will naturally raise theirs. What domestic industry really needs right now is access to resources and as many potential buyers as possible, not privileged access to an atrophied marketplace.  We need friends in foreign capitals and we need markets for our products, and the adoption of protectionist measures are guaranteed to win us neither.  Now is the time to lower barriers to trade, not to raise them; to work with nations around the world to ensure our mutual survival, not to work alone and assure our mutual depression. 
Protectionist moves in the midst of a worldwide economic contraction threaten to provoke massive retalitation.

During the Cold War, a favorite acronym of Defense Department planners was MAD, which stood for mutually assured destruction.  The logic of MAD was straight forward: if the Soviets fired their nuclear weapons, and we could launch ours before theirs hit us, thereby ensuring that we would all be destroyed, nobody would ever be crazy enough to launch their warheads.  Interestingly, at this moment of profound economic crisis, the 'MAD logic' is once again applicable, though today it means something slightly different: mutually assured depression. 

If, in a misguided effort to stimulate the American economy, we raise barriers to trade, which would be akin to a first strike, our trading partners will do the same, and this crisis will be prolonged and severely deepened.  Yet unlike the Cold War period, where our leaders were typically very careful not to be too provocative in their public pronouncements, leaders today keep publicly toying with this idea of launching our economic nuclear weapons. 

As our domestic purchasing power continues to fall, reliable access to global markets, where some demand for American goods and services remains, is critical to preventing the further collapse of our domestic economy.  Yet in the recently-passed stimulus bill, Congress inserted a broad ‘Buy American' provision, and its virtues continue to be touted by its supporters.  The superficial appeal of such a provision is clear, but in the current economic environment, America can ill-afford the kind of retaliation that will result from adherence to such a measure.  

Perhaps what is most shocking about this continuing debate over protectionism in a time of crisis is its familiarity.  The United States tried raising barriers to commerce to get us out of a depression once.  It didn't work.  In 1930, as the country was entering the throes of the Great Depression, Congress passed the Tariff Act of 1930, which is more commonly known today as the Smoot-Hawley tariff.  Economists disagree over whether the Tariff Act turned a depression into the Great Depression, but they widely agree that the wave of retaliatory protectionist measures and 'beggar-thy-neighbor' policies in response to the Act lengthened and intensified the global depression.  Yet that lesson, which made it clear that global economic crises demand the removal of barriers to commerce, rather than their imposition, appears to have been forgotten by many. 

In order for an economy to thrive without vibrant international trade, it must have a domestic market large enough to support a nation's merchants and manufacturers.  In boom times, the United States could theoretically generate enough overall demand to sustain our economy, at least for a period of time.  In bad times, however, shriveled domestic markets are simply incapable of providing enough demand to sustain our domestic producers, and at the moment, the United States is facing a situation marked by, among other things, an astonishing slowdown in domestic demand. 

Though the entire global economy is enduring a sharp contraction in demand, access to overseas markets offer American producers opportunities that currently do not exist at home.  As the economy's collapse has continued, the purchasing power of U.S. businesses and consumers has dropped precipitously.  Businesses are struggling to invest and consumers are struggling to buy.  In early February, the Commerce Department announced what may have seemed like a nugget of good news amidst all the economic doom and gloom.  Unfortunately, it was not.  The Department announced that the U.S. trade deficit had dropped 4% in December 2008, to $39.9 billion, a 6-year low.  Considering all of the ink that has been spilled in recent years decrying our ballooning trade deficit, one could be forgiven for thinking that this was a positive development.  Certainly, restoring balance to our trade deficit -- by selling more goods in foreign markets and buying more from domestic markets -- is a worthy long-term policy goal, but that is not what actually happened in those final weeks of 2008 when the deficit fell.  Rather, our trade deficit fell because neither businesses nor consumers could afford to invest or buy, so as domestic demand plunged, the amount we imported dropped relative to the amount we exported. 

Since consumer demand, unlike trade policy, does not discriminate based on product origin, if American consumers and businesses lack the capital to purchase goods and services from abroad, they also lack the capital to purchase goods and services at home.  In fact, when money is tight, it is often demand for the American-made version of a good that falls first.  A manufacturer who imports textiles from, say, India, does so because they are cheaper.  If buyers cannot afford as much of the Indian textiles -- hence, the decline in imports -- they certainly cannot afford to fill the gap in their supply with the more expensive American version.  But, for the American seller of textiles that operates in a global marketplace, all is not lost when domestic customers cannot afford to buy.  They have access to a much greater volume of market participants, and they can look beyond American borders for customers that may still have sufficient purchasing power. 

If, on the other hand, demand for American-made goods and services were limited to American consumers -- meaning that U.S. producers had no alternative but to exclusively shop their wares in our withered domestic markets -- those producers would be in grave trouble and the country would now be in an even deeper economic hole.  Yet in the global economy, the sheer size of the marketplace means opportunity for American producers, particularly when our domestic marketplace is so constricted.  
 
Notwithstanding these facts, arguments favoring protectionism as a policy response to our current crisis keep cropping up in our national debate.  Those that favor raising barriers to trade argue that it is a means of stemming this devastating economic spiral.  If the government raises tariffs on imports, they argue, Americans will buy American products rather than their foreign counterparts, thereby jump-starting the domestic economy.  This argument, however, ignores the fundamental reality that any gains that accompany increased tariffs will be more than offset by a loss of access to the very markets that are currently keeping the U.S. economy from drowning and that will be critical to our eventual recovery.

Perhaps it is unfortunate, but barriers do not usually operate in only one direction.  If we want American producers to serve as the engines of recovery -- as job-creators and as investors -- then their access to global markets must be protected, but if we raise economic barriers our trading partners will naturally raise theirs. What domestic industry really needs right now is access to resources and as many potential buyers as possible, not privileged access to an atrophied marketplace.  We need friends in foreign capitals and we need markets for our products, and the adoption of protectionist measures are guaranteed to win us neither.  Now is the time to lower barriers to trade, not to raise them; to work with nations around the world to ensure our mutual survival, not to work alone and assure our mutual depression.