Closing the Door on Free Trade

Why all the talk of protectionism?

Because over the last few months, global free trade has appeared under threat on a number of fronts: the World Trade Organisation (WTO) meeting in Cancun in September collapsed without agreement after a group of 21 developing countries walked out in protest at the lack of progress on agricultural reform. It is now highly unlikely that the Doha round of trade talks will be completed on schedule. Instead, the US and EU are focusing their efforts on securing bilateral trade deals that circumvent the WTO altogether. Meanwhile, the US has introduced a number of protectionist measures that appear to be a flagrant breach of WTO rules. Last year, it introduced tariffs on steel imports. And last week, it imposed import quotas on various Chinese textiles, including bras and dressing gowns. The fear is that other countries will respond to this protectionism with retaliatory measures, leading to a full-scale trade war.

Why is the US introducing tariffsPartly to protect key industries. The US steel industry, for example, is bankrupt and would probably disappear altogether if left to face market forces. This would be a disaster for the hundreds of thousands of current and former steelworkers whose pension and healthcare rights are tied to the fortunes of the steel industry. But the import quotas on Chinese textiles owe more to politics. The US is becoming increasingly worried about its vast trade deficit, much of which is accounted for by imports from China. The US believes that the deficit has grown so large because China keeps its currency artificially low by pegging it to the dollar at the wrong rate. America has been trying to cajole China into revaluing the Reminbi to enable the deficit to shrink, but so far it has refused. Slapping quotas on Chinese imports is, therefore, an attempt to shrink the trade deficit by other means.

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Is the US in breach of WTO rulesThe US claims not. It says that both its steel tariffs and import quotas for Chinese textiles are justified under WTO rules that specifically allow countries to take temporary measures if a domestic industry is threatened by a sudden surge in imports. The steel tariffs were introduced to give the US steel industry breathing space while it restructured and were originally designed only to last 18 months. But the WTO has now ruled that they were not justified under its temporary measures rules and have ordered they be removed. The import quotas on Chinese bras, dressing gowns and other fabrics also followed a surge in imports. Few commentators think the WTO will decide that these are legal either.

Who benefits from these tariffsThe tariffs are estimated to have brought the US steel industry $240m of extra income and saved 5,000 jobs. These benefits are largely concentrated in the four main steel-producing states: West Virginia, Ohio, Indiana and Pennsylvania - all targets for Bush in next year's election. But there are many more losers than there are winners. The Institute of International Economics estimates that higher tariffs have cost steel users $600m in lost profits and 26,000 jobs.

How will the rest the world respondThey may hit back with tariffs of their own, raising the spectre of a trade war. EU Trade commissioner Pascal Lamy says that if the US has not lifted its steel tariffs by 15 December, the EU will impose tariffs of 8-30% on $2.2bn of US imports. The EU has drawn up a list of industries to hit with its tariffs, including orange juice and jeans. Similarly, China may also respond with tariffs of its own against US imports. A trade war between China and the US would have huge global ramifications, since between them the two have accounted for half the growth in global GDP in the last five years.

Are there other ways to tackle the US trade deficitThe best way would be via a gradual devaluing of the dollar, as this raises the price of imports and lowers the cost of exports. To a certain extent, this is happening already: the dollar now trades at an all-time low against the euro. But there are two problems with this. First, many of America's most important trading partners in Asia and Latin America peg their currencies to the dollar too, so if the dollar falls, their currencies fall. This means that the sort of devaluation needed is hard to bring about. Second, there is a risk that the dollar falls too far too fast, thereby triggering a sharp rise in inflation, leading to higher interest rates and a stalled global recovery.

Where does all this leave the WTO?

In the current climate, an early resumption of the Doha round of trade talks looks highly unlikely. The group of 21 developing countries that blocked a deal at the Cancun meeting in September appear to be hardening their demands, and it would most likely take a significant gesture by either the EU or US to restart the round now. The EU has decided to leave its own agricultural subsidies intact until at least 2007, while the US is unlikely to remove its subsidies in an election year. The upshot is that, as further trade liberalisation under the WTO looks unlikely, both the EU and US will continue looking for bilateral trade deals, hence paving the way for regional trading blocks.