Protectionism would be a disaster no matter what Stephanie Flanders says
Stephanie Flanders (BBC Economics Editor) has posted a worrying entry on her blog arguing that the Great Depression was caused by a collapse in global demand not by protectionism. Flanders is clear she is not a protectionist, she just wants to set the historical record straight. She argues that it was attempts by nations to shrink domestic demand for imports in order to protect their gold reserves that really caused the Depression rather than US tariff barriers. But I think this is to draw a very narrow definition of protectionism. Any unilateral action by a government to protect its own economic or financial position at the expense of others can be protectionist, or can at least amount to a “beggar-thy-neighbour” policy. Such policies presents a very high risk of global economic decline if everyone pursues the same approach. So to argue that protectionism did not cause the Depression because the evidence suggests that US tariff barriers did not cause the Depression is misleading.
The argument made by Flanders is worrying because this sort of analysis will be seized on by those who will argue for protectionist measures over the coming months. This is a real concern because whatever the economic facts, the rise of protectionism in the 1930s also ramped up political tensions between nations creating a very sour international environment which contributed to the conflicts which led to the Second World War. I have no doubt that a serious drift to protectionism now would have an even bigger impact on jobs across the world than the current slowdown in demand, particularly in China and the rest of Asia, which could easily lead to the rise of ultra-nationalist sentiment and to serious international tensions.
The obvious political lesson of the 1930s is that we have to find a solution to this crisis based on international co-operation and co-ordination not unilateral policies which save national economies by destroying others. A fact, to be fair, Flanders does ackowledge.
However, there are two other points Flanders makes which need to be scotched.
Firstly, she quotes the Milton Friedman argument that what caused the Depression was the failure of the US Federal Bank to inject capital into the collapsing banking system. This is a case of free market economists having their cake and eating it. For them economies only grow when the market is given free rein but they only collapse when the state fails to come to their aid. The truth is the Fed failed to react adequately to the banking crisis but it didn’t cause the Depression. Just like today, an under-regulated and self-serving financial sector went into meltdown and dragged the world down with it.
And just like today, you won’t have to go far to find economists and bankers who claim the cause of this crisis is the weak monetary policy of the USA. It’s important to resist this line of argument because it will be used to prevent future constraints on the financial sector. And to come back to the earlier point, I can imagine some politician sooner or later saying that protectionism is fine so long as you have the right monetary policies in place because it’s the latter that causes Depression not the former.
Secondly, Flanders claims that Keynes argues for protectionism in his essay National Self Sufficiency which I have mentioned elsewhere. This is a terrible line of argument because with Keyne’s credibility as an economist higher than it has been in decades, we must be careful not to present him in a way that allows him to be used to legitimise protectionist arguments. In fact, in that essay, Keynes is very clear in his rejection of the protectionist policies of the 1930s:
In those countries where the advocates of national self-sufficiency have attained power, it appears to my judgement that, without exception, many foolish things are being done.
What Keynes is actually saying is that given that the free trade approach has made such a mess of things and we don’t really know yet what may replace it, it may be time to allow a series of national economic experiments to bloom to find out the best way forward and this may involve some national isolationism. But he is clear that if we do do this, it has to be a very careful slow process:
Yet, at the same time, those who seek to disembarrass a country of its entanglements should be very slow and wary. It should not be a matter of tearing up roots but of slowly training a plant to grow in a different direction.
Keynes reveals a certain naivety in this essay but by the time we get to the post-war period, there is no doubt that Keynes prefers an ordered and well-governed form of global trade. Indeed, he argued hard at the Bretton Woods conference for a radical new approach to global economic governance that would reduce global economic instability and render protectionism unnecessary. Unfortunately, the US vetoed his plans and we are still paying the price today – more than ever maybe.