Not every nail needs hammering with trade policy

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The writer is leading a review of international development for the UK government and is a member of the House of Lords

Trade policy is probably the area in which the views of the public and those of economists diverge most substantially. Polls in the US regularly show that the majority of people think that protectionism is a good thing, whereas only a minority of professional economists would agree. But when asked if they would be willing to pay more for goods and services in order to have more domestic production, people tend to change their minds.

Public opinion is one reason why politicians sometimes reach so quickly and easily for tariffs and other trade restrictions as a solution to many problems. But so is the fact that even though there are many better alternatives to tariffs for achieving growth in jobs, industrial development, fairer outcomes and national security goals, these are often harder to sell to voters. So it is easy to opt for the politically expedient but often ultimately ineffective imposition of tariffs, provision of subsidies and state aid, and localisation of public procurement.

Some current supporters of trade restrictions have a zero-sum view of the world and reject the classical arguments for the gains from trade that originate in the work of David Ricardo and Adam Smith. They ignore the fact that a rules-based trading system has contributed hugely to prosperity and poverty reduction, especially for developing countries. Since 1990, global trade has contributed to a 24 per cent increase in global incomes, including a massive 50 per cent gain for the poorest 40 per cent of the world’s population. 

Supporters of trade restrictions often also fetishise trade deficits and manufacturing exports. But trade deficits are not a problem if they can be financed sustainably and are often a consequence of other macroeconomic imbalances. And there is nothing better about dollars earned from manufacturing exports than dollars earned from services exports.

More interesting are those who believe in economic openness but want to use trade policy to achieve other objectives such as competitiveness, redistribution of incomes, climate change mitigation or national security. In most cases, however, there are better ways to achieve those worthy goals than through trade policy.

Consider the case of industrial policy, where a variety of trade restrictions have been imposed in the US and elsewhere in the hope of achieving competitive advantage in industries such as electric vehicles or chips and artificial intelligence. The history of such industrial policies is long and the successes have arguably been fewer than the failures. But the main point is that there are much better and more successful policies to build competitiveness, such as financing research and development, building a skilled labour force and providing incentives for investment.

Using trade policy as the answer to regional inequality and income inequality is far less effective than building a proper social safety net and investing in declining regions and in people. Countries that have adequate safety nets and policies that help workers reskill and adjust to economic change experience far less protectionism than those that allow global shocks to be felt across the population. It is possible to build safety nets that act like trampolines — enabling workers to bounce back with support that kicks in early and comprehensively to support incomes and also gets people into new jobs.

As for accelerating progress to address climate change, it bears repeating that the most efficient way to do this is through a carbon tax with a rebate to protect the poor. Trade restrictions, such as local content requirements or tariffs, make it more expensive to transition to a green economy. Some argue that new green technologies will emerge behind protectionist barriers. But targeted subsidies to research and development would do a better job of making that happen. If we want to address the urgent challenge of climate change, we should focus on policies that make it cheaper and faster to deliver emissions reductions. Similarly, national security is better served by diversifying supply chains. In other words, we need more trade not less. 

Trade policy is first and foremost about fostering competition to create growth and jobs and to serve consumers efficiently. In most cases, there are better alternatives for achieving competitive industries, fairer income distribution, mitigation of global warming and national security objectives. As the old saying goes, “use the right tool for the job”. Not every nail needs to be hammered with trade policy. A bigger and more varied toolkit would get the job done better and preserve the global trading system that has done so much to improve lives in recent decades.