New Walls IV: The Developing World and the Rise of Protectionism

The rising use of restrictive trade measures around the world and political incidents like the trade disputes between China and the US show that the world order, which has been predominantly liberal over the last decades, is currently shifting towards protectionism. In this post, we discuss the role of restrictive trade policies and the possible economic consequences of increasing protectionism for developing countries. 

Although globalization has steadily grown over the last decades, the historical development of trade policy in the last century shows that protectionism rather than liberalization has been the norm for developed and especially less developed economies. In the case of developing countries, restrictive trade policies have been put in place as a means to counteract the deterioration of commodity prices, to save foreign exchange for debt payments, or as a development strategy embodied in what is known as Import Substitution Industrialization.

The fall of the Berlin Wall sparked hopes of a new, borderless and peaceful global society. Many developments since then fostered this dream, ranging from European integration and digital knowledge sharing to the rise of low- and middle-income countries into the ranks of leading world economies. 30 years later, we have witnessed not only the construction of new physical barriers, but also new divides like digital censorship, social media taxes, and protectionist trade policies. By barring goods, ideas and aspirations from spreading freely across countries, “new borders” contribute to unequal access to public goods, regional disintegration, disinformation, and disrespect for human rights. We ought to get to know them better – in our mini-series “New walls”.

Seeking the Gains of Globalization

However, globalization has rapidly spread across the world, particularly since the 1980s. Not only developed economies targeted trade liberalization as a growth strategy, but also many less developed economies that wanted to profit from economic integration. Developing countries in all regions of the world reformed their trade regimes in the direction of trade liberalization reducing and eliminating tariffs and quotas, simplifying import procedures or integrating themselves to international trade organizations like the WTO. According to international organizations and policy experts, the rapid economic growth of low and middle-income countries has been the result of this increased participation in the global economy.

Several factors pushed developing countries towards outward-oriented policies during this time. First, for many developing economies the 1980s and 1990s were decades of debt crisis, high and variable inflation, as well as of fiscal and balance-of-payments crisis. This led to high macroeconomic instability, which made the reconsideration and restructuring of internal and external economic policies necessary – trade liberalization was one component of this economic reform. Second, trade liberalization was also triggered, if not forced, by foreign creditors like the IMF or the World Bank. These institutions, serving as lenders of last resort for many countries in crisis, highly recommended trade liberalization reforms or made trade liberalization policies pre-conditions for structural adjustment loans.

Additionally, the international ideology of that time and the economic performance of industrialized countries also played an important role in the economic reform of less developed countries. On the one hand, this liberalization process developed in a moment of history where the world underwent an ideological shift towards market liberalism that contradicted active state interventions. On the other hand, the economic performance of industrialized economies showed that trade openness could be advantageous for an economy, not only in terms of increased productivity but also in access to greater resources and technology.

This process of liberalization has continued until these days. Developing and emerging countries have not only gradually opened up for commercial exchange, as their Bertelsmann Transformation Index (BTI) scores for free trade liberalization show, but have actively sought bilateral and regional cooperation through treaties and trade agreements among themselves (e.g. Mercosur and ASEAN) or with developed economies (e.g. trade agreement Mercosur-EU).

Relative Gains Trump Absolute Ones

Despite their rhetoric to support the global trade regime and its goal of further trade liberalization, governments in several developed countries have actually promoted a new rise in protectionism over the past decade. The reasons are manifold, but two stand out: Both on the national and on the international level the concerns for relative as opposed to absolute gains from trade have increased. In other words: The distribution of the economic and political global cake has become more important than its size.

On the national level, middle class incomes have been stagnating relative to top earners incomes, fueling skepticism of the benefits of globalization among major parts of the population. In many developed countries, this translates into growing support for protectionist political platforms, which reinforce these beliefs – or even put in place additional protectionist trade measures that, in turn, provoke retaliatory counter-measures from other states.

On the international level, globalization has become a victim of its own success. The integration of major emerging countries in the global economy has led to their economic and political rise. As a result, Western states have become more sensitive to how emerging economies use the multilateral trading system to become formidable competitors, even questioning whether the liberal world order still benefits its original founders and traditional upholders.

When Elephants Fight, it is the Grass that Suffers

The two tendencies mentioned above are most prominently on display in the United States. Skepticism of globalization and efforts to contain China’s rise have reached a new peak under the Trump campaign and administration. Its most obvious expression has been the instigation of a trade war with China, which has inflicted serious economic damage on both countries in the short-term and which is about to cause even more harm for the global economy in the medium-term.

In the case of less developed countries, there are two central channels through which the rising protectionism and specially the ongoing trade war can impact these economies:

1. The reciprocal introduction of various punitive tariffs on imports from the other country weakens the US and China’s economic development. If the world’s two largest economies suffer growth losses, both countries will import less – even from developing and emerging countries.
2. The weaker economic growth in the USA and China is dampening global economic development and world trade. As a result, global demand for raw materials is declining. For countries whose economies depend on commodity exports, this is a double disadvantage: they can only sell a smaller quantity for which they receive a lower price.

Moreover, the living conditions in developing and emerging countries can be seriously affected. Two aspects are of particular importance:

1. Fewer exports mean lower employment levels. An increase in unemployment is often a harder blow for those affected than in the industrialized countries. The latter have more or less stable social security networks to rely on, which mitigate the loss of income caused by job losses, the former not.
2. If commodity prices fall in the wake of reduced world trade due to protectionism, this worsens the so-called “terms of trade” of those developing countries and emerging markets that are mainly exporters of raw materials. These indicate how many units of an imported good the domestic market receives for one unit of its export good. A deterioration in the terms of trade due to protectionism means that the domestic population can consume a smaller quantity of goods and services. For people living in absolute poverty, this can be an existential threat.

Thinking ahead

Facing protectionism at an international level represents a large challenge for the developing world. However, how countries might face this challenge goes far beyond the interdependencies mentioned above. Less developed countries are highly diverse, making their comparison and, most importantly, the suggestion of countermeasures for the entire group difficult. Large economies like India or Brazil might be able to countervail some negative effects on their own, while smaller countries like Ecuador or Botswana might have to find multilateral solutions. Nonetheless, although it is too soon to estimate the real and individual impact of rising protectionism, it is undeniable that the potential losses for the developing world can be substantial.

Daniela Arregui Coka, Thieß Petersen and Thomas Rausch work in the Bertelsmann Stiftung’s Global Economic Dynamics project. They regularly publish analyses and comments on current international economic trends at www.ged-project.de.