The Return Of Protectionism & Why It Is Bad News
One of the major themes that we would like to focus on this year is that the abrupt and significant pivot to zero sum economic.
By "zero sum thinking" we mean that we are moving sharply away from a world where there was a "win-win" mentality to economic growth and instead one where "your win is also my loss" predominates.
This is a huge mistake as it completely ignores one of the most fundamental tenets of economic orthodoxy - the power and virtue of free trade. The notion that unfettered trade can bring absolute benefits to all parties involved is not just under fire but suddenly finds itself almost bizarrely unpopular.
It is important to recognize that this new trend has profound consequences for investing, for the economy and even for how our society works. It is concentrated in the fashion for encouraging "green investment" and the carbon transition but will quickly find adherents elsewhere.
We will look at this in a few ways in the coming months but for now let us begin with the basics.
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Another way to frame this is that we are all protectionists now.
That is a shocking thing to write. It is even more shocking to realize how uncontroversial this (negative) development has become. In fact, the below argument would be viewed in many circles as either laughably out of touch or dangerously attached to the "neoliberal" paradigm.
The populist wave of the last few years has, on both the right and the left, had an incredible and surprisingly easy victory in discrediting laissez-faire capitalism.
In the end we will discover that our turn to populist "interventionism" is an error, the only question is how big of one it will be.
The Ricardian idea of comparative advantage (from the famous classical economist David Ricardo) is not just under threat, it has been canceled. One of the greatest means of wealth creation in human history is not just flawed but wrong.
Ricardo's idea was that a country or a firm should specialize to its own advantage and thereby everyone will profit more than they would have otherwise. It has been proven mathematically that, when it comes to trade, 1+1 can, in fact, equal 3 or at least more than 2.
Suddenly, that assumption has gone from being a core tenet of our political economy and a goal of much of global policymaking to now being studiously ignored by those who should know better. This essential and hard won truth has rapidly been forgotten by the political elite as well as many academics, journalists, policymakers and business leaders. We will almost certainly regret it extremely.
This anti-laissez faire and pro-zero sum approach is newly and impressively bipartisan in the US. The left assails the plight of the "left behind worker" sacrificed for better profits while the right attacks free trade as unpatriotic and risking our national interest for a marginally cheaper cost of living.
The former forgets that (all) workers are consumers as well, while the latter seems to ignore that the Cold War (and much else besides) was won by offering a system of free trade that all countries could sign up to regardless of creed, wealth or, most importantly, size.
Laissez-faire capitalism and free trade won because it was flexible, self-regulating and a big tent welcoming to all: Christian and Muslim, big and small countries, European or African. All could just compete at what they were best at and find interested customers. It also delivered.
Yes, it was more complex than that and yes, there are drawbacks and mistakes were made with truly unfettered trade and globalization but that ignores the hundreds of millions dragged out of subsistence penury and tremendous decades long economic boom.
Regardless, today, we are in the process of committing such serious and lasting errors to the international system of commerce that we have laboriously built up over a century of pain staking multilateralism that the nuances are just not that important at present.
Nuances have been made irrelevant while we casually ignore the painful lessons of the last several hundred years.
We have never had a perfectly system of free made two categories of errors in the last decade. Helpfully, they have occurred on both sides of the political aisle.
The first was that the Trump Presidency brought back trade tariffs as an economic weapon of political competition.
The second and perhaps larger error is the Biden administration's decision to make industrial policy and massive subsidies a huge part of its Inflation Reduction Act.
Both of these policy paradigms will cause significant problems.
Now, it is true that we are not calling it protectionism of course. In a truly modern flourish we have rebranded the concept as an amalgam of "industrial policy" and protecting "strategic" assets and sectors.
That might be true in some extreme cases but overall it is a weak argument without a lot of evidence and the future downsides will be significant.
Even worse, we have found a way to marry "strategic" with "green" in our "existential" battle with climate change. The virtue inherent in this moral angle will make these bad ideas even harder to refute and rubbish.
And they are bad ideas, make no mistake about it. The worst part is they will create a very corrosive set of incentives.
Prediction:
Very quickly we are going to find out that lots of industries are "strategic."
After all, what are companies and their executives implicitly encouraged to do?
The cry around today's semiconductors and artificial intelligence technology firms are going to slowly (rapidly?) spread to other parts of the economy. Automobiles, agriculture, steel, energy, healthcare, even software could claim the mantle of being vital to the national interest.
What could be more strategic than food? Perhaps medicine? Childcare?
Provided this projection comes true there will be several very predictable consequences:
The first is that these policies will prove to be very, very expensive (see next story) and also incredibly difficult to undo.
The second is that they will distort the economy.
And third, this sets off a race to the bottom as countries and industries go tit-for-tat desperately trying to stay competitive against the subsidies provided elsewhere.
The first point is covered in greater detail below but is obvious on its face. The reason free trade works so well is that a country can receive the goods it wants at the best possible price - including better than it itself can achieve. You can make wine in Canada but it is far more sensible to grow the grapes in Italy and trade timber or oil or bauxite or Arcteryx jackets for them.
Further, if you somehow restrict the ability of free trade - via tariffs, subsidies, non tariff barriers such as ludicrously high safety standards or shifting labelling requirements - then you will be paying more for goods than you otherwise would.
In our case we are not just paying more than we should. We are setting up a structural system that will be devilishly hard to undo. We are still laboring under an agricultural subsidies system that dates from the Second World War....
The second point is that a system of trade protectionism and especially the massive subsidies set up by the misnamed Inflation Reduction Act provide a very distorting signal to market participants.
Rather than competing on the global stage to build the best possible product companies will instead cluster around trying to get the government to support their company or project or product. You are not looking to attract customers or find product market fit, you are looking to attract public financial support. The incentive structure is therefore all wrong if you want to build great products. It is right if you want to create deeper public
There is a second and related issue that this co-dependence also encourages corruption. After the Global Financial Crisis we were horrified to discover the revolving door between financial regulators and Wall Street's biggest banks. What, exactly, do we think a gigantic national subsidy scheme for "green" industries will do?
It is like finance but without the greedy over tones. That may be a big problem because it will make it harder to get rid of.
You will also get inferior products because, of course, what matters is not the quality of the goods but the nationality of the producer. Anyone who drove in cars built in America in the 1970s and 1980s will be familiar with what happens when industries are coddled and protected.
For those who didn't have the pleasure we have two words for you:
Most disturbingly though less appreciated right now, is what this all does to the incredible international system of trade laboriously constructed over the last 30-40 years. This architecture was always imperfect and also had drawbacks but it was also the greatest wealth creation mechanism of all time not least because it allowed small countries and companies to compete on the global stage with giants.
Nothing has supported the West's system of international norms and values more than the fact that any country could sign up and hope for a reasonably fair shake. We routinely buy Korean smartphones and clothes from Bangladesh, not just Chinese made iPhones and German automobiles.
We will return to this specific fact in the coming weeks.
In 2021 we learned that inflation was not "dead" and could in fact, come roaring back. In 2022 we regrettably re-learned a very important lesson about might not making right. In the years to come we will almost certainly relearn that government bureaucrats aren't great allocators of capital no matter whether the reason is the industry is "strategic" or simply "big and important."
Until then the taps are open and boy is the money flowing. For a closer dive on that subject we turn to one of the most popular new protectionist crusades.
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