The case for protectionism (sort of)

Paul Krugman adds some nuance to our recent discussion on protectionism and the stimulus:

"...one part of the problem facing the world is that there are major policy externalities. My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt. As I explained a while back, this means that the bang per buck on stimulus for any one country is less than it is for the world as a whole.

And this in turn means that if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere.

Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap."

Krugman is quick to point out that this is not an argument in favor of long-term protectionism or even that protectionism is the best possible policy. The crux of his argument is the last sentence of the quote: the negative effect of a tax (like an import quota) is smaller than the negative effect of unemployment due to reduced total output.

Do some countries free ride on the fiscal stimulus of their partners? Probably. So in that sense, anything that encourages coordinated stimulus is a good thing. The clear downside is the risk of a trade war. Hopefully, we now have the global regulatory structure in place (such as the WTO) to prevent things from devolving into a situation like we saw in the 1930s.

I'm more pessimistic than Krugman about the potential for a trade war; but then again, he just won a Nobel Prize for his work on trade theory.