Protectionism could trigger global conflict

The following is my latest comment from Fund Strategy.

The proposed bail-out of Detroit’s big three car manufacturers raises several potential problems.

For a start it raises the question of what capitalism means. Generally market economies are characterised by substantial private sectors. The state usually plays a role in the economy but its ownership of business assets is limited. Now it seems that even in America, generally seen as the world’s pre-eminent market economy, key parts of the financial and auto sectors could soon be in state hands.

This in turn raises the question of the soundness of state finances. The more governments spend rescuing troubled companies the more their finances are likely to suffer. At some point they are likely to have to pay a high price in terms of higher taxes, reduced public spending or a combination of the two. They may be able to postpone the day of reckoning by increasing public borrowing but at some point their time will come.

But perhaps the biggest problem, and probably the least understood, is that of protectionism. Rescuing, say, General Motors (GM) raises the question of public money for other car makers such as Fiat, Toyota or Renault. Each could make a case to their own national governments that GM has an unfair advantage owing to its access to Federal funding. To make matters worse Barack Obama, the president-elect, has shown leanings towards protectionism with his criticisms of the North American Free Trade Association.

Protectionism is often wrongly understood as simply relating to tariffs. Yet there are many ways that states can back their own home-based companies besides tariffs. Providing subsidies of various sorts is probably the most important.

The rise of protectionism could easily undermine international cooperation. As economic circumstances get harder it could become increasingly difficult for countries to cooperate. The recent row between European Union countries over guarantees for retail bank depositors could be a sign of things to come. And the spat between Britain and Iceland could be a forewarning of larger-scale conflicts.

Of course all countries maintain some interest in international cooperation. Nobody is likely to benefit from all-out economic conflict. But the more protectionism takes hold the harder it will become to resist the forces pushing the world towards international rivalry.