Bailouts and protectionism - the slippery slope to Depression

To almost everyone, it seems obvious. When the economy is turning down, it's better to spend your money close to home. If the jobs of Canadian workers are threatened, then isn't it best to buy from local businesses, even if it costs a little more?

Last week I found myself thinking that same way. The heels of my aging hiking boots - perfectly suited to the slush of Toronto winters - were getting rounded. The shoe repairman across the road from the CBC said he could carve out a heel-shaped hole in the one-piece soles and glue in a new heel. But it would cost me $40. Outrageous. But I reassured myself that at least the 40 bucks was going into the pocket of a local business, rather than to an overseas shoe factory.

Strange to say, this way of thinking is blamed for helping to create the Great Depression.

I don't refer to my urge to be a cheapskate, which also hurts the economy.

More significantly, I was leaning toward the great evil that many economists say helped to turn the Depression into the Great Depression: protectionism. And despite all the warnings, it appears to be happening again.

Building barriers

China and the new Obama administration have exchanged veiled threats of a trade war. Russia has tacked on tariffs for imported cars, leading to riots in Vladivostok. Businesses and workers around the world are demanding that their industries should be protected from foreign competition.

Even though we don't yet have another Smoot-Hawley Tariff Act, which helped seize up trade in the 1930s, the early signs of protectionism are showing.

In a race to the bottom, many countries are letting their currencies fall in the hope of selling more abroad, while convincing consumers to shop at home.

Driving your currency down is one thinly disguised barrier to trade. A cheap Chinese yuan, for example, makes China's goods cheaper around the world, while making foreign goods more expensive in China.

But China is not the only one playing that game. In a race to the bottom, many countries are letting their currencies fall in the hope of selling more abroad, while convincing consumers to shop at home.

Another hidden trade barrier is the bailout.

As the World Trade Organization has warned, bailouts for car companies, aerospace companies, banks and many others could also be seen as unfair subsidies, giving the bailed-out company an unfair price advantage in world trade. The WTO says it could lead to tit-for-tat action by other countries.

That's why U.S. auto bailouts were immediately followed by similar announcements around the world, even in Germany where the car industry is relatively strong, and in China where manufacturers already have lots of advantages - including their low currency.

Is local the best buy?

"Buy local" campaigns do something similar.

In the U.S., Massachusetts businesses have gathered together to create a new currency that gives you 10 per cent off on everything bought locally. As I write, Congress is considering putting "Buy American" provisions on its massive government spending campaign.

Whatever methods a country uses, it is obvious that if people spend their money at home, they will spend less abroad. Already world trade is declining. Ships that until recently were carrying goods around the world are being moored in out-of-the way inlets.

In the Dirty Thirties, world trade collapsed. And protectionism, by whatever name, made things worse.

To some people, the idea that declining trade hurts the world economy is obvious. But the mechanics, as explained by economic theory, are a little more difficult.

Let me offer a homey example of trade's advantages.

My partner and I both cook, and we both walk the dog. My microwave-brown-rice-and-eggs is the best hot meal you can make in two minutes. My wife walks the dog on-leash and on-sidewalk.

But there is no doubt that for really good food, with variety from mango curries to mom's Irish stew, for dishes that need many pans, spices and chopped vegetables, my wife is the winner. And if you want the dog completely exhausted, having raced through deep snow and chased squirrels and sticks, I am the guy.

Even though we can, and do, both jobs, our family life is made richer by me doing more dog walking and my dear spouse doing more cooking. In the crassest terms, I trade units of superior dog walking, which I can generate myself, for units of superior cooking, which I can't.

If we were to divorce, I would have a well-walked dog, but a boring diet. I would be forced to eat meals out. My wife would eat well, but the during the weeks she had custody of the pooch, it would be restless and inclined to chew shoes. She would have to hire a dog walker. By ending our trade, we would both be poorer. This principal, described by the English economist David Ricardo around 1800, is called Comparative Advantage.

Economists insist that in a recession, no matter how bad it gets, cutting off the advantages of trade just makes the situation worse.

Trading countries, like partners in a marriage, may be able to make all the same products. Of course in international trade, there are many, many countries, and within each country many manufacturers.

The benefit comes when everyone trades the products they make best.

Ricardo talked of French wine for English cloth, but in the modern context it's RIM BlackBerrys for Taiwanese computer monitors, Canadian maple syrup for Belgian chocolate, and Canadian ginseng for Thai Rice.

It is a confusion of trade so complex that no central authority can keep track - but the same principle applies. Putting our efforts into what we do best, and selling it, while buying the things we want at the best price, wherever they are made, makes us all richer.

Economists insist that in a recession, no matter how bad it gets, cutting off the advantages of trade just makes the situation worse.

The trouble is, of course, that understanding the advantages of trade and comparative advantage may not save us. Even the word "protectionism" implies that it's not our country being the bad guy. Heck, we're just protecting ourselves from all those other unfair traders.

In broken trade, just as in a broken marriage, it's always the other side's fault.

Don Pittis has reported on business for Radio Hong Kong, the BBC and the CBC. He is currently senior producer of CBC News Business.