Assault on free trade a key political risk

By Andrew Marshall, Asia Political Risk Correspondent

SINGAPORE (Reuters) - As the world plunged into the Great Depression eight decades ago, governments tried to stem the damage by erecting trade barriers, and only made the crisis worse. The risk is growing that history will repeat itself.

The specter of beggar-thy-neighbor protectionism has emerged as a key global political risk in 2009. In the major industrial economies and in the developing world, faith in the benefits of globalization is being replaced by growing pressure from labor unions and corporate leaders to curtail free trade.

It is a classic example of the Prisoner's Dilemma -- it is in the interests of individual governments to try to safeguard domestic industry and keep key interest groups happy, but the overall result will be an even more painful global slump.

"Politicians struggling to develop a coherent policy response to the crisis, and in many cases also struggling with falling popularity ratings because of the worsening economic climate, will doubtless exploit the fact that foreign trading partners are an easy target," an Economist Intelligence Unit analysis said.

As in the 1930s, there is no effective global institution that can coordinate policy and escape the dilemma.

"We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty," the G20 declared after its November summit aimed at agreeing a global response to the crisis. Nations pledged not to raise trade barriers for 12 months and to revive the Doha round.

Yet Russia and India soon increased tariffs. There has been no movement on Doha. The G20 summit was billed as a historic meeting of countries representing 90 percent of global GDP, but clearly could do little to prevent the slide toward protectionism.

"The financial crisis exposed fundamental flaws in global governance," the World Economic Forum said in its 2009 Global Risks report this month. "Global risks know no borders and global solutions are also beyond the realm of any one government."

There is wide agreement among analysts that protectionism will worsen the crisis this year. The only question is how much.

The Economist Intelligence Unit forecasts global merchandise trade will contract 1.5 percent, assuming moderate protectionist measures. But, it added, "a more aggressive move against free trade could further undermine global economic conditions and prolong the downturn".

WASHINGTON AND BEIJING HOLD KEY

The key factors determining how far free trade will retreat will be the policies of two countries -- the United States and China -- and whether they can avoid a serious falling out.

The incoming U.S. administration is widely seen as leaning toward protectionism, raising fears of a repeat of the infamous Smoot-Hawley act of 1930 that worsened the Great Depression.

But several analysts say protectionist rhetoric during the campaign may not translate into destructive policy, citing the makeup of the cabinet and President Barack Obama's key advisers.

"Obama's cabinet nominations ... seem aimed at striking a balance between supporters of liberal markets and members who may be more skeptical of the merits of free trade," said Alastair Newton, political analyst at Nomura.