The rhetoric of favouring local firms with trade policies cuts no ice with students of history. Such favouritism—which essentially involves taking unilateral policy measures that discriminate one way or another against foreign rivals—is undesirable for at least two reasons. First, it distorts competitive processes at home—which means it slows down the process by which successful domestic firms destroy failing local firms that cannot match the winners’ salary offers and terms for suppliers. As a result, precious national resources—talent, capital, and the like—are trapped in lower value-added activities, which holds back the nation’s productivity and economic growth.
Second, discrimination at home—especially by medium and large economies—encourages copycat behaviour abroad. For some reason, politicians are more susceptible to arguments for protectionism when other governments have the first move, as if two wrongs make a right. Smarter political leaders would propose even-handed supply side reforms that would enable local firms to compete more effectively against protected foreign rivals. Of course, copycat behaviour typically harms the commercial interests of trading partners including, potentially, the government that kicked off the spiral of unilateral discrimination.
Protectionism strikes back
Yet, despite these truths discriminating against foreign commercial interests is pervasive. There are two principal reasons for this. One is that favouritism has little immediate adverse impact on an economy—the damage cumulates over time and most voters don’t recognise that. Second is that domestic and foreign opponents to unilateral discrimination are often starved of the proof necessary to act against those local commercial interests that cannot stand on their own two feet.
This is not the place to go into depth as to why national policy is not transparent and why the WTO rules on transparency have fallen into disrepute. For sure, there are some areas where transparency is better but ultimately the current system is not fit for purpose. To anyone who disagrees with the last two statements, they can make themselves look ridiculous by arguing to the contrary. The facts are clearly on the side of those worried about a non-transparent trading system.
In light of these realities, what form does unilateral trade discrimination take and how much trade does it cover? Here I draw upon the 13 year-long evidence collection exercise on unilateral trade policy intervention undertaken by the Global Trade Alert team, headquartered in St. Gallen, Switzerland. This independent monitoring initiative—which in the interests of transparency I established—has documented over 44,000 policy interventions worldwide since 1 November 2008. Over 60 different types of policy intervention have been identified. Trade liberalising measures as well as those that discriminate against foreign commercial interests (deemed “harmful”) are found in the database. The latter outnumber the former by at least four to one—which hints at where this argument is going.
The harmful policy intervention in force on 1 October 2022 covered over 80% of world goods trade. Similar estimates for services trade and FDI aren’t available because no public sector international organisation assembles granular information on cross-border commerce beyond physical goods. Still, the total value of world goods trade is shy of $20 trillion, which is significant.
Figure 1 also provides a breakdown of how much trade is unimpeded and what shares of trade have been hit by 1-5, 6-10, 11-15, 16-20, 21-25 and 26 or more times. Standard approaches were used in these trade coverage calculations as was the most granular international trade data available. The findings are depressing. For example, over 28% of world goods trade currently faces six or more trade distortions—revealing just how difficult life is for many exporting firms.
Subsidies as the most used barrier
Underlying these statistics is the sustained build-up of discriminatory policy intervention since the Global Financial Crisis. Put bluntly, this has not been an era of free trade, of neoliberalism etc. It has been an era of pervasive and growing support for local firms over foreign rivals.
Two forms of subsidies account for the largest coverage of world trade with discriminatory policy. To analysts of agricultural trade policy, the notion that domestic and export subsidies can distort cross-border commerce, misallocate national resources, and limit market access is well accepted. In a nutshell, thanks to sustained support of manufacturing firms since the Global Financial Crisis, we are now in the same place with non-agricultural shipments.
Subsidies to import-competing firms are in products and markets that cover 41% of world goods trade (see Figure 2). State-provided export incentives—typically in the form of tax breaks—cover 64% of world trade. These statistics only refer to corporate subsidies—state payments to individuals, transfers to local and other sub-regional governments, and even payments to firms to keep their employees idle during the pandemic do not count towards these statistics. In contrast, transparent forms of protectionism—such as taxes on imports—cover less than 19% of world goods trade at the start of October 2022.
Others have noted the subsidy build-up, although they have often framed the matter in terms of bailouts. After reviewing evidence of resort to subsidies by many Western governments in its 1 October 2022 edition, The Economist noted “For now, governments are unlikely to change course. So long as they are not directed at banks, bailouts tend to be popular.” Looking forward, this magazine noted “When the next recession hits, as it may well soon, expect another round of furlough schemes, additional benefits, and stimulus cheques. When the next industry fails, expect a rescue package. We are all bankers now.”
From the perspective of the functioning of the world trading system, it is worth repeating that only corporate subsidies that confer a competitive advantage on selected firms potentially engaged in international commerce are a problem. Selectivity can take many forms: a subsidy could be sector-specific, region-specific, activity-specific, sourcing-specific, and even firm-specific. Government money spent on national infrastructure, on schools and universities, and on public goods enjoyed by all is not controversial and does not influence any of the statistics reported in Figures 1 and 2.
Firm-specific subsidies are the preferred tool for government favouritism for at least three reasons. First, they are less costly than sector-specific subsidies and the recipient of the state largesse is happy to have a commercial advantage over domestic rivals as well as over foreign competitors. Second, subsidies take many forms and if direct immediate payments are not made to a firm from the government budget then, even in democracies that purport to have good governance systems, there are plenty of ways to hide subsidies.
Third, governments can create agencies (such as state development banks) that issue subsidies and are kept off the central government’s balance sheet. Moreover, reporting requirements for such semi-detached arms of the state are often scant. Contrast all these reasons with that of raising an import tariff. Only a government—such as Donald Trump’s Administration—that wanted to trumpet a tariff increase to domestic constituencies would brazenly antagonise trading partners and domestic buyers of the imported goods being taxed more highly.
A trade distortion to be dealt with
In conclusion, corporate subsidies cover more goods trade than any other trade distortion. After painstaking evidence collection sustained over many years, this claim can now be defended convincingly with evidence. The next question is: what to do about this problem? Pessimists argue that growing geopolitical rivalry and the desire on the part of some countries to assume or retain technological leadership will lead to ever more subsidy races, as we are arguably seeing now in semiconductors.
Optimists expect subsidisation to continue for some time but each subsidy becomes a negotiating chip to be bargained away in some global deal restraining awards of state largesse. Such a negotiation would not be easy and it would have to take account of a small number of circumstances where resort to subsidies is legitimate public policy. But such a negotiation is necessary—lest the remaining benefits generated by the world trading system are eaten away by subsidy-related termites.