Protectionism: The 'Crack Cocaine' of Economics Is On The Rise

Richard Fisher, the president of Federal Reserve Bank of Dallas, is known as one of the more independent (and sometimes less predictable) central bankers. He's no exception today. Fisher is blasting the rising threat of protectionist sentiment emerging in Washington, including some possibly dangerous anti-trade policies included in the stimulus package. He's reminding us that the "Buy America" provisions under review in the newly signed $819 billion stimulus plan could boost growth in the short-term, but anti-trade policies have long-term consequences. From Reuters:

"Let me just be blunt. Protectionism is the crack cocaine of economics. It may provide a high. It's addictive and it leads to economic death," Fisher told C-Span television in an interview for its "Washington Journal" program.

President Barack Obama seeks a $825 billion stimulus plan to end the country's yearlong recession. U.S. lawmakers are debating rules that will insist that public money is spent on U.S-made products, although the White House has already said it will review any Buy America provisions.

"We just cannot afford to go down that path and I hope our senators, Democrats and Republicans, will be very sensible on that front," said Fisher, who is not a voting member of the Fed's policy-setting committee this year.

For more, watch Fisher in that C-Span appearance here. The temptation of protectionism is obvious. There's no denying that protecting jobs and output at home is a simple, effective message during tough economic times. As the lending crisis spreads around the globe, such sentiment pops up again and again. Merrill Lynch economist Richard Bernstein also sees protectionism on the march, and not just in the U.S. From a recent note, where consolidation and protectionism are the twin results of a troubling mix of over-capacity and slowing growth:

Protectionism is the natural political response to consolidation.

Politicians tend to fight consolidation because employment tends to decline during periods of consolidation. Interestingly, though, the protectionist trend is gaining strength much faster than we thought even just a few weeks ago.

The latest protectionist plan appears to be in Japan.

Our Japan Strategist, Masatoshi Kikuchi, highlighted in a note yesterday that the Japanese government announced that it will use public funds to provide capital injections into major companies. He further notes that such government support is becoming more common, and cites the US loans to GM, Taiwan’s support for DRAM manufacturers, and China extending financing to automakers. Kikuchi expects Japan to support its major electronics and auto companies. To qualify under the plan, companies must show plans to increase productivity and improve balance sheets.

Additionally, the latest versions of the US fiscal stimulus package contain provisions regarding “domestic content.” While the knee-jerk reaction might be that prices will increase, it is hard to believe that non-manufacturers will be raising prices in light of these provisions. Margins will be under pressure around the world, as firms fight for the remaining market share.

Basically, you can use protectionist policies to fight off outside competition but there's no guarantee that propping up domestic companies at the expense of trade will boost the economy. Further out, it could be damaging. At a time when the stock market is already dealing with more uncertainty than anybody wants, adding new rules that punish efficiency and innovation are the last thing investors want to see.