ANALYSIS: The End of Globalization and Protectionism’s Rise

Prime Minister Pedro Sánchez of Spain speaks with the president of the World Economic Forum Børge Brende at the World Economic Forum Annual Meeting 2023 in Davos, Switzerland (Flickr). 

“You’re hurting my country.”

French President Emmanuel Macron’s blunt statement in late 2022 came before a state dinner at the White House in response to the passage of the Inflation Reduction Act (IRA) in Congress, capturing the feelings of anxiety within European countries from both a trade and energy standpoint. However, the current transatlantic feud between the United States and the European Union over the $369 billion IRA bill is only the latest consequence of rising protectionism in the global economy. 

At the World Economic Forum in Davos, Switzerland in mid-January, EU officials projected anxiety over the implications of the IRA and its future impact on the European energy industry. The IRA’s vast array of tax credits and subsidies will heavily favor domestic made-in-America energy investments at the expense of those overseas; EU leaders are thus concerned that the legislation will incentivize companies into shifting investments out of Europe and into the United States.

Perhaps the most surprising ramification of the IRA may be the startling turn away from the principles of free trade by the Biden administration. For decades, liberalized trade was the default trade policy of the United States political elite and a cornerstone of the global economy. However, while President Biden has presented himself as a protector of the liberal international order, on economic policy he has broken with his predecessors and continued many of Donald Trump’s protectionist policies.

This development is a key part of the rapidly-weakening global consensus around free trade, as countries scramble to enact tariffs, subsidies, and tax incentives to protect vital domestic industries and impair adversaries. Coupled with rising anti-globalist populism and a souring attitude towards the benefits of neoliberalism, the future of free trade seems increasingly in doubt.

Protectionism’s Rise 

After World War II, a post-war consensus based around heavy regulation, high taxes, and strong trade unions emerged. Most countries were also influenced by Keynesian economics, which believed that government spending and lower taxes would stimulate demand and pull the economy out of a recession. But with the oil crises of the 1970s, a new consensus based around free trade and globalization emerged. As the price of oil rose rapidly and the money supply expanded too quickly, countries began experiencing both a slowing economic growth rate and rising inflation (stagnation plus inflation creating “stagflation”). Unfortunately, traditional Keynesian methods of government expenditures and lower taxes could not adequately counter stagflation. 

With the failure of Keynesianism, countries and governments embraced monetary and fiscal discipline, rejecting the post-war consensus in favor of privatization and deregulation as well as the lowering of protective tariffs. The dissolution of the Soviet Union and the end of the Cold War signaled a new era of unregulated capitalism centered around the free flow of capital, goods, and people.

However, with the growth of globalization and a concurrent hollowing out of American industry, large segments of the American workforce were made redundant and entire regions were economically devastated. The downfall of Detroit and the birth of the Rust Belt are emblematic of globalization’s less positive impacts on the American economy, and similar stories appear across the developed world as deindustrialization led to the loss of millions of jobs to countries like China. 

The resultant economic decline of formerly industrial regions also fuelled the rise of far-right and far-left populism united against neoliberalism and its embrace by mainstream political parties. Trump’s rise to power and his policy of trade wars and tariffs against both allies and adversaries is the most prominent expression of populist protectionism in the United States. But while his trade policy was the subject of much ridicule by economists and political pundits during his administration, Trump’s protectionist leanings are now one of his few policies that have gained traction among the mainstream political establishment. Indeed, the shift towards becoming tougher on trade seems to be one of the few things that unites both major political parties in the United States today.

Additionally, concerns about national security increasingly drive protectionist economic policies, particularly in the areas of critical industries such as technology and defense. Concern that relying too heavily on foreign suppliers for these industries could leave countries vulnerable in times of crisis is incentivizing the push for self-sufficiency in technologies such as semiconductors.

For instance, America is now subsidizing domestic production of semiconductors through the so-called CHIPS and Science Act, aiming to reduce reliance on China among other suppliers. Even more drastically, the Biden administration has imposed harsh new rules intended to limit China’s access to American advanced semiconductor technology and hobble Chinese technological capacity. In this sense, protectionism has been brought into the broader rivalry between the United States and China.

The Growing Impotence of International Institutions

With many countries doubling down on erecting barriers to trade, prominent economic institutions such as the World Trade Organization (WTO) that embody the rules-based order have increasingly been sidelined. Both President Trump and now President Biden are ignoring WTO authority and passing tariffs and subsidies that are provoking concern from allies.

In December 2022, WTO panels ruled that the Trump administration’s tariffs on imported steel and aluminum were illegitimate and their rationale of protecting national security was insufficient. In response to the panel’s ruling, the Biden administration essentially told the WTO to get lost, constituting an unusually blunt rejection of the WTO’s authority to regulate the rules for global commerce. If others follow U.S. precedent of upholding protectionist policies in the name of national security, the entire system will likely weaken even more.

At the same time, China is also flouting the WTO’s authority and flexing its economic muscle against competitors. Normally when companies complain about their treatment in China, they can expect Beijing to retaliate by initiating investigations and throwing roadblocks against further economic development, and thus these firms usually stay silent. But another problem is that China routinely punishes countries that cross it diplomatically by blocking imports or tourism, without outwardly saying so: this behavior makes countries more hesitant to bring a WTO complaint against China.

The outcome is that now, the WTO is effectively unable to discipline its largest and second largest members, leaving a deglobalizing world without an effective enforcer to ensure the rules are being followed.

It is likely that mechanisms for settling trade disagreements will still remain relevant. But the roles of agencies such as the WTO will be less important and minimized as countries resolve trade disputes through more tariffs and subsidies rather than through negotiation. 

WTO flag. Recent events suggest that the WTO’s influence in global trade is weakening amidst increasing protectionism.

A Divided Future 

The outlook of a more protectionist and insulated global economy has major implications for economic development and international affairs that cannot always be accurately predicted. However, one almost-certain outcome is that such a development will not create a level playing field. 

Larger countries will wield significant leverage and influence over smaller and weaker countries, who must accept whatever terms are offered. And as more powerful nations increasingly ignore the rulings of organizations such as the WTO, weaker nations will experience the loss of a neutral mediator and get a raw deal on trade agreements.

Smaller, less diversified countries are also at risk during a rise of protectionism because they are more heavily dependent on a small number of industries or sectors. When protectionist policies target these industries, the entire economy could be negatively impacted. For example, if a country is heavily dependent on a single commodity or industry, such as oil or electronics, and protectionist policies are implemented that make it harder to export products to foreign markets, the economic hit would be much more painful than if there were multiple significant industries within the economy to soften the blow.

Additionally, one strategy countries may implement in response to a more protectionist world is to strengthen regional economic and political ties. 

The European Union is the most obvious example of a trade bloc formed by like-minded neighboring nations seeking strength in numbers, but other groups such as the Association of Southeast Asian Nations (ASEAN) are also good models for intergovernmental cooperation on economic matters. The Biden administration’s efforts to reshore jobs and chip production in Canada and Mexico could also portend a new strategy of keeping critical technologies “in-house” among trusted allies.

So rather than a unified consensus based on free trade, the world will slowly move toward a system of regional alliances or spheres, where countries will rely more on neighbors and trusted partners for critical supply chains such as semiconductors. Many countries may even decide to manufacture crucial technologies and products within their own borders, trading off higher production prices in return for greater self-sufficiency. 

Such a compartmentalization of the global economy is an inevitable consequence of protectionism, with more barriers to trade and fewer opportunities for mutually beneficial growth. And yet, with growing distrust of globalization and its regulatory institutions, there is little reason to hope that countries will return to the old international order anytime soon.