eco TV Week

The psychology of protectionism

7/20/2018

Corporate America is increasingly confronted with the consequences of tariff increases and is concerned that more is to come. This is a reminder that protectionism influences the economy not only directly via prices or changes in supply and demand but also indirectly because of increased uncertainty.

William DE VIJLDER

TRANSCRIPT // The psychology of protectionism : July 2018

In the Federal Reserve’s recently published Beige Book, manufacturing companies across the United States have expressed concern about rising tariffs. Prices have increased in many regions, and supply chain disruptions have been reported, largely due to the new trade policy.

Protectionist measures are beginning to have a real impact on both prices and activity, but the threat of further retaliatory measures is also having a psychological effect by increasing uncertainty. The longer the period of uncertainty lasts, the greater the consequences for activity.

This is especially true for decisions that imply long-term commitments that are quasi-irreversible. As a result, corporate investment is much more sensitive to protectionist uncertainty than household consumption.

As a factor of influence, uncertainty is completely different from other transmission channels: even assuming that trading partners manage to reach an agreement after virtually unending negotiations, the damage may already have been done through a drop-off in investment.

Mark Carney, Governor of the Bank of England, indicated in a speech recently that the psychological impact – via the erosion of confidence – and the deterioration in financial conditions could be just as big as the direct impact of tariff measures.

The power struggles, tit-for-tat retaliatory threats, and deal-making process of trade wars have a high psychological content through the confusion and turmoil they create for spectators, foremost of which are companies, but also for the negotiators themselves.

A recent article in the New York Times drew attention to the role of loss aversion. This concept of behavioural economics was developed by Richard Thaler, winner of the Noble Prize of Economics, among others. International trade specialists have applied this concept to their field by claiming that politicians would be more sensitive to the complaints of businesses hurt by international competition than from those praising its benefits

Yet, as the New York Times points out, this logic reverses itself when a lot of companies begin to feel the pain of protectionist threats. The Beige Book seems to confirm this trend, and the US media is reporting lots of stories along these lines.

Optimists will see this as providing a ray of hope, that with the approach of mid-term elections on 6 November, President Trump could be pressured to seek compromise with his trading partners.

The alternative is an extended period of uncertainty that will increasingly carry over to economic surveys and the financial markets, and the equity market in particular.

 

To go further on this subject

Read The New York Times article: Two Words That Could Shape the Politics of the Trade War: Loss Aversion

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