COVID-19 Recession - Using Protectionism to reduce deficit

Protectionism reduces current account deficit

COVID-19 Recession : Things get costlier or cheaper ?

The COVID — 19 recession, could be a major global recession which arose as an economic consequence of the continued Coronavirus pandemic. Since World War 2, coronavirus pandemic could cause the worst global recession. Most of the countries saw a falling GDP from January to March 2020, because the economic impact of coronavirus began to hit. For April to June official figures haven’t been published yet, but they’re likely to point out even bigger falls, this can mean the second quarter of negative growth, confirming that much of the globe is in recession.

In such a situation, what can a government do to beat its economy from such an oversized recession? In this article, we are going to know whether we can use protectionist policies during this recession.

Protectionism

The practice of following protectionist trade policies is Protectionism. It is an economic policy that is imposed by the government of a country to confine international trade and to promote domestic producers, and thereby boost the domestic production of goods and services. Some of the primary policy tools a government can use in enacting protectionist policies are Tariffs, import quotas, product standards, and subsidies.

Standardization may also be used, where a government may make all foreign products to adhere to certain guidelines. For instance, the Government of a country X may demand that all imported shoes must include a certain proportion of leather. This tends to reduce foreign products in the market.

Local Production Local Consumption Model

It is the most simple market linkage pattern in which products produced by local people are sold in local markets. Many countries followed the Local production, Local consumption model, during the 18th and 19th centuries.

If so, Why are countries not following this model nowadays?

The reason is that it is all due to the history of the countries, where they faced economic problems. Let us consider the history of a country. For example, India. After its Independence from the British in 1947, the country spent decades trying to survive without international trade. Near the end of the 20th century, it suffered a currency crisis and asked the International Monetary Fund for help. It was helped with conditions, that India had to open up to foreign investment, cut red tape, and remove trade barriers.

Today, India runs a trade deficit. Since India is struggling with a trade deficit, we may think that India should not have entered the international market. To overcome a trade deficit, various protectionist policies may be incurred by India and will be able to overcome it.

But if India continues to follow Local production Local consumption models then, its unemployment rate may rise, the price of goods will be more expensive, there will be not much variety or selection. So, If India had not entered the international market then its currency crisis would be a greater problem than its trade deficit.

India followed Local production Local consumption model

Current Account

The current account balance is an obscure economic concept. The current account is the point at which international economics collides with political reality, especially countries that spend a lot more abroad than they are taking in. The current account is the difference between the value of exports and imports of goods and services, payments made to foreign investors, and transfers such as foreign aid.

Current Account Deficit

A current account deficit arises when a country imports more goods and services than it exports. A deficit may, therefore, reflect a low level of national savings relative to investment or a high rate of investment or even both.

Usually, private capital often flows from developing to advanced economies. The advanced economies of the world, run current account deficits, whereas developing countries and emerging market economies often run surpluses. Poor countries run large current account deficits.

A large current account deficit in a floating exchange rate should put downward pressure on the currency. Consider, a country X. If Country X imports more than exports then this involves selling the currency of X to buy foreign currency to be able to afford the imports. A depreciation of the currency will make the country X’s exports cheaper, imports more expensive and thus help to reduce the current account deficit and reduce the disequilibrium.

Let us consider the fact that country X has a current account deficit in a recession. This is a strong indicator that X’s exchange rate is overvalued and there needs to be a depreciation in the exchange rate to rebalance ( increasing exports and reducing imports) the economy.

Competitive Devaluation — During Recession

Competitive devaluation is also a protectionist policy that will be very useful to implement during a recession. If a country seeks to gain a trade advantage over other countries, then this is possible by causing the exchange rate of its currency to fall concerning other currencies.

If a country is severely uncompetitive, with a large current account deficit, then it should allow a devaluation, as keeping a currency artificially high in a recession would be a great mistake.

Competitive devaluation must be used only in a recession, as it can also be inflationary. During a recession, inflation is unlikely to be a problem.

Devaluing a currency

The country X may devalue its currency by reducing interest rates to reduce capital flows or intervene in the FOREX and increase currency supply on the market. Making all exports appear relatively cheaper on foreign markets and increasing the relative price of imports in the domestic market, are the results of devaluation.

Foreign consumers experience a rise in consumer surplus, as export prices become cheaper, increasing the demand for exports, thus reducing the current account deficit. Expenditure in the domestic economy also may switch to cheaper domestically made goods rather than imports. This policy may not be effective in the long-run, as this policy does not cure structural issues leading to a persistent fall in the currency.

The price of elasticity heavily determines the extent to which exports rise and the deficit is reduced.

Implementation of import controls in the form of quotas puts a direct limit on the volume of imports and is, therefore, a direct solution to the problem, the current account should improve, as imports are directly reduced, given that demand remains constant.

Protectionist trade policies help us to reduce the current account deficit during a recession

If domestic goods are of worse quality than imported goods, then this may cause adverse effects restricting the consumption of imports such as commodities and reducing consumer surplus and living standards.

Due to import prices rising after a tax, the implementation of import tariffs is likely to generate disincentives to consume imports. Therefore consumers may switch demand to domestic goods.

The price elasticity of demand for imports and the value of the tax imposed determines the extent to which the deficit is reduced. This may also lead to retaliation of major trading partners, leading to long-term issues and future trade problems, perhaps even resulting in a world recession.