Fair Competition was Distorted but There is No Protectionist Surge

Author: Uri Dadush
Originally published by Europe’s World

The purpose of anti-crisis policies is to restore macroeconomic stability, but an inevitable by-product is to affect competition and distort international trade. These are measures that therefore risk being perceived as protectionist, even when that is not intended. In light of the far-reaching government interventions prompted by the Great Recession, the interesting question is not whether competitive distortions were avoided, obviously they were not, but whether stability was restored in a way that did not undermine markets in the longer-term.

In his provocative account, Elie Cohen argues that go-it-alone national responses to the crisis in Europe have massively distorted competition, increased protectionism and resuscitated national industrial policies. All believers in the benefits of competition and trade – including myself – will have some sympathy for Cohen’s arguments, but in the specific case of international responses to the recession I tend towards a less negative assessment of the policy response in Europe.

There are five reasons for this. First, the crisis was almost without precedent in terms of the severity of the credit crunch and the depth and speed of decline of economic activity. Restoring macro-economic and financial stability was not only the overriding priority, it was also essential to avoid a repeat of the trade wars and destruction of competition that was one of the defining features of the Great Depression of the 1930s.

Second, governments had to respond quickly to such highly specific situations, as the rescue of large financial institutions and automobile manufacturers using limited and untested instruments. It is unlikely that a more centralized European approach, however well designed, could have coped with the need to extinguish so many fires at the same time without seriously affecting competition in many areas. Though the United States possesses federal institutions charged with these tasks, America’s many rescue operations also caused massive competitive distortions among banks both large and small in different states that to varying degrees had been affected by the housing bust. As to the three large automobile companies, each of these was treated differently.

Third, as more than a few commentators have argued, competition policy in the financial sector must take account of the fact that the health of individual banks has systemic implications. Preventing a systemically important bank from failing does not necessarily hurt its competitors, but may instead help avoid a chain of loan losses. That is why, for example, Lehman’s fiercest competitors tried very hard to save it even after the U.S. government refused to provide aid.

Fourth, in the circumstances that reigned a year ago, the large automobile companies on whose survival depended directly or indirectly millions of jobs also took on systemic significance. As consumers panicked and credit dried up, demand for automobiles collapsed. The failure of a large automobile company due to an exogenous and temporary credit shock would have been unjustified – and politically unjustifiable – and it would have had immediate consequences on the banking system.

Last, although Cohen places protectionism at the center of his concerns, the fact is that despite the depth of the crisis and the massive government interventions, protectionism has remained within reasonable bounds. The evidence for this comes not only from the WTO sources referred to by Cohen, but from the very rapid recovery of world trade since March 2009, when the trough of the crisis was reached.

Anti-crisis policies may have been broadly appropriate, but that does not mean that the job is finished or that greater coordination across European countries is not needed. Once we’re over the crisis, we need a cold-eyed assessment of the competitive conditions in sectors that received state aid and where weak companies were merged with strong ones. Decisive steps to reduce structural overcapacity in the automobile sector are essential. Finally, the European Commission’s competition watchdogs should carefully examine what measures during the crisis worked, and what did not, thus drawing valuable lessons on how better to handle future crises.