FACTBOX-The threat of protectionism

Feb 18 (Reuters) - Policymakers are united in the fear that protectionism -- efforts to salvage jobs by blocking imports or encouraging exports unfairly -- could make the recession much worse.

The risk is that such moves would prompt retaliation by other countries and drive down the overall level of trade, destroying output and jobs around the world.

Politicians have a difficult task balancing the long-term economic need to keep markets open and the short-term political pressure to defend jobs at home. Workers in Britain went on strike over the use of foreign contractors this month, and protests over unemployment and living standards have swept other European countries.

THE LESSON OF THE 1930s

The classic example of the damage that protectionism can do is the Great Depression.

In 1930, the United States raised tariffs, or import duties, on hundreds of products in legislation sponsored by Senator Reed Smoot and Representative Willis C. Hawley, known as the Smoot-Hawley Tariff Act.

This made foreign products more expensive, encouraging American consumers to buy U.S.-made goods. But other countries responded with similar moves to shut out American goods and protect their own production.

By 1932 U.S. imports from Europe and U.S. exports to Europe were about one third of their 1929 levels. World trade fell by 66 percent between 1929 and 1934. U.S. unemployment, which had been 7.8 percent in 1930 when the Smoot-Hawley act was passed, jumped to 16.3 percent in 1931 and reached 25.1 percent in 1933.

The resulting unemployment and misery was a major factor behind the rise of extremist governments in Europe, such as the Nazis in Germany, and the military regime in Japan, which found itself cut off from markets and resources. Thus a protectionist rise in tariffs helped cause World War Two.

Some economists say the Great Depression was caused not by the tariff hike but by a contraction of credit due to policy errors by the Federal Reserve following the 1929 Wall Street Crash and the subsequent wave of bank collapses.

NEVER AGAIN

Nevertheless, at the end of World War Two, economists and policymakers got together to create international institutions that would avoid the beggar-thy-neighbour policies of the 1930s.

The International Monetary Fund, World Bank, and eventually the World Trade Organisation (WTO) emerged from this, along with the United Nations.

Countries signing up to the WTO, and its predecessor the General Agreement on Tariffs and Trade (GATT), agreed not to discriminate against each other's imports, and to treat foreign suppliers in the same way as domestic producers.

In a series of multilateral negotiations or "rounds," tariffs and other trade barriers were reduced and limited, and more countries joined the system. The WTO now has 153 members.

World trade grew sharply. It averaged 6.2 percent a year from 1950 to 2007, far outstripping growth in output, and bringing greater prosperity to hundreds of millions of people.

Greater specialisation among countries produces losers as well as winners within economies, and recent years have seen many calls in rich countries to protect jobs from unfairly priced imports or competition from low-wage nations.

But policymakers have so far preferred to maintain an open trading system and resolve any tensions or disputes within the rules agreed at the WTO.

DIFFERENT FORMS OF PROTECTIONISM

The economic slowdown and recession that has followed the explosion of a financial crisis in September 2008 has encouraged many countries to support their economies or individual sectors.

The WTO is monitoring these packages and other trade measures for signs of protectionism.

Countries that want to protect domestic industry or farmers have many options, some legal, some less so:

-- Permitted tariff hikes. Countries negotiate maximum levels, or "bound rates" for their tariffs at the WTO, but often cut them further to lower levels. Many developing countries now have large gaps between these "applied rates" and the bound rates. They retain the right to raise them back to the ceiling.

-- Subsidies. The WTO's Doha round to open up trade would abolish export subsidies for agricultural goods and limit other farm subsidies. In the meantime countries with the resources can subsidise farm output and exports. The European Union recently reinstated export subsidies for dairy produce, something it is entitled to do even if it sends a bad signal.

-- Anti-dumping. WTO rules allow countries to raise tariffs on goods that are dumped in their markets -- imported for less than they cost at home. Unfair anti-dumping measures can be challenged in the WTO's disputes procedures. A big rise in anti-dumping cases and related disputes would be a sure sign that protectionist sentiment is picking up.

-- Subsidies. Government subsidies can be challenged under WTO rules if they give an unfair advantage to exports.

-- Industry bailouts. Many countries are working on support packages for economically important industries, especially automobiles. Developing countries say that is unfair because poor countries cannot afford them. The packages may be presented to promote the purchase of more environmentally-friendly vehicles. But if they discriminate against foreign producers they could be challenged under WTO rules, for instance those governing subsidies. A French proposal linking aid to carmakers with promises to keep factories open in France has upset France's EU partners.

-- Financial bailouts. Following the credit crunch and financial crisis, many countries pumped money into banks and other financial institutions or took them over. These bailouts are exempt from WTO subsidy rules if they are necessary to save a country's financial system.

-- Financial mercantilism. Banks dependent on state aid or capital may come under pressure to direct their lending to domestic borrowers away from foreign business. It is still unclear how this is affected by WTO rules.

-- Buy local. The U.S. stimulus package requires iron and steel and other manufactured goods used in infrastructure investments to be American, as Congress wants the funds to benefit the economy at home. That led many U.S. partners to fear they would be shut out of the market for such projects. In response the bill requires "Buy American" provisions to conform to Washington's international obligations. In practice that means that countries like the European Union, Japan, Canada and South Korea that have signed up to the WTO's government procurement agreement would be able to bid for work under the package, but big emerging markets like China, India and Brazil could not.

-- Non-tariff barriers. Countries can use safety standards, or other rules such as labelling, customs procedures or security provisions, to make it difficult for imports to get in. Sources: Reuters, World Trade Organisation, U.S. Census Bureau, U.S. State Department (Reporting by Jonathan Lynn; Editing by Janet McBride)