160 FAQ

Answering this requires backing up a step. When countries are in recession - that is to say, their economies are shrinking or at least are not growing fast enough to keep up with growth of the labor force and other stuff like that - the country's economy needs to adjust to alleviate this. Adjustment is costly, though. Some part of the economy will need to be restructured - some people will need to find new jobs, some industries might close, etc. This adjustment occurs internally through a process of "creative destruction." Less efficient firms close and their workers need to find new jobs (presumably in more efficient industries). As you might imagine, this is politically costly to politicians who rely on those workers (or on owners of capital in less efficient industries) for electoral support.

Beggar-thy-neighbor policies refer to a class of strategies for adjusting one's economy by displacing the costs of adjustment onto one's trading partners. By putting up tariffs, for example, a state can protect its less efficient industries from international competition. Tariffs are taxes that raise the price of imported goods until those prices are similar to the prices domestic producers must charge. Those inefficient domestic firms are able to remain in business longer than they "should." What happens, though, is that firms in your trading partner's country are no longer able to sell their goods in your market, and so because they have nowhere to sell their goods, they close. So instead of YOUR workers in that less competitive industry being out of work, your PARTNER's workers in that industry (which is presumably more competitive, which is why they were successfully exporting to you), are now out of work. The costs of adjustment (or perhaps, rather, non-adjustment) in your economy are being paid by your trading partner.

This is a bad thing by itself, for one country to do, but when a bunch of countries do this, total trade drops. Now, we're both losing: we lose both export markets (and the jobs those create), and we lose the specialization created by trade. With the decline of trade, some things that we had previously imported from more efficient producers abroad now must be produced at home by our less efficient producers; this means that they'll produce less stuff for more cost, and GDP will decrease. So everyone in a country is made worse off, overall, by beggar-thy-neighbor protectionism - even if some individuals benefit from the protection.

Similar effects occur from devaluing a fixed exchange rate. A lower exchange rate - where one of my currency buys fewer of yours - means that imported goods are no longer as attractive. Let's say the US dollar was fixed to the Japanese yen at a rate of US$1 = Y100. Before the devaluation, my $1 bought a good worth 100 yen. If the US devalues now, so that my US$1 is now only worth Y90, I can't buy as much of the foreign good as I could before. Buying the same Y100-valued good would now cost me $1.10 instead of $1. So what would a consumer do? He'd buy a domestic good instead - the price of the domestic good hasn't changed. What happens to the Japanese producers, though? They lose market share in the US export market, and so they pay the cost of the US government's steps to increase domestic economic activity. Trade shrinks as a result of this, too.

This was a hugely popular way of increasing domestic economic activity (or trying to, at any rate) headed into the Great Depression. States defected from the classical Gold Standard left and right, trying to stay one step ahead of their trading partners. What ended up happening is that these frequent devaluations scared off international investors and traders, who had benefited from the stability of the fixed rate, and so trade and investment dropped even more. After the competitive devaluations, the net result was that both sides had paid the other's adjustment costs (loss of export jobs, etc.), trade had dropped as a result, and the investors were spooked. Everyone was worse off than they would have been had they resisted the urge to protect.