By Jeremy Gaunt, European Investment Correspondent
LONDON, Jan 27 (Reuters) - It must have been clear to even the most blinkered politician watching Japan's stock market on Tuesday that investors are dumping any philosophical adherence to free markets in favour of government help.
The announcement of a bailout plan for capital-strapped companies -- a heavy government footprint -- pushed the benchmark Nikkei stock average <.N225> up more than 4.9 percent, regaining more than a third of its year-to-date losses.
A happy day for investors, but also a classic portrait of recent market phenomena: desperation has prompted wide support from investors for hands-on government globally, in stark contrast to their past embrace of all things free market.
The risk is that "soft" protectionism such as bailouts will translate into something more virulent and ultimately damaging.
"The chances of a protectionist agenda emerging now is much greater (than before)," said Andrew Clare, professor of asset allocation at Cass Business School in London.
In the latest high-profile bailout, the Japanese government said it would offer public funds to companies whose capital has been seriously hurt by the financial crisis.
But it is far from alone in this kind of thing. A number of countries are now helping out specific firms or industries alongside their macro stimulus programmes.
Consider U.S. banks and automakers, for example, or Europe's more relaxed approach to state aid and competition policy. Britain offered loan guarantees to its automakers on Tuesday.
PROTECT AND SERVE
Investors now clearly welcome this kind of intervention, even if many see it as a necessary evil. A typical reaction has been for stock markets to rise on the news, then fall as uncertainty grips and investors ponder whether more is needed.
But such support goes against the previous confidence that markets could be left alone to purge what is unhealthy, righting the system sooner or later.
Protectionism is widely viewed by free marketeers as a major cause of the Great Depression, and the U.S. State Department says protectionist policies knocked 66 percent off world trade in the five years after the Wall Street Crash in 1929.
The argument is that while bailouts or trade laws protecting a specific company or industry can be beneficial in the short term, they are ultimately damaging over a longer period.
Many of the actions taken by governments in the face of the global financial and economic crises -- nationalisations, bailouts etc -- would have brought howls of complaints from competitors or competing countries in the past.
This has changed primarily because most countries see themselves now in the same boat. And, of course, because the threat of joblessness, financial loss and political backlash is real.
"Unfortunately we need government to do this now. Otherwise, what is the alternative?" said Franz Wenzel, senior investment strategist at AXA Investment Managers in Paris.
THINGS TO COME
Some see the danger of protectionism as quite acute. In a recent note, for example, Societe Generale strategist Albert Edwards suggested economic trouble in China could be a trigger.
"It is becoming clear that the Chinese economy is imploding and this raises the possibility of regime change," he wrote.
"To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression."
The more typical view, however, is that while current government intervention may create a "moral hazard" -- that is, precedent -- for trouble, lessons have been learnt from the 1930s and are unlikely to be repeated.
Clare, of Cass Business School, agrees. But he also wonders how smooth the transition will be when the global economy recovers and governments around the world have to reassess their role in companies and markets.
Could it be then that the tensions between countries rise?
"The issue might be how (hands-on government) is withdrawn," he said.
(Editing by Patrick Graham)
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