Protectionism
Protectionism Protectionism: is the placement of legal restrictions on international trade and includes tariffs, quotas, subsidies, and other bureaucratic barriers Despite the obvious gains made by trade, all countries try to protect some industries from the unpredictability and threat of foreign competition Protectionist measures run counter to the principle of comparative advantage where countries specialize in the goods with the lowest opportunity cost, and then trade those goods with others The term free-trade describes the process of lowering protectionist barriers and thereby realizing those gains from trade.
Arguments for Protectionism The proponents of protectionism argue that their vulnerable domestic markets face unfair and damaging foreign competition There are several arguments in support of protectionism and proponents argue these policies can be used to, o 1) Protect domestic employment o 2) Protect infant industries o 3) Protect against cheap foreign labor o 4) Diversify the production base o 5) Prevent the dumping of foreign goods o 6) Overcome a balance of payment deficit o 7) Protect strategic industries o 8) Enforce product standards o 9) Raise government revenue
Domestic Employment Argument Imports involve diverting domestic spending to another nation s output In this argument, reducing imports will divert spending on another nations output to domestic spending Thus, domestic output and employment will rise This argument is used to justify protecting declining industries to cushion them from structural unemployment Even when the industry has lost its comparative advantage, the adjustment costs from rapid change may justify temporary protection. Consumers pay the cost in terms of higher prices, by being denied cheaper imports
Shortcomings There are several shortcoming with this argument, While imports may eliminate some jobs, they often create others Import restrictions alter the composition of employment, but they may have little or no effect on the volume of unemployment Example; In the US, imports may have eliminated many steel and textile jobs but workers have gained jobs flying imported aircraft and selling imported electronic goods. Fallacy of composition: the false idea that what is true for part is necessarily true for the whole
All nations cannot simultaneously succeed in restricting imports while maintaining their exports o What is true for one nation is not necessarily true for all nations The exports of one nation must be the imports of the other nation If one country expands its economy through a trade surplus (X M > 0) another economy is worsened through a trade deficit (X M <0) Short-run domestic goals are achieved by making trading partners poorer Trade barrier war: situations where nations adversely affected by tariffs and quotas retaliate causing a trade war that choke off trade and make all nations worse off. Example; Smoot-Hawley Tariff a policy of high tariffs in the 1930 s meant to reduce imports and stimulate US production was a contributing cause of the Great Depression
Forcing an excess of exports over imports cannot raise domestic employment in the long-run It is through a home countries imports that foreign nations earn dollars to buy a home countries exports In the long-run protectionism doesn t increase domestic employment It reallocates workers away from export industries and to protected domestic industries This shift implies a less efficient allocation of resources
Infant Industry Argument Infant industry argument: protective tariffs are needed to allow new domestic industries to establish themselves Temporarily shielding young domestic firms from the competition of more established and efficient foreign firms will give infant industries a chance to develop and become more efficient producers The argument is that young industries have not had the chance to make long-run adjustments needed for larger scale and greater efficiency in production If they face mature foreign competitors they will never have the chance to make these changes and will decline
An infant industry with high costs, point A, is protected The industry can then expand and move down the cost curve Once mature, point B, the barriers are removed
Counterarguments In developing nations, it is difficult to determine which industries are the infants that are capable of achieving economic maturity and deserving of protection Tariffs may persist even after industrial maturity has been realized There are better means than tariffs to protect infant industries o Direct subsidies have the advantage of increased transparency and making explicit which industries are being aided and to what degree
Strategic Trade Policy In recent years, the infant industry argument has taken a modified form Strategic trade policy: the use of trade barriers to reduce the risk inherent in product development by domestic firms, particularly involving advanced technology Firms protected from foreign competition can grow more rapidly and achieve greater economies of scale than unprotected foreign competitors The protected firm can eventually dominate world markets because of their lower costs o Enabling the domestic firm to return high profits to the home nation
These profits exceed the domestic sacrifices caused by trade barriers Advances in high-technology industries are deemed beneficial because the advances in one domestic industry often can be transferred to other domestic industries The problem with this strategy, is that nations put at a disadvantage by strategic trade policies tend to retaliate with tariffs of their own The outcome may be higher tariffs worldwide, reduction of world trade, and the loss of potential gains from technology advances
Cheap Foreign Labor Argument Cheap foreign labor argument: suggests that domestic firms and workers must be shielded from competition of countries where wages and labour standards are low If protection is not provided, cheap imports will flood the home market and the price of home goods along with wages will be pulled down o The domestic living standards will be reduced
Counterarguments The argument suggests that it is not beneficial for rich and poor countries to trade o Gains from trade are based on comparative advantage, not on absolute advantage The proponents of the argument focus on labour costs per hour o What actually matters is labor costs per unit o Differences in productivity mean that labour costs per unit are often nearly identical despite huge differences in labor costs per hour
It is because of this greater productivity, we can expect wages and living standards to be higher in developed countries Less productive labor, such as in developing nations, will receive lower wages and consequently have a lower standard of living For many goods, labor productivity in high-wage countries is much higher than labour productivity in low-wage countries o Consequently, it may actually be cheaper per unit of output to manufacture those goods in high-wage countries This is why, for instance, Intel still makes microchips in the US and cars are still produced in the US, Japan and Europe rather than low-wage countries
Diversification for Stability Argument Highly specialized economies are heavily dependent on international markets for their income Example; Saudi Arabia (based on oil) and Cuba (based on sugar) In these economies, fluctuations in world supply and demand for one or two particular goods can cause deep declines in export revenues and domestic income o Wars o International political developments o Recessions abroad
Tariff and quota protection are needed to enable greater industrial diversification That way, these economies will be not so dependent on exporting these goods to obtain imports Such goods, previously imported, will be available domestically thereby providing greater domestic stability
Protection against Dumping Argument The argument contends that tariffs are needed to protect domestic firms from dumping by foreign producers Dumping: is the selling of goods to another country at a price below the original domestic production costs Under WTO rules, countries are allowed to impose trade restrictions on products that are being dumped o Most nations prohibit it because it is an unfair trade practice Where dumping is shown to injure domestic firms, the home country imposes tariffs called anti-dumping duties on the goods
Overcoming a Balance of Payment Deficit The balance of payments measures the flow of money into and out of a country o The export and import of goods and services, called the trade balance, is normally a major part of that accounting Therefore, countries that find they are spending excessively on imported goods, thereby worsening their trade deficit, may enact protectionist policies to address this imbalance This approach, called expenditure-switching is regarded as a temporary solution o While it may lower imports for a short-time, the structural problems that are causing the imbalance are not addressed by this policy
Protection of Strategic industries Arguments can be made that strategic industries such as military or defence should be produced domestically for security reasons o Buying from foreign suppliers, could make a country vulnerable if relations grow strained between buying and selling countries Similar arguments can be used, less convincingly, to protect commodity industries such as food and metals o Example; A heavy reliance on oil from the Middle-East puts countries that import this oil, such as the US, at risk of supply-side shocks. Consequently, the US subsidizes domestic oil production
Enforce Product Standards Product standards exist to protect consumers from hazardous products, as well as to ensure a reputation of quality production across an industry o These standards raise the cost of production In recent years, countries have used product standard rules to challenge the import of goods, arguing that those products threaten national safety or health o Example; Several European countries, as well as Japan, have imposed restrictions on beef imports from the US, after public health concerns over US hormone-injected beef
Raise Government Revenue A nation can raise government revenue through a variety of tax methods In poor countries, where income tax compliance is low, custom duties can provide a significant source of government revenue o The additional taxes still distorts the market by taxing goods that are wanted or needed by the domestic population By raising import prices, it may also limit the importation of important resources need for growth and development
Arguments Against Protectionism There are several counter-arguments against protectionist policies, 1) Misallocation of resources: countries that protect declining industries compel their consumers to pay higher prices o This is an unnecessary misallocation of income to inefficient producers o Further, because these industries are larger than under free-trade conditions they draw more workers and capital o Industries with the potential to realize their comparative advantage do not get these workers, nor the benefit of access to capital
2) Escalation to a trade war: disputes over unfair trading practices can degenerate quickly into a damaging trading conflict o Trade can grind to a halt and economic growth can be put at risk o Example; This kind of escalation took hold during the Great Depression, as governments resorted to protectionism as a way to prevent unemployment from deepening 3) Protection may lead to corruption: industries that appeal for protection have a distinct economic interest in securing as much of it as they can o Higher tariffs mean more revenue for those producers, which creates a potentially large incentive to bribe lawmakers to enact such laws
4) Domestic complacency causes higher prices and costs: protected industries have less of an incentive to actually modernize or innovate for greater efficiency o Thus, consumers and firms that buy from the protected firms pay higher prices o These higher costs, if borne by domestic producers, harm the ability of other domestic firms to supply products, reducing potential output o For consumers, this can result in a lower standard of living, especially if the protected goods are necessities 5) Higher import costs: protectionist measures directly affect the firms and consumers who buy imported goods o These higher prices may drive some imports out of the market, relegating domestic producers and consumers to higher prices and possibly inferior quality goods
o These costs cause lower output levels for firms and a lower standard of living for consumers 6) Reduced export competitiveness: firms that use imported resources pay higher costs o Exporting firms may suffer the indirect harm of having workers and resources drawn away by inefficient producers o Protectionism can corrode seemingly unrelated export-based businesses o Example; China expanded its quota on cotton imports, allowing in more cotton, after pressure from textile makers who were paying ever-higher prices on a market protected by quotas