Abstract:
To understand whether protectionism is good or bad, it should be first compared with free trade. Then we look through several cases to find out whether the way doing this is right or wrong. The government should use the best policy for the country and as good as possible for the world as a whole.
What is protectionism?
Protectionism is the economic policy protecting businesses and workers within a country by restraining trade between nations, discouraging imports, and preventing foreign take-over of local market and companies. The policy is closely aligned with anti-globalization, and contrasts with free trade. [1]
Main protectionist policies: [2]
Ø Tariffs:
Tariff is a tax levied when a good is imported. Tariff rates vary according to the type of goods imported, government get the revenue. Import tariff will increase the price of imports, lower the quantity of goods imported. Therefore, the price of local goods will go up as well.
Ø Import quotas:
An import quota is the limitation on the quantity of import. The economic effects are similar to tariff, except the tax revenue will distribute to those who receive import licenses.
Ø Voluntary export restrains:
It means the limitations on the quantity of export—usually imposed by the exporting country’s request (eg. Limitation on auto exports to US enforced by Japan).
Ø Administrative barriers:
Countries sometimes accused of using their administrative rules (eg. Japan accuse Chinese dumpling poisonous) as a way to introduce barriers to import.
Ø Direct subsidies:
Government subsidies are sometimes given to local firms that cannot compete with foreign firms.
Ø Export subsidies:
It means the percentage paid to the exporters. It’s the opposite of export tariff.
Ø Exchange rate manipulation:
A government may intervene the foreign exchange market to lower its currency, so that in the short run, the price of imports will raise, exports will be cheaper.
What is free trade?
Free trade is a type of policy allows trade happening without interference from the government. Smith was in favor of free trade. He derived his support for free trade among nations by basing it on the obvious desirability of trade among individuals: "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy". [3]
Argument against protectionism
1. Substantial majority would lose from such protectionism. As it showed below, the price will be higher, so consumers will lose the most, the lose will subsidy the producer and government, what’s more, the societal loss will lead the consumer loss in vein.
Source: Wikipedia
2. It will Increase the opportunity cost. As trade protectionism is against comparative advantage, the world’s resource will be not used so efficiently, it’s a waste for the society.
3. The possibility of high inflation will occur. As the domestic price rises, the consumer need spend more to buy the things then could buy cheaper before. The CPI is likely to go high.
4. The profit margin of down-stream enterprise will go down. The trade barrier will push the companies towards expensive local products, once the price of materials goes up, the cost goes up, thus the benefit will go down.
5. Unfair trading practices. Government subsidizing the export of good will makes the price below the actual cost of production, which will make the demand of other countries’ goods go down, hence, it’s likely to have the tariff revenge from other countries.
Argument against free trade:
1. Foreign products cause loss of jobs. If the government doesn’t intervene the market, the country which has less advantage will be driven from the global market, and then lots of people will be fired. The unemployment will be affected.
2. The balance of trade deficit and foreign investment. If the country is less competitive than others, the consumers will choose imports rather than domestic ones. So the balance sheet will be deficit. If the situation continues, domino effect will occur—exchange rate slumps, less of investment, high inflation, real wage declines and unemployment soars.
3. Harmful to infant industries. Infant industries are those who just start, and cannot compete with other skilled countries. It doesn’t mean the country will not have the advantage forever. The Korean example followed by will improve it.
Cases:
1. Korean car industry
Korean car industry was an infant industry at 1960s, but from 1970s, government decided to impose high tax of import cars to protect domestic firms. In the mean time, Korea started using the advanced technology on a large scale. In 2008, the number of car export reached 4086,000, which is the fifth in the world.
The protectionism has great effect on import, in 2006, import cars only had the market share of 3.3% in Korean market. Besides, the protectionism also helped this infant industry. New industries have high costs because they haven’t learned yet to produce efficiently, so they can’t compete under free trade with foreign firms. Industries can reduce the cost through new technology. Korean car industry went through a leap within 40 years. With the help of the government, Korean cars grew from infant industry to a well-know famous global brand, reaching economics of scale.
So in this case, protectionism is definitely right, however, some experts think a production subsidy will create the same benefit without distorting the market and raising the price to consumers compared with tariff. The opposers think tariff should be used upon the goods which are demand inelastic (eg. car), things have little substitute (eg. petrol) or people will only spend little amount of money on it (eg. sugar), so that even if the price rises, the demand will not change much, besides, government can get more revenue. However, when comes demand elastic goods, production subsidy seems more reasonable, it can not only protect domestic firms but keep consumer surplus.
2. Japan give administrative barriers to Chinese vegetables
Since 2000, Japan has imported lots of vegetables from China, not only because its low price, but also high demand. However, as the price was lower than the domestic price, Japanese agricultural market was badly affected. Farmers demanded the government impose strict controls over Chinese vegetable imports. The government had to agree under such a pressure, in April 2001, the government announced that they would have emergency administrative barriers to Chinese vegetable for 200 days. Chinese farmers suffered lots of loss because of that. Although Japanese protected domestic agriculture industries, the welfare of consumers seemed lost more. The price of vegetables soared. In the meantime, Chinese government use tariff revenge, imposing the tax of Japanese car and air conditioner to 30%-100%. Japanese manufacture suffered even a much huge loss than China. Under the big pressure of manufacture, Japan had to cancel the trade barrier soon.[4]
Bob Harris said that “When each countries making foreign policies, they all believe each country’s interest is at the first place, and they are willing to sacrifice any else countries’.” However, the government should not make such an urgent decision without sorting on how much of the price gap is accounted for the quality, the effect of protection cannot be accurately assessed. The cost of Japanese consumers totals around 3.8% of GDP. [5]
As we know Japan is a country which is lack of resources, it is born with keen demand of imports. So the more Japan wants to protect domestic firms, the more likely to get revenge. Therefore, Japan should try some different ways, such as red-tape barriers, if the government doesn’t restrict imports so formally, the effect would be not so bad.
3. Great Wall Street Crash of 1929
In 1930s, tariff soared to unprecedented levels as countries sought to protect their domestic market. In particular, in 1929 an ill-conceived tariff law was introduced to protect US farmers and industries. U.S. under the Smoot-Hawley tariff, duties of more than 60% were slapped on 3200 imported products and by 1933 imports into the U.S. had fallen from $4.4 bn to $1.3 bn, while exports had decreased 69% over that time period. In 1933, the unemployment rate in U.S. was 25%, and other countries were around 15%-25%. [6]
We can see that erected obstacles to trade just made things worse. Protectionism can only exacerbate the situation under this situation, as global economic crisis, enemy number one is isolationism.
Now the sub-prime crisis is quite similar as that time, global recession, America are suffering high unemployment and bankrupt. The president Obama wanted to buy American goods to protect the economy, which caused criticism all over the world. The protectionism was also discussed in G20. It was reported that after meeting in London, the heads of the Group of 20 nations vowed “to do whatever is necessary to promote global trade and investment and reject protectionism.”[7]
Free trade is need when come across the global recession. First comparative advantage will distribute the resources more efficiently and ensure every country can buy the cheapest things from the global market. Second, it’s a good way to revalue the real wage. Due to wages depend on the purchasing power, exchange rate decides purchasing power, and exchange rate is partly depending on product ability. Hence, only if the country has enough product ability, the wage will not fall.
4. The tragedy of The Republic of Haiti
The Republic of Haiti used to be a big produce country for grain. More than 90% of the grain is produced domestically, more than 70% of the population is doing farming at that moment, and the trade balance is surplus at that moment. Afterwards, U.S. use agricultural subsidies to stimulate the export, which lower the global price. Haiti’s farmers lost their profit immediately, and they gave up going farming, the bought the grain from America instead. The current account turned deficit, and became bigger. In 1988, the world’s agricultural prices soared, Haiti had trouble of its currency, then the crisis came. Now Haiti is one of the poorest countries in the world.
If the government use protectionism such as tariff at that moment to protect farmer’s profit, the country would be much better than present. As agriculture is the key resource to human’s life, in terms of strategy, government should intervene.
5. U.S.—large country government interference analysis
Unite State is the only large country in the world, which means the change of trade policy (eg. Impose tariff, import quotas) could lower the world’s price. This makes the U.S. differently; the loss of consumer will be less than foreign countries under the same situation. What’s more, as US Dollar is the world’s main foreign reserve, every country thinks U.S. T-bill is the safest equity in the world. They use their trading surplus buy American equity, so that U.S.’s financial account is always surplus, though current account is deficit. That makes the domestic economy stable.
A study of the impact of anti-dumping actions on the performance of U.S. showed the average petitioner between 1980 and 1992 received with preliminary or final determinations of the international trade commission, except when petitions received a negative determination at the final stage of the process.[8] The loss comes from import restrictions estimated around 0.75%-1% of U.S. national income. [9]
Britain’s Prime Minister Gordon Brown recently warned “protectionism could lead to a difficulty in dealing with issues such as incorporation countries like China, India and Brazil into global economy.”[6]
If countries are too small to affect world prices, a tariff will unambiguously harm them, regardless of whether other countries are using tariff. It’s true that large countries may benefit by using a tariff, but if so, this too is true whether or not other countries will use it to restrict you. A nation cannot undo an effect from a foreign tariff by having one of its own. [10] The threat of retaliation, as a last resort, provides the ultimate enforcement tool of WTO rules.
Conclusion:
In the 5 cases, 3 of them convincingly demonstrate that he protectionism is costly product of a negative sum political game, rather than the product of a government benignly maximizing a social welfare function designed to put us somewhere on the maximal tradeoff between equity and efficiency. So under most situations, free trade is better. However, when it comes to countries’ strategy or infant industries, some measures should be taken.
References:
[1] Protectionism - Wikipedia, the free encyclopedia, http://en.wikipedia.org/wiki/Protectionism
[2]Paul R. Krugman, Maurice Obstfeld, International Economics Theory & Policy, seventh edition, p176-193
[3] Adam Smith, The Wealth of Nations, Book IV Chapter II
[4]Zhao Quanhai, The study of relationship between trade protection and political interests,2008
[5]Japan’s protection racket: How much do barriers to import cost Japanese consumers? The economist, Jan 7, 1995, P58
[6]The dangers of trade protectionism, BBC news, 2009/02/04
[7]G-20 Leaders Reject Protectionism as Trade Barriers Proliferate, Bloomberg
[8] Sarah J. Marsh, Creating barriers for foreign competitors: a study of the impact of anti-dumping actions on the performance of U.S. firms
[9] Robert C. Feenstra, How costly is protectionism, 1992
[10]Fachhochschule Bremen, Argument for and against protection, 2003
To understand whether protectionism is good or bad, it should be first compared with free trade. Then we look through several cases to find out whether the way doing this is right or wrong. The government should use the best policy for the country and as good as possible for the world as a whole.
What is protectionism?
Protectionism is the economic policy protecting businesses and workers within a country by restraining trade between nations, discouraging imports, and preventing foreign take-over of local market and companies. The policy is closely aligned with anti-globalization, and contrasts with free trade. [1]
Main protectionist policies: [2]
Ø Tariffs:
Tariff is a tax levied when a good is imported. Tariff rates vary according to the type of goods imported, government get the revenue. Import tariff will increase the price of imports, lower the quantity of goods imported. Therefore, the price of local goods will go up as well.
Ø Import quotas:
An import quota is the limitation on the quantity of import. The economic effects are similar to tariff, except the tax revenue will distribute to those who receive import licenses.
Ø Voluntary export restrains:
It means the limitations on the quantity of export—usually imposed by the exporting country’s request (eg. Limitation on auto exports to US enforced by Japan).
Ø Administrative barriers:
Countries sometimes accused of using their administrative rules (eg. Japan accuse Chinese dumpling poisonous) as a way to introduce barriers to import.
Ø Direct subsidies:
Government subsidies are sometimes given to local firms that cannot compete with foreign firms.
Ø Export subsidies:
It means the percentage paid to the exporters. It’s the opposite of export tariff.
Ø Exchange rate manipulation:
A government may intervene the foreign exchange market to lower its currency, so that in the short run, the price of imports will raise, exports will be cheaper.
What is free trade?
Free trade is a type of policy allows trade happening without interference from the government. Smith was in favor of free trade. He derived his support for free trade among nations by basing it on the obvious desirability of trade among individuals: "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy". [3]
Argument against protectionism
1. Substantial majority would lose from such protectionism. As it showed below, the price will be higher, so consumers will lose the most, the lose will subsidy the producer and government, what’s more, the societal loss will lead the consumer loss in vein.
Source: Wikipedia
2. It will Increase the opportunity cost. As trade protectionism is against comparative advantage, the world’s resource will be not used so efficiently, it’s a waste for the society.
3. The possibility of high inflation will occur. As the domestic price rises, the consumer need spend more to buy the things then could buy cheaper before. The CPI is likely to go high.
4. The profit margin of down-stream enterprise will go down. The trade barrier will push the companies towards expensive local products, once the price of materials goes up, the cost goes up, thus the benefit will go down.
5. Unfair trading practices. Government subsidizing the export of good will makes the price below the actual cost of production, which will make the demand of other countries’ goods go down, hence, it’s likely to have the tariff revenge from other countries.
Argument against free trade:
1. Foreign products cause loss of jobs. If the government doesn’t intervene the market, the country which has less advantage will be driven from the global market, and then lots of people will be fired. The unemployment will be affected.
2. The balance of trade deficit and foreign investment. If the country is less competitive than others, the consumers will choose imports rather than domestic ones. So the balance sheet will be deficit. If the situation continues, domino effect will occur—exchange rate slumps, less of investment, high inflation, real wage declines and unemployment soars.
3. Harmful to infant industries. Infant industries are those who just start, and cannot compete with other skilled countries. It doesn’t mean the country will not have the advantage forever. The Korean example followed by will improve it.
Cases:
1. Korean car industry
Korean car industry was an infant industry at 1960s, but from 1970s, government decided to impose high tax of import cars to protect domestic firms. In the mean time, Korea started using the advanced technology on a large scale. In 2008, the number of car export reached 4086,000, which is the fifth in the world.
The protectionism has great effect on import, in 2006, import cars only had the market share of 3.3% in Korean market. Besides, the protectionism also helped this infant industry. New industries have high costs because they haven’t learned yet to produce efficiently, so they can’t compete under free trade with foreign firms. Industries can reduce the cost through new technology. Korean car industry went through a leap within 40 years. With the help of the government, Korean cars grew from infant industry to a well-know famous global brand, reaching economics of scale.
So in this case, protectionism is definitely right, however, some experts think a production subsidy will create the same benefit without distorting the market and raising the price to consumers compared with tariff. The opposers think tariff should be used upon the goods which are demand inelastic (eg. car), things have little substitute (eg. petrol) or people will only spend little amount of money on it (eg. sugar), so that even if the price rises, the demand will not change much, besides, government can get more revenue. However, when comes demand elastic goods, production subsidy seems more reasonable, it can not only protect domestic firms but keep consumer surplus.
2. Japan give administrative barriers to Chinese vegetables
Since 2000, Japan has imported lots of vegetables from China, not only because its low price, but also high demand. However, as the price was lower than the domestic price, Japanese agricultural market was badly affected. Farmers demanded the government impose strict controls over Chinese vegetable imports. The government had to agree under such a pressure, in April 2001, the government announced that they would have emergency administrative barriers to Chinese vegetable for 200 days. Chinese farmers suffered lots of loss because of that. Although Japanese protected domestic agriculture industries, the welfare of consumers seemed lost more. The price of vegetables soared. In the meantime, Chinese government use tariff revenge, imposing the tax of Japanese car and air conditioner to 30%-100%. Japanese manufacture suffered even a much huge loss than China. Under the big pressure of manufacture, Japan had to cancel the trade barrier soon.[4]
Bob Harris said that “When each countries making foreign policies, they all believe each country’s interest is at the first place, and they are willing to sacrifice any else countries’.” However, the government should not make such an urgent decision without sorting on how much of the price gap is accounted for the quality, the effect of protection cannot be accurately assessed. The cost of Japanese consumers totals around 3.8% of GDP. [5]
As we know Japan is a country which is lack of resources, it is born with keen demand of imports. So the more Japan wants to protect domestic firms, the more likely to get revenge. Therefore, Japan should try some different ways, such as red-tape barriers, if the government doesn’t restrict imports so formally, the effect would be not so bad.
3. Great Wall Street Crash of 1929
In 1930s, tariff soared to unprecedented levels as countries sought to protect their domestic market. In particular, in 1929 an ill-conceived tariff law was introduced to protect US farmers and industries. U.S. under the Smoot-Hawley tariff, duties of more than 60% were slapped on 3200 imported products and by 1933 imports into the U.S. had fallen from $4.4 bn to $1.3 bn, while exports had decreased 69% over that time period. In 1933, the unemployment rate in U.S. was 25%, and other countries were around 15%-25%. [6]
We can see that erected obstacles to trade just made things worse. Protectionism can only exacerbate the situation under this situation, as global economic crisis, enemy number one is isolationism.
Now the sub-prime crisis is quite similar as that time, global recession, America are suffering high unemployment and bankrupt. The president Obama wanted to buy American goods to protect the economy, which caused criticism all over the world. The protectionism was also discussed in G20. It was reported that after meeting in London, the heads of the Group of 20 nations vowed “to do whatever is necessary to promote global trade and investment and reject protectionism.”[7]
Free trade is need when come across the global recession. First comparative advantage will distribute the resources more efficiently and ensure every country can buy the cheapest things from the global market. Second, it’s a good way to revalue the real wage. Due to wages depend on the purchasing power, exchange rate decides purchasing power, and exchange rate is partly depending on product ability. Hence, only if the country has enough product ability, the wage will not fall.
4. The tragedy of The Republic of Haiti
The Republic of Haiti used to be a big produce country for grain. More than 90% of the grain is produced domestically, more than 70% of the population is doing farming at that moment, and the trade balance is surplus at that moment. Afterwards, U.S. use agricultural subsidies to stimulate the export, which lower the global price. Haiti’s farmers lost their profit immediately, and they gave up going farming, the bought the grain from America instead. The current account turned deficit, and became bigger. In 1988, the world’s agricultural prices soared, Haiti had trouble of its currency, then the crisis came. Now Haiti is one of the poorest countries in the world.
If the government use protectionism such as tariff at that moment to protect farmer’s profit, the country would be much better than present. As agriculture is the key resource to human’s life, in terms of strategy, government should intervene.
5. U.S.—large country government interference analysis
Unite State is the only large country in the world, which means the change of trade policy (eg. Impose tariff, import quotas) could lower the world’s price. This makes the U.S. differently; the loss of consumer will be less than foreign countries under the same situation. What’s more, as US Dollar is the world’s main foreign reserve, every country thinks U.S. T-bill is the safest equity in the world. They use their trading surplus buy American equity, so that U.S.’s financial account is always surplus, though current account is deficit. That makes the domestic economy stable.
A study of the impact of anti-dumping actions on the performance of U.S. showed the average petitioner between 1980 and 1992 received with preliminary or final determinations of the international trade commission, except when petitions received a negative determination at the final stage of the process.[8] The loss comes from import restrictions estimated around 0.75%-1% of U.S. national income. [9]
Britain’s Prime Minister Gordon Brown recently warned “protectionism could lead to a difficulty in dealing with issues such as incorporation countries like China, India and Brazil into global economy.”[6]
If countries are too small to affect world prices, a tariff will unambiguously harm them, regardless of whether other countries are using tariff. It’s true that large countries may benefit by using a tariff, but if so, this too is true whether or not other countries will use it to restrict you. A nation cannot undo an effect from a foreign tariff by having one of its own. [10] The threat of retaliation, as a last resort, provides the ultimate enforcement tool of WTO rules.
Conclusion:
In the 5 cases, 3 of them convincingly demonstrate that he protectionism is costly product of a negative sum political game, rather than the product of a government benignly maximizing a social welfare function designed to put us somewhere on the maximal tradeoff between equity and efficiency. So under most situations, free trade is better. However, when it comes to countries’ strategy or infant industries, some measures should be taken.
References:
[1] Protectionism - Wikipedia, the free encyclopedia, http://en.wikipedia.org/wiki/Protectionism
[2]Paul R. Krugman, Maurice Obstfeld, International Economics Theory & Policy, seventh edition, p176-193
[3] Adam Smith, The Wealth of Nations, Book IV Chapter II
[4]Zhao Quanhai, The study of relationship between trade protection and political interests,2008
[5]Japan’s protection racket: How much do barriers to import cost Japanese consumers? The economist, Jan 7, 1995, P58
[6]The dangers of trade protectionism, BBC news, 2009/02/04
[7]G-20 Leaders Reject Protectionism as Trade Barriers Proliferate, Bloomberg
[8] Sarah J. Marsh, Creating barriers for foreign competitors: a study of the impact of anti-dumping actions on the performance of U.S. firms
[9] Robert C. Feenstra, How costly is protectionism, 1992
[10]Fachhochschule Bremen, Argument for and against protection, 2003
The wall street journal
