Protectionism

Last updated on 24 June 2017


In economics, protectionism is the economic policy of restraining trade between states (countries) through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations. According to proponents, protectionist policies can counteract unfair trade practices, to allow fair competition between imports and goods and services produced domestically, decrease the trade deficit, maintain employment in certain sectors, or favor the growth of certain industries. However, they hurt consumers in general, and the producers and workers in export sectors

Protectionism is associated with the strategy of Import substitution industrialization. It has been advocated by Alexander Hamilton in "Report on Manufactures" and Friedrich List. Supporters of protectionism like Erik Reinert, say that the law of comparative advantage, the founding theory of free trade, is based on unrealistic assumptions and cannot be applied in reality [1][2][3][4] So, they think that equal and reciprocal free trade never existed and don't consider that free trade implies enrichment and mutual benefit for partners. They view the foreign trade as a zero-sum game, in which any gain by one party require a loss by another [5]: countries with trade deficit (especially in industrial sector) lose in wealth, and those with surpluse are winners. They support like Paul Bairoch "Economics and World History: Myths and Paradoxes" that "it 's economic growth that leads to the development of foreign trade and not the reverse"[6] and rejecte the “cheaper is better” argument : a country cannot thrive through economic specialization and free importation of goods at low price, but rather through interventionist and protectionist economic policies aimed at the development, diversification and preservation of its industry [7][8][9]. They affirm that the industrial sector is one of the sectors where the productivity gains are the most important, thus allowing a high wage growth and contributing the most to the formation of the middle class[10]. Thus, phenomena affecting the domestic production like a trade deficit or the dutch disease are considered destructive for country's development.

There is a broad consensus among economists that protectionism has a negative effect on economic growth and economic welfare, while free trade and the reduction of trade barriers to trade has a positive effect on economic growth.[11][12][13][14][15][16] However, liberalization of trade can cause significant and unequally distributed losses, and the economic dislocation of workers in import competing sectors.[12]

Storck Harbour scene.jpg
Storck Harbour scene.jpg

Protectionist policies

A variety of policies have been used to achieve protectionist goals. These include:

  • Protection of technologies, patents, technical and scientific knowledge [17][18][19]
  • Prevent foreign investors from taking control of domestic firms[20][21]
  • Tariffs: Typically, tariffs (or taxes) are imposed on imported goods. Tariff rates usually vary according to the type of goods imported. Import tariffs will increase the cost to importers, and increase the price of imported goods in the local markets, thus lowering the quantity of goods imported, to favour local producers. Tariffs may also be imposed on exports, and in an economy with floating exchange rates, export tariffs have similar effects as import tariffs. However, since export tariffs are often perceived as "hurting" local industries, while import tariffs are perceived as "helping" local industries, export tariffs are seldom implemented.
  • Import quotas: To reduce the quantity and therefore increase the market price of imported goods. The economic effects of an import quota is similar to that of a tariff, except that the tax revenue gain from a tariff will instead be distributed to those who receive import licenses. Economists often suggest that import licenses be auctioned to the highest bidder, or that import quotas be replaced by an equivalent tariff.
  • Administrative barriers: Countries are sometimes accused of using their various administrative rules (e.g. regarding food safety, environmental standards, electrical safety, etc.) as a way to introduce barriers to imports.
  • Anti-dumping legislation: "Dumping" is the practice of firms selling to export markets at lower prices than are charged in domestic markets. Supporters of anti-dumping laws argue that they prevent import of cheaper foreign goods that would cause local firms to close down. However, in practice, anti-dumping laws are usually used to impose trade tariffs on foreign exporters.
  • Direct subsidies: Government subsidies (in the form of lump-sum payments or cheap loans) are sometimes given to local firms that cannot compete well against imports. These subsidies are purported to "protect" local jobs, and to help local firms adjust to the world markets.
  • Export subsidies: Export subsidies are often used by governments to increase exports. Export subsidies have the opposite effect of export tariffs because exporters get payment, which is a percentage or proportion of the value of exported. Export subsidies increase the amount of trade, and in a country with floating exchange rates, have effects similar to import subsidies.
  • Exchange rate control: A government may intervene in the foreign exchange market to lower the value of its currency by selling its currency in the foreign exchange market. Doing so will raise the cost of imports and lower the cost of exports, leading to an improvement in its trade balance. However, such a policy is only effective in the short run, as it will lead to higher inflation in the country in the long run, which will in turn raise the real cost of exports, and reduce the relative price of imports.
  • International patent systems: There is an argument for viewing national patent systems as a cloak for protectionist trade policies at a national level. Two strands of this argument exist: one when patents held by one country form part of a system of exploitable relative advantage in trade negotiations against another, and a second where adhering to a worldwide system of patents confers "good citizenship" status despite 'de facto protectionism'. Peter Drahos explains that "States realized that patent systems could be used to cloak protectionist strategies. There were also reputational advantages for states to be seen to be sticking to intellectual property systems. One could attend the various revisions of the Paris and Berne conventions, participate in the cosmopolitan moral dialogue about the need to protect the fruits of authorial labor and inventive genius...knowing all the while that one's domestic intellectual property system was a handy protectionist weapon."[22]
  • Political campaigns advocating domestic consumption (e.g. the "Buy American" campaign in the United States, which could be seen as an extra-legal promotion of protectionism.)
  • Preferential governmental spending, such as the Buy American Act, federal legislation which called upon the United States government to prefer US-made products in its purchases.

In the modern trade arena many other initiatives besides tariffs have been called protectionist. For example, some commentators, such as Jagdish Bhagwati, see developed countries efforts in imposing their own labor or environmental standards as protectionism. Also, the imposition of restrictive certification procedures on imports are seen in this light.

Further, others point out that free trade agreements often have protectionist provisions such as intellectual property, copyright, and patent restrictions that benefit large corporations. These provisions restrict trade in music, movies, pharmaceuticals, software, and other manufactured items to high cost producers with quotas from low cost producers set to zero.[23][24]

History

Tariff Rates in Japan (1870-1960).gif
Tariff Rates in Japan (1870-1960)
Tariff Rates in Spain and Italy (1860-1910).gif
Tariff Rates in Spain and Italy (1860-1910)

Historically, protectionism was associated with economic theories such as mercantilism (which focused on maintaining full employment, domestic industry, and a positive trade balance), and import substitution.

In the 18th century, Adam Smith famously warned against the "interested sophistry" of industry, seeking to gain advantage at the cost of the consumers.[25] Friedrich List saw Adam Smith's views on free trade as disingenuous, believing that Smith advocated for freer trade so that British industry could lock out underdeveloped foreign competition.[26]

Some have argued that no major country has ever successfully industrialized without some form of economic protection.[27][28] Economic historian Paul Bairoch, for instance, wrote that "historically, free trade is the exception and protectionism the rule".[29]

In the United States

Droits de douane (France, UK, US).png
Tariff Rates(France, UK, US)
Average Tariff Rates in USA (1821-2016).png
Average Tariff Rates in USA (1821-2016)
U.S Trade Balance (1895-2015).png
U.S. Trade Balance (1895–2015)

In Economics and World History: Myths and Paradoxes, Paul Bairoch notes that the United States was "the homeland and bastion of modern protectionism" since the end of the 18th century and until the post-World War II period. A very protectionist policy was adopted as soon as the presidency of George Washington by Alexander Hamilton, Secretary of the Treasury from 1789 to 1795 and author of the text "Report on the Manufactures, 1792 " which called for customs barriers to allow American industrial development. This text was one of the references of the German economist Friedrich List (1789-1846). This policy remained throughout the 19th century and the overall level of tariffs was very high (close to 50% in 1830). The victory of the protectionist North states against the free trade states of the South at the end of the Civil War (1861-1865) perpetuated this trend, even during periods of free trade in Europe (1860-1880).

According to Michael Lind, protectionism was America's de facto policy from the passage of the Tariff of 1816 to World War II, "switching to free trade only in 1945, when most of its industrial competitors had been wiped out" by the war.[30]

The fledgling Republican Party led by Abraham Lincoln, who called himself a "Henry Clay tariff Whig", strongly opposed free trade, and implemented a 44-percent tariff during the Civil War—in part to pay for railroad subsidies and for the war effort, and to protect favored industries.[31] William McKinley (later to become President of the United States) stated the stance of the Republican Party (which won every election for President from 1868 until 1912, except the two non-consecutive terms of Grover Cleveland) as thus:

Under free trade the trader is the master and the producer the slave. Protection is but the law of nature, the law of self-preservation, of self-development, of securing the highest and best destiny of the race of man. [It is said] that protection is immoral…. Why, if protection builds up and elevates 63,000,000 [the U.S. population] of people, the influence of those 63,000,000 of people elevates the rest of the world. We cannot take a step in the pathway of progress without benefitting mankind everywhere. Well, they say, "Buy where you can buy the cheapest"…. Of course, that applies to labor as to everything else. Let me give you a maxim that is a thousand times better than that, and it is the protection maxim: "Buy where you can pay the easiest." And that spot of earth is where labor wins its highest rewards.[32]

In Kicking Away the Ladder, developmental economist Ha-Joon Chang reviews the history of free trade policies and economic growth, and notes that many of the now-industrialized countries had significant trade barriers throughout their history. The United States and Britain, sometimes considered the homes of free trade policy, employed protectionism to varying degrees at all times. During the 1820s, during the height of the Industrial Revolution, Britain's exports on manufactured goods stood at over 50%. In 1846 the Corn Laws, which restricted import of grain, were repealed due to domestic pressures caused by the Irish Potato Famine. Britain reduced protection rapidly until its industry began to collapse during the late 19th century, in response to pressure from American and German competition.[33]

The United States maintained weighted average tariffs on manufactured products of approximately 40–50% up until the 1950s, although they dipped to lows of roughly 10% during the 1920s, which were augmented by the natural protectionism of high transportation costs in the 19th century.[34] The most consistent practitioners of free trade have been Switzerland, the Netherlands, and to a lesser degree Belgium.[35] Chang describes the export-oriented industrialization policies of the Four Asian Tigers as "far more sophisticated and fine-tuned than their historical equivalents".[36]

In Europe

Europe became increasingly protectionist during the eighteen century.[37] Economic historians Findlay and O'Rourke write that "the immediate aftermath of the Napoleonic Wars, European trade policies were almost universally protectionist," with the exceptions being smaller countries such as the Netherlands and Denmark.[37]

Europe increasingly liberalized its trade during the 19th century.[38] Countries such as Britain, Netherlands, Denmark, Portugal and Switzerland, and arguably Sweden and Belgium, had fully moved towards free trade prior to 1860. According to Findlay and O'Rourke, "Britain finally made the decisive move toward free trade by repealing the Corn Laws in 1846". The shift towards liberalization in Britain occurred in part due to "the influence of economists like David Ricardo ", but also due to "the growing power of urban interests".[38]

Findlay and O'Rourke characterize the 1860 Cobden Chevalier treaty between France and the United Kingdom as "a decisive shift toward European free trade." This treaty was followed by numerous free trade agreements: "France and Belgium signed a treaty in 1861; a Franco-Prussian treaty was signed in 1862; Italy entered the “network of Cobden-Chevalier treaties” in 1863 (Bairoch 1989, 40); Switzerland in 1864; Sweden, Norway, Spain, the Netherlands, and the Hanseatic towns in 1865; and Austria in 1866. By 1877, less than two decades after the Cobden Chevalier treaty and three decades after British Repeal, Germany “had virtually become a free trade country” (Bairoch, 41). Average duties on manufactured products had declined to 9–12 percent on the Continent, a far cry from the 50 percent British tariffs, and numerous prohibitions elsewhere, of the immediate post-Waterloo era (Bairoch, table 3, p. 6, and table 5, p. 42)."[38]

The countries of Western Europe began to steadily liberalize their economies after World War II and the protectionism of the interwar period.[37]

In Latin America

According to one assessment, tariffs were "far higher" in Latin America than the rest of the world in the century prior to the Great Depression.[39][40]

Arguments for

Protectionists believe that there is a legitimate need for government restrictions on free trade in order to protect their country’s economic, and therefore political independence. This was the contention of the American School of economics.

Growth

Economic historian Paul Bairoch argued that economic protection was positively correlated with economic and industrial growth during the 19th century. For example, GNP growth during Europe's "liberal period" in the middle of the century (where tariffs were at their lowest), averaged 1.7% per year, while industrial growth averaged 1.8% per year. However, during the protectionist era of the 1870s and 1890s, GNP growth averaged 2.6% per year, while industrial output grew at 3.8% per year, roughly twice as fast as it had during the liberal era of low tariffs and free trade.[41] One study found that tariffs imposed on manufactured goods increase economic growth in developing countries, and this growth impact remains even after the tariffs are repealed.[42]

According to Dartmouth economist Douglas Irwin, "that there is a correlation between high tariffs and growth in the late nineteenth century cannot be denied. But correlation is not causation... there is no reason for necessarily thinking that import protection was a good policy just because the economic outcome was good: the outcome could have been driven by factors completely unrelated to the tariff, or perhaps could have been even better in the absence of protection."[43] Irwin furthermore writes that "few observers have argued outright that the high tariffs caused such growth."[43]

A prominent 1999 study by Jeffrey A. Frankel and David H. Romer found, contrary to free trade skeptics' claims, while controlling for relevant factors, that trade does indeed have a positive impact on growth and incomes.[44]

Infant industry argument

Protectionists postulate that new industries may require protection from entrenched foreign competition in order to develop. This was Alexander Hamilton's argument in his "Report on Manufactures", and the primary reason why George Washington signed the Tariff Act of 1789. The idea was that for America to retain her political independence, she must become economically independent. Mehdi Shafaeddin has noted that no major nation has ever industrialized without protectionist policies.[27] New Trade theorists also challenge the assumption of diminishing returns to scale. They argue that using protectionist measures to build up a large industrial base in industries with increasing returns (i.e. manufacturing) can set those sectors up for international dominance once they mature.

Mainstream economists do concede that tariffs can in the short-term help domestic industries to develop, but are contingent on the short-term nature of the protective tariffs and the ability of the government to pick the winners.[45][46] The problems are that protective tariffs will not be reduced after the infant industry reaches a foothold, and that governments will not pick industries that are likely to succeed.[46] Economists have identified a number of cases across different countries and industries where attempts to shelter infant industries failed.[47][48][49][50][51]

Sovereignty

Milton Friedman, in his free trade manifesto Free to Choose, acknowledged that import dependency poses a credible threat a country's security and sovereignty. His proposed solution was to maintain adequate stockpiles.[52]{{Clarify}}

Arguments against comparative advantage

Opponents of free trade have argued that comparative advantage does not apply in a globally integrated world, in which capital is free to move internationally.

David Ricardo himself was the first to recognize this critique, and duly noted that his theory only applied in situations where capital is immobile. Regarding his famous example, he wrote:

it would undoubtedly be advantageous to the capitalists [and consumers] of England… [that] the wine and cloth should both be made in Portugal [and that] the capital and labour of England employed in making cloth should be removed to Portugal for that purpose.[53]

Ricardo recognized that applying his theory in situations where capital was mobile would result in offshoring, and therefore economic decline and job loss. To correct for this, he argued that (i) "most men of property [will be] satisfied with a low rate of profits in their own country, rather than seek[ing] a more advantageous employment for their wealth in foreign nations", and (ii) that capital was functionally immobile.[53] However, because capital is now mobile, it is argued that comparative advantage is not necessarily applicable in today's economy.

For evidence, protectionists point to the shifting of production to Mexico by US companies after the passing of the North American Free Trade Agreement as support for this argument. Herman Daly argues that: "Free capital mobility totally undercuts Ricardo's comparative advantage argument for free trade in goods, because that argument is explicitly and essentially premised on capital (and other factors) being immobile between nations. In the new global economy, capital tends simply to flow to wherever costs are lowest—that is, to pursue absolute advantage."[54]

Arguments against

Protectionism is frequently criticized by economists as harming the people it is meant to help. Mainstream economists instead support free trade.[25][55] The principle of comparative advantage shows that the gains from free trade outweigh any losses as free trade creates more jobs than it destroys because it allows countries to specialize in the production of goods and services in which they have a comparative advantage.[56] Protectionism results in deadweight loss; this loss to overall welfare gives no-one any benefit, unlike in a free market, where there is no such total loss. According to economist Stephen P. Magee, the benefits of free trade outweigh the losses by as much as 100 to 1.[57]

There is broad consensus among economists that free trade helps workers in developing countries, even though they are not subject to the stringent health and labour standards of developed countries. This is because "the growth of manufacturing—and of the myriad other jobs that the new export sector creates—has a ripple effect throughout the economy" that creates competition among producers, lifting wages and living conditions.[58] The Nobel laureates, Milton Friedman and Paul Krugman, have argued for free trade as a model for economic development.[11] Alan Greenspan, former chair of the American Federal Reserve, has criticized protectionist proposals as leading "to an atrophy of our competitive ability. ... If the protectionist route is followed, newer, more efficient industries will have less scope to expand, and overall output and economic welfare will suffer."[59]

Economists have speculated that those who support protectionism ostensibly to further the interests of workers in least developed countries are in fact being disingenuous, seeking only to protect jobs in developed countries.[60] Additionally, workers in the least developed countries only accept jobs if they are the best on offer, as all mutually consensual exchanges must be of benefit to both sides, or else they wouldn't be entered into freely. That they accept low-paying jobs from companies in developed countries shows that their other employment prospects are worse. A letter reprinted in the May 2010 edition of Econ Journal Watch identifies a similar sentiment against protectionism from 16 British economists at the beginning of the 20th century.[61]

Protectionism has also been accused of being one of the major causes of war. Proponents of this theory point to the constant warfare in the 17th and 18th centuries among European countries whose governments were predominantly mercantilist and protectionist, the American Revolution, which came about ostensibly due to British tariffs and taxes, as well as the protective policies preceding both World War I and World War II. According to a slogan of Frédéric Bastiat (1801–1850), "When goods cannot cross borders, armies will."[62]

According to economic historians Findlay and O'Rourke, there is a consensus in the economics literature that protectionist policies in the interwar period "hurt the world economy overall, although there is a debate about whether the effect was large or small."[37]

A 2016 study found that "that trade typically favors the poor", as they spend a greater share of their earnings on goods, and as free trade reduces the costs of goods.[63]

Current world trends

Protectionist measures taken 2008%E2%80%932013 according to Global Trade Alert.png
Protectionist measures taken since 2008 according to Global Trade Alert.[64]

Since the end of World War II, it has been the stated policy of most First World countries to eliminate protectionism through free trade policies enforced by international treaties and organizations such as the World Trade Organization[65] Certain policies of First World governments have been criticized as protectionist, however, such as the Common Agricultural Policy[66] in the European Union, longstanding agricultural subsidies and proposed "Buy American" provisions[67] in economic recovery packages in the United States.

Heads of the G20 meeting in London on 2 April 2009 pledged "We will not repeat the historic mistakes of protectionism of previous eras". Adherence to this pledge is monitored by the Global Trade Alert,[68] providing up-to-date information and informed commentary to help ensure that the G20 pledge is met by maintaining confidence in the world trading system, detering beggar-thy-neighbor acts, and preserving the contribution that exports could play in the future recovery of the world economy.

Although they were reiterating what they had already committed to, last November in Washington, 17 of these 20 countries were reported by the World Bank as having imposed trade restrictive measures since then. In its report, the World Bank says most of the world's major economies are resorting to protectionist measures as the global economic slowdown begins to bite. Economists who have examined the impact of new trade-restrictive measures using detailed bilaterally monthly trade statistics estimated that new measures taken through late 2009 were distorting global merchandise trade by 0.25% to 0.5% (about $50 billion a year).[69]

Since then however, then-President-elect Donald Trump announced in November 2016 that he would abandon the TPP (Trans-Pacific Partnership) deal, placing the protectionist policies reflected in Trumponomics very much on the table, despite the wishes of all the other G20 nations.

See also

References

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