Protectionism is anything that creates a “protection” from or safe harbor from the impact of international competition.

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One very interesting aspect of protectionism is that it usually bestows large benefits to a small number of firms that can be spread out as costs to a large number of households.

That is interesting because it shows that the politics might favor the legislation or implementation of various kinds of protectionism. Consider the vigor and enthusiasm and resources that a local steel mill might have to devote to the passage of a high tariff on imported steel. These few companies might exert considerable pressure on government to obtain this end. Consider also that while this tariff might increase the price of steel in the home country, the extra amount that each household or each voter might have to pay could be a few bucks – perhaps not even enough to notice. If government can convince the voters that the cost to each person is negligible and the gain to a local industry is worth millions of dollars and could save jobs – then the chances are it will be able to pass this legislation. This underscores how the politics do not necessarily stand in the way of growing protectionism. It also emphasizes how difficult it is to stop it. The discussion above about why free trade is to be desired is pretty complicated and not always easy to explain.

So there is always some pressure to produce more protectionism. How does a nation protect itself against international competition? The answer is that there are both subtle and obvious ways to protect domestic producers from outside competition. The most obvious ways have been the use of tariffs and quotas. A high tariff on an imported item gives a local producer a great advantage. An option to a tariff is a quota. This is a quantity constraint that says that a particular country can import only so many bananas, pounds of sugar, or textile garments. Thus while this does not add to the price of the imported good, it does leave the domestic producer with a larger share of the market.

According to an article published by the Cato Institute, because of US protection of the sugar industry, Americans paid double the world price from 1985 to 1998 and the gap has gotten worse since then. They cite a US International Trade Commission estimate that by abolishing US sugar protection would create a net annual welfare gain of $1 billion per year. See the full article.

Anti-dumping and safeguards are other obvious forms of protectionism. Anti-dumping duties are levied against countries that violate the spirit of fair trade by taking what they cannot sell at home and selling it at lower-than-bargain-basement prices in other countries – that is, they sell them at prices that are below their costs of production. This seems logical from the standpoint of the dumping company – why let goods collect dust in a local warehouse when you could sell them for a penny more than transportation costs to another country? But what is logical is not always deemed fair – especially if your company has to compete against a foreign company that is dumping. Let them dump it and disrupt their own country!

This seems pretty clear – countries ought to be able to react against such unfair practices. But it is hardly ever so clear. The problem is that it isn’t always easy to calculate if a foreign company is selling below its costs. It might just be selling at a very low price at home and everywhere. Since costs of production are usually private affairs within companies – it takes a lot of work to determine if dumping is occurring. Most countries know that and they can at least temporarily fend off competition by using dumping duties.

Safeguards differ from anti-dumping duties. Safeguards allow a country to protect itself from any kind of significant but largely unpredictable wave of new imports that threatens a particular industry. The perpetrator need not be dumping. The safeguards give the local industry some time to adjust to the new competition. More is said about the steel safeguards below.
Other forms of protectionism may derive in conjunction with some very legitimate goals of government that relate to public health, safety, information, certification, and environment. This makes them subtle forms of protection. One recent example has to do with GMOs – or genetically modified organisms. U.S. farms had a considerable first-mover advantage. U.S. companies found that by genetically modifying seeds, they could make them more resistant to disease. There have been no studies to link any specific health hazards to GMO corn or other products, but we all share some concern that something negative could occur in the longer term. The U.S. is studying these problems but is allowing GMO products to be sold. Some other countries, however, do not want GMO corn sold in their country and prohibit it on the grounds of health issues. Is this a legitimate health issue – or is this simply a way to protect local corn producers from U.S. corn?

Varied customs duties among the 25 countries of the European Union were viewed as a trade barrier by the U.S. in 2004.

Dealing with up to 25 different tariff regimes raised the knowledge requirement and costs for foreign companies wanting to export to various parts of the EU. This is an interesting case. Notice that the U.S. was not lodging a similar complaint against the countries of S. America or Africa. Why? The answer is that these continents do not advertise or have goals to create a common and free economic space. It might be a free unimpeded market place for the 25 countries within the EU – but having to deal with up to 25 different trade regimes for everyone else could be considered unfair. The EU reacted by saying that if the U.S. had a problem with Europe, they should have brought it directly to them. This raises the question of whether trade problems should be dealt with bilaterally – or by the whole world.

Is protectionism bad?

Paul Krugman, in The Age of Diminished Expectations, said that the negative aspects of protectionism are exaggerated. While Krugman does not argue that protectionism is a good thing – he does explain why he thinks that the case against protectionism is less clear than most economists are willing to admit. Consider some of Krugman’s points.

 

  • While some economists point to the Smoot Hawley tariffs as contributing to the severity of the Great Depression, Krugman comments that Smoot-Hawley didn’t cause the Great Depression. These tariffs designed to help U.S. farmers in 1930 by Herbert Hoover, led to retaliation by other countries. In the end, world trade decreased by about 66% between 1929 and 1934. While Krugman is right that these tariffs didn’t cause the Great Depression, not many economists ever said they did. But they did, no doubt, have a very negative impact on most countries during a very bad time. It is correct to worry that protectionism can bring harmful retaliation and is therefore a threat to economic wellbeing.

 

Krugman’s better point is that neither trade deficits nor protectionism hurts a country’s job situation. His logic is that employment is determined by supply-side factors – not by the composition of demand. He likens protectionism to something that would simply divert foreign demand to domestic demand. But adding a protective tariff to an imported good – especially an input like a part or capital good – simply increases the cost of production. This kind of negative impact on jobs became very apparent with the steel safeguards in the U.S. Some economists noted that the protection for any one steel job in the U.S. put in jeopardy a multiple of jobs for workers in the steel-using industries.

Industrial Application: The Steel Safeguards and Employment

Gary Hufbauer and Ben Goodrich of the Institute for International Economics  commented on these job losses in the steel-using industries. While the press bandied about estimates as high as 200,000 jobs lost, Haufbauer and Goodrich conclude their analysis with  the following quote, “These figures (meaning estimates in the range of 15,000 to 25,000 jobs lost) are in the range of an earlier CITAC estimate of 15,000 jobs dislocated in steel-using industries (narrowly defined) as a result of proposed tariff remedies. Whether steel-using firms discharged 15,000 or 26,000 workers or 52,000 workers on account of safeguard tariffs, a lot of unnecessary misery was created. The misery is especially hard to justify when there was little pickup in employment among steel-producing firms.”

Why did President Bush adopt these “safeguards” for steel?  Safeguards, unlike dumping cases, do not require a proof of below cost pricing – they simply require a large harm to an important industry that needs temporary protection. Bush explained the safeguards in a speech announcing their end as follows: “Today, I signed a proclamation ending the temporary steel safeguard measures I put in place in March 2002. Prior to that time, steel prices were at 20-year lows, and the U.S. International Trade Commission found that a surge in imports to the U.S. market was causing serious injury to our domestic steel industry. I took action to give the industry a chance to adjust to the surge in foreign imports and to give relief to the workers and communities that depend on steel for their jobs and livelihoods. These safeguard measures have now achieved their purpose, and as a result of changed economic circumstances it is time to lift them.”

An interesting sidelight of the steel “safeguards” is that President Bush withdrew them shortly before countries could retaliate against them. The WTO found that the U.S. “safeguards” were illegal. “Safeguards” are available to countries as a means to legally protect their companies and workers in specific cases – after unpredictable import surges that caused direct harm. The WTO panel disputed the facts in the U.S. steel case. As a result, President Bush withdrew the “safeguards” shortly before other countries would have been able to legally retaliate. While the President noted that the “safeguards” gave steel producers some time to reorganize and adjust, one cannot come away from this experience with a good feeling about the benefits of protectionism.

 

  • Krugman says that the “real harm” from protectionism is really very small. He acknowledges that protectionism causes inefficiency and loss of opportunities of scale, but then says that these losses are estimated to be less than 0.5% of GDP. He says the U.S. Savings & Loan crisis loss was much bigger. That might be true, but the S&L crisis was a very big problem that thankfully does not come along every year. But protectionism is with us every year. This GDP loss – 0.5% ⎯ continues each year. If this loss can be translated into dollars ⎯ it means roughly $50 billion per year. If a job averages $40,000 per year, then that is equivalent to more than 1 million jobs per year.

 

  • Krugman says that some people see protectionism as a bargaining tool to pry open foreign markets for exports. Krugman says this won’t work. U.S. goods aren’t kept out of markets by government policies in large amounts (except agricultural products) and even if they were, most governments have protectionist polices for very strong domestic political reasons. Bullying won’t get very far.

 

Krugman says there is a case to be made for protectionism ⎯ the New View. While much trade is formed on the basis of comparative advantage of nations, much is also done because of historical accident or first-mover advantage that led to scale economies. In short, why can’t countries without comparative advantage create their own “historical accident” by subsidizing or investing in industries that could become trade champions (with government help and protection). One example is high-tech high-value-added industry development. Krugman’s most persuasive argument is that other countries are heavily involved with subsidies aimed at developing new industries. If they can create first-mover advantages by offsetting very large fixed costs, it is possible that a temporary subsidy could go a long way. The potential for technology developments that have spillovers into other industries broadens the appeal of these subsidies. If the U.S. doesn’t play at this game, then we might lose out. The problem with this line of reasoning is that it leaves out the risk involved with “picking winners”. There are plenty of examples of government attempts to subsidize industries that didn’t succeed. Looking at this in a planning sense, how do governments make good decisions about which promising new developments are worth subsidizing and which ones are not? What if the government had spent billions developing 8-track music players in the 1970s just around the time that people decided they preferred the cassette technology? How many of these kinds of “duds” can a government afford? How many failures can be justified for each blockbuster?

  • Krugman might be correct on some facts, but he isn’t correct enough if one interprets his meaning to imply that increased protectionism would be a good thing. One final lament of those who would seek more protectionism is that small or low income countries simply cannot and never will be able to survive and compete. A look at a country like Haiti might draw sympathy for this worry, but even for impoverished Haiti opening the country to foreign trade makes sense. Consider the words of the World Bank (quotes come from an editorial “Growing pains,” Financial Times, Sept 29, 2004, page 12,

 

As the Peruvian development expert, Hernando de Soto has persuasively argued, the lack of effectively enforced property rights in poor countries, together with opaque and inefficient legal and judicial systems, prevents the extension of credit and economic growth. Moreover, excessive bureaucracy is a recipe for corruption by allowing unscrupulous officials to exact tribute from businesses wishing to transverse the passes of regulation they guard so closely…Many of the policies that are needed do not require a lot of money to implement….improving the climate for doing business is, as the bank’s report says, a marathon rather than a sprint….a process rather than an event….nor is it one size fits all…policies must fit local conditions. But the overall direction of policy is clear. Poor countries’ economies are strangled by red tape and blinded by uncertainty. They should be freed from both.

Industrial Application:  Job Loss and the Outsourcing of Jobs

Outsourcing of service jobs has attracted much attention and concern for U.S. employment. For many years we have dealt with manufacturing plants moving abroad to take advantage of being closer to foreign markets, lower wages, and other benefits. More recently, however, we find U.S. companies outsourcing many services to foreign countries. A lot of attention has been paid to Indian call centers, but we are finding that more and more business services can be outsourced to foreign countries.

Why business services? Largely because technology now makes it easier to do business. Faster computers with better software hooked up to the Internet mean it is possible that a trained draftsman half-way around the globe can be working on architectural drawings  for a U.S. architect as the latter sleeps and dreams about lower costs. Bookkeepers, consultants, tax specialists, and many other workers abroad can learn the U.S. system and provide rapid, higher quality, and low cost services.

Whereas the threat to even high paid U.S. jobs seems obvious, the truth is that not many U.S. jobs have been replaced by these kinds of outsourcing. C. Alan Garner studied the phenomenon and reported his conclusions in, “Offshoring in the Service Sector: Economic Impact and Policy Issues, Federal Reserve Bank of Kansas City Economic Review, Third Quarter 2004, pages 5-37.  He concludes that (page 29), “….offshoring should not permanently lower the nation’s employment or production. It is likely to improve the average living standard if displaced workers are retrained and moved into new jobs with higher value added.” He then focuses on national policy, “Laws protecting a particular service industry will likely raise the costs of services to consumers and other businesses, hurting overall welfare. Instead policymakers should ease the movement of resources from sectors that are losing to international competition towards sectors that are gaining. Improved educational systems, better trade adjustment programs, and international negotiations to open foreign markets and guarantee intellectual property right can improve national welfare.”