Written By: Arshiya Chaudhary
“The philosophy of protectionism is a philosophy of war” – Ludwig Von Mises. Cited by a renowned libertarian economist, this quote communicates the popular perception behind trade protectionism. But, can protectionism ever be a good idea? Or does it always contradict its own purpose?
Simply put, Protectionism is a policy that restricts free trade. In terms of world trade, it restricts imports from other countries using control methods like tariffs, quotas, production standards and government regulations. Protectionism within a country can be implemented to protect small firms and businesses from competition, by regulating taxes and subsidies.
Forms of Protectionism
Protectionism can take various forms. One way it is exercised is by decreasing the value of a country’s currency in the foreign exchange markets. This exchange rate control can be used to make a country’s product cheaper abroad. The idea is that a country can sell its currency in foreign exchange markets until it loses value in comparison to other currencies. Import prices will rise as a result of this, while export prices would fall. However, exchange rate control can result in inflation. Since the value of its currency will be low in foreign markets, any foreign products sold in the country itself would be available at a higher price. (3)
Ideology Behind Protectionism
Advocates of trade protectionism have a long list of reasons which define why it is necessary in the first place and what does it aim to achieve, but the consequences of protectionism speak otherwise.
The policy is implemented to boost domestic production by protecting domestic producers from foreign competition. Enhanced production is bound to increase the economic growth of a country and cause the GDP to rise. The reinforced production also implies an increase in the number of jobs in a country and thereby, a reduction in unemployment.
Supporters of protectionism frequently argue that it is necessary to protect jobs in specific industries. However, protectionism turns out to be a very expensive way of safeguarding jobs because it raises consumer prices for both imported and domestically produced items. Tariffs and quotas on imported TV sets cost $74,155 per job saved in 1980; tariffs and quotas on footwear cost $77,155; and tariffs and quotas on carbon steel cost $85,272. Due to the import limitations imposed that year, American consumers paid an estimated $53 billion more in higher prices in 1984 (4).
Infant Industry Thesis
According to the Infant Industry Thesis proposed by Alexander Hamilton in 1792, emerging manufacturers in industrialized countries have a tough time competing against well-established, well-funded, and tremendously lucrative enterprises. Whereas, new manufacturers in developing countries may lack the financial and economic resources, as well as the technology and physical equipment to compete with these industries. Therefore, governments must put in place short-term support mechanisms for small industries and new enterprises until they reach a level where they can compete with international corporations in order for them to obtain market share and a competitive edge over well-established firms. (3)
This poster depicts the difference in a country’s economy with and without protectionist measures. Evidently, a country that promotes free trade enjoys more customers than a country that restricts the free flow of trade. Moreover, the difference in the quality of goods in both the pictures clearly communicates how protectionist policies impact domestic production.
According to a study conducted by the world bank in 1987, countries that practice free trade are more likely to perform better economically than those countries that place restrictions on the free flow of trade. Protectionism might encourage inefficient businesses to stay in business, limiting specialization and economies of scale. (1)
Consequences of Protectionism
A country’s policy of protecting its domestic industries can be used, but for how long is a major question. In order to protect an infant sector, a government may have to spend a large amount of money and financial resources. This may encourage inefficiencies in the industry, as it will have no motivation to make efficient, rational, long-term investments by borrowing cash or issuing common stock on domestic and international capital markets. This sort of protectionism may stifle the maturation and growth that the infant industry needs to go through in the short and long term if it is to be successful and competitive in global markets and eventually gain a comparative advantage. (3)
However, the protection of domestic firms often takes place at the expense of domestic consumers. With a limited number of goods available, consumers are propelled to pay high prices for the goods that are produced within their country. The minimal access to goods and services, owing to trade restrictions, reduces consumer choice and satisfaction. Moreover, as domestic producers face negligible competition, they tend to put little effort into improving the quality of the goods being produced. Producers don’t have any incentive to invest in technology or make the production process more effective due to the lack of competition.
Political Impact of Protectionism
When a government employs protectionist policies, its decisions have far-reaching consequences not only for other countries, but also for the country itself. At times, protectionism leads to reciprocal trade policies and trade wars. Trade wars are damaging to the economies of both the nations involved and can increase economic and political disturbances between them. For instance, the ongoing trade war between US and China has negatively impacted both countries. China experienced a decline in its economic growth and the US experienced a hike in prices for consumers and an increase in costs for producers.
The economic tensions between the US and Canada owing to American protectionist policies demonstrated the retaliatory trade effects. On June 1, 2018, the U.S. imposed a 25 percent tariff on imports of Canadian steel and a 10 percent tariff on imports of Canadian aluminum under Section 232 of the Trade Expansion Act. In response, Canada imposed retaliatory tariffs against a proportionate amount of imports from the United States. (2)
The retaliatory tariffs adversely impacted American consumers and producers since the steel and aluminum industries in both countries are highly integrated. Thus, the policy that aimed at promoting American interest eventually impeded the interest of a large fragment of the American population.
Every economic decision is bound to impact various segments differently. As in the case of protectionism, consumers and producers to a great extent, are impacted negatively.
Protectionism hinders production in the long run by reducing the pressure from overseas competition. In the long run, protectionism slows down the economic progress of a country, causes inflation and decreases consumer satisfaction. Thereby, contradicting its own purpose.
1.Abboushi. 2010. “Trade Protectionism: Reasons and Outcomes.” Competitiveness Review. CR 20(5) 384-394. Duquesne University, Pittsburgh, Pennsylvania, USA. https://www.researchgate.net/publication/235283803_Trade_protectionism_Reasons_and_outcomes
2.Canada, Global Affairs. “Government of Canada.” GAC. Government of Canada, January 7, 2022. https://www.international.gc.ca/trade-commerce/controls-controles/steel_alum-acier_alum.aspx?lang=eng
3.Guarino. 2018. “The Economic Effects of Trade Protectionism.” Economic Forecasts from the World’s Leading Economists. Focus Economics. https://www.focus-economics.com/blog/effects-of-trade-protectionism-on-economy
4.Lawrence and Litan. 2014. “Why Protectionism Doesn’t Pay.” Harvard Business Review. https://hbr.org/1987/05/why-protectionism-doesnt-pay
5.Political poster from the British Liberal Party displaying their views on the differences between an economy based on free trade and protectionism. Wikipedia, 2021. “Protectionism.” https://en.wikipedia.org/wiki/Protectionism