chapter 10: arguments for and against protection

Chapter 10:Arguments for and against Protection

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The Ideal World of First Best• In an ideal or a “first-best” world, all private

incentives are aligned with benefits and costs to society as a whole (no positive or negative externalities are present). In the first-best world supply and demand curves represent both private and social costs and benefits to society and all market are perfectly competitive.


Distortions and Their Effects


The Realistic World of Second Best• Private actions will not lead to the best possible

outcomes for society• Two major distortions in an economy

– Market failures– Government policies can distort an otherwise economically

private market• Externality is a spillover effect associated with

production or consumption that extends to a third party outside the market. Negative externality exits when an external effect generates costs to a third party. Positive externality exits when an external effect generates benefits to a third party.


Government Policies toward Externalities

• Tax-or-subsidy approach• Property-rights approach


The Specificity Rule• It is usually more efficient to use the

government policy tool that acts as directly as possible on the source of the distortion separating private and social benefits or costs

• A barrier against imports can be better than doing nothing in a second-best world, the specificity rule shows us that some other policy instrument is usually more efficient than a trade barrier in dealing with a domestic distortion


Promoting Domestic Production or Employment

• Local production produces spillover benefits• New worker skills and attitudes• Firms can find ways to lower their costs over time• Extra costs to workers if they are forced to switch

to jobs in other industries• Pride in producing product locally• Essential to national defense• Way to redistribute income to poor or

disadvantaged members of society


Two-Ways to Promote Import-Competing Production


The Infant Industry Argument

• A temporary tariff is justified because it cuts down on imports while the infant domestic industry learns how to produce at low enough costs

• Eventually the domestic industry will be able to compete without the help of a tariff


The Infant Industry Argument


How Valid is It?

• There can be a case of some sort of government encouragement

• A tariff may or may not be good• Some form of government help other than a

tariff is a better infant industry policy than a tariff• It is hard for a government to know which

industries to support because it is difficult to predict which industries can reduce their costs enough in the future to create national benefits


Cost per Job Maintained, 1990


The Dying Industry Argument and Adjustment Assistance

• Should government intervene to save a dying industry? - If we are in a “first-best” world, the answer is no. Since the social value of anything is already included in private incentives, ordinary demand and supply curves already lead us to the socially optimal choice.

• Trade adjustment assistance to workers and firms in import-threatened industries is a better policy, using the direct-policy rule, than for example a tariff, because it focuses on income losses, training, and job mobility.


The Developing Government (Public Revenue) Argument

• According to this argument, in poor developing countries the import tariff becomes an important source, not just protection but government revenue.


Other Arguments for Protectionism: Noneconomic Objectives

• National pride argument • National defense argument • Income distribution argument


The Politics of Protection• The basic elements of the political-economic analysis:1. The size of the gains for winners from protection, and how many individuals are in the group of winners. Bp = total gains by producers, Np = the number of

individuals benefiting from the protection 2. The size of the losses for the losers from protection, and how many individuals are in the group of losers.


The Politics Protection Bc = total gain by defeating the tariff, Nc = the

number of individuals losing from protection (gaining from defeating protection.) 3. Individuals’ reasons for taking positions for or against protection. ( a. The size of Bp and Bc

b. sympathy for various groups and c. ideology) 4. Type of political activities and their costs ( the costs of participation: time and money)5. Political institutions and political process.


When are Tariffs Unlikely? 1. Direct democracy:

a. direct vote by individuals on tariffb. voting is costless so that almost everybody votes. c. each person’s voting is based on her direct interest as

winner or loser from protection. • Almost always Nc > Np • But countries usually do not use direct votes to set protection.

Rather, a group of selected representatives make the decision. Winning the political fight is gaining the support of a majority of these representatives of officials.

• Are some forms of government, like representative democracy, inherently protectionist?


When are Tariffs Unlikely? 2. Representative democracy can lead to little or no protection.

a. each group is willing to devote all of its total gains (Bp and Bc) to political activity like lobbying or contributions

b). politicians decide which side to support according to the amount of lobbying or contributions they receive. Since Bc > Bp those opposed to the tariff (consumers) would be willing to spend up to Bc to prevent the tariff, while the protectionists would not rationally spend more than Bp. The inefficiency of the tariff, which equals Bc – Bp, defeats the tariff.


When are Tariffs Likely? • If the protectionist groups are more effective than the other

groups in organizing their political activities, the group with smaller number of individuals can be more effective

• If the benefits of participation are less than the costs to the individual, he/she is not likely to participate in the activity. The average gain per supporter of protection (Bp/Np) > average gain per opponent of protection (Bc /Nc)

• The individual gains tend to be larger as the number of individuals in the group is smaller! Opponents of protection compare (Bc / Nc) to individual costs of participation (time and money)


Applications to Other Trade-Policy Patterns

• Tariff escalation pattern: the importance of group size

and concentration for effective lobbying in favor or against a policy. Economists have found that nominal and effective tariff rates rise with the stage of production, i.e. tariff rates are typically higher on final consumer goods than on intermediate goods and raw materials sold to producing firms. Why? Because consumers are usually less organized than producers in lobbying activities.



• The bias in favor of producer interests over consumer interests also show up in international negotiations to liberalize trade. – A concession by a country reflects the nation’s import duties,

and allowing more imports. Each country is pressured to allow as much import expansion as export expansion. This concession-balancing rule is further evidence of the power of producer groups over consumer groups.

– The trade negotiators view their own import tariff cuts as a sacrifice because they have to answer politically to import-competing producer groups but not to masses of poorly organized consumers.



• The sudden – damage effect : Sympathy often increases when a group suffers a big income loss at once.

• The sympathy can arise from two sources: – Compassion for those suffering large income

losses.– When a deep recession hits the whole economy.

More people will identify with the less fortunate, thinking that, “that could be me.”


Can an Import Barrier Be Better than Doing Nothing, and Is It the Best Policy?

chapter 10: arguments for and against protection

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infant domestic industry

domestic production

social costs

better infant industry

social benefits

national benefits

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