ProtectionismProtectionism

Where politics, foreign policy Where politics, foreign policy and (occasionally) rational and (occasionally) rational economic debate collideeconomic debate collide

ProtectionismProtectionism

Definition: Imposition of trade Definition: Imposition of trade barriers in order to protect domestic barriers in order to protect domestic producersproducers

By definition, protectionism is a By definition, protectionism is a topic that involves politics as much topic that involves politics as much as “pure” economicsas “pure” economics

But for the moment … let’s stick But for the moment … let’s stick with economicswith economics

Types of ProtectionismTypes of Protectionism DirectDirect

EmbargoEmbargo TariffTariff QuotaQuota SubsidySubsidy

IndirectIndirect Voluntary Export Restraint (VER)Voluntary Export Restraint (VER) Exchange rate controlsExchange rate controls Import licensesImport licenses Regulatory and administrative barriersRegulatory and administrative barriers

EmbargoEmbargo

A total ban on tradeA total ban on trade Can be applied by domestic Can be applied by domestic

governments or imposed by foreign governments or imposed by foreign governmentsgovernments

ExamplesExamples Jefferson’s Embargo Act (1807)Jefferson’s Embargo Act (1807) U.S. embargo of Iraq post Gulf WarU.S. embargo of Iraq post Gulf War

Often used as an economic weapon to Often used as an economic weapon to achieve foreign policy objectivesachieve foreign policy objectives

Implications of an Implications of an EmbargoEmbargo

Embargo = elimination of trade = Embargo = elimination of trade = pure domestic marketpure domestic market

Prices go up (consumers pay more)Prices go up (consumers pay more) Domestic producers lose the Domestic producers lose the

opportunity to sell their products in opportunity to sell their products in foreign markets but benefit from foreign markets but benefit from higher prices for their goods higher prices for their goods domesticallydomestically

Equilibrium Without Equilibrium Without TradeTrade

DomesticSupply

DomesticDemand

ConsumerSurplus

Producer Surplus

Pd

Qd

Impact of TradeImpact of Trade To understand the impact of trade, you To understand the impact of trade, you

must start with an analysis of relative must start with an analysis of relative prices and comparative advantageprices and comparative advantage

If the domestic equilibrium price for a If the domestic equilibrium price for a product is lower than the world price – product is lower than the world price – the country will become an exporter of the country will become an exporter of this productthis product

If the domestic equilibrium price is If the domestic equilibrium price is higher than the world price – the country higher than the world price – the country will import the product from foreign will import the product from foreign supplierssuppliers

Who Wins and Who Who Wins and Who Loses?Loses?

To simplify our analysis, assume that To simplify our analysis, assume that the world price is a given – the actions the world price is a given – the actions of our small, insignificant country have of our small, insignificant country have no impact on the prevailing world priceno impact on the prevailing world price

Graphically, this assumption is Graphically, this assumption is represented by a flat supply curve at represented by a flat supply curve at the world price (i.e. we can import or the world price (i.e. we can import or export unlimited quantities at that export unlimited quantities at that price) price)

Impact on an ExporterImpact on an Exporter

Domestic Supply

Domestic Demand

ExportsConsumer Surplus

Producer Surplus

World Price

Impact on an ExporterImpact on an Exporter

When a country is an exporter, When a country is an exporter, generally consumers lose (higher prices, generally consumers lose (higher prices, reduction of consumer surplus)reduction of consumer surplus)

But, domestic producers gain (higher But, domestic producers gain (higher prices and increased production)prices and increased production)

Higher production translates into more Higher production translates into more jobs, happy constituents and reelected jobs, happy constituents and reelected politicianspoliticians

Domestic economy realizes a net benefitDomestic economy realizes a net benefit

Impact on an ImporterImpact on an Importer

Domestic Supply

Domestic Demand

World Price

Consumer Surplus

Producer Surplus

Imports

Impact on an ImporterImpact on an Importer

When a country is an importer, consumers When a country is an importer, consumers benefit (lower prices and higher consumer benefit (lower prices and higher consumer surplus), but domestic producers lose surplus), but domestic producers lose (lower prices, decreased production)(lower prices, decreased production)

Reductions in domestic production means Reductions in domestic production means job losses and often an increase in political job losses and often an increase in political rhetoric and calls for the government to rhetoric and calls for the government to protect domestic industries from foreign protect domestic industries from foreign competition, despite the fact the overall competition, despite the fact the overall economy realizes a net benefit from tradeeconomy realizes a net benefit from trade

TariffTariff

The most common restriction on The most common restriction on trade is a tarifftrade is a tariff

Tariff = tax on imported goodsTariff = tax on imported goods Results of a tariff:Results of a tariff:

Prices go upPrices go up Domestic production increasesDomestic production increases Government gets more revenueGovernment gets more revenue

Effects of a TariffEffects of a Tariff

Domestic Supply

Domestic Demand

World Price

Price with Tariff

Qd1Qd2Qs2

Qs1

Imports

QuotaQuota

Another very common restriction on Another very common restriction on trade is the quotatrade is the quota

A quota is a limitation on the quantity A quota is a limitation on the quantity of a good allowed to be imported into a of a good allowed to be imported into a countrycountry

Quotas limit the impact of international Quotas limit the impact of international trade on the domestic markettrade on the domestic market

Usually enforced through government Usually enforced through government issued permits to tradeissued permits to trade

Quota (Cont’d)Quota (Cont’d)

Impact of quotas:Impact of quotas: Domestic prices go up (consumers pay Domestic prices go up (consumers pay

more)more) Domestic producers increase Domestic producers increase

productionproduction Government gets more revenue (import Government gets more revenue (import

license fees)license fees) Let’s go to the graph …Let’s go to the graph …

Impact of a QuotaImpact of a Quota

Domestic Demand

World Price

Domestic Supply

Supply with Import Quota

Quota

Q1 Q2 Q3

SubsidySubsidy

Government payment to producers Government payment to producers in order to either reduce the impact in order to either reduce the impact of imports or make a country’s of imports or make a country’s exports more competitiveexports more competitive

First, let’s examine the impact of an First, let’s examine the impact of an import subsidy …import subsidy …

Import SubsidyImport Subsidy

Domestic Supply with no subsidy

Domestic Supply with subsidy

World Price

Domestic Demand

Q1 Q2 Q3

Export SubsidyExport Subsidy An export subsidy enables domestic An export subsidy enables domestic

producers to lower their prices in the world producers to lower their prices in the world market below their true cost of production, a market below their true cost of production, a otherwise known as dumping (and a definite otherwise known as dumping (and a definite WTO violation)WTO violation)

Export subsidies protect domestic producers Export subsidies protect domestic producers from foreign competition and increase from foreign competition and increase domestic production and employment – very domestic production and employment – very tempting outcomes for governmentstempting outcomes for governments

Which leads to predictable accusations and Which leads to predictable accusations and figure pointing during international trade figure pointing during international trade negotiations negotiations

Indirect ProtectionismIndirect Protectionism

Voluntary Export RestrictionsVoluntary Export Restrictions Self-imposed export restrictionsSelf-imposed export restrictions Can be imposed on a firm upon itself, an Can be imposed on a firm upon itself, an

industry upon itself, or by a domestic industry upon itself, or by a domestic government over domestic producersgovernment over domestic producers

Negotiation tool to avoid trade wars Negotiation tool to avoid trade wars and stay within WTO rulesand stay within WTO rules

Exchange Rate ControlsExchange Rate Controls Limitation on amount of foreign Limitation on amount of foreign

currency available to importerscurrency available to importers

Indirect Protectionism Indirect Protectionism (Cont’d)(Cont’d)

Import LicensingImport Licensing Government issued licenses required to Government issued licenses required to

import goodsimport goods In practice, works like a quotaIn practice, works like a quota

Regulatory and Administrative BarriersRegulatory and Administrative Barriers Regulations that increase the cost of Regulations that increase the cost of

production for imported goodsproduction for imported goods Can take the form of safety standards, Can take the form of safety standards,

environmental controls, terrorism lawsenvironmental controls, terrorism laws

Arguments for Arguments for ProtectionismProtectionism

Infant Industry ArgumentInfant Industry Argument In theory, used to provide “temporary” In theory, used to provide “temporary”

protection for domestic producers during protection for domestic producers during their early stage of development in order to their early stage of development in order to give them time to grow and develop give them time to grow and develop economies of scaleeconomies of scale

Argument also used to justify protection for Argument also used to justify protection for declining industries to give them time to declining industries to give them time to restructurerestructure

In practice – “temporary” can be a very long In practice – “temporary” can be a very long time time

Arguments for Arguments for Protectionism (Cont’d)Protectionism (Cont’d)

The Exploitation ArgumentThe Exploitation Argument Workers in developing countries are Workers in developing countries are

exploited by MNCs and domestic firms are exploited by MNCs and domestic firms are forced to cut corners in order to competeforced to cut corners in order to compete

Activist groups push for restrictions Activist groups push for restrictions (especially through regulation) by (especially through regulation) by developed nationsdeveloped nations

Rebuttal – Workers in developing countries Rebuttal – Workers in developing countries are relatively better off from trade; are relatively better off from trade; restrctions only make goods more restrctions only make goods more expensive and force MNCs out of expensive and force MNCs out of developing nationsdeveloping nations

Arguments for Arguments for Protectionism (Cont’d)Protectionism (Cont’d)

The Jobs ArgumentThe Jobs Argument Trade destroys domestic jobsTrade destroys domestic jobs Rebuttal – Depends on which jobs you Rebuttal – Depends on which jobs you

are talking (or care) about; trade costs are talking (or care) about; trade costs some jobs and creates others; any some jobs and creates others; any attempt to protect domestic attempt to protect domestic employment will create inefficiency and employment will create inefficiency and reduce long-term competitivenessreduce long-term competitiveness

Arguments for Arguments for Protectionism (Cont’d)Protectionism (Cont’d)

National Security ArgumentNational Security Argument We must protect industries that are We must protect industries that are

“vital to our national security”“vital to our national security” Trade makes us more vulnerable to Trade makes us more vulnerable to

terrorismterrorism Rebuttal – “Vital to national security” is Rebuttal – “Vital to national security” is

very broad, tough to define, and often in very broad, tough to define, and often in the eye of the beholder; trade creates the eye of the beholder; trade creates economic interdependency that builds economic interdependency that builds political bridges and mutual interests political bridges and mutual interests

Arguments for Arguments for Protectionism (Cont’d)Protectionism (Cont’d)

Unfair Competition ArgumentUnfair Competition Argument The “they don’t play fair” argumentThe “they don’t play fair” argument Foreign governments subsidize exportsForeign governments subsidize exports We face a tougher regulatory We face a tougher regulatory

environmentenvironment They are dumping products in our marketThey are dumping products in our market Rebuttal – Very slippery slope; we should Rebuttal – Very slippery slope; we should

lead by example; a shift toward lead by example; a shift toward protectionist policies will hurt everyone protectionist policies will hurt everyone

And Finally …And Finally …

Bargaining Chip ArgumentBargaining Chip Argument Protectionism as a tool of foreign policyProtectionism as a tool of foreign policy Use threat of trade restrictions as a Use threat of trade restrictions as a

bargaining chip to get concessions from bargaining chip to get concessions from our trading partnersour trading partners

Rebuttal – Using trade as a political Rebuttal – Using trade as a political weapon has the potential to snowball weapon has the potential to snowball with very negative consequences, so if with very negative consequences, so if (when) we employ this tactic – it better (when) we employ this tactic – it better work work