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What Is Protectionism? Is It Bad For The Global Economy?
The article explores the idea of protectionism and the key motivation for economies pursuing this strategy. The article also questions the damaging nature of this policy , pursued by many economies like the US and China.
Date : 06/07/2022
What is protectionism?
Protectionism is the economic policy of restricting imports in hopes to shift the demand towards domestically produced goods. Protectionism can be imposed through policies such as quotas or tariffs. A tariff is a tax on imports that can be used to subsidise domestic firms. A quota is a government imposed trade restriction that sets a limit (either on volume or monetary value) of potential imports.
Something can be said to be damaging for an economy if it has a negative effect on the country s macroeconomic objectives, these include their economic growth, inequality, unemployment and steady inflation, it can also depend on social factors such as quality of life. The alternative to protectionism is free trade, which is where the government takes a laissez-faire approach and does nothing to try and affect the levels of imports and exports. The implementation of tariffs works to encourage people to buy from domestic producers rather than foreign producers. This works by setting a tax on foreign producers, therefore making their product more expensive and reducing the demand for their product, meaning that domestic firms now have more supply in the market. Quotas have very similar effects as tariffs as they too cause the price of imports to rise, however, the government receives to tax revenue as the only reason the prices are increased is because the foreign firms can increase their prices due to the increased demand due to decreased supply, especially when the price elasticity of supply is large and elastic.In 2014 South Korea moved from quotas to tariffs on imported rice with the goal to protect domestic rice farmers. As shown above a quota can actually be beneficial for both economies, with some governments entering a mutually agreed quota, known as a Voluntary Export Restraint. The EU used to have a VER with Japan over the imports of Japanese cars.
Another form of protectionism is the provision of subsidiaries to firms who are perceived as either important to the UK economy or produce merit goods. Here, subsidiaries will be supplied in order to protect local firms, this occurs within the EU and USA where the governments spend billions on the protection of their farmers. The governments trying to enforce protectionism can also simply favour domestic producers over foreign producers when choosing to hand out government contracts. However, this can lead to government failure as the contracts can go to a firm who doesn t have the capabilities to produce the level of product that is required but are simply chosen because they are a domestic producer. This has links to murky protectionism where a government will indirectly discriminate against foreign producers.
The alternative to protectionism is free trade. The advantage to a government pursuing a free trade economy is that it takes advantage of comparative advantages that some economies may naturally have. A country has a comparative advantage if it is able to produce goods at a lower opportunity cost than its trade partners, leading to lower prices and potentially better quality of goods if the firm is dynamically efficient. Free trade also allows for increased competition and the potential for economies of scale. Increased competition will occur due to domestic monopolies facing more competition from domestic firms, causing them to try and improve the quality of their goods or lose out on potential profits. Free trade will also allow for economies of scale as economies are allowed to specialise for specific goods. According to Adam Smith s theory of specialisation this will lead to reduced average costs and higher outputs. Firstly, protectionism can be damaging to an economy due to increased costs, decreased variety, decreased global efficiency, misallocation of resources and the potential for a trade war. Protectionism also causes the economy to lose out on the benefits of having a free market economy (comparative advantages/ specialisation). Protectionism causes consumers to have to pay higher costs with less choices, this leads to the exploitation of consumer surplus and is therefore damaging to the economy as quality of life is a measurement of the development of an economy (HDI).Protectionism can also be damaging to an economy due to the potential for a trade war to occur. A trade war can lead to inflation as it acts as a negative supply shock. This leads to increased costs of production (due to increased costs of factors of production, such as raw materials) and therefore increased output costs whilst simultaneously decreasing the level of supply. A trade war can also be damaging for an economy as it slows down economic growth due to decreased trade. Whilst protectionism decreases the level of imports that a country has (leakages from the circular economy theory) in hopes to fix the economy s negative balance of trade, if a trade war occurs then the economy s exports will also fall, which could be further damaging for the economies balance of trade, this will be an example of government failure as the economy will be in a worse position than before any protectionist policies were introduced. This is shown by the US / China price war.
It is estimated that the cost of this war for the US was around $300 billion up to the end of 2020 and it is estimated to have wiped $1.7 trillion off of US stock prices. The price war between the EU and China began due to anti-dumping tariffs that the EU imposed on China. China retaliated by imposing a levy on EU wine imports. This shows another negative of a price war, that it can affect global trade. The issue here is that if the price war escalates it could negatively impact the UK economy, a seemingly peaceful bystander. This would be detrimental for the UK economy as the UK aimed to increase exports to China to $30 billion by 2015, China is also the UK s 5th biggest trade partner.
Global efficiency will also decrease due to foreign country`s comparative advantages not being exploited. If a country decides to only allow domestic production of a good it is missing out on the advantages that some economies have that would lead to a cheaper production of the good with less opportunity cost. This can also lead to misallocation of resources as subsidiaries and raw materials will go to firms who may not be the most efficient in producing these goods, but are allowed to stay at the same efficiency level due to lack of competition, this may also lead to these firms becoming dependent on the government to be constantly bailed out in times of economic hardship.
Protectionism may actually be beneficial for some economies and could choose to adopt a protectionist approach if they are a newly emerging economy with lots of infant businesses and are facing high levels of structural unemployment. They also may be trying to reduce the consumption of demerit goods or trying to protect their economy against dumping. Infant businesses are new businesses that require protection from anti-competitive practices such as dumping, which involves foreign firms pricing their goods below the cost of production in order to draw all of the demand away from other firms, this is only a short term tactic.
The Chinese economy has come under fire for its dumping of goods such as steel. Furthermore, if protectionism is employed correctly it can fix a country`s balance of trade. This will work by reducing the level of imports in an economy, however, it is likely to also reduce exports as other economies are unlikely to trade with an economy that doesn t trade with them. A government could also choose to employ protectionist policies in order to try and increase the quality of life for its inhabitants. This is due to the protection of jobs that occurs when local firms are protected from anti-competitive behaviour. Also, the government may choose to put tariffs on specific goods that are deemed as demerit goods (the social cost is greater than the private cost or the social benefit is less than the private benefit). An example of this could be the UK government putting trade sanctions on goods coming from Indonesia that produce a lot of greenhouse gases (a demerit good).
Protectionism is more likely to be a beneficial policy for a developed economy as they are more likely to be able to be self-sufficient. However, this could be bad for developing economies as they lose potential trading partners. This is shown by the largest economy in the world recently choosing to adopt more protectionist policies (USA). A less serious form of protectionism that is beneficial for an emerging economy would be an artificial setting of it s exchange rate. A NEE could choose to set its exchange rate at a low price in order to attract exports and to make imports less incentive to its inhabitants to minimise leakages.
Overall, protectionist policies are definitely not inevitably damaging to economies, they are likely to be damaging to the world economy by certainly not inevitably damaging to all economies. There are many examples of protectionism being successful (such as India which is a very protectionist economy but has been forecasted as an economy with one of the greatest potential for economic growth) for some economies with most economies using some protectionist policies to try and maximise economic growth. On the whole, it seems that protectionist policies seem to benefit the richer countries enforcing them at the expense of the poorer countries. If protectionist policies were inevitably damaging then no economies would ever choose to undertake a protectionist approach.This resource was uploaded by: Shweta
Protectionism is the economic policy of restricting imports in hopes to shift the demand towards domestically produced goods. Protectionism can be imposed through policies such as quotas or tariffs. A tariff is a tax on imports that can be used to subsidise domestic firms. A quota is a government imposed trade restriction that sets a limit (either on volume or monetary value) of potential imports.
Something can be said to be damaging for an economy if it has a negative effect on the country s macroeconomic objectives, these include their economic growth, inequality, unemployment and steady inflation, it can also depend on social factors such as quality of life. The alternative to protectionism is free trade, which is where the government takes a laissez-faire approach and does nothing to try and affect the levels of imports and exports. The implementation of tariffs works to encourage people to buy from domestic producers rather than foreign producers. This works by setting a tax on foreign producers, therefore making their product more expensive and reducing the demand for their product, meaning that domestic firms now have more supply in the market. Quotas have very similar effects as tariffs as they too cause the price of imports to rise, however, the government receives to tax revenue as the only reason the prices are increased is because the foreign firms can increase their prices due to the increased demand due to decreased supply, especially when the price elasticity of supply is large and elastic.In 2014 South Korea moved from quotas to tariffs on imported rice with the goal to protect domestic rice farmers. As shown above a quota can actually be beneficial for both economies, with some governments entering a mutually agreed quota, known as a Voluntary Export Restraint. The EU used to have a VER with Japan over the imports of Japanese cars.
Another form of protectionism is the provision of subsidiaries to firms who are perceived as either important to the UK economy or produce merit goods. Here, subsidiaries will be supplied in order to protect local firms, this occurs within the EU and USA where the governments spend billions on the protection of their farmers. The governments trying to enforce protectionism can also simply favour domestic producers over foreign producers when choosing to hand out government contracts. However, this can lead to government failure as the contracts can go to a firm who doesn t have the capabilities to produce the level of product that is required but are simply chosen because they are a domestic producer. This has links to murky protectionism where a government will indirectly discriminate against foreign producers.
The alternative to protectionism is free trade. The advantage to a government pursuing a free trade economy is that it takes advantage of comparative advantages that some economies may naturally have. A country has a comparative advantage if it is able to produce goods at a lower opportunity cost than its trade partners, leading to lower prices and potentially better quality of goods if the firm is dynamically efficient. Free trade also allows for increased competition and the potential for economies of scale. Increased competition will occur due to domestic monopolies facing more competition from domestic firms, causing them to try and improve the quality of their goods or lose out on potential profits. Free trade will also allow for economies of scale as economies are allowed to specialise for specific goods. According to Adam Smith s theory of specialisation this will lead to reduced average costs and higher outputs. Firstly, protectionism can be damaging to an economy due to increased costs, decreased variety, decreased global efficiency, misallocation of resources and the potential for a trade war. Protectionism also causes the economy to lose out on the benefits of having a free market economy (comparative advantages/ specialisation). Protectionism causes consumers to have to pay higher costs with less choices, this leads to the exploitation of consumer surplus and is therefore damaging to the economy as quality of life is a measurement of the development of an economy (HDI).Protectionism can also be damaging to an economy due to the potential for a trade war to occur. A trade war can lead to inflation as it acts as a negative supply shock. This leads to increased costs of production (due to increased costs of factors of production, such as raw materials) and therefore increased output costs whilst simultaneously decreasing the level of supply. A trade war can also be damaging for an economy as it slows down economic growth due to decreased trade. Whilst protectionism decreases the level of imports that a country has (leakages from the circular economy theory) in hopes to fix the economy s negative balance of trade, if a trade war occurs then the economy s exports will also fall, which could be further damaging for the economies balance of trade, this will be an example of government failure as the economy will be in a worse position than before any protectionist policies were introduced. This is shown by the US / China price war.
It is estimated that the cost of this war for the US was around $300 billion up to the end of 2020 and it is estimated to have wiped $1.7 trillion off of US stock prices. The price war between the EU and China began due to anti-dumping tariffs that the EU imposed on China. China retaliated by imposing a levy on EU wine imports. This shows another negative of a price war, that it can affect global trade. The issue here is that if the price war escalates it could negatively impact the UK economy, a seemingly peaceful bystander. This would be detrimental for the UK economy as the UK aimed to increase exports to China to $30 billion by 2015, China is also the UK s 5th biggest trade partner.
Global efficiency will also decrease due to foreign country`s comparative advantages not being exploited. If a country decides to only allow domestic production of a good it is missing out on the advantages that some economies have that would lead to a cheaper production of the good with less opportunity cost. This can also lead to misallocation of resources as subsidiaries and raw materials will go to firms who may not be the most efficient in producing these goods, but are allowed to stay at the same efficiency level due to lack of competition, this may also lead to these firms becoming dependent on the government to be constantly bailed out in times of economic hardship.
Protectionism may actually be beneficial for some economies and could choose to adopt a protectionist approach if they are a newly emerging economy with lots of infant businesses and are facing high levels of structural unemployment. They also may be trying to reduce the consumption of demerit goods or trying to protect their economy against dumping. Infant businesses are new businesses that require protection from anti-competitive practices such as dumping, which involves foreign firms pricing their goods below the cost of production in order to draw all of the demand away from other firms, this is only a short term tactic.
The Chinese economy has come under fire for its dumping of goods such as steel. Furthermore, if protectionism is employed correctly it can fix a country`s balance of trade. This will work by reducing the level of imports in an economy, however, it is likely to also reduce exports as other economies are unlikely to trade with an economy that doesn t trade with them. A government could also choose to employ protectionist policies in order to try and increase the quality of life for its inhabitants. This is due to the protection of jobs that occurs when local firms are protected from anti-competitive behaviour. Also, the government may choose to put tariffs on specific goods that are deemed as demerit goods (the social cost is greater than the private cost or the social benefit is less than the private benefit). An example of this could be the UK government putting trade sanctions on goods coming from Indonesia that produce a lot of greenhouse gases (a demerit good).
Protectionism is more likely to be a beneficial policy for a developed economy as they are more likely to be able to be self-sufficient. However, this could be bad for developing economies as they lose potential trading partners. This is shown by the largest economy in the world recently choosing to adopt more protectionist policies (USA). A less serious form of protectionism that is beneficial for an emerging economy would be an artificial setting of it s exchange rate. A NEE could choose to set its exchange rate at a low price in order to attract exports and to make imports less incentive to its inhabitants to minimise leakages.
Overall, protectionist policies are definitely not inevitably damaging to economies, they are likely to be damaging to the world economy by certainly not inevitably damaging to all economies. There are many examples of protectionism being successful (such as India which is a very protectionist economy but has been forecasted as an economy with one of the greatest potential for economic growth) for some economies with most economies using some protectionist policies to try and maximise economic growth. On the whole, it seems that protectionist policies seem to benefit the richer countries enforcing them at the expense of the poorer countries. If protectionist policies were inevitably damaging then no economies would ever choose to undertake a protectionist approach.This resource was uploaded by: Shweta