Sep 29 2011

Protectionism’s many weaknesses

After our lesson on tariffs and protectionism the other day, one of my year 2 IB Econ students emailed me with a few questions she had not had the chance to ask in class. I thought I’d post my responses here, since they were such good questions!

Question: Hi Mr Welker, I asked this on Monday’s blog about self-sufficiency, but no one answered my question and I have been meaning to ask this in class but I always get distracted and I forget. And perhaps you have already answered this, pardon me if you have.

Since Exports and Investment have a great effect on economic growth, why would a government want to protect its nation by imposing barriers to trade? Because by doing so, foreign firms cannot invest in that nation and potentially create job opportunities and also contribute to that nations GDP since, even though it’s a foreign investment, the revenue is collected by that government.

Answer: Protectionism is not typically aimed at reducing the amount of exports from the nation engaging in it, rather reducing the amount of imports or promoting increased exports. You’re exactly right that exports and investment contribute to aggregate demand (and therefore economic growth and employment) in a nation. But imports are a ‘leakage’ from the nation’s economy, and the greater the level of import spending, the lower a nation’s net exports. A nation with a trade deficit actually experiences negative net exports. The purpose of protectionism is to reduce import spending, or increase export revenues, and thereby increase net exports and aggregate demand and employment in the nation.

As for foreign investment, one of the consequences of a large trade deficit is increased foreign ownership of domestic resources or factors of production. Since a country that imports more than it exports spends more on foreign goods than it earns from the sale of its own goods to foreigners, foreign governments and firms end up with large amounts of that country’s money that is NOT being spent on that country’s goods. Much of this ends up back in the deficit country as foreign investment. Sometimes foreigners will buy government bonds (invest in the deficit country’s debt, in other words), but sometimes the money comes back home as foreigners buying up factories and real estate. Foreign investment may indeed help create jobs at home, but so does domestic investment, and when foreigners invest it means the country’s resources are now owned by interests abroad, which many countries view as a threat to their national and economic security. This can also serve as a justification for protectionism: to prevent foreign ownership of domestic assets.

Question: Also if the country is not exporting, it’s not enjoying the benefits of revenue from exported goods that could boost their economic growth. And anyway, isn’t the point of making money to spend it? Otherwise what is the incentive of being employed and earning an income? Unless of course, one can argue that income earned can then be spent on domestically produced goods.

Again, the purpose of protectionism is not to reduce a country’s exports, rather to reduce its imports and to increase its exports. But you have made a very important observation here that points to a major flaw in the argument for protectionism. The purpose of exporting goods it to make money to spend on imported goods, otherwise, WHY TRADE? A country gains from trade not only because it has a wider market for its own goods, but because the people of the nation have a wider market from which to choose the goods they themselves can consume. When a nation erects barriers to trade, it will ultimately have the effect of reducing not only imports, but possibly the nation’s own exports. Since foreigners earn less money from selling goods to the protected nation, they have less money to spend on that nation’s goods!

All protectionism can hope to do is increase the welfare of particular industries while reducing the welfare of the rest of society. It is rarely justifiable on the grounds that it will increase the total welfare of society as a whole, unless of course the protected industry is one vital to national security, such as the defense sectors or the energy sector (even this one is debatable!)

Question: Or do government spending (through subsidies, and creating job opportunities) and increased consumption due to income gains caused by government intervention overcome these factors and compensate for the lost opportunity of exports and investments.

Increasing government spending to off-set the fall in social welfare resulting from protectionism will only lead to greater inefficiency in society. Government may have to spend more on unemployment benefits for workers whose jobs are lost due to protectionism, which may require higher taxes on those workers whose jobs are being protected. As explained above, one industry’s gain leads to a loss of welfare for society as a whole. This is the problem with protectionism. It favors certain industries but imposes higher prices on consumers and higher costs of production on other industries. It should not be the government’s job to “pick winners and losers” in the global economy. By protecting certain industries, however, government attempts to do just that, but society as a whole loses.

I hope you understand what I am asking for here. Whenever you have time, I would love to hear your perspective.

Maphrida

Great questions, Maphrida!

Discussion Questions:

  1. How might protectionism lead to an increase in aggregate demand and domestic employment?
  2. Why does a large trade deficit lead to a build-up of foreign ownership of domestic factors of production?
  3. Discuss the view that protectionism in the form of tariffs on particular goods helps certain industries but harms the rest of society. Can you imagine an example of a protectionist policy that could increase the welfare of society as a whole?
  4. Explain how a protectionist policy that makes imports more expensive and thus reduces demand for imported goods can ultimately lead to a reduction in demand for the protected country’s exports abroad.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

6 responses so far

6 Responses to “Protectionism’s many weaknesses”

  1. angel chenon 04 Oct 2011 at 3:52 am

    1. since” Protectionism is not typically aimed at reducing the amount of exports from the nation engaging in it, rather reducing the amount of imports or promoting increased exports”, protectionism will make turn import into domestic demand. When the domestic demand increases, factories, shop will need more workers to produce. This is the reason that increases domestic employment.

    2. Large deficit will suppose that import is larger than export. Foreigners will be able to invest in that nation.

    3. Protectionism in the form of tariffs on necessary goods helps the industries but harms the rest of society. For example, when a country increase the tariffs on the foreign oil industries. People will be led to choose domestic oil industries. People will increase their demand for domestic oil industries. Hence domestic oil industries will offer more jobs which increase the employment, and increases the welfare of society. Since the employment rate increases, government will spend less on unemployment benefits for workers whose jobs are lost.

    4. Because of the protectionism, the imported goods will become more expansive; people will need more money to buy the same amount of imported goods as before. So people will decrease their demand for the imported goods. Thus foreigners will earn less money from it.Then their income will decrease which cause them decrease demand for the goods (including the goods from protected country).That is the processes that protectionism finally reduces the export of protected country.

  2. Alex Wangon 06 Oct 2011 at 5:25 pm

    Although it is true that protectionism actions would lead to a definite lost in efficiency in the globe as a whole society, it could also in a way adjust the existing efficiency lost in the globe. Let's look at a example:

    Trade between the USA and China.

    The US has a considerable trade dificit to China which has been worsen because of China's artificially adjusted, fake currency exchange rate (The modifier "fake" is not subjective because the exchange has not represent PPP well for many years, thus "fake" is an objective adjective to this situation). We both believe that resources for production should be allocated in the most efficient way; and clearly, many America's products are lest costly and more efficiently produced compared to China's. But people in the US buy Chinese products because they are cheaper (of course to the society, they are more expensive).

    Then certain protectionism actions, especially tariffs, would effectively "fight back" and make sure products produced in higher efficiency ways. That is to eliminate "artificial factors" among international trade, in other words, protect "free trade".

  3. Esane Guoon 08 Oct 2011 at 2:42 pm

    1. How might protectionism lead to an increase in aggregate demand and domestic employment?

    The government wants to protect its nation by imposing barriers to trade mainly because that the protectionism can decrease the amount of imports and increase the amount of exports of the country. In this way the citizens of the country would demand more goods of their own country, then that provides more job opportunity for people.

    2. Why does a large trade deficit lead to a build-up of foreign ownership of domestic factors of production?

    Larges trade deficit states that the country’s imports from other countries greatly outweigh the amount of goods that the country exports to foreign countries. As in the article stated “foreign governments and firms end up with large amounts of that country’s money that is NOT being spent on that country’s goods”, so foreign countries would spend more money on the investments and buying bonds of that country.

    3. Discuss the view that protectionism in the form of tariffs on particular goods helps certain industries but harms the rest of society. Can you imagine an example of a protectionist policy that could increase the welfare of society as a whole?

    The protectionism in the form of tariffs on particular goods helps certain industries because it reduces the imports the country have from foreign countries and the demand of the good of local would increase. But it harms the rest of society because the customers would have less choice between want they can buy. But on the other hand, by having a policy would provide people with more work opportunity, so in short the protectionist policy mainly brings benefits to the whole society

    4. Explain how a protectionist policy that makes imports more expensive and thus reduces demand for imported goods can ultimately lead to a reduction in demand for the protected country’s exports abroad.

    The protectionist policy would make the imports harder to be permitted into the country or put a large number of taxes on it, in this way the price would be higher for the consumer to buy or they would have less choice between what they can buy.

  4. Peter Chen(Group1)on 09 Oct 2011 at 4:04 pm

    1. As the exports increase, more and more products will be exported to the foreign countries, so the aggregate demand will increase, which result in more and more people find jobs.

    2. As a country’s import exceed the exports, a large amount of foreign money will flow to the other country, which cannot spend in their domestic products, so the other country can buy bund of the deficit country to earn interest, which result in the increase of their ownership of the domestic resources or factors of production.

    3. This idea sometimes goes wrong. Because when a country experience a situation of abruptly development, like China, and its own industries are not strong enough to beat the foreign industries. For instance, currently there are more and more entrepreneur in country A, and their production experience a weak time, which cannot beat the low cost of the foreign countries, so they must rely on the help of the government. After the tariff policy, the bosses benefit a lot from that, and also due to the large amount of new industries occur in A, the whole country get profit.

    4. If the foreign countries cannot earn money from the imports from our country, they also have less money to buy the exports of our country, which result in the reduction of the export of our country.

  5. Vincent Wengon 30 Oct 2011 at 11:59 am

    1. As we know, the purpose of protectionism is not to reduce a country’s exports, rather to reduce its imports and to increase its exports. So when the protectionism occurs, the domestic people will turn from buying foreign goods to domestic goods, as a result, the aggregate demand of domestic goods will increase, furthermore the domestic employment will increase soon afterward.

    2.A large trade deficit means a country spent more money on foreign country's good than earned from foreign country, in this condition, foreigners may end up with large amounts of money on this country's investment, such as government's bonds, factories, real estate, etc. These investments will lead to a build-up of foreign ownership of domestic factors of production

    3.I think it's true that the tariffs on particular goods helps certain industries may harms the rest of society, think about it, if your country set up a tariff on the watermelon, it will block the international trade of watermelon, as a result, you can only always taste your own country's watermelon or spend a great quantity of money on foreign's ones. In another point, your country will suffer a efficiency loss since it can no longer show it's comparative advantage freely. Maybe the example of a protectionist policy that could increase the welfare of society as a whole is on the country's defense sector, because this industry is one vital to national security, on this condition, "welfare" is not only equal to money, but also safety of this country.

    4.Once you reduce the imports from foreign countries, they will have less money to import your goods, finally, the demand of your country will decrease and you will export less.

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    Protectionism?s many weaknesses | Economics in Plain English