Protectionism, what is it and how does it impact trade?

With the topic once again in the media lime light, its seems appropriate to discuss protectionism in this post. However, this rather advanced economic concept is best understood if we take a few steps back first.

Before looking at the ins and outs of protectionism, we first have to understand the concept of trade. The idea of trade, and why we don't just all make everything we need ourselves, goes back to an economic theory called "comparative advantage". Developed by economist David Ricardo in 1817 it sets up a scenario in which two people make two products and need different amounts of time to make them. While I could write out the example and go through it step by step, it probably makes more sense for you to go here and watch the video, or go here for the super in depth Wikipedia explanation.

Now that we understand the underpinnings of why we trade, we take a look at how comparative advantage applies to the real world. We see that, like most economic theories, it does hold true; Singapore is known as the banking hub of Southeast Asia, but you won't find it ranked highly on the list of the largest grain producers in the world. Nevertheless, we can't give Mr. Ricardo too much credit, because if you look closely, some flaws start to emerge in his theory. Why is it, for example, that the USA both exports and imports coal? Surely if ole' Dave was right then it would be one or the other? Well, as is so often true, economic theories are just that, theories. They make sweeping generalizations and an abundant use of assumptions, ultimately taking some of the real world aspects out of the equation.

So where does that leave us on trade and protectionism? Well, if you need to know one thing about economists it's that they never pass up the chance to build a new and improved theory or model that attempts to revolutionize the way of thinking on a given topic. Cue Eli Heckscher and Bertil Ohlin. These guys did just that, they took the concept of comparative advantage and built on it. And yes, you guessed it, they named the outcome the Heckscher-Ohlin model (the second thing to know about economists is that they have huge egos). Often abbreviated to just the H-O model (bet they hate that), it tackles the real world applicability of David Ricardo's rather simple example. Though there is a ton of math involved (click

for a video that goes pretty in depth), essentially the model introduces the idea of something called "factors of production" which are nothing more than: land, labor, and capital (sometimes entrepreneurship is included too, but lets keep it simple).

Eli and Bertil go on to state that any economy will produce, and consequently export, goods and services that utilize the factors of production that the economy has in the most abundance. Woah, what on earth does that mean? Well, going back to our previous example, Singapore is an island nation of only 276 square miles (716 square km) which works out to roughly half the size of Los Angeles, but has lots of capital in the form of office buildings and top-notch software. The H-O model would take a look at this and come to a clear conclusion: it makes the most sense for Singapore to focus on things such as banking or tech startups because those need a lot of capital, what Singapore definitely should not focus on is anything that requires land. Aha, that makes sense...but unfortunately as you may have gathered, even the H-O model has its limitations. For example, the US is well known for its (in)famous investment banks, but is also home to huge farms that span miles and miles.

So now that we have a pretty solid understanding of economic trade theories, lets get back on track. Protectionism is of course the idea that trade is not good for your economy and you wish to suppress it. This can be done a number of different ways.

1) Taxes (also called tariffs): If you make Japanese manufactures pay a 45% tax on exporting their motorcycles, do you think they will keep 'em rolling? Probably not since your domestically produced motorcycle now looks much cheaper in comparison (this was actually a real thing back in the 80's).

2) Quotas: The less popular brother of tax, a quota is just a set number of a specific good that is allowed to be imported in a given time frame (usually a year). If there is a quota that your economy will only allow 5,000 Swiss wheels of cheese each year, after those are devoured by the end of January, that's it, no more until next year

3) Embargoes: The US until recently had an embargo on Cuban cigars. This meant that, legally, not a single Cuban cigar was allowed to be exported. This most extreme form of protectionism is rarely seen in today's world, and when it is, the reason is usually economic punishment (such as Iranian oil sanctions) to the recipient of the embargo rather than utilizing it as a form of protectionism.

4) Domestic subsidies: This is a tricky one. If two economies make the same $1 product that costs $0.50 to make and the government of economy A decides to institute a domestic subsidy of $0.15 per unit, then the producers in economy A could either lower the price of the product or make more of the product at the same cost (or a bit of both). Either way, the producers in economy A would be able to sell more, leaving the non-subsidy-receiving producers in economy B with the short end of the stick.

Now, all of these measures essentially do the same thing, they stem the flow of trade between economies. While it may be good for Joe, the ailing car laborer that the factory he works for isn't being moved to China (where his job would be filled by someone being paid a quarter of his salary) because it would mean paying a tariff on the car when it is imported into the country, an economist would argue that this is wrong. In the greater-picture, Joe should lose his job, retrain as a robotics engineer and found a company that automates the process of car manufacturing. This would be making use of abundant factors of production and create efficiency. Then again, Joe probably doesn't want to hear that, he wants to keep his job, and so he is in favor of protectionism.

There are more arguments to be made on either side, but honestly, you could probably write a book on the subject (oh wait, somebody already did). Each debate whether to implement protectionism or reduce it has its own nuances. One thing though is certain, it is always better to be well informed about a topic, especially when everyone and their grandmother are talking about it. So next time someone asks you about what you think about protectionist measures your local politician is suggesting, introduce them to your three new friends Ricardo, Heckscher, and Ohlin, and given them background knowledge so that they too can partake in the great joy that is the field of economic trade theories!

Happy trading!

 

We can have a civil disagreement, but my stance is that the idea should be to open up China more, not to become as closed as China had been.

Be excellent to each other, and party on, dudes.
 

We don't want a system where our goods get tariffed more than theirs, tolerated intellectual property theft, and their currency is manipulated to make their goods cheap

Overwhelming grasp of the obvious.
 
Best Response

Fair points, and a lot to unpack in those three assertions.

China since 2001's WTO ascension has been steadily opening up to foreign markets and have had to deal with a great number of contingencies put in place. It might be more constructive to talk about specific examples, but generally the tariff level is transparent and has been improving over time rather than getting more restrictive. Would be nice to see that progress continue or accelerate, but again that is my original point. The US imposing punitive tariffs across the board starts a trade war that will not help the goals of either country.

I agree than an inordinate amount of intellectual property theft has taken place in China, but shutting down trade will provide China and Chinese firms with more incentives to do so rather than fewer. Also, to the extent to which theft has been "tolerated," punishment would be more effective through global trade bodies rather than bilateral tariffs.

The currency manipulation is a red herring, and China is really shooting itself in the foot through its capital controls. The US dollar is strengthening against practically all world currencies at the moment, and China is running out of the US foreign reserves it would take to stabilize its currency against this movement. Looking at the ~10 year historical exchange rate, I don't think the current level of 7 CNY / USD is sustainable. It will drop within the next few years.

Be excellent to each other, and party on, dudes.
 

Interesting write-up, OP, but we're talking about protectionism because of the false narrative that continues to get tossed around by the media (and, admittedly, Trump is a terrible communicator of his ideas). What is mainly being discussed is making the U.S. more competitive in trade through regulatory and tax reform, and punishing countries for unadulterated violations of trade norms (such as the grotesque and obvious IP theft by the Chinese) or for being countries that are straight-up U.S. antagonists (such as Mexico, which encourages its poorest citizens to illegally cross into the U.S.). The whole concept of "secular stagnation" (where the U.S. economy simply cannot grow anymore due to fundamental and immutable laws) is complete and utter horseshit and was an excuse for pursuing left-wing policies of redistribution over seeking economic growth--the U.S. has one of the highest corporate income tax rates in the industrialized world; the U.S. banking sector is the most regulated industry on Earth (that's not even an exaggeration); half of U.S. states are not right-to-work; the U.S. has endless supplies of untapped energy (the development and export which the federal government has attempted to foil for decades); and the list goes on.

The United States has a ton of ability to enhance its economic growth and its global trade position. Most of what I've heard is about the U.S. making itself more competitive in trade and enforcing the letter-of-the-law when it comes to trade agreements and WTO norms, and cracking down on U.S. domestic employers that abuse the legal and illegal system of immigration.

Array
 

America's greatest asset is its near limitless ability to attract talented immigrants. How can America possibly abuse legal immigration? Every qualified candidate that we turn from our shores goes to compete against us in the global marketplace.

One thing I have learned from this election is I must be part of the globalist cabal against which both far left and right rail.

Be excellent to each other, and party on, dudes.
 

One thing they must address is the education of foreign students. If we educate you, then you become a us citizen. It helps talent stay here verses having them return home and compete against us.

26 Broadway where's your sense of humor?
 

There is sense in going against free-trade if your goal is to court the votes of the economically illiterate. If your goal is economic prosperity, then no, there is no sense in doing so.

 

From a macro perspective, the answer is clear. Globalization certainly is the best way forward for societies and nations as a whole. The economic logic on that is irrefutable. The problem is that globalization and free trade do have losers. Low-skilled workers in America, for example, have been hurt by globalization. When many of these low-skilled workers lose their jobs because of globalization, they're stuck because they lack the economic resources to gain new skills. The benefits of globalization and free trade tend to accrue disproportionately to those with capital resources. Leaders should do a better job of talking about the gains from globalization to societies as a whole but also distributing the gains from free trade and open border policies to those who are hurt most by them.

 

Correct me if I understood this wrongly - Isn't this exactly what protectionist policies are aiming for? Government income is not the key reason for protectionism. When Airbus shifts their manufacturing to North America, it brings along technical know-know, jobs and capital into the region.

Have a read on Thailand and it's auto-manufacturing industry as a prime example of how protectionism benefited developing economies in the short-run amidst global behemoths attempting to monopolize markets through free trade. Tiger16 @lwmg"

 

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