It is sometimes alleged that for all the microeconomic distortions that protectionist policies inflict, there can be a silver lining in terms of macroeconomic gains: more jobs, more output and a stronger trade balance.
Indeed, some economies today are seemingly using commercial policy to pursue macroeconomic objectives. Tariffs can dampen imports, boost net exports the difference between exports and imports, or the trade balance , and so boost GDP, other things being equal. Economists, however, have generally been skeptical.
Since the time of Adam Smith or maybe even before , open and competitive markets have been seen as most likely to maximize output by directing resources more productively. Tariffs, on the other hand, encourage both the deflection of trade to inefficient producers and smuggling in order to evade them; such distortions reduce any beneficial effects.
Further, consumers lose more from tariffs than producers gain, so there is deadweight loss. And the redistributions associated with tariffs tend to create vested interests, so harm tends to persist.
Broad-based protectionism can also provoke retaliation, which adds further costs in other markets. Moreover, economists believe macroeconomic policies fiscal and monetary policies such as interest rates or the budget deficit to be the natural instruments for achieving macroeconomic goals, such as raising growth and jobs.
Tariffs are more likely to lead to offsetting changes in exchange rates that frustrate the achievement of macroeconomic objectives; less imports and a stronger trade balance increase demand for the domestic currency, and so its value.
There is in addition a powerful lesson from history. Protectionist policies helped precipitate the collapse of international trade in the s, and this trade shrinkage was a plausible seed of World War II. So while protectionism has not been much used in practice as a macroeconomic policy, most economists emphatically consider that this is as it should be. More recently, world trade has shown tentative signs of renewed vigour. Yet, the nascent recovery in trade is at risk of being derailed by the introduction of impediments to global economic integration.
There are signs that the anti-globalisation sentiment that has become more pervasive since the crisis has begun to be translated into actual policy measures. Retaliatory measures have already been announced by some economies. These steps are taken despite the benefit of trade for aggregate welfare being one of the rare points of consensus for economists.
At the same time, the benefits of globalisation have not been spread evenly, neither across nor within countries, something that economists have not given sufficient consideration for a long time. While textbook economics suggests that lump sum transfers from the winners of trade can ensure that all are better off, such transfers — or adequate training and educational measures — have not happened in sufficient scale to compensate everyone.
Protectionism is not the right answer to these challenges, however. It is unlikely to solve the distributional consequences of globalisation while it is certain to reduce aggregate global living standards. There are no winners in trade wars, just different degrees of losers.
But to defend openness by listing its aggregate benefits is no longer fully convincing. The question of the distribution of those benefits and the disruptive effects that come with them has to be answered. Economists and policymakers therefore have a responsibility to propose and design policies that help those not benefiting directly from globalisation. I have previously spoken about the need to make globalisation efficient, enduring and equitable. I would like to flag two main implications should impediments to the free movement of goods and services increase significantly.
The first is the effects higher tariffs would have on growth and inflation in the near to medium term. There are a number of important channels to consider, including the direct impact of tariffs on prices and growth, changes to financial conditions and effects on expectations and confidence.
The second main implication is the possible impact on long-run potential output growth, and how that may influence the conduct of monetary policy. Let me first look at the channels through which increases in tariffs may affect output and inflation in the short to medium term.
As with all models, the uncertainties involved mean precise estimates from these scenarios should be treated with caution, but they are useful to explain the different channels at work. To illustrate the potential effects of rising protectionism, I do not want to dwell on the specifics of the tariffs currently being discussed.
This would miss the bigger picture. I rather want to consider a hypothetical scenario where the United States raises tariffs on all imports of goods by 10 percentage points, and its trading partners impose the equivalent on US exports. According to our model simulations, such a scenario would have significant adverse effects on the global economy, including, and in particular, on the economy that raises tariffs in the first place.
The reasons are essentially threefold:. They include:. The premise is that without trade protectionism a nation could lose long-established industries and companies that first made a product in a particular nation. National security is used for trade protectionist policies since the industries involved include defense-related companies, high-tech firms, and food producers. Protecting consumers is an argument used by policymakers to protect consumers from unsafe imported products.
Consumer advocates, domestic manufacturers, and certain policymakers claim that foreign-made goods may fail to follow requirements for product safety in the manufacturing and distribution process. This could result in serious illness, unsafe products, and even possibly death of the consumer.
Domestic manufacturers argue that if they must follow government-imposed safety and production requirements then foreign producers must also do so. The infant industry argument was first put forth by Alexander Hamilton in This idea states that new manufacturers have an extremely difficult time competing against well-established, well-funded, extremely profitable companies in developed countries. New manufacturers in developing nations may not have the economic and financial resources, as well as the technology, physical equipment, and research and development expertise to compete against older, established firms.
In order that infant industries and new companies gain market-share and a competitive edge against well-established firms, governments must put into place short-term support mechanisms for these infant industries until they have reached a level so they can compete with foreign companies.
It can also be argued that a developing nation in attempting to diversify its economy, must protect its infant industries. Government intervention of an infant industry may come in the form of tariffs, subsidies, administrative trade policies, or quotas.
These effects include:. A key effect of trade protectionism is that consumers will have a limited choice of products and goods since there may be quotas on how much may be imported. Due to these quotas, consumers will have a very limited choice as to the quantity, quality, and type of product that would otherwise be available to them without trade protectionism.
Protectionist policies that intended to safeguard industries, companies, and jobs actually mean that consumers are limited in the availability of products and goods and may have to settle for poor quality instead.
Another problem that consumers will face is that they will have to pay more for the limited quantity of goods and products, thus causing inflation to possibly greatly increase. If consumers have a limited choice, must settle for lower quality, and pay more for a particular product, then they may either pay that amount, purchase less of that product, or not make a purchase at all.
Domestic firms may also be hurt financially since they may have to purchase parts to make their products and then pass the increased cost on to the consumer. Overall, global competition is a key factor in keeping the price of numerous goods and products down and give consumers the ability to spend. Infant industries may never grow up due to government trade protection policies.
The key questions are: When will an infant industry no longer need protection from its home government? When will it be regarded as a mature company that has a comparative advantage against foreign companies and in overseas markets? A nation can use the policy of protecting its infant industry, but for how long is a key concern.
In particular, this has helped boost the chemicals and pharmaceuticals sector with both sectors improving their export performance. Between and , GVC participation rate for most developing countries declined, a recent World Bank report shows. But the decline for India has been sharper than for others. Higher protectionism does not seem to have brought any sizeable benefits for the country whereas greater integration did benefit the economy as a whole. India can realize its ambitions of becoming the next factory of the world only if it opens up its economy and adopts fair and predictable trade rules.
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