The advantages and disadvantages of Protectionism

Consumers pay more with protectionism too. Without a system of competitive pricing, domestic companies are free to raise their prices without raising the quality of their goods. Put more simply, when a business is without competition then the consumer is without options.

Businesses suffer from protectionism as well, though theirs is more of a head-in-the-clouds brand of suffering. Government support often builds corporate complacency, which in turn could lead a business to believe that it has a nice safety net set up behind it. In the event of strong foreign competition, these businesses might not have the resources necessary to survive on their own.

Finally, trade protectionism limits consumer access to foreign goods and non-domestic companies that offer unique products and services are also subject to the aforementioned restrictions. 

Foreign businesses and domestic consumers face the greatest disadvantages of trade protectionism. Businesses face unfair restrictions while their domestic competitors are offered financial boons, and consumers end up paying higher prices for a limited variety of products that aren't always worth their cost.

3. The Advantages for Free Trade

Free trade is a trade policy that allows traders to transact business without any sort of interference or intervention from the government. It is believed that free trade leads to mutual benefits for both the trading partners. It differs from other forms of trade in that there is no creation of artificial prices, or a false demand and supply of products. In a protectionist trade economy, government intervenes in the form of subsidies, taxes, tariffs, etc to lower prices of goods or adjust supply of products. Free trade overcomes all this and gives a true picture of the actual demand and supply. To understand how free trade creates a better market and trade environment, let’s take a look at its benefits. There are at least 10 advantages to free trade.

Increased Production and Efficiency. In 1776 Adam Smith stated, "If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage." Smith's comment states the largest advantage of free trade:

1. Countries that specialize in creating commodities where they have the comparative advantage will increase their production, instead of focusing on products or industries in which other countries have the comparative advantage. What is comparative advantage? In economics, comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies. As a result, this explains that by specializing in goods where countries have a lower opportunity cost, there can be an increase in economic welfare for all countries. Free trade enables countries to specialize in those goods where they have a comparative advantage.

2. Economy of scale. When countries specialize in certain goods that they can produce, they can take advantage of economy of scale and produce these goods at lower average costs. This is more useful to industries where the fixed cost of production is very high or where the investment required is very high. By specializing in such products, the industry can ultimately gain from economy of scale and lower production costs. This would transfer to the consumer as lower prices for the finished goods.

3. Production efficiencies. Free trade improves the efficiency of resource allocation. The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services. By increasing production, countries increase their efficiency. By specializing, countries better allocate their resources and purchase cheaper resources from other countries.

4. Increases healthy competition. When demand increases from abroad, industries will respond to the demands by reducing costs and increasing efficiency. This will prevent the creation of monopolies within the domestic market, which lead to high prices. Thus free trade brings about a healthier competition within the domestic industry. Because free trade leads to a global market, consumers benefit from the competition and variety brought to the market. When other countries produce some items cheaper, than the consumer purchases products for less.

5. Increase of innovation. Another benefit to consumers is increased innovations. As free trade expands, competition also expands. To stay competitive, companies must seek ways to create the comparative advantage. This leads to increased innovation that improves products.

6. Employment. Although free trade may cause jobs in one particular industry to wind up overseas, jobs in the exporting and importing sides will increase. When productivity increases in importing and exporting, wages also tend to rise.

7. Increases economic growth. Trade is the greatest factor that leads to economic growth. When the trade occurs as a result of true demand and supply, the economic growth that occurs also truly reflects the increase in economic welfare. Thus, free trade brings about increased economic growth, which means better and more jobs; better standards of living; etc.

8. Foreign Exchange Gains and Decreased Poverty. When a country purchases a product from another country with money, they essentially send the exporting country non-interest IOUs in exchange for real goods. The exporting country, though, must use the money within the country that imported the products. For example, the United States purchases steel from China with U.S. money at the current market value. China will later use the U.S. money to purchase computer programs from the United States at the future market value. Countries that open their trade barriers to allow free trade have the chance to enter the global market, which will increase income for the country. In the 1990s, developing countries that lifted trade restrictions tended to grow three times faster than countries that restricted trade.

9. Increased Export. Countries with stringent trade restrictions often cause animosity with other countries. Therefore, the country with the restrictions also limits its own ability to export. When a country removes their trade restrictions, other countries are more willing to accept the exports.

10. Effective use of raw materials. Free trade not only brings about economic growth but also effectively uses raw materials, especially highly valuable and highly limited raw materials. For instance, the Middle East is a rich source of oil, but there isn’t much else in these countries. Trade is what ensures that this limited resource is distributed to different countries that lack this resource and the Middle East, in turn, gets the products necessary for their day-to-day living and business.

11. Lesser cost of living. When governments add tariffs and taxes to protect their interests, it leads to the industries selling products at a higher cost. This leads to higher costs of living. On the other hand, free trade does away with government interventions such as subsidies, tariffs, and taxes. This ensures that the products and services are efficiently produced and at a lower cost. This transfers to lesser prices for products and thereby lesser cost of living.

12. Good government and peaceful international ties. Free trade prevents the need for protectionist government policies. It is such policies that lead to corruption among the government officials. Thus, a free trade economy promotes healthier governance. A healthy government also works towards a healthier economy. This ensures smoother and healthier trade and political relationships between countries. Thus, free trade leads to healthier domestic governance and peaceful international ties.

4. Disadvantages of Free trade

Unrealistic Policy. Free trade policy is based on the assumption of laissez-faire or government non-in­tervention. Its success also requires the pre-condition of perfect competition. However, such conditions are unrealistic and do not exist in the actual world.

Non-Cooperation of Countries. Free trade policy works smoothly if all the countries cooperate with each other and follow this policy. If some countries decide to gain more by imposing import restrictions, the system of free trade cannot work.

Economic Dependence. Free trade increases the economic dependence on other countries for certain essential products such as food, raw materials, etc. Such dependence proves harmful particularly during wartime.

Unbalanced Development. Free trade and the resultant international specialization lead to unbalanced development of national economy. Under this system, only those sectors are developed in which the country has a comparative advantage. Other sectors remain undeveloped. This results in lop-sided development.

Dumping. Free trade may lead to cutthroat competition and dumping. Under dumping, goods arc sold at very cheap rates and even below their cost of production in order to capture the foreign markets.

International Monopolies. Free trade may lead to international monopolies. It encourages the estab­lishment of multinational corporations. These corporations tend to acquire monopoly position and thus harm the interest of the local people.

Reduction in Welfare of Certain Groups. While free trade tends to maximize world production of goods and services, it may simultaneously hurt the welfare of certain group in every country. Under free trade, the output of those commodities in which the country has comparative advantage tend to increase to meet the export demand, and the output of goods in which the country has comparative disadvantage contracts due to pressure from import competition. Thus, the real income of the groups engaged in the export industries will rise and real income of those engaged in the import competing industries will fall.

With the removal of trade barriers, structural unemployment may occur in the short term. This can impact upon large numbers of workers, their families and local economies. Often it can be difficult for these workers to find employment in growth industries and government assistance is necessary.

Increased domestic economic instability from international trade cycles, as economies become dependent on global markets. This means that businesses, employees and consumers are more vulnerable to downturns in the economies of our trading partners, eg. Recession in the USA leads to decreased demand for Australian exports, leading to falling export incomes, lower GDP, lower incomes, lower domestic demand and rising unemployment.

International markets are not a level playing field as countries with surplus products may dump them on world markets at below cost. Some efficient industries may find it difficult to compete for long periods under such conditions. Further, countries whose economies are largely agricultural face unfavorable terms of trade (ratio of export prices to import prices) whereby their export income is much smaller than the import payments they make for high value added imports, leading to large CADs and subsequently large foreign debt levels.

Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by governments, according to the infant industries argument. It is difficult to develop economies of scale in the face of competition from large foreign TNCs. This can be applied to infant industries or infant economies (developing economies).

Free trade can lead to pollution and other environmental problems as companies fail to include these costs in the price of goods in trying to compete with companies operating under weaker environmental legislation in some countries.

Pressure to increase protection during the GFC. During the global financial crisis and recession of 2008-2009, the impact of falling employment meant that protection pressures started to rise in many countries. In New South Wales, for example, the state government was criticized for purchasing imported uniforms for police and firefighters at cheaper prices rather than purchasing Australian made uniforms from Australian companies. Similar pressures were faced by governments in the United States, Britain and other European countries.

THE PRACTICAL PART

Why Free Trade Is Far More Preferable Than Protectionism on the USA example

Free Trade vs Protectionism

The financial meltdown of 2008 and the resulting deep recession have brought enormous pressure upon the governments of the many nations of the world including the United States. The world economy has been remarkably slow in recovering from this sharp downturn. The resulting unemployment, slow GDP growth, and continuing depressed housing markets stubbornly persist. Politicians often look for quick fixes during these times of severe economic distress. Protecting domestic industries sounds like the the logical action to take under these conditions. Unfortunately these same politicians do not consider the long term implications of protectionism. They need to examine history, macroeconomics, and foreign policy before making these hugely momentous decisions. All policy actions have reactions and thus they often have dire consequences. Often these consequences create much more damage than the initial problem ever did. In this analysis I will describe the four main types of protection that a country may provide to an industry or the economy itself. They are tariffs and quotas, industry subsidies, currency manipulation, and import product regulations. Furthermore I will present both the benefits and the dangers of each of these forms of protectionism. Finally I will attempt to give a full global picture of why free trade is a far more preferable long term policy than protectionism.

Let us start with the most common forms of protectionism which are tariffs and quotas. Pure free trade exists when countries trade with one another without placing any barriers upon any of their trading partners. In other words all nations would be trading on a level playing field. However many nations decide to protect one or more of their industries by placing tariffs on imports from other countries within that industry. They may also place quotas limiting imports relating to that industry. Tariffs make imports more expensive compared to the products of the domestic industries. Quotas overtly limit imported products from other nations. These forms of protectionism are often instituted to protect a developing domestic industry or a declining one. Third world developing nations use these mechanisms to allow their infant industries to grow and solidify. Unfortunately many of these nations become addicted to these methods and fail to remove them when the protected industry matures. Some political leaders in the developed world feel political pressure to save a domestic industry of theirs when it is declining. This is usually because companies in the developing world are gaining ground on them quickly due to wage cost advantages. These countries are still poor so their wages are naturally much lower at this point. This type of protection is usually futile due to these vast wage differences. It is also counterproductive to trade in general. The Smoot-Hawley tariff was passed by the U.S. Congress in 1930 during the height of the Great Depression to protect primarily their agricultural industry. The tariffs were record highs at the time and it sparked a worldwide trade war that further exasperated an already decimated world economy. The U.S. also negotiated quotas with Japan on steel and automobiles in the 1980's to protect these declining industries. They were successful but only to the extent that they left extremely shrunken domestic industries for those products. The lesson to be learned from this is that negotiation works. Unilateral trade actions often spark trade wars which hurts everyone involved very badly.

Another form of protectionism utilized by many countries is industry subsidies. This method is generally used to help fledgling industries grow or to protect mature industries from unfavorable market conditions. Giving help to a growing industry is a norm for most countries whether they are developed or not. Developing nations do it to establish new industries and to grow their economy. Developed countries normally utilize this method to move off declining industries and establish more advanced industries such as biotechnology or alternative renewable energy. Sometimes these developed nations use this method as protection for an aging or vital industry. The United States provides very large subsidies to its farming industry. These subsidies were first implemented during President Franklin Roosevelt's administration as part of his New Deal during the Great Depression. Prices for farming crops had fallen to rock bottom levels and farmers were going bankrupt in record numbers. The U.S. food supply was now being threatened and something needed to be done. The Roosevelt administration instituted a number of programs and subsidies that allowed farmers to stay in business and make a livable income. This worked very well and has continued to be used to ensure a stable farming economy. Unfortunately these programs have become institutionalized and farm subsidies are now the norm. My belief is that they should only be used as a backstop to ensure that farmers do not go bankrupt and not to ensure a certain income level for farmers. This is a prime example of a misuse of industry subsidies. The proper use of subsidies is to employ them to meet vital national needs such as developing a cutting edge industry or ensuring that a national security requirement is met.

The third major form of protection that nations use to aid their industries is currency manipulation. All nations perform currency manipulation at one time or another. Most nations have a broad range in which they feel it is safe for their currency to fluctuate without damaging their economy. Any fluctuations beyond this are usually deemed a threat to their economy and the government will take action to bring that currency back into the acceptable trading range. A strong currency favors cheap imports, lower inflation, and lower interest rates. A major disadvantage is that your exports are are more expensive hurting most of your domestic industries. Conversely, a weak currency aids your domestic industries greatly but could lead to higher interest rates and higher inflation. The major problem regarding currency manipulation occurs when a nation conducts this method with the goal of obtaining a competitive trade advantage over other nations. The prime example of a country employing this form of protectionism currently is China. The Chinese economy is overwhelmingly driven by their export industries. Their economy would begin to stall without the component of consistently rising export levels. This growth is critical to the retention of power for the Chinese Communist Party government. Of course the Communist name is misleading in this case because the Chinese economy is now actually a Capitalist economy. The problems the Chinese government is faced with involve the lack of democracy as well as the fact that their country has a population of 1.3 billion people and growing rapidly. They need to maintain the growth of their economy to support China's massive population. There is also a large group of their citizens that remain in poverty. This is additionally critical for the ruling Communist party due to the fact that their populace does not have elections as an outlet for their frustrations. Therefore the Chinese government employs currency manipulation as a means to keep their export industries strong and to maintain a huge trade surplus. This in turn allows the government to use the funds from this surplus to buy up dollars on the open currency market. This is the mechanism that the Chinese government uses to keep the Chinese Yuan value low relative to the U.S. dollar and other world currencies. It not only helps their export industries but it hurts the export industries of other countries making it a very unfair trading practice. They are not the only offender of this sort but they are certainly the most prominent and blatant practioner.

Finally we turn to import product regulations. As with the other three forms of protectionism, regulating imports can be a double edged sword. This method is key to ensuring that the products imported into a nation are up to the quality standards that the receiving nation holds for its own domestic products. Some nations, especially developing ones, look the other way in regards to ensuring high quality standards for the products of their exporting industries. Their main priority is usually facilitating the rapid growth of their industries rather than maintaining the safety and quality of their products. China has been implicated in several scandals regarding dangerous export products in recent years. One was a recall of poisonous pet food in 2007. Another example is an ongoing problem with sub-standard dry wall that is damaging many homes in the United States. The Chinese government has begun punishing these industrial malefactors severely when these instances of gross neglect or incompetence are found. This is an attempt to uphold China's industrial reputation before it substantially hurts its exports. There is still a lot of improvement that needs to be done. The U.S. and all other countries must remain vigilant and take action against offenders such as this to ensure that these practices are halted. Developing countries already have a substantial advantage in regards to labor costs. Taking shortcuts on quality should never be allowed both for safety reasons and trade fairness. This is the proper and necessary use for import product regulations. Unfortunately some nations utilize extraordinarily onerous regulations on imports as a means of excluding them from their country. These nations use this method to effectively block certain imports from entering their country much like tariffs and quotas operate. They get the benefit of this result without appearing to be protectionist. The bottom line is that regulations should be used for the protection of their nation's citizenry and not for the promotion and protection of their domestic industries.

I have now outlined the four major forms of protectionism. My belief is that all nations will become more prosperous in the long run as more trade protections are dropped and trade becomes freer. Of course nations do not operate within a utopian world. Some countries are marvelously wealthy with a myriad of resources. Others have been poor for centuries due to geography, wars, nature, or government corruption. These are the major reasons for a nation's poverty though by no means the only ones. Therefore different governments have different problems and pressures. Developing countries have fledgling industries to nurture while developed ones have jobs in declining industries to preserve. I believe protection should only be given in three situations and even then only on a limited basis. The situations are aiding a brand new industry to start up and develop, protecting an industry that is vital to national security, and the using of regulations strictly to exclude dangerous products from entering one's country. All other trade problems should be handled through in depth trade negotiations. People lose their lives when nations enter into shooting wars. People lose their jobs when nations enter into a trade war. No one wins in either of these types of wars. Nations close down their trade markets during a trade war shrinking the field for everyone. Trade negotiations are the most optimal way to settle trade disputes. This is true in state diplomacy among nations just as it is with trade negotiations. The North American Free Trade Agreement (NAFTA) is an excellent example of successful trade negotiations that have benefited all nations involved. Now it is true that some U.S. jobs have been lost primarily in older low-tech industries. Conversely lower market barriers have expanded the market share of our hi-tech industries which greatly expanded job creation in these areas which represent our future. This is the model of economic progress we should be striving for all over the world. The World Trade Organization (WTO) embodies this. The WTO is an outgrowth of the General Agreement on Tariffs and Trade (GATT) which was a set of trade rules agreed upon by many nations in 1947. It was negotiated under the auspices of a United Nations conference on trade. There were eight rounds of negotiated agreements under GATT which each time substantially lowered tariffs and other barriers among the participating nations. GATT was replaced by the WTO in 1993. The major difference between the two is that the WTO is an actual institutional negotiating body and not simply a set of agreements. The WTO and smaller trade negotiations such as the one that resulted in NAFTA are the best mechanisms to open up all trade markets and expand the world economy. Our world is a much smaller one now due to the incredible advances in communications and transportation. These are wonderful developments which if handled correctly and openly among nations should result in a more prosperous and peaceful world. I know this sounds like a "Pollyanna" viewpoint especially with all the tumult going on in the world presently. Yet think about how the idea of democracy has been spreading like wildfire in the Middle East. Dictatorial tyrants are quaking in their boots. Practically instantaneous information transmission via the internet has sparked this. It has also given the tools to millions of entrepreneurs around the world to start up companies and grow them. Barriers among nations are coming down by way of this information phenomenon without any input of world governments. I hope to see them get onboard this train and continue to negotiate to tear down protectionist barriers on the road to free trade. We are inevitably moving in that direction anyhow. Let us accelerate this process and make this a better world for all.