The Causes of Poverty (12): Protectionism

Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards. N. Gregory Mankiw

Types and justifications of protectionism

Most governments in the world apply restrictions on the international trade of goods. They limit the imports into their countries by way of different measures:

  • Import tariffs (or taxes – “duties” ’96 on imported goods)
  • Regulatory legislation (e.g. public health legislation or sanitation legislation, “purity” legislation etc.)
  • Quotas (limits on quantities of certain goods that can be imported)
  • Anti-dumping laws (laws against selling below production cost)
  • Government-imposed monopolies on the sale of certain goods
  • And other measures.

They do so in order to protect local producers and farmers against foreign competition. That is where the word “protectionism” comes from. The reasons they state for introducing these measures are usually the following:

  • Someone else did it first.
  • Labor in other countries is cheaper, and therefore the products are cheaper.
  • Labor in other countries may be forced labor, e.g. in prison camps.
  • Labor in other countries may be child labor.
  • Governments’ first duties are towards their own citizens.
  • Countries should be self-sufficient and should protect certain important industries such as the food and energy industries, so as not to depend on foreign countries, even if the local products are more expensive than their foreign equivalents.
  • It may take some time for industries to become fully operative. Before that, countries can protect these industries by shielding them from foreign competition.
  • It is more environmentally responsible to consume local goods than products that have to be transported over thousands of miles.
  • Free trade favors the stronger party in a deal, and hence is neocolonial. The outcome of a free deal between unequal partners means more inequality.
  • Free trade encourages off-shoring and outsourcing, and hence job losses in the unprotected markets.
  • Etc.

Many of these justifications are also commonly used in the debate on globalization. (I will not examine the merits of these arguments here ’96 although I believe that some have some merit – because this post deals with the rationale of trade liberalization, not protectionism.)

Both developed and developing countries uses these measures to protect their own producers.

Another distortion of free international trade comes in the form of subsidies for the production of goods to be exported. This is also a protectionist measure because the aim is to protect industries in difficulties, industries which would have problems selling their goods abroad at normal prices.

Origins of protectionism

As is apparent from the quote above, these measures are usually not inspired by economic thought, but emanate from political concerns. Pressure groups in different industries lobby the government and try to have specific protections put in place. At the same time, however, the international community of states has been involved in trade liberalization negotiations (GATT, WTO etc.) that have been going on for decades already and that should result in the scaling down of the different protection measures. Some success has been achieved so far but the talks are still going on.

Trade liberalization and poverty

One of the aims of these negotiations is the reduction of poverty around the world. But does liberalization of farm trade help the poor? I think it does. Free trade brings down the cost of some products, because it may be cheaper to buy these products elsewhere than to produce them yourself. The cost of producing them yourself may be higher than the cost to produce them elsewhere (e.g. because of the climate in your country, or the available knowledge etc.), even if you include the profit margin of the seller in this cost.

Also, international trade’a0allows countries to specialize in certain products only, and specialization increases productivity and diminishes prices (see also the concept of comparative advantage).

There’s yet another reason why free trade may bring down the price of goods. Normally, if trade is free and restrictions on international trade are abolished, then competition will increase. And when competition increases, prices tend to go down.

So there are several reasons why free trade brings down prices. And when prices go down, consumers pay less. And when people pay less, they are generally less poor.

Import tariffs

Also, when import tariffs are cut in trade liberalization measures, prices for the consumers in importing countries go down, and exports in relatively poor export countries go up. So this would help the poor everywhere, the poor consumers in importing countries, and the poor producers in exporting countries.

However, when import tariffs are cut, local production in some countries will go down because local companies will have to compete with lower priced goods from abroad, lower priced because of the absence of tariffs, but often also because of cheaper foreign labor. With job losses as a consequence and hence more poverty for the people working in certain sectors of the economy. Consumers in general may be better off, but not those working in the industries that were protected by tariffs. For them, the benefits of cheaper products may be outweighed by the financial loss of losing their employment.

Furthermore, the government loses tax revenues when tariffs are cut, and therefore may be less able to provide a social safety net to cushion the adverse effects of competition.

However, most economists believe that removing tariffs and having free trade would be a net gain for society (for some evidence of this see here and here).

Import quotas

Import quotas limit the number of foreign goods that can enter a country and be sold there. This increases the prices of the goods because the supply is limited, and also because many of the foreign goods are cheaper than the local equivalents (mostly because of cheaper labor costs abroad). Restrictions on competition push up prices as well. Eliminating quotas therefore lowers prices and benefits the poor.

However, similarly to import tariffs, quotas protect local producers because they suffer less competition from foreign producers. Quotas can save jobs and therefore diminish poverty. But the people in these saved jobs are less numerous than the total population of consumers who benefit from lower prices (and they are also consumers themselves).

Quotas, contrary to tariffs, do not generate tax revenue, so there abolition would not cut into government benefits.

Export subsidies

Export subsidies depress prices and make it harder for non-subsidized producers, often in the poorer countries, to compete. Many local producers and workers will go bankrupted when the same products that they produce, are freely imported from countries where their production is heavily subsidized, sometimes to the extent that they can be sold below production price.

However, the initial effect of slashing export subsidies is an increase in prices of goods. Take the important example of food prices or prices for farm products. Even in rural societies, most people buy more food than they sell. Slashing subsidies would therefore hurt the poor because it makes it more expensive for them to buy food. The World Bank has estimated that slashing all farm subsidies would lead to a 5% increase in average prices. However, net food buyers are generally richer than net sellers; higher prices therefore transfer income from the rich to the poor, on average. Moreover, even the poor who buy more food than they sell (and those who do not sell at all), may benefit from higher prices for farm products because these higher prices boost demand for rural labor and push up wages for farm workers. The farm sector as a whole grows because of an increase in profitability, and this creates employment.

The World Bank has argued that the net effect of all these elements (price increases because of slashing subsidies, higher wages in farm jobs etc.) is positive for the poor.

Conclusion

Free trade helps the poor, and the ongoing trade liberalization talks in the framework of the WTO should be pursued. But at the same time it should be made clear that free trade is not a miracle solution. Poverty has many causes and many solutions and should be attacked from many fronts at the same time.

12 thoughts on “The Causes of Poverty (12): Protectionism”

  1. First visit here…

    I have an abiding interest in human rights from the moral perspective.

    I have rarely read an article so balanced and clear that comes from the “pragmatic” perspective.

    I will be back.

    ~ Alex from Our Evolution

    Like

    1. So that the is reason for getting rid of the car industry? I think the comments by the Prime Minister are out of touch and wrong. We should never destroy our skills base because that will definitely lead to poverty. Our poverty at the expense of high skill jobs elsewhere.negotiated favourable with other governments for its people……And all our leaders can do is come up with slogans

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