TheMarketForIdeas

One might think that any market imperfection is a good reason to adopt protectionist measures. Indeed, a number of economists have fallen into this trap for almost two centuries: from the beginning of the modern history of international trade, in the first decades of the 19th century, to the 1950s, the solution of protectionism was repeatedly tried. Today, most economists argue, on the contrary, that protectionism is an inadequate and ineffective way of correcting internal market deficiencies. For example, if wages do not adjust quickly enough to the decline in demand for the products of a particular branch, a reduction determined by foreign competition, some contemporary economists argue that the appropriate government policy is to intervene – or, possibly, to cease intervention – in the labor market, where remedial measures can indeed be adopted that directly target the causes of the problem.

From this perspective, a relevant case is that of countries in a monetary union (e.g. the euro area), which have abandoned their national currency and, therefore, the exchange rate regulatory mechanism. According to the theory of optimal currency areas, in this case, the regulatory functions of the exchange rate must be replaced by those of the cross-border mobility of production factors (capital and labor), which excludes any form of protectionism. However, in the case of the euro area countries, the labor market does indeed present a series of rigidities, which affect the internal and cross-border mobility of the workforce. As a result, the elimination of these rigidities, not protectionism, is the true solution to the economic problems facing these countries.

Some economists also argue that even if protectionism were appropriate in theory, it would be “captured” in practice by interest groups (rent-seekers), who would abuse the measures to pursue their own narrow interests, not the national interest.

The main cost of protectionism is that it forces consumers to give up cheap imported goods. As a result of paying a higher price for those goods, the incomes obtained by producers/sellers increase. And if, in addition to being more expensive, indigenous goods are of poorer quality, the harm suffered by consumers is even greater.

Another important cost of protectionism is that of lobbying (influence trading), borne by those seeking protection against foreign competition. This cost constitutes the source of rent that accrues to the people who grant the protection (politicians, bureaucrats, technocrats, etc.) and, possibly, to those who support them in the media (journalists, analysts, spokespeople, etc.).

The main feature of modern international trade theory is, therefore, the significant diminution of the relevance of the arguments in favor of protectionism and the revolutionization of the traditional way of understanding the relative merits of free trade.

Protectionism appears in various and ingenious forms. When the followers of free trade manage to eliminate it in a certain area, it appears in another: the supporters of protectionism always seem to be one step ahead of the followers of free trade in inventing new ways of protecting against foreign competitors.

The main forms of protectionism are:

– a) tariff measures, mainly customs duties – calculated as a percentage of the price of goods (ad valorem); these duties increase the price of imported products, which, in this way, can become higher than the price of domestic products; consumers/buyers are thus forced to buy domestic products with preference, which obviously favors domestic producers/sellers, but eventually contributes to the development of the respective branches and to the reduction of unemployment; the cost of the entire process is borne by consumers/buyers, not by the state, as is often said;

– b) non-tariff measures, such as establishing quotas to limit the quantities of imported goods or to avoid increasing these quantities;

– c) “gray” or “disguised” protectionism, so called because it is less visible and bureaucratic; an example is the imposition of various norms: technical, hygiene, security, consumer protection, etc.; recently, labor law rules (e.g., the prohibition of child labor) or environmental protection rules have emerged.

In the past, states have mainly used tariff (customs duties) and non-tariff measures. Currently, various forms of “gray” or “disguised” protectionism are practiced. One form is the so-called “voluntary export restrictions” or “orderly trade agreements”. Instead of the importing country restricting imports by imposing tariffs or quotas, the exporting country restricts exports, but the protectionist effect is the same. The real difference, which makes exporting countries prefer export restrictions to import restrictions imposed by partner countries, is that the former allow exporters to obtain higher prices and, therefore, to appropriate the profits generated by the price increases caused by protectionism. An example is the voluntary quotas established by Japan on the export of automobiles to the USA. It is obvious that the United States could have limited the import of Japanese cars by imposing tariffs. However, this measure would have led to higher prices and, therefore, fewer cars being purchased by American citizens. As a result, the Japanese government voluntarily limited the number of cars exported to the United States. Because supply was reduced, Japanese car manufacturers were able to raise their prices and continue to export cars to the United States. Ironically, the additional profits generated by the voluntary export restrictions probably helped Japanese car manufacturers to increase their investment and thus become more competitive.

In the 1980s, the number of cases of voluntary restrictions increased, and this phenomenon was a disruptive factor for another reason. Such agreements selectively benefit exporters, rather than letting the market determine which participants would lose out from the restriction of international trade. In the previous example, the alternative would have been for the United States to protect American automakers by imposing tariffs or quotas on all foreign car imports, leaving American buyers to decide whether to buy fewer Japanese or European cars or more American cars. In other words, through voluntary export restrictions, the criterion of efficiency is in effect replaced by various political considerations.

Protectionism has recently taken on an even more insidious form, called “administrative protection”. This type of protection results from the application of regulations designed to respond to specific market conditions or events, established by legislative or administrative authorities. Thus, in almost all developed countries, there are regulations on so-called “fair trade”, which aim, on the one hand, to prevent other countries from subsidizing their exports (which would indeed distort market incentives and therefore affect the international division of labor), and on the other hand, to avoid situations in which foreign companies practice dumping prices on the goods they export. Some governments therefore practice anti-subsidy tariffs or anti-dumping duties to neutralize the effects of such practices. In theory, these so-called “fair trade” mechanisms are intended to support free trade.

In practice, however, “fair trade” is often used instead of, rather than in support of, free trade. These are cases in which the aforementioned procedures are clearly directed against competing foreign firms in order to simply force them to accept voluntary restrictions. Thus, commercial practices that are normally permitted to domestic firms (for example, price reductions during holidays) are prohibited to foreign firms, which in fact amounts to full-blown protectionism.

The literature shows that in the 1980s, many techniques for achieving “fair trade” turned into real protectionist means, used unjustifiably against foreign competition. As a result, some proposals have been made to prevent the “capture” of these mechanisms by certain interest groups. Their essence is the creation of bilateral dispute settlement procedures that would ensure more objectivity than national procedures. Such solutions are provided for, for example, in the “Canada-US Free Trade Agreement” and the “North American Free Trade Agreement”. However, these agreements are being jeopardized by the recent trade offensive of the Trump administration.

Another possibility is to make greater use of the dispute settlement procedures existing within the WTO.

Despite all these ideas and institutionalization efforts, there are many producers who say that the policies and institutions of certain countries actually constitute “unfair trade”. Thus, opponents of free trade agreements with some countries argue that, in those cases, free trade is impossible, due to the great differences in environmental standards, quality, wages, etc. The list of objections to free trade with countries where such causes of “unfair trade” exist is endless. And, in fact, this is where the main source of inspiration for the arguments against free trade lies.

Recent research on protectionism has focused on two major issues. First, the possibilities of eliminating agricultural protectionism in developed countries, especially subsidies for the production and marketing of food products, which were exempted from GATT rules in 1965, have been studied. Second, economic analysts have been concerned with the proliferation of bilateral free trade agreements, which are, in fact, preferential trade agreements. They show that, due to the massive expansion of preferential treatment of developing countries, through which they are exempted from the application of the most-favored-nation clause, the principles of GATT are being severely eroded, which endangers the freedom of international trade. To all these negative developments, add the unpredictability and chaos that currently come from the US government.

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