Pros and Cons of Protectionism

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In a perfect world, business would be as simple as offering a good or service and having the public want what you are offering. But it is a complicated world in an era of globalization, which has brought about international trade and other considerations that businesses even 50 years ago would not have had to ponder.

From raw materials to the sales markets in overseas opportunities, globalization has opened doors for good and for ill. The list of free trade pros and cons is a long one, especially when populism in politics is causing voters to cheer for protectionist policies while not necessarily understanding all the ramifications such policies can introduce.

What Is Protectionism?

When the pendulum swings to one end of the scale, you have got free trade, and at the other end, it is protectionism. Most countries and territories fall somewhere in the middle, employing protectionist policies on some industries while trying to encourage mutually-beneficial free trade in other sectors.

Usually, protectionism is deemed to protect the home-court advantage against imports from countries where there could be unfair competition. Governments achieve protectionism through four primary strategies that insulate domestic producers while making the playing ground more challenging for foreign ones.

Reasons for Protectionism

Reasons for protectionism can be widespread — from political pressure to seemingly insurmountable issues like when the Great Depression occurred. The Great Depression caused all kinds of protectionist attempts, such as the Smoot-Hawley Tariff Act of 1930, which myopic legislators passed in hopes of protecting Dust Bowl-afflicted farmers.

Unfortunately, other countries retaliated and launched their own tariffs and protectionist moves, spurring a trade war that arguably both deepened and prolonged the Great Depression globally. That ended the honeymoon period for protectionism and the beginning of a world that saw value in encouraging trade with each other.

The Four Methods of Protectionism

  1. Tariffs: When importing products of any kind, a tariff is nearly always applied and is paid by the importer. So, if Jimmy in Omaha is importing wrenches from China to sell in his shop, he pays the tariff imposed by customs officers, and the cost of said tariffs are passed on to consumers through higher prices. This is done to try to make domestic products more competitive and appealing.

  2. Product Standards: Compliance to industry standards can be a huge business cost for industries, and if imports roll in without having to meet such standards — like Chinese children’s toys made with toxic materials — it can affect domestic producers in many ways.

    The appeal of the Chinese toys might be that they are half the price of American toys, so even a tariff would not level the playing ground. But imposing manufacturing standards on them could exclude them from the market entirely, with American manufacturers benefiting from their exclusion.

  3. Subsidies: Issued in the form of tax credits or even direct payments, subsidies can help producers maintain a market share or overcome competition. Soy farmers, for instance, were issued heavy subsidies as the 2018/2019 trade war with China ramped up and hurt their export chances. Subsidies are often thought to be a Band-Aid, and wounds are sometimes more serious than such measures can help.

  4. Product Quotas: When the United States renegotiated NAFTA with Mexico and Canada in 2018 and 2019, one of the sticking points was Canada’s refusal to open up the market for American cheeses, which was done to protect Canadian dairy farmers. It is an example of how trade policies will allow a product to enter the country, but they will only allow a certain amount in order to protect their domestic producers.

The Lesser-Known Fifth Method

Currency manipulation is a subtle and frowned-upon method of manipulating the markets by trying to lower the value of a national currency. If this is achieved, it means that nation's exports become more affordable on the global market. Some countries accuse the United States of doing that by creating more national debt so the dollar plunges, but America is far from alone in doing it, if true.

It is a more common practice than is generally acknowledged, but with so many factors affecting currencies, it is also dubious as to how effective nations’ attempts to manipulate really is on the world trading stage.

Advantages of Protectionism

While the list of protectionism pros (and cons) is a long one, here are a few key ways it can benefit an economy.

  • Stimulates local job growth: By making imports or outsourced services prohibitive in their costs, it can create local opportunities for workers and businesses.

  • Corrects imbalances: The cost of living varies internationally, so labor costs in making a pair of shoes in Mexico might be 75% lower than making them in the United States. Naturally, the Mexican shoes can sell for cheaper on Los Angeles shelves than their American counterpart might. Tariffs, subsidies and other protectionist policies can level the retail playing field.

  • Boosts tax revenues: Governments make money off tariffs since they are a tax collected by them. In 2017, American tariffs raked in over $44 billion in funds for the government.

  • Protects industries: New or old, tariffs and other protectionist stances can ensure a struggling or new industry is given a competitive advantage.

Downsides to Protectionism

By limiting or shutting down trade, the first reaction is to think domestic markets will do fantastically without all that external competition. Unfortunately, history shows the opposite to be true.

  • Prices go up: Jobs may get created, but all kinds of factors can play into why this results in higher prices. Those tariffs on Jimmy’s wrenches need to be paid by someone, and that someone is the consumer. But even if it is not an imported finished product, it is often raw materials and agriculture that take the brunt of tariffs.

    It is  then the family of four in San Diego who is caught paying 20% more for groceries because the government launched a trade war. Or it could be the cost of lumber from Canada skyrockets and brings down the rate of new home construction, which can impact the entire American economy; it can be a wild game of dominoes.

  • Trade wars happen: When the United States moved to protect farmers, the ripple effects in the 1930s wound up playing out over the next few years as costs were passed to consumers around the world thanks to everyone bringing in their protection moves.

    Economic recovery was hindered internationally. A trade war with China in 2019 has echoed those alarm bells because it is hurting American companies trying to sell in the Chinese market (particularly in agriculture) and it is having ripple effects domestically.

  • Choice is limited: When protectionism kicks in, it is possible that consumers can be spoiled for choice locally, but the reality is it often goes the other way. It can also mean quality goes down if the competition is not healthy and forces producers to aim high to maintain market share.

Free Trade or Protectionism?

There are no easy answers. When domestic markets receive no protection, they can flounder to catastrophic effect. On the flip side, when governments curtail international trade in favor of local producers, trade wars and knee-jerk punitive measures can have a catastrophic effect on the world's economy.

In the end, it is all about a delicate dance of diplomacy and defense. Ripple effects can happen so quickly, as has been witnessed recently in some agricultural sectors, where a bad year of trade with China has seen some growers and producers close their shops. These choices impact everyone from Omaha's Main Street to board rooms on Wall Street. Unfortunately, once the damage has begun, reversing the effects is often too little, too late, as international markets will have already felt the reverberations.

References

About the Author

Steffani Cameron is a professional writer who has written for the Washington Post, Culture, Yahoo!, Canadian Traveller, and many other platforms. Some writing projects have included ghost-writing for CEOs and doing strategy white papers. She frequently writes for corporate clients representing Fortune 500 brands on subjects that include marketing, business, and social media trends.