What Is Protectionism?

Its Impact on Global Investments

Focused worker examining steel part in factory
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Protectionism is what a country does to protect its domestic manufacturing from foreign competition.

Defining Protectionism

Protectionism has a broad definition that encompasses a number of different economic policies designed to restrict trade and boost domestic manufacturing. From new taxes to import restrictions, these policies are implemented by both emerging markets and developed economies, and can have a negative impact on global free trade.

For instance, the United States may believe that China is undervaluing its currency to make exports cheaper, and impose a tariff on certain goods imported from the country.

In other cases, a government may only seek to protect a single strategic industry. In 2012, many countries imposed tariffs on Chinese photo voltaic solar panels after the country began dumping them into the global market to handle an oversupply due to a slowdown in demand. The goal was to protect their own domestic solar operations and ensure energy security in the future.

Most of the time, protectionism stems from a desire to strengthen the domestic manufacturing industry by making it more competitive with imported goods. And often times, these desires result from a weak job market that could be improved with more domestic manufacturing jobs.

In other cases, developing countries restrict imports to give their domestic businesses the time to acquire enough expertise to manufacture products of a quality that allows them to compete globally.

Types of Protectionism

Some of the most popular protectionist policies include:

  • Import tariffs: Taxing imported goods increases the cost to importers and raises the price of the imported goods in local markets.
  • Import quotas: Limiting the number of goods that can be produced abroad and sold domestically limits foreign competition in domestic markets.
  • Domestic subsidies: Subsidizing costs or providing cheap loans to domestic companies can increase their competitiveness against foreign imports.
  • Exchange rates: Intervening in the foreign exchange (Forex) market to lower a currency's valuation can raise the cost of imports and lower the cost of exports.
  • Administrative barriers: Excessive government regulations can place huge burdens on foreign imports, making it difficult to sell them in domestic markets.

Costs of Protectionism

There's little question among economists that protectionism is harmful, with costs that far outweigh benefits over the long term. Comparative advantage provides much of the rationale for this argument, saying that two countries can benefit from free trade, even if one is more efficient in the production of all goods than the other.

Comparative advantage has its roots in the 18th century and was conceived by economist David Ricardo. He maintained that it is best for a country to focus on what it can produce most efficiently and trade with countries that lack its capabilities in other areas. For instance, England had an advantage creating products requiring machinery while other countries are more suited to produce wheat because of their climate and land.

In yet another example, suppose that China can produce 10 toys and 10 appliances per hour, while the United States can produce only three appliances and six toys per hour. The United States can trade toys with China for appliances. Without trade, the opportunity cost per appliance would be two toys, but that cost could be reduced to one toy by trading with China.

Arguments for Protectionism

Despite the beliefs held by many mainstream economists, there are others who argue for protectionism. These economists insist that the mobility of capital around the world undercuts comparative advantage, as capital can move to wherever costs are lowest to pursue an absolute advantage, thereby eliminating the key premise.

Proponents for protectionism further argue that nearly all developed countries have successfully implemented protectionist programs. Yet it's difficult to determine cause and effect when looking at why a certain industry has succeeded. The reason may be despiteĀ protectionism and due to higher quality or better marketing.