Trade protectionism is a policy that protects domestic industries from unfair foreign competition. The four primary tools used in trade protectionism are tariffs, subsidies, quotas, and currency manipulation.
Protectionism is a politically motivated defensive measure. In the short run, it works, but it can be destructive in the long term. Protectionism can make a country and its industries less competitive in international trade.
Definition and Examples of Trade Protectionism
Trade protectionism is a measured and purposeful move by a country to control imports while promoting exports. It is done in an effort to promote the economy of the country above all other economies.
For example, if a U.S. auto company were to move all of its operations out of foreign countries to the U.S., cars made in the U.S. would become more expensive. If tariffs were put on foreign cars, this move would make it so the cars made in the U.S. weren't any more expensive than those being exported from other countries.
How Trade Protectionism Works
The most common protectionist strategy is to enact tariffs that tax imports. That immediately raises the price of imported goods. They become less competitive when compared to local goods. This method works best for countries with a lot of imports, such as the U.S.
The chart below shows the share of tariffs collected on U.S. imports since 1790. Tariffs hit a record 57.3% in 1830 due to the Tariff of Abominations. They hit a record low in 2008 at 1.2%.
Protectionism fell out of favor after the Smoot-Hawley Tariff of 1930. It was designed to protect farmers from agricultural imports from Europe. U.S. farmers were already suffering from the Dust Bowl. European farmers were ramping up production after the destruction of World War I. But Congress added many other tariffs. Other countries retaliated. The resultant trade war restricted global trade. It was one reason for the extended severity of the Great Depression.
The Use of Subsidies
Governments also frequently subsidize local industries to help them compete in the global market. Subsidies come in the form of tax credits or direct payments. The most commonly used are farm subsidies. That allows producers to lower the price of local goods and services. This support makes the products cheaper, even when shipped overseas. Subsidies work even better than tariffs. This method works best for countries that rely mainly on exports.
But sometimes subsidies can have the opposite effect. The Agricultural Adjustment Act of 1933 allowed the government to pay farmers not to grow crops or livestock. The government wanted to control supply and increase prices. Farmers could also let their fields rest and regain nutrients due to overproduction. It helped the agriculture industry but raised food costs during the Depression.
Using Import Quotas and Currency Manipulation
A third method is to impose quotas on imported goods. This method is more effective than the first two. No matter how low a foreign country sets the price through subsidies, it can’t ship more goods.
Currency manipulation is a deliberate attempt by a country to lower its currency value. This manipulation makes exports cheaper and more competitive. This method can result in retaliation and start a currency war. One way countries can lower their currency's value through a fixed exchange rate, like China's yuan. Another way is by creating so much national debt that it has the same effect. Some countries criticize the U.S. government for doing that, creating a U.S. dollar decline.
Advantages and Disadvantages of Trade Protectionism
Protects a country's new industries from foreign competition
Temporarily creates jobs
Companies without competition decline in quality
Leads to the outsourcing of jobs
Slows economic growth
- Protects a country's new industries from foreign competition: If a country is trying to grow strong in a new industry, tariffs will protect it from foreign competitors. That gives the new industry’s companies time to develop their competitive advantages.
- Temporarily creates jobs for domestic workers: The protection of tariffs, quotas, or subsidies allows domestic companies to hire locally. This benefit ends once other countries retaliate by erecting protectionism.
- Companies without competition decline in quality: In the long term, trade protectionism weakens industry. Without competition, companies do not need to innovate. Eventually, the domestic product will decline in quality and be more expensive than what foreign competitors produce.
- Leads to outsourcing of jobs: Job outsourcing is a result of declining U.S. competitiveness. Competition has declined from decades of the U.S. not investing in education. This failure is particularly true for high-tech, engineering, and science. Increased trade opens new markets for businesses to sell their products. The Peterson Institute for International Economics estimates that ending all trade barriers would increase U.S. income by $500 billion.
- Slows economic growth: Protectionism cause more layoffs, not fewer. If the U.S. closes its borders to trade, other countries will do the same. These actions could cause layoffs among the 12 million U.S. workers who owe their jobs to exports.
- While trade protectionism is used to promote a domestic economy, in a global economy, it is damaging to everyone.
- The four primary tools used in trade protectionism are tariffs, subsidies, quotas, and currency manipulation.
- While countries may experience a temporary period of economic stability as a result of protectionism by getting rid of outside competition, they will end up suffering from their isolation.
- Protectionist countries eventually see drops in innovation, jobs, and economic growth.