Trade protectionism is a stance that some countries adopt to protect their domestic industries from foreign competition. It may work in the short run to bolster domestic production and business, but in the long run, trade protectionism can make a country and its industries less competitive in international trade.
According to the Corporate Finance Institute, trade protectionism can be politically motivated and lead to trade isolationism. The four primary tools used in trade protectionism are tariffs, subsidies, quotas, and currency manipulation.
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 and 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. Some of the most commonly used subsidies are granted to farms, which allows farmers to lower the price of the food they produce. In turn, these subsidies make the products affordable for the consumer while still allowing the producer to turn a profit.
There are instances when subsidies can cause problems. For instance, 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. The act also enabled farmers the chance to let their fields rest and regain nutrients due to overproduction. In this case, the subsidies helped the agriculture industry but raised food costs during the Depression and hurt consumers.
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. While it can make exports cheaper and more competitive in the short term, currency manipulation can also result in retaliation by other countries and start a currency war. One way countries can lower their currency's value is through a fixed exchange rate. Another way to manipulate currency is by creating so much national debt that the currency becomes less valuable.
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 causes 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.