Trade Protectionism: 4 Methods with Examples, Pros and Cons

Why Protectionism Feels So Good, But Is So Wrong

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Many Americans protested the NAFTA free trade agreement because it cost American jobs. Photo: Getty Images

Definition: Trade protectionism is a type of policy that limits unfair competition from foreign industries. It's a politically motivated defensive measure. In the short run, it works. But it is very destructive in the long term. It makes the country and its industries less competitive in international commerce.

Four Methods with Examples

Countries use a variety of strategies to protect their trade. One way is to enact tariffs that tax imports.

That immediately raises the price of the imported goods. They become less competitive when compared to local goods. This method works the best for countries with a lot of imports, such as the United States.

The most famous example is the Smoot-Hawley Tariff of 1930. It was designed to protect farmers from agricultural imports from Europe, which was stepping up farming after the destruction of World War I. But by the time the bill made it through Congress, it had slapped tariffs on many more imports. Other countries retaliated. The resultant competitive war restricted global trade. It was one reason for the extended severity of the Great Depression.

A second way of protecting trade is when the government subsidizes local industries. Subsidies come in the form of tax credits or even direct payments. That allows producers to lower the price of local goods and services. This makes the products cheaper even when shipped overseas.

That means subsides work even better than tariffs. This method works best for countries that rely mainly on exports.

But sometimes subsidies can have the opposite effect. A good example of this is, once again, in the U.S. agricultural industry. The Agricultural Adjustment Act of 1933 allowed the government to pay farmers not to grow crops or livestock.

That would allow their fields to rest and regain nutrients. It also restricted supply. That increased prices. It helped farmers devastated by the Dust Bowl, but made food even more expensive for consumers.

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.

Most textbooks omit the fourth type of trade protectionism because it is subtle. It is a deliberate attempt by a country to lower its currency value. This would make its 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. This is like China's yuan. Another way is by creating so much national debt that it has the same effect, like the U.S. dollar decline.

Advantages 

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 own competitive advantages.

Protectionism also 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 their own protectionism.

Disadvantages 

In the long term, trade protectionism weakens the industry. Without competition, companies within the industry have no need to innovate. There's no need to. Eventually, the domestic product will decline in quality. It will be lower quality and more expensive than what foreign competitors produce.

Job outsourcing is a result of declining U.S. competitiveness. Competition has declined from decades of the United States not investing in education. This 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.

Increasing U.S. protectionism will further slow economic growth. It would cause more layoffs, not fewer. If the United States closes its borders, other countries will do the same. This could cause layoffs among the 12 million U.S. workers who owe their jobs to exports.

Free Trade Agreements

Free trade agreements reduce or eliminate tariffs and quotas between trading partners. The largest agreement is the NAFTA. It is between the United States, Canada and Mexico. If approved, two other agreements would be larger: the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership.

Another free trade agreement is the Dominican Republic-Central America Free Trade Agreement, which is between the United States and Central America. There are also bilateral agreements with Chile, Colombia, Panama, Peru, Uruguay, most countries in Southeast Asia and the Middle Eastern countries of Israel, Jordan, Morocco, Bahrain and Oman.

But FTAs don't eliminate protectionist measures like subsidies or currency wars. One of the disadvantages of NAFTA was that subsidized U.S. farm products put Mexican farmers out of business. For more, see Free Trade Agreements Pros and Cons