Is Protectionism Really Necessary For The US?

13 April 2018 | World Views | Natalie Mayer
 


Since the dissolution of the Soviet Union in 1991, the United States has been the world’s hegemon - the global seat of political, economic and military power. But the balance of power began to shift some decades ago as China, the world’s most populous country, gained momentum in its process of industrialisation to become the second largest economy, in around 2008.

Trump’s recent steps towards stronger trade protection suggest that he sees China as a serious contender for the number 1 spot as the global superpower. At the start of March, the president announced a 25% tariff on all steel imports, 10% on aluminium, and other tariffs on a list of more than 1,000 products that amount to about $60 billion worth of Chinese goods - partly a response to alleged theft of intellectual property by China, and other unfair trade practices.

Numerous economists are calling these measures protectionist, and there is growing concern that America may be initiating a trade war. But will Trump’s policies effect the results he demands?

What is trade protection or protectionism?

Protectionism is intended to protect the local economy from foreign competition. For an importing country such as the US, it’s usually achieved by restricting imports from other countries through tariffs on imported goods, import quotas, and/or a variety of other government regulations. These methods immediately raise the price of the imported goods, so that they become more expensive than local goods. This encourages people to switch to buying locally made goods, thus boosting the local economy.

For an export-reliant country, subsidising local industry through tax breaks or direct contributions is another way to protect the local economy. There is a third type of trade protection which is probably the most subtle of the ones mentioned here, and involves a deliberate attempt by a country to lower its currency value, e.g. through a fixed exchange rate (like China’s yuan) making its exports cheaper and more competitive.

Interestingly, protectionism is more often a politically motivated defensive measure than an economic one. Although in the short term it may be effective, it can be very destructive in the long term as it makes a country less competitive in international trade.

What are the advantages and disadvantages?

The advantages of protectionism include allowing time for new industries in a country to develop their own competitive advantage, and creating local jobs. However, as soon as other countries establish their own protectionist measures, these benefits come to a grinding halt. So the advantages are only enjoyed in the short term.

In the long term, trade protection actually weakens local industries as they don’t need to innovate to compete, and products can decline in quality and increase in price, negatively impacting the consumer.

Perhaps the most well-known example of the destructiveness of trade protection in the US is the Smoot-Hawley tariff of 1930. It was intended to protect farmers from agricultural imports from Europe, which was increasing farming after the destruction of World War I. However, by the time the bill was passed by Congress, many more import tariffs had been added. Other countries retaliated, and trade war broke out, limiting global trade. This was one of the reasons why the Great Depression was so severe and protracted.

What’s the real US situation?

President Trump’s argument to support his trade protection policies is that the US is suffering from a trade imbalance, with an annual trade deficit of around $800 billion in 2017. He’s concerned that companies are outsourcing jobs to people in other countries and leaving US citizens unemployed. He’s also worried that the US relies too much on other countries for its metals, and that it couldn’t make enough weapons or vehicles using its own industry if a war broke out.

But critics have solid answers to his concerns. Firstly, the trade deficit was $566 billion in 2017, not $800 billion, which was the value of the goods imported by the US last year. Trump has ignored the value of US services exported, totalling $242.7 billion - a significant portion of the American economy and evidence of the shift to an economy primarily based on services rather than manufacturing. This is an important omission in data - the service sector provides 90 million US jobs and makes up 80% of US economic activity. Anyway, tariffs and other protectionist measures are unlikely to reverse the deficit significantly. Increased trade, on the other hand, opens new markets for companies to sell their goods; in fact, the Peterson Institute for International Economics estimates that ending all trade barriers would increase US income by $500 billion.

Secondly, it’s true that US companies have outsourced many jobs to countries whose labour costs are lower. However, the reason for this is that the US has not remained labour competitive due to a lack of investment in education, particularly in engineering and technology. Also, America doesn’t have the unemployment safety net and skills retraining offered across Europe, for example, so the effects of factory closures are more apparent. Increasing protectionism is likely to cause more layoffs, not fewer - if other countries retaliate with similar measures (such as the EU has threatened to do), it would lead to unemployment among the 12 million US workers in the export industry. Another factor to consider is the increase in automation in manufacturing which has contributed to job losses, a trend identified in many industrialised nations and those moving to a service-based economy – and a trend unlikely to be reversed through the imposition of tariffs. Yet President Trump wants to see the US return to being a manufacturing country, perhaps instituting these tariffs as a political manoeuvre to appeal to workers in manufacturing swing states like Ohio.

Thirdly, Trump’s response to his claim that the US relies too much on other countries for its metals doesn’t stand up on closer scrutiny. The US obtains most of its steel from Canada and the EU (strong US allies) and China is only their 8th largest supplier, contributing only around 2% of America’s steel imports. So why target China with tariffs, and exempt the bigger suppliers?

China’s response

China’s response has been fairly measured so far, in contrast to the US. The world’s second-largest economy is planning to tax US agricultural and industrial products, from soybeans, pork and cotton to aeroplanes, cars and steel pipes. In theory, China could also tax US tech companies like Apple, forcing them to raise prices to stay in business.

The impact of trade protection

A global trade war could hurt consumers around the world by making it harder for all companies to operate, forcing them to push higher prices onto their customers. But the general trend is towards freer trade, not protectionism, however much the media is focusing on Trump’s policies right now. In fact, the latest World Trade Organization (WTO) statistical review showed that trade restrictive measures have fallen to their lowest since 2008, and Trump’s tariffs are only expected to have marginal impact globally.

The WTO says that protectionist measures "ultimately lead to bloated, inefficient producers supplying consumers with outdated, unattractive products, in the end, factories close and jobs are lost despite the protection and subsidies". The organisation does admit however that the gains from free trade are "often uneven" and "may have led to rising wage inequality", particularly affecting lower-income groups.

And that last “minor detail” is the focus of Trump’s argument and the reason for its success so far - it’s much easier to garner political support for action against factory closures than the hard-to-quantify benefits of free trade.

But the fact remains that protectionism will hurt the US in the long term, and is an inadequate solution to America’s lack of labour competitiveness, which underpins all three of Trump’s concerns.

cta


natalie

Natalie Mayer
Editor

Natalie Mayer is an independent writer and editor with 12 years’ experience. She has a B.Com in Economics (UCT) and a Master’s in Sustainable Development (University of Stellenbosch) and has worked for a number of high-profile clients, such as the United Nations Educational, Scientific and Cultural Organization (UNESCO), Nedbank, the Sustainability Institute, Counterpoint Asset Management, Pearson Education, and of course, Sharenet - to name a few. Natalie has written and edited research papers, textbooks, print and online articles, and website content on a vast array of topics, including finance and money matters, education, property, social and environmental issues. She is passionate about communication that meets the needs of the audience, and her particular strength is to bring clarity to text.


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