Pros and Cons of Trade Protectionism Methods

Sometimes, countries need to safeguard local industries against foreign competition. Policies known as trade protectionism are a means of economic defence. Through tariffs and other measures, states deter rivals from abroad. Whenever domestic industries need a boost, support may take the shape of trade protectionism.

Like anything imposed from the top, protectionism is based on political motives. Despite its effectiveness in the short-term, long-term effects are usually negative. This is because domestic manufacturers lose their competitive edge in international trade. Here are four crucial aspects of such strategies. The arsenal includes:

  1. tariffs;
  2. subsidies;
  3. quotas;
  4. currency management.

Here is an overview of these methods. Each of them has specific pros and cons. The tools may be used separately or combined.

Tariffs: Taxing Imports

The primary tool is tariffs. Their purpose is to restrict import through taxes. As a consequence, imported goods become more expensive for the population, and therefore lose part of their appeal. Normally, the strategy is most efficient for countries which import a lot. A classic example is the USA.

Subsidies: Money for Local Producers

Some governments decide to provide domestic industries with funding, which takes the form of subsidies. The measure helps them to stay competitive internationally. This is why subsidies are most effective for exporting nations. The money comes as either direct payments or tax credits.

Most frequently, subsidies are received in the agricultural realm. Farm subsidies bring down the prices for local produce. The cheaper the goods — the higher the appeal for local and international customers. As history shows, this method is more effective than tariffs.

Quotas: Control of Imported Quantities

Quotas restrict the import of goods. It is more effective than tariffs or subsidies. Here, the government sets the maximum volumes of acceptable imports. No matter how low the prices are, foreign producers may not exceed the limit.

Currency Manipulation: Subtle Tactics

The method is rarely mentioned in the textbooks, but it is clear for any ForexTime trader. National currencies are always priced against one another. The rates are affected by an extensive range of factors. From geopolitics to domestic initiatives, there are many ways to sway the values.

Here, the government tries to help local exporters by depreciating the national currency. As a consequence, exported goods become cheaper and more attractive to foreign buyers. However, there could be a backlash, sometimes as serious as a currency war.

One way to achieve depreciation is through fixed currency rates. This is what happened with the Chinese yuan. Alternatively, the government may build up the national debt to attain the same goal. This approach is practised by the United States.

Benefits of Protectionism

There are two main advantages. First, the measures keep foreign competitors at bay or restrict their activity on the local market. Tariffs, for example, make their offerings more expensive. Quotas limit the overall volumes that may be shipped lawfully.

This is essential for a country which is focused on developing a certain industry. While competition is restricted, local businesses have time to grow. They can improve their products and find unique selling points.

Secondly, protectionism creates jobs in the country. Companies supported by the government may afford to hire more staff. As a result, unemployment declines. It is, however, vital to understand than any value gained through the policy has meaning until other nations impose their own protectionism measures.

Drawbacks of Protectionism

As mentioned above, protective measures lose their effectiveness in the long term. Moreover, they become counterproductive. The local industry loses strength and competitive power. Safeguarded against rivals, producers lose the incentive to innovate. As a result, the quality of locally produced goods and services deteriorates. Both manufacturers and producers are on the losing side.

Negative effects are most visible in the United States, which heavily rely on outsourcing. This is a consequence of three conditions:

  • low competition;
  • weakened local industry;
  • slower economic growth.

For decades, education has not received sufficient funding from the government. According to the Peterson Institute for International Economics, if the country dropped its trade barriers, the effect would be colossal. The nation would get an additional $500 billion in income.

Falling Out of Favour

Countries started questioning the efficiency of protectionism in 1930. This was when the Smoot-Hawley Tariff was introduced by the US government. The measure was designed to protect local farmers against European imports. Back then, American farmers were trying to cope with the aftermath of dust storms.

Meanwhile, European farmers were increasing their exports. The set of tariffs imposed by the Congress backfired. Other nations decided to retaliate, and a trade war unfolded. It exacerbated the destructive effects of the Great Depression.

This was the turning point for many nations. Today, protectionism still exists. Restrictive measures help the government endorse local industries. Its use, however, should not last too long.