Why Free Trade Is Far More Preferable Than Protectionism
Free Trade vs Protectionism
The financial meltdown of 2008 and the resulting deep recession have brought enormous pressure upon the governments of the many nations of the world including the United States. The world economy has been remarkably slow in recovering from this sharp downturn. The resulting unemployment, slow GDP growth, and continuing depressed housing markets stubbornly persist. Politicians often look for quick fixes during these times of severe economic distress. Protecting domestic industries sounds like the the logical action to take under these conditions. Unfortunately these same politicians do not consider the long term implications of protectionism. They need to examine history, macroeconomics, and foreign policy before making these hugely momentous decisions. All policy actions have reactions and thus they often have dire consequences. Often these consequences create much more damage than the initial problem ever did. In this article I will describe the four main types of protection that a country may provide to an industry or the economy itself. They are tariffs and quotas, industry subsidies, currency manipulation, and import product regulations. Furthermore I will present both the benefits and the dangers of each of these forms of protectionism. Finally I will attempt to give you a full global picture of why free trade is a far more preferable long term policy than protectionism.
Let us start with the most common forms of protectionism which are tariffs and quotas. Pure free trade exists when countries trade with one another without placing any barriers upon any of their trading partners. In other words all nations would be trading on a level playing field. However many nations decide to protect one or more of their industries by placing tariffs on imports from other countries within that industry. They may also place quotas limiting imports relating to that industry. Tariffs make imports more expensive compared to the products of the domestic industries. Quotas overtly limit imported products from other nations. These forms of protectionism are often instituted to protect a developing domestic industry or a declining one. Third world developing nations use these mechanisms to allow their infant industries to grow and solidify. Unfortunately many of these nations become addicted to these methods and fail to remove them when the protected industry matures. Some political leaders in the developed world feel political pressure to save a domestic industry of theirs when it is declining. This is usually because companies in the developing world are gaining ground on them quickly due to wage cost advantages. These countries are still poor so their wages are naturally much lower at this point. This type of protection is usually futile due to these vast wage differences. It is also counterproductive to trade in general. The Smoot-Hawley tariff was passed by the U.S. Congress in 1930 during the height of the Great Depression to protect primarily their agricultural industry. The tariffs were record highs at the time and it sparked a worldwide trade war that further exasperated an already decimated world economy. The U.S. also negotiated quotas with Japan on steel and automobiles in the 1980s to protect these declining industries. They were successful but only to the extent that they left extremely shrunken domestic industries for those products. The lesson to be learned from this is that negotiation works. Unilateral trade actions often spark trade wars which hurts everyone involved very badly.
Another form of protectionism utilized by many countries is industry subsidies. This method is generally used to help fledgling industries grow or to protect mature industries from unfavorable market conditions. Giving help to a growing industry is a norm for most countries whether they are developed or not. Developing nations do it to establish new industries and to grow their economy. Developed countries normally utilize this method to move off declining industries and establish more advanced industries such as biotechnology or alternative renewable energy. Sometimes these developed nations use this method as protection for an aging or vital industry. The United States provides very large subsidies to its farming industry. These subsidies were first implemented during President Franklin Roosevelt's administration as part of his New Deal during the Great Depression. Prices for farming crops had fallen to rock bottom levels and farmers were going bankrupt in record numbers. The U.S. food supply was now being threatened and something needed to be done. The Roosevelt administration instituted a number of programs and subsidies that allowed farmers to stay in business and make a livable income. This worked very well and has continued to be used to ensure a stable farming economy. Unfortunately these programs have become institutionalized and farm subsidies are now the norm. My belief is that they should only be used as a backstop to ensure that farmers do not go bankrupt and not to ensure a certain income level for farmers. This is a prime example of a misuse of industry subsidies. The proper use of subsidies is to employ them to meet vital national needs such as developing a cutting edge industry or ensuring that a national security requirement is met.
The third major form of protection that nations use to aid their industries is currency manipulation. All nations perform currency manipulation at one time or another. Most nations have a broad range in which they feel it is safe for their currency to fluctuate without damaging their economy. Any fluctuations beyond this are usually deemed a threat to their economy and the government will take action to bring that currency back into the acceptable trading range. A strong currency favors cheap imports, lower inflation, and lower interest rates. A major disadvantage is that your exports are are more expensive hurting most of your domestic industries. Conversely, a weak currency aids your domestic industries greatly but could lead to higher interest rates and higher inflation. The major problem regarding currency manipulation occurs when a nation conducts this method with the goal of obtaining a competitive trade advantage over other nations. The prime example of a country employing this form of protectionism currently is China. The Chinese economy is overwhelmingly driven by their export industries. Their economy would begin to stall without the component of consistently rising export levels. This growth is critical to the retention of power for the Chinese Communist Party government. Of course the Communist name is misleading in this case because the Chinese economy is now actually a Capitalist economy. The problems the Chinese government is faced with involve the lack of democracy as well as the fact that their country has a population of 1.3 billion people and growing rapidly. They need to maintain the growth of their economy to support China's massive population. There is also a large group of their citizens that remain in poverty. This is additionally critical for the ruling Communist party due to the fact that their populace does not have elections as an outlet for their frustrations. Therefore the Chinese government employs currency manipulation as a means to keep their export industries strong and to maintain a huge trade surplus. This in turn allows the government to use the funds from this surplus to buy up dollars on the open currency market. This is the mechanism that the Chinese government uses to keep the Chinese Yuan value low relative to the U.S. dollar and other world currencies. It not only helps their export industries but it hurts the export industries of other countries making it a very unfair trading practice. They are not the only offender of this sort but they are certainly the most prominent and blatant practitioner.
Finally we turn to import product regulations. As with the other three forms of protectionism, regulating imports can be a double edged sword. This method is key to ensuring that the products imported into a nation are up to the quality standards that the receiving nation holds for its own domestic products. Some nations, especially developing ones, look the other way in regards to ensuring high quality standards for the products of their exporting industries. Their main priority is usually facilitating the rapid growth of their industries rather than maintaining the safety and quality of their products. China has been implicated in several scandals regarding dangerous export products in recent years. One was a recall of poisonous pet food in 2007. Another example is an ongoing problem with sub-standard dry wall that is damaging many homes in the United States. The Chinese government has begun punishing these industrial malefactors severely when these instances of gross neglect or incompetence are found. This is an attempt to uphold China's industrial reputation before it substantially hurts its exports. There is still a lot of improvement that needs to be done. The U.S. and all other countries must remain vigilant and take action against offenders such as this to ensure that these practices are halted. Developing countries already have a substantial advantage in regards to labor costs. Taking shortcuts on quality should never be allowed both for safety reasons and trade fairness. This is the proper and necessary use for import product regulations. Unfortunately some nations utilize extraordinarily onerous regulations on imports as a means of excluding them from their country. These nations use this method to effectively block certain imports from entering their country much like tariffs and quotas operate. They get the benefit of this result without appearing to be protectionist. The bottom line is that regulations should be used for the protection of their nation's citizenry and not for the promotion and protection of their domestic industries.
I have now outlined the four major forms of protectionism. My belief is that all nations will become more prosperous in the long run as more trade protections are dropped and trade becomes freer. Of course nations do not operate within a utopian world. Some countries are marvelously wealthy with a myriad of resources. Others have been poor for centuries due to geography, wars, nature, or government corruption. These are the major reasons for a nation's poverty though by no means the only ones. Therefore different governments have different problems and pressures. Developing countries have fledgling industries to nurture while developed ones have jobs in declining industries to preserve. I believe protection should only be given in three situations and even then only on a limited basis. The situations are aiding a brand new industry to start up and develop, protecting an industry that is vital to national security, and the using of regulations strictly to exclude dangerous products from entering one's country. All other trade problems should be handled through in depth trade negotiations. People lose their lives when nations enter into shooting wars. People lose their jobs when nations enter into a trade war. No one wins in either of these types of wars. Nations close down their trade markets during a trade war shrinking the field for everyone. Trade negotiations are the most optimal way to settle trade disputes. This is true in state diplomacy among nations just as it is with trade negotiations. The North American Free Trade Agreement (NAFTA) is an excellent example of successful trade negotiations that have benefited all nations involved. Now it is true that some U.S. jobs have been lost primarily in older low-tech industries. Conversely lower market barriers have expanded the market share of our hi-tech industries which greatly expanded job creation in these areas which represent our future. This is the model of economic progress we should be striving for all over the world. The World Trade Organization (WTO) embodies this. The WTO is an outgrowth of the General Agreement on Tariffs and Trade (GATT) which was a set of trade rules agreed upon by many nations in 1947. It was negotiated under the auspices of a United Nations conference on trade. There were eight rounds of negotiated agreements under GATT which each time substantially lowered tariffs and other barriers among the participating nations. GATT was replaced by the WTO in 1993. The major difference between the two is that the WTO is an actual institutional negotiating body and not simply a set of agreements. The WTO and smaller trade negotiations such as the one that resulted in NAFTA are the best mechanisms to open up all trade markets and expand the world economy. Our world is a much smaller one now due to the incredible advances in communications and transportation. These are wonderful developments which if handled correctly and openly among nations should result in a more prosperous and peaceful world. I know this sounds like a "Pollyanna" viewpoint especially with all the tumult going on in the world presently. Yet think about how the idea of democracy has been spreading like wildfire in the Middle East. Dictatorial tyrants are quaking in their boots. Practically instantaneous information transmission via the internet has sparked this. It has also given the tools to millions of entrepeneurs around the world to start up companies and grow them. Barriers among nations are coming down by way of this information phenomenon without any input of world governments. I hope to see them get onboard this train and continue to negotiate to tear down protectionist barriers on the road to free trade. We are inevitably moving in that direction anyhow. Let us accelerate this process and make this a better world for all.