Is Protectionism Good for Economic Growth?

From the emergence of the industrialised world to the modern day, arguments over trade policy have held a key and lasting place in debates around economic policy. In the UK, protectionism acted as a focal point for political crisis in 1846, 1906 and 2016, whilst the rest of the developed world has regularly fluctuated between free trade and varying degrees of protectionism over the past 200 years. From a narrow theoretical perspective there is an economic case to made for protectionism. However, such a case fails to appreciate both the obvious direct economic benefits, and the less tangible, more long term benefits of free trade between nations.

The case for protectionism has been made many times over the course of history, and there are some recurring themes. The infant industry argument was first fully articulated by Alexander Hamilton in his 1790 Report on Manufactures. He summarised the idea by comparing American attempts to break in to new industries already well developed in Europe to ‘the intrinsic difficulties incident to first essays toward a competition with those who have previously attained to perfection in the business to be attempted’. This initial idea has been expanded on by many, and academics like Wood can point to cases, such as ‘Germany and the USA in the 19th Century, Japan in the early 20th Century and the Asian newly industrialised countries (NICs) in the late 20 Century’, which all ‘built highly successful export-oriented manufacturing industries from within protective tariff walls’. Indeed, Lehmann and O’Rourke’s analysis shows that ‘Industrial tariffs were positively correlated with growth’ in ‘a sample of relatively well-developed countries between 1875 and 1913’. It is argued that, through tariffs, nations are able to diversify into industries they do not currently have a competitive advantage in. This serves as a possible means of escape from what is known as the ‘low income trap’, wherein production of basic commodities and raw materials, which requires a low-skill work force, perpetuates low incomes in a vicious cycle that industrial protection may offer a way out of. Aside from these directly economic arguments, many have historically advocated protectionism as a means of achieving autarky. In this context, nations like Nazi Germany and Soviet Russia saw material dependence on others, especially in sectors relevant to their militaries, as enough of a threat to the long-term survival and growth of their nations as to forego the benefits of free trade. Though this was, of course, in the context of the extreme threat of destruction by foreign powers, these examples illustrate how protectionism has the potential to be the economically logical policy in certain contexts. In most instances, however, the arguments for protection are narrow and disconnected from reality, both in terms of implementation issues and the plethora of benefits of free trade.

In the modern world it has become almost axiomatic that nations ought to liberalise their trade policies, and indeed the case for free trade increasing economic growth has been well-elaborated, with economists identifying multiple convincing transmission mechanisms. In terms of issues with the arguments for protectionism outlined above, Schularick and Solomou start by pointing out that Lehmann and O’Rourke’s correlation analysis fails to factor in the fact that tariff policy is endogenous to a nations’s industrial development. As they argue, ‘it is entirely possible that trade policy itself could be a function of economic growth as well as impacting on growth’, with industrialising nations like Germany in the late 19th century erecting tariff barriers because their industrial sectors were already expanding. In addition to this, it is unclear what the criteria for intervention in certain industries would be, and when protection should be lifted. The risk of entrenched rent-seekers resisting the abolition of tariffs once the industry in question is no longer in its infancy is also not addressed. Furthermore, the basic economic argument for free trade, comparative advantage, still holds and demonstrates that protectionism is fundamentally not a Pareto efficient set-up. The idea dates back to David Ricardo and John Stuart-Mill, and Krugman and Obstfeld assert that ‘even though much about international trade has changed, the fundamental principles discovered by economists at the dawn of a global economy still apply’. The argument for free trade is, however, not limited to comparative advantage; some of the most important benefits of free trade are much less tangible and exert their influence in the long-run. For instance, Williamson argues that ‘history offers an unambiguous positive correlation between globalization and convergence’, and that ‘the correlation turns out to be causal: globalization played the critical role in contributing to convergence’. Thus the globalisation of trade has and will play a key role in the convergence of world economies, and this is a trend that fundamentally benefits all nations; more educated humans on earth means an increased likelihood of innovation, and globalisation means those innovations will be shared across the globe. In this sense, global economic development in a globalised world is a positive sum game and there is no doubt trade has played a vital role in creating this environment. Globalisation has other important effects. For instance, Jacks et al.’s research shows that ‘world market integration breeds less commodity price volatility’. This is positive for all businesses wishing to plan for the long run, but is especially useful for developing economies, who suffer from higher degrees of volatility. Herein lies another mechanism by which trade globalisation encourages convergence. An alternative perspective is provided by Martin et al., who argue that international trade replaces the risk of multilateral war with that of bilateral war. Though clearly a trade off, there is no doubt that multilateral war is a much more destructive phenomenon, and is much harder to prevent using international institutions of arbitration. In this vein, increased international trade reduces the destructiveness of warfare, undoubtedly a plus in light of the two conflicts that defined the 20th century. As a caveat, it should be noted that increases in trade volumes between the late 19th century and the First World War can in large part be attributed to widespread adoption of the gold standard, as Estevadeordal et al. demonstrate. When free trade is encouraged by such means, the cons of the gold standard, including limited monetary flexibility and shock transmission, must be taken into account. Thus, the benefits outlined above are best achieved through natural growth in trade driven by tariff liberalisation and regulatory convergence.

The debate between protectionism and free trade has rumbled on from the beginning of the industrial age to the modern day, and continues to define political economy. There is broad consensus that the case for protectionism is economically narrow and does not consider the wide range of benefits that the global economy derives from free trade. Increased efficiency, convergence, reduced inequality, less volatile prices and less destructive wars all contribute positively to economic growth in a way protectionism patently fails to.

BIBLIOGRAPHY:

  • D. Irwin, ‘The Aftermath of Hamilton’s “Report on Manufactures”’, The Journal of Economic History, vol. 64, no. 3 (2004), pp. 800-821
  • A. Wood, ‘Symposium on Infant Industries: Introduction’, Oxford Development Studies, vol. 31, no. 1 (2003), pp. 3-20
  • S. Lehmann, K. O’Rourke, ‘The Structure of Protection and Growth in the Late 19th Century’, The Review of Economics and Statistics, vol. 93, no. 2 (2011), pp. 606-616
  • M. Schularick, S. Solomou, ‘Tariffs and economic growth in the first era of globalization’, Journal of Economic Growth, vol. 16, no. 1 (2011), pp. 33-70
  • P. Krugman, M. Obstfeld, International Economics: Theory and Policy. 8th ed, Boston, Pearson Addison-Wesley, 2009
  • J. Williamson, ‘Globalization, Convergence, and History’, Journal of Economic History, vol. 56, no. 2 (1996), pp. 277-306
  • P. Martin, P. Mayer, M, Thoenig, ‘Make Trade not War?’, Review of Economic Studies, vol. 75, no. 3 (2008), pp. 865-900
  • D. Jacks, K. O’Rourke, J. Williamson, ‘Commodity price volatility and world market integration since 1700’, Review of Economics and Statistics, vol. 93, no. 3 (2011), pp. 800-813
  • A. Estevadeordal, B. Frantz, A. Taylor, “The Rise and Fall of World Trade, 1870-1939”, Quarterly Journal of Economics, vol. 118, no. 2 (2003), pp. 359-407

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