Protectionism for Dummies
Here is the outline of a secret analysis with the above title that I obtained from a White House source. The report starts by quoting Alexander Hamilton:
“Commerce, like other things, has its fixed principles, according to which it must be regulated. … To preserve the balance of trade in favor of a nation ought to be a leading aim of [the government’s] policy.”
Then, the report goes into analytical mode. It asks us to imagine a world made of two countries, a free-trading country (call it H, for Home country), and another one (F, for Foreign country) where the government subsidizes all exports. Assume that the subsidies are large enough to prevent any competition from unsubsidized businesses. The free-trading country will sustain a large trade deficit and crash. Hence, Hamilton was right, and the report’s conclusion blames the Broadway musical for not emphasizing that.
OK, the story about the secret White House report is fake news. But it is not far from the ideas that seem to circulate there. (And the Hamilton quote is real.) Let’s look under the hood.
One consequence of the model laid out above is that the residents of H buy imports cheap and sell exports dear. The country H (its consumers) has very good terms of trade: it gets a lot for what it (its producers) sell. H exporters specialize in goods not subsidized by the F government. This looks like trade nirvana for H consumers, but it can only last as long as F taxpayers are willing and able to continue subsidizing F exports and thus H consumers.
To better understand, let’s imagine a still more extreme case. Intent on developing a trade surplus, the government of F further forbids its residents to import anything from H. In this case, however, the residents of H would have no F¥ (the currency of F, pronounced “F-yuan”) to import, so the producers of F could not export anything, and the purpose of the subsidies would be defeated. This illustrates the general fact that a country cannot export if it does not import. There must be, at least over time, some balance between exports and imports.
As Jean-Baptiste Say wrote in his 1803 Treatise on Political Economy, “nothing can be bought from strangers, except with native products.” Protectionism is self-defeating. For those interested in the “real world,” it is interesting to note that Say, just like David Ricardo, was a practical and successful businessman before turning to economic analysis.
Note that the problem is not solved if exporters of F accept h$ (the currency of H) as payment for their exports. Either they do nothing with their h$, and it amounts to exporting their goods free, an even better bargain for H; or F exporters sell their h$ to fellow citizens who use them to import goods from H, defeating their government’s protectionism. If you think it’s arduous to be a mercantilism ruler, you’re right. (Mercantilism includes both protectionism and export pushing.)
Aha! the mercantilism will reply, F businessmen (or the F government) can simply use the h$ gained from exports to invest in H, which will provide H residents with the currency necessary to import from F. True, but it remains that at some point, the residents of F will run out of money to subsidize H residents’ imports. F residents won’t be able forever able to export at low prices and import at high prices. F will start exporting less to H and will consequently import less from, or invest less in, H. Protectionism and mercantilism against a free-trading country are self-defeating.
Compounding these problems is another one. F is a socialist or fascist country (or on its way there): how else can its government subsidize exports and forbid imports to such an extent? History and theory suggest that its producers will not long be able to compete with the more efficient free-enterprise producers of H. Except if the government of F forbids exports and can in some way prevent all smuggling, some trade will continue because a country will always have some comparative advantage. But trade flows will be low—as they were between the Soviet bloc and the freer world.
This trade slowdown is, of course, unfortunate, because residents of H and F would benefit from more exchange and more division of labor (and economies of scale). But short of war (provided it is not too destructive), the residents of H and their government can do little about it. Transforming H into a socialist or fascist country too would only make its residents worse off, compounding the problem.
The more mercantilist a country is against a free-trading country, the more costly and the least sustainable its mercantilism will be.
The only serious, non-sentimental way around this conclusion seems to be that F’s mercantilism will lead to the destruction of whole economic sectors in H, which will be costly to rebuild after F’s demise. But this scenario underestimates the resilience, flexibility, and “bounceability” (capacity to bounce back) of businesses used to creative destruction in a free market economy. The scenario also overestimates the competitiveness of producers in a dirigiste economy. Add to this that the situation of H is much easier if other more or less free-trading countries exist in the world (steel and shoes are not only made in China).