Sunday, June 26, 2011

The Fallacies of Protectionism

Calls for legislation, or action, to be taken by the government in the mold of protectionist policies can be heard from a good amount of unions, as well as other prominent talking heads. Former prospective presidential candidate, Donald Trump, proudly advocated for protectionist policies in his campaign-like speeches he gave before his ruling out of a presidential bid. This is a very common practice and is rooted in a lack of basic understanding of some economic principles. I will illustrate.

Firstly, protectionism calls for policies that discourage consumers and businesses from purchasing products, labor, capital from overseas, namely China. These discouragements usually take the form of tariffs on imports. By placing an additional charge, or tax, on imported goods, you discourage producers from making those items available to their consumers, and are therefore signalling to producers to instead look in the United States for its products as to avoid additional charges that they would face if they chose to go with imported goods. Quite simply this is a distortion of signals that the market is otherwise making clear. Market economies have an inherent natural regulatory mechanism: competition. Competition ensures that entrepreneurs and businesses provide goods to consumers at the lowest possible price and quality demanded. However, tariffs, and other protectionist policies, distort what signals the market is trying to illustrate through competition.

For example, the reason Wal-Mart is able to be such a thriving business is that it provides products that consumers demand at both the price and quality they demand. For Wal-Mart to ensure that it keeps the voluntary patronage of its customers, and not lose it to competitors like Target, Wal-Mart must go about finding ways to import products at the lowest possible price which they can then proceed to sell to consumers at a price at least as great as the cost of importing that item to ensure expenses do not exceed revenues. If consumers demand pencils at a price of $1 then Wal-Mart must go about bringing in pencils to meet that demand and sell it at the market clearing price (the price at which producers want to sell exactly the number of units consumers want to purchase). Wal-Mart then shops around for its supply of pencils and finds that China produces and sells pencils for the lowest price and quantity demanded by Wal-Mart. However, once tariffs are set in, Wa-Mart is then discouraged from paying additional costs, or taxes, by means of tariffs and instead looks at the USA for its pencils, where they are sold for a higher price than China.

We are already beginning to see the adverse effects of protectionism. Now, when Wal-Mart then decides to buy these more expensive pencils, they must find a way to defray these additional costs. They can do it any number of ways; all of them detrimental. One way they could defray the costs would be by raising its price of pencils that it sells. This, of course, is bad for the consumer as the consumer is demanding these pencils at a lower price. This then forces consumers to not buy as many pencils they demand, resulting in a decline in the quantity demanded by consumers. Another way Wal-Mart could defray the costs it faces due to tariffs is by making up for those additional expenses by cutting back on its labor force. Therefore, in order to accommodate for the expensive price in pencils, Wal-Mart must fire x number of employees to ensure that the balance of revenues and expenses is kept profitable.

So, we already see two adverse effects of protectionism: rising prices for consumers and rising unemployment due to layoffs by the company incurring new expenses. How could either of these results possibly be good for the economy? Quite simply, they can't.

Then the argument comes up, "How could we (American workers) ever expect to compete with China where their wages are unfairly much less than those here?"

Well, there are a few responses to this:

Firstly, their wages are so much less compared to those in the United States precisely because of policies pursued by the government, mainly minimum wage laws. For example, a company who wants to make shoes wants to hire a low skilled worker. In China, that company could hire a low skilled worker for exactly the amount his labor is worth, say $5 an hour. However, in the United States, thanks to minimum wage laws that distort market salaries, a company cannot hire a low skilled worker for exactly the amount his labor is worth. For example, the market worth of the labor of the worker is only $5 an hour, however, because of minimum wage laws that distort market salaries, that company MUST pay $7.25. The benefit of hiring this worker is less than the cost as his/her salary is $2.25 over market price. What does this company do? Well, it can either move to China and pay workers what their labor is valued at. Or it can stay in the United States and pass along the increased cost to its customers. Either scenario is detrimental to the American economy.

Secondly, there is the principle of comparative advantage. What comparative advantage means is that one person, or entity, has relative superiority when taking other tasks into account. In this case, say the United States' wage rates and prices in a industry like manufacturing are inherently high because we are just that much better than China and that's why Chinese goods are priced lower. Well, then if that were true, then it is in the best interest of the United States to allow China to continue providing lower priced goods. This would then allow the United States to pursue its superiority in a different industry, like the servicing industry. What we would then have is low priced goods coming in from China, while Americans make their money in services provided to other countries. Win-win.

So, it really does seem as though protectionism sounds good on the surface ("Buy American," raise tariffs on Chinese goods) but in actuality, it is detrimental to the American economy as a whole. Think of that the next time you see some ignoramus, like Donald Trump, advocating for an increase in the minimum wage or a tariff on foreign goods.

1 comment:

  1. DP…Well written and good defense of this argument. Protectionism I hate to admit is not a great policy. Wal-Mart for me is a bad example, but it is one that average people might understand. You state they would fire workers to make up the cost of the pencils, have you been to Wal – Mart lately? There is never any help. However look at how we manufactured cars? We got lazy in the 70’s and the Japs cleaned the floor with us. This for me speaks volumes of the average American Worker, many are lazy and feel entitled. But, did you take into account the nature of a corporation? A corporation regardless of anything else must make more profit every year. I work in a service economy and while we make a profit every year, they want more. How do they do this? They cut equipment, safety etc, etc. If a corporation could and they are, they would bring workers in from India on Visa’s and have them work for less than minumn wage.
    I am not saying a corporation shouldn’t make a profit, but shareholders who have no clue about the business should not dictate what is good for me. Plus how can we justify outrageous salaries of the CEO’s? And how can we quantify the value of labor, by seeing who will do it for cheapest to enrich the owner?
    Now here is an example of something from my industry.
    Caskets are largely American made, and its one of the few things made with quality. But did you know that they are marked up almost 100% if not more? But now we might get caskets from China and they will be cheap, you think we are going to sell them for cheaper? In the meantime a factory in Indiana will lay off its workforce or downsize.
    It used to be an honest days work for an honest day’s pay. I’m not so sure that the original thinkers, maybe Adam Smith saw how large a corporation would become and how the world would have changed. How both the government and private industry wrestle for control. Remember unions did bring us a 40 hour work week. If it was up to a company they would put us in sweatshops. Plus did you forget, the shit made in China is usually made in a sweatshop? The problem for Americans is we fell asleep and now even if we wanted to buy American, it’s to late.
    It would be cheaper for Wal – Mart to ship workers here and build the crap in the back of the store.
    However I wonder if fuel costs will get so large that eventually it will be cheaper to build it here again instead of shipping it here from overseas. This argument could go on into other things, I agree with you in the theory, your solution is not that clear, even our service is outsourced to other countries.