Chapter 9
Arguments for and against Protection
Overview
This chapter has three purposes:
-To present a framework and a rule for evaluating arguments
offered in favor of limiting imports,
to apply the framework and rule to several prominent arguments
for protection,
-and to examine the political processes that result in government
policies toward imports.
The framework allows us to look at situations in which the free
market may not result in economic efficiency, because of
incentive distortions that result in market failures. In the “firstbest” world with no distortions, private marginal benefits (MB)
to consumers who make buying decisions equal social marginal
benefits (SMB), because there are no consumption externalities
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or spillovers, private marginal costs (MC) recognized by sellers
equal social marginal costs (SMC), because there are no
production externalities or spillovers, and all of these are equal
to market price, because the market is perfectly competitive and
there are no distorting taxes.
=An externality is said to exist is one agents behaviour affects
another agents satisfaction or profit. E.g. pollution, neighbour
with a beautiful garden, smoking…
When external costs, external benefits, a distorting tax,
monopoly power, or monopsony power exists, the market will
usually not yield the first-best outcome, because social marginal
benefit will not equal social marginal cost.
-In situations in which the free-market outcome is second-best,
there is a potential role for government policy to contribute to
economic efficiency.
- This could done through creation of new property rights (e.g.
case of two roomates-smoker and non-somker-specifify
clearly the rights)
- The other procedure is by imposing tax or providing a
subsidy to eliminate distortions in private incentives.
This ensures that SMB=SMC.
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We focus on the later since trade policy isa concern with taxes
(tariffs) and subsidies.
If SMC > MC=P=MB=SMB-impose tax. Size of the tax should
be equal to (SMB-SMC)
If SMB >MB e.g education, R & D.
Can trade barriers help deal with these distortions?
Fortunately, there is a useful rule that works well in most cases.
If the problem is an incentive distortion, the specificity rule
indicates that government policy should intervene at the source
of the problem, to act as directly as possible on the source of the
distortion. (Later in the chapter, we offer a second version of the
specificity rule. If the government has a noneconomic objective,
the government policy to achieve this noneconomic objective
with the least economic cost is usually the policy that acts
directly to achieve it.)
Externalities
The specificity rule is powerful in its applications. Consider the
situation in which there is too little domestic production in an
import-competing industry, because of marginal social side
benefits from this production say employment. What is the best
government policy to address the distortion?
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-A tariff can be used to increase domestic production, so it may
be better than doing nothing, but it is not the direct policy,
because it acts on imports directly, not on domestic production.
The best government policy is a subsidy to domestic production.
Domestic production is increased, correcting the distortion. The
production subsidy is better because it does not distort domestic
consumption.
- A tariff would squeeze some consumers out of buying,
resulting in the inefficiency of the consumption effect
(triangle d). See Fig. 9.2.
With Tariff loose b and d and gain g is one social side benefits.
The tariff is indirect and not the best policy to address the
production distortion.
-Subsidy-optimal price $330.Market price 300. Offer subsidy to
producers of $30. In fact, if we can be more specific about
exactly what the source of the distortion is, we should employ a
more specific policy. If the distortion arises from external
benefits (e.g., training or acquiring better work habits) to
working in the industry, then the best government policy acts
directly, by subsidizing employment or training in the industry.
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The box “How Much Does It Cost to Protect a Job?” (another
Focus on Labor) examines the cost of maintaining jobs in
import-competing industries using trade barriers. Estimates for
highly protected industries in the United States and in Europe
show that the costs (to consumers or to the nation) can be very
high. For the typical highly protected industry, it would be less
expensive to pay workers not to work.
Infant industry argument
The infant industry argument leads to another application of the
specificity rule, as well as raising a set of other interesting
issues.
-The argument is that import competition prevents an initially
uncompetitive domestic industry from starting production. But,
if the industry is shielded from foreign competition, it can begin
production, and over time it will be able to lower its production
costs, so that it become competitive.
-At that time in the future the protection can be removed, and
the industry will provide national benefits in the form of
producer surplus.
See Fig. 9.3. Note in this analysis it is assmed that the world
price and Domestic Demand do not change.
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In this scenario, a tariff can be better than doing nothing, for
national well-being over the long term. But the specificity rule
indicates that the better government policy is one that acts
directly on the source of distortion.
- If the issue is to foster initial domestic production, then a
production subsidy is a better government policy. One may even
wonder why this is needed. Why cannot the firms in the infant
industry borrow to finance initial losses and then pay back the
loans using future profits when the industry is grown up? If
there are defects in the lending markets, then the government
could extend loans. If the industry will create external benefits,
such as training workers or new technologies, then the best
government policy acts directly on the source of the external
benefits (for instance, subsidies to training, or subsidies to
research and development). In addition, one may wonder if the
infant industry will actually “grow up.”
Another argument in favor of protection is assistance to
industries that are declining because of rising import
competition. Moving resources out of an industry is costly.
People who lose their jobs because of increased imports often
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have a difficult time finding new jobs and often suffer
substantial declines in earnings. The marginal social side benefit
of continuing domestic production in this industry is avoiding
these costs of moving resources to other uses. Again, a tariff can
be used to maintain domestic production, and it may be better
than doing nothing (so that the industry shrinks). But again the
specificity says to attack the externality directly. A subsidy to
domestic production will be better than a tariff, and other
policies like subsidizing retraining of workers can be even better
and more direct. Unfortunately, the retraining offered through
this program is generally not that effective.
A different argument in favor of protection is that the
government gains revenue. For a poor country with a weak tax
system, the lack of government revenue can lead to inadequate
supply of public goods (disease control, schooling,
infrastructure).
- Tariffs and taxes on imports may be some of the few taxes
that the government can collect effectively—they are a direct
response to the source of the distortion.
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- The benefits from better public goods can be much larger that
the deadweight losses from the trade taxes.
- While this is potentially a valid argument for taxing trade,
there is no guarantee that the government will use the
revenues to fund socially useful investments.
- And as the country develops, it should shift toward broaderbased taxes that are less distorting.
Non-Economic factors
-National pride gained by production of a product calls for a
production subsidy as the least-cost way to achieve the
objective. National pride in self-sufficiency calls for a tariff or
other import limit, because in this case the objective is
specifically to reduce or eliminate imports.
- National defense
Have products that will be important in future military
emergency. Food, ships, fotwear..providing for the national
defense is usually least costly using a subsidy to domestic
production capacity, leaving depletable resources in the ground,
or building stockpiles. In the latter two cases imports can be part
of the solution, if they are the least costly way to acquire items
during peacetime for consumption or to build up the stockpiles.
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- Third, income redistribution is best achieved through income
taxes and transfers and not by trade restrictions.
The Politics of protection
The chapter concludes by surveying the political economy of
trade policy, using analysis based on five major elements:
 how much the winners gain from protection and how many
benefit.
 how much the losers are harmed by protection and how many
lose.
 what reasons individual people and companies have for taking
positions for or against protection.
 what types of political activities people and companies can
use and their costs.
 what the political institutions and processes are.
Tariffs and other trade barriers are unlikely under at least two
combinations of these elements:
 when decisions are made by direct voting and people vote
based on whether they are winners or losers from protection,
or
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 when individuals are willing to devote all of their gains from
winning (for or against protection) to lobbying or
contributions and elected representatives (or other
government officials) decide on the basis of the amount of
lobbying or contributions they receive.
Tariffs and other trade barriers are more likely to be adopted
when the group that will gain from protection is better organized
in its lobbying and contributions.
In fact, we often expect that the group with the smaller number
of individuals can be more effective, because the larger gain per
individual is likely to result in more activity by the smaller
group, and because the smaller group is more likely to find ways
to overcome the free-rider problem.
The small number of import-competing producers are motivated
to participate and overcome the free-rider problem, so they
become a well-organized group with substantial resources to use
politically to seek protection. The outcome is that the wellorganized protectionist lobby sways a majority of politicians to
enact tariffs or other import barriers. (The box on sugar
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protection provides an example of these forces and the
outcome).
In addition to explaining the general political process that leads
to protection, this model of political activity can explain several
specific features of trade policy. Tariff escalation occurs because
the buyers of materials and component are firms that can
organize to oppose tariffs on these intermediate goods.
Offers to reduce tariffs in a multilateral trade negotiation are
called concessions because producer groups are politically
powerful.
In addition, sudden damage creates sympathy, so that even
those who are hurt by protection sometimes say that they favor
protection to assist those hurt by rising imports. In fact, given
this discussion, the surprising thing is not that there is some
protection, but that there is not more protection that we actually
have in countries with representative democracies.
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