Chapter 10:
Arguments for and against Protection
The Ideal World of First Best
• In an ideal or a “first-best” world, all private
incentives are aligned with benefits and costs
to society as a whole (no positive or negative
externalities are present). In the first-best
world supply and demand curves represent
both private and social costs and benefits to
society and all market are perfectly
competitive.
© 2016 McGraw-Hill Education. All Rights Reserved.
2
Distortions and Their Effects
© 2016 McGraw-Hill Education. All Rights Reserved.
3
The Realistic World of Second Best
• Private actions will not lead to the best possible
outcomes for society
• Two major distortions in an economy
– Market failures
– Government policies can distort an otherwise
economically private market
• Externality is a spillover effect associated with
production or consumption that extends to a third
party outside the market. Negative externality exits
when an external effect generates costs to a third
party. Positive externality exits when an external effect
generates benefits to a third party.
© 2016 McGraw-Hill Education. All Rights Reserved.
4
Government Policies toward
Externalities
• Tax-or-subsidy approach
• Property-rights approach
© 2016 McGraw-Hill Education. All Rights Reserved.
5
The Specificity Rule
• It is usually more efficient to use the
government policy tool that acts as directly as
possible on the source of the distortion
separating private and social benefits or costs
• A barrier against imports can be better than
doing nothing in a second-best world, the
specificity rule shows us that some other
policy instrument is usually more efficient
than a trade barrier in dealing with a domestic
distortion
© 2016 McGraw-Hill Education. All Rights Reserved.
6
Promoting Domestic Production or
Employment
•
•
•
•
Local production produces spillover benefits
New worker skills and attitudes
Firms can find ways to lower their costs over time
Extra costs to workers if they are forced to switch
to jobs in other industries
• Pride in producing product locally
• Essential to national defense
• Way to redistribute income to poor or
disadvantaged members of society
© 2016 McGraw-Hill Education. All Rights Reserved.
7
Two-Ways to Promote ImportCompeting Production
© 2016 McGraw-Hill Education. All Rights Reserved.
8
The Infant Industry Argument
• A temporary tariff is justified because it cuts
down on imports while the infant domestic
industry learns how to produce at low enough
costs
• Eventually the domestic industry will be able
to compete without the help of a tariff
© 2016 McGraw-Hill Education. All Rights Reserved.
9
The Infant Industry Argument
© 2016 McGraw-Hill Education. All Rights Reserved.
10
How Valid is It?
• There can be a case of some sort of government
encouragement
• A tariff may or may not be good
• Some form of government help other than a tariff
is a better infant industry policy than a tariff
• It is hard for a government to know which
industries to support because it is difficult to
predict which industries can reduce their costs
enough in the future to create national benefits
© 2016 McGraw-Hill Education. All Rights Reserved.
11
Cost per Job Maintained, 1990
© 2016 McGraw-Hill Education. All Rights Reserved.
12
The Dying Industry Argument and
Adjustment Assistance
• Should government intervene to save a dying
industry? - If we are in a “first-best” world, the
answer is no. Since the social value of anything is
already included in private incentives, ordinary
demand and supply curves already lead us to the
socially optimal choice.
• Trade adjustment assistance to workers and firms
in import-threatened industries is a better policy,
using the direct-policy rule, than for example a
tariff, because it focuses on income losses,
training, and job mobility.
© 2016 McGraw-Hill Education. All Rights Reserved.
13
The Developing Government
(Public Revenue) Argument
• According to this argument, in poor
developing countries the import tariff
becomes an important source, not just
protection but government revenue.
© 2016 McGraw-Hill Education. All Rights Reserved.
14
Other Arguments for Protectionism:
Noneconomic Objectives
• National pride argument
• National defense argument
• Income distribution argument
© 2016 McGraw-Hill Education. All Rights Reserved.
15
The Politics of Protection
• The basic elements of the political-economic
analysis:
1. The size of the gains for winners from
protection, and
how many individuals are in the group of
winners.
Bp = total gains by producers, Np = the number of
individuals benefiting from the protection
2. The size of the losses for the losers from
protection, and how many individuals are in the
group of losers.
© 2016 McGraw-Hill Education. All Rights Reserved.
16
The Politics Protection
Bc = total gain by defeating the tariff, Nc = the
number of individuals losing from protection
(gaining from defeating protection.)
3. Individuals’ reasons for taking positions for or
against protection. ( a. The size of Bp and Bc
b. sympathy for various groups and c. ideology)
4. Type of political activities and their costs ( the
costs of participation: time and money)
5. Political institutions and political process.
© 2016 McGraw-Hill Education. All Rights Reserved.
17
When are Tariffs Unlikely?
1. Direct democracy:
a. direct vote by individuals on tariff
b. voting is costless so that almost everybody votes.
c. each person’s voting is based on her direct interest
as winner or loser from protection.
• Almost always Nc > Np
• But countries usually do not use direct votes to set
protection. Rather, a group of selected representatives
make the decision. Winning the political fight is gaining the
support of a majority of these representatives of officials.
• Are some forms of government, like representative
democracy, inherently protectionist?
© 2016 McGraw-Hill Education. All Rights Reserved.
18
When are Tariffs Unlikely?
2. Representative democracy can lead to little or no
protection.
a. each group is willing to devote all of its total gains
(Bp and Bc) to political activity like lobbying or
contributions
b). politicians decide which side to support
according to the amount of lobbying or contributions
they receive. Since Bc > Bp those opposed to the
tariff (consumers) would be willing to spend up to Bc
to prevent the tariff, while the protectionists would
not rationally spend more than Bp. The inefficiency
of the tariff, which equals Bc – Bp, defeats the tariff.
© 2016 McGraw-Hill Education. All Rights Reserved.
19
When are Tariffs Likely?
• If the protectionist groups are more effective than the
other groups in organizing their political activities, the
group with smaller number of individuals can be more
effective
• If the benefits of participation are less than the costs to
the individual, he/she is not likely to participate in the
activity. The average gain per supporter of protection
(Bp/Np) > average gain per opponent of protection (Bc
/Nc)
• The individual gains tend to be larger as the number of
individuals in the group is smaller! Opponents of
protection compare (Bc / Nc) to individual costs of
participation (time and money)
© 2016 McGraw-Hill Education. All Rights Reserved.
20
Applications to Other Trade-Policy
Patterns
• Tariff escalation pattern: the importance of group size
and concentration for effective lobbying in favor or
against a policy. Economists have found that nominal
and effective tariff rates rise with the stage of
production, i.e. tariff rates are typically higher on final
consumer goods than on intermediate goods and raw
materials sold to producing firms. Why? Because
consumers are usually less organized than producers in
lobbying activities.
© 2016 McGraw-Hill Education. All Rights Reserved.
21
Applications to Other Trade-Policy
Patterns
• The bias in favor of producer interests over consumer
interests also show up in international negotiations to
liberalize trade.
– A concession by a country reflects the nation’s import duties,
and allowing more imports. Each country is pressured to allow
as much import expansion as export expansion. This
concession-balancing rule is further evidence of the power of
producer groups over consumer groups.
– The trade negotiators view their own import tariff cuts as a
sacrifice because they have to answer politically to importcompeting producer groups but not to masses of poorly
organized consumers.
© 2016 McGraw-Hill Education. All Rights Reserved.
22
Applications to Other Trade-Policy
Patterns
• The sudden – damage effect : Sympathy often
increases when a group suffers a big income
loss at once.
• The sympathy can arise from two sources:
– Compassion for those suffering large income
losses.
– When a deep recession hits the whole economy.
More people will identify with the less fortunate,
thinking that, “that could be me.”
© 2016 McGraw-Hill Education. All Rights Reserved.
23
Can an Import Barrier Be Better than
Doing Nothing, and Is It the Best Policy?
© 2016 McGraw-Hill Education. All Rights Reserved.
24