When Protection Does Harm

Originally published on Jheconomics.com

Yellowstone is America’s first national park. Today, after almost 150 years in existence, it is one of the largest nearly intact ecosystems on the planet. Teams of park rangers and ecologists carefully guard it from damaging invasive species and it is a great example of how humans can draw a boundary around something for its protection.

When it comes to economies, the early months of this new decade are a good time to examine whether a different kind of ‘protection’ can ever be good – shielding an economic system from imports and immigration, as well as from foreign capital and technologies.

The question is worth considering because economic protectionism is on the rise. Five years ago, that statement would have drawn ridicule. Today it is a reality, and not just in Trump’s America. In nations around the world, diminished economic growth and unmet expectations have led to political frustration that has manifested itself in new policies that serve as impediments to the free movement of goods and services, as well as to the factors of production – labor, capital and know-how.

Free trade and open borders are under attack not only from nativists and nationalists, but also from some academics and many policymakers. Ideas, some old and others newer, are circulating about when tariffs, subsidies, and even outright prohibitions on cross-border movements make sense.

So, let’s examine those debates.

To begin, we note that protectionism has gone global. The Trump administration has applied tariffs to a huge range countries and products. It has unilaterally ripped up actual or pending trade agreements, only one of which it has subsequently re-signed (i.e., CUSMA, the successor treaty to NAFTA). Physical and legal barriers to immigration in the United States are going up. Cross-border technology transfer is under scrutiny. It is the stated policy of the Trump administration to thwart China’s advance into new technologies, such as artificial intelligence and big data. The US has led a global effort to block countries from adopting Huawei’s 5G technology.

Other countries have also begun to erect border barriers. Across Europe, physical walls and barbed wire hold back migrants, chiefly from the Middle East and Africa. For Brexit to mean Brexit, Britain must forgo free trade with the EU after the transition period expires at the end of this year. India’s Finance Minister Nirmala Sitharaman is widely expected to announce new import duties (tariffs) to promote Indian manufacturing. The European Union is mulling a carbon border tax, a tariff on imports whose manufacture emits more CO2 than comparable EU products, as a way of leveling the carbon playing field. And, of course, China has responded in kind to US tariffs. The list goes on.

The sheer amount of activity begs the question whether any of these barriers make sense?

In unique cases, the answer is yes. For example, temporary curbs on tourism and other forms of non-essential travel to contain a possible pandemic, as in the case of the coronavirus, are rational. Equally, if new technologies are intended to enable foreign espionage, restrictions on their import can be a reasonable policy response for governments to protect their citizens.

Yet these examples are unusual, involving either temporary and emergency public health considerations, or legitimate and specific national security concerns. The other barriers – whose justification is put forth on economic, broader national security, environmental or social grounds – are more complicated.

Is there ever a good economic argument for protectionism? This question is as old as economics itself, first raised in Ancient Greece as well as by Adam Smith and David Ricardo. It was endorsed by John Stuart Mill in 1848 in the form of the ‘infant industry’ argument – the idea that emerging industries need protection until they reach a scale whereby they can hold their own against other nations’ competitors. This is ironic because Mill is considered one of the bulwarks of free market economics, and later in life he rather unsuccessfully tried to rein back his ‘infant-industry’ views.

The infant industry argument has some logic, to a point. It also often finds support with politicians, such as India’s Modi. It even has echoes among defenders of legacy industries (Trump’s support of US coal comes to mind) who want to use tariffs or subsidies as a strategy to nurture them back to vitality.

But ultimately neither infant nor geriatric industry arguments make the grade among most economists. The approach, after all, smacks of industrial policy. Politicians are almost always worse than markets at picking winners. Protecting certain sectors can also hamper growth by diverting scarce resources away from more productive uses. And it is an invitation to run amok with protectionism – after all, who decides who gets special treatment?

Economists are also in agreement that protectionism is the wrong policy prescription to address global trade surpluses and deficits. Such imbalances are a reflection of discrepancies between national savings and investment. If deficit countries, such as the US, are unhappy with their predicament, they need to produce more and spend less. They can also urge surplus countries to spend more. Using protectionist measures to address global imbalances is akin to leaching a patient suffering from high blood pressure: a mis-diagnosis, archaic, ineffective, and, in extremis, potentially fatal.

For similar reasons, economists have generally concluded that restrictions on immigration are a poor way to address legitimate concerns about stagnating living standards, employment insecurity or skewed income distribution. Most studies conclude that technological change, for example, is a bigger threat to traditional forms of employment than globalization.

Still, economics has advanced in its thinking from the days of Smith or Ricardo. New ways of thinking about firm concentration or economic geography have deepened our understanding about how, where and why trade takes place in ways classical economics never envisioned. Some of this work has even been used to support modern versions of the infant industry argument, but most economists express doubts about its prescriptive value, for many of the same reasons noted above.

Turning to national security, this, too, is an old saw in the political economy of trade. The US imposed quotas, to little avail, on Japan in the 1930s to halt its expansionist policies. Mercantilism nearly always embeds nationalism, not merely national security. Protecting industries in the name of the flag is prone to abuse by firms masquerading the national interest for self-interest. Yet in some cases, such as nuclear non-proliferation, restrictions on exports are justifiable. In the modern era, it may also be wise to consider whether importing certain technologies might expose citizens, industries or the country as whole to ‘trojan-horse’ forms of espionage, unlawful data transfer or malware. If countries can restrict individuals’ movements to address pandemics, the same probably applies to the need to halt the spread of man-made viruses.

What about carbon border taxes or other duties, subsidies or restrictions aimed at achieving broader societal goals? Conceptually and in international law, these measures are permissible, provided they are non-discriminatory and in accord with the rules of the World Trade Organization (WTO). For instance, a country may prohibit foreign investment to develop protected green spaces, provided the same restriction applies to domestic investors. The EU is among the leaders in considering a carbon border tax. Legal trade experts and economists, however, are still searching for ways to ensure it can be implemented in WTO-compliant fashion. Meanwhile, the Trump Administration, hardly a champion of the multi-lateral trading system and its rules, has grumbled about the EU’s intentions, potentially setting up another trade dispute should Europe decide to tax the excessive carbon content of imports.

Returning to Yellowstone, protectionism in economics – unlike for national parks – is almost always a guaranteed path to damaging one’s own environment. Most restrictions on cross-border trade, capital and labor movements are both bad economics and bad policy. They are likely to be seriously damaging and should be resisted.