Trade Protectionism Benefits No One

by: Nikhil Raheja

The Obama administration has decided to impose steep import duties of 35% on Chinese passenger and light truck tires. This was done in response to a surge in Chinese tire exports, that has rocked the domestic U.S. tire industry and displaced thousands of jobs. China, in retaliation, said it would investigate complaints by the Chinese industry that U.S. companies are dumping chicken and auto products in the local market, and might impose similar duties. Trade protectionism benefits neither the exporter nor the importer. It leads to lower total production in the importer country since fewer raw materials are available, while it causes the exporters to dump their exportable produce in their own countries, leading to declines in profits and a possible recession.

Let us suppose a case of two countries, A and B. Private exporters in Country A export salt to country B. This causes the domestic salt manufacturers in Country B to lose money and they press their legislators to impose tariffs on the exporters of Country A. As a result, import duties of 50% are imposed on salt originating from Country A. As a result, salt becomes expensive and many businesses are forced to reduce production lest the total costs rise. This translates into a decrease in the total number of employees as well as in the total purchase of salt for operations. In effect, the production amongst the businesses using salt as raw material decreases. On the other hand, the revenues of the domestic manufacturers of salt increase. As production falls, eventually, prices rise and cause the standard of living of the entire population to fall.

On the other hand, Country A`s salt exporters export lower quantities of salt and hence face a glut of salt, to be sold in the domestic markets. As a result, the higher total supply of salt causes salt prices to fall. In fact, a lot of the salt is not purchased and goes waste. The exporters lose money and many of them go out of business. This causes an impact on their Banks/lenders, who also lose the money lent to the exporters. Consequently, the banks restrict credit to the businesses and that reduces the total production.

Ironically, it is possible that Country A too, in retaliation, imposes tariffs on the cars, clothes, sugar, and honey it imports from Country B. Hence, it is realized that in stead of helping its domestic manufacturers increase their revenue, the government of Country B unwittingly reduces their revenue since Country B`s exporters sell their produce within the confines of the country and not export to Country A. The disadvantages of the cancellation of exports for Country B outweigh the benefits from reduced imports. This causes a recession in Country B.

A popular instance from history when the above events occurred was the passing of the Smoot-Hawley Tariff act in the US during the Great Depression. The Great Depression caused many industries to lose money, and that led congress to blame the imports for it. The Congress, in turn, raised tariffs on 20,000 imported goods. Consequently, boycotts broke out from foreign governments and they moved to import duties against American products. By September 1929, Hoover's administration had received protest notes from 23 trading partners, but threats of retaliatory actions were ignored. Canada preemptively imposed new tariffs on 16 products that accounted altogether for around 30% of U.S. exports to Canada. Britain protested and developed new trade partners. Germany developed a system of autarky.

As a result, U.S. imports decreased 66% from US$4.4 billion (1929) to US$1.5 billion (1933), and exports decreased 61% from US$5.4 billion to US$2.1 billion, both decreases much more than the 50% decrease of the GDP. Trade protectionism worsened the depression as the domestic manufacturers competed with a glut of products in the market. It led to a loss in the next Presidential elections for President Hoover, who had signed the bill into law.

There is a possibility that the actions of the current administration are going to start a new trade war, with China, Canada, European Union and India already voicing their opposition to other such protectionist measures taken by the President. A trade war would worsen the economic situation in the US on the lines of that done under the Hoover administration.