Chapter 10
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 distortions that result from market failures or from
efficiency-reducing government policies. In the “first-best” world with no distortions, private
marginal benefits (MB) to consumers who make buying decisions equal social marginal benefits
(SMB), because there are no positive externalities or spillovers, private marginal costs (MC)
recognized by sellers equal social marginal costs (SMC), because there are no negative
externalities or spillovers, and all of these are equal to market price, because the market is
perfectly competitive and there are no distorting government policies like a tax or a subsidy.
When external costs, external benefits, monopoly power, monopsony power, a distorting tax, or a
distorting subsidy exists, the market usually does not yield the first-best outcome, because social
marginal benefit does not equal social marginal cost.
In situations in which the free-market outcome is second-best because of a market failure, there
is a potential role for government policy to contribute to economic efficiency. We mention the
approach of creating new property rights, but we focus in this chapter on the tax-or-subsidy
approach to eliminate distortions in private incentives.
In such a situation, a question is what government policy (tax or subsidy) to use. Fortunately,
there is a 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.)
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 external benefits
from this production. What is the best government policy to address the distortion? 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). The tariff is indirect and not the best policy to address the
production distortion. 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.
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.
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 becomes 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. 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 have a difficult time finding new jobs and often suffer
substantial declines in earnings. The marginal external 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 rule 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 (more direct). The U.S. government does offer trade adjustment
assistance to some workers who lose their jobs because of rising imports. 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 on imports and/or taxes on
exports may be some of the few taxes that the government can collect effectively—they are a
direct response to the source of the distortion. 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 broader-based taxes that
are less distorting.
The chapter then examines several arguments in favor of protection that involve national pursuit
of “noneconomic objectives.” First, 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. Second, 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. Third, income redistribution is best achieved through income taxes and transfers.
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
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 well-organized protectionist lobby sways a majority of
politicians to enact tariffs or other import barriers. The box on sugar 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.
Tips
This chapter builds on the analysis of Chapters 8 and 9, but the flavor of the analysis is different.
Students who like conceptual depth but dislike graphs will find relief here. The spotlight is now
on the ideas, with the geometry more in the shadows. Logic still rules, but it is now more verbal
and less mechanical.
Role playing can be used to bring the issues raised in the chapter to life. For instance, the class
can be divided in half, with each half taking the opposite side in a debate about an actual trade
problem. One possible topic: To protect U.S. jobs and raise the low U.S. wages in the clothing
manufacturing sector, the U.S. government should tighten quotas or raise tariffs on imported
clothing drastically. Another possible topic: The Japanese government should sell its scarce
rights to land international flights at its airports to the highest bidders, even if this means that
some Japanese airlines go out of business. Yet another: Brazil should limit its imports of personal
computers, in order to foster the development of its own personal computer industry. Current
events can offer other topics. After playing the assigned roles in the debate, the students can be
asked to drop their roles and vote on the question.