Question

What is protectionism and why would a country base trade policy on it? Explain at least two reasons.

Answer 1

Trade protectionism is used by countries when they think their industries are being damaged by unfair competition from foreign industries. It's a defensive measure, and is usually politically motivated. It can often work, in the short run. However, in the long run it usually does the opposite of its intentions. It can make the country, and the industries it is trying to protect, less competitive on the global marketplace.

What Exactly Is Trade Protectionism?

Countries use a variety of ways to protect their trade. One way is to enact tariffs, which tax imports. This immediately raises the price of the imported goods, making them less competitive when compared to locally produced goods. This works especially well for a country like the U.S., which imports a lot of consumer products and oil.

A good example of this is, once again, in the U.S. agricultural industry. The Agricultural Adjustment Act of 1933 allowed the government to pay farmers to not grow crops or livestock, thus restricting supply and raising prices. This subsidy helped farmers who had been devastated by the Dust Bowl.

A third method is by imposing quotas on imported goods. This can one of the most effective methods for protecting trade, since the foreign country cannot ship more goods no matter how low it sets the price through subsidies.

There is a fourth type of trade protectionism that is not usually mentioned in text books, because it is subtle. That is a deliberated attempt by a country to lower its currency value, thereby making its exports cheaper and more competitive. However, this can ultimately result in retaliation, and start up a currency war. Countries can lower their currency's value through either a fixed-exchange rate, like China's yuan, or by creating so much national debt that it has the same effect, like the U.S. dollar decline.