Protectionism

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Protectionism is defined as an economic policy of restricting international trade among countries by means of tariffs, import quotas, restrictions on foreign direct investment, anti-dumping policies and various other government regulations. Historically, protectionism was associated with economic theories such as Mercantilism, an economic policy, focusing on maximizing exports and minimizing imports and import substitution. Global wars such as the World Wars gave rise to extensive government trade restrictions leading to protectionist policies. Shifts in Comparative Advantage for countries have also led to protectionist policies. However, over a period of time, it has been realized that protectionism does not lead to exponential growth and sustained development.

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Comparative Advantage

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An economy's ability to produce a particular good or service at a lower opportunity cost than its trading countries is called comparative advantage. Economists have used the theory of Comparative Advantage to propagate opening of economies and liberalising them. Economists clearly argued that countries having absolute advantage of producing goods were also better off trading and having free trade policies due to the concept of comparative advantage.

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Let’s take an example to understand this. Assume that there exists only 2 countries, A and B, and that they produce only 2 goods, wheat and cars. Country A has the ability and resources to produce both goods in greater quantity or the same quantity at a lower cost. Here country A has an absolute advantage in production. However, if the opportunity cost of producing wheat for country B is lower than that of country A then the former has the Comparative Advantage in producing that good. Economists have proven that its more beneficial for both countries to trade goods regardless of country A having an absolute advantage. A classic example of this is Great Britain’s transformation from a protective country to a globalised and liberalized nation importing grains and thus becoming the industrial powerhouse.
 

A shift from protectionism to liberalisation- Impact of Theory of Comparative Advantage?

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Europe was mostly protectionist during the eighteenth century and became liberalized during the 19th century. The US was also predominantly protectionist during the period of 1790 to 1860 with average tariffs increasing from 20 to 60 percent. From 1861 to 1933, the average tariffs increased to 50 percent and remained at that level for several decades. This period was characterized by economic historian Douglas Irwin as the "restriction period”. From 1934 onwards, which Irwin characterizes as the "reciprocity period", the average tariff declined substantially until it levelled off at 5 percent. India after its independence also followed an “inward-looking” trade policy focusing on import substitutions, tariffs and quotas etc. This was mainly done to protect Indian industries and domination of other countries. However, after 1991, India liberalized its economy.

 

Problems with the theory of Comparative Advantage and its influence on protectionist policies

 

• Comparative Advantage: Not a static concept

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Comparative Advantage enjoyed by a country is not static; it may change over time. Today’s world is characterised by an exponential rate of technological growth and development. With such fast advancement, it should not come as a surprise that new countries may develop Comparative Advantage of producing goods over other countries.

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For example, Vietnam’s development of Comparative Advantage for coffee production. Despite having a long history of coffee production, it is only in the last 30 years that it has become a global player. Its global market share has increased from just 1% in 1985 to 20% in 2014, making it the world’s second-largest producer.

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Another example is of Bangladesh. It has started to substantially grow the export of garments to China. Ironically, China is known for being a low-cost manufacturer. However, over a period of time, there has been a shift in comparative advantage. Earlier, China had a massive Comparative Advantage in unit labour costs. This has recently changed with the rise in wages and other costs. A lower per unit labour cost in Bangladesh than in China has led to cheaper production in comparison.

Countries, therefore, might resort to protectionist policies to tackle this issue which is very prevalent in today’s world.

 

• Disregarding Comparative Advantage for production of certain goods

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 Let us assume that a country depends upon some other country for food grains because the latter has Comparative Advantage in producing food grains. However, due to unforeseen circumstances like war or other events, trade restrictions are imposed, leading to fall in imports of food grains. This would be devastating for the dependent country. Due to this, many countries strive for food security. Even if they should specialise in non-food products, they would still prefer to keep a minimum level of food production i.e. even if they do not have a comparative advantage, they still might choose to go for protectionist policies for supporting their own farmers and increase food production internally leading to greater food security.

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This concludes that even though a country may not have Comparative Advantage of producing certain goods, however, it would still choose a protectionist policy to increase internal production for achieving the goal of self-sufficiency, security etc.

 

Conclusion:

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It is indisputable that the theory of Comparative Advantage has massive benefits. This was historically proven by the countries shifting from protectionism to more or less a total free trade policy, resulting in many trade agreements and formation of the General Agreement on Tariffs and Trade (GATT) and subsequently the World Trade Organisation (WTO). Economists and countries have developed the understanding that using the theory of Comparative Advantage for trading goods leaves both parties in a better state. However, there are exceptions to everything. Comparative Advantage has certain flaws of its own, as mentioned above, especially in this fast-developing world. This has led to protectionism still being a strong economic theory with countries still adopting such policies to either continue trade wars between countries or to protect domestic industries.