Western Standard

The Shotgun Blog

« "Go Home Stupid" | Main | Putting arbitrary morality before economic reality is a one way trip to hell »

Friday, July 31, 2009

Understanding protectionism

With every industrialized nation struggling to survive the Great Recession, government focus has shifted back to the idea of protecting their respective economies. Up until the recession, focus seemed to be global economic interdependence ended up creating a large portion of nations’ wealth. That being said, it was and still is of the best interest of nations to trade with others. This is due mostly to the idea of comparative advantage; for instance, let’s say Country ‘A’ is able to produce wheat at $5 per unit, while Country ‘B’ can produce the same unit of wheat for $7. On the other hand, Country ‘B’ is able to produce steel at $10 per unit, while Country ‘A’ can only produce it at $15 per unit. Assuming there are little to no trade barriers between the two countries, it benefits both equally to trade with each other: Country ‘A’ sells their wheat to Country ‘B’, and Country ‘B’ sells their steel to Country ‘A’ (let’s say $6 per unit of wheat and $12.50 per unit of steel). Both countries receive profit from one good and gets another good for a lower cost than if they were forced to produce it themselves.

It’s easy to see that this simple concept is a timeless idea, but it’s not so easy to understand why some governments, particularly now, create policies that go the opposite way and hinder comparative advantage. Besides the fact that currently it’s often a matter of economic survival, it’s important to understand the various arguments or reasons why protectionism still exists in an age of mass economic globalization.

The first and most common argument involves the labour force; labourers from foreign countries that produce the same goods are often paid less than those in high-income countries like the U.S. or Canada, where the cost of business is higher. Because of this, some governments are worried companies (in other words, jobs) will move overseas to reduce the cost of operation. As we all know, wages and benefits are huge expenses for Western companies. Although most governments these days are at least partially in support of free trade, there are occasions where countries are losing jobs at an alarming rate. Governments will understandably be skeptical of the advantages of free trade if the one disadvantage out-shadows all else.

The second argument worth mentioning focuses on emerging domestic industries. In particular, governments of developing nations sometime set up tariff policies in place to protect “infant” industries; developing industries that are not yet stable and productive in comparison with the industries of more industrialized nations. These advanced economies have stable, mature industries which would otherwise crush the common industries of developing countries in a free trade situation.

Developing nations often have the lingering worry that if they allow completely free trade in the cultural industries, then the most commercially successful companies will dominate. This has the possibility of the cultural values of the developing country to erode away, replaced by the dominant culture. It’s a no-brainer that many will chose to sell American films if they far outsell films from the their home country, and America happens to have the most viable entertainment industry in the world. Unfortunately one of the most disliked countries in the world also happens to be America.

Finally, there is the case of countries deciding that another country’s trade policies unfairly discriminate against them. In retaliation, a common response is to impose similar barriers against the discriminating country. Although retaliatory tariffs and quotas can provide an incentive for negotiations (not a positive one at that), it can also lead to escalating trade wars, making both sides worse off than the original situation.

It’s now easy to see that these policies, though detrimental in the long-run, are tempting to nations desperate to survive the Great Recession. Whether they help, or whether they are morally and economically justifiable, will depend on who you ask. In the end it’s best to at least understand these anti-free trade practices, even if we don’t like them; especially if we don’t like them!

[Cross-posted at The Right Coast]

Posted by Dane Richard on July 31, 2009 in Economic freedom | Permalink


Anti free trade practices can be very subtle. I had a meeting this morning with an executive of a small pharmaceutical company this morning. He had this story to tell:

They have a drug that's been approved by the FDA and Health Canada. It's been on the market for 30 years. They applied for a license to sell this drug in France and Germany. The bureaucrats in both jurisdications decided that new trials were required in order to sell the drug (regardless of an outstanding track record in N.A.). The company assessed the situation, realized that the NPV would most likely be negative if it spent the money to do the trials, and has concluded it will not sell its product in Europe.

Here's the rub. This product is half the price of the competing products, just as safe, and more effective. The Europeans get screwed (paying more) and we get scrwed (they had to fire staff in Canada). Everyone loses.

Posted by: Charles | 2009-07-31 2:01:50 PM

Here's a question...
Now that Canada can no longer feed itself due to our knowlegeable leaders selling (various aspects to this) out our farmer's and industry to third world countries...what are we protecting?
And when will government subsidies stop paying people to produce nothing at a time when we may well most need our own capabilities up and running...not collecting welfare.

Posted by: The original JC | 2009-07-31 3:50:16 PM

They have a drug that's been approved by the FDA and Health Canada.It's been on the market for 30 years.

Posted by: Charles | 2009-07-31 2:01:50 PM

So it's been on the market for 30 years and never sold in Europe? I find that hard to believe.

They applied for a license to sell this drug in France and Germany. The bureaucrats in both jurisdications decided that new trials were required in order to sell the drug (regardless of an outstanding track record in N.A.).
Posted by: Charles | 2009-07-31 2:01:50 PM

BS. The European Medicines Agency has sole approval authority within the EU.

Posted by: The Stig | 2009-07-31 8:58:37 PM

I totally support free trade-with non-hostile nations.

Posted by: GeronL | 2009-08-01 1:11:52 AM

Dane, good example on compariative advantage. I woudl take it a step further though. For example, country A may be able to produce wheat and steel for less than country B. But they are better off producing only wheat and buying steel from B because they are better off focusing only on wheat because their comparative advantage is even greater.

One thing many people forget is that a countries borders are a political creation and wealth is hindered every time any limits of any kind are created.

GeronL, I get where you are coming from as I hate the idea of doing business with a hostile country. However, countires don't do much business with each other. People do. And the more free trade is the more peace is possible.

Posted by: TM | 2009-08-01 10:18:51 AM

The same thing happened during the Great Depression. America raised tariffs in an attempt to protect her domestic industries; other nations retaliated with tariffs of their own. The immediate result was that international trade was cut in half, resulting in even more people out of work. Now, 75 years later, people are doing the same thing over again.

One popular (if technically inaccurate) definition of insanity is to repeat the same exercise under the same conditions, over and over, and expecting a different result.

Posted by: Shane Matthews | 2009-08-01 10:49:53 AM

What is a "respectful economy"? And is it a better than a disrespectful one?

Posted by: Craig | 2009-08-01 6:40:04 PM

I think he meant "respective" economies, Craig. As in "to each his own."

Posted by: Shane Matthews | 2009-08-01 7:34:04 PM

Thank you Shane, that is indeed what I meant. I will fix it.

Posted by: Dane Richard | 2009-08-02 6:57:41 AM


"BS. The European Medicines Agency has sole approval authority within the EU."

You idiot. The European countries each have a vote within the EMA. The French and Germans have a lot of power and the rest of the countries usually vote along the same lines. Since the firm now had to run trials for the entire European union, it decided to not enter Europe. Period.

"So it's been on the market for 30 years and never sold in Europe? I find that hard to believe."

I don't give a crap what you believe Stig. This product has about 80M in sales and is marketed by a small firm, which up until now, did not have the resources to enter the European market. Other than calling me a liar, do you have anything productive to add?

Posted by: Charles | 2009-08-03 7:51:38 AM

Actually Stig, the firm used the decentralized method to get approval. Meaning you can apply for a few individual licences in specific countries. If you succeed, then the EMEA reviews the evidence and decides if you get approval in the entire Euro Zone.

I left these details out because my post would have became very technical, boring, and probably too long.

Posted by: Charles | 2009-08-03 8:14:03 AM

The comments to this entry are closed.