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Analysis

Maintaining a stable and attractive currency is just one policy objective of governments in the area of foreign trade. Most nations adopt measures aimed at preserving a trade surplus and a positive balance of payments. As part of these efforts, some nations provide protection for their domestic industries from foreign competition.

Protectionism is a set of policies aimed at protecting a nation’s industries from foreign competition. When, for example, an American buys a Volkswagen instead of a Ford, American dollars leave the country and (most likely) German workers, rather than American workers, draw a paycheck. To prevent this, governments impose tariffs, quotas, and embargos. A tariff is just a tax on stuff imported from other another country; the tax raises its price and thus diminishes its attraction. A quota is a limit placed on the quantity of a specific good allowed into the country. An embargo is a complete prohibition against bringing a certain good into a country.

Protectionist measures are usually aimed at protecting a domestic industry and the jobs it represents. But governments also pursue these measures to maintain a positive balance of trade or trade surplus. If a country exports more than it imports, it has a trade surplus—this means that more currency is flowing into your country than flowing out—currency that can pay domestic wages and fuel business expansion. A trade deficit, on the other hand, means a country is importing more than it is exporting and, on balance, more money is flowing out of the country than flowing in. This means that your dollars are paying foreign wages and fueling foreign rather than domestic economic growth.

Most economists argue that trade deficits rarely tell the entire story. A more critical statistic is the balance of payments. This measures not just the net exchange of goods between countries, but also the amount of money other countries spend on services, such as a banking and insurance, and the amount of money foreigners invest in your country’s economy. American dollars, for example, may flow to Japan to purchase Nintendos, but they may return when Japanese investors purchase American golf courses.

US Balance of Trade and US Balance of Payments (1 and 2)

US International Trade in Goods and Services

US International Transactions

Citations: 1. US Census Bureau: Foreign Trade Statistics
http://www.census.gov/indicator/www/ustrade.html
2. “US International transactions, 3rd Quarter 2009,” Bureau of economic Analysis, http://www.bea.gov/newsreleases/international/transactions/transnewsrelease.htm

Governmental trade policy can therefore be complicated. Policies aimed at one element of international commerce will trigger another set of reactions—for example, if the American government placed strict quotas on a long list of Japanese manufactured goods, American manufacturers might benefit. But what would be the effect on American real estate prices if Japanese consumers were thereby removed from the market?

Most economists argue that protectionist policies are, as an economic rule, misguided. By insulating American producers from foreign competition they discourage modernization and improvement. And American consumers are forced to pay higher prices—the foreign imports that might bring down retail prices are artificially elevated by government intervention. And no protectionist measure, critics add, goes unpunished. Foreign nations retaliate by imposing protectionist measures of their own–usually on a vulnerable American industry. A quota designed to protect American car manufacturers might lead to a retaliatory tariff on American wheat—in short, American farmers pay the price for government efforts to protect American autoworkers.

These arguments are part of a preference for free trade—unrestricted commerce between nations. According to free trade thinking, protectionist measures only hurt consumers and impede innovation in production. They buttress industries that can no longer compete in the world economy and invite retaliation from other nations. While foreign competition may displace local workers in the short term, this forces local entrepreneurs to seek out better uses of their capital and human resources—in other words, it forces nation to renew the search for those industries in which they enjoy an absolute or comparative advantage.

Alright, now we’ve come full circle. Check out the International Trade Game to see how you would do managing a foreign trade challenge if you were the President of the United States.

Why It Matters Today

Especially during hard economic times, protectionist policies tend to become more popular with politicians and with much of the public.  Impose tariffs, the argument goes, to protect American companies from foreign competition and thus to save American jobs.

But is that really a good idea?

Tariffs come with serious costs.  A 1994 analysis found that steel tariffs at the time cost the US economy more than $32 billion... a staggering $170,000 for each of the American steel-industry jobs it saved.  More recently, a new tariff imposed on Chinese tires raised the price to American consumers from $60 to $70 each.  Multiply by four wheels on your car and that really starts to add up.

Sometimes, a Song Says it Better: Trades and Tariffs, by The Dodos

“We stick to what we know” which is trades and tariffs.

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