A RGUMENTS FOR P ROTECTION

I NTRODUCTION First Best World Second Best World Distortions due to market failure Distortions due to monopoly/monopsony power Specificity Rule

A RGUMENT 1: PROMOTING DOMESTIC PRODUCTION OR EMPLOYMENT Protectionist have many reasons for maintaining production or employment How is this best for a nation as a whole? Typical Argument : there are many spillovers or extra social benefits to domestic production or employment in "this particular import-competing industry". [ thus we are in a 2 nd best world ] Examples of spillovers to domestic production or employment: 1. Knowledge, technical know-how or management technique spillovers 2. Spillovers of worker skills/attitudes 3. Decreases production costs in the long run 4. Increased costs of job search when switching industries 5. Home countries take pride in local production ( Made in USA ) 6. Product is essential to national defense () 7. Employment in this industry is a way to redistributed income to low-income (disadvantaged) members of society.

A RGUMENT 1: PROMOTING DOMESTIC PRODUCTION OR EMPLOYMENT A small country case analysis: German Wheat Market Suppose a tariff is imposed to restrict imports 1 st problem: Some import decline comes from a  in demand due to higher prices 2 nd problem: Is it realistic to assume there is enough fixed capital, ready to be put into production once the tariff is imposed? 3 rd problem: Potential retaliation by other countries

A RGUMENT 1: PROMOTING DOMESTIC PRODUCTION OR EMPLOYMENT Now is promoting domestic production or employment a valid argument in this case? It is possible that there are spillovers to production/employment Thus it is possible that the "spillover" benefits are greater than the DWL created by imposing a tariff or a quota. The tariff may be better than free trade in a 2 nd best world

A RGUMENT 1: PROMOTING DOMESTIC PRODUCTION OR EMPLOYMENT What is a better way to achieve more domestic production of a good (not less consumption or fewer units of it)? Domestic subsidy - not a tariff Doing so encourages production without the DWL from the consumer’s perspective

A RGUMENT 2: I NFANT I NDUSTRY A RGUMENT Infant Industry Argument: a temporary tariff is justified because it cuts down on imports while the infant domestic industry learns how to produce at low enough costs.

A RGUMENT 2: I NFANT I NDUSTRY A RGUMENT Difficulties in practice: 1. How do countries know which industries have the greatest potential? 2. Is it always true that infant industries need or should be protected? Is any gov. policy really needed? 3. If the gov. provides assistance, what assistance is best?

A RGUMENT 2: I NFANT I NDUSTRY A RGUMENT Infant Industry in Practice Import substitution – industrialization was a trade policy adopted by many low and middle income countries before the 1980s. Policy aimed to encourage domestic industries by limiting competing imports 1. The principle justification was/is the infant industry argument 2. Goal was economic development 3. How did countries pay for this? 4. Did it work? No…

A RGUMENT 3: D YING I NDUSTRY A RGUMENT The protectionist argument is identical to the other arguments discussed, just a different setting. Why do we worry about with a dying industry? Loss of production and jobs.

A RGUMENT 4: D EVELOPING COUNTRY PUBLIC REVENUE ARGUMENT Developing country argument: a poor developing country imposes tariffs to earn gov. revenue to pay for public goods.

A RGUMENT 5: I NCOME R EDISTRIBUTION Income Redistribution What did Stolper-Samuelson Theory say? Argument: It is irrelevant that free trade increases national income if you are an unskilled worker in a developed country! Is there merit to the argument that trade hurts unskilled workers in developed countries? From US perspective, is there some merit to the argument that trade hurts low skilled workers? What are the solutions to the income distribution?

O THER ARGUMENTS FOR PROTECTION 6. National Pride 7. National Defense 8. Closing a Trade Deficit