Protectionism has been a rallying cry for many disaffected voters this year. Insurgent campaigns on both the right and the left have been calling for higher import duties and economic incentives for domestic industry. Meanwhile, across the Atlantic, protectionist sentiment was a key driver in the campaign for the United Kingdom to leave the European Union.
Protectionism–the idea that you can improve the economy by taxing foreign imports and subsidizing domestic industry–is a comforting notion. We all want a vibrant economy with thriving local industry. But as is often the case with economic policy, regulatory intervention in the form of tariffs and subsidies can be ineffective or even counterproductive.
Capitalism rests on a simple premise: mutually beneficial exchanges make us all richer. When foreign goods show up at our ports, they’re not accompanied by warships forcing us to take them at gunpoint. We buy imported goods because we perceive a benefit in doing so. If we can buy a $100 foreign-made widget instead of a $200 widget manufactured locally, that leaves us $100 richer.
Protectionists argue that buying these cheap imported goods is short-sighted and self-destructive because it harms domestic industries. To be sure there are winners and losers in this scenario, and cheap foreign competition will hurt domestic widget makers. If we take an even bigger view, though, it becomes difficult to see how it benefits us to prop up inefficient industries at the expense of everyone else. Raising the cost of importing widgets helps out widget manufacturers, but it hurts consumers who have to pay more to buy widgets. Worse, it hurts industries that use a lot of widgets. And worst of all, it actually hurts all U.S. export industries.
Tariffs hurt our exports in two ways: first, and most obviously, other countries are not going to be happy with us, and will eagerly retaliate by levying their own tariffs against us. But beyond that, money that gets sent overseas to pay for imports is not “lost”, as enriching other countries helps create markets for our own exports. We would not be able to sell as many exports to other countries if we weren’t buying their imports as well. Again, commerce makes us both richer.
More subtly, subsidizing industries creates economic inefficiencies through distortion. If the domestic widget industry is failing, ultimately the solution is not to pump money into widget manufacturers to sustain an unsuccessful industry, it’s to reinvest those resources into other industries (such as ones that benefit from having access to cheap foreign widgets.)
To be clear, we realize that there is a lot of real hardship involved in this process. This is true of any economic progress: the horse-drawn carriage industry was devastated by the invention of the automobile, for example, but the solution was not to tax automobiles to save carriage makers’ jobs. Adapting to economic changes may be painful, but the pain is eased by having a vibrant, efficient economy—which we believe is ultimately incompatible with protectionist trade policies.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.