Protectionist Jan Feb1988

7/31/2019 Protectionist Jan Feb1988

1/18

FEDERAL RESERVE BANK OF ST. LOUtS JANUARY/FEBRUARY 1988

Protectionist Trade Policies: A

Survey ofTheory, Evidence andRationale

Cletus C. Coughlin, K.Alec Chrystal andGeoffrey E. Wood

ROTECTIONIST pm-essures have been mounting

won-idwide during the 1980s. These pn-essmmres are due

to various economic problems incltnding the lam-ge and

persistent balance of tnade deficits in the UnitedStates; the hard times expenienced by seven-al indus-

tries; and tire show growth of many foreign countn-ies.

Pn-oponents of protectionist trade policies amgue that

international trade has contributed substantially to

these problems and that protectionist tmade policies

will head to improved nesults. Professional economists

in the United States, however-, generally agree that

tmade restn-ictions such as tariffs and quotas substan-

tially reduce a nations economic well~being.2

This article surveys the theory, evidence and na-

tionale concen-ning protectionist trade policies. The

first section illustrates the gains from fm-ce tn-ade usingthe concept ofcompan-ative advantage. Recent demel-

opments in international trade theorm that emphasize

other reasons for- gains from trade are also reviewed.

The theoretical discussion is followed hiy an exami-

nation of recent empirical studies that demonstm-ate

the large costs of protectionist trade policies. Then,

the rationale for restricting trade is presented. The

concluding section summarizes the papers main

arguments.

CletusC. Coughlin is a senior economist attheFederal Reserve Bank

ofSt Louis. K. Alec Chnystal is theNational WestminsterBankProfes-sor of Personal Finance at City University, London. Geoffrey E Woodisa professor of economics at City University, London. This article waswritten while Chrystal was a professor of economics attheUniversity ofSheffield, Sheffield, England. ThomasA. Pollmann provided researchassistance.

See Page (1987) for a detailed examination of trade protectionismsince 1974.

2 This consensus was found in a survey published in the late 1970s(Keart et at., 1979). Recent developments in international tradetheory, which can be used to justify governmental intervention intrade policy, have not altered the consensus (Krugman, 1987).

THE GAINS FRONt FREE TRADE

The most famous demonstration of the gains fn-om

tnade appear-ed in 1817 in David Ricardos PrinciplesofPolitical Economy and Ta,vation. We use his example

inmolming tn-ade between England and Portugal to dem

onstnate how both countries can gain fn-om tnade.. The

two countnies pn-oduce the same two goods, wine and

cloth, and the only pn-oduction costs ane labor- costs.

The figures below list the amount of lahior leg..

won-ker-daysi requin-ed in each country to pn-oduce one

bottle (ifwnne on-one hiolt of cloth.

England

Portugal

Wine

3

1

Cloth

Since both goods ar-c tiione costly to produce in En-

gland than in Por-tugal, England is ahisolmrtely less

efficient at producinig both goods than its prospective

trading partner. Portugal has an absolute advantage in

hioth wine and cloth. At fin-st glance, this appear-s to

r-ule. (iut mutual gains fn-om trade; howeme,n-, as we

demonstrate below, absolute advantage is irrelevant in

discerniing whether tnade can hienefit both countn-ies.

The natio of the pr-oductioni costs fon the two goods

is diffenent in the two countries. hn England. a bottle (if

wine will exchange for 3/7 ofa bolt (ifcloth becamnse the

labor content of the wine is 3/7 of that for (:10th. In

Portmtgal, a bottle ofwinie ivill exchanige for 1/5 ofa boltof cloth. Thus, wine is relatively cheaper in Portugal

than in Englanid and, conmersels, cirith is relativehs

cheaper in England than in Portmngal. the example

indicates that Pom-tugal has a compam-atime admamitage in

mvimie pr-oduction and England has a comiiparative ad-

vantage in cloth pnocluction.

The different relative pm-ices provide the basis fom


2/18

FEDERAL RESERVE SANK OF ST. LOUIS JANUARVIFEBRUARY lies

both countries to gain fn-omn iriternational trade. The

gains arise from both exchange and specialization.

The gains from exchangecan be highlighted in the

following manner. Ifa Portn.mguese wine producer sells

five bottles of wine at home, he receives one bolt of

cloth. Ifhe trades in England, he receives more than

two bolts ofcloth. Hence, he can gain by expon-ting his

mvine to England. English cloth-pn-oducen-s are willing

to trade in Portugal; for emeny 3/7 ofa bolt of cloth the

sell there, they get just (iven twri bottles of wine. The

English gain from exporting cloth to land imponting

wine fn-omi Por-tugal, and the Portuguese gain from

expon-tingwine to land importing cloth fromi England.

Each country gains by expon-tinig the good in which it

has a compan-ative advantage and by impon-ting the

good in which it has a compam-ative disadmantage.

Gains fn-om specialization can be denionstrated in

the follomming manner. tnitially, eachi country is pto-ducing some ofboth goods. Suppose that, as a n-esutt of

tr-ade, 21 units of labor are shifted fnom mvine to cloth

pnoduction in England, while, in Portugal, 10 units of

labor- are shifted from cloth to wine production. lhis

reallocation oflabor- does not altet- the total amount of

labor used in the two countn-ies; howeven-, it causes the

pn-oduction changes listed below.

Bottles of Wine Bolts of Cloth

7 3

The shift of 21 rnnits of labor to the English cloth

industr raises cloth production by three bolts, while

reducing wine production by seven biotttes. In Pomtrn-

gal, the shift (if 10 units of labor from cloth to wine

raises winie pmoduction liv 10 bottles, while n-educing

cloth pm-oduction by two liolts. This reallocation nif

labor imicreases the total pnoduction of Iiothi goods

wine by thn-ee bottles and cloth hiy one bolt. This

increased output will be shared Iiy the two countries.

Thus, the consumption of liothi goods and the wealth

of both countries ane incn-eased by the specializa

tion bm-ought about by trade based on compar-ative

advantage.

TRADE THEORY SINCE HICARDO

Since 1817, numerous analyses have gener-ated in-

sights concerning the gains from tmade, lhiey chiefly

examine the consequences rif relaxing the assump-

tions used in the pn-eceding example. For example,

labor was the only resource used to produce the two

goods in the example above; yet, labor is really only

one of many resources used to prodmnce goods. The

example also assumed that the costs of producing

additional units of the goods ar-c constant. For exam-

ple, in England, three units of labor an-c used to pro-

duce one bottle ofwine regardless of the level ofwine

pn-oduction. In reality, unit production costs could

either increase or- decrease as more is produced. A

thim-d assumption was that the goods an-c produced in

per-fectlv competitive mat-kets. tn other- won-ds, an indi-

vidual firm has no effect on the price ofthe good that it

pnoduces. Some industries, however-, are dominated

by a small numhier of firms, each of which can affect

the manket pr-ice ofthe good iw altering its production

decision. Sonic of these extensions at-c discnnssed in

the appendix.

These theoretical developnients genem-atly have

strengthened the case for an open rn-ading system.

They suggest thn-ee soun-ces of gains fi-om trade. First,

as the market potentially served by firms expands

from a national to a world market, then-c are gains

associated with declining per unit pnoduction costs. A

second sour-ce of gains results fn-om the reduction in

the monopoly power- of domestic firms. Domestic

firms, facing more pressure from fon-eign competitors,

are forced to produce the (iutput demanded by con-

sumers at the lowest possible costlhird is the gain to

consumers from increased product variety and lomver

prices. Generally speaking, the gains fiomn tm-ade r-esult

from the increase in competitive pressures as the

domestic economy becomes less insulated from the

world economy.

The gains fmoni free trade can also he illustrated

gt-aphicallv. The shaded insert on pages 14 and 15

examines the gains fiom ttade in pemfectly competitime

markets using supply and demand analysis. The in-

sert also analyzes the effects of tn-ade n-estn-ictions, a

topic that we discuss below.

COSTS OF TRADE PROTECTIONISM

Protectionist trade policies can take numenous

forms, some of which are discussed in the shaded

insert on pages 16 amid 17. All forriis of lirotectioni an-e

A profit-maximizing firm produces its output at minimum cost. Whenfirms are insulated from competition, costs are not necessarily beingminimized. This situation, which is catted X-etficiency, has beenstressed by Leibenstein (1980). The increase in competitive pres-sures due to international trade reduces the probability that costsare not minimized.

England

Portugal 10

Net 3

9

1


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A Supply and Demand Analysis of the Gains from FreeTrade and the Effects of a rliarjff

A starndaid flinstr-aliori tnt liii gains 1mm tree tiad, puikm liii nragrrilLrdr- mt tlrtse grin, and

hat], arid tie ctin-ls ol il till ill is pn~crnturIhrIm~- Io~s-s trsing thr- cm mt-ph ut roiIsmirniii- .uiti jil ii

I lu ,rl,i\ sk issl_rnhis Irr-tr-I~m m-onrpctiti p nw- uiu,-i-i smnr-1

nltjs air inn seen iii tir4lri-i I - C mrrp,LrrrIt-is

Lets tlniorrghoni. gain i tno na s_ Iniliaiim ,tniistrnnitr-s i;irrclras-tI

ft. al a purr 11cr trnil ii I - flitir Ire tiatlr. Ihm-~- , inmrriliast V. at till- inner 11cc ill-n minnrt cr1 P I iii,,

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tin tigtri-i I tit- rum-s S anti I) an tint L S. sirinpi\ atidrtioni tIn irn~,r 1niict irrnlirt-ts ,nrisirnltrs rn

unit] rienirunti rmr\ts Irir a lnptnliiehrral wind. lit-i- ii i-ri-_tsr Lli,ii- i)triilizisis h,rnn 0 tin iF -- liii, gain

ultirrsprluin at B irsmrlls In the rritrrirlni-itrrir maltips ~5

n-pi r,rriirci Irm I ht Ir iarngic- tIC I -l he total g;tir I to

tot1

rri~- arrd qmrarrlit\ ii I arid 0 \~strminuti- rininsLnrnrer-s is I IC i_ in nsirng the- itrnm-r case

etc-c] Stai,-s has a ronlpar-.itn ( dnsaLi\ uoNr4e IcItu-i s to rrpi-t-srrit tiers a - Ii - r .\inalogoList\

pitidirtioni cii this gnu,] lii, Pr icr- n ill lit ion cr- piteltrici s lo,c un,- to the loner- ruin- tIr,-m ri-theabroad than iii tie trnit,-tl stains i_it [Iris tinner br Uteri- nmitirmrt. . - anti kr,- to ihprrrnrrnti-artimnri nil

~~m,niciPri I- he P rind asurne th,t t s prrtIisr-s ]~nrtitcIrun li-tin, to S - I he tori1 toss tir

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iiiiri-seintrmI iiv lint Iic,ir,,rrit,i t~mnrtcistr1

nptm tmrrmc, tic- inctimri as a nhrln ~zrinis inr,,nusp lint- curl

S It onpalionslurti-tp trade this lunerncnrtl ~ snrnwr ialris mt a - In emcee,l tin innnmlmrc-

has tnuu ittirts. I insI I s (trnstrriwrs mmiii inlrrvasp misses otah~ in -- c I inisanahsisranalsuIni-mrened

tin,-ir- c-runi.,Iirin1

nlicnul 1,1 I nrrci. t S. nnindnrm9s irsirin4agunti ihat inc t nnIt,i5tttr,c\jflnri~ in ritin,-,-

mmiii contract their pi-(nultrm-tiorr In S~ iii, (mimss oh nnri-cis tire t rlited States mmiii inam, a nunirpriilIi\n

S muniistrnipliuri n.Imen-prciciLwnoin is I _S nnrrliasrs atlurnitag,- hr itt innrulrrrlnn cr1 a gtnrcl I or Liii

tiom tor-,-i~niprodtrr-er-s hat k. rnrports- export ~ocrd. the change tin lit, track- mmiii miLri-

lint Ion cc ill_u_i- ~innmillanernu~Imhem-IrIs t roii urmrtirct-r gains liar i-u-c-mci rnrin,imnncr losses.

srrrritrs ain,i hunts I _S iirintlircnr~ a fact tirat

civil es tin,- nec-cot cturitiinu-rsral mli,c-tesruins in! I 5.

Ihe E/Jietsoju lari/J

tiu maLi lie ariatmsisoi proteu-tiorli~~Itrade rulirm

Fiq.-ro rs strrrghttmrrmmmrti is ncnsiinii tiii- jrrmji~t,-t nI

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rated ri lrgiri-i 2. Gim,ni ihc In-,-,- Lr-,icic- mmmuntd ~r~~- cr1

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B t~ i lu p1-itt- in tire I rued Slates mrnmm r-u-i-c-ck prirm-

Pu in tInt mmrutd irm the arriorunt mt tin,- unit P_U

p a bHN.,c s -F w i he higher I ~ p ri 1 Jrtists t-miinsLrrnir it

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4/18

FEDERAL RESERVE SANK OF ST. LOUIS JANUARYIFEBRUARY ION

not-slit- intudtnm tnri priitertc-mi at tint n\1

nuiist~ru

- titnnlnmslit ,-lniIsmlnie-s

-nyu. 4p (Jilt- c-nnri

1iit-atirjmn sti-nlns minim tarili nemeuiint~ I am

ill rmenurc mmllicIl marl lit- m iemmemi as a gain Rn the

gtu\ en runt-mt t-Cithiis the hrntt P_P tinlirs tlr, tjtnani

tit~ nt ulm1

rumts ~ 1Y t In, il-men,rc is Ninal tin aica

t 1(11 tnm I.

C)m,-r-ahi lint- rnalnrnmn i,)sis ini-e;Imrsc lint ccumnsnrmiltrs

tcr~st-scIti - i- - I - n_&emm-eni the prLruhnm-11-s g;rirls

Al f :n.~m~

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mm nmlslm imi~it ii In

mnili-rm,hith tim immmimllmm liii inrn_ilmnmr nt ninrnnn,stmr- nitntmmi rlmrrnns inn inrniilit him i-~rmni1

nir it c1

nirrtn, iii

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tim-iris mr srnmniiiiiimm mnsini,l Ilir- ,ic-n-I-~s ri

rhmnri-n Iii liii- chrnmin,-stnr nmnriL,-t

Then-c have lieeni numerous studies of the costs of

protectionism. We begin by examining three recent

studies of pm-otectioriism in the United States, then

The specific goal of protectionist tn-ade policies is to proceed to studies examining developed and finally,

expand domestic pn-oductioni in the protected indus developing countries.

ti-ies, benefiting the owners, workers and suppliers of

r-esour-ces to the protected industry. The govennment CostsqfProtectionism in theCratedimposing pr-otectioniist trade policies may also benefit, Statesfor example, in the form of taniff revenue.

- - - . Recent studies by Tan and Morkre 119841, t-lickok1 he expansiomi ofdoniestic pn-odnnctnon mni protected - - -

- - - . - - - 1985) and Huliuauer et al. 11986) esttmated the costs ofnndusti its is not costless it n quit is tddntnonal

pi otcctnotusni in tin Unitc d St ntis I lit s studn s uscsources from other itidustrres. Consequently, output - . - - - -.- - . - - , , . different estnmatnoni procedunes, examine diffem-entiii other domestic industm-ies is i-educed. these nndus - .. - -

- - - . . protectnonnst policies arid cover dnfferent tnriie periods.trres also might be made less competrtnve hecanise ot - -

Norn thiclcss thcv ptovnde consnstenit mesultshigher pt-ices for imported inputs. Since protectionist

tr-ade policies frequently incr-ease the price of the Tair and Mork,-e 11984) estimate annual costs to the

protected good, domestic consumers are liar-med. U.S. economy of812.7 billion 1983 dollars) from all tan

lhey lose in two ways. I-inst. their consuniption of the ifs and from quotas on automobiles, textiles, steel and

pr-otected good is n-educed because of the, associated sugar-. Their cost estinuate is a net measur-e in which

rise in its price. Second, they consume less of other the losses ofconsumers are offset partially by the gainsgoods, as their output declines and pm-ices r-ise. of domestic producers and the U.S. government.

The preceding discussion highlights the domestic Estimates liv thickok 1985) indicate that tr-ade rt~

winniers and losers due to pnotectionist trade policies. strictions on only three goods clothing, sugam-, and

Domestic produrcers of the liiotected good and the automobiles caused increased consumer expenidi

government iftariffs an-c imposed) gain; domestic con- tunes of $14 billion in 1984. I-Iickokalso shows that low

somers and otliei cloniestic pnoducem-s lose. Fon-eigni income families am-c affected mom-c than highincome

interests an-c also affected by trade resti-ictions. The fnnilies. The import restmaints on clothing, sugar and

pnotection of doniestic pn-oducers will harm some automobiles are calculated to be equivalent to a 23

foreigni pmoducers; oddly emiourgbi, other foreign pmt percent income tax sun-charge that is, an additional


5/18

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6/18

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY/FEBRUARY ION

sltim-imonis miram be lint imni1

nm,sitrtnni cit salt-tm on-1

iotltn i-:_1rIIum~tccj,nrolstmoni st(tmn,l:tn-cls that mu-n-c mini I~ im,mislm bt-imng met

hm tomuizmn m;mms _th ot 11mm alflimm- ri-late dir-entim tin tilt iimimm ol- gomnci. \ hmmai class ml n-,-stm-ic-tiomis mmmnrks b~nt-strict . imng ai-,-i-ss hr tb~ inr-emgri rmionnn n tqinin-tci to imnim

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N to stibsmdm/e cloinuestir jnmumthmeen-s.sulnsuhes mmnam ate artmht-nailm Iomm \s a mcstnil tcnnvigmt goods mmmnmmi~ilie Iortmsntl unron ami imidItNin in M~~~mr mtpon the ~ m-x

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tic I _s_ sinipimumhhng inndLmstmm - _~mn esanmn1

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latter us tine iimnamieial _msmstinnreto inn lease e\jn~nnIs tit- rum tint - I its nmmm It isscnmcl cionrmmstic cnnnmnem

nomi,l,-ci in lint t ~, I-.minnmmtimniptnmt ilanik thm-nmtngh imnt-mt-aa-s the donirtstir nimomnt~msunk amid evmmnttrailm

nlnnucI loans imiamr ~irtarautues amid imnstnn amine. annit m-amnsm-s imuiialimnnn tnmllnitiomnaum iioIntits am-p mini non

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_\ni innllioi-iamni clill,n-,rin-t- lu-tmmet-tn strlisi,iies annni Iii, jrmstitimatitimr is tin(tt pm-~mc-mininng limimnun, m-esitipmntst;mniti, imnm mm i-s tint- u-im mnlmnt- imnriilit-ationms rim gt,mmmmn tm-nnnim inimtstinis4 tr\ cm Sta, immtmietils ,Iinnnit,sti, gu-cmmm tin

miemnt_ tin, lmmn-nmner mmnttnlmes be gomei-minimennt inn in~.\ (us ml lead, to greater tttimmn,stn, nvtl imImestniitnlt tmi

imnn_r nitnt nim,nmn,m mmii, nm-nt, tam-ills gentnate nlm-otnn,- tom nm-alitm ml ,rtmld tim emanli_m tIne opptnsitu Restr imtinmglint- grim em-nunri-unt -t me t-tt,-m-t mnnm ,ionmnestir rniidLnntiomi an-c css to tnmnt-ign ass,-ts nnrav raise tim, mamiznnee anti;nniti mmeliart imnrmmnm tm tarn be tInt- saline unmien , tmtn, i t nnmmem lint- nttnnm n It, dJmmilc9s iii ,tmnmiiestit mm tnltln. tnn

cImt-s as innnmier tantts amid tirmotas In all menses tin, tin, simmnmt 11111 ii alsni rmn(t\ nppnur erie lu dnmmnntsUr

mm m,tnmI,ti inicb_tEmm is hi-imig strinsidi-,c-iI hm iii- rent ni esnhanngm rzntt tund him-mtin - wiLt ticnrnmn-sth- pmmn~timtpt,nmimjrnnm cttntmns ins ,trmnm

1),Iitimi

tax added to the normal income tax) for families with

incomes less than $10,000 in 1984 and a 3 percent

income tax sin-charge fom families with incomes cx-

ceeding $60,000.

Hufbauer et al. 11986) examined 31 cases in which

trade volumes exceeded $100 million arid the United

States imposed protectionist trade restrictions.4

They

generated estimates of the welfare consequences for

each major- group afected see table 1). The figures in

the table indicate that annual consumer losses exceed$100 million in all hut six of the cases. The largest

losses, $27 billion pen- year-, come fnom protecting the

textiles and apparel industry. There also ane lan-ge

~Whilethere were cases in which the industry adjusted to its newcompetitive position and the protection was terminated, these caseswere more the exception than the rule. In far more cases, protection-isi policies were maintained indefinitely or removed because offavorable demand changes.

consumet losses associated with protection in car-hon

steel $6.8 billion), automobiles $5.8 billion) and dairy

products $5.5 billion).

The purpose of pr-otectionism is to IJmotect jobs in

specific industries. A useful approach to gain somepenspective on consumer- losses is to express these

losses on a per-job-saved basis. In 18 of the 31 cases,

the cost per-job-saved is $100,000 or more pen-year-; the

consumer losses per-job-saved in benzenoid chemni-

cais, carbon steel )two separate periodsL specialtysteel, and bolts, nuts and screws exceeded $500,000

per year.

Table I also neveals that domestic producers were

the primary beneficiaries of protectionist policies;

however, there are some noteworthy cases where fom~

eign producers realized relatively lam-ge gains. For the

US-Japanese voluntary export agn-eenient in automo-

biles, foreign producers gained 38 percent of what

domestic consumers lost, while a similar computation


7/18

FECfRAL RESERVE BANK OF sr. LOWS JANUARY/FEBRUARY lOSS

Table 1

Distribution of Costs and Benefits from Special Protection

Producer- consumer Losses Gains eltare costs of Restraints

Gamn to Tariff EfficiencyTotals Per job Totals foreigners revenue loss

(million saved (million (million (million (mmIlion

case dollars) (dollars) dollars) dollars) dollars) dollars)

Murutaciun mgSt-OK r-nanaoclmnra S 500 5 ~00 000 S KTh n--c S 0 5 29Benzpr-ond clrernca~ 2 650 fl? 1 2 2h0 ceo 252 14

:n-tnt:.rl

200 2Lno 000 1-30 meg 54 13Rr,Lbe- tr,otwoa. 230 30 000 90 rreg 139 33sc-am--; am:nrjen 9u 47.500 25 --cg 69 6erarm;clc-s 116 135000 oP ~ 55 11Orarnge u-ce 525 240 oco 39O neq 29 150Gannenlnna 9~ 7~.00Q 74 5 10 4laxnlr-s ond apoae Phase; 9.400 22 njOO 6700 ico 1 56 lOUlexlnles ond appasl Phase ml 20 000 37000 8000 350 243 3 100Texmnies and Hpnarci Phase UI oT 000 42000 22000 1 800 2.535 4850Gareo-~steel- Pt-aspi 1.970 240.000 1 330 330 290 50

carbon steel rb-,~etn 4 30 62000(3 2 /70 940 a56 120Carbon steel Phase lit 6 $00 750 000 3 800 2.000 560 33crBail 004nnnus 43 90000 21 neq 18 -cc

Snou only slee- 520 1 000 Xc cc so 32 30Nr-nwbner trMnwea 700 55 000 250 220 lbColor leiev-snom-s 420 420 000 190 140 77 7~B aoo; 55 93.000 n4 nt-a 32 3Bolts -Us arge svews ~10 550 000 50 nanPetared imnsnrcorns 3S 11/000 reg /5 r) 8Autrynob-les 5.800 105 000 2.1-00 2200 /90 200

MolomnyLe~ 04 50 000 67 meg 1 1 7

St- rv.cosMdr tnme nrouslnes 3000 270 000 2 njOO req 10 1 000

Agr.cul~reard fnsbemnesSugar 930 60 000 550 410 -, 130

690-acreDavy pmoduris 5 500 220 000 5 000 S0 3-4 I 370

800 ~ow

Pcanuis 1/0 000 dcrP 170 nag 9 14Meat - 800 150000 1 600 135 44

725 t-paoFnsh 560 21-300 200 170 1// 5

M-nnrgPelroneum 6 900 160 000 4 800 2 000 /0 3 000Leacljr-Lzrnc 67 30000 41- 4 I:

Neo mneg: gnoieUnless oherwnse sr-pc -fpc. t.ommro: ire oar wor-0rEsI marco eumncs colk.clecn on sn-n) mepanns on-fnrmeo -abroaci-i Ions case becaLse of Ihe way tnt: ouctas were alnoratoni the ganrs to iporir ms arc- Led ~Urjonnestnc metnnos ratit-r tar tnmengrexporters

SOURcE Irude Protpn Inorl nt-ne Umnn:ed blaIcs 31 Case Stuc-es


8/18

FEDERAL RESERVE BANK OF ST. LOWS JANUARY/FEBRUARY IS

for the latest phase of protection for carbon steel was

29 percent.

Finally, table 1 indicates that the efficiency losses

ane small in compan-ison to the total losses borne by

consumers. These efficiency losses, which are defined

precisely and illusu-ated in the fir-st shaded insert,

result fr-on) the excess domestic production and the

reduction in consumption caused lw pr-otectnonisttrade policies. En laige cases such as textiles and

apparel, petroleum, dairy pm-oducts and the maritime

industries, these losses equal or exceed $1 billion. It is

likely that these estimates understate the actual costs

because they do not capture the secondary effects that

occur as pn-oduction and consumption changes in one

industry affect other industries.~ In addition, restric-

tive trade policies generate additional costs because of

hun-eaucn-atic enforcement costs and efforts by the

pi-ivate sector to influence these policies fon- their own

gain as well as simply comply with administrative

r-egulations.

Costs o/Protectionism Throughout the

World

In 1982, the Organization for Economic Co

opet-ation and Development OECD) began a pn-oject to

analyze the costs and benefits of protectionist policies

in manufacturing in OECD countnes. The DEC131983) highlighted a numbei- ofways that protectionist

policies have generated costs far in excess of benefits.

Since protectionist policies increase pr-ices, the i-epon-t

concludes that the attainment of sustained non-

inflationary growth is hindered by such priceincreasing effects. Moreovei-, economic growth is po

tentiallv reduced ifthe uncertainty created by varying

tnace policies depnesses investment.

Wood and Mudd 1978), and many others, have

shown that impoi-ts do not cause higher unemploy-

ment. Conversely, the OECD study stresses the fact

that a r-eduction in imports via trade restr-ictions does

not cause gn-eater employment. A reduction in the

value of imports i-esults in a similar reduction in the

5Recent estimates of the costs of protectionist policies using general

equilibrium models suggest thai the secondary effects, to the limitedextent they are measurable, are substantial. For example, Grais, deMelo and Urata (1986) estimate that the elimination of quotas inTurkey in 1978 would have caused a 5.4 percent rise in grossdomestic product, while Clarete and Whalley (1985) estimate thatthe elimination of tariffs, quotas and export taxes in the Philippines in1978 would have caused a 5.2 percent rise in gross nationalproduct.

value of exports. One r-ationale for this finding is that a

reduction in the pun-chases of foreign goods reduces

foreign incomes and, in turn, causes reduced foreign

purchases of domestic goods.

While the reduction in impot-ts increases employ-

mnent in industries that produce pn-oducts similar to

the previously imported goods, the reduction in cx-

por-ts decreases employment in the expor-t industries.In other words, while some jobs are saved, other-s ar-c

lost; however-, this economic n-ealitv may not be obvi-

ous to businessmen, labon- union leaders, politicians

and others. Luttrell 1978) has stressed that the jobs

saved by piotectionist legislation are more readily

obsened than the jobs lost due to protectionist legis-

lation. In other words, the jobs that are protected in,

say, the textiles industry by U.S. import restrictions on

foreign textiles are more readily apparent land publi-

cized) than the jobs in agriculture and high technol-

ogy industries that do riot materialize because of the

impoi-t restrictions. These employment effects will net

to appi-oximately zei-oY

the OECt) study also stresses that developing coun-

ti-ies need exports to offset their debts. Thus, pr-otec-

tionist tn-ade policies by developed countries affect not

only the economic activity of the developing coun

tries, but the stability of the intet-natiorial financial

system as debtor nations find it increasingly difficult

to service their debts.

Not only does a free trade policy by developed

countries benefit developing countries, hut a free

trade policy by developing countries benefits develop-

ing countries. A recent World Bank study (1987) of41

developing countr-ies compar-ed the perion-mance of

countries following a fr-ce tr-ade policy with countries

following a restricted trade policy. Table 2 lists the

eRecent evidence shows that protectionist legislation actually mayreduce employment. Denzau (1987) estimated that 35,600 manu-facturing jobs were lost as a result of the September 1984 voluntaryexport restraints that limited the level of U.S. steel imports. Despitean increased employment for producers of steel (14000) and pro-ducers of inputs for steel producers (2,800), these increases weremore than offset by the 52,400 job losses by steel-using firms.These losses are due to the higher steel prices that cause steel-using firms to be less competitive in export markets and subjectthem to more foreign competition in the U.S. market.

The World Bank study divides trade strategies into two groups:outward oriented and inward oriented. An outward-oriented strat-egy, which we call a free trade policy, is one in which trade andindustrial policies do not discriminate between production for thedomestic market and exports, nor between purchases of domesticand foreign goods. An inward-oriented strategy, which we call arestricted trade policy, is one in which trade and industrial policiesare biased toward production for the domestic market relative to theexport market.


9/18

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY/FEBRUARY 1988

Table 2

Annual Average Growth of Per Capita Real Gross National ProductFree Trade Restricted Trade

Period Strongly Moderately Moderately Strongly

1963-73 S;ngapore 9 0-~ Braznl 55% Ynngoslav-a 49% Turkey a 5--.Soutn Korea 7 1 lsrae- 5.4 Mexnco 43 Dornnr-cun Pc-publnc 34Hong Kong 6 0 Tha-and 4 9 Nngena 4 2 Burur-dn 3 2

l-ndonesna 4 6 Turrs:a 4 0 Arger-t na 3costa Rnca 3 9 Kenya 3 9 Pakrstar 3Malays.a 3 8 Phnlnppnnes 22 Tanzanna 2 7Ivory coast 3 5 Bolnvna 2 0 Sm Lanka 2 3co-orbna 33 Honduas 1 9 Erhnoona 1 9Guaremaa 27 E Sa-vador 1 4 Chnle 1 7~amerooi 01 Madagascar 1 1 Peru i

N-caraoua 1 I Uruguay l 5Senegal 0 6 7amb-a 1 2

Inc-na 1.1

Ghana 0Bang:aoesh 4Sudan 1.9

197355 Snngapore 65 Malaysn~ 4 1 Cameroon 56 Banglacesh 20HongKong 63 Tnanlano SO lndorc-sna 40 mona 20South Korea 54 Tunrsna 29 Sn Lanka 33 Buruno 1 2

Braz-- 1 ~ Pa~nsnan 31 Domnnncan Repub.rc 05Turkey 1 4 Yugoslavia 2 7 Efhnoona 0 4Isree. 04 cola-tb-a 1 8 Sudan 0 4Uruguay 0.4 Mexnco 1 3 Peru 1chnne 0.1 Phnlnpp-nes 1 1 Tan?anna 6

Kcnya 0 3 Argenrnna 2 0Honduras 0 I Zamh,a 2 3Senegan 0 5 Nnqerna 2 5

costa Rca 1 0 Bonnvna 31Guatemala 1 0 Ghana 3 2Ivory Coast 1 2 Madagascar 3 4En Savaoo 35Nncaragua 39

SOURCE World Doveroomenn Reporl 1987 and TheEconomist l1987l

;rnirLnai nu-nar4n gn-uniii ni fl ii pin r.npil;r gnnnss Hr innustninenil ~einrrured mmmi- aiidiimrnn 1

Innun_nI pniniinirl trr-emr-k tnt line II rniinritnir, tim 19mM 7% rnnnrnti ni-s luIInfl\nnlg a liii- 1mar11 pn1

i thur .1 ri

nd 97:; M_5 I hrrsr rrrtnmitniis hat did nut bias indi_ns stnin-ni-d path- pnnIni-~ Ike n1.nsunn is that a

tii;tijinimdnmnlionilo~~rndrhrdrnnni-stnnmnnarknlim\ mum- nilinlniiinnn-mit nlinn~snr~mnrnlInn 11r\\ in, is mmI hn~lnl~

mnslri-lnrnnms r~nn~\ri t_n,lri natr-~tIn~nnn lutist- rlnnl nun \~rlineniInss ~~lniin a rvstnirlnl traIt- n-nn~innnninn,ennl tinsfinn i-\mnnnpli- lInt n.m-n-ar_re amninnn.nl ginn~~tImn-atm iii n-n-rI linris n-r-nmnmnnnmnjr inremniiw

pt-n r-.r1

nil I inn nun,- Inn- lUh%-7% ~as U.U penlenni innnm-rnnnr)nunin--, sin-nmnnj.l~ inn triter

1Inn rye Marie rrnrl

in lInt- et-n,nnrrnmies stnnninr_I~ nmnni-mnierl mm n_n

sIr jeir-mI p adi- I inn 1)7% 55 lines. r nfl tin n nit-s flint- i 9

iir run 0 I ni-er- nil ni-s1

nei-tn~n-Is

Inn- stnnnI~ )nn)n(mni-, Inn nrIrnitii~ Ii.- Iin.nlrr)nlmrmniimnnir- It j)nmntnrIirnnnn~.nnnis,mnnnnstl~.~~in~i.1

mnnrli-n-Iir,niisnnn sin

nr,,mnni mm liii LrruinrnI tinnninmnr_r \ Un\mnn nrnnrntnmnt ni nnn~\1

nin\nsnn~ I !ni~snrtnnnln n-n~nn~~~tint rnn.nlnnn nnr4nnnmninni.


10/18

FEDERAL RESERVE BANK OF Si. LOUIS JAIIUARYIPEBRUARY INS

for restricting tiade and provides explanations for the

existence ofprotectionist trade policies.

National he/ease

The national defense argument says that impor-t

barrier-s are necessary to ensure the capacity to pro-

duce cr-ucial goods in a national emergency. While thisar-gument is especially appealing for weapons dun-ing

a war, then-c will likely be demands from other indus-

tn-ies that deem themselves essential. For- example, the

footwear industry will demand protection because

militam personnel need combat boots.

The national defense ar-gument ignores the possibil-

ity of purchases from friendly countries dur-ing the

emer-gency. The possibilities of storage and depletion

r-aise additional doubts about the general applicability

of the aigument. If crucial goods can be stored, for

example, the least costly way to prepare for an erner-

gency might be to buy the goods from foreigners at the

low world pr-ice befone an emer-gency and store them.

Ifthe crucial goods ar-c depletable miner-al resour-ces,

such as oil, then the restriction ofoil imports befon-e an

erner-gency will cause a more rapid depletion of do-

mestic r-eserves. Once again, stockpiling might be a far

less costly alternative.

Income Redistribution

Since pr-otectionist tr-ade policies affect the distribu-

tion of income, a trade restriction might be defended

on the grounds that it fayors some disadvantaged

group. It is unlikely, however, that trade policy is thebest tool for dealing with the perceived evils ofincome

inequality, because ofits bluntness and adverse effects

on the efficient allocation of resources. Attempting to

equalize incomnes directly by tax and transfer pay-

merits is likely less costly than rising trade policy. In

addition, as Hickoks 19851 study indicates, trade re-

strictions on many items increase r-ather than de-

crease income inequality-

Optirnurn Tariff.zirgurnent

The optimum tar-iffargument applies to situations

in which a country has the economic po\\el to alter

won-Id prices. This power exists because the countr

or a group of countries acting in consor-t like the

Organization of Petroleum Exporting Countr-iesl is

such a large producer- or consumer of a good that a

change in its production or- consumption patterns

influences world prices. For- example, by imposing a

tarifL the countny can make tbr-eign goods cheaper.

Since a tariffreduces the demand for foreign goods, if

the tariff-imposing country has some mar-ket power-,

the world price for the good will fall. The tariff-

imposing countr will gain because the pr-ice per unit

ofits imnports will have decreased.

There ar-c a number of obstacles that preclude the

widespread application ofthis ar-gnment. Few couri-

tries possess the necessary market power and, when

they do, only a small number of goods is cover-ed.

Secondly, in a won-Id of shifting supply and demand,

calculating the optimum tan-iff and adjusting the rateto changing situations is difficult. Finally, the possibil-

ity offoreign retaliation to an act of economic warfare

is likely. Such metaliation could leave both countries

won-se off than they would have been in a fm-ce trade

environment -

Balancing the Balance o/Trade

Many conntnies enact prDtectionist tnade policies in

the hope of eliminating a balance of trade deficit on

increasing a balance of tr-ade surplus. The desire to

increase a balance of ti-ade surplus follows from the

mer-cantilist view that larger trade surpluses are bene-

ficial from a national perspective.

This argument is suspect on a numben of grounds.

First, there is nothing inherently undesir-able about a

tr-ade deficit or- desirable about a surplus For exam-

ple, faster economic growth in the United States than

in the rest of the won-Id would tend to cause a trade

deficit. In this case, the trade deficit is a sign of a

healthy economy. Second, protectionist policies that

r-educe irnports will cause exports to decrease by a

comparable amount. Hence, an attempt to increase

exports permanently relative to imports will fail. tt is

doubtful that the trade deficit will be reduced even

tempor-ar-ily because imnpont quantities do not decline

quickly in r-esponse to the higher- impor-t pr-ices and

the revenues offoreign producer-s might r-ise.

If a country such as the United States has no market power, theworld price is fixed. Consequently, the price faced by U.S. con-sumers and producers rises by the full amount of the tariff. In theoptimum tariff case, the price faced by U.S. consumers and pro-ducers rises, but not by the full amount of the tariff. This must be thecase because the world price falls and the amount of the tariff is thedifference between the world price and the U.S. price.

See Chrystal and Wood (1988) earlier in this issue.See Pine (1984).


11/18

FEDERAL RESERVE BANK OF Si. LOUIS JANUARYIFEBRUARY INS

Protection ofJobs Public Choice

The protection of jobs ar-gumenit is closely related to

the balance of trade argument. Sinceareduction in

imports via trade n-estr-ictions will result in a similar

reduction in exports, the over-all employment effects,

as found in the OECD 1985) study and many others,

are negligible. While the overall effects are negligible.

won-kens land r-esour-ce owners) in specific industriesame affected differently.

A domestic industry faced with increased impomts

fr-ore its foreign competition is under pressure to n-e-

duce production and lower- costs. Pn-oductive n-c-

sources mnust mnove fi-om this industry to other domes-

tic industmies. Wor-ker-s must change jobs and, in some

cases, relocate to other cities. Since this change is

forced upon these workers, these won-ken-s hear m-eal

costs that they are likely to resist. A similar statement

can be made about the owner-s of capital in the af-

fected industry.

Workers and other mesoinr-ce owner-s ~villllikely resist

these changes by lobbying for trade r-estr-ictions. Thepr-eviously cited studies on the costs of protectionism

demonstt-ated that tr-ade restrictions entail substantial

neal costs as well. lhese costs likely exceed the adjust-

mnent costs because the adjustment costs ar-c one-time

costs, while the costs of protectionism continue aslong as trade restrictions are maintained.

An obvious question is why politicians supply the

protectionist legislation demanded by workers arid

otlier resource owner-s. A bm-anch of economics called

public choice, which focuses on the interplay between

individual pr-eferences and political outcomes, pro-vides an answer. The public choice liter-atur-e views the

politician as an individual who offer-s voters a bundle

of governmentally supplied goods in order to win

elections. Many argue that politicians gain by pr-ovid

ing protectionist legislation. Even though the national

economic costs exceed the benefits, the politician

faces different costs and benefits.

lhose hat-med by a protectionist trade policy for a

domestic industry, especially household consumen-s,

will incur a small individual cost that is difficult to

identify. For example, a consumer is unlikely to pon-

der how much extra a shirt costs because of protec-

tionist legislation for the textiles and apparel industry.

The role of pressure groups, acting in their economic self-interest,has been stressed by Stigler (1g71) and Peltzman (1976). Forreferences, as well as an example of an international trade studyfocused on the interaction of politicians and interest groups, seeCoughlin (1985).

Even though the aggregate effect is lange, the harm to

each consumen- may be small. this small cost, ofwhich

an individual may not even be awar-e, and the costs of

organizing consumers deter the formationi of a lobby

against the legislation.

On the other hand, worker-s arid other- nesoun-ce

owner-s are vex-v concer-ned about protectionist legisla

tiori for their industry. liieir benefits tend to be largeindividually and easy to identity. Their voting and

campaign contributions assist politicians who sup-

port thein positions and penalize those who do riot.

Thus, politiciarns are likely to respond to their de-

mnands for- pr-otectionist Iegislationiz

In/Cat .Industries

Ehe preceding ar-gunient is couched in terms of

protecting a domestic industry. A slightly different

argument, the so-called infant industry case, is

couched in terms ofpromoting a domestic industry.

Suppose an industry, already established in othercountm-ies, is being established in a specific coinntrv.

The country might riot he able to realize its compar-a

tive advantage in this industry because of the existing

cost and other advantages of foreign fir-nis. Initially,

owner-s ofthe fledgling firm must be willing to suffer

losses until the firm develops its mar-ket and lower-s its

production costs to the level of its fon-eign rivals. Inon-den- to assist this entr-ant, tan-ill pn-otection can be

used to shield the fir-ni fnom some for-eign competition.

After this temnporan~period ofprotection, free trade

should be n-estor-ed; howeven-, the removal of tariff

protection frequently is resisted. As the industry de-velops, its political power- to thwan-t opposing legisla-

tion also increases.

Another- pr-oblenn with the infant industry arguniierit

is that a tariff is not the best way to intervene. A

production subsidy is super-ion- to a tariff if the goal isto expand pn-oduction. A suhsidv will do ibis directly,

while a tariff has the undesin-able side effect ofr-educ

inig consumptioti.

In many cases, intervention might not be appr-opri

ate at all. Ifthe infant industny is a good candidate for

being competitive inter-nationudly, borr-ouing from the

2Special interests benefiting from trade will likely resist the forces forprotectionist legislation. Destler and OdeIl (1987) identify exporters,industrial import users, retailers of imported products, businessesproviding trade-related services, foreign exporters, and foreign gov-ernments as interest groups capable of exerting some anti-protection pressure. Decisions about protectionist legislation resultfrom the interaction of both pro-protection and anti-protectionforces.


12/18

FEDERAL RESERVE BAtIK OF ST. I.OUiS JANUARYIFEBRUART INS

pr-ivate capital markets can finance the expansion.

Investors are willing to ahsor-b losses temporarily ifthe

prospects for- future profits ar-c sufficiently good.

Spillover Effects

The justification for pn-otecting an industry, infant orotherwise, frequently entails a suggestion that the

industry generates spilloven benefits for other in

dustrres ot individuals fon which the industry is not

compensated. Despite patent laws, one common sug-

gestion is that cer-tain industn-ies are not fully compen-

sated for their- r-esear-ch arid development expendi-

tur-es. This argument is frequently clirected toward

technologically progressive industries where some

firms can capture the nesults of other- finns nesearch

and development simply by dismantling a pr-oduct to

see how it works.

The application of this ar-gumnent, however-, enigeti-

den-s a niurnbem of pn-oblems. Spillovens of knowledge

ane diffic,ult to measure. Since spilloven-s am-e not mar-

ket tr-ansactions, they do not leave an obvious tr-ail to

idemitifv their- heneficiar-ies. The lackofniar-ket tr-ansac-

tions also complicates an assessment of the value of

these spillovers. To determine the appr-optiate sub-

sidy, one must be able to place a dollar value on the

spillovers genen-ated by a given reseamch and develop-nient expenditure. Actually, the calculation requires

munch mom-c than the alneady difficult task of recon-

stn-ucting the past. It r-equir-es complex estimates ofthe

spillovens future worth as well. Since resources are

moved fioni other industries to the targeted industry,

the goven-nment must tinder-stand the functioning of

the entire economy.

Finally, then-c are political pr-ohlems. An aggressive

application of this an-gumuent might lead to retaliation

and a mutually destructive tn-ade war. In addition, as

intenest groups compete for the gover-nmental assis-

tance, there is no guar-antee that the tight gr-oups

will be assisted or that they will use the assistance

efficientl.

Strategic Trade PolicyRecent theor-etical developments have identified

cases in which so-called stn-ategic tr-ade policy is supe-

rior- to fl-ce trade. As we discussed earlier, decreasing

unit production costs and market structures that con-

tain monopoly elements ar-e conirnon hi industr-ies

involved in inter-miational tmade. Mar-ket imperfections

immediately suggest the potential benefits of govern

mental intervention. In the str-ategic trade policy argu-

ment, gover-nmnent policy can alter the terms ofcom-

petition to favor-domestic over foreign firms and shift

the excess returns in monopolistic mar-kets from for-

eign to domestic fir-ms.

Knugman 1987) illustrates an example of the angu-

rnent. Assume that there is only one firm in the United

States, Boeing, and one multinational Iir-m in Europe

Airbus, capable of producing a 150-seat passenger

aircraft. Assume also that the aim-cr-aft is pn-oduced only

for export, so that the returns to the firm can be

identified with the national interest. This export mar-

ket is pn-ofitable for either fin-nm if it is the only producer;

however, it is unprofitable for both fir-ms to pnodtice

the plane. Finally, assume the following payoffs are

associated with the four combinations of production:

1) ifboth Boeing and Airbus pr-oduce the aircr-aft, each

firm loses $5 million; 2) if neither Boeing non Ainbus

pnoduces the aircn-aft, profits are zero; 3) if Boeing

pn-oduces the aircraft and Air-bus does not, Boeing

profits by $100 million and Air-bus has zero pr-oUts; and4) ifAir-bus produces the air-cr-aft and Boeing does not,

Airbuns profits by $100 million and Boeing has zero

profits -

Which finnn)s) will pr-oduce the air-craft? The exam-

ple does not yield a unique outcome. A unique out-

come can be genen-ated if one firm, say Boeing, has a

head stant and begins production before Airbus. tn

this case, Boeing will n-cap pn-ofits of $100 million and

will have deter-n-ed Airbus from emitening the niarketbecause Air-bus will lose $5 million if it enters after

Boeing.

Stnategic trade policy, however-, suggests that judi-

cious gover-nmental intervention can alter the out-

come. Ifthe Eunopean governments agree to subsidize

Air-bus production with $10 million no mnatter what

Boeing does, then Airbus will produce the plane. Pro-

duction by Air-bus will yield more profits than not

producing, no matter- what Boeing does. At the same

time, Boeing will be cleterred fiom pnoducing because

it would lose money. Thus, Airhus will captur-e the

emitime rnar-ket and reap profits of $110 mnillion, $100

mnillion of which can be viewed as a tnansfer of pr-ofits

from the United States.

The criticismns ofa strategic trade policy ar-c similar

to the criticisms agaimist pr-otectimig a technologically

pr-ogn-essive industry that gener-ates spilloverbenefils.

Then-c are major- infonmational pn-obleniis in applying a

3A recent volume edited by Paul Krugman (1986) examines theolicy implications of the new trade literature, See Grossmansarticle in that volume for a discussion of the information require-ments.


13/18


strategic trade policy. The government must estimate

the potential payoff of each course of action. Eco-

nomic knowledge about the behavior of industnies

that have monopoly elements is limited. Firms mnay

behave competitively on- cooper-ativel~and may com-

pete by setting pm-ices on- outpr.rt. The behavior- of rival

govem-nments also must he amiticipated. loreign retalia-

tiomi must be viewed as likely where substantial profits

are at stake. In addition, many intem-est gr-oups will

compete for the govem-nmental assistance. Though

only a small number of sector-s can be conisidered

poterrtiall~stmategic, many industries will make a case

for assistance.

Reciproci~vand the Level Playing Field

Bhagwati and Irwin 1987) note that U.S. tnade policy

discussions in recent year-s have frequently stressed

the importance of fair tr-ade. The concept of fair

trade, which is technically n-efen-red to as reciprocity,means diffen-ent things to different people.

Under the Genen-al Agreement on Iariffs and made,

negotiations to reduce trade ham-mien-s focus upon

matching concessions. This form of reciprocity,

known as first-difference reciprocity, attempts to n-e-

duce trade barrier-s by r-equiring a country to provide a

tariff rtduction of value compan-able to one pr-ovided

by the other country. In this case, neciprocity is

defined in terms of matching changes.

Recent U.S. demands, exemplified by the Gephardt

amendment to the cur-rent tn-ade legislation, r-eyeal an

approach that is called fbll reciprocity. This approachseeks r-eciprocitv in terms of the level of pr-otection

bilaterally and ovem a specific n-ange of goods. Beci-

pn-ocitv n-equines equal access and this access can he

deter-mined by bilatemal tnade balances. A tnade deficit

with a trading partner is claimed to be prima fade

evidence of unequal access. Examples ahounnd. For

example, U.S. construction fin-mns have not had a major

contract in Japan since 1965, while Japanese con-

stm-uction fim-ms did $1.8 billion wonth ofbirsiness in the

United States in 1985 alone. Recent legislation liar-s

Japanese panticipation in U.S. public won-ks pnojects

until the Japanese offer r-ecipn-ocal pr-ivmleges.

As the name suggests, the fundamental argument

for fain- trade is one ofequity. Domestic producens irm a

fl-ce tnade country argue that foneign trade harrier-s am-c

unfair because it places them at a competitive disad-

vantage. In an extreme yer-sion, it is asserted that this

unfain competition will vir-tually eliminate [1.5. mnanu

factoring, leaving only jobs that consist primarily of

flipping hamburgers at fast food restaun-ants on-, as

Bhag%%-ati and Inwin have said, rolling mice cakes at

Japanese-owned sushi bar-s. While domestic pm-o-

ducers are relatively disadvantaged, the wisdom ofa

pn-otectionist response is doubtful. Again, the costs of

pr-otectionismn exceed substantially the benefits froni a

miatiorial perspective.

In an attempt to reinfon-ce the ar-gument for fair

tnade, pr-oponents also an-gue that n-etaliatory thn-eats,

combined with changes in tariffs and miontamiffbarri-

ers, allow for the simultaneous pr-otectiomi of domesticindustries against unequal comnpetition and indunce

mon-c open fom-eign mnar-kets. This mom-c flexible ap-

pr-oach is viewed as super-ior to a onesided free

trade policy. lhe suggestion that a fair tnade policy

produces a tnading environment with fewer- trade ne-

strictions allows pmoponents to asser-t that such a

policy serves to pn-omote both equity and efficiency. In

other- words, not only will domestic and foreign pno-

ducem-s in the same industry be treated equally. but the

gains associated with a fneer tr-ading envir-onment will

he n-ealized.

On the other- hand, critics ofa fair trade policy argue

that such a policy is simply disguised protectionisni

it simply achieves the goals of specific intemest

gn-otnps at the expense of the nation at lam-ge. In mnany

cases, fair tr-ader-s focus ori a specific pr-actice that can

be portr-ayed as pn-otectionist while ignon-imig the entine

package ofpolicies that are affecting a nations comn-

petitive position. In these cases, the fon-eign coumitmv is

muon-c likely either not to respond or retaliate by in-

cr-easing r-athcr- than n-educing their tracle barriens. In

the latter- case, the escalation oftrade han-mien-s causes

losses for- both nations, which is exactly opposite to

the alleged efiects of an activist fair trade policy.

Critics of fain trade proposals ar-c especially both-

er-ed by the use of bilateral trade deficits as evidence of

unfair trade. In a world of many tn-ading countries, tle

trade between two countnies need not be balanced for

the tr-ade of each to be in global balance. Diffemimig

demands and pr-oductive capabilities across countries

will cause a specific coumitry to have trade deficits with

some countries and sur-pluses with other- counitmies.

These bilateral imbalances an-c a rionmual result of

coumitmies tradimig on the basis of comnpar-ative advan-

tage.4

Thus, the focuns on the hilater-al tnade deficit can

produce inappr-opriate conclusions about fain-ness

and, niiore impor-tantly, policies attempting to elimi-

nate bilatenal trade deficits ar-c likely to be very costly

becaunse they eliminate the gains from a multilateral

tn-ading system.

~Bergstenand Cline (1985) estimate an equilibrium U.S-Japanesebilateral trade deficit of $20$25 billion annually.


14/18

FEDERAL RESERVE BANK Of ST. LOUIS JANUARY/FEBRUARY INS

CONCLUSION

The pr-olifer-ation of pnotectm()nist tr-ade policies in

recemit year-s pm-ovides an impetus to m-econsidem their

wor-th. In the won-id of tr-aditionial trade theory, chan-ac

terized by perfect competition, a definitive recoin

mendatiori in favor- of fl-ce trade can he made. The

gains fnonii initen-nationial trade result fm-om a m-ealloca

tioni ofpn-oducti~em-esour-ces towam-d goods that cami he

lino(lumced less costly at home than abroad amid theexchange ofsome of these goods for goods that can he

pm-odunced at less cost aljnoad than at home.

Recent developments in inter-national tm-ade theory

have examitied the consequences of international

tr-ade in mar-kets when-c tliene ar-c nianket imperfec-

tions, such as momiopoly and technological spillo\er-s.

Do these imperfections justitv protectionist trade poli-

cies? The answer- continues to he no. While protec-

tionist trade policies may offset monopoly power- over-

seas or advantageously use domestic moniopol~

power, trade restrictions tend to reduce the competi-tion faced by domestic producers, protecting domes-

tic producer-s at the expense of domestic conisunIens.

chic empirical evidence is clear-cut. The costs of

pr-otectionist tr-ade policies far exceed the benefits.

the losses suffer-ed by consumer-s exceeml the gains

reaped by domestic pr-oducens and government. Low-

inconiie consumer-s ar-c nelatively more adversely af-

fected than high-income consumers. Not only are

then-c inefficiencies associated with excessive domes-

tic production and restricted consumption, but then-c

ane costs associated with the enfor-cemnent of the pm-o

tectionist legislationm and attempts to influence tradepolicy.

The primam~reason for these costly protectionist

policies relies on a public choice an-gumemit. The desireto influence trade policy arises froni the fact that trade

policy changes benefit some gr-oups, while har-ming

others. Consumer-s are ham-med by pr-otectionist legis-

lation; however-, ignor-ance, small individual costs, and

the high costs of or-ganizing consumers pr-event the

consumers from beirig an eflective for-ce. On the other

hand, wor-ken-s and other resour-ce owner-s in an indus-

tn-v ar-c mor-e likely to be effective politically because of

their relative ease ofom-ganizing and their- individually

large and easy-to-identify benefits. Politicians inter--

ested in reelection will most likely respond to the

demands for- pmotectionist legislation ofsuch an inter-

est group.

Ihe enmpimical evidence also suggests that the ad-

~er-seconsumer effects ofpr-otectionist trade policies

ame riot shor-t-lived. These policies genem-ate lower eco-

nomic gn-owth n-ales than the rates associated with fr-ce

trade policies. In turn, slow gr-owth contributes to

additional pr-otectionist pressum-es.

Interest gr-oup pressunes from industries expenienc-

ing difficulty and the gener-al appeal ofa level playing

field combine to make the reduction oftrade hiar-riersespecially difficult at the present timmic in the United

States. Nonetheless, national inten-ests will be served

best by such an admittedly difficult political comm-se. Imi

light of the cur-rent tJmuguay Round negotiations un-

der- the General Agn-eement on Taniffs and Tm-ade, as

well as numerous bilateral discussions, this fact is

especially timnely.

REFERENCES

Bergsten. C. Fred, and William R. Cline. The United States-JapanEconomicProblem (Institute for International Economics, October1985).

Bhagwati, Jagdish N., and Douglas A. Irwin, The Return of theReciprocitarians U.S. Trade Policy Today, World Economy(June 1987), pp. 10930.

Brander, James A. Intra-Industry Trade in Identical Commodities,JournalofInternational Economics(February 1981), pp. 114.

Brander, James A.. and Paul R. Krugman. A Reciprocal DumpingModel of International Trade, JournalofInternational Economics(November 1983), pp. 31321.

Chrystal, K. Alec, and Geoffrey E. Wood. Are Trade Deficits aProblem? this Review(January/February 1988), pp. 5i 3.

Clarete, Ramon L., and John Whalley. interactions Between TradePolicies and Domestic Distortions, Center for the Study of Inter-national Economic Relations Working Paper 8522C (London, On-tario: University of Western Ontario, 1985).

Coughlin, Cletus C. Domestic Content Legislation: House Votingand the Economic Theory of Regulation, EconomicInquiry (July1985), pp. 43748.

Denzau, Arthur T. How Import Restraints Reduce Employment,Washington University Centerfor the Study of American Business,Formal Publication #80 (June 1987).

Destler, I. M., and John S. Odell, Anti-Protection: Changing Forcesin United States Trade Politics (Institute for International Eco-nomics, 1987).

Dixit, Avinash K., and Victor D. Norman. Theory of InternationalTrade(Cambridge University Press, 1980).

Dixit. Avinash K., and Joseph E. Stiglit2. Monopolistic Competitionand Optimum Product Diversity, American Economic Review(June 1977), pp. 297308.

The Economist. July 4,1987, p.74

.

Grais, Wafik, Jaime de Melo, and Shujiro Urata. A General Equilib-rium Estimation of the Effects of Reductions in Tariffs and Quanti-

tative Restrictions in Turkey in 1978, in T. N. Srinivasan and JohnWhalley, eds. General Equilibrium Trade Policy Modeling (MITPress, 1986).

Grossman, Gene M. Strategic Export Promotion: A Critique, Stra-tegic Trade Policy and theNew InternationalEconomics in Paul R.Krugman, ed. (MIT Press, 1986), pp. 4768.

Helpman, Elhanan. International Trade in the Presence of ProductDifferentiation, Economies of Scale and Monopolistic Competi-tion, Journal ofInternational Economics (August 1981), pp. 30540.

Hickok, Susan. The Consumer Cost of U.S. Trade Restraints,Federal Reserve Bank of New York Quarterly Review (Summer1985), pp. 112.


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FEDERAL RESERVE BANK OF ST. LOWS

Hufbauer, Gary Clyde, Diane T. Berliner, and Kimberly Ann Ellioti,TradeProtection in theUnitedStates:31 Case Studies (Institute forInternational Economics, 1986).

Kearl, James R., Clayne L. Pope, Gordon C. Whiting, and Larry T.Wimmer, A Confusion of Economists? American EconomicReview, Papers and Proceedings (May 1979), pp. 2837.

Kierzkowski, Henry K. Recent Advances in International TradeTheory: A Selective Survey, OxfordReviewofEconomicPolicy(Spring 1987), pp. ii9.

Krugman, Paul R. Is Free Trade Pass? Journalof EconomicPerspectives (Fall 1987), pp. 131-44.

Strategic Trade Policy and theNew InternationalEco-nomics (MIT Press, 1986).

Lancaster, Kelvin. Intra-Industry Trade Under Perfect MonopolisticCompetition, JournalofInternational Economics(May 1980), pp.15175.

Variety, Equity, and Efficiency (Columbia UniversityPress, 1979).

Leibenstein, Harvey. Beyond Economic Man (Harvard UniversityPress, 1980).

Luttrell, Clifton B. Imports and Jobs The Observed and theUnobserved, this Review (June 1978), pp. 210.

Mill, John Stuart. PrinciplesofPolitical Economy, W. J. Ashley, ed,

(Longman, 1909).Morici, Peter, and Laura L. Megna. U.S. EconomicPolicies Affecting

Industrial Trade: A Quantitative Assessment (National PlanningAssociation, 1983).

Munger, Michael C. The Costs of Protectionism: Estimates of theHidden Tax of Trade Restraint, Washington University Center for

JANUARY/FEBRUARY 1988

the Study of American Business, Working Paper #80 (July 1983).

Organization for Economic Co-Operation and Development(OECD). Costsand Benefits ofProtection (1985).

Page, Sheila. The Rise in Protection Since 1974, OxfordReviewofEconomicPolicy(Spring 1987), pp. 37Si.

Peltzman, Sam, Toward a More General Theory of Regulation,JournalotLawand Economics (August 1976), pp. 211-40.

Pine, Art. Footwear Industry Tells Congress Shoe Gap Threatens

U.S. Defense, Wall StreetJournal, August 24, 1984.Ricardo, David. The Principles of Political Economy and Taxation

(Penguin, 1971).Stigler, George J. The Theory of Economic Regulation, BellJour-

nal ofEconomics and ManagementScience (Spring 1971), pp. 321.

Stolper, Wolfgang, and Paul A. Samuelson, Protection and RealWages, ReviewofEconomicStudies (November 1941), pp. 5873.

Tarr, David G., and Morris E. Morkre. AggregateCosts totheUnitedStates ofTariffs and Quotas on Imports: General Tariff Cuts andRemovalofQuotas on Automobiles, Steel, Sugar, and Textiles,Bureau of Economics Staff Report to the Federal Trade Commis-sion (December1984).

Venables, Anthony, and Alasdair Smith, Trade and Industrial Pol-

icy Under Imperfect Competition, Economic Policy (October1986), pp.62172.

Wood, Geoffrey E., and Douglas R. Mudd. The Recent U.S. TradeDeficitNo Cause for Panic, this Review (April 1978), pp. 27.

World Bank. World Development Report 1987 (Oxford UniversityPress, 1987).


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FEDERAl. RESERVE BANK OF ST. LOUIS JANUARYIFEBRUARY INS

Appendix

Developments in International Trade Theory and theGains from Trade

Since 1817, numerous developments have taken

place in inter-national trade theory. The consequencesof mone than one factor ofpn-oduction, increasing amid

decn-easing unit pn-oduction costs, amid imper-fectly

competitive markets are examined mi this appemmdix.

Special attention is focused on developments in inten-

natiomial tm-ade theory in the last decade.

Increasing the Number ofFactors of

Production

Assume that, in the United States, two resoun-ces,

labor- arid capital (e.g., machinesi, ar-c used in the

pr-oduction of two goods, automobiles amid air-planes.The pnices of these resources will be affected differ-

ently by tr-ade. As trade develops, demnanid for- the

exported good that is, the good in which the United

States has a comparative advantage) will incnease amid

demand for U.S. pr-oductiomi of the imported good will

fall. hhis demand shift causes the price of the ex-

ported good to rise nelative to the pr-ice of the ire

ported good. Similar-h, the shiff may also pn-oduce

changes imm the pr-ices of r-esoun-ces: however-, these

pm-ice changes an-c not always obvious.

Initially, assumne that the resoum-ces cannot be tm-ans

ferred across industnies. For examnple, the labor- and

capital used to pr-oduce automobiles, the good im

ported into the United States, cannot he used to pro-

duce aimplamies, the expon-ted good. Consequently, as

the pr-ice of airphanes n-ises imi the United States, the

compensation for- lahor and capital in the air-plane

industry will rise; meanwhile, the decline in automo-

bile pr-ices causes a decline in compensation for- labor

and capital in the industry. It would riot be surpn-ising

if labor and owners of capital in the imidustrv would

mesist such changes by asking for- tn-ade pm-otection.

While resources may not be easily transfer-n-edacr-oss industries imi the shont n-un, worker-s can change

jobs and capital cart be moved as time passes. hf

resources are mobile, then the longer-run conse-

quences for- labom- and owmiens of capital an-c different

from those described above. Even iflahor and capital

are perfectly mnobihe, however, one set of mesource

owner-s may benefit while another- gn-oup is har-mned by

trade.

The real world is more complicated than this dis-

cussion has allowed. Them-c are mon-c thami two factor-sof pr-oduction amid vamyimig degrees of mobility for

these factor-s. For example, the U.S. labor- for-ce contaimis scientists and engirmeers as well as shorton-dem-

cooks. Nonetheless, the underlying analysis does sug-

gest somne generalizations. When trade occur-s, owners

of the resoun-ces that ar-c mor-e specialized imi the

pn-oduction ofexport goods will tend to become weal

Who wins and who loses? It depends on the U.S. endowment ofcapital to labor relative to other countries. If the United States hasrelativelylarger amounts of capital to labor relative to othercountries,then owners of capital would benefit, while labor would be harmed.

This result follows from the Stolper-Samuelson Theorem (Stolperand Samuelson, 1941). In the example. the United States is definedto be capital-abundant. The example also implicitly assumes thatairplanes are produced by capital-intensive methods and automo-biles by labor-intensive methods, Thus, the production of airplanesrequires the use of more capital relative to labor than automobiles,Since the United States is relatively well-endowed with capital andthe production of airplanes is capital intensive, the United States willhave a comparative advantage in the production of airplanes. Withthe elimination of trade barriers, the relative price of airplanes toautomobiles will increase. The Stolper-Samuelson Theorem showsthat an increase in the relative price of the capital intensive good willincrease the return to capital relative to the prices of both goods andreduce the return to labor relative to the prices of both goods.


17/18


thier; those who own n-esoun-ces mon-c specialized in

the production of import-competing goods will tend

to lose wealth. People also gain or- lose, howeven,

depending on what happens to the pr-ices of the goods

they buy. Individuals who chiefly consume imported

goods will benefit, while those who pr-efer- consuming

the exported goods will lose. Thus, the net effect on

any individual depends on both the gains or losses

associated with the price changes on the goods thathe consumes and the effect oftrade on his wealth (or-

income I.

Increasing UnitProduction Costs

A second assumption underlying the Ricandian ex-

ample of the gains fr-ore trade is that unit production

costs are constant. If unit production costs rise as

more is produced, however, the general conclusions

about the gains fr-nm tr-ade remain essentially un-

changed. The major- difference is that rising unit pro-

duction costs limit the extemit to which speciahizatiomioccurs.

Decreasing UnitProduction Costs and

Imperfect Competition

On the other hand, if unit production costs de-

crease as production increases, the extent to which

actual trade patterns can be explained by comparative

advantage becomes unclear. lt also fonces tr-ade theory

to deal with nunmerous char-acteristics ofinternational

trade in the real wor-hd. The market structure ofindus-

tries engaged in tnade is fr-equently highly concen-

tnated. In other words, the individual firms in an

industry, contrany to those in a perfectly competitive

industry, can affect the manket price oftheir good by

their productiomi and advertising decisions. In addi-

tion, trade statistics show that intra-industny trade

(i.e., the simultaneous export and import of the output

of the same industnz accounts for- incn-easinglv larger

shames ofwon-Id trade.

In Ihe last decade, trade theorists have developed

numnen-ous models to deal with these facts. An exhaus-

tive r-eview of this rapidly expanding hitenature is be-

yond the scope of this appendix; howeven, a few illus-trative articles are discussed in order to establish

some key points. Brander (1981) and Br-ander and

Knugman (1983) developed models using a homogene-

ous good to highlight how imperfect competition can

cause intra-industry trade and how intna-industry

tn-ade can arise in the absence of cost differences.

Assume two countries with one firm in each coun-

try. The firms an-c pmoducing a homogeneous good

under identical cost situations and then-c am-cno trans-

pontation costs. Each firm openates under what istermed a Cournot comijectun-e, meaning that each

firm assumnes its pmoduction decision ivill not affect its

rivals pmoduction decision. Before inter-national tnade,

each firm has a monopoly position in its home man-ket.

Aliowing for- fr-ce trade induces each fin-rn to emiter the

othen br-ms niarket, because price exceeds mnamginalcost in each coumitry. Thus, the same good will flow to

and fr-om each country.

Kierzkowski l1987n has noted that the bulk of intn-a-

industry trade involves differentiated rather than ho-

mogeneous goods. Two approaches, Lancasters

(1979) chanacteristics approach and Dixit and Stighitzs

(1977) hove of variety appr-oach, have pr-ovided the

foundation for- trade models involving differentiated

goods.

In the chanactenistics approach, individuals have

pn-eferences for- the characteristics of goods m-ather

than for- collections of time goods themselves, A group

of goods is defined as goods possessing the sanre

characteristics but in diffem-ent pn-oportions. A diversity

in consumner pr-eferences causes different consumner-s

to pr-efen different products (i.e., vanieties) ofa gr-oup of

goods.

Fleipman (1981) and Lancaster)lSSD) used the char--

actem-istics approach to show how intra-industry tnade

results fnom combining the demand for- variety with

economies of scale, The change fr-om autan-chy to free

trade enlarges the mar-ket and causes output of the

existing varieties to increase and the production of

new varieties to begin. Consumers gain from the pro-

ductiomm of more varieties and lowem pr-ices as econo-

mies of scale are realized,

The sources ofgains from tr-ade are identical using

the love-of-variety and character-istics appr-oaches. In

the love-of-variety approach, which is used by Dixit

and Norman )1980r, consumers have identical tastes

and prefen to consume as many types of the differenti-

ated product as possible.

The introduction of imperfect competition and de-

clining unit pm-oduction costs suggest three sources of

gain from free trade. As the market potentially served

by firms expands fi-om a national to a world market,

there will be gains due to declining unit production

costs. The second is the reduction in nmonopol~power

of firnms faced with foreign competitors. The thin-d isthe gain to consumer-s fm-onn lower prices and in-

creased product variety. Gener-ally speaking. gains

from trade result from the increase in competitive

pr-essures as the domestic econonmy becomes less

insulated from the world economy. Nonetheless, time

numerous market structur-es and firm hehavions pos-

sible under imperfect competition preclude a defini-

tive statement about the optimahity offr-ce trade.


18/18

FEDERAL RESERVE BANK OF ST. LOUIS JANUARYIFEBRUARY ISa

Figure 3

Ttj~

P4V

ICUS

D~512

~ D~5

a

The demand curve is D,, and the marginal cost curve is

MC,,~.(The mnarginah revenue curve associated with lJ,,~

is omitted.) The monopoly pr-ice and output are P,~

and Q~

The change from autarchy to free tnade transforms

the national monopolies into a world duopoly. As-

suninng the firnis follow a Cournot str-ate~, price

declines from P~ to P,~, sales in the United States

incnease from Q,,, to Ii,,,, and consumers gain an-ca P~

ES P,, or h + i. Profits ignoring fixed costs) in the

United States decline fr-om area P,,, RWM or i + j + k toarea P, SXM or j + k + 1. The domestic firm has one-half ofthe domestic market, so its profits an-c j with k +I going to the foreign firm. The domestic firms expon-ts

allow it to captune one-half of the foreign mar-ket. Ifthe

foreign mar-ket is identical to the domestic market, the

firms profits on ibr-eign sales will equal k + I. There-

fore, the net reduction in the domestic fin-rns profits is

I and the overall welfare gain to the economy is

h + I.

Sometimes the benefits of expanded consumption

resulting from fl-ce trade an-c less than the costs associ-

ated with distorted pr-oduction. Venables and Smith

(1986) pn-ovide a graphical illustn-ation, duplicated in

figure 3, of the preceding point using the Br-ander-

Kr-ugman duopoly model. Assume the U.S. market and

the market in the rest of the won-Id for- a specific good

are monopolies, the good is produced at a constant

marginal cost, and there are no tr-ansportation costs.

Ifthe assumption of identically sized domestic and

foreign mar-kets is dropped, then a different conclu-

sion is possible. Ifthe foreign market is smaller- than

the domestic, the profits of the domestic firm in the

foreign market will be less than k + 1 . Assuming zero

exports, the domestic gains fr-nm trade are h k, and

the domestic economy could lose from fnee trade. In

this case, consumer- gains can be mon-c than offset by

the shifting of profits fi-onm the domestic to the fbreign

economy. lhis shifting reflects the contraction of an

activity that is already too little to an even smaller- level.

TI

w~x

Documents

Protectionist Jan Feb1988