Protectionism ensures slower growth

An interesting article in Forbes by Jeffrey Dorfman, a professor of economics at the University of Georgia. USA , is (mostly) copied below

Tariffs help uncompetitive industries:

  • They put a penalty on imports in the form of a tax
  • Domestic producers that would otherwise lose market share to imports are able to produce more and find domestic markets for those goods
  • This maintains jobs in the protected industry
  • And, by keeping factories open, it also means more capital stays in the industry benefiting from the tariffs

These outcomes are pretty much the point of the tariffs, but they impose both obvious and hidden costs on the economy

The obvious costs are twofold:

  • First, consumers of the products sold by the protected industry must pay a higher price thanks to the tariffs
  • Second, jobs and profits are lost in the rest of the economy because the higher prices induced by the tariffs leave less money to be spent on everything else

These costs have been much discussed during the recent ramp up in trade disputes and tariff levying

What has been mostly overlooked is a hidden cost of tariffs – slower economic growth

At any given time, the US economy has a certain amount of capital to invest in productive activities – tariffs protect uncompetitive businesses from shrinking or going bankrupt – because these protected industries are larger with the tariffs than without them, more capital is trapped in those low-growth or shrinking sectors of the economy benefiting from tariffs – that lowers the average return on capital

Without tariffs, those industries would shrink, and capital would be reallocated to faster-growing parts of the economy

This reallocation of capital would boost aggregate output thanks to the faster growth and mean there would be more future capital to invest in other productive uses

Economies with more capital have higher economic growth and higher wages thanks to the productivity derived from that capital

Thus, removal of tariffs would boost economic growth and create a feedback loop that would keep economic growth accelerating

Protectionism doesn’t just mean current economic losses from both the taxes and the disruption of rearranging global logistic networks – it also means slower growth for as long as certain industries are protected

This effect compounds over time, growing for every year protectionism continues and protected industries remain larger than optimal

One thing markets are good at is allocating capital

Sure, they make mistakes and those investors lose money – sometimes, when enough bad capital allocation decisions are made, we get recessions

However, markets do a better job than politicians of choosing which industries to protect from foreign competition

More tariffs mean an inferior capital allocation, a lower average return on capital, and thus slower economic growth

A good analogy is the bailout of banks and automakers by Presidents Bush and Obama during the last recession – by trapping capital in the low-growth industries of auto manufacturing and finance, the bailouts contributed to the slow growth of the US recovery – if capital markets had been allowed to adjust more fully to the over-investment in those two industries, growth could have been faster and the recovery quicker

Tariffs thus cost the economy jobs because the costs imposed on the rest of the economy outweigh the gains awarded to the protected industries

Unfortunately, that is not the end of the story – it gets even worse

Because tariffs cause capital to be mis-allocated, we suffer lower economic growth in both the short and long run

When you look at the big picture, tariffs are like an unwanted house guest that just won’t leave

Every day, the damage continues to increase and the effects linger even after the tariffs are removed

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