Friday, January 30, 2009

The Fatal Flaw of Protectionism

The Democrats in House of Representatives have put something particularly stupid in the national recovery legislation they have just passed. It is a requirement that none of the infrastructure projects purchase steel from any country other than the United States.

The stimulus bill passed by the House last night contains a controversial provision that would mostly bar foreign steel and iron from the infrastructure projects laid out by the $819 billion economic package.

A Senate version, yet to be acted upon, goes further, requiring, with few exceptions, that all stimulus-funded projects use only American-made equipment and goods.

See: Washington Post, 'Buy American' Rider Sparks Trade Debate

It is widely accepted that one of the things that made the Great Depression far worse than it would have otherwise been, and that made the war that followed much more likely, was the protectionist legislation that sprang up as the world economies crashed. Countries cut economic ties with other countries, demanding that more and more purchases be done locally.

One of the effects of cutting international trade was to promote international job loss and economic decline.

Another effect comes from the fact that as economic relationships between countries weaken, the possibilities for armed conflict tend to increase.

To see the truth of the first of these effects, simply imagine that you are living alone. You are stranded on an island where you must gather food and water buy yourself, create your own clothes, build your own shelter, build your own tools for farming, tailoring, and construction, provide for your own health care, predict the weather, determine which natural foods are poisonous, and the like.

This is not a life with a particularly high standard of living.

Introduce just one more person, and both of you are better off. That one person can focus on growing and preserving food for two people. This makes him much more efficient at his job. Furthermore, it gives him an opportunity to learn how to do his job better. He need not be distracted by other jobs such as building a house or making clothes – you are doing those things. And, as with your partner, you become better and more efficient at the tasks you specialize in.

Add a third person, and a fourth. Every additional person creates more opportunity for specialization and trade.

Add enough people, and soon you have people specifically devoted to the study of health, to predicting the weather so as to better determine when to plant and when to harvest, the study of engineering, and construction itself allowing the community to build aqueducts and to harvest power from the flowing streams.

It no more matters that some of your trading partners live across the ocean than that some of them once lived on the other side of the stream or a mountain. Distance increases the cost of trade (more so for physical goods and services, and less so for information) but is not relevant to the fundamental benefit of trade.

Any time anybody stands up and demands that we cut off trade with some group of people, that we make the economic community smaller rather than larger, then this person is promoting a system that will make all of us worse off. It makes us worse off by blocking our trade with others, and makes those others worse off by blocking their trade with us.

If it makes sense to say that smaller communities can be more prosperous than larger communities, then it makes sense to say that none of us should be engaged in trade with any other person, and we should all live a life where we each grow our own food, manufacture our own clothes, construct our own shelter, and tend to our own doctoring.

Perhaps more important is the fact that isolated tribes are the type who are more likely to go to war with each other. If two tribes have economic links – if the wealth and well-being of one tribe is tied to the wealth and well-being of the other – then there are all sorts of incentives to preserve the peace. But, if there economic borders are closed, then the only way to get something that the other tribe has is to take it by force of arms.

It is quite reasonable to suspect that, without the protectionist policies of the 1930s and its adverse effects not only on the global economy but the severing of incentives to maintain peace between nations, came to be followed by the largest global military conflict in human history.

What the United States does in this economic crisis sets an example for the rest of the world. We have many and good reasons to set an example of keeping economic relationships between different countries open – to foster trade rather than sever economic ties. We have many and strong reasons to demand that, this time, the world works together to get through this economic crisis, rather than split off into isolated tribes.

Because it typically is not long after countries quit trading bread and butter across their national boundaries, that the find they are soon trading bullets.


Justus Hommes said...


Steelman said...

"The stimulus bill passed by the House last night contains a controversial provision that would mostly bar foreign steel and iron from the infrastructure projects laid out by the $819 billion economic package."

Hold on. Does the bill state that only domestically manufactured steel products may be used? If so, then foreign steel coil can be used by U.S. mills. Coil is the rolled up bands that can be manufactured into pipe, tube, and other shapes for construction and other industries.

If it stipulates only domestic raw materials, then there may still be an exemption (as there has been in past tariff and countervailing duty actions against foreign steel) for U.S. coil mills to use foreign ingots and billet. Those are the big solid chunks that get melted and rolled into coil.

If the bill specifically states "melted and manufactured", then I believe only foreign ore (and other ingredients) are excepted from the ban.

So, the level of economic impact to foreign produces depends on the wording in the bill. Whatever the actual restrictions, this bill will probably drive the cost of steel products, and the products that are in turn manufactured from them, higher. The U.S. doesn't have the capacity to satisfy the country's overall demand for steel in a normal market, so prices may or may not increase markedly at first, but they will probably increase as a result of this bill.

I think a lot depends on the reactions of the world's steel producers, and what they are willing and able to do with subsidies.

Steelman said...

BTW, Alonzo, I agree with your points about lack of trade and warfare. The interdependency of free trade between nations is somewhat akin to the old practice of intermarriage between European nations' royal families, only more so.

piahwef said...

Distance increases the cost of trade (more so for physical goods and services, and less so for information) but is not relevant to the fundamental benefit of trade.

I realized something when I read that sentence. There's already a natural "penalty" for buying foreign goods, and a bit of incentive to buy locally to save on shipping. How ridiculous is it that foreign companies already have a built-in handicap, and we still complain that they're "cheating" and need even more of a handicap?

No matter how we try it, we can't create value by isolating ourselves and fudging the figures. We're going to have to work harder and try to win a fair fight. The way we've been running ourselves into the ground and dodging blame the whole way down, it doesn't seem like we'll be such a world power for very long.

anton said...

If the stimulus bill is supposed to create some protection for US American business, it would be more effective if it dealt with the products and services that could be provided by small business. The US could do this by forcing the Walmarts et al to buy "their" products in the US. US America could also penalize corporations when they export jobs to take advantage of cheaper foreign labor. For example, Hewlitt Packard has been a notorious exploiter of cheap technicians from India by first, housing them in barrack-style rooming houses within the US and then transferring entire departments to Indian once telephone technology permitted them to do so.

If anyone notices, solutions primarily tend to help out Al Cap's General Bullmoose types with the theory that the benefits would eventually trickle down to the little guys. Margaret Thatcher tried a similar approach in England and it was a disaster!

How long will it take the average US American to realize that its future does not lie in protecting is big manufacturing and financial corporations whose executives are primarily out to make themselves personally wealthy. It is still a matter of "when the little guy making widgets runs out of money he goes bankrupt and often is made to feel like a terrible failure" while the big guys who caused his bankruptcy get bailed out. YUK!!!!

Anonymous said...

Anton - so basically, you're for protectionism?

Alonzo - Protectionism in general seems to have been an awful failure. However... there is a matter of correcting for externalities. For instance, wouldn't it be appropriate for a country that strictly limits it's carbon emissions (thus increasing the cost of doing business there) to put tarrifs on goods imported from a country that doesn't limit carbon emissions at all, at a rate aproximately equal to the cost of reducing carbon emissions? This way domestic industries wouldn't be penalized for being responsible.

If so, should such externality-tarrifs be imposed for lack of work-place saftey or child-labor laws? Would that be counter-productive?

anton said...


Younger citizens of US America forget that their country imposed a highly restrictive form of protectionism to spur the country's growth while preventing other countries from "getting ahead". The original form of US America's protectionism was alleged to protect the "workers" and the "small guys", or at least that is what the "small guys" believed.

During the 1950s and 1960s your country practiced a ruthless form of protectionism that "forced" US production into other countries, while restricting other countries for doing the same, unless, of course, those foreign countries allowed US American corporations to "middle man" the products entry into the US. This is what helped the US America gain "control". For example, US America placed an embargo on sugar from Cuba which exists to this day. US American's championed their countries stand against communism. However, US corporations, with the governments assistance, managed to find loopholes in its "trading with the enemy" laws and continued for many years to supply industrial equipment and services to Cuba through "other countries" including Canada and the Bermudas.

It has practiced similar forms of control at least four times since 1950 and it has failed the US, and the world, each time. The US solution invariably has been to "undermine" other governments. This time is has been particularly hurtful because, while the US has helped destroy economy's all over the world, it is now being "protectionist" as we all are struggling to stay afloat.

My suggestion that the US consumer no longer have access to Chinese products is more of a punishment as US American's are forced to pay the price for products it has to produce and no longer avails itself of cheap foreign labor.