Costs of protectionism

July 31, 2012

Free Market Foundation

Nations that impose tariff or trade restrictions on entry into their markets engage in protectionism. In the past, many economists contended that the costs of protectionism were a small portion of gross national product (GNP). However, critics have argued for decades that the price of protectionism is significant.

A paper by Harry Johnson in 1960 argued that the cost of protectionism ranged from 1 to 2 percent of GNP.

Richard Harris echoed these views in 1984, saying that “It is well known that conventional calculations of the costs of protection give numbers that are quite small; often in the order of 0.5 to 2.0 of GNP.”

Many economists now believe that even these estimates are far too low. Using past data to model, researchers find that:

Tariffs less than 15 percent are unlikely to have welfare costs exceeding 1 percent of GNP.

However, beyond that tariff level, high levels of protection can readily lead to losses nearing 10 percent.

Additionally, if there are large fixed costs of introducing products into the market and unproductive profit-seeking, then even modest protection can lead to large deadweight losses.

For example, in 1807 the United States imposed an embargo of 45 percent on imports. This led to a direct cost ranging from 7 to 10 percent of GNP, far exceeding the 1 to 2 percent of GNP predicted by previous models. Protection may have cost India 7.3 percent of GNP in 1964 and Turkey 15 percent in 1968.

This has implications for future trade talks. If the costs of protection are higher than previously thought, there are substantial gains to be had from future globalisation. Conversely, imposing new tariffs can lead to extremely costly results.

Source: Arvind Panagariya. Cost of Protection: Where Do We Stand, American Economic Review. Volume 92, Number 2. May 2002.

For more on Case Against Protectionism http://www.ncpa.org/iss/tra

FMF Policy Bulletin\27 August 2002