Often hailed as the most influential economist ever, Keynes regularly imparted wisdom that shook the foundations of modern economics. His off-hand remarks are now cemented in history, and he is frequently quoted by modern economists and journalists. One of the issues he was very passionate about was the necessity of free trade amongst countries, even going as far as calling protectionism (the opposite of free trade) a ‘dystopian recipe…reducing global trade and prosperity and ultimately hurting everyone.’ Such words from this economics great are not to be taken lightly. However, protectionism and trade wars are rampant throughout the global stage. This begs the question: if protectionism is so obviously detrimental, why do nations continue to engage in it?
To understand the dangers of protectionism, it is crucial to first analyse the aspects of free trade which make it the better alternative. The gains received from free trade stem from the Theory of Comparative Advantage, first recognised by David Ricardo 2 centuries ago. Along with his other discoveries, this classical economist realised that certain economies worldwide could produce a particular good or service for a lower cost. If each country, therefore, produces what they are best equipped to and then trades with other countries, everyone would be better off. One must look at their local supermarket to look for an example of the benefits of the Theory of Comparative Advantage. All across the globe, exotic fruits line the shelves even though they only grow in a few climates found in fewer still countries. So the next time you buy a mango, thank David Ricardo!
Despite the universal advantages of free trade, governments in many countries employ protectionist policies. Although seeming irrational, there are a few motives for this selfish action.
The first is to protect the industry. If a country has a large amount of investment into an asset such as oil, if a new, more lucrative well is built in another country, according to Ricardo, the initial country should turn to another industry it can produce more efficiently than any rival state. However, in reality, the government will use sanctions and subsidies to protect its industry since many capital resources such as machinery and money have been sunk into it.
Additionally, abandoning an industry leaves many people unemployed, and it is comparatively cheaper to retain these jobs through protectionism than to retrain a large proportion of the workforce. Concurrently, many of the adult population’s inability to work leads to other economic consequences such as increased welfare payments and crime.
By protecting industry and jobs, governments will be more popular than if they obeyed Ricardo’s theory. Therefore, to win elections, governments follow the people’s will and protect their less efficient industries to the detriment of the rest of the world.
Having understood the causes of protectionism, it is vital to see the damage done to society by lowering living standards. An example that demonstrates this perfectly is the Canada-US lumber dispute. Canadian subsidisation (the Canadian government paying for the land on which the wood was built) in the softwood lumber industry led to American retaliation in the form of sanctions. Due to America being the biggest importer of Canadian wood, 10,000 jobs were lost, as well as American consumers had to pay much higher prices for America’s unsubsidised wood. Overall, both the Canadian producers and American consumers lost out due to these protectionist actions, as shown in the graph below.
Only the American producers benefited from the altercation since they received the business of those consumers who would typically buy from Canada but have no choice but to go with the more expensive American wood, serving as a reminder that the protection of industry is detrimental to the vast majority of the world.
Trade protectionism can also lead to trade wars, and this is because protectionist actions often lead to retaliation (as was seen in the example above). This tit-for-tat exchange can escalate exponentially from a ‘minor’ altercation like the softwood discord to conflicts that shake the very foundations of geopolitics, like the current Sino-American struggle.
China, being a significant exporter of goods, has been an unashamed culprit of currency manipulation over the past decade. This is because if they keep the Yuan low relative to other countries, their cost of production decreases relative to other countries. Due to this artificially low cost of production, Chinese companies can sell their products for less than their international competitors, cutting them out of the market.
To put a stop to this, as a means to protect American industries such as steel, US President Donald Trump placed tariffs on Chinese steel as well as other goods to change ‘longstanding unfair trade practices, such as the currency manipulation in 2018. As is consistent with trade wars, China retaliated with their own tariffs to punish America’s reliance on Chinese products.’ This diagram shows the escalation of tariffs.
These new sanctions meant that by early 2020, consumers in both Goliaths had to pay around 20% more than before the tariffs, decreasing trade as people are priced out of the market leading to producer losses on both sides.
Analysing this example demonstrates the ‘no winners’ nature of trade wars. The one-upmanship and desire to protect one’s own economy at the expense of another led to consumers feeling the higher prices of the sanctions and restrictions. At the same time, the producers have seen their consumer base drastically reduced. Both economies have been adversely impacted, the opposite of what would have occurred if the Theory of Comparative Advantage was followed.
Having recognised the destructive nature of these trade wars is derived from protectionist policies, free trade is the better alternative to these restrictive rules. No victors emerge unscathed from trade conflicts, bringing us back to the question – Why do countries engage in trade wars and protectionism? It seems to stem from a government’s desire to shield a country’s producers from international competition after the external country’s cost of production has decreased. This protection is done in a bid to preserve the economy as well as jobs that would otherwise be under threat. Without solutions to these problems, protectionism, as Keynes put it, will continue to ‘reduce global trade and prosperity and ultimately hurt everyone.’