The Economic Basics of Protectionism

This is great stuff from Professor Mark Perry. Economics 101 of Protectionism versus Free trade.

Professor Perry writes, (bold emphasis mine)

The graphical analysis above shows what happens economically to a country that moves from: a) free trade with the rest of the world, with consumers paying the world price for a given product, to a b) protectionist trade policy and a new higher price that includes a tariff (tax) that reduces the amount of trade that takes place. Here are the key outcomes of this protectionism:

1. The domestic producers are now better off because they are protected from more efficient foreign competition, and can charge higher prices and increase output. Economically, they have converted consumer surplus (gains) to producer surplus (gains) because of the tariff, and that transfer is represented by the yellow area labeled "Producer Surplus" above. Nothing lost there on net because of the tariff, although domestic producers have used the political process to gain at the direct expense of domestic consumers, who now pay higher prices and purchase fewer units.

2. With a tariff (tax) on imports, the government is now able to generate "Tax Revenue" in an amount represented by the blue rectangle above. This is also a transfer, this time from what used to be consumer surplus (gains from trade) to the federal government. Nothing necessarily lost here either on net, assuming that the government will transfer the tax revenue back to the consumers in the form of beneficial government spending (maybe) or lower taxes elsewhere (maybe).

3. However, the two pink triangles labeled "Societal Loss" are the amount of losses to the consumers and the economy (society) from the protectionist tariffs that are NOT offset by a gain to some other group: producers or government, and represent what economists call the "deadweight loss" or "deadweight cost" of protectionism.

Bottom Line: The deadweight losses from protectionism mean that the economy is worse off on net, or that there has been a reduction in total economic welfare, the total number of jobs, wealth, prosperity, and/or national income. You could argue about the size of the deadweight loss triangles, but it would be really hard to argue that they don't exist. Protectionism has to make the country worse off, on net, and that proposition is supported by 200 years of economic theory and hundreds of empirical studies.

Two additional comments:

-You get economic lessons free on the web.

-When you get to hear people babble about the benefits of protectionism, you can be assured that they’re not dealing with economic realities. Instead, protectionism is grounded on emotionally charged politics—characterized by the rhetoric of good intentions (social signaling or arguing for social conformity purposes or for getting votes), rather than what truly works.