Protectionism is an economic blind alley

The IEA has recently published articles by Mark Pennington on the subject of Ha Joon Chang’s 23 Things They Don’t Tell You About Capitalism. As Pennington addresses each of his accusations, I am reminded that Chang has, in the meantime, been writing on behalf of Civitas, the Institute for the Study of Civil Society.

In the foreword to Reviving British Manufacturing: Why? What? How?, Mr. Chang suggests that the UK should indulge in one of the most fundamental economic blind alleys in the Handbook of Bad Government: protectionism.

Citing the UK’s balance of trade deficit, which measures the net flow of payments for goods and services into/out of an economy, the report argues that the ‘Government should encourage an increase in manufacturing output by about £10 billion per year’ and further that this should be achieved not through promoting exports but by import substitution: ‘exporting is costly … in the short run … it will be much easier to focus on the home market and out-compete importers.’

Deliberate attempts by governments to ‘promote exports’ are themselves unwise, but import substitution is economic madness. It completely ignores the Ricardian Law of Association (better known as the Principle of Comparative Advantage); indeed, it undermines the whole basis of trade, i.e. specialisation and the division of labour.

Why should the UK indulge in a practice that harks back to the days when theTories banned wheat imports to protect the interests of their landed backers? Civitas argues that ‘We … have a balance of payments problem… With the annual trade deficit in goods now at a new record of £97.2 billion… only radical Government action will prevent Britain’s permanent decline as an industrial society.’ Actually, this is exaggeration, as they later admit. The real trade deficit is £46.2 billion, as the higher figure ignores the trade surplus from services.

Even accepting that there is a trade deficit, does this matter? As Milton Friedman noted, £100 billion is only of use to foreigners because it enables them to buy £100 billion worth of British goods. The pounds themselves are useless to them: ‘they cannot eat them, wear them, or live in them. If they were willing simply to hold them, then the printing industry – printing [pounds] – would be a magnificent export industry… [that] would enable us all to have the good things in life provided nearly free’ by people foolish enough to swap perfectly good goods and services for paper adorned with the Queen’s face.

In fact, many foreign nations seem quite prepared to do that, and worse: they then lend the money back to the UK. This has exacerbated the problem, enabling us to buy even more of the good things in life (such as the public services spending splurge from 2001 to 2010), but only by borrowing against our future and that of our children, while at the same time keeping our currency high and theirs low, thus making our exports less competitive and theirs more attractive, and so exacerbating the balance of trade problem. But this can only be a finite strategy: eventually, there must be deleveraging.

In fact, if Mr Chang and Civitas were really worried about the balance of trade and UK manufacturing, one might think they would focus on UK government borrowing from China and other countries. If the Chinese can’t lend us the pounds we’ve given them in exchange for goods, they will have to use them to buy goods or services in the UK, thus restoring  equilibrium in our balance of trade but with a weaker pound – a rather better and more ‘classical liberal’ solution than protectionism.

In passing, it is also worth considering which four industries Civitas suggests the UK could specialise in over the next few years. Where should we focus our efforts, expanding domestic supply by throwing up walls to prevent cheap foreign imports? In a companion essay, Civitas cites four particular industries that might not strike the average reader as particularly promising: paper; glass; steel and motor vehicles – hardly areas of high value-added manufacturing. There is also a suggestion that Britain should establish a ‘Ministry for Economic Growth, focused purely on reducing the trade deficit through increasing production’ (where to begin with this one?).

In 1962 Milton Friedman argued that ‘It is not too much to say that the most serious short-run threat to economic freedom… is that we shall be led to adopt far-reaching economic controls in order to ‘solve’ balance of payments problems. Interferences in international trade can seem innocuous: they can get the support of people who are otherwise apprehensive of interference of government into economic affairs… yet there are few interferences which are capable of spreading so far and ultimately being so destructive of free enterprise.’

Tom Papworth is Director of Policy at Liberal Vision and a Fellow of the Adam Smith Institute. This piece is adapted from an article for the Liberal Vision blog.

Development Manager

Tom Papworth joined the IEA in January 2012 as Development Manager. He holds a Bachelors in History at Royal Holloway (University of London) and a Masters in International Relations from the University of Kent (Canterbury). Between 1999 and 2002 he worked at two of Europe’s leading security studies think tanks, before taking a role at the Cabinet Office. He subsequently set up the Policy and Research function at the National Childminding Association and between 2009 and 2011 was a Policy Advisor at Universities UK. Tom is a Fellow of the Adam Smith Institute and a founding member of Liberal Vision.

3 thoughts on “Protectionism is an economic blind alley”

  1. Posted 22/08/2011 at 19:08 | Permalink

    The principle of comparative advantage only works to the benefit of all on the assumption that factors of production are mobile within each country, but not between them.

    In a world of free capital movements this is not a description of reality.

  2. Posted 23/08/2011 at 10:20 | Permalink

    It is true that simple models of trade do not adequately reflect the complexity of the real world, and it is possible to demonstrate theoretically that ‘second-best’ policies might involve some interference with the market. However the empirical record of import substitution policies needs to be looked at before anybody leaps to the conclusion that governments – buffeted by often febrile public opinion, and prey to special pleading from organised interest groups – can do better.

    I don’t know where Civitas is coming from on this one, but I’ll have a look.

  3. Posted 23/08/2011 at 10:50 | Permalink

    My point is, that if you drop the assumption that capital is immobile between countries, you find that capital follows absolute advantage: it will migrate to where labour is cheapest.

    The best way to understand the difference between the two is this.

    Comparative advantage answers the question “What job should I be doing?”

    Absolute advantage answers the question “Who is the best person for the job?”

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