Tuesday, September 15, 2009

Protectionism, part 2

Based on my earlier post, Anonymous makes the following comment:

Since you are an economist I would have expected your title to this entry to read "Depending on Where You Sit, Protectionsim Doesn't Work Folks". The tire retailers will sell tires no matter who makes them, China, Taliban or Americans. American tire makers do care. I would rather read your list of solutions for fair trade between nations instead and maybe find out the extent that Chinese tire manufacturers are competing on an even playing field their US counter parts. By the way, you need to update this entry because the Major Indicies ended up today, I guess on news of US China trade disputes? Come on Charlie, lets leave the politics out of economics.
First, I am delighted to receive the comment (we bloggers really appreciate them) and I can also appreciate the sentiment/perspective that Anonymous provides. I will be the first to admit that I am sometimes too transparent in my political leanings, but I have always encouraged readers to "understand where folks are coming from when we read or listen to them. To me, it is important to know enough to know the difference." (click here for citation)

But I think, in this case, the economics underlying these types of scenarios does point out the shortcomings of such a protectionist strategy.

For example, let's use the graph above (HT: Mark Perry) to demonstrate the probable effects of the tariffs on consumer and producer surplus, where:
Pw is the tire price in the U.S. before the tariff and Pw+t is the higher tire price after the tariff. As a direct result of the tariff protection for inefficient domestic producers, their output expands from Q1 to Q3, and imported tires decrease from Q2 to Q4.

As a result of higher tire prices and fewer tires purchased, American consumers as a group will be worse off by the area (-a, -b, -c, and -d), which represents the loss of "consumer surplus" from the tire tariff.

American tire manufacturers will be better off by an amount represented by the area +a, because they have both increased sales (to Q3) and raised prices (to Pw+t) as a result of their protection from more efficient Chinese tire producers.

The U.S. government will collect tariff (tax) revenue on imported Chinese tires by an amount represented by the area c, which is the product of tire imports (Q4-Q3) times the tariff (t). If we can assume that the tariff revenue in area c will be redistributed efficiently to the economy, we can treat that as a net gain to the economy (this could obviously be argued by supporters of the tariff).
But when you add it all up, considering the costs of the tire tariffs, American consumers are made worse by the area (-a + -b + -c + -d). (Note: This area could be quantified as a specific dollar amount if we had information about the supply and demand for tires.)

When we consider the benefits of the tire tariffs, U.S. producers are better off by area +a, and the government is better off by area +c.

So there is a net loss to the system in that the costs of the tire tariff (-a + -b + -c + -d) are greater than the benefits of the tire tariff (+a + +c), for a net welfare loss of (-b + -d), which will be the "deadweight loss" of the tire tariff (costs to the economy that are not offset by benefits).

One can only conclude therefore that America will be worse off with the tire tariff, not better, and we (collectively) will suffer from higher tire prices, a net loss of jobs, lower economic growth, and a reduction in our country's standard of living.

That is why economists almost universally support free trade and oppose tariffs and trade protection - economic analysis and empirical evidence clearly show that there are always net welfare losses from tariffs. Therefore, politics aside, it will be Americans in the end who will be punished with the punitive tire tariffs.

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