December 15, 1993
"GATT on a Hot Tin Roof - In Most Cases, Protectionism is Just a Poorly Designed Industrial Subsidy"
San Jose Mercury News
By Timothy Taylor
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ONE REASON that free trade advocates are having such a tough time, first in the NAFTA disputes and now in the GATT talks, is that many people don't seem to understand what trade protectionism is, or why the overwhelming majority of economists oppose it so strongly.

Protectionism doesn't mean protecting "America," or "the economy," or "jobs," or some other generic, general good. It's not the economic equivalent of self-defense. Instead, protectionism is simply one method of subsidizing a particular domestic industry.

The subsidy happens indirectly. When America limits competition from imports -- whether through tariffs, quotas, or some other method -- it allows domestic industry to charge more, keep sales high, and earn higher profits.

Protectionist trade barriers are nothing more than a government-enforced method of having consumers of a product pay higher prices to subsidize producers of that product.

For example, restrictions on import competition in the textile and apparel industry cost U.S. consumers $16 billion in higher prices every year, according to the U.S. International Trade Commission. If the barriers to foreign competition were removed, the average price of clothing would fall 11.4 percent.

Protectionism raises two basic questions. Is subsidizing that particular industry a benefit to the entire economy? If a subsidy is justified, are limitations on foreign competitors the most sensible way of providing that subsidy?

The problem with subsidizing any particular industry is that the money has to come from somewhere. Just transferring consumers' money from one industry to another doesn't represent any overall gain for the economy.

If the subsidies are being provided with tax money, the point is fairly obvious, but the indirect subsidies of protectionism have the same effect. The extra $16 billion that the U.S. government forces Americans to spend on textiles and apparel is money that won't be spent on other products. Sure, it helped promote investment in textiles and training of textile workers, but it did so by draining resources from other industries.

Subsidizing a certain industry only makes sense, from an economic view, if helping that industry grow provides benefits -- in the term economists sometimes use, "positive spillovers" -- to the rest of the economy.

It seems likely, for example, that subsidizing the semiconductor industry makes more economic sense than subsidizing commercial real estate. Why? Because faster, more powerful computer chips are more likely than new office buildings to create efficiency gains that spill over and create economic benefits throughout the economy.

Of course, there is no guarantee that politically powerful U.S. industries will also be economically deserving. Protectionism has offered substantial subsidies to the textile, agriculture, steel and auto industries in recent years. In none of these industries are positive economic spillovers likely to be very high.

Instead, they are simply cases of transferring money that would otherwise have been spent on other industries. It should be no big shock that corporations in these industries are opposed to the current GATT talks; they fear losing their subsidies.

However, now consider the situation of a high technology industry where the benefits of a government subsidy, because of positive economic spillovers, are likely to outweigh the costs. In this case, the question becomes how to design the most useful subsidy.

Remember that protectionism delivers an industrial subsidy by reducing foreign competition so that American consumers pay higher prices, allowing the domestic industry to earn higher profits. An alternative is to have taxpayers pay the subsidy.

As one example, industry subsidies can be provided through government support of education and training, savings and investment, and research and development. Although somewhat general in nature, these policies definitely favor the positive spillover industries based on investing in well-educated people and new technology.

Another option is direct government funding of particular companies or industries. This commonly happens now through federal contracts (in the defense industry) and through federal funding for research projects and consortia.

Open subsidies, whether of the general or industry-specific variety, have three advantages. First, the costs of public subsidies are out in the open, debated and decided by democratic vote. By contrast, restricting foreign competition makes it too easy to pretend that American consumers aren't footing the bill.

Second, direct taxpayer spending allows society to exert pressure for something particular in return, like higher investment, training, or a research project. But when protectionism subsidizes industry profits, there is no guarantee that the extra funds will be spent in a way that advances positive economic spillovers or long-term productivity growth.

Finally, tax subsidies are collected broadly, from all across society. The protectionist subsidy is collected narrowly, from users of the product, which is more economically harmful.

For example, a few months back the U.S. proposed subsidizing domestic companies that produce flat-panel displays for laptop computers, by limiting imports of the displays. Even if a subsidy for the display industry makes sense (which it might), it makes no sense to raise the money by imposing higher prices on users of such displays -- after all, the point of helping the industry is to have the displays be cheaper and more widely used, not to raise their price and make them more difficult to buy.

Defenders of protectionism often like to pretend that they are practical thinkers, while any opponent of protectionism must be a laissez-faire, invisible hand, Adam Smith necktie, free market zealot. It's a smooth debating strategy, but it misses the actual arguments over subsidies to industry.

The real issues involve whether general subsidies to learning, investment and technology are more sensible than industry-specific subsidies; how society chooses which industries to subsidize; if the costs should be distributed widely or narrowly; and whether subsidies should be discussed and delivered openly, or indirectly by restricting competition.

Thus, protectionism only makes sense if subsidizing a particular industry is appropriate; if the U.S. political process can pick the appropriate industry; if the costs of the subsidy should be imposed only on those who use the products of that industry; and if the amount and existence of the subsidy is best kept unclear.

It would be unwise to impose an ironclad rule against limiting imports. The world is a complicated place. Situations do arise, now and again, where a threat of restricting imports -- or even a temporary act of protectionism -- makes sense as a political negotiating tool. Never say never. But with protectionism, a good rule is hardly ever.

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