The Economic consequences of protectionism: more than just inflation

ANALYSIS

Understanding the Impact Channels

Protectionist policies impact the economy through multiple channels, extending beyond the initial tariff imposition. As the trend towards protectionism accelerates, it is crucial to consider these distinct factors to grasp the full potential economic effects.

Tariffs Increase Domestic Costs

Fundamentally, tariffs act as taxes on domestic consumers and businesses. While levied on imports, these costs are overwhelmingly passed on, leading to higher prices for consumer goods and increased input costs for domestic producers. For example, 2018 US tariffs caused washing machine prices to jump nearly 12%. This directly reduces purchasing power and contributes to inflation. It also hurts US exporters by increasing input costs and strengthening the US dollar which makes American products more expensive abroad.

Retaliation and Supply Chain Disruption Follow

Protectionist actions predictably provoke retaliatory tariffs from other countries, harming export-focused industries; for instance, US soybean exports to China plummeted from $12.3B (2017) to $3.1B (2018) after China imposed retaliatory tariffs. The result of tariffs is often reduced overall trade volume and the dynamics can disrupt global supply chains, creating uncertainty and raising operational complexity for businesses.

“While protectionism might preserve specific jobs in targeted sectors, economic analyses consistently show this comes at an extremely high cost to the broader economy. Studies of recent US steel tariffs, for example, estimated the cost at over $800,000 per job annually, paid through higher prices and taxes by the rest of the economy.”

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Reduced Competition Hinders Progress

Shielding domestic industries from foreign competition demonstrably limits consumer choice and can allow lower-quality goods to persist. More critically, it reduces the pressure for firms to innovate, improve efficiency, or adopt new technologies, potentially leading to complacency and slower productivity growth. This hinders long-term economic prosperity.

Inefficient Use of Economic Resources

Protectionism diverts capital, labor, and investment away from potentially more productive sectors towards artificially supported industries where the nation may lack a true competitive advantage. Economic analyses confirm this leads to inefficient resource allocation, lowering overall economic efficiency and yielding weaker returns on investment.

The High Cost of "Saving" Jobs

While protectionism might preserve specific jobs in targeted sectors, economic analyses consistently show this comes at an extremely high cost to the broader economy. Studies of recent US steel tariffs, for example, estimated the cost at over $800,000 per job annually, paid through higher prices and taxes by the rest of the economy. Furthermore, job gains in protected sectors are often offset by job losses in industries facing retaliation or higher input costs. There may be perfectly good reasons to use trade policy to create and/or protect manufacturing jobs in particular sectors like high-tech manufacturing, but that could be achieved in a much more targeted way.

Risks to the US Dollar and Fiscal Stability

Beyond direct trade impacts, escalating protectionism and trade conflicts pose risks to the US dollar's prominent global role. Reduced global trade, potential damage to US economic competitiveness, and increased geopolitical friction could erode international demand for the dollar and US assets. Strong demand for the dollar has been an enormous asset to the US, and eroding that benefit poses significant risks. Factors like trade fragmentation and heightened geopolitical risk, potentially exacerbated by trade disputes, could influence long-term demand for reserve currencies like the dollar. A significant decline in foreign demand for US debt could necessitate higher interest rates, increasing federal borrowing costs and constraining fiscal policy.

Looking Ahead

The trajectory of the US economy will be strongly influenced by the path chosen for trade policy. Maintaining elevated tariffs risks cementing the outcomes discussed – higher costs, reduced innovation and efficiency, potential fiscal strain, and slower growth. Conversely, negotiating a reduction in trade barriers offers a potential path to alleviate these economic headwinds and foster conditions more conducive to long-term growth.