The Chronic Malady of Trade Protectionism

Protectionism undertaken by a government to restrict international trade, often done with the intention of protecting local businesses and jobs from foreign competition, hurts Iranian consumers.

This is because when imports turn out to be more expensive, consumers have to pay extra for goods, economist Ali Sarzaeem said in a write-up for the Persian monthly Ayandehnegar titled “Protectionism in Foreign Trade and Us”. Below is a free translation of the article:

Export is not necessarily virtuous, nor is import vicious. Through export, a country obtains enough foreign currency to purchase from an overseas supplier. In fact, foreign currency has no value per se unless it is used for importing goods with comparative advantages.    

Comparative advantage is an economic law that refers to the ability of any given economic actor to produce goods and services at a lower cost than other economic actors.

One of the most important concepts in economic theory, comparative advantage lays out the case that all actors at all times can mutually benefit from cooperation and voluntary trade.

Restricting the entry of foreign goods would translate into a limited competition in the domestic market and dampen producers’ economic motivations. When the walls go up, domestic producers become complacent and less productive than their international peers at the expense of consumer interests.  

Another function of economic competition between local products and imported ones is to show whether the limited resources of the country have been committed to comparative advantages or not. If yes, local products will win the race with foreign products, otherwise they will lose the game to their foreign counterparts.

Such a defeat is a useful one for the economy, as it reveals how unsound the investment was and underlines the need to re-channel resources into other sectors.

A considerable part of the problems facing Iranian industries are rooted in bad investments that are economically unviable. For example, official figures show that tens of millions of square meters of tiles and ceramics in excess of demand are produced and piled up in warehouses across the country and the factories start operating at a fraction of their capacity.

The machinery and human capital invested in this industry could be transferred to industries that can be more constructive for the country. Another example is numerous steel mills constructed in desert areas far from bodies of water. The costlier steel these factories produce compared to foreign products is a clear sign that the sites of these plants are inappropriate.

The third point is whether government intervention is effective enough to turn the comparative advantages of different countries to its own advantage.

Can a government give an edge to the country by producing items in which it has no comparative advantage? The answer economists give is that government interference will deteriorate the economic welfare of people. Imposition of tariffs would generate revenues for the government, but increase the end price of products for consumers.

On the other hand, more expensive and better quality foreign products naturally become attractive to smugglers. The phenomenon of smuggling is an indication of an economic reality rather than a crime or illegal act. It proves that government interference is uncalled for.

When tariffs are low, there remains no motive for smuggling. Police connivance with smugglers gives rise to bribery and corruption.

Some recommend importing only commodities that are not domestically produced. The main flaw of this idea is the challenging task of deciding what items have local counterparts. Occasionally, a similar item may not have the same function or practicality as the imported one due to the precision involved in the work.

Drawing a distinction between goods that should be imported and those that have similar local counterparts would be subjective and gives way to corruption and creates problems for manufacturers who import raw materials or capital goods.

Finally, protective policies might be defensible under certain circumstances. For instance, South Korea has made advancements, thanks to incentives provided by the government to producers. Such policies need to be purposeful and provisional.

Government support should be lent to sectors with comparative advantage and is not universal.

Moreover, it must be result-focused and time-bound. The duration of government support should be determined. However, only few countries have adopted such a difficult policy effectively.