By Austin Rose

On Friday, January 26, President Donald Trump stood before a packed crowd of global elites at the famously ritzy World Economic Forum in Davos and proclaimed that “the United States will no longer turn a blind eye to unfair economic practices including… industrial subsidies and pervasive state-led economic planning.” Ironically, that very same week he announced massive new tariffs on the import of solar panels and washing machines, making him guilty of the same economic practices he condemns. Despite what Mr. Trump might tell global financial elites, he clearly believes that industrial subsidies and some economic planning can help a country develop. I wager that he is not alone—lots of people, and not just Trump supporters, probably consider themselves what I might call “clever protectionists.”

Clever protectionism is nothing more than the resurrected zombie of Import Substitution Industrialization, a policy that emerged more than 60 years ago and which died at the hands of the World Bank after failing catastrophically all around the globe. A clever protectionist argues that Trump was wise to protect the solar industry because without an artificial 30% price advantage, domestic manufacturers could never compete with their Chinese counterparts. After all, the Chinese producers can make goods more cheaply because of lower labor costs and greater government support. And, if American solar companies cannot compete, they die, putting people out of jobs and preventing the U.S. solar industry from reaching its full potential. As a high growth industry of the future, solar is simply too important to not be competitive in, the clever protectionist warns.

To avoid this nightmare scenario, the clever protectionist supports a period where the government temporarily shields the solar industry from outside competition, so that it can improve its product without worrying about its more efficient foreign rivals. In theory, the solar industry eventually becomes strong enough to no longer need state protection. At that point, the government can safely remove tariffs and allow the U.S. solar industry to compete with the outside world. This distinguishes clever protectionism from punitive tariffs like the 50 billion dollars of Chinese imports that president Trump has recently targeted or at least technically security-oriented tariffs like the sort that have been levied against foreign steel and aluminum.

Press Conference for Countries Adopting an Anti-Protectionism Pledge
“2011 anti-protectionism pledge conference. The US have signed the pledge.” Source: Flickr. 

Unfortunately, that is not a realistic story. The fundamental mistake of clever protectionism is assuming that the state can effectively manage the economy. In truth, government bureaucracies are hindered by political pressures, lack of knowledge, and lags in recognition, implementation, and response. Simply put, clever protectionism is inferior to free trade because government is not as nimble, knowledgeable, or rational as the market.

Trump  thought he was being clever by “helping” the solar industry with a tariff. But consider that the vast majority of jobs associated with the industry come from installing solar panels, 80% of which are foreign made. When prices for solar panels go up as a result of tariffs, fewer consumers buy panels that need installation. Less demand for installation means fewer jobs. It comes as no surprise then that Trump’s solar panel tariffs were a disaster, turning an installation job market expected to grow by more than 100% over the next decade into a stagnant dud that will shed 23,000 jobs this year alone. That drop represents the first job loss in the industry ever.

Also: Is a country really better off if some domestic industry is insulated from competitive price pressure? Prices for everyone will be higher, which means that consumers will have less to spend on other goods. Consequently, the industries producing other goods will suffer. For instance, sugar protectionism costs American consumers billions a year, which translates to the destruction of at least 75,000 food industry jobs.

If protectionism truly strengthened companies to compete better in the future, then these enormous costs would be easier to justify. However, it does not. The incentives for companies in a protected industry change radically for the worse, as companies need not worry about international competition providing cheaper or higher quality goods. They are permanently competitive through no effort of their own and will dominate the local market without effort. Everyone suffers as result except a small number of corporations which collude to keep prices artificially high. In Brazil and Pakistan, protectionism-induced cronyism cost those countries as much as 7% of GDP.

But here’s the kicker—the training wheels for protected industries can never come off. An industry that is not competitive internationally now will not magically become more competitive by being coddled while the rest of the world competes. In the U.S. since 1950, we have tried some version of clever protectionism on at least 16 different industries. Only one, the bicycle industry, managed to come out stronger for all that planning.

America’s poor experience with protectionism is by no means exceptional. Recent history is rife with examples of protectionism failing spectacularly. Latin America had a wave of protectionism during the 1950s and 60s. Although it initially sparked relatively high growth, in the long run it led led to a balance of payments crisis, inflation, and a general reversal of fortunes. There are plenty of reasons that a Latin America full of natural resources and cheap labor might grow at high rates independent of protectionism. Bad economic policy was undoubtedly responsible for a huge economic downturn.

A similar story can be seen in Africa. The authors of a Brookings Institution set of case studies on no fewer than eight countries in Sub-Saharan Africa found that “high protection and heavy import dependency meant that African industry was poorly prepared for international competition… Investments were often made with little regard to efficiency”. In this case, central planners were particularly ill suited to omnipotent control and growth suffered greatly.

Supporters of protectionism may accuse me of cherry picking historical evidence and point to South Korea as a an example of a protectionism success story. There is no denying that South Korea has grown at a consistently high rate for a very long time and smoothly transitioned from a low to high skill economy. However, even there, stories of protectionism backfiring abound. The first ships manufactured by Hyundai, a huge Chaebol (family business with deep government ties), went unsold because their prices were much greater than  global market prices. The government ended up rescuing Hyundai from the consequences of this blunder by inventing a new company to buy the ships, and then mandating that all crude oil had to be shipped to Korea in those vessels. Had the South Korean government not provided Hyundai with perverse incentives to price its goods excessive high, this expensive embarrassment could have been avoided.

Moreover, I am not convinced that South Korea’s prosperity is due to protectionism. If you break down the portion of growth attributable to protectionist policies, you find that they are responsible for no more that 35% of Korea’s success story… for only the first four years.  That share very quickly drops to around 10% through the 60s and 70s, at which point Korea intensified its economic liberalization. Thus, even the brightest star in the tiny constellation of protectionist successes doesn’t shine brightly enough to discredit the mountain of opposing evidence.

So, realistically, what should be the path forward for the U.S. regarding clever protectionism? Quite clearly the economic theory, current evidence, and history all indicate that that underlying hubris of the instinct to direct is badly misplaced. The U.S., like any other state, is most powerful when it keeps the markets free.

 

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