The Cost of Economic Protectionism…

Now that times are getting bad, protectionist sentiment seems to raging all over the world. Everywhere you look, there are calls to “buy American”, “buy Canadian”, and “buy local”. The economic stimulus package that recently passed in the U.S. Senate also originally contained a buy American requirement for receiving funds. Hmm…

At its core, protectionism is based on the feeling that it is better to buy goods and services produced locally rather than produced far away. The rationale is that if I spend my money locally, it’s more likely to then be spent at other local businesses, including potentially my own. Or more generally, it means preferring to employ my fellow countrymen rather than foreigners. After all, we have to protect our own first, right? Well, before you jump on the “buy American” bandwagon, just make sure you understand its costs first…

The standard of living for those of us living in the western world has dramatically improved over the last hundred years. Today we have more books, clothes, iPods, big screen TVs, and cars than our grandparents would have imagined possible. We also have bigger houses, we work shorter hours, and we often have health coverage and pensions. We, on average, have a much more comfortable standard of living than those living a hundred years ago. So how did we achieve such levels of prosperity?

1. Huge breakthroughs in manufacturing technology and materials
2. Efficient global shipping & transportation
3. Government deficits and borrowing from our children
4. Outsourcing labor to emerging economies

People like to complain about their jobs going overseas and protectionists may argue about the benefits of outsourcing, but it’s quite straightforward if you think about it.

Labor costs, just like everything else in free markets, are driven by supply and demand. If you’re offering your services at a cost of $40,000 a year, and someone else is offering the same services at a cost of $4,000 a year, what do you think is going to happen? As long as there are enough people willing to do the job for $4,000 a year, eventually no company (that wants to remain solvent) will be willing to pay $40,000 for that job anymore.

And outsourcing isn’t the only reason why the value of a job can drop. The same thing happened with automation in factories – millions of jobs were destroyed and replaced by cheaper machine labor. And the refrain was the same: machines are bad, they put people out of work – we must protect our good paying jobs.

You might call outsourcing labor to emerging economies exploitation, but then it becomes a moral debate. The fact is, if you can pay someone overseas (or build a machine) to produce goods for you at a fraction of what it would cost to produce locally, the economy will benefit because companies are able to do more with less.

The mistake protectionists make is to think that they can somehow prevent this natural revaluing of jobs; that somehow we can pretend that a job is magically still worth $40,000 a year when it’s not. In order to artificially “protect” domestic jobs you can do a couple of things. You can subsidize domestic production, or you can tax or add tariffs to foreign products. But both options reduce the society’s wealth, and thus standard of living, because it protects less efficient methods of production and puts that cost onto the society. Does anyone think it’s a good idea to tax machine-created products, or subsidize manual labor over machine labor?

Protectionism often seems more interested in protecting the effort associated with producing goods. But don’t forget, the point of the economy is not to create jobs for people; it’s to produce stuff. And the only reason to work is to have money to buy that stuff. And despite many decades of outsourcing, we don’t seem to be running out of jobs yet. People get retrained and find new jobs.

There may be legitimate political reasons to endorse protectionism, like avoiding dependence on less than friendly foreign regimes, but there aren’t good economic ones.

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