Undesirable and Unnecessary


Protectionism is creeping insidiously into the rhetoric of financial TV.  "Taxpayer money should be spent to stimulate the domestic economy, not foreign economies."  "We should be creating domestic jobs, not foreign jobs."

This slippery slope to protectionism is undesirable. It won't work. It will invite retaliation.

However, it's not only undesirable, it's unnecessary.  Listen carefully.

When we import goods and services, we do generate income and employment abroad rather than at home. However, the exporter now has more dollars to use importing from us. When we export goods and services, we get the foreign currency to use on imports. The simple fact is that imports stimulate exports and exports stimulate imports. Imports and exports tend to move together, in the same direction and largely to the same degree. In all countries, including ours, imports and exports rise and fall together, not by coincidence, but through cause and effect. I'll elaborate on that more later.

If we attempt to keep income and jobs by importing less, we may seem to be successful in the first instance. However, with fewer dollars, our trading partners will import less from us. The income and jobs we gain or retain are more likely to be known to us. We probably won't know the resulting loss of income and jobs; or, at least, the cause and effect is likely to be lost. But the fact remains: when we protect jobs through protectionist trade measures, we lose other jobs. We delude ourselves.

Exports and imports and their consequences do tend to rise and fall together, but, in the short run, they aren't likely to move perfectly together. A small deficit or surplus may result and be sustained for a time. However, this does not destroy the conclusions above because the small deficit or surplus will tend to affect domestic income and jobs in a compensating manner.

For example, if our exports rise 10 percent and the resulting rise in imports is 12 percent, the two percent trade deficit will be matched by an equal increase in capital inflows. A surplus would reduce net capital inflows by a like amount. These capital flows will tend to affect the domestic economy in the same way as if trade had been perfectly balanced.

It's another example of the seen and the unseen. If protectionist measures help one part of the economy, and are seen; they will harm another part of the economy, likely unseen. They not only will lead to retaliation and bad consequences in the long run; they don't even work in the short run.

A footnote: the internal adjustment mechanism that keeps imports and exports in line with each other depend on many factors, but especially on the exchange rate regime. If exchange rates are free to adjust, the necessary price and income signals that motivate the necessary resource shifts will result primarily from incipient exchange rate changes and secondarily from nominal changes in prices, wages and interest rates. If exchange rates are fixed or rigid, nominal changes in home-country prices and incomes will be necessary. The real internal changes will be similar, but they are more likely to take place without frictions that might cause unemployment under flexible exchange rates.

Comments (2)

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  1. Tamas says:

    Just theoretically speaking… if fixed exchange rates are bad between countries in general, then does this mean that individual states within the US could or should have their own currencies ? Practicalities would be of course a nightmare, but similarly would Europe be better of without the Euro in these tough times as flexible exchange rates would keep unemployment lower in general, especially as labour forces are not so mobile across language boundaries (not a problem in US)? Similarly a number of eastern european countries are working towards joining this single currency and a number of African countries have pegged theirs to the Euro as well. Other than the practical reasons, what are the benefits during a global recession?

  2. dWj says:


    There are benefits and costs to a currency union; transaction costs are lowered, but some flexibility is reduced. In the United States, when regional economies diverge, there are automatic fiscal cross-stabilizers that tend to support the weakest regions at the expense of the strongest; we also benefit from the most flexible (mobile, among other things) labor market in the developed world, and an integrated capital market, so that resources will tend to flow from regions where they’re unused to regions where they can be better deployed. In a region in which the flow of labor and capital are impeded and such fiscal stabilizers aren’t present, the costs of the rigidity introduced by fixed exchange rates is likely to be higher.