Tariffs Benefit Few, at Cost to All

October 11, 2010 • Commentary
This article appeared in The Australian Financial Review on October 11, 2010.

Australia can teach President Barack Obama and his economic advisers a lesson on how to defeat protectionism in the US and elsewhere. At their Washington meeting in November 2008, leaders of the Group of 20 nations made a commitment to “resist” protectionism. At their London summit in April 2009, they undertook to “reject” protectionism. And at the Pittsburgh meeting in September 2009 — just days after Obama neither “resisted” nor “rejected” but put a 35 per cent tariff on Chinese tyres — the G20 vowed to “fight” protectionism.

What we really need is a plan to defeat protectionism. That plan, in two words, is “domestic transparency”. Australia used the domestic transparency provided by its Productivity Commission to expose the true cost of protecting inefficient industries and they transformed their economy from the highly protected, productivity laggard of the 1970s and 1980s to one of the fastest‐​growing developed economies. Here is what domestic transparency entails. Defeating protectionism will require a domestic policy focus, not high‐​profile pledges of international fraternity. After all, politicians are accountable to domestic constituencies, not their counterparts in foreign governments — as Obama’s tyre decision made perfectly clear.

But domestic accountability doesn’t have to mean acquiescing to protectionist demands. It just so happens that the current incentive structure encourages activism from those seeking protection and quiescence from those who bear its costs, skewing perceptions of what it means to be accountable at home.

Protectionism still flourishes — even in our deeply integrated global economy and even though economists almost unanimously find it short‐​sighted — because there is an asymmetry of information between stakeholders, which produces an asymmetry of motivations. Protection seekers have a reasonably good idea of the windfall to expect if their proposals are implemented. A steel tariff of 20 per cent, for example, might enable domestic producers, through higher prices and greater market share, to increase profits by an aggregate $100 million a year. However, the typically larger costs associated with a steel tariff are borne by a mostly unwitting public, whose incentives to lobby against the tariffs are muted by the fact that those large costs are spread across millions of consumers. These costs include: higher prices for automobiles, appliances, housing, and transportation; lost export sales on account of foreigners having fewer exchange dollars or because of trade retaliation; and forgone opportunities to grow businesses that require affordable steel.

Protection seekers individually have much more to gain than the average consumer has to lose individually. But the cost of protectionism to the broader economy can be substantial.

When protection seekers come asking of politicians, there is rarely compelling, countervailing pressure from other interests to reject their request. There is usually some dissent about adverse economic consequences, but rarely is it packaged coherently with an emphasis on the political consequences that await policymakers who impose restrictions. Instead, the politician sees little downside in obliging protection seekers.

The solution is to borrow from Australia’s experience and establish an independent, politically neutral, domestic institution to analyse objectively the costs and benefits of any proposed trade restrictions. The results would be made available to policymakers and the public before decisions are taken with respect to the proposed measures. The results would not have to bind policymakers to any particular course of action, but would ensure that their ultimate decisions were rendered in a transparent environment.

Domestic transparency would likely increase the political cost of allowing protectionism. The public would have foreknowledge of the costs of protectionist measures, which would help ensure that the domestic constituencies to whom policymakers are accountable were more diverse than in the tyres case.

In the steel tariff example, the “institution” might publish results that indeed show a $100 million benefit for steel producers, but also a $300 million overall cost to the economy. Having such information reported in a transparent manner from a credible, objective source would not only energise domestic interests to oppose the tariff, but it would also serve as a tool to help decision makers overcome the leverage exerted by protection seekers.

An institution devoted to domestic transparency would certainly be in the public interest and it would likely be welcomed by politicians, who are often pressured to support protectionist measures. As a result of his tyre decision, Obama is likely to be confronted with more requests for protection from other industries over coming months. The rapidly approaching 2010 elections give protection seekers additional leverage over the President.

The existence of a politically independent, credible, and objective institution to expose publicly the costs of protectionism could provide the counter‐​leverage Obama might need to reject demands for protection. That would be a crucial victory in the battle to defeat protectionism.

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