What is Protectionism?

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Definition:

Protectionism refers to a wide range of government economic policies that protects domestic industries from competition from businesses in other countries.

🤔 Understanding protectionism

In today's global economy, companies have to compete on an international playing field. Because every country has different laws and regulations, some businesses may have an advantage when producing certain types of goods. If a government wants to help protect one of its industries from international competitors, it can use protectionist policies to do so. Things like tariffs, taxes, subsidies, and import restrictions can all help protect domestic businesses from global competition. Protectionism is often complicated and can have both positive and negative effects depending on how and why a government implements its policies.

Example

Imagine Country A has many domestic businesses that focus on making clothing, but Country B also produces and exports clothes internationally. Country B has lower minimum wages and access to cheaper materials than Country A, making its products more affordable.

To protect its clothing industry, Country A implements a tariff on clothing imports, making imported clothes 25% more expensive. This makes domestic clothing comparably priced to imported clothing, helping protect local clothes makers' revenue.

Takeaway

Protectionism is like playing defense to protect local businesses…

In a game of hockey or soccer, a team has to defend its net (domestic businesses) from the other side (foreign exporters). There are a lot of ways to play defense: focus on stealing the ball away, getting in the way of the opposition, or forcing the other team to take bad shots on the net. Similarly, there are a lot of policies governments can use to protect their industries. Focusing on protectionism also has a danger. If a team plays too much defense, it will never have the chance to score a goal of its own. In the same way, some protectionist policies can have drawbacks and ultimately weaken domestic industry.

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What is protectionism?

Protectionism is a government's efforts to promote its country's domestic businesses from competition from other countries.

Many policies can play a role in protectionism, such as taxes and tariffs on foreign goods, subsidizing domestic corporations, or the creation of standard rules for products that local businesses currently meet, but many foreign ones do not.

Governments typically use protectionist policies to accomplish a few different goals. One reason for implementing protectionist policies is to protect domestic businesses from foreign competition.

A country might perceive another nation's firms as having an unfair advantage over them. For example, a country with loose labor laws and low minimum wages may have an advantage over businesses from countries with strong worker protections. Protectionist policies can help negate that advantage.

Protectionism can also be a matter of national security. It might not make sense, economically, for individual countries to have large farms growing food or businesses making other staples. Instead, it's cheaper to import those goods. However, relying on imports in times of turmoil could expose the country to risk of rising prices or an unwillingness from the other country to export essential goods. Protectionism can help a country build and sustain industries that it otherwise couldn't.

Protectionism stands in contrast to the concept of free trade, which promotes the reduction of trade restrictions and promotes free movement of goods between countries.

What are protectionist trade policies?

Many policies can be used to pursue a protectionist trade policy.

Quotas

A quota is a limit on the quantity or value of a product that a nation imports. Quotas can apply to exporters, limiting each trading partner to exporting only a certain amount of a good. Quotas can also apply independent of the exporting nations, with the importing country accepting only a set quantity of a product, regardless of the selling nation.

Once the quota for a period (such as a month, quarter, or year) is met, the importing nation either applies heavy taxes to imports or refuses to accept further imports entirely.

By limiting imports of an item, quotas incentivize production by domestic businesses. These domestic businesses can often create and sell a product, even if their costs are higher than the competition's because consumer demand will not be met by the goods imported before reaching the quota.

Tariffs

A tariff is a tax levied on imported products when they reach the importing country. These taxes directly increase the price of a product.

For example, if there is a 10% tariff on electronics and a company wants to import a phone worth $1,000 to sell to consumers, it needs to pay a $100 tax when it imports the phone. This means that it must increase the cost of the phone by at least $100 if it wants to cover the money it spent on tariffs.

By raising the cost of foreign-made products, tariffs make it easier for domestic companies to sell their goods. Even if local businesses are less efficient or spend more to make a similar product, they can price their products competitively because they don't have to pay tariffs.

Subsidies

Subsidies are, in some ways, the opposite of tariffs. Instead of levying taxes against imported goods, subsidies give tax benefits or direct payments to domestic businesses that produce specific products.

Subsidies directly reduce the costs faced by domestic companies. This lets them price their goods lower. This helps them compete with international competitors who may have lower production costs but who don't receive subsidies.

Standards

Implementing product standards may disincentivize foreign companies from importing goods to a market, mainly if the standard significantly differs from standards in an exporting country.

For example, a government might require that all dairy products imported for sale undergo pasteurization. In other countries, there may be specialty products, like cheese, that do not use pasteurization. This blocks companies from importing those products and lets domestic businesses control that market.

What are examples of protectionism?

One real-world example of protectionism is the European Union’s “banana war.”

The European Union levied tariffs of €176 per ton of bananas imported to the customs union from Latin American countries. It provided an exception to the duties for former European colonies in the Caribbean and Africa.

This did not protect domestic businesses but helped protect companies in Europe's former colonies. The EU repealed the tariffs in 2012, which helped reduce the price of bananas in Europe.

The Smoot-Hawley Act of 1930 is an example of American protectionism.

The Smoot-Hawley Act implemented more than 800 tariffs on imported goods from goldfish to wool. Part of the goal of the act was to defend American business during the Great Depression.

The goal was to ensure that local producers were not competing with imported goods, helping Americans retain their jobs and keep the economy moving. Ultimately, the act failed at this, and the United States stepped further into economic depression.

A modern example of protectionism is President Donald Trump’s tariffs on goods imported from China. He implemented these tariffs — claiming that Chinese businesses could compete unfairly with American ones — to help bolster American companies. These tariffs set off a trade war with China as both countries implemented additional restrictions on trade.

How does protectionism affect trade?

Protectionism tends to reduce the amount of trade that occurs between countries. Because it becomes more expensive to export goods to a country with protectionist policies, fewer businesses are willing to produce and ship the products. This can weaken foreign companies but also causes domestic consumers to pay more for goods because of the decreased supply.

Protectionism can also lead to a trade war. A trade war isn't fought with guns and other weapons. Instead, two countries use things like tariffs and quotas as their weapons. The idea behind trade wars is that restricting trade with specific countries can harm their economies if they rely on exports to raise money.

If one country implements protectionist policies, its trade partners might respond with tariffs of their own. Trade wars can also happen for other political reasons, using protectionist policies as leverage in negotiations.

Trade wars can last for a long time, with the nations involved in the war implementing additional restrictions regularly. Trade wars end when the countries begin loosening trade restrictions.

Why is trade protectionism important?

Trade protectionism is used for many reasons, including protecting domestic businesses and influencing foreign governments.

One of the primary reasons that governments implement protectionist policies is to protect companies within their borders. If foreign businesses can sell goods for less than a domestic company, that company may have to cut its workforce or close down.

Governments want to encourage high levels of employment and successful businesses, so protecting their companies from foreign competition might help promote high employment.

Protectionism also defends new industries that a government wants to grow. For example, certain areas, such as Silicon Valley, are known for being technology hubs, and many of the world's most important tech businesses operate in the area. For entrepreneurs, it may be hard to justify locating their new business outside of the place known for technology.

A country that wants to encourage tech companies within its borders might use policies like tax subsidies to give business owners a reason to operate within their borders. Over time, the new industry may grow to the point that it can hold its own against the competition.

National security is another reason that protectionist policies may be used. If a country relies on imports to get an essential product, like gasoline, countries that export gas have a powerful influence over the importer.

Using protectionism to ensure that there is some level of production of essential goods within a country’s borders can help a government ensure that it has access to those goods during a crisis.

Governments can also use protectionism to protect their consumers. If foreign countries don't have the same safety regulations, trade restrictions can keep unsafe products out of the country. This keeps the nation's residents safe from hazardous goods.

What are the advantages and disadvantages of protectionism?

The benefit of protectionism is that, when it works, it can help defend domestic companies from competition. This can promote higher levels of employment and production, bolstering a nation's economy. Protectionist policies that involve high levels of standards might force other countries' businesses to produce more top quality goods.

However, protectionism is risky and has several drawbacks.

One risk is that protectionism often increases prices for domestic consumers. Because the country imports fewer goods, supply is lower. This causes prices for products to rise, forcing consumers to spend more than they would have to if there were no protectionist policies in place. Some also claim it can reduce innovation and the quality of goods.

Another risk is that protectionism can lead to trade wars. If one country places tariffs on imports from another country, that nation's government might respond in kind. This can damage both countries' economies.

What is the difference between protectionism and free trade?

Protectionism and free trade are on opposite ends of the spectrum. Protectionism refers to policies that reduce the amount of trade that occurs between nations, whether it be tariffs, quotas, or standards that other countries' producers do not meet. Free trade refers to trade between countries that occurs without restriction or limit.

Both protectionism and free trade have pros and cons. Free trade tends to cause the price of goods to fall as businesses can import products from countries where they are cheap to make to places where production costs are expensive. It also lets different regions utilize their absolute or comparative advantages. However, free trade can weaken a country's industries, especially when that industry is cheaper or more efficient in another country.

Protectionism helps ensure that domestic companies don't face stiff competition from foreign businesses. However, protectionism increases costs to consumers and could anger other governments.

The modern economy relies on a mix of free trade and protectionist policies, each country implementing its own protectionist policies and signing free trade agreements as it sees fit.

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