Housefull Housefull Economics

The Folly of Protectionism

Our weekly explainer on economics using lessons from popular culture. In Installment 61, Padman exposes Smriti Irani’s ignorance of the ill-effects of Protectionism.

Padman depicts the real life events of Arunachalam Muruganantham, often tagged as the man who pioneered the sanitary-pad revolution in India. His on-screen character, Lakshmi (played by Akshay Kumar), procures raw materials and develops an ingenious process to produce affordable sanitary pads, sold at Rs 2. Some raw materials (like cellulose fiber and foam wrapping material) critical to the manufacturing process are imported from the USA and Malaysia. It is hard to imagine a sanitary-pad revolution in India if these imported products had obnoxious duties attached to them as a result of Protectionism – policies that artificially increase the price of foreign goods with the help of tariffs, quotas and other regulations.

Such real life examples are supported by 200 years’ worth of economic analysis and hundreds (if not thousands) of studies that oppose tariffs and trade restrictions. It is a scientifically and mathematically provable fact  that tariffs are detrimental to economic growth regardless of the time and country in which they are implemented. Yet, our politicians seem ecstatic about policies that restrict trade, especially imports.

All the three objectives mentioned in the tweet above mislead the masses into believing that protectionism is beneficial; but we must dig deeper to understand some of the unseen effects at play here.

Objective 1: Relief to domestic manufacturers

Domestic producers have a higher cost of production and cannot compete with the foreign producers in terms of price and/or quality. The easiest way to increase demand for domestic textile is to make imports more expensive. With the help of import duties, the government compels consumers to switch to domestic products that are actually more expensive in a world without the import duty. Obviously this comes as a relief to domestic producers as they no longer have to worry about foreign competition.

What if teachers start penalizing the toppers with arbitrary negative marks to lift the poor performers to the top of the class? This would definitely bring relief to the poor performers, and incentivize them to keep performing badly. That is exactly what protectionist policies do – encourage inefficient, incompetent and high-cost producers to stay in the market by driving out the more efficient, cheaper low-cost foreign producers from the market. With the government posing as their personal bodyguards, domestic firms don’t have the incentives to innovate, expand and improve. All this levies a great cost on the economy as resources are wasted on producing expensive goods that could instead be purchased at a cheaper price abroad.

Objective 2: Promote “Make in India”

In her tweet, Irani ignores an important concept of international trade – an outflow of money from the home country is always offset by an equal inflow of money from the rest of the world. Take for example, a foreigner who sells goods to Indians – the rupees she earns by selling to Indians will, in turn, be spent by her on Indian goods or services (think exports) or investments in Indian assets (think foreign direct investment). Alternatively, she can exchange the rupees with someone else who wants to purchase Indian goods, services or assets. In essence, higher imports may lead to higher demand for Indian products and more investment in India. Protectionist policies actually end up suppressing the opportunity to create jobs in the long run by discouraging exports and investment in the home country.

That is the opposite of what Make in India aims to do.

Objective 3: Boost job creation

Yes, in the short term, jobs will be created as the domestic market (that was being catered to by foreign producers) will now turn towards domestic producers. Domestic producers, however, are more expensive than foreign producers. Say, for example, before an import duty is levied, the price of imported good is Rs 100 and the price of domestic good is Rs 110. Now, the government introduces an import duty of 20% which increases the price of imported good to Rs 120, thereby making the domestic good more competitive. This erodes the consumer’s disposable income as they are forced to pay an additional Rs 10 to obtain the good after an artificial increase in the price of the imported good (they are now paying Rs 110 for something they earlier bought for Rs 100). Lesser disposable incomes lead to lesser consumer spending which reduces overall demand and ultimately jobs in the economy.

Increasing the import duty to “boost job creation” in one industry will eventually lead to lesser job opportunities in various other directions in the economy.

Finally, a protectionist policy ignores the presence of consumers in an economy. A sound policy considers long-term effects on all groups of people, not just short-term effects on one group. Import duties are, in reality, punitive taxes on Indians who want to purchase cheaper goods from other parts of the world. Entrepreneurs like Arunachalam will never be able to produce affordable products if the imported raw materials they need are artificially made more expensive. The costs of protectionist trade policies far exceed the benefits.

Just to pick one study from the USA – the tire industry gained $48 million when tariffs were raised, but consumers ended up paying $1.1 billion extra for tires, not to mention costs to other industries. On one hand, the costs of protectionism to consumers are diffused, delayed and mostly invisible. On the other hand, the benefits of protectionism to producers are concentrated, immediate and visible. That is why protectionist policies are so popular among the masses.

Based on the goals stated in Irani’s tweet, a policy that increases import duty is self-defeating in nature. At the end of the day, if we want to strive for economic growth, innovation and a spirit of entrepreneurship like that of Arunachalam Muruganantham, we need to move as far away from protectionist policies as possible.

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About the author

Yash Mehta

Yash is an economics graduate who discovered his love for economics after graduating. He currently works in the development research space. Being a football aficionado, he counts winning a FIFA tournament as one of his finest achievements.