Thursday, 14 January 2010

Why "Buy American'' is a bad idea but politicians still like it

and, of course, its not just "Buy American" that's a bad idea, all "buy local" campaigns are dumb. This point is made in a new working paper by Mario Larch and Wolfgang Lechthaler called Why Buy American'' is a Bad Idea but Politicians Still Like it, Kiel Institute for the World Economy, Kiel Working Paper No. 1570, November 2009.

Larch and Lechthaler are interested in whether it is a good idea to respond with protectionism in the case of a negative productivity shock. They analyse the dynamics of transitory changes to trade barriers as a short-run response to an economic downturn in a dynamic, general equilibrium new trade theory model with heterogenous firms. They look at a number of different scenarios, where they distinguish whether the trading partner responds to increased trade barriers or not. The main conclusion is that protectionism hurts all countries, including the country imposing the protectionist measures, even if the other countries do not react with protectionism by themselves. Thus they show that the beggar-thy-neighbour policy does not work. A country cannot shield itself from an economic downturn of its trading partners by imposing temporarily higher trade barriers, but rather hurts itself. Thus, the results from their model yields a powerful argument against any kinds of protectionism.

But politicians still seem to like protectionist measures, Why? Is there a way to rationalise the actions of politicians? The answer from Larch and Lechthaler is yes. There are two rationales that help to understand why countries consider protectionism to be a good idea as a response to a recession: Firstly, even though higher trade barriers deter the gains from trade, they mitigate the negative spill-over effects from shocks in other countries. Secondly, firms are hit differently by protectionism. Domestic firms that do not export at all gain in terms of total profits from raising trade barriers, whereas exporting firms loose. Governments may raise trade barriers in order to support local firms, which may be important campaign contributors and voters in the next election. So rent seeking by non-exporters influences politicians.


Crampton said...

Isn't the easiest explanation that voters are just stupid and that politicians give them what they want? And that protectionist pressures increase in bad times?

Paul Walker said...

Voters may be stupid but why are they stupid in this particular way? Why does being stupid mean being protectionist? Or why do voters want protectionist policies? There has to be a reason for this.