free trade and protectionism

Indonesian money (rupiah)

Image via Wikipedia

what is the difference between free market and protectionism? let me explain about it elaborately.

a little background, if we have free trade, foreign multinationals are free to come in and set up shop and then take their earnings out of the country. hence if we protect domestic businesses, their earnings will have more stimulus on the economy because they will waste their earnings within the country. but there are other facts that you should know.

It’s much harder to take money out of a country than you’d think.

Let’s say a Japanese corporation sells a lot of Sailor Moon dolls to Indonesia, and makes one billion rupiah in profits. Local doll manufacturers cannot compete and close.

But what are they going to do with all those rupiah? They want yens.

  • If they just leave rupiah in a vault indefinitely, they pretty much sent you these Sailor Moon dolls for free. Getting free stuff isn’t exactly bad for you, and in any case makes no sense to them so such doll company will goes bankrupt.
  • If they spend rupiah buying stuff from Indonesia – some other business will profit from that.
  • They probably won’t do either – they’ll go to a bank and sell rupiah to buy yens. This will increase make yen more valuable, and rupiah less valuable – making theirs and others’ Japanese exports to Indonesia less profitable, and Indonesian’s exports to Japan more profitable. because our currency that is rupiah is cheap enough for people from japan to buy whilst stuff that are imported from japan become expensive and people in indonesia can’t afford it anymore.

One way or another, balance of trade gets restored, and quite fast. Exports and imports match very closely. another things that should be known.

  • If people value foreign currency for its own sake – like China acquring more and more dollars and doing nothing with them – imbalance can last a very long time.
  • This doesn’t really work that smoothly if you use the same currencies, or exchange rate is fixed – the result is a huge pile of fail due to wage stickiness. For example is Greece.
  • If you have other flows of money than exports and imports – investment, remittances, international aid etc. – it might also result in imbalance. However keeping levels of these flows constant, Indonesian protectionism will still hurt indonesian exporters to Japan as much as Japanese exporters to Indonesian.

let’s take an example of china, where the chinese government manipulated the value of yuan currency to make it undervalued so that it would give chinese exporter greater advantage than the US exporters that has its dollar value higher than yuan.

In the present day, the ILO has estimated that a 20 percent yuan appreciation against the US dollar will decrease US unemployment by about 0.1 percent. (Conversely, Chinese unemployment would rise by 1.8 percent; and frankly, as a developing country, they need the jobs more.) The economic problems in the US have more to do with other factors, like the lack of an industrial policy and the funneling of money into expensive foreign wars.

The potential pitfalls of protectionist action are huge and detrimental but since I already explained the disadvantages of it, now I will suggest possible arguments for protectionist action.

1: Pricing in externalities. Different jurisdictions have different regulations regarding things like environmental impacts. A jurisdiction which does not take action to ensure that these costs are applied to the price of the final good or service have an arguably unreasonable competitive edge in the marketplace. Protectionism can price in these externalities, fixing the disparity.

2: Temporary price fluctuations (including deliberate undercutting). When a price is volatile or held artificially low, legitimate, competitive firms can fail. Protectionism can reduce volatility and punish dumping tactics ensuring the viability of efficient firms.

3: Critical sovereign assets. Some resources such as food supply or some forms of resource extraction and manufacturing require time and investment to initially construct, but a sudden need for them may occur in a time-frame too short for this to occur (war, disaster, etc). As a security measure, protectionism can ensure the existence of these facilities within a jurisdiction when they are needed most even if they are not competitive.

4: Economic transition. If an economic area is highly invested in the viability of certain firms, the sudden loss of those firms due to changing economic conditions can cause secondary and tertiary investments to lose value unnecessarily. Protectionism can slow the rate of decline and provide time for replacement economic drivers to be developed, protecting the other community investments.

as you see for yourself there are some others important benefit when it came to protectionism. or in other word, Protectionism is when we prevent cheaper, better products from entering our country so we can buy more expensive, shoddier products from domestic manufacturers. and also protectionism will mean world trade will diminish and will overall reduce global prosperity.


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