A Wave of Protectionism?

In light of the US current account deficit, pressure is high on Asian countries to revalue their currencies. The calls from some US policymakers for tariffs on imports from China have sparked fears of a world-wide surge in protectionism. This study evaluates the risk of protectionism, considering two dimensions: first, the economic effects; second, the incentives for policymakers to adopt tariffs. The study distinguishes between ‘benevolent’ policymakers-who care about long-term GDP-and ‘myopic’ policymakers, for whom short-term considerations are important. An analysis of the economic effects using the Bank of Canada’s Global Economy Model shows that the gains from import tariffs are small: import tariffs raise the price of imports and shift consumption toward domesticallyproduced goods; but they also lead to a real appreciation. This improves the terms of trade, but falling export volumes lead to a reduction in GDP in the long run. The conclusion therefore is that a ‘benevolent’ policymaker would not adopt tariffs, because of negative long-term consequences, but ‘myopic’ policymakers might be tempted to exploit short-term political gains. Given the potentially high costs of protectionist trade policies, protectionism is therefore rightly viewed as an important risk.