The Welfare Effects of Protection: A General Equilibrium Analysis of Canada’s National Policy

In this paper, we study the impact of Canada’s adoption of protectionist trade policy in 1879 on Canadian welfare. Under the National Policy the Canadian average weighted tariff increased from 14% to 21%. The conventional view is that this was a distortionary policy that negatively affected Canadian welfare. We argue that this view is incomplete because it ignores general equilibrium effects. Using a multi-industry general equilibrium model with differentiated goods, we show that the welfare effects of tariffs can potentially be positive, even for small open economies, due to their impact on the terms of trade. We apply these theoretical insights in a reassessment of the welfare consequences of the National Policy for Canada using newly compiled granular trade and production data from 1870 to 1913, and newly estimated historically contemporaneous import demand elasticities. Our results suggest that the National Policy’s tariff changes actually improved Canadian welfare by between 0.13% to 0.20% of gross domestic product, although a multilateral move to free trade would have resulted in an even better welfare outcome for Canadians.