Why Trade, and What Would Be the Consequences of Protectionism?

Trade liberalization affects the economy via three main channels: (1) efficiency/productivity gains, (2) purchasing power gains for consumers, and (3) consequences on incentives and governance. These give rise to adjustment costs and distributional impacts, as well as potentially large environmental consequences. Much of the impact of possible increases in EU trade barriers can be seen as forfeiting gains from trade, and it would also entail adjustment costs. Possible (but often unlikely) gains for workers in protected industries will be offset by increases in the cost of imported inputs, hurting competitiveness. This is increasingly important due to the rise of global value chains. Protection can also trigger a trade war, with widespread consequences; Noland et al. (2016) estimate that nearly 4.8 million jobs might be lost by 2019 in the U.S. in case of a full-blown trade war. We calculate that for Europe more than 20% of the value of total manufacturing extra-EU imports is composed of products that are not produced locally; this implies that substitution with local production is unlikely in the short to medium run. We discuss two recent episodes of protectionist policies: the U.S. safeguard on tire imports from China (2009-2011), and the U.S. safeguard measure on steel products vis-à-vis all source countries (2002-2003). In both cases, the estimated employment benefit in the industry protected was insignificant, while negative impacts on downstream industries were disproportionately large, including outsourcing jobs overseas. Protected sectors witnessed higher stock share prices – benefitting owners, not workers – and even this was offset by declines in downstream industries. We assess plausible scenarios for the future, in relation with the context of the recent U.S. presidential election. While the new administration’s policy remains highly uncertain, we discuss three main directions it might take: bilateralism, aggressive use of trade defense, and breach of agreed principles. We argue that the best way for the E.U. to defend its interests requires monitoring closely the U.S. practices, defending the rules-based system, and displaying resolve in the willingness to impose reciprocity.