Can Protectionism/Scarcityism Encourage Industry?

Short answer: not likely

Long answer: Protectionists Scarcityists like to argue that protectionism is needed (or can otherwise) to encourage industry.  Foreign competitors use “unfair” practices to undermine the domestic industry and protectionism scarcityism is there to protect the industry from these shenanigans.  This, in turn, will foster more domestic investment and encourage industry.  But how likely is this to be?  Let’s take a look at the logic.

From a protected industry perspective, it is possible that scarcityist policies encourage some investment in that protected industry.  Domestic production increases (although this is merely a substitute for some of the imports and overall output decreases).  This increased production may encourage more investment, but it is hardly guaranteed to.  These protected industries are protected from competition, so there isn’t much incentive to invest and improve; they are output restrictors.

Enlarging our view to the economy as a whole, scarcityism is far more likely to reduce investment and industry.  As I pointed out above, scarcityism works because it reduces output, forcing prices to rise.  This necessarily means consumers have to spend more to achieve the same standard of living.  In turn, this means fewer savings and since savings are funds used for investment, this means less investment.*  Additionally, since imports are reduced, foreigners now have fewer dollars with which to buy exports or invest in the US economy.  Reduced savings, and thus reduced investment, comes from this area as well.

There are secondary effects of scarcityism as well.  Not only does it reduce overall output in an industry, it encourages the use of wasteful use of current resources.  The protected firms are using less efficient methods of production, which is eating up resources that could otherwise have been released for more valuable purposes.  This, in turn, means fewer resources for industry to use and grow.

In order for scarcityism to foster growth, it’d require an awful lot of luck and some highly specific conditions which are improbable in the real world.

*Note that this same logic holds even if consumers switch to a cheaper substitute for the now-more-expensive goods.

Sorry Scarcityists: Demand Curves Still Slope Downward

At Cafe Hayek, Don Boudreaux writes a response to the scarcityist argument, as he puts it:

[P]rotectionism is justified if enough consumers or voters are willing to pay higher prices in order to help workers.

Don lists three reasons why the scarcityists’ reasoning is incorrect.  Below is my addition of a fourth reason from the comments section of that post:

I’d add a fourth one, one which shows that this scarcityist’s plan to save jobs though higher prices cannot work:

When the relative prices of protected domestic goods rises, then some sacrifices must be made. Scarcityists assume, incorrectly, that all the goods where quantity demanded falls is from the importers rather than the domestic producers, and thus only foreigners’ jobs are harmed. But this is not so; we only import a fraction of our goods. If the relative prices of domestic protected goods X, Y, and Z rise, and if the scarcityists do not change their purchases of X, Y, and Z, then necessarily other purchases of domestic goods that were not subject to import competition (say, goods A, B, and C) will be cut back. For instance: if one has to spend more on sugar, steel, and toys, one has less to spend on dinner out, movies, and baseball games.

The scarcityist may respond by saying “But wait! I am not on my budget constraint. I don’t spend every penny I have. I can afford to spend more.” I have two responses to this: 1) Good for you, but for many of us, we are not that wealthy, and 2) Then that necessarily means you are saving less. By saving less, there are less loanable funds, which means less money for people to borrow to build homes and businesses, persue education, buy cars, etc. So, you’re taking jobs away from people in construction, business, education, automaking, etc. In short, as long as relative prices rise, quantity demanded of something has to fall. Why? Scarcity is still a thing.

In his 1971 book “Economic Theory,” Gary Becker has a neat little proof of this (see pages 21-23 of the 2007 edition). A more detailed proof and discussion can be found here: http://www.jstor.org/stable/1827018

 

Savings Is Not A Cost

Don Boudreaux draws my attention to an opinion piece at the Washington Post written by Robert Samuelson.  Don addresses one concern Samuelson has, but I want to address another, more fundamental point.

Samuelson writes (emphasis added):

A simple example shows why the theory works. Consider (hypothetically) widgets. Assume that new technologies cut widget production costs by 20%. These savings must go somewhere, and the chances are that they will be spent, thereby creating new jobs. The major candidates to receive the windfall are: (a) consumers, who could benefit from lower widget prices; (b) widget workers, whose salaries might be boosted; or (c) the shareholders of widget makers, which might raise dividends or build factories.

This logic could be thwarted if the windfall were saved and not spent.

Strictly speaking, this is not true.  If the windfall were saved and not spent, that does not mean that benefits do not occur.  Savings are economically productive, too.  Even if 100% of the windfall were saved, that would mean there are more funds for investment: housing loans, car loans, retirement, business loans, etc.  An increase in savings would help boost the economy, too.

Let’s do some thinking on the margin.  Let’s say that the windfall results in $1m saved.  Taking Samuelson’s argument above at face value, it’d mean that the $1m saved was a loss for the economy.  However, that $1m is loaned out to a new business owner who uses it to build his building, stock his store, and, once up and running hires more workers and produces more wealth for his community and the world.  The economy certainly has benefited.  I would suggest the following edit to Dr. Samuelson’s paragraph (bold and italicized part is my writing):

A simple example shows why the theory works. Consider (hypothetically) widgets. Assume that new technologies cut widget production costs by 20%. These savings must go somewhere, and the chances are that they will be spent, thereby creating new jobs. The major candidates to receive the windfall are: (a) consumers, who could benefit from lower widget prices; (b) widget workers, whose salaries might be boosted; (c) the shareholders of widget makers, which might raise dividends or build factories; or (d) borrowers/investors who now have a larger pool of loanable funds from which to draw, if some of the windfall is saved.

This logic could be thwarted if the windfall were saved and not spent.