Hylke Vandenbussche and Jozef Konings argue in an article at VoxEU.org that there is evidence to suggest that old-fashioned protection can have an unexpected negative effect on firms that are part of a global value chain. In an increasingly globalised world, exporters’ success seems to positively depend on the free entry of imports rather than the other way round.
Protection is often viewed as a powerful instrument to help domestic firms to raise their sales at the expense of foreign importers. But this view is now being challenged by recent research showing that the effects of protection really depend on the international orientation of the firms i.e. whether they are exporters or not. Protected firms that are well integrated in global value chains may actually lose sales whenever the imports of inputs are subject to protection. This observation may not come as a surprise, but it is important to realise that trade policy has not kept pace with this aspect of globalisation.
The main reason is that many of the current WTO rules governing trade protection stem from an era where trade models predicted that all domestic firms would benefit from import protection. Traditional theory models assumed that all firms in the protected industry are import-competing and only sell domestically. However, in recent years an increasing number of papers have shown that even within narrowly defined industries, firms can be very different. Some firms only produce for the domestic market, others mainly export or sell both domestically and internationally. Thus, the question that can be raised is whether all domestic firms benefit from import protection given that some of the protected firms may be exporters
What does this tell us about trade policy?
Some trade policy uses protection as an instrument to protect its domestic import-competing sector. If this policy does not take its negative externality on protected firms’ exports into account, it may have negative long-run consequences. Firms today no longer operate within the confines of a singular country or market, and their operations are increasingly international. Two decades ago, when firms mainly sold domestically, import protection laws may have been an effective way to temporarily boost a country’s trade surplus and current account. It is no longer the case today. In an increasingly globalised world, exporters’ success seems to positively depend on the free entry of imports rather than the other way round.
So we have another reason, if we needed one, to be anti-protection.