Protectionism and growth: a question of equilibrium(s)
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Protectionism is a hotly debated topic on the international stage. Often framed as a response to the economic disruptions of globalisation, this policy approach seeks to strengthen domestic industries against foreign competition. However, a recent study by economic researchers suggests that its impact on economic growth and stability is more complex, especially in emerging markets.
Since his return as president of the United States, Donald Trump - an emblematic proponent of protectionism - has intensified efforts to raise tariffs on imports from countries such as China, Canada, Mexico, and the European Union. The goal is to boost American production, by making imported goods more expensive.
However, protectionist policies can have significant secondary effects. Higher prices on imports reduce consumers’ purchasing power and raise production costs for businesses, leading to lower investment and slower economic growth. To mitigate these effects, the government can intervene in various ways, by providing subsidies to industries affected by rising raw material costs for example, offering tax relief, or promoting innovation to enhance local competitiveness.
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During his first term, Trump imposed a 25% tariff on steel and a 10% tariff on aluminium. Shortly after, Ford estimated that these measures added $1 billion to its production costs. The U.S. auto industry, however, later benefited from the Inflation Reduction Act (IRA), a $370 billion initiative passed under Joe Biden in 2022 to support green industrial policy, including incentives for domestic electric vehicle production.
The United States, through its economic power, has no difficulty in cushioning the costs associated with protectionism by taking on debt on international markets. But what happens when an emerging country decides to erect customs barriers? This is the question posed by economic researchers Nastasia Henry and Alain Venditti in the scientific article "On the (de)stabilization role of protectionism" published in 2024 in the Journal of Mathematical Economics.
Behind the Scenes of Emerging Economies
Emerging economies are often burdened with high public debt, and face challenges in securing loans from financial markets. They require substantial funding to develop infrastructure, education, and healthcare systems. Additionally, many of these countries run trade deficits, importing more than they export. Their ability to finance public debt is constrained, however, as financial markets view them as "risky" due to their high debt levels.
In this context, some governments in emerging economies see protectionism as a viable development strategy. By raising tariffs on imported goods, they can generate additional tax revenue, which provide valuable help for in financing public investments.
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A Question of Balance
Researchers Nastasia Henry and Alain Venditti highlight that the effects of protectionism must be considered from a nuanced perspective. Raising tariffs can lead the economy down two very different paths, depending on the circumstances.
When customs duties remain moderate, the economy follows a single equilibrium, which the researchers call the ‘high equilibrium’ - a virtuous cycle. In this scenario, despite high debt, growth remains strong, and economic actors are optimistic: banks lend easily, businesses invest, and consumers spend. The government, benefiting from increased revenue through borrowing, expands public spending, further fuelling growth.
Conversely, if tariffs become too high, the economy shifts toward a second equilibrium, the ‘low equilibrium’, which paints a more subdued picture. Growth slows, banks become more hesitant to lend, investments shrink, and consumption weakens. While tariffs provide the government with additional resources to manage high debt amid sluggish growth, economic activity remains stagnant.
Growth vs. Stability
The study reveals that despite its seemingly favourable performance, the ‘high equilibrium’ trajectory - characterised by strong growth - proves to be unstable. It is subject to what economists call "expectation-driven fluctuations."
Even when there is a single equilibrium with moderate tariffs, the high level of public debt makes the economy highly sensitive to economic actors' expectations and overall sentiment. If businesses and consumers are optimistic about the future, they are more likely to invest and spend, driving further growth. In other words, confidence fuels action, and as a result, growth materialises.
However, these self-fulfilling expectations work in both directions. If uncertainty arises, the situation can deteriorate quickly. A mere rumour of economic trouble can lead to reduced consumption, investment, and borrowing, triggering heightened volatility - periods of growth followed by phases of recession.
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However, this scenario can worsen if tariffs become too high. The existence of the ‘low equilibrium’ trajectory, associated with weaker growth, can serve as a reference point for economic expectations.
Along this path, tighter credit constraints restrict borrowing and investment, further deteriorating the economic environment. If doubts arise about debt sustainability, expectations may align with this lower equilibrium, pushing the economy into a prolonged recession. In this case, higher tariffs not only fail to stabilise the economy but instead heighten economic instability - an inherent vulnerability of highly-indebted economies.
The Surprising Effect of Customs Duties
Another phenomenon revealed by the study is that a further increase in customs barriers has paradoxical consequences depending on the economic trajectory.
In the high-growth scenario, the increase in tariffs produces an unexpected boomerang effect, slowing growth. The reason for this is that the trajectory is essentially based on public spending as a growth engine. The government uses tax revenues to invest in the economy. However, when taxes increase further, a negative effect occurs. Households, faced with higher prices, are seeing their purchasing power decrease. Companies, faced with higher costs, are reducing their investments. Faced with this, the small increase in taxes relative to the government's public spending does not significantly increase growth capacities. The net effect then corresponds to a contraction in economic activity that eventually reduces tax revenues, further limiting the government's ability to stimulate the economy.
On the contrary, in the low-growth scenario, an increase in tariffs can provide an additional boost. This situation can be explained by the fact that growth here is driven by private investment. When taxes rise, even if private investment decreases, it is offset because the additional revenues allow the government to significantly increase its public investment. The net effect is then positive and growth is stimulated.
In a world where trade tensions are intensifying, this study sheds new light on the impacts of protectionism, particularly on internal market mechanisms. As an economic policy tool, it can have unexpected effects. The results of this study underline the need to take into account the specificities of each economy, and the trade-offs between different economic objectives: growth or economic stability, particularly for emerging economies faced with strategic development choices.
