Impact of Protectionist Policy on Macroeconomic Stability: A Case Study of United States and Australia

This paper analyzes the impact of protectionist policy on macroeconomic stability of United States and Australia. It discusses the recent protectionist measures taken by Donald Trump and its likely consequences on the economy. The paper also evaluates the welfare analysis of protectionist policy.

Running head: ECONOMICS FOR BUSINESS
Economics for Business
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Table of Contents
Introduction......................................................................................................................................2
Analysis...........................................................................................................................................2
Stability in macroeconomic equilibrium.....................................................................................2
Protectionist policy and its impact on United State.....................................................................3
Protectionist policy and its impact on Australia..........................................................................4
Welfare analysis of protectionist policy..........................................................................................6
Conclusion.......................................................................................................................................7
Reference list...................................................................................................................................8

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Introduction
Trade protectionism measures refer to form of policies aiming to restrict unfair
competition generated from foreign nation. Protectionist policy is generally a defensive measures
motivated politically. One common method of implementing protectionists measure is to impose
tariff or tax on import. Direct impact of this policy is to raise the price of imported goods.
Second way is to provide subsidy to local industries. Government now a day imposes a quantity
restriction or import quota as an effective measure of protection (Helpman & Razin, 2014). The
interventionist measures taken by the government affects macroeconomic stability of an
economy. The paper discusses recent protectionists policy measure taken by Donald Trump and
its likely consequences on economy of United State and Australia.
Analysis
Stability in macroeconomic equilibrium
Figure 1: Stable macroeconomic equilibrium
(Source: as created by Author)

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Macroeconomic equilibrium is attained where planned injections in the economy matches
with planned withdrawals. It is a stable economic equilibrium in the sense that that investment,
government spending and export earnings match with taxation, saving and spending on imports.
It also corresponds to equalization of planned aggregate demand and planned aggregate supply.
Figure 1 portrait long run equilibrium in an economy. Long run equilibrium is attained where
potential long run supply (LRAS), short run aggregate supply (SRAS) and aggregate demand
meet at a point. Any deviation in either of the three components interrupts stability in the
economy and calls for correction. Classical economist suggested self-adjustment mechanism for
correcting instability (Kawai & Takagi, 2015). Keynesian school of economists on the other
hand suggested that government intervention is needed to correct instability in the economic
state. Government use different stabilization tools depending on state of the economy.
Protectionist policy and its impact on United State
Donald Trump, the president of United State has shaken the international trade basis in
terms of imposing a higher tariff on imported goods worth billions of dollar from EU, Mexico,
China and Canada. The widening trades’ deficit of United State has held responsible behind such
protectionists measures. Import restriction has mainly been placed on import of steel and
aluminum (bbc.com, 2018). Hiking the tariff rate is not the only measure of protectionism.
President has also abandoned Trans-Pacific Partnership and announced to deviate from North
American Free Trade Agreement.
The impact of such protectionist measures on short run and long run equilibrium can be
evaluated using the figure.

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Figure 2: Short run and long run impact in United State
(Source: As created by Author)
The initial stable equilibrium in the economy is shows at E. Protectionist policy measures
would restrict inflow of final and intermediary goods export in United State. This alters the short
run aggregate supply leftward to SRAS1. The new shirt run equilibrium occurs at point E1 with a
lower real GDP at Y1. As actual GDP is less than the potential GDP, there is a negative output
gap of the amount E1F. The supply shortage however leaves US companies to purchase from
domestic sellers in US (Lowande, Jenkins & Clarke, 2018) The increased price and demand of
domestic products encourage suppliers to supply more. The supply curve then shifts to outward
and long run equilibrium is reinstated at E.
Protectionist policy and its impact on Australia
Protectionist policy of Donald Trump in the form of higher tariff initially has initially
exempted any such measure on Australia (pwc.com.au, 2018). This though is a positive sign for
Australian businesses the potential risk on Australian economy cannot be ignored. If tariffs are
imposed on other industries, then this might impact Australia through reduced export. US

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however has imposed significant tariff on imports from China triggering a trade war between US
and China. The resulted trade war has possible impact on Australian economy.
In the short run, the impact on Australian business will be limited as Australia until
Australia is not targeted directly. Given the fact that Australia till now is exempted from the
proposed import tariff and United State actually maintains a trade surplus with Australia, the
nation is unlikely to come to closer target of such protectionist policy (dynamicbusiness.com.au,
2018). From short term perspective Australia might be benefitted from US-China trade war
provided it can meet the substitute demand.
The long term impact on Australian economy however is uncertain. If the policy pursues
in future and there is no political negotiation economy will be hit along with a decline in global
economic growth.
Figure 3: Short run and long run impact in Australia
(Source: As created by Author)

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The slow-down of China’s economy hurt Australian export reducing aggregate demand.
Aggregate demand curve swings to the left to AD1. This changes the short run equilibrium to the
left to E2. The economy is then left with a negative output gap of E2G. In the long run, aggregate
demand however expands in response to weak Australian dollar and other external forces
(Slopek, 2018). The aggregate demand thus back to AD restoring economic stability.
Welfare analysis of protectionist policy
The figure below illustrates the welfare impact of an imposed tariff. The proposed tariff
by Donald Trump would alter surplus to consumers, producers and aggregate welfare.
Figure 4: Impact of an import tariff
Without tariff, the world price is given as PWorld. The imposition of tariff increases the
price to Ptariff. The increase in price after tariff imposition reduces consumer surplus by the area A
+ B + C + D. As demand in the domestic market increases, producers enjoy an increased surplus
of A. Volume of import lowered to (Q4 – Q3) from earlier (Q2 – Q1) (McGillivray, 2018).

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Government though earns a revenue shown by C, the society suffers a dead weight loss as given
by the area B + D.
Conclusion
In view of on-going trade deficit of United State, President Donald Trump has announced
some protectionists measures to restrict trade flow in United State. A significant higher tariff has
been imposed on steel and aluminum coming from China, Mexico and some EU nation. In
United State, immediate impact is to a reduction in aggregate supply. This though benefits
domestic producers by raising but causes an overall welfare loss. Australia though is initially
excluded from tariff imposition the impact on Australia is indirect. Australia impacted from
resulted US-China trade war and an overall decline in global economic growth.

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Reference list
bbc.com. (2018). What is a trade war and why should I worry? Retrieved from
https://www.bbc.com/news/world-43512098
Helpman, E., & Razin, A. (2014). A theory of international trade under uncertainty. Academic
Press.
Huang, R. (2018). How will Australian business be affected by Trump’s protection. Retrieved
from https://www.dynamicbusiness.com.au/news/how-will-australian-business-be-
affected-by-trumps-protection.html
Kawai, M., & Takagi, S. (2015). Improving Macroeconomic Stability. In Rebalancing for
Sustainable Growth (pp. 65-102). Springer, Tokyo.
Lowande, K. S., Jenkins, J. A., & Clarke, A. J. (2018). Presidential particularism and US trade
politics. Political Science Research and Methods, 6(2), 265-281.
McGillivray, F. (2018). Privileging industry: The comparative politics of trade and industrial
policy. Princeton University Press.
pwc.com.au. (2018). Trump’s Trade War: what does this mean for Australian Businesses?
Retrieved from https://www.pwc.com.au/tax/taxtalk/assets/alerts/trumps-trade-war-
16mar18.pdf
Slopek, U. D. (2018). Export Pricing and the Macroeconomic Effects of US Import
Tariffs. National Institute Economic Review, 244(1), R39-R45.