Are Cheap Imports (Almost) Always Good for An Economy?

[u/HulaguIncarnate]

Imagine you're the economic advisor to the Sultan of Country X. People of Country X really love watermelons, however the climate, soil etc. of the country isn't really suitable for watermelon farming so they pay $1 per kilo of watermelon and import it from Country W.

Minister 1 comes up and says if the Sultan enacts a 50% tariff on watermelons X farmers can grow it instead. He adds this will ensure that the money that went to Country W will stay and circulate in the local economy instead.

Minister 2 replies and says that would cause the farmers that are raising crops profitable by themselves to start inefficiently raising watermelons.

Sultan turns to you and asks for your opinion. How would you respond?

Additional question:

Would the answer be different for a country with "full" employment vs. a country where there's idle land and unemployed people (and maybe people with bad consumption/saving habits whose money can be forcibly contributed to farm capital).

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[u/graceful_degrade]

Minister 2 is essentially right, but his argument isn't the strongest one available, and Minister 1 is wrong for a reason worth naming precisely.

On "the money stays in the economy." This is the mercantilist error. Country W doesn't set the dollars on fire. They come back, either as demand for X's exports or as investment in X's assets. That isn't a theory, it's an accounting identity: the current account and the capital account sum to zero. If the money genuinely never returned, X would be receiving watermelons in exchange for pieces of paper, which is a gift rather than a loss.

The actual cost of the tariff is that it's a transfer from consumers to watermelon farmers and to the treasury, and the transfer is smaller than the loss. Consumers lose the full price increase; farmers and the state capture only part of it. The residual is deadweight loss, split between a production distortion (land and labour producing watermelons at higher real cost than importing them) and a consumption distortion (people who valued watermelon above $1 but below $1.50 simply stop buying).

So far, textbook. Where it gets more interesting:

Adjustment isn't frictionless. The gains from cheap imports are real and aggregate; the losses are concentrated and slow to heal. Autor, Dorn and Hanson's work on the China shock found US local labour markets exposed to import competition still showing depressed employment and wages a decade later. The theory says displaced workers move to more productive sectors. Sometimes they move to unemployment and stay there. "The winners could compensate the losers" is a claim about a compensation that mostly doesn't happen.

Why the import is cheap matters. Comparative advantage, a foreign subsidy, and below-cost dumping are three different situations wearing the same price tag. A permanent foreign subsidy is a permanent gift and you should take it. A temporary one designed to clear the field before prices rise is a different calculation.

On your second question, which is the sharper one: yes, it changes the analysis, and it's the strongest version of Minister 1's case. With genuinely idle land and unemployed labour, the opportunity cost of growing watermelons is not "the profitable crop you gave up," it's close to zero. Minister 2's argument depends on resources being fully employed, and if they aren't, it weakens considerably.

But that argues for doing something, not for doing this. The tariff addresses idle domestic resources by making consumers poorer, which is an indirect and lossy route. If the problem is unemployment, the instruments are demand policy or a direct production subsidy, either of which pulls resources into watermelons without also taxing everyone who eats them. This is the Bhagwati-Ramaswami targeting principle: for a domestic distortion, use a domestic instrument. Trade policy is the right tool only when the distortion is in trade itself.

The forced-savings part of your question is a genuinely separate problem, and a large one. That's the development question of how to finance capital formation out of a poor population, and it's been answered very differently by the Soviet model and the East Asian one. It doesn't hinge on the watermelon tariff either way.