People who support domestic-content (or "local-content") laws for imported automobiles argue that they would reduce unemployment in the United States. They are wrong.
As long as the United States maintains a floating exchange rate, the adoption of protectionist measures to help one industry will merely shift jobs from elsewhere in the economy to the favored sector, with no significant effect on total employment. Changes in the exchange rate for the dollar are the mechanism through which output and jobs are lost in the unprotected industries. Protectionism is never a sensible way to increase domestic employment, but it is wholly self-defeating for a country with a floating exhchange rate.
Under fixed exchange rates, it might be possible to view the short-term effects of a tariff solely in terms of impact on the protected industry, because there would be no exchange rate movement to cause undesirable effects elsewhere in the economy. If foreign countries did not retaliate against U.S. restrictions on car imports, for example, employment would increase in Detroit without loss of jobs elsewhere in the United States.
But since the exchange rates began to float in 1973, this is no longer true. A decision to apply domestic-content rules to cars sold in the United States, for example, would greatly reduce imports from Japan, causing a parallel decline in the U.S. demand for yen to pay for those cars. The yen would then depreciate and the dollar would appreciate until the balance in international transactions was restored. As consumers in the United States and abroad responded to this change in relative prices by purchasing fewer U.S. goods and more foreign products, sales and employment would be lost in a range of U.S. industries. The U.S. car industry might gain from the imposition of domestic-content rules, but other domestic industries that must compete in world markets would lose. Total employment in the U.S. economy would not increase.
With fixed exchange rates among currencies, the worldwide employment effects of U.S. protectionism would be a "zero-sum game," in that job gains in the United States would be offset by job losses abroad. Under the existing system of floating exchange rates, the effects of protectionism on employment are a "zero-sum game" within the United States. Job gains in Detroit are matched by job losses in Boston and Seattle, with exchange rate changes imposing the losses on unprotected parts of the U.S. economy.
A statistical study has recently been completed in the Labor Department supporting this argument. It concludes that the original form of the domestic-content bill would create about 300,000 jobs in automobile manufacturing and related industries, but that about the same number of jobs would be lost elsewhere in the U.S. economy as the exchange rate for the dollar rose. The study indicates that the apparel and electronic components industries would be particularly injured by the exchange rate change, and that computers and commercial aircraft would also be seriously affected. The study suggests that because the U.S. auto industry uses fewer workers per milion dollars in sales than do many other affected industries, the adoption of the domestic-content bill for cars might actually cause a slight net loss of employment in the United States.
It is surprising that industries such as apparel and computers have not realized that protectionism for automobiles would hurt them, and entered the lobbying battle against the domestic- content bill. The late Harry Johnson of the University of Chicago argued many years ago that floating exchange rates were a good idea precisely because they would destroy the traditional arguments for tariffs and encourage an era of free trade. He optimistically assumed that politicians and lobbyists would understand that protection for one industry was merely a tax on other domestic industries under floating exchange rates. But it doesn't seem to be working out that way. Walter Mondale's conversion to protectionism is a particularly unfortunate example.
If Washington wants to help U.S. industries compete against foreign firms, the first goal must be to reverse the sharp increase in the exchange rate for the dollar that has occurred during the last 18 months. A decline of the dollar to more realistic levels would be expensive for American tourists abroad, but it would greatly help U.S. industries that compete against imports, such as cars and apparel, and those that export, such as computers and aircraft.
Bringing down the exchange rate for the dollar requires a continuing decline in U.S. interest rates. Although interest rates are determined by a number of factors, predictions of huge federal deficits have been a dominant element in maintaining high U.S. yields since early 1981. Gaining permanent control over federal deficits requires decisions that are painful and politically risky. It is far easier for politicians to promise help for U.S. workers and industries through domestic- content rules and other protectionist policies. Such an approach will actually produce no increase in employment or any other help for the economy, but that result would be apparent only in the long run. Election results are always in the short run.