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Protectionism Barriers to Trade

Protectionism - Import Controls



Trade disputes between countries happen because
one or more parties either believes that trade is being
conducted unfairly, on an uneven playing field, or
because they believe that there is an economic or
strategic justification for some form of import control.

Protectionism represents any attempt to impose
restrictions on trade in goods and services. The aim
is to cushion domestic businesses and industries
from overseas competition.
1. Tariffs- a tax that raises the price of imported
products and causes a contraction in
domestic demand and an expansion in domestic supply for example, the average import tariff on
goods entering the Russian economy is 10%, although there will be higher rates for a number of
products
2. Quotas - quantitative limits on the level of imports allowed.
3. Voluntary Export Restraint Arrangements where two countries make an agreement to limit the
volume of their exports to one another over an agreed period of time.
4. Intellectual property laws (patents and copyrights)
5. Technical barriers to trade including product labeling rules and stringent sanitary rules, food safety
and environmental standards. These increase product compliance costs and impose monitoring
costs on export agencies in many countries. Huge scale vertically integrated transnational
businesses can cope with these non-tariff barriers but many of the least developed countries do not
have the some technical sophistication to overcome these barriers.
6. Preferential state procurement policies where a government favour local/domestic producers
when finalizing contracts for state spending e.g. infrastructure projects
7. Export subsidies - a payment to encourage domestic production by lowering their costs. Soft loans
can be used to fund the dumping of products in overseas markets. Well known subsidies include
Common Agricultural Policy in the EU, or cotton subsidies for US farmers and farm subsidies
introduced by countries such as Russia. In 2012, the USA government imposed tariffs of up to 4.73
per cent on Chinese manufacturers of solar panel cells, judging that they benefited from unfair export
subsidies after a review that split the US solar industry.
8. Domestic subsidies government financial help (state aid) for domestic businesses facing financial
problems e.g. subsidies for car manufacturers or loss-making airlines.
9. Import licensing - governments grants importers the license to import goods.
10. Exchange controls - limiting the foreign exchange that can move between countries.
11. Financial protectionism for example when a national government instructs its banks to give
priority when making loans to domestic businesses.
12. Murky or hidden protectionism - e.g. state measures that indirectly discriminate against foreign
workers, investors and traders. A government subsidy that is paid only when consumers buy locally
produced goods and services would count as an example.
Quotas, embargoes, export subsidies and exchange controls are examples of non-tariff barriers




Tariffs



China joined the WTO in 1991 and since then average import tariffs have been falling on a consistent basis.
Our analysis diagram below shows the standard effects of an import tariff on an imported product. The world
price before the tariff is Pw and at this price, domestic demand is Qd and domestic supply is Qs.


Because of the tariff, the import price rises to Pw + T. This causes a contraction in demand to Qd2 and an
expansion of supply to Qs2. The result is that the volume of imports falls to quantity M. Tariffs have welfare
consequences, one of which is that the welfare of consumers who must now purchase the imported product
at a higher price has fallen there is a deadweight loss of consumer surplus. The effects of a tariff on
quantities depend on the price elasticity of demand and price elasticity of supply of domestic businesses that
have been given a cushion of increased competitiveness by the tariff.


Price
Output (Q)
Domestic Demand
Domestic Supply
World Price
Qd Qs
Pw
Pw + Tariff
Qd2 Qs2
Revenue from Tariff
M
Pw + T
Deadweight loss of
economic welfare
from the tariff


Arguments for Protectionism
Infant industry argument: Certain industries possess a possible comparative advantage but have
not yet exploited economies of scale. Short-term protection allows the infant industry to develop its
comparative advantage at which point the protection could be relaxed, leaving the industry to trade
freely on the international market.
Externalities and market failure: Protectionism can also be used to internalize the social costs of
de-merit goods.
Protection of jobs and improvement in the balance of payments
Protection of strategic industries: The government may also wish to protect employment in
strategic industries, although value judgments are involved in determining what constitutes a
strategic sector.
Anti-dumping duties: Dumping is a type of predatory pricing behaviour and a form of price
discrimination. Goods are dumped when they are sold for export at less than their normal value.
The normal value is usually defined as the price for the like goods in the exporters home market.
Recent examples of disputes about alleged dumping have included
o India complaining about the dumping of bus and truck tires from China and Thailand
o The EU imposing an anti-dumping tariff on Norwegian farmed salmon in response to
complaints from farmers in Scotland and Ireland
o EU shoemakers alleging that Chinese and Vietnamese shoe manufacturers have illegally
dumped leather, sports and safety shoes in the EU market
o In 2009 EU imposed temporary "anti-dumping" taxes on Chinese wire, candles, iron and
steel pipes, and aluminum foil from Armenia, Brazil and China.
In the short term, consumers benefit from the lower prices of the foreign goods, but in the longer-term,
persistent undercutting of domestic prices might force the domestic industry out of business and allow the
foreign firm to establish itself as a monopoly. Once this is achieved the foreign owned monopoly is free to
increase its prices and exploit the consumer. Therefore protection, via tariffs on 'dumped' goods can be
justified to prevent the long-term exploitation of the consumer.

The World Trade Organisation allows a government to act against dumping where there is genuine
material injury to the competing domestic industry. In order to do that the government has to be able to
show that dumping is taking place, calculate the extent of dumping (how much lower the export price is
compared to the exporters home market price), and show that the dumping is causing injury. Usually an
anti-dumping action means charging extra import duty on the particular product from the particular exporting
country in order to bring its price closer to the normal value.

Tariffs are not a major source of tax revenue for the Government that imposes them. In the UK for example,
tariffs are estimated to be worth only 2 billion to the Treasury, equivalent to only around 0.5% of the total
tax take. Developing countries tend to be more reliant on tariffs for revenue.

Arguments against Protectionism
1. Market distortion: Protection can be an ineffective and costly means of sustaining jobs.
a. Higher prices for consumers: Tariffs push up the prices faced by consumers and insulate
inefficient sectors from competition. They penalize foreign producers and encourage the
inefficient allocation of resources both domestically and globally.
b. Reduction in market access for producers: Export subsidies depress world prices and
damage output, profits, investment and jobs in many developing countries that rely on
exporting primary and manufactured goods for their growth.
2. Loss of economic welfare: Tariffs create a deadweight loss of consumer and producer surplus.
Welfare is reduced through higher prices and restricted consumer choice.


3. Regressive effect on the distribution of income: Higher prices that result from tariffs hit those on
lower incomes hardest, because the tariffs (e.g. on foodstuffs, tobacco, and clothing) fall on those
products that lower income families spend a higher share of their income.
4. Production inefficiencies: Firms that are protected from competition have little incentive to reduce
production costs. This can lead to X-inefficiency and higher average costs.
5. Trade wars: There is the danger that one country imposing import controls will lead to retaliatory
action by another leading to a decrease in the volume of world trade. Retaliatory actions increase
the costs of importing new technologies affecting LRAS.
6. Negative multiplier effects: If one country imposes trade restrictions on another, the resultant
decrease in trade will have a negative multiplier effect affecting many more countries because
exports are an injection of demand into the global circular flow of income.
7. Second best approach: Protectionism is a second best approach to correcting for a countrys
balance of payments problem or the fear of structural unemployment. Import controls go against the
principles of free trade. In this sense, import controls can be seen as examples of government failure
arising from intervention in markets.
Economic nationalism
o Economic nationalism describes policies to protect domestic consumption, jobs and investment
using tariffs and other barriers to the movement of labour, goods and capital
o Examples of economic nationalism include China's controlled exchange of the Yuan currency, and
the United States' use of tariffs to protect domestic steel production
o The term gained a more specific meaning in recent years after several European Union governments
intervened to prevent takeovers of domestic firms by foreign companies. In some cases, the
national governments also endorsed counter-bids from compatriot companies to create 'national
champions'. Such cases included the proposed takeover of Arcelor (Luxembourg) by Mittal Steel
(India). And the French government listing of the food and drinks business Danone (France) as a
'strategic industry' to block potential takeover bid by PepsiCo (USA
The Collapse in World Trade in 2009



After many years in which global trade in goods and services grew quickly and the ratio of world trade to
world GDP continued to rise, in 2009 there was an abrupt decline in international trade. We see this shown
in the data chart above. The value of global trade in goods and services collapsed 12% in 2009. Several
factors combined to cause the slump in trade:
A freezing of trade credit many exporters have found it difficult to get the finance necessary to
pay for making and then transporting products to overseas markets


Dominance of manufactured products in global exchange: The percentage of world trade now
accounted for by manufactured durable products has grown over the years but in the current
international downturn this is where cancelled orders have been concentrated. Exporting countries
such as Germany and Japan have suffered most from the collapse in demand.
Export quotas: Some food-producing countries have taken steps to limit food exports in the
aftermath of rising world foodstuff prices. They want to make sure that there is sufficient to eat at
affordable prices for their own population first.
The vertical disintegration of global production there is a misconception that iPods are all
made in China. Final assembly might take place there but the broader manufacturing process
including components takes place in more than a dozen countries. A slump in demand for consumer
durable products and capital goods (e.g. new machinery and technology) has hit supply-chain
industries across the world causing a steep decline in intra-industry trade.
Fortunately there was a pick-up in trade in 2010 and two further positive years in 2011 and 2012. That said
the slump in trade was a stark reminder that globalisation is not inevitable.

Trading Blocs and Regional Trade Agreements (RTAs)

Over the years average tariffs and other import controls have
declined, with progress especially marked in developing Asia and in
Eastern Europe after the break-up of the Soviet Union. But the
breakdown of the Doha trade talks has dashed hopes of a globally
based multi-lateral reduction in import tariffs and other forms of
protectionism. In its place there has been a flurry of bi-lateral trade
deals between countries and the emergence of regional trading blocs.

Some of these deals are free-trade agreements that involve a
reduction in current tariff and non-tariff import controls to liberalise
trade in goods and services between countries. The most
sophisticated RTAs include rules on flows of investment, co-
ordination of competition policies, agreements on environmental
policies and the free movement of labour.

Examples of Regional Trade Agreements:
The European Union (EU) a customs union, a single market and now with a single currency
The European Free Trade Area (EFTA)
The North American Free Trade Agreement (NAFTA) created in 1994
Mercosur - a customs union between Brazil, Argentina, Uruguay, Paraguay and Venezuela
Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
Common Market of Eastern and Southern Africa (COMESA)
South Asian Free Trade Area (SAFTA) created in January 2006 and containing countries such as
India and Pakistan
In 2012 alone there were numerous new bi-lateral trade agreements between countries here is a selection:
US Colombia
Panama Peru
China Costa Rica
New Zealand Malaysia
Australia - Malaysia
South Korea United States
European Union South Korea

Each of these is a reciprocal trade agreement between two or more partners that the countries hope will
stimulate cross-border trade and investment. One of the dangers of this bi-lateral approach rather than
progress in reaching multi-lateral trade agreements through the World Trade Organisation is that a
patchwork quilt of trade deals is emerging, including over-lapping agreements between clusters of countries.
Malaysia and Australia have signed
a free trade agreement. The
agreement, which has been in
negotiations since 2005, aims to
scrap the majority of export tariffs.
It is hoped that the deal will boost
trade between the two countries
which currently stands at 8bn a
year on average

Source: BBC news, May 2012.



Far from promoting mutual gains, RTAs might cause numerous distortions of markets. Keep in mind also
that trade agreements can be expensive to monitor eating into some of the economic welfare benefits.

STAGE OF
ECONOMIC
INTEGRATION
NO
INTERNAL
TRADE
BARRIERS

COMMON
EXTERNAL
TARIFF
FACTOR AND
ASSET
MOBILITY
COMMON
CURRENCY
COMMON
ECONOMIC
POLICY
1. Free Trade
Area
X
2. Customs
Union
X X
3. Single Market X X X
4. Monetary
Union
X X X X
5. Economic
Union
X X X X X

Customs Union

The European Union is a customs union. A customs union comprises countries which agree to:
o Abolish tariffs and quotas between member nations to encourage free movement of goods and
services. Goods and services that originate in the EU circulate between Member States duty-free.
However these products might be subject to excise duty and VAT.
o Adopt a common external tariff (CET) on imports from non-members countries. Thus, in the
case of the EU, the tariff imposed on, say, imports of Japanese TV sets will be the same in the UK
as in any other member country.
o Preferential tariff rates apply to preferential or free trade agreements that the EU has entered into
with third countries or groupings of third countries.
o Europe is a huge economic region - The EU (1090bn euro) was the largest exporter of goods in
2009, followed by China (860bn) and the United States (760bn). The EU (1 200bn) was also the
largest importer of goods in 2009, followed by the United States (1 150bn) and China (720bn).
The EU, as well as all its member states are a member of the World Trade Organisation and, officially at
least, subscribes to its free trade ethos. The EU certainly argues in principle for more free trade, but mainly
in areas where free trade is to the advantage of the EU! For example, the EU is ready to use the WTO
appeals mechanism.

1. A customs union shares the revenue from the CET in a pre-determined way in this case the
revenue goes into the EU budget fund. The EU receives its revenues from customs duties from the
common tariff, agricultural levies and countries paying 1% of their VAT base. Payments are also
made through contributions made by member states based on their national incomes. Thus relatively
poorer countries pay less into the EU and tend to be net recipients of EU finances.

2. A single market represents a deeper form of integration than a customs union. It involves the free
movement of goods and services, capital and labour and the concept are broadened to encompass
economic policy harmonization for example in the areas of health and safety legislation and
monopoly & competition policy. Deeper economic and business ties requires some degree of
political integration, which also requires shared aims and values between nations

Trade Creation and Trade Diversion in a Customs Union



The economic effects of the creation and development of a customs union can be analysed both in the short
term and the long term. We make an important distinction between trade creation and trade diversion effects

Trade Creation
o This involves a shift in domestic consumer spending from a higher cost domestic source to a
lower cost partner source within the EU, as a result of the abolition tariffs on intra-union trade
o So for example UK households may switch their spending on car and home insurance away from a
higher-priced UK supplier towards a French insurance company operating in the UK market
o Similarly, Western European car manufacturers may be able to find and then benefit from a cheaper
source of glass or rubber for tyres from other countries within the customs union than if they were
reliant on domestic supply sources with trade restrictions in place.
o Trade creation should stimulate an increase in intra-EU trade within the customs union and should,
in theory, lead to an improvement in the efficient allocation of scarce resources and gains in
consumer and producer welfare.

Trade Diversion
o Trade diversion is best described as a shift in domestic consumer spending from a lower cost world
source to a higher cost partner source (e.g. from another country within the EU-15) as a result of the
elimination of tariff on imports from the partner
o The common external tariff on many goods and services coming into the EU makes imports more
expensive. This can lead to higher costs for producers and higher prices for consumers if previously
they had access to a lower cost / lower price supply from a non-EU country
o The diagram next illustrates the potential welfare consequences of imposing an import tariff on
goods and services coming into the European Union.
o In general, protectionism in the forms of an import tariff results in a deadweight social loss of welfare.
Only short term protectionist measures, like those to protect infant industries, can be defended
robustly in terms of efficiency. The common external tariff will have resulted in some deadweight
social loss if it has in total raised tariffs between EU countries and those outside the EU.
The overall effect of a customs union on the economic welfare of citizens in a country depends on whether
the customs union creates effects that are mainly trade creating or trade diverting.
Focus on East Africa: East Africa creates a single market to boost trade and investment

Price
Output (Q)
Domestic Demand
Domestic Supply
Supply price from EU Supply
Qd2 Qs2
Supply price from outside the EU
Qd1 Qs1
Trade creation access
to cheaper supplies allows
allows a lower price
which benefits consumers
P1
Lower price leads to an
expansion of demand and
a rise in consumer surplus
+ a net improvement in
economic welfare


On 1st July2010 East Africas common market came into force with Burundi, Kenya, Rwanda Tanzania and
Uganda agreeing to the free movement of trade and labour in a trading area of 126 million people. What will
be some of the likely effects? There have been fears that Kenya the economic powerhouse of the five
countries will dominate and that neighbouring countries could be swamped by higher skilled Kenyan workers

The EAC

Initially founded in 1999 by Kenya, Uganda and Tanzania and then joined by Rwanda and Burundi in 2007,
the EAC is a potential precursor to the establishment of the East African Federation, a proposed federation
of its five members into a single state. The EAC launched its own common market for goods, labour and
capital within the region, with the goal of a common currency by 2012 and full political federation in 2015.
This region with a combined population of about 126 million; total yearly economic output of $73bn and; GDP
per capita of $506, is hoping that this move towards a common market will allow goods to move freely across
the region

Free trade

As with the EU, the EAC have already adopted a common external tariff, an identical tax applied to imports
outside the bloc, and allowed duty-free trade with the exception of Kenya, the largest economy. Furthermore,
with the free movement of people and capital, and the abolition of import duties this will free-up the
economies of the EAC although it is likely that free trade will not be fully operational until 2015.
However, there are those that see Kenya, the Germany of the EU, dominating and exploiting the other four
member states.

The Kenyan takeover

Kenya can be seen as the hub of EAC and it will no doubt benefit from this common market. However, it is
the poorer member states of Rwanda and Burundi that could lose out by Kenyas larger businesses
marginalizing the local economy in those countries. Furthermore, the free movement of people might mean
other member states might have to cope with the influx of better-trained Kenyan workers and there is already
concern in Uganda that the local jobs will be taken over by Kenyans. However, in the long-run there is
potential for significant benefits

Benefits of the EAC
1. Small economies find it hard to attract any meaningful investment in a globalised world. With the
creation of a customs union this region has the potential for greater presence in trade and
investment by simply joining forces
2. The EAC Customs Union should provide a fairer and homogeneous set of laws, procedures, external
tariffs etc in order to assist in economic development and poverty reduction.
3. The enlarged market of five countries should not only encourage cross-border investment, but also
foreign investment with the ease of custom clearance formalities and access to a larger consumer
base rather than smaller protected markets. With a regionally administered CET, trade policy will
tend to be more stable and therefore more conducive to economic expansion.
4. For local businesses, there is the opportunity in the region to develop cost advantages by accessing
labour and other resources from the whole of the
5. EAC area without having the burden of tariff protection rates, business transaction costs between
countries and custom clearance formalities. On the
6. Kenyan border they operate 24 hours a day but on the Tanzanian side it is only 12 hours a day. In
some instances truck drivers have been on the border for four days.

The world is ever more being slit up into trading blocs, which dominate international trade negotiations. As
many recent trade talks have ended in stalemate, observers believe regional groupings will play an even
bigger role - more recently bilateral agreements between trading blocs have become more common.
Therefore it will be vital that Africa has a regional trading bloc that can increase its presence in determining
the direction of future trade agreements

Source: Mark Johnston, EconoMax, spring 2011