©0427950162 WINNERS DON'T DO DIFFERENT THINGS, THEY DO THINGS DIFFERENTLY NEERU CLASSES FOR ALL SUBJECTS OF 11TH, 12TH & F.Y., S.Y., T.Y. B.COM 2nd Floor, Shri Ram Complex, Harni Warasia Ring Road, Near Kalavati Hospital, Vadodara - 390006 T.Y. B.COM (SEM - V) - INTERNATIONAL TRADE (IT) UNIT -II1 TRADE POLICIES AND GAINS FROM TRADE This study material covers: " Gains from International Trade Free trade v/s protection Q.1. What are the gains from trade ? OR Explain the nature of gains from international trade. Al. Introduction International trade provides benefits of international specialization and division of labour. It provides a variety of gains and benefits to all the participating (trading) countries. Nature of gains from the international trade :- Following are different forms of gain to trading countries from international trade - (1) Efficient Utilization of Resources :~ = International trade provides the benefits of geographical division of labour & international specialization. = This leads to optimum allocation and efficient utilization of available resources of the world. (2) Increase in Value :- = Due to international trade, exporting country gets a higher price for its exports and the importing country has to pay less price for its imports. => Thus, there is increase in the exchangeable value of possessions, means of enjoyment and wealth of each trading country (3) Product Mobility (Leading to Equalization of Commodity Prices) :- = We know that the factors are immobile internationally. = But, products, which are produced by using these factors, can move from one country to another country. = Thus, the disadvantage of the immobility of factors is overcome by the product movement between the trading nations. (4) Widens the Size of Market :- = International trade widens the size of market for a country. So, it can dispose off its surplus output. TRADE POLICIES AND GAINS FROM TRADE(5) (6) (7) Q.2. A.2. (1) (2) (3) (4) NEERU CLASSES = On one hand, it reduces the risks of huge investments made in home industries & on the other hand it permits large scale production and reduces the cost of production. = So, the goods are available to the consumers at lowest prices. Varity of Goods Due to international trade, the consumers of each country get wide varieties and better quality of goods in large quantity. World Production :~ = International trade leads to increase in world production. = If every country specializes in the production of goods (in which it has comparative advantages), then world production increases. = This leads to increase in world’s prosperity & living standards of people. World Welfare :- = International trade also increases the welfare of each nation by making available larger output at cheaper cost. = This increases the standard of living of the trading countries. = However each country may not gain equally from trade. The size of gain depends upon many factors. Explain the factors affecting or determining the size of gains to each country from international trade ? OR Does the gain from international trade is shared equally by all the trading partner ? Why ? There are several sources of gain due to international trade. But it would be reasonable to express these sources in terms of factors determining the size of the gain. Following are the important factors determining the size of the gain — Nature of terms of trade :- = The size of gain from trade depends upon the terms of trade. => Terms of trade is the rate at which the goods of one country are exchanged against the goods of another country. => The terms of trade may be favourable or unfavourable depending upon the prices of exports and imports. = A favourable term of trade provides relatively larger share of gain to a country. Differences in Cost Ratios :- = The gain from international trade arises because of the differences in the cost ratios of two commodities in two countries. = If the cost difference is larger, gain will be more. But, if the cost difference is less, gain will be less. Productive efficiency in the country :- = Productive efficiency of a country also influence gain from trade. = If the productive efficiency of a country increases, it can produce goods at lower cost. = So, it can sell its goods at lower price. This will be beneficial to another country. = Further, it leads to an expansion in the volume of trade. So, the total gains from trade will increases. Factor endowment and technological conditions :- = Availability of factors of production and technological development also influence the size of gain = The quantum and quality of factor availability directly affects the size of gain. = If a country has large amount of resources with technological advancement it will get larger gain from trade than another country. TRADE POLICIES AND GAINS FROM TRADE 2Q.3. A3. @ (2) NEERU CLASSES Relative elasticity of demand :- = The size of the gain also depends upon the relative elasticity of demand and elasticity of supply in different countries. = If demand is relatively more elastic, the volume of trade, output and real income will be larger. So, total gain will be larger. = On the other hand, if demand is relatively inelastic, gain is less. Similarly, if supply is relatively inelastic, then gain is more, but if supply relatively elastic, then gain is less. Explain various criteria of measuring gain from international trade. OR 1 2 7 a > The classical economists have adopted following three criteria for measuring the gain from international trade - Reduction in Cost of Production :- = According to classical economists, a country will specialize in the production and export of those goods in which it has comparatively higher cost advantage or lower cost disadvantage = Now, specialization, leads to increase in output and a fall in cost of production. = Further, specialization also leads to improvement in efficiency and productivity of labour, in the export sector. = $0, it is the cost reduction or improvement in marginal physical product of labour, which indicates gains from trade. = This means, gains from trade can be measured in terms of (a) Cost reduction, or (b) Improvement in marginal physical product of labour. So, in the first case, gain from trade can be measured by following formula - G =G-G Where, G = gain from trade, Cz = Per unit cost of production after trade, & C, = Per unit cost of production before trade. Here, if G is negative it indicates cost reduction. So, there is gain from the trade (But, if G is positive it indicates an increase in per unit cost. So, a country will not gain). Similarly, in second case, gain can also be measured by following formula - G = MPP,-MPP, = 20-15 = 5 units (gain) Where, G gain from trade, MPP, = Marginal physical product of labour after trade. MPP, = Marginal physical product of labour before trade. Here, if G is positive, it indicates a gain from trade to a country. (But, if G is negative, it indicates loss). Enhancement of Real Income :- = International trade and specialization results into an increase in real income (the net national product) of the country. = So, increase in real income of a country can be regarded as gain from international trade. Thus, gain can be measured by following formula - TRADE POLICIES AND GAINS FROM TRADE 3(3) NEERU CLASSES G =Y.-Ye Where, Y, = the national income after trade, Y, = the national income before trade. Here, if G is positive, it indicates gain from trade. Terms of Trade :- The most important criteria of measuring gain is terms of trade index. Terms of trade refers to the ratio of export price (P,) to import price (P.,) of a country. Symbolically, It can be expressed as follow - P, ToT = ------ Pry Now, the terms of trade may be favourable or unfavourable to a country. It should be remembered that : B, (a) IF - -- > 1, it indicates that ; Poy A country gets relatively more price for exports as compared to price of imports. So, the terms of trade are favourable to a country and a country will gain from trade. - < 1, the terms of trade are unfavourable to country, So, a country will not get gain from trade (c) If - Poy [Now, greater the value of TOT, larger is the share of a country in total gain from foreign trade. Now, terms of trade depends upon the elasticity of demand in two countries for the goods of each other] 1, then there is neither gain nor loss to a country. Qa. AL. (A) Meaning of Free Trade: (1) Free trade means absence of any restrictions on the movement of goods between the countries. (2) Free trade policy is that type of commercial policy: - which does not impose any restriction on the imports of goods, and - does not give any special favour to domestic goods TRADE POLICIES AND GAINS FROM TRADE 4(c) NEERU CLASSES Arguments in favour of Free Trade (Economic Advantages of Free trade): (1) Optimum use of productive resources: Under free trade policy, a country can allocate its manpower and other resources according to principle of comparative advantage. Production of goods can be increased through application of international division of labor. Therefore factors of production are used in optimum manner. (2) More Earning:- All factors of production are employed for better use. So, they will be able to earn more. Thus, wages, interest and rent will be higher under free trade policy. (3) Cheaper Imports: Because of free trade, imports are available at cheaper prices. The consumers are getting goods at cheaper rate. (However, domestic producers have to face more competition). (4) :- Free trade widens (expands) the size of the market. This leads to better division of labor. The production would be optimum and costs will fall, everywhere. This is beneficial for world as a whole. (5) Increases Competition:- Under free trade policy, domestic producers have to become more efficient for their survival. They have to adopt improved techniques of production and better methods. Thus, free trade has educative effect. (6) Against Monopolies:- Free trade policy prevent monopolies or at least makes them more difficult. (In practice, the policy is not a complete safeguard against monopolies. International and local monopolies may develop.) H :- All free trade policy is abandoned by most of the countries due to following reasons: (1) Under free trade, under developed countries like India have to suffer more because of the competition from the developed countries like U.K. The Indian handicraft industries were destroyed because of (free trade) imports from U.K. Due to competition from foreign developed countries, underdeveloped countries have te face certain problems, such as unemployment, mis- utilization of resources, underdevelopment of market and so on. Therefore, many countries do not apply free trade policy. (2) During war times, free trade policy proved dangerous. For political freedom, this policy is not desirable. In other words, to maintain political independence, economic independence is necessary. For this purpose, trade restrictions are necessary. (3) Countries cannot allow free imports of harmful products. So trade restrictions become necessary. (4) Free trade create cut-throat competition in the world market, many exporters apply dumping. No government can allow this dumping beyond a limit. So trade restrictions become necessary. (5) Free entry of products by powerful foreign companies is harmful for the economic interest of a country. Hence, restrictions are necessary. (6) Infant industries should be protected till they develop. Hence, protection should be given to them in the initial period of their development TRADE POLICIES AND GAINS FROM TRADE 5NEERU CLASSES OR Are you in favour of policy of protection ? Why ? OR Why do most countries adopt regulated trade policy even if free trade policy looks theoretically more sound ? Give reasons. Protection refers to the foreign trade policy of encouraging home industries by giving subsidies to domestic producers, or by imposing customs duties on foreign duties. The term ‘protection’ refers to any policy that raises the price of import substitution and safeguards the interest of domestic producers against foreign competition, Tariff system, i.e customs duties is an important and most common method of protection. By Tariff we mean only those taxes, which are intended to restrict international trade. (1) Infant Industry Argument :- Many economists like Hamilton, F. List, and 1.S. Mill argued that infant industries during the early stages of their development require protection fro keen competition from long-established foreign industries. Such an industry, in the initial stages of its growth, need full protection. For an infant industry, operating costs during the transition period are high. So, it cannot compete with established foreign exporters. So, infant industry requires protection. However, it is argued that protection should be temporary and should be removed immediately after it has performed its function of ‘nursing’. In this regard, it is said that ‘nurse the baby, protect the child, and leave the adult’. It is also argued that protection should be given to only those infant industries, which have potentialities to develop fast and become self-financing and efficient in the long-run. Criticism : The infant industry argument has been opposed on following grounds- (a) It is difficult to decide correctly which infant industry deserves protection (b) Once protection is given, even if it is found unsound, vested interests are created and it becomes almost impossible to withdraw it (c) All sorts of industries begin to claim protection once protection is given on the ground of infant industry. This may result into political corruption. (d) An infent is always an infant. So, it is rarely possible that protection will be given up once it is offered. Protected industries tend to become negligent and depend more and more upon state assistance. However, under certain assumptions, the infant industry argument does seem sound, because protection can speed up industrialization by giving encouragement to newly started industries. (2) Diversification of Industry Argument :- Protection is essential to diversify the industries of a country, when there is unbalanced economy as a result of excessive specialization. Excessive specialization leads to over dependence of a country on other countries. There is dangerous, politically as well as economically. In times of war, imports from foreign countries become difficult and people have to suffer hardships. Economically there is a danger of serious economic dislocation. Therefore, to ensure a harmonious and balance growth of all industries and self-sufficiency, it is necessary to bring about a diversification of industries through protection. Criticisms : This argument has been criticized on the following grounds - (a) Diversification may not be possible due to lack of natural resources. (b) It violates the principle of comparative cost advantage and relative specialization as a basis of international trade. TRADE POLICIES AND GAINS FROM TRADE 6NEERU CLASSES (c) Complete isolation is not possible in the modern world. (d) The diversification argument is weak. Further, protection in any case should not mean complete abandonment of international economic relations. (3) Promotion of Employment Argument :- It is believed that when tariff is imposed, it leads to expansion of employment and incomes. Imposition of tariff restricts certain imports. The money so saved can be spent on the purchase of the products of protected home industries. As the protected industries expand, employment and income in other sectors of the economy also. This requires more capital. So, net investment in capital goods industries rises, This will stimulate further investment, employment and income through ‘acceleration effect’. So, net investment in capital goods industries will rise. This further leads to increase in investment, employment and income. (4) Balance of Payments Argument :- Tariff duty is advocated as one of the most effective instrument to correct disequilibrium in the balance of payments. When restrictions are imposed on imports through tariffs, it will reduce imports. This can correct disequilibrium in Balance of Payments (5) Terms of Trade Argument :- For correcting disequilibrium in the balance of payments, tariff duty can be used. Tariffs can make the terms of trade more favourable to the country. The terms of trade can be improved by making foreigners pay whole or part of the tariffs. If tariff duty is imposed, the price will rise in an importing country and fall in an exporting country. If the demand for the commodity of exporting country is elastic, a small rise in the price will lead to greater fall in demand. If the supply of the commodity is more elastic, the price will rise to a lesser extent. But, if the domestic supply is inelastic, then the price will rise to a larger extent. (6) Revenue Argument :- Protection is also advocated on fiscal grounds. Tariffs are a good source of revenue to a government. This is because, it is the foreigners who pay tariff duties. In India, customs duties have been a very productive source of state revenue. Tariffs are regulated as a superior source of revenue on the following grounds - (a) Tariffs kill two birds with one stone, as these provide revenue to the state as well as protection to home industries. (b) Usually, tariff duty will be borne wholly or partly by the foreigners. (7) The Pauper Labour Argument (Cheap Labour Argument) :~ Particularly in developed countries, protection is advocated in order to protect interest of labour. It is argued that in the absence of protection, there will be unhealthy competition between countries having dear labour and those having cheap labour. In advanced countries, people enjoy high real wages. So, their standard of living will be undermined, if cheap goods are imported from low wage countries. Hence, to protect a country's high standard of living and maintain high wages, tariffs become essential to meet competition from a pauper labour country. This argument, however, overlooked two points — (i) Labour is not the only factor of production. Dear labour does not necessity mean higher cost of production. When capital-intensive technique is adopted, productivity may be high, and the average cost may be lower. (ii) Industrially advanced countries pay high wages not only because labour is scarce, but because it is more efficient and productive. (8) Conservation of National Resources Argument :- Protection is essential to conserve the national resources of a country. This argument is particularly applicable to those countries, which export mineral and other essential raw TRADE POLICIES AND GAINS FROM TRADE 7NEERU CLASSES materials. By restricting exports through high tariffs, national resources should be conserved for the benefit of the country itself. (9) Key Industry Argument :- For rapid economic development, a country should have a stable and sound industrial structure. To achieve this, it must develop its key and basic industries like iron and steel, heavy chemical, metallurgical, etc. Protection is necessary for the development of such key industries. (10) Anti-dumping Measures of Argument :- A foreign country may resort to dumping to capture markets in another country. Here, a high tariff is necessary in order to protect home producers against dumping of foreign goods in the home market at a much lower price that what the foreign monopolist charges in his own country. (B) Non-Economic Arguments : (1) Defense :- From the standpoint of national defense, each country should be self-efficient as far as possible. It should avoid too much dependence upon other countries, even if such avoidance involves an economic loss. If 2 country is dependent on another country for the supply of certain essential articles and war goods, it becomes politically weaker and in times of war, its economy will be in trouble if the supply is stopped. (2) Nationality (Patriotism) :- Protection is essential to satisfy patriotism of the people. It is the duty of every citizen to buy homemade (Swadesh) goods Further, the homemade goods should be available in the right quantity and quality. This is not possible without granting protection to domestic industries. (3) Preservation :- Protection is desirable to preserve certain classes of population or certain occupations. The agricultural community is always considered as an important part of the society, whose interests are affected by the import of cheap foodgrains from outside. Protection is advocated to maintain the price of agriculture at a high level Q.3. Discuss the barriers of international trade. A.3. There are two types of barriers to international trade. (a) Natural Barriers to Trade :- They arise due to the cost and distance involved in the movement of goods and services from one country to another country. (b) Man-made Barriers to Trade :- Such barriers include imposition of tariff and non-tariff_measures and creation of customs ui markets. Such barriers are created by the commercial policy. The effects of natural and man-made barriers are identical i.e. both distort and reduce volume of international trade. Following are ‘different man-made barriers to trade. (A) Tariffs :- Tariffs are visible and the most common instruments of commercial policy. Tariffs are the taxes or duties on the imported or exported goods. But import duties are more common in tariffs. Tariffs raise the *rices of imported goods. So, imported goods become more costly. Further, tariffs also : = discourage imports, = encourage consumption and production of domestic goods and = lead to import- substitution Tariffs lead to a fall in the volume of international trade. It reduces gains from trade. It also reduces consumption and economic welfare of countries. TRADE POLICIES AND GAINS FROM TRADE 8NEERU CLASSES (B) Non-Tariff Barriers :- They are hidden or invisible barriers to trade. They include direct restrictions (quota), monetary restrictions, and technical and administrative regulations. They distort the pattern and volume of international trade. These barriers are as follow :~ (1) Quantitative _Restrictions/Quotas :- The main purpose of quota restrictions is to reduce the quantity of imports. The effects of quotas are more severe than that of tariffs. (2) Monetary Restrictions (Exchange Controls) :- In this case, a country adopts the policy of exchange control. In this measure, there are controls on foreign exchange transactions. Further, foreign exchange is made available for import of only certain items or for imports from only certain countries. This reduces the volume of imports. (3) Administrative and Technical Regulations :- There are a number of administrative and technical barriers (restrictions on trade) e.g. A country may not allow imports of certain items (like foodstuffs or fruits or toys or drugs) on the ground of safety, health, environment and other technical hazards. e.g. US does not allow imports of certain drugs which do not meet requirements’ of safety caps on the drug containers. In addition to above, there are certain regulations regarding labeling, packing, and custom formalities. Many times, there are administrative delay, red-tape and corruption in custom formalities. All these are barriers to trade. (4) Govt. Procurement Policies or State Trading Practices :- Many time, government encourages and protects domestic producers. For this, it uses audio- visual measures (like TV, Radio or Newspaper) to spread the slogans like "Be Indian Buy Indian, Use Swadeshi & not foreign goods", etc. Further govt. promotes domestic products by giving tax concessions, subsidies and other fiscal and monetary measures. All these are man-made or hidden non-tariff barriers. DFOOOOOO TRADE POLICIES AND GAINS FROM TRADE 9