TOPIC FIVE

INTERNATIONAL TRADE AND INSTRUMENTS OF TRADE POLICY

Learning objectives

 Explain the need for international trade

 Explain tariff and non-tariff trade barriers

 Explain arguments for and against free trade

 Arguments in favor and against Protectionism

 Explain the rationale for and stages of economic integration

 Explain the role of World Trade Organization (WTO) in international trade


International trade means trade between the two or more countries. International trade
involves different currencies of different countries and is regulated by laws, rules and
regulations of the concerned countries. Thus, International trade is more complex.

The buying and selling of goods and services across national borders is known as
international trade. International trade is the backbone of our modem, commercial
world, as producers in various nations try to profit from an expanded market, rather
than be limited to selling within their own borders. There are many reasons that
trade across national borders occurs, including lower production costs in one region
versus another, specialized industries, lack or surplus of natural resources and
consumer tastes.

There are two basic types of trade between countries:

 The first in which the receiving country itself cannot produce the goods or
provide the services in question, or where they do not have enough.

 The second, in which they have the capability of producing the goods or
supplying the services, but still import them.

The rationale for the first kind of trade is very clear. So long as the importing country
can afford to buy the products or services they are able to acquire things which,
otherwise they would have to do without. Examples of differing significance are the
import of bananas into the UK, in response to consumer demand, or copper to China, an
essential for Chinese manufacturing industry.

The second kind of trade is of greater interest because it accounts for a majority of world
trade today and the rationale is more complex. The UK imports motor cars, coal, oil, TV
sets, domestic appliances and white goods, IT equipment, clothing and many more
products which it was well able to produce domestically until it either transferred
production abroad or ceased production as local industries became uncompetitive. At
first sight, it would seem a waste of resources to import goods from all over the world in
which a country could perfectly well be self-sufficient.

However, the reasons for importing this category of product generally fall into three
classifications:

 The imported goods may be cheaper than those produced domestically;

 A greater variety of goods may be made available through imports;
 The imported goods may offer advantages other than lower prices over domestic
production better quality or design, higher status (eg prestige labeling), technical
features, etc
However, international trade among different countries is not a new a concept. History
suggests that in the past there were several instances of international trade

The economic, political, and social significance of international trade has been
theorized in the Industrial Age. The rise in the international trade is essential for
the growth of globalization. The restrictions to international trade would limit the
nations to the services and goods produced within its territories, and they would
lose out on the valuable revenue from the global trade. International trading provides
countries and consumers the chance to be exposed to those services and goods
that are not available in their own country. International trading lets the developed
countries use their resources effectively like technology, capital and labor. As many of
the countries are gifted with natural resources and different assets (labor, technology,
land and capital), they can produce many products more efficiently and sell at
cheaper prices than other countries. A country can obtain an item from another
country if it cannot effectively produce it within the national boundaries.

International trade has flourished over the years due to many benefits it has
offered to different countries across the globe. With the help of modem production
techniques, highly advanced transportation systems, transnational corporations,
outsourcing of manufacturing and services, and rapid industrialization, the
international trade system is growing and spreading very fast.

The role of International trade

 International trade has played an important role as a major driver of

economic growth for the latter half of the 20th century. Nations with strong
international trade have become prosperous and have the power to control
the world economy. International trade has a major role in economic
development of any country. International trade has significant role in following
key areas of economic development:

 Through specialization and increased world output, international trade

expands the range of commodities available to the population and thus
increases choice and welfare of the population. International trade provides
countries with access to resources, which they may not have naturally. It
provides access to markets for products which may not be consumed
domestically. In this way, international trade stimulates economic growth.

 Trade leads to increased and more efficient use of a nation’s resources. As seen
from the Hecksher- Ohlin model, it leads to factor price equalization and a
rise in the real incomes of resource owners.
 An outward looking trade policy is superior to partial or complete isolation.
International trade leads to higher output, increased consumption and higher
rewards for those sectors where a country has comparative advantage.

 International trade helps to attract foreign investment to exploit a country’s

comparative advantage. This can also result into investment in other sectors of
the economy. For example, mining and export of minerals can lead to new
investments in power generation, plantation agriculture, tourism, etc. When
markets and good relations are created abroad. Expanded markets would lead to
increased supply of foreign investment, domestic savings and skilled labour. The
international trade helps expand economy by outward shift of Production
Possibility Frontier (PPF) and allows consumption outside of PPF. Under
the field of macroeconomics PPF represents the point at which an economy
is most efficiently producing its goods and services and, therefore, allocating
its resources in the best way possible

 Export-led growth creates linkages which stimulate the development of other

industries. A steady growth of an export industry, such as textiles may
create sufficient demand for some input such as dyes to warrant its
production. This is the backward linkage associated with trade. For example,
the wheat industry in North America created sufficient demand for rail
transport and farm equipment so that these industries had to be established.

 International trade may lead the development of infrastructure such as

roads, rails, power plants and telecommunications to facilitate trade.

 Foreign trade, especially the export sector may encourage the development
of local entrepreneurs and skilled labour. Trade leads to travel and exposure
to different places and cultural, which can promote learning and enhance
experience.

 International trade enhances competitiveness of domestic industry as

domestic industry is required to compete with international products which
may be of superior quality and at a lesser price.
From an individual company’s point of view international trade offers
following benefits

 Enables overcoming domestic marketing constraints like saturated market, small

size of market, recession in domestic market etc.
 Helps to achieve economies of scale of production.
 Company can tap growth opportunities in other countries.
 Sometimes selling in international markets may enable to earn high profits in
overseas markets than domestic market. Company can avail benefit of
government policies and regulations like tax concessions and other incentives.
 Company can enjoy spin-off benefits like improvement image of a company and
develop better products in domestic market also due to development of quality
culture in company.

Need for International Trade

In today’s global economy, international trade is at the heart of development. Nations

developed or underdeveloped trade with each other, because trade is mutually
beneficial. In other words, the basic motivation of trade is the gain or benefit that
accrues to nations.

In a state of autarky or isolation, benefits of international division of labour do not flow

between nations. It is advantageous for all the countries of the world to engage in
international trade. However, the gains from trade can never be the same for all the
trading nations. Thus, benefits or gains from trade may be inequitable; but what is true
is that “some trade is better than no trade”.

Here are basic reasons for international trade:

Differences in Technology

Advantageous trade can occur between countries if the countries differ in their
technological abilities to produce goods and services. Technology refers to the
techniques used to turn resources (labor, capital, land) into outputs (goods and
services).

Differences in Resource Endowments

Advantageous trade can occur between countries if the countries differ in their
endowments of resources. Resource endowments refer to the skills and abilities of a
country’s workforce, the natural resources available within its borders (minerals,
farmland, etc.), and the sophistication of its capital stock (machinery, infrastructure,
communications systems).
Differences in Demand

Advantageous trade can occur between countries if demands or preferences differ

between countries. Individuals in different countries may have different preferences or
demands for various products. For example, the Chinese are likely to demand more rice
than Americans, even if consumers face the same price. Canadians may demand more
beer, the Dutch more wooden shoes, and the Japanese more fish than Americans would,
even if they all faced the same prices. There is no formal trade model with demand
differences, although the monopolistic competition model in Chapter 6 "Economies of
Scale and International Trade" does include a demand for variety that can be based on
differences in tastes between consumers.

Existence of Economies of Scale in Production

The existence of economies of scale in production is sufficient to generate advantageous

trade between two countries. Economies of scale refer to a production process in which
production costs fall as the scale of production rises. This feature of production is also
known as “increasing returns to scale

Existence of Government Policies

Government tax and subsidy programs alter the prices charged for goods and services.
These changes can be sufficient to generate advantages in production of certain
products. In these circumstances, advantageous trade may arise solely due to differences
in government policies across countries. "Consumption Taxes as a Reason for Trade"
provide several examples in which domestic tax or subsidy policies can induce
international trade.

NOTE

There is, however, a strong debate around the role of trade in the development of mainly
less developed countries. Historically, there was a consensus amongst many people that
trade acts as an ‘engine of growth’ (in the 19th century and early 20th century). But in
the 1950s, evidence showed that benefits of trade did not accrue to the LDCs; trade was
beneficial to the developed countries only.
 Theories of international trade
In this sub-topic, we examine the development of trade theory from the seventeenth
century through the first part of the twentieth century. This historical approach is useful
not because we are interested in the history of economic thought as such, but because it
is a convenient way of introducing the concepts and theories of international trade from
the simple to the more complex and realistic

The basic questions that we seek to answer in this sub topic are:

1. What is the basis for trade and what are the gains from trade? Presumably (and as in
the case of an individual), a nation will voluntarily engage in trade only if it benefits
from trade. But how are gains from trade generated? How large are the gains and how
are they divided among the trading nations?

2. What is the pattern of trade? That is, what commodities are traded and which
commodities are exported and imported by each nation?

We then go onto discuss the theory of absolute advantage, developed by Adam Smith. It
remained, however, for David Ricardo, writing some 40 years after Smith, to truly
explain the pattern of and the gains from trade with his law of comparative advantage.
The law of comparative advantage is one of the most important laws of economics, with
applicability to nations as well as to individuals and useful for exposing many serious
fallacies in apparently logical reasoning.

The earliest theory of international trade was mercantilist view on trade. During
the seventeenth and eighteenth centuries a group of men (merchants, bankers,
government officials, and even philosophers) wrote essays and pamphlets on
international trade that advocated an economic philosophy known as mercantilism.
Briefly, the mercantilists maintained that the way for a nation to become rich and
powerful was to export more than it imported. The resulting export surplus would then
be settled by an inflow of bullion, or precious metals, primarily gold and silver

The mercantilists believed that a nation could gain in international trade only at the
expense of other nations. As a result, they advocated restrictions on imports, incentives
for exports, and strict government regulation of all economic activities
The law of Absolute Advantage

According to Adam Smith, trade between two nations is based on absolute advantage.

When one nation is more efficient than (or has an absolute advantage over) another in
the production of one commodity but is less efficient than (or has an absolute
disadvantage with respect to) the other nation in producing a second commodity, then
both nations can gain by each specializing in the production of the commodity of its
absolute advantage and exchanging part of its output with the other nation for the
commodity of its absolute disadvantage. By this process, resources are utilized in the
most efficient way and the output of both commodities will rise. This increase in the
output of both commodities measures the gains from specialization in production
available to be divided between the two nations through trade.

For example, because of climatic conditions, Canada is efficient in growing wheat but
inefficient in growing bananas (hothouses would have to be used). On the other hand,
Nicaragua is efficient in growing bananas but inefficient in growing wheat. Thus,
Canada has an absolute advantage over Nicaragua in the cultivation of wheat but an
absolute disadvantage in the cultivation of bananas. The opposite is true for Nicaragua.

Under these circumstances, both nations would benefit if each specialized in the
production of the commodity of its absolute advantage and then traded with the other
nation. Canada would specialize in the production of wheat (i.e., produce more than
needed domestically) and exchange some of it for (surplus) bananas grown in
Nicaragua. As a result, both more wheat and more bananas would be grown and
consumed, and both Canada and Nicaragua would gain.

Illustration of Absolute Advantage

Consider the table below

USA UK
Wheat (bushels/hour) 6 1
Cloth (yards/hour) 4 5

The table above shows that one hour of labor time produces six bushels of wheat in the
United States but only one in the United Kingdom. On the other hand, one hour of labor
time produces five yards of cloth in the United Kingdom but only four in the United
States. Thus, the United States is more efficient than, or has an absolute advantage over,
the United Kingdom in the production of wheat, whereas the United Kingdom is more
efficient than, or has an absolute advantage over, the United States in the production of
cloth. With trade, the United States would specialize in the production of wheat and
exchange part of it for British cloth. The opposite is true for the United Kingdom

Absolute advantage, however, can explain only a very small part of world trade today,
such as some of the trade between developed and developing countries. Most of world
trade, especially trade among developed countries, could not be explained by absolute
advantage.

It remained for David Ricardo, with the law of comparative advantage, to truly explain
the basis for and the gains from trade. Indeed, absolute advantage will be seen to be only
a special case of the more general theory of comparative advantage.

The Law of Comparative Advantage

According to the law of comparative advantage, even if one nation is less efficient than
(has an absolute disadvantage with respect to) the other nation in the production of
both commodities, there is still a basis for mutually beneficial trade. The first nation
should specialize in the production and export of the commodity in which its absolute
disadvantage is smaller (this is the commodity of its comparative advantage) and import
the commodity in which it’s absolute disadvantage is greater (this is the commodity of
its comparative disadvantage).

USA UK
Wheat (bushels/hour) 6 1
Cloth (yards/hour) 4 2

The statement of the law can be clarified by looking at Table 2.2. The only difference
between Tables 2.2 and 2.1 is that the United Kingdom now produces only two yards of
cloth per hour instead of five. Thus, the United Kingdom now has an absolute
disadvantage in the production of both wheat and cloth with respect to the United
States.

However, since U.K. labor is half as productive in cloth but six times less productive in
wheat with respect to the United States, the United Kingdom has a comparative
advantage in cloth. On the other hand, the United States has an absolute advantage in
both wheat and cloth with respect to the United Kingdom, but since its absolute
advantage is greater in wheat (6:1) than in cloth (4:2), the United States has a
comparative advantage in wheat. To summarize, the U.S. absolute advantage is greater
in wheat, so its comparative advantage lies in wheat. The United Kingdom’s absolute
disadvantage is smaller in cloth, so its comparative advantage lies in cloth. According to
the law of comparative advantage, both nations can gain if the United States specializes
in the production of wheat and exports some of it in exchange for British cloth. (At the
same time, the United Kingdom is specializing in the production and exporting of cloth.)
Note that in a two-nation, two-commodity world, once it is determined that one nation
has a comparative advantage in one commodity, and then the other nation must
necessarily have a comparative advantage in the other commodity.

The Case of No Comparative Advantage

There is one (not very common) case where there is no comparative advantage. This
occurs when the absolute disadvantage that one nation has with respect to another
nation is the same in both commodities. For example, if one hour produced 3W instead
of 1W in the United Kingdom (see previous table). The United Kingdom would be
exactly half as productive as the United States in both wheat and cloth. The United
Kingdom (and the United States) would then have a comparative advantage in neither
commodity, and no mutually beneficial trade could take place.

USA UK
Wheat 6 3
(bushels/hour)
Cotton (yards/hour) 4 2

The reason for this is that (as earlier) the United States will trade only if it can exchange
6W for more than 4C. However, now the United Kingdom is not willing to give up more
than 4C to obtain 6W from the United States because the United Kingdom can produce
either 6W or 4C with two hours domestically. Under these circumstances, no mutually
beneficial trade can take place.

This requires slightly modifying the statement of the law of comparative advantage to
read as follows: Even if one nation has an absolute disadvantage with respect to the
other nation in the production of both commodities, there is still a basis for mutually
beneficial trade, unless the absolute disadvantage (that one nation has with respect to
the other nation) is in the same proportion for the two commodities.

Although it is important to note this case, its occurrence is rare and a matter of
coincidence, so the applicability of the law of comparative advantage is not greatly
affected. Furthermore, natural trade barriers such as transport costs can preclude trade
even when some comparative advantage exists. At this point, however, we assume that
no such natural or artificial (such as tariffs) barriers exist
 Free Trade Policy
Adam Smith (and the other classical economists who followed him) believed that all
nations would gain from free trade and strongly advocated a policy of laissez-faire (i.e.,
as little government interference with the economic system as possible). Free trade
would cause world resources to be utilized most efficiently and would maximize world
welfare. There were to be only a few exceptions to this policy of laissez-faire and free
trade. One of these was the protection of industries important for national defense.

Trade has always been a routine everyday business activity since ancient times. Today it
is important source of wealth for nations, governments and businesses. Most developed
and developing countries are trying to achieve trade liberalization which includes open
markets, lower tax rates for businesses and free trade in order to maintain and increase
their competitiveness. Free trade is a policy where governments intervene in neither
exports nor imports

In the simplest of terms, free trade is the total absence of government policies restricting
the import and export of goods and services. While economists have long argued that
trade among nations is the key to maintaining a healthy global economy, few efforts to
actually implement pure free-trade policies have ever succeeded. What exactly is free
trade, and why do economists and the general public view it so differently? 

Key Takeaways: Free Trade

 Free trade is the unrestricted importing and exporting of goods and services
between countries.
 The opposite of free trade is protectionism a highly-restrictive trade policy
intended to eliminate competition from other countries.
 Today, most industrialized nations take part in hybrid free trade agreements
(FTAs), negotiated multinational pacts which allow for, but regulate tariffs,
quotas, and other trade restrictions. 

Free Trade Definition

Free trade is a largely theoretical policy under which governments impose absolutely no
tariffs, taxes, or duties on imports, or quotas on exports. In this sense, free trade is the
opposite of protectionism, a defensive trade policy intended to eliminate the possibility
of foreign competition.

In reality, however, governments with generally free-trade policies still impose some
measures to control imports and exports. Like the United States, most industrialized
nations negotiate “free trade agreements,” or FTAs with other nations which determine
the tariffs, duties, and subsidies the countries can impose on their imports and exports.
For example, the North American Free Trade Agreement (NAFTA), between the United
States, Canada, and Mexico is one of the best-known FTAs. Now common in
international trade, FTA’s rarely result in pure, unrestricted free trade.

In 1948, the United States along with more than 100 other countries agreed to the
General Agreement on Tariffs and Trade (GATT), a pact that reduced tariffs and other
barriers to trade between the signatory countries. In 1995, GATT was replaced by the
World Trade Organization (WTO). Today, 164 countries, accounting for 98% of all world
trade belong to the WTO.
Despite their participation in FTAs and global trade organizations like the WTO, most
governments still impose some protectionist-like trade restrictions such as tariffs and
subsidies to protect local employment. For example, the so-called “Chicken Tax,” a 25%
tariff on certain imported cars, light trucks, and vans imposed by President Lyndon
Johnson in 1963 to protect U.S. automakers remains in effect today.
Arguments for Free Trade
There are several key arguments in favor of free trade:

First classic economists David Hume, Adam Smith, David Ricardo recognized the
importance of free markets and free trade that stimulates the efficient use of economy`s
resources and brings economic prosperity. These assumptions and insights argue that
gains from free trade come due to country`s specialization to particular products and
comparative advantage.

Free trade enhances specialization of production in countries or sectors based on

comparative advantage, it broadens the export markets, thus in turn generates growth
of export, but in order to avoid constrains on trade balance, exports should surpass
imports. Furthermore, recent studies indicate that countries with more open market
have higher rate of growth. In addition, by lowering price of fixed capital and increasing
rate of return on capital and savings rate, trade liberalization raises rate of capital
formation. In turn it will lead to the growth of real outputs and real incomes

Free trade increases the size of the economy as a whole. It allows goods and services to
be produced more efficiently. That’s because it encourages goods or services to be
produced where natural resources, infrastructure, or skills and expertise are best suited
to them. It increases productivity, which can lead to higher wages in the long term.
There is widespread agreement that rising global trade in recent decades has increased
economic growth.

Free trade is good for consumers. It reduces prices by eliminating tariffs and
increasing competition. Greater competition is also likely to improve quality and choice.
Some things, such as tropical fruit, would not be available in the UK without trade.

Reducing non-tariff barriers can remove red tape, thus reducing the cost of trading. If
companies that trade in several countries have to work with only one set of regulations,
their costs of ‘compliance’ come down. In principle, this will make goods and services
cheaper. In contrast, protectionism can result in destructive trade wars that increase
costs and uncertainty as each side attempts to protect its own economy. Protectionist
rules can tend to favor big business and vested interests, as they have the resources to
lobby most effectively.
Arguments against free trade
Many economists support free trade. However, in some circumstances, there are
arguments in favor of trade restrictions. These include when developing economies need
to develop infant industries and develop their economy.

Infant industry argument

If developing countries have industries that are relatively new, then at the moment these
industries would struggle against international competition. However, if they invested in
the industry then in the future they may be able to gain comparative advantage.
 This shows that comparative advantage can change over time.
 Protection would allow developing industries to progress and gain experience to
enable them to be able to compete in the future.
 More on infant industry argument

The Senile industry argument

If industries are declining and inefficient they may require significant investment to
make them efficient again. Protection for these industries would act as an incentive to
for firms to invest and reinvent themselves. However, protectionism could also be an
excuse for protecting inefficient firms

Protection against dumping

Dumping occurs when a country has excess stock and so it sells below cost on global
markets causing other producers to become unprofitable. The EU sold a lot of its food
surplus from the CAP at very low prices on the world market; this caused problems for
world farmers because they saw a big fall in their market prices. Other examples include
allegations that China has been dumping excess supply of steel on global markets
causing other firms to go out of business.

To diversify the economy

Many developing countries rely on producing primary products in which

they currently have a comparative advantage. However, relying on agricultural products
has several disadvantages

 Prices can fluctuate due to environmental/weather factors

 Goods have a low-income elasticity of demand. Therefore with economic growth
demand will only increase a little.
Raise revenue for the government.
Import taxes can be used to raise money for the government – however, this will only be
a relatively small amount of money

Help the Balance of Payments

Reducing imports can help the current account as it restricts imports. However, in the
long-term, this is likely to lead to retaliation and also cause lower exports so it might
soon prove counter-productive.

Advantages of Free Trade

 It stimulates economic growth: Even when limited restrictions like tariffs are
applied, all countries involved tend to realize greater economic growth. For
example, the Office of the US Trade Representative estimates that being a
signatory of NAFTA (the North American Free Trade Agreement) increased the
United States’ economic growth by 5% annually.

 It helps consumers: Trade restrictions like tariffs and quotas are implemented to
protect local businesses and industries. When trade restrictions are removed,
consumers tend to see lower prices because more products imported from
countries with lower labor costs become available at the local level.

 It increases foreign investment: When not faced with trade restrictions, foreign
investors tend to pour money into local businesses helping them expand and
compete. In addition, many developing and isolated countries benefit from an
influx of money from U.S. investors.

 It reduces government spending: Governments often subsidize local industries,

like agriculture, for their loss of income due to export quotas. Once the quotas are
lifted, the government’s tax revenues can be used for other purposes.
 It encourages technology transfer: In addition to human expertise, domestic
businesses gain access to the latest technologies developed by their multinational
partners.
Disadvantages of Free Trade

 It causes job loss through outsourcing: Tariffs tend to prevent job outsourcing by
keeping product pricing at competitive levels. Free of tariffs, products imported
from foreign countries with lower wages cost less. While this may be seemingly
good for consumers, it makes it hard for local companies to compete, forcing
them to reduce their workforce. Indeed, one of the main objections to NAFTA
was that it outsourced American jobs to Mexico.

 It encourages theft of intellectual property: Many foreign governments, especially

those in developing countries, often fail to take intellectual property rights
seriously. Without the protection of patent laws, companies often have their
innovations and new technologies stolen, forcing them to compete with lower-
priced domestically-made fake products.

 It allows for poor working conditions: Similarly, governments in developing

countries rarely have laws to regulate and ensure safe and fair working
conditions. Because free trade is partially dependent on a lack of government
restrictions, women and children are often forced to work in factories doing
heavy labor under slave-like working conditions.

 It can harm the environment: Emerging countries have few, if any environmental
protection laws. Since many free trade opportunities involve the exporting of
natural resources like lumber or iron ore, clear-cutting of forests and un-
reclaimed strip mining often decimate local environments.
 It reduces revenues: Due to the high level of competition spurred by unrestricted
free trade, the businesses involved ultimately suffer reduced revenues. Smaller
businesses in smaller countries are the most vulnerable to this effect.
The benefits of free trade have long been understood by economists, thus the faster
trade distortions are removed, the sooner gains from free trade will be enjoyed, as
market accelerates growth and stimulates industrialization. In particular, to consumers
who are winners in broad sense, free trade gives liberty to buy from a worldwide market,
greater choices, lower prices and high quality in available goods. It also enables
consumers to improve their individual welfare through the least cost alternatives and
buy products that are produced according to their ethical and philosophical preferences
 Protectionism policy
Protectionism, an economic policy of restraining trade between nations, through
methods such as tariffs on imported goods, restrictive quotas, and a variety of other
restrictive government regulations is designed to discourage imports, and prevent
foreign take-over of local markets and companies. This policy is closely aligned with
anti-globalization. This term is mostly used in the context of economics; protectionism
refers to policies or doctrines which "protect" businesses and "living wages" within
a country by restricting or regulating trade between foreign nations

Trade protectionism is the deliberate government action to attempt to limit imports or

promote exports by putting up barriers to trade. Despite in arguments in favor of free
trade and increase in openness, protectionism is vital in enhancing trade fairness

A country‘s protectionism will mean the protection of home industries or infant

industries‘(until they are large enough to achieve economies of scale and strong enough
to compete internationally.), producers and consumers.

The Political Economy of Protectionism

In this section, we analyze the various arguments for protection. These range from
clearly fallacious propositions to arguments that can stand up, with some qualification,
to close economic scrutiny.

Fallacious and Questionable Arguments for Protection

One fallacious argument is that trade restrictions are needed to protect domestic labor
against cheap foreign labor. This argument is fallacious because even if domestic wages
are higher than wages abroad, domestic labor costs can still be lower if the productivity
of labor is sufficiently higher domestically than abroad. Even if this were not the case,
mutually beneficial trade could still be based on comparative advantage, with the cheap-
labor nation specializing in the production and exporting of labor-intensive
commodities, and the expensive-labor nation specializing in the production and
exporting of capital-intensive commodities.

Another fallacious argument for protection is the scientific tariff. This is the tariff rate
that would make the price of imports equal to domestic prices and (so the argument
goes) allow domestic producers to meet foreign competition. However, this would
eliminate international price differences and trade in all commodities subject to such
“scientific” tariffs.

Two questionable arguments are that protection is needed;

 To reduce domestic unemployment and

  To cure a deficit in the nation’s balance of payments (i.e., the excess of the
nation’s expenditures abroad over its foreign earnings).

Protection would reduce domestic unemployment and a balance-of-payments deficit by

leading to the substitution of imports with domestic production. However, these are
beggar-thy neighbor arguments for protection because they come at the expense of other
nations. Specifically, when protection is used to reduce domestic unemployment and the
nation’s balance-of-payments deficit, it causes greater unemployment and worsened
balance of payments abroad. As a result, other nations are likely to retaliate, and all
nations lose in the end. Domestic unemployment and deficits in the nation’s balance of
payments should be corrected with appropriate monetary, fiscal, and trade policies
rather than with trade restrictions.

The Infant-Industry and Other Qualified Arguments for Protection

One argument for protection that stands up to close economic scrutiny (but must
nevertheless be qualified) is the infant-industry argument. It holds that a nation may
have a potential comparative advantage in a commodity, but because of lack of know-
how and the initial small level of output, the industry will not be set up or, if already
started, cannot compete successfully with more established foreign firms. Temporary
trade protection is then justified to establish and protect the domestic industry during
its “infancy” until it can meet foreign competition, achieve economies of scale, and
reflect the nation’s long-run comparative advantage. At that time, protection is to be
removed. However, for this argument to be valid, the return in the grown-up industry
must be sufficiently high also to offset the higher prices paid by domestic consumers of
the commodity during the infancy period.

The infant-industry argument for protection is correct but requires several important
qualifications which, together, take away most of its significance.

First of all, it is clear that such an argument is more justified for developing nations
(where capital markets may not function properly) than for industrial nations.

Second, it may be difficult to identify which industry or potential industry qualifies for
this treatment, and experience has shown that protection, once given, is difficult to
remove.

Third, and most important, what trade protection (say, in the form of an import tariff)
can do, an equivalent production subsidy to the infant industry can do better. The
reason is that a purely domestic distortion such as this should be overcome with a purely
domestic policy (such as a direct production subsidy to the infant industry) rather than
with a trade policy that also distorts relative prices and domestic consumption. A
production subsidy is also a more direct form of aid and is easier to remove than an
import tariff. One practical difficulty is that a subsidy requires revenues, rather than
generating them as, for example, an import tariff does. But the principle remains.

The same general principle also holds for every other type of domestic distortion. For
example, if an industry generates an external economy (i.e., a benefit to society at large,
say, by training workers who then leave to work in other industries), there is likely to be
underinvestment in the industry (because the industry does not receive the full benefit
from its investments). One way to encourage the industry and confer greater external
economies on society would be to restrict imports. This stimulates the industry, but it
also increases the price of the product to domestic consumers. A better policy would be
to provide a direct subsidy to the industry. This would stimulate the industry without
the consumption distortion and loss to consumers that result from trade restrictions.
Similarly, a direct tax would also be better than a tariff to discourage activities (such as
automobile travel) that give rise to external diseconomies (pollution) because the tax
does not distort relative prices and consumption. The general principle that the best way
to correct a domestic distortion is with domestic policies rather than with trade policies

Trade restrictions may be advocated to protect domestic industries important for

national defense. But even in this case, direct production subsidies are generally better
than tariff protection. Some tariffs can be regarded as “bargaining tariffs” that are to be
used to induce other nations to agree to a mutual reduction in tariffs. Here, political
scientists may be more qualified to judge how effective they are in achieving their
intended purpose.

The closest we come to a truly valid economic argument for protection is the optimum
tariff .That is, if a nation is large enough to affect its terms of trade, the nation can
exploit its market power and improve its terms of trade and welfare with an optimum
tariff. However, other nations are likely to retaliate so that in the end of nations loses. Be
that as it may, Broda, Limao, and Weinstein (2009) provide evidence that countries set
higher tariffs on goods with lower export supply elasticites than on goods with higher
supply elasticities.

Who Gets Protected?

By increasing the commodity price, trade protection benefits producers and harms
consumer (and usually the nation as a whole). However, since producers are few and
stand to gain a great deal from protection, they have a strong incentive to lobby the
government to adopt protectionist measures. On the other hand, since the losses are
diffused among many consumers, each of whom loses very little from the protection,
they are not likely to effectively organize to resist protectionist measures. Thus, there is
a bias in favor of protectionism.
In recent years, economists have developed several theories regarding which groups and
industries get protected, and some of these theories have been empirically confirmed. In
industrial countries, protection is more likely to be provided to labor-intensive
industries employing unskilled, low-wage workers who would have great difficulty in
finding alternative employment if they lost their present jobs. Some empirical support
has also been found for the pressure-group or interest-group theory (see Hilmann, 1989;
Grosman and Helpman, 1994), which postulates that industries that are highly
organized (such as the automobile industry) receive more trade protection than less
organized industries. An industry is more likely to be organized if it is composed of only
a few firms. Also, industries that produce consumer products generally are able to
obtain more protection than industries producing intermediate products used as inputs
by other industries because the former industries can exercise countervailing power and
block protection (since that would increase the price of their inputs).

Furthermore, more protection seems to go to geographically decentralized industries

that employ a large number of workers than to industries that operate in only some
regions and employ relatively few workers. The large number of workers has strong
voting power to elect government officials who support protection for the industry.
Decentralization ensures that elected officials from many regions support the trade
protection. Another theory suggests that trade policies are biased in favor of
maintaining the status quo. That is, it is more likely for an industry to be protected now
if it was protected in the past. Governments also seem reluctant to adopt trade policies
that result in large changes in the distribution of income, regardless of who gains and
who loses. Finally, protection seems to be more easily obtained by those industries that
compete with products from developing countries because these countries have less
economic and political power than industrial countries to successfully resist trade
restrictions against their exports.

Some of the above theories are overlapping and some are conflicting, and they have
been only partially confirmed empirically. The most highly protected industry in the
United States today is the textiles and apparel industry
 Tariff and Non-Tariff Trade Barriers
Tariff Trade Barriers

Although free trade maximizes world welfare, most nations impose some trade
restrictions that benefit special groups in the nation. The most important type of trade
restriction historically is the tariff. The most important type of trade restriction has
historically been the tariff. A tariff is a tax or duty levied on the traded commodity as it
crosses a national boundary.

An import tariff is a duty on the imported commodity, while an export tariff is a duty on
the exported commodity. Import tariffs are more important than export tariffs, and
most of our discussion will deal with import tariffs.

When a small nation imposes an import tariff, the domestic price of the importable
commodity rises by the full amount of the tariff for individuals in the nation. As a result,
domestic production of the importable commodity expands while domestic
consumption and imports fall. However, the nation as a whole faces the unchanged
world price since the nation itself collects the tariff.

When a large nation imposes an import tariff, the volume of trade falls but improving
the nation’s terms of trade. The optimum tariff is one that maximizes the net benefit
resulting from improvement in the nation’s terms of trade against the negative effect
resulting from reduction in the volume of trade. However, since the nation’s benefit
comes at the expense of other nations, the latter are likely to retaliate, so that in the end
all nations usually lose. A tariff leads to inefficiencies referred to as protection cost or
deadweight loss.

Export tariffs are most prohibited by the developed countries but are often applied by
developing countries on their traditional exports (such as Ghana on its cocoa and Brazil
on its coffee) to get better prices and raise revenues. Developing nations rely heavily on
export tariffs to raise revenues because of their ease of collection

Tariffs can be ad valorem, specific, or compound. The ad valorem tariff is expressed as a

fixed percentage of the value of the traded commodity. The specific tariff is expressed as
a fixed sum per physical unit of the traded commodity. Finally, a compound tariff is a
combination of an ad valorem and a specific tariff.

The optimum tariff is that rate of tariff that maximizes the net benefit resulting from the
improvement in the nation’s terms of trade against the negative effect resulting from
reduction in the volume of trade. That is, starting from the free trade position, as the
nation increases its tariff rate, its welfare increases up to a maximum (the optimum
tariff) and then declines as the tariff rate is raised past the optimum. However, since the
nation’s benefit comes at the expense of other nations, the latter are likely to retaliate, so
that in the end all nations usually lose.

Tariffs have been sharply reduced since the end of World War II and now average 3
percent on industrial products in developed nations, but they are much higher in
developing nations. Trade in agricultural commodities is still subject to relatively high
trade barriers.

The Rate of Effective Protection

Very often, a nation imports a raw material duty free or imposes a lower tariff rate on
the importation of the input than on the importation of the final commodity produced
with the imported input. The nation usually does this in order to encourage domestic
processing and employment. For example, a nation may import wool duty free but
impose a tariff on the importation of cloth in order to stimulate the domestic production
of cloth and domestic employment.

When this is the case, the rate of effective protection (calculated on the domestic value
added, or processing, that takes place in the nation) exceeds the nominal tariff rate
(calculated on the value of the final commodity).Domestic value added equals the price
of the final commodity minus the cost of the imported inputs going into the production
of the commodity. While the nominal tariff rate is important to consumers (because it
indicates by how much the price of the final commodity increases as a result of the
tariff), the effective tariff rate is important to producers because it indicates how much
protection is actually provided to the domestic processing of the import-competing
commodity.
Non-tariffs trade barriers
Although tariffs have historically been the most important form of trade restriction,
there are many other types of trade barriers, such as import quotas, voluntary export
restraints, and antidumping actions. As tariffs were negotiated down during the postwar
period, the importance of nontariff trade barriers was greatly increased.

The non tariffs include the following; an import quota, others include a discussion of
voluntary export restraints and other regulations, as well as trade barriers resulting
from international cartels, dumping, and export subsidies

Import Quotas

A quota is the most important nontariff trade barrier. It is a direct quantitative

restriction on the amount of a commodity allowed to be imported or exported. Import
quotas can be used to protect a domestic industry, to protect domestic agriculture,
and/or for balance-of-payments reasons. Import quotas were very common in Western
Europe immediately after World War II. Since then import quotas have been used by
practically all industrial nations to protect their agriculture and by developing nations to
stimulate import substitution of manufactured products and for balance of payments
reasons.

Voluntary Export Restraints

One of the most important of the nontariff trade barriers, or NTBs, is voluntary export
restraints (VERs). These refer to the case where an importing country induces another
nation to reduce its exports of a commodity “voluntarily,” under the threat of higher all-
around trade restrictions, when these exports threaten an entire domestic industry.
Voluntary export restraints have been negotiated since the 1950s by the United States,
the European Union, and other industrial nations to curtail exports of textiles, steel,
electronic products, automobiles, and other products from Japan, Korea, and other
nations. These are the mature industries that faced sharp declines in employment in the
industrial countries during the past three decades. Sometimes called “orderly marketing
arrangements,” these voluntary export restraints have allowed the United States and
other industrial nations making use of them to save at least the appearance of continued
support for the principle of free trade.

The Uruguay Round required the phasing out of all VERs by the end of 1999 and the
prohibition on the imposition of new VERs. When voluntary export restraints are
successful, they have all the economic effects of (and therefore can be analyzed in
exactly the same way as) equivalent import quotas, except that they are administered by
the exporting country, and so the revenue effect or rents are captured by foreign
exporters.
Voluntary export restraints were less effective in limiting imports than import quotas
because the exporting nations agree only reluctantly to curb their exports. Foreign
exporters also tend to fill their quota with higher-quality and higher-priced units of the
product over time. This product upgrading was clearly evident in the case of the
Japanese voluntary restraint on automobile exports to the United States. Furthermore,
as a rule, only major supplier countries were involved, leaving the door open for other
nations to replace part of the exports of the major suppliers and also for transshipments
through third countries.

Technical, Administrative, and Other Regulations

International trade is also hampered by numerous technical, administrative, and other

regulations. These include safety regulations for automobile and electrical equipment,
health regulations for the hygienic production and packaging of imported food products,
and labeling requirements showing origin and contents. Many of these regulations serve
legitimate purposes, but some (such as the French ban on scotch advertisements and the
British restriction on the showing of foreign films on British television) are only thinly
veiled disguises for restricting imports.

Export Subsidies

Export subsidies are direct payments (or the granting of tax relief and subsidized loans)
to the nation’s exporters or potential exporters and/or low-interest loans to foreign
buyers to stimulate the nation’s exports. As such, export subsidies can be regarded as a
form of dumping. Although export subsidies are illegal by international agreement,
many nations provide them in disguised and not-so-disguised forms.

For example, all major industrial nations give foreign buyers of the nation’s exports low-
interest loans to finance the purchase through agencies such as the U.S. Export–Import
Bank. These low-interest credits finance about 2 percent of U.S. exports but a much
larger percentage of Japan’s, France’s, and Germany’s exports. Indeed, this is one of the
most serious trade complaints that the United States has against other industrial
countries today. The amount of the subsidy provided can be measured by the difference
between the interest that would have been paid on a commercial loan and what in fact is
paid at the subsidized rate.

Dumping

Trade barriers may also result from dumping. Dumping is the export of a commodity at
below cost or at least the sale of a commodity at a lower price abroad than domestically.
Dumping is classified as persistent, predatory, and sporadic. Persistent dumping, or
international price discrimination, is the continuous tendency of a domestic monopolist
to maximize total profits by selling the commodity at a higher price in the domestic
market (which is insulated by transportation costs and trade barriers) than
internationally (where it must meet the competition of foreign producers).

Predatory dumping is the temporary sale of a commodity at below cost or at a lower

price abroad in order to drive foreign producers out of business, after which prices are
raised to take advantage of the newly acquired monopoly power abroad. Sporadic
dumping is the occasional sale of a commodity at below cost or at a lower price abroad
than domestically in order to unload an unforeseen and temporary surplus of the
commodity without having to reduce domestic prices.

Trade restrictions to counteract predatory dumping are justified and allowed to protect
domestic industries from unfair competition from abroad. These restrictions usually
take the form of antidumping duties to offset price differentials, or the threat to impose
such duties.

However, it is often difficult to determine the type of dumping, and domestic producers
invariably demand protection against any form of dumping. By so doing, they
discourage imports (the “harassment thesis”) and increase their own production and
profits (rents). In some cases of persistent and sporadic dumping, the benefit to
consumers from low prices may actually exceed the possible production losses of
domestic producers.

Over the past four decades, Japan was accused of dumping steel and television sets in
the United States, and European nations of dumping cars, steel, and other products.
Many industrial nations, especially those that belong to the European Union, have a
tendency to persistently dump agricultural commodities arising from their farm support
programs. When dumping is proved, the violating nation or firm usually chooses to raise
its prices (as Volkswagen did in 1976 and Japanese TV exporters in 1997) rather than
face antidumping duties. In 2007, 29 countries (counting the European Union as a
single member) had antidumping laws (including many developing countries).
 Economic Integration
Economic integration is the process whereby several countries cooperate, coordinate
and link their economic policies (barriers of trade between market diminishes or
abolished for the sake of enjoying economic benefit such as to promote trade and
enlarge market resulted from specialization, creation of employment, investment
opportunities, political federation, economic development and growth

Economic integration refers to the commercial policy of discriminatively reducing or

eliminating trade barriers only among the nations joining together. In a preferential
trade arrangement (such as the British Commonwealth Preference Scheme), trade
barriers are reduced on trade among participating nations only. A free trade area (e.g.,
the EFTA and NAFTA) removes all barriers on trade among members, but each nation
retains its own barriers on trade with nonmembers. A customs union (e.g., the EU) goes
further by also adopting a common commercial policy toward the outside world. A
common market (the EU since 1993) goes still further by also allowing the free
movement of labor and capital among member nations. An economic union harmonizes
(e.g., Benelux) or even unifies (e.g., the United States) the monetary and fiscal policies
of its members.

Examples of economic integration

 East African Community-EAC,

 Common Market of East and Southern Africa-COMESA,

 Oil and Petroleum Exporting Countries- OPEC,

 Southern Africa Development Community (SADC),

 Economic Community for West African States-ECOWAS,

 European Union-EU,

 African Union- AU,

 African Caribbean Pacific Countries (ACPC)

 Economic Community of the Great Lakes Countries (CPGL) etc

Rationale of Economic Integration

Despite the fact that the general aim of making trade flourish remains the same,
particular objectives of economic integration agreements have changed to correspond to
modern political and economic circumstances.
  To enlarge and diversify market for local produced commodities in the region.

 To reduce or eliminate trade barriers among themselves e.g. use of one currency
or allowing local currencies between member states or encouraging barter trade.

 To avoid duplication of commodities by encouraging specialization in each

country

 To increase the utilization of domestic resources which cannot be exploited by a

single country

 To reduce the cost of production by adopting large scale enterprises which makes
them enjoy economies of scale.

 To increase the bargaining power of member states in the international market

 To improve the terms of trade of member states

 To boost industrialization and production of commodities to out compete

manufactured imports and reduce dependence among member states.

 To expand employment opportunities for member states

 To decrease the exploitative powers of developed countries by reducing or

stopping imports from developed countries that are always expensive.

Conditions Necessary for Successfully Formation of Economic Integration

 Common political policies and ideologies

 The member state should be at equal stage of development in order to reduce

uneven distribution of gains among the member countries because rich member
countries gain more than poor member countries.

 Common geographical boundaries though with different size of countries or

states

 Geographical proximity i.e. member states should be geographically near in order

to reduce transport costs

 Political stability among member states to ensure mutual understanding among

trade partners.

 Availability and well developed infrastructure to facilitate the movement of goods

and services and factors of production.

 Common currency to smoothen exchange

  Common language to ease communication among people in social economic and
political activities

 The economies of the countries should be competitive in nature i.e. potential of

producing different products so that exchange is promoted

 There should be production of diversity of commodities thus specialization and

exchange

 Citizens in the cooperative countries should have enough income so as to

promote adequate market for commodities.

 There should be political stability among cooperative countries so as to ensure

smooth operation of the regional activities.

 There should be a well-developed infrastructure in all cooperative countries.

 Countries should be complementary to one another so as to exchange their

commodities.

 There should be a common language in the region.

Identified Six Stages of Economic Integration

Preferential Trading Areas (PTA) is a trading bloc that gives preferential access to
certain products from certain countries. This usually carried out by reducing but not
eliminating tariff.

Free Trade Area (FTA) is an agreement made between member countries to trade
freely or to eliminate trade restriction (tariff, import or export quota) but each member
country are able and free to establish independent tariff against non member countries.

Customs Union is an agreement made between member countries, where to trade

freely and adopt common external barrier or common external tariff against non-
member countries attempting to import into the custom  

Common market is a custom union with common policies on product regulation, and
free movement of goods, services, capital and labour within member countries.

Economic and monetary Union is the common market with a common currency
among member countries i.e. Euro zone of EU and euro as currency also involve
removing physical boarder, technical standard and removing fiscal taxes barriers, joint
ownership of certain enterprises.
Complete economic integration is the final stage of integration that member
countries have no or negligible control of economic policy (full monetary union and
complete harmonization of fiscal policy)

Advantages of Economic Integration

As a country joins different economic groupings, it is very much expectant to achieve its
goals and benefit from them. These benefits include among others the following:

 Trade creation effect: This is where the creation/formation of the economic

cooperation results into a shift from consumption of expensive products from
non-member countries to consumption of cheap products in member countries.

 Expansion and extension of large markets: Most economic integration provides

sufficient wide export markets since member countries have to import within the
region which therefore boosts production and promote rapid economic growth.

 Skill development and technological transfer i.e. due to free mobility of factors of
production, it facilitates skill development and technological transfer within
cooperative countries.

 It increases the bargaining power of member countries in the international

market; therefore this increases their benefits from the international trade.

 It increases the competition which leads to high productivity in terms of quantity

and quality.

 It facilitates specialization based on comparative cost advantage i.e. countries

avoid competition in the production but instead specialize on the basis of
comparative advantage which boosts production hence more volume of exports.

 It promotes industrialization among member states by establishing

manufacturing industries.

 Common currency is used and each state adopts a common currency and it is
strong and always stable which stabilizes prices in the region.

 There is creation and expansion of employment opportunities and reduction of

unemployment among member states due to the flow of factors of production
freely amongst themselves.

 It helps in redistribution of income in the region i.e. economic integration fosters

a more equitable distribution of resources when factors of production are allowed
to flow freely between or among countries thus equalizing returns to each factor.
  It reduces balance of payment deficit because economic integration leads to
reduction of foreign exchange expenditure and increased export earnings.

 It increases consumers’ choice i.e. since a variety of goods are produced with in
the region, countries get commodities at low prices and low costs thus
maximizing profits.

 It reduces administrative costs involved in import-export restrictions.

 It promotes self-reliance among the cooperative countries i.e. it reduces

economic dependence of LDCs on MDCs.

Disadvantages of Economic Integration

 Much as a country expects benefits from joining different economic groupings, it

should as well expect the adverse effects out of it which may include the
following:

 Trade diversion i.e. this is where trade is diverted from low cost producers
outside the integrated region to high cost producers within the region. In
addition, countries might continue using low quality products from within the
region when they could have secured high quality goods from outside region.

 Loss of revenue which could have been got from tariffs due to free flow of goods
and services and factors of production within the region and common tariff
structure on non-member states.

 It may lead to loss and movement of resources and goods from less developed
countries to more developed countries.

 Most LDCs produce similar products and find it hard to trade among themselves
leading to surplus.

 When many industries are constituted in one country due to pull factors, it causes
uneven distribution of industrial benefits.

 Cooperative countries are forced to forego some of their national interests which
reduce self-reliance and sovereignty.

 It may lead to production of low quality products because of restriction of similar

commodities from non-member countries.

 It may lead to over exploitation and quick exhaustion of resources in order to

supply a large market.
  Large scale ventures may experience diseconomies of scale. It leads to loss of
political sovereignty in case of a political integrated federation.

 When there is political instability in one country, it may affect the whole
integrated region because all countries depend on each other.

 Other countries may retaliate and also impose restrictions on imports and thus
may lead to formation of rival trade.

 It may lead to unemployment i.e. firms will be relocated to more cost effective
location within the bloc thus it may lead to unemployment to other countries
from where the firms move.

Obstacles to Successful Economic Integration in Developing Countries

Below are the obstacles to economic integration in Africa

 Dependence on a few primary exports: A major rigidity of most African

economies is that their colonial masters encouraged the development and export
of a few primary raw material products meant to service factories in Europe, a
situation that has changed very little in the 1990s. Overdependence on
commodity exports is at the heart of Africa’s trade crisis.

 More than any other developing region, Africa depends on primary commodities
for instance coffee, cocoa, cotton and copper to generate the foreign exchange
needed to buy imports.

 Underdeveloped human resources: People have been neglected, badly educated

and in poor health, with their capacities frequently under-utilized. The
consequence is low labour productivity and lack of competitiveness.

 Capital versus labour intensity: Another structural bottleneck of African

economies is their reliance more on capital rather than labour-intensive
techniques of production, a situation many critics attribute to the nature of the
import-substitution industrialization strategy embarked upon after independence
for most of these countries. Import-substitution policies tend to favor production
of relatively capital-intensive products; the application of capital intensive
technologies because of relatively low barriers to imports of capital goods; and an
inefficient use of capital owing to the lack of competition in domestic markets.

 Excessive dependency of African states on the developed west: Many African

nations generally still depend on the West for imports of raw material-supplies
 and manufactured products, even in cases where products of comparable quality
may be available in member states.

 This runs counter to the rationale for creating bigger markets to facilitate the
growth of viable production ventures. High dependence on imported raw
materials from the ‘West’ makes African economies particularly vulnerable to
foreign exchange availability which in Africa is typically in short supply.

 Transport problems: The transport infrastructure for intra-Africa trade

(including roads, rail systems, air and some shipping) is not only inadequate, but
in many cases non-existent. Burundi, Comoros, Lesotho, Mauritius, Rwanda and
Somalia, for instance, have no railway systems. In some cases, parts of the
network (especially in war-torn states such as Mozambique, Angola, Democratic
Republic of Congo and Burundi) need urgent rehabilitation and upgrading. The
existing network has been characterized by high operating costs due to poor road
conditions and cumbersome transit operations. This limitation does not help the
integration process.

 Different stages of development: Some countries in Africa are economically more

advanced than others. Economic integration works on the promise that the
benefits of integration will be distributed among member states in an equitable
manner. However, the elimination of trade barriers and the adoption of common
investment policies do not necessarily lead to an equitable distribution, but
rather support or stimulate the tendency of investments to concentrate on the
relatively more advanced economies. As a consequence, some countries have not
benefitted from the integration.

 Lack of information: Lack of information has hindered the development of intra-

Africa trade. Most African nations are traditionally linked to their former colonial
masters. As a consequence, there is an acute lack of awareness of what other
African countries can offer to substitute for the products currently being sourced
from the developed countries. Lack of information is also a direct result of
inadequate economic infrastructure in Africa, especially in telecommunications
and transportation facilities, directly hindering interaction among African
countries.

 Unfavorable world economic conditions: African economies have suffered as a

result of negative developments in the wider world economy. The most adverse
effects have come from changes in the terms of trade. Unfavorable terms of trade
reduce output by increasing the cost of imported intermediate and capital goods,
on which all African countries are heavily dependent. Consequently, this hinders
integration.
 World Trade Organization (WTO)
The World Trade Organization (WTO) is a multinational organization that seeks
to negotiate global trade agreements as well as adjudicate trade disputes between
member countries. It was officially commenced on 1 January 1995, replacing the
General Agreement on Tariff and Trade (GATT) which commenced in 1948.

 It deals with the rules of trade between nations at a global or near-global level

 It operates a system of trade rules

 an organization for liberalizing trade

 a forum for governments to negotiate trade agreements and to settle disputes

The WTO adheres to four principles. These are:

 Non-discrimination

 Reciprocity, e.g. mutual tariff reduction

 Transparency, e.g. clear unambiguous trade measures

 Fairness, e.g. restrictions on dumping goods

Brief History of WTO

The World Trade Organizations (WTO) originated from The General Agreement on
Tariffs and Trade (GATT) which was an international organization, created in 1947 and
headquartered in Geneva (Switzerland), devoted to the promotion of freer trade through
multilateral trade negotiations. Originally, it was though that GATT would become part
of the International Trade Organization (ITO), whose charter was negotiated in Havana
in 1948 to regulate international trade. When the ITO was not ratified by the U.S. Senate
and by the governments of other nations, GATT (which was less ambitious than ITO)
was salvaged.

GATT rested on three basic principles:

 Non discrimination. This principle refers to the unconditional acceptance of the

most-favored-nation principle discussed earlier. The only exceptions to this
principle are made in cases of economic integration, such as customs unions, and
in the trade between a nation and its former colonies and dominions.
  Elimination of nontariff trade barriers (such as quotas), except for agricultural
products and for nations in balance of payments difficulties.

 Consultation among nations in solving trade disputes within the GATT

framework. By 1993, a total of 123 nations (including the United States and all
major countries, with the exception of the countries of the former Soviet Union
and China) were signatories of the GATT, and 24 other nations had applied for
admission. The agreement covered over 90 percent of world trade

THE ROLE OF WTO AND HOW IT OPERATES

The WTO’s main aim is to promote free trade by lowering tariffs and other barriers. It
does this through agreements negotiated and signed by most of the world’s trading
nations. The WTO then polices these agreements to make sure all nations stick to the
rules. When trade disputes between governments flare up, it steps in as mediator and, if
necessary, arbitrator. And when member countries don’t play by the agreed rules, the
WTO can impose trade sanctions against them.

How does it work?

The WTO is governed by its member countries there are currently 164 which make the
major decisions, via ministers, ambassadors or delegates. Day to day operations are
coordinated by the Secretariat, in Geneva, Switzerland, which employs more than 600
staff and experts, including lawyers, economists and statisticians.

The Ministerial Conference is the WTO’s highest decision-making body. It usually meets
every two years, bringing together all members (countries and customs unions) and is
the backdrop for the WTO’s trade rounds, the multilateral negotiations aimed at
lowering barriers to free trade.

The General Council acts on behalf of the Ministerial Conference and runs the Dispute
Settlement Body and the Trade Policy Review Body. It is made up of representatives
(usually ambassadors) from all member governments.

The Role of the World Trade Organization

The World Trade Organization (WTO) is one of the three international organizations
(the other two are the International Monetary Fund and the World Bank Group) which
by and large formulate and co-ordinate world economic policy.

It can be argued that the WTO plays a particularly significant role in the promotion of
free international trade. The organization acts as an umbrella institution, that is an
organization covering the agreements concluded at the Uruguay Round. The Uruguay
Round was the preparatory stage for the launch of the WTO. The Round was based on
the General Agreement on Tariffs and Trade (GATT).

The crucial role of the WTO is to provide a common institutional framework for the
implementation of those agreements. The organization is the result of the Uruguay
Round of negotiations (1986-1994) and was formally created in 1995.

Others include;

 It administers the WTO agreements

 It reviews trade policies of member states acting as a forum for the resolution of
international trade disputes

Organizational Structure of the WTO

The Ministerial Conference is the highest organ of the WTO and is to meet at least once
every two years. It is normally composed of all the Ministers of Trade of the Members of
the WTO. The Ministerial Conference has supreme authority over all matters, as
expressed under Article IV: 1 WTO Agreement.

The General Council is composed of representatives of all the members – normally

country delegates based in Geneva. The General Council is in session between the
meetings of the Ministerial Council. In essence this is the real engine of the WTO and
has all the powers of the Ministerial Council when that body is not in operation. The
General Council also acts as the Dispute Settlement Body and the Trade Policy Body
(Article IV: 2-4 WTO Agreement).

The Council for Trade in Goods, the Council for Trade in Services and the Council for
Trade-Related Aspects of Intellectual Property Rights (TRIPS) has been established with
specific spheres of responsibility. In fact, there are separate agreements within the
framework of WTO that define and confine their operation (Article IV: 5 WTO
Agreement).

The Committee on Trade and Development, the Committee on Balance-of-Payments

Restrictions and the Committee on Budget, Finance and Administration have self-
evident functions (see Article IV: 7 WTO Agreement). Likewise the Director-General and
the Secretariat operate on a purely administrative basis. However, it should be stated
that the Director-General and the staff of the Secretariat shall be exclusively
international in character and they shall not seek or accept instructions from any
government or any other authority external to the WTO (Article VI: 4 WTO Agreement).
More limited deals (Critique)

 Critics of the WTO argue that it is pursuing an agenda driven by business

interests and that its rules undermine the sovereignty of its member states.

 In recent years, the lack of progress in the Doha Round talks has led some
countries to seek trade agreements among smaller groups. These include the
Trans-Atlantic trade and Investment Partnership (TTIP), a negotiation underway
between the EU and US and the Trans-Pacific Partnership (TTP), which also
involves the US.

 As the negotiating effort of major governments has shifted towards these

agreements, so has the attention of critics. All the leading world economies are
members of the WTO. European Union countries are all members, but they act
together in the WTO as the EU. As well as its existing 162 members, a further 21
countries have applied to join the WTO, including Iran, Iraq and Syria.

 Negotiations can be very slow. Algeria for example applied in 1987 (to the WTO's
predecessor, the GATT) and has still not agreed membership terms.
 REVIEW QUESTIONS
1. In what way was Ricardo’s law of comparative advantage superior to Smith’s
theory of absolute advantage? How do gains from trade arise with comparative
advantage? How can a nation that is less efficient than another nation in the
production of all commodities export anything to the second nation?

2. What is the difference between a nominal tariff and an effective tariff?

3. What is meant by an ad valorem, a specific, and a compound tariff? Are import or

export tariffs more common in industrial nations? or in developing nations?

4. What is the exception to the law of comparative advantage? How prevalent is it?

5. What is the primary function of tariffs in industrial nations and in developing

nations?

6. Why do nations subsidize exports? To what problems do these subsidies give

rise?

7. What is the effect of the tariff on the degree of specialization in production in a

small nation? The volume of trade? The welfare of the nation? The distribution of
income between the nation’s relatively abundant and scarce factors?

8. What is meant by the optimum tariff? What is its relationship to changes in the
nation’s terms of trade and volume of trade?

9. Why are other nations likely to retaliate when a nation imposes an optimum tariff
(or, for that matter, any import tariff)? What is likely to be the final outcome
resulting from the process of retaliation?

10. What are the fallacious and questionable arguments for protection? Why are they
fallacious and questionable?

11. What is the infant-industry argument for protection? How must this argument be
qualified?

12. What are the other qualified arguments for protection? In what way must they be
qualified?

13. Why free trade is harmful to less developed countries

14. ‘’Only Protectionism can build Developing countries’’ Discuss

15. Discuss the rationale and role of World Trade Organization (WTO) in dealing
with global trade.
16. Write short notes on the following items

 Absolute advantage
 Comparative advantage
 Laissez faire
 Ad valorem tariff Vs Compound tariff
 Import tariff Vs Export tariff
 Optimum tariff
 Import Quotas
 Voluntary Export Restraints
 Dumping
 Export Subsidies
 Economic integration
 Preferential trade agreements
 Free trade Area
 Customs Union
 Common market
 Economic Union
 Duty free Zones or Free Economic Zones
 Trade Creation Vs Trade Diversion
 World Trade Organization (WTO)
 Practical Questions and Group Assignment
1. Poor countries should abandon free trade agreements. Discuss

2. Discuss with relevant examples, How protectionism leads to trade wars.

3. Economic integration is crucial for the development of less Developed Countries

(LDCs). Discuss

4. Discuss the challenges facing East African Community (EAC) from becoming
complete economic integration. (NOTE; focus on ‘’economic challenges’’)

5. Discuss the experiences and lessons from European Union (EU) that can help
other Economic Integration to become successful

6. Discuss the history and evolution of international trade in the world

7. Discuss trade agreements and how they have helped or undermined developing
countries

8.

a) Which economic groupings does Tanzania belong?

b) Analyze the contribution of each economic groupings to Tanzania economy

9.

a) Discuss the success and the challenges of world Trade Organization (WTO)

b) What can be done to eradicate these problem faced by WTO?

10. Discuss the outstanding trade problems facing the world today

11. a) How COVID-19 affected international trade around the world?

b) Discuss the impact of COVID19 on the international trade in the world. Use
relevant examples in your explanation.