Trade

Protectionism
Getting Started

Research recent examples of restrictions on free trade used by

countries such as the United States and China.

• What reasons do the governments in these countries give for

any new restrictions used?

• Who might benefit and who might lose from these trade
restrictions?

• What arguments can be put forward to justify protectionist

policies?
Restrictions on free trade
a) Reasons for restrictions on free trade:
• to protect infant and geriatric industries
• to protect domestic industries and employment
• to protect national security
• to prevent dumping
• to correct a deficit on the current account of the balance of payments
• to raise revenue.

b) Types of restrictions on free trade:

• tariffs
• quotas
• non-tariff barriers
• subsidies to domestic producers.

c) Impact of protectionist policies on:

• consumers
• producers
• governments
• living standards
• equality.
To protect infant (sunrise) industries
• New low-volume producer will find it impossible to compete on price against an
established foreign high-volume producer: may face higher costs than foreign
competitors -Partly due to large EOS in the industry.
• It also takes some time for managers and workers in a new industry to establish
efficient processes and working practices (learning benefits). particularly for the
industries which have a comparative advantage in the long run > resources will have
been allocated efficiently.
• Many countries have financial systems which tend to take a short view of investment.
It is difficult to find backers for projects which might only become profitable in 10
years' time.

EV:
However, infant industries in general have not grown successfully behind trade barriers
because:
• hard to identify those infant industries with potential
• industries protected by trade barriers lack the competitive pressure to become
efficient
Also, may be more efficient to use policy weapons such as specific subsidies, training
grants, tax reductions, or even the creation of state enterprises
To protect geriatric (or sunset, declining) industries
A geriatric industry in a country is one which is in decline, often because it cannot compete
with those abroad.

Industries start to lose their competitiveness in global markets because:

• Wage costs differ greatly across the world explain
• The industry has been run inefficiently.

Reason for protectionist:

• Large investment may help the industry compete in the long run
• It helps the economy reallocate resources more gradually in the short run. If the industry is
concentrated in one region, then closing the industry would set off a significant negative multiplier
effect in the local area. A more gradual approach over time might help workers to acquire the
necessary skills to switch between jobs more quickly.
• In some cases, the protection of geriatric industries in advanced economies has been supported
as a response to unfair trade practices used by developing countries.

EV:
• most geriatric industries are unlikely to regain any comparative advantage they might previously
have enjoyed.
• this also depends on the quality of re-training schemes
To protect domestic industries and employment
Protectionism can protect domestic industries and create or at least preserve jobs. If there is a
large increase in the quantity of steel imported, domestic steel producers will see reduced orders. They
will reduce production cutting jobs and possibly closing plants. Protecting the local steel industry from
foreign competition means the orders, jobs and plants are preserved.

EV:
• consumers might suffer from higher prices and less choice
• foreign countries could retaliate by imposing trade restrictions on
exports, leading to a loss of jobs in the domestic economy

To raise revenue
A tariff is a tax on imported goods. (also called an import duty or a customs duty).
For some developing countries tariff revenue is an important source of income for the government
-partly because relatively easy to collect compared to other taxes.
-other taxes, e.g. income tax, will raise relatively low levels of revenue in developing countries

EV:
• Tariff might raise cost for domestic firms and affect their profits-> less domestic taxes are collected
 Anti-dumping
Dumping can be defined as the sale of goods below their cost of production,
whether marginal cost, average total cost, or average variable cost.

Reasons why foreign firms sell products at a loss:

• They may have produced the goods and failed to find a market for them, so they are dumped on one
country in a distress sale (where an asset is sold urgently, even if incurring a loss)
• They may have excess capacity
• They may deliberately price at a loss to drive domestic producers out of business. Once it has achieved
this, it can increase prices and enjoy monopoly profits.
It is difficult to say whether short-term distress dumping leads to a loss of domestic welfare.
• domestic producers and their workers may suffer a loss of profits and wages
• consumers gain by being able to buy cheap goods, even if only for a limited period and might suffer
from being exploited by foreign producer’s monopoly power

EV:
 effects of dumping depend on
• Duration: The impact on employment should be limited if dumping is only a short-term phenomenon.
• whether domestic producers are driven out or also cut their prices
• Magnitude: scale of dumping
 might be more efficient to subsidise domestic industries
To correct a deficit on the current account of the
balance of payments
protectionism -> reduce the value of imports or increase the value of exports -> correcting a
deficit on the current account of the balance of payments.

EV:
 It depends on the:
• price elasticity of demand
• degree of trade protection
• whether and to what extent trading partners retaliate

 May also decrease exports

As supply chains are increasingly global, using protectionist measures is
likely to raise the costs for many domestic firms who import raw materials
and components from abroad. A rise in costs may cause these firms to
lose their price competitiveness in international markets. This may cause
the value of exports to fall. As a result, the deficit on the current account
might remain largely unchanged.
To protect national security
A country may need a particular domestic industry for national security purposes including military and
non-military dimensions, such as energy security, food security, cyber security and environmental
security.
In 2018, the United States imposed a 25% tariff on steel and 10% on aluminium imports on countries
such as China and the EU members. The US claimed that over reliance on imported metals would
threaten the country's national security.

EV:
This might add to domestic costs if these strategic products are used in the production of other goods

Other reason: To diversify the economy

Some small developing countries rely almost entirely
on one crop, such as cocoa, bananas or sugar cane
->are subject to large fluctuations in price on world
markets. Falls in price can give rise to large falls in
living standards in these economies. Diversifying could
provide a valuable insurance policy against commodity
price fluctuations.
Types of restrictions on free trade—— tariffs
A tariff is a tax on imported goods. (also called an import duty or a customs duty).

Tariffs can be used by governments

• to raise revenue to finance spending
• used in a deliberate attempt to restrict imports

A tariff, by imposing a tax on a good, is likely to raise its final price to the consumer.
A rise in the price -> a fall in demand and the volume of imports will fall -> some
consumers will switch consumption from imported goods to domestically produced
substitutes following the imposition of a tariff-> A tariff help domestic producers to
increase revenue.

Activity:
Try to draw a graph where foreign trade exist.
with foreign trade, world producers are assumed to be prepared to supply any
amount of the product at a fixed price.
Effects of imposing a tariff:
If the world price of a good is OP a tariff of PQ will shift the supply curve upwards from S world to
Swith tarif. Domestic consumption will fall by MN while domestic production will rise by JK. Imports
will fall from JN to KM.

Loss in consumer surplus:

Gain in producer surplus:

Tax revenue:

Deadweight loss:
Evaluative comments:
• Effects of a tariff depend on:
- elasticities of demand for imports and supply of domestic products
- the degree of the tariff

• Might arouse retaliation

• Cost of imported components or raw materials might increase
Types of restrictions on free trade—— Quota
Non-tariff barriers are any restrictions on free trade.other than a tariff. Examples of non-tariffs
barriers are quotas, subsidies, administrative barriers and exchangerate manipulation.

A quota is a physical limit on the quantity of a good imported.

It is an example of a physical control. Imposing a limit on the quantity of goods imported into a
country will increase the share of the market available for domestic producers. However, it will also
raise the price of the protected product.

Loss in consumer surplus:

Gain in producer surplus:

Deadweight loss:

Gains by foreign firms:

Types of restrictions on free trade—— Subsidies
Subsidies can be used both to increase exports and to reduce imports.
• Export subsidies might be given on goods that are actually exported. e.g. many countries
subsidise exports of agricultural produce.This increases exports and supports farm incomes.
• Or might be given to products, firms or industries where exports are a large proportion of
output.

For example, the Boeing has on many occasions accused European governments of
subsidising Airbus. (European governments want to support a strong aircraft manufacturing
base in Europe to create exports and jobs)

• Governments can reduce imports by giving subsidies to domestic firms that compete with
imports- almost always indirect subsidies rather than direct subsidies
e.g. Governments but give cheap loans or tax breaks on investment to domestic steel
producers to allow them to compete more effectively with steel imports.
- Domestic subsidies are hard for WTO to tackle because they are not overt protectionism
Other types of non-tariff barriers
Administrative barriers
• Imposing product standards that differ from those in other countries
• Putting red tape on imports such as licenses, designated ports or airports,
months to clear paperwork

Exchange rate manipulation

• Lowering the exchange rate will make exports cheaper and imports more
expensive. Some governments control their exchange rates in various
ways. If these controls are used to lower the value of the currency, it will
increase exports and reduce imports.
Impact of protectionist policies on
Consumers:
• Unable to buy imported goods at a lower price than goods produced domestically.
• Suffer restrictions on the range of goods being offered to them for sale. Their choice is therefore
restricted. Protectionist policies also tend to raise the price of domestically produced goods.
• Goods and services in the supply chain of domestically produced goods may be subject to import
restrictions. For example, if there are tariffs on the import of wheat, the price of bread in the shops
is likely to be higher. Equally, import restrictions limit competition for domestic producers. They
have less incentive to become more efficient and lower costs or produce new innovative products.
EV: they might also gain if demerit goods are banned or reduced from imports

Producers
• Domestic firms can both gain and suffer from protectionism. If their domestic markets are
threatened by imports, then protectionist policies can help keep out imports. This means higher
output, higher sales and higher profits.
• Equally, if they benefit from measures to encourage exports, then their output and profits should
be higher. However, overtime domestic producers could become even less internationally
competitive as the incentive to innovate and productive efficiency falls.
• Other domestic firms could also suffer. If tariffs are imposed increased cost for some firms.
Workers Help to maintain jobs in the short-term.
However, workers in the long term would be better off if production did close down as a result of foreign
competition. The market would reallocate resources into industries where the country was able to
compete. New jobs would be created.

Governments Governments gain higher tax revenues in the short term.

However, in the long term, governments can lose out if protectionist policies result in an inefficient
economy where growth is restricted ->Their tax revenues smaller and more spending on welfare benefits

Living standards Protectionism in the short term may protect living standards. However, if it leads to a
less efficient, slower growing economy in the long run, then there will be a negative impact on living
standards.

Equality Trade union members ->higher wages->protectionist policies may create greater equality where
unionised jobs are threatened.
It raises small farmers’ incomes which are often low because they are too small and inefficient->create a
more equal distribution of income.
However, these benefits are likely to be short-term benefits. If protectionism leads to lower growth, over
time workers are likely to lose out in absolute terms even if in relative terms they have maintained their
incomes
 FREE TRADE VS PROTECTIONISM

Supporters of free trade argue that it leads to a more efficient allocation of resources between
countries,allowing for specialisation. It also encourages competition between producers, reducing
costs of production and leading to innovation and greater choice for consumers; this leads to both
static and dynamic efficiencies.

“The risk of a trade war between the US and China was particularly high in 2018. The US said that it
wanted to reduce its large trade deficit with China. The US believed that this deficit was in part due to
unfair practices used by China. US businesses operating in China had long complained about
intellectual property theft and forced technology transfers. The state support of industries in China,
such as aluminium and steel, was also a cause for concern, as well as claims of currency
manipulation of the renminbi. The US president said he wanted to protect US jobs.”