4.3 Arguments for and against trade control/ protection Flashcards
Terms of Trade: definition
Index of export prices/ index of import prices x 100
consequences of a change in terms of trade for a country’s balance of payments and domestic economy
The significance of deteriorating terms of trade for developing countries
Trade Protection
Occurs when a country’s government intervenes in international trade, imposing trade restrictions to prevent the free flow of imports into the country and protect the domestic economy from foreign competition
Main types of protectionist methods
- Tariffs
- Quotas
- Production subsidies
- Administrative barriers
They all share the same effect of decreasing the number of imports, and increasing the quantity of goods and services domestically produced
Arguments FOR:
Infant Industry argument
An infant industry is a new domestic industry that has only just established itself, not having the time to grow larger, and achieve economies of scale. Thus, the firms will have relatively low efficiencies, and be unable to compete with “efficient” foreign firms.
Without any type of production, the new infant industries would shut down, unable to compete and grow amongst much more efficient firms.
Arguments FOR:
Infant Industry argument (Extra)
After first being introduced as an argument in 1791, the argument is primarily used now by developing countries trying to expand production. Economists consider this theory to be one of the strongest justification for trade protection, possible because it obeys the theory of comparative advantage
(the theory of comparative advantage states that along as opportunity costs in two (or more) countries differ, it is possible for all countries to gain from specialization and trade according to their comparative advantage; this results in a improvement in the global allocation of resources, resulting in greater global output and consumption)
The country in question may have a comparative advantage compared to another country, but first must receive protection. This can only be justified if the production is limited to a temporary period. As soon as the infant industry can compete, the protection should be eliminated.
However, this theory can be misused and wrongly implemented. Governments can misjudge different firms; wrongly deciding which firms could become low-cost producers. This also presents the opportunity for corruption from governments
Furthermore, once a firm is protected, it may not see the need to become efficient, forever existing as an ‘infant industry’. Similarly, a firm could protect an ‘infant industry’ long after it has achieved economies of scale. The infant industry argument here has been purely reduced to a subsidy
Arguments FOR:
Strategic Trade Policy
High-technology firms are protected, as their presence is deemed important to the future growth of an economy. Their growth is assisted until they are large enough to compete for themselves.
This argument also applies to developed countries, who may also aspire to increase their high technology industries.
Here though the trade protection is not only limited to the traditional methods, but can also take the form of various supply-side policies, such as lower taxes, low-interest loans and even government financing of research and developing.
However, along with the infant industry argument, there are also difficulties about who to protect, and also selecting appropriate protectionist measures
Also, if many firms use this kind of protection at the same time, the idea of comparative advantage is made redundant. The protection could also last much longer than necessary, the government, continuing their protection for too long.
Arguments FOR:
National Security
Some industries, such as aircraft, weaponry, chemical substances and ores and minerals are believed to be beneficial for national defence, and thus are deemed necessary for protection, in the event of an attack. In war, a country may have to rely on its own industries for defence, and thus industries which benefit national security should be protected.
In this sector, specialisations is discouraged. For example, if a volatile or dangerous country specialises in weaponry, or a country is relied upon for aircraft, but then ends ties with other countries, the situation could become dangerous.
However, governments will differ in what they deem to be important to national security, however countries could also use this argument a façade, purely to subsidize products and employ trade protection.
Arguments FOR:
Health, Safety and Environmental Standards
Countries have health, safety and environmental standards that imported goods and services must meet before they can enter a country. Although each country can set its own standards, sometimes these standards can be used as a type of ‘hidden protection’ to keep some goods out, so they cannot compete with locally-produced goods.
Arguments FOR:
Efforts of a Developing Country to Diversify
Countries may employ trade protection on certain goods in order to diversify
Diversification = generally refers to change involving greater variety, and is used to refer to increasing the variety of goods and services produced and/or exported by a country; it is the opposite of specialization
In the past, the world has seen developing countries specialise in particular products, for example, Cuba in sugar and Ecuador in bananas.
The Theory of Comparative Advantage
The theory of comparative advantage states that along as opportunity costs in two (or more) countries differ, it is possible for all countries to gain from specialization and trade according to their comparative advantage; this results in a improvement in the global allocation of resources, resulting in greater global output and consumption
Arguments AGAINST:
These goods which we have seen developing countries specialize in are generally primary sector goods. However, as countries grow, manufacturing and services become progressively more important. In developing countries, this is made possible by diversifying its range of goods are services into other sectors
Arguments AGAINST:
Each step in production adds value to the good. For example, in the extraction of metal ores, we see processes such as refining add value to the good, if developing countries not only manufacture but also extract, they can sell their products for higher princes and receive more revenue
Arguments AGAINST:
Primary goods also have much higher price volatillities than manufactured goods, and services, due to the low price elasticities of demand and supply of such goods. This can result in fluctuating wages for farmers, due to the low price stability of such goods. This is another factor supporting the diversification of goods.
Arguments for Free Trade:
Advantages of Specialization
Free trade secures all the advantages of international division of labour. Each country will specialize in the production of those goods in which it has a comparative advantage over its trading partners. This will lead to an optimum and efficient utilization of resources and, hence, economy in production
Arguments for Free Trade:
All-Round Prosperity
Because of unrestricted trade, global output increases since specialization, efficiency, etc., make production large scale. Free trade enables countries to obtain goods at a cheaper price. This leads to a rise in the standard of living of people of the world. Thus, free trade leads to higher production, higher consumption and higher all-round international prosperity
