Chapter 36 - Trade policies and negotiations Flashcards
What is protectionism?
Measures taken by a country to restrict international trade.
What is a tariff?
A tax imposed on imported goods
How is are tariffs forms of protectionism?
Not all the effects of the tariff are favourable for the economy. Consumers are certainly worse off, as they have to pay a higher price for the good; they therefore consume less, and there is a loss of consumer surplus. Some of what was formerly consumer surplus has been redistributed to others in society. The government has gained the tariff revenue, as mentioned. In addition, producers gain some additional producer surplus. There is also a deadweight loss to society. In other words, society is worse off overall as a result of the imposition of the tariff. Effectively, the government is subsidising inefficient local producers, and forcing domestic consumers to pay a price that is above that of similar goods imported from abroad.
Some would try to defend this policy on the grounds that it allows the country to protect an industry, therefore saving jobs that would otherwise be lost. However, this goes against the theory of comparative advantage, and forces society to incur the deadweight loss. In the longer term it may delay structural change. For an economy to develop new specialisations and new sources of comparative advantage, there needs to be a transitional process in which old industries contract and new ones emerge. Although this process may be painful, it is necessary in the long run if the economy is to remain competitive. Furthermore, the protection that firms enjoy which allows them to reap economic rents from the tariff may foster complacency and an inward-looking attitude. This is likely to lead to X-inefficiency, and an inability to compete in the global market.
Even worse is the situation that develops where nations respond to tariffs raised by competitors by putting up tariffs of their own. This has the effect of further reducing the trade between countries, and everyone ends up worse off, as the gains from trade are sacrificed. President Trump’s decision to extend the tariffs on steel to Canada, the EU and Mexico in 2018 brought an immediate response from those countries, threatening a trade war that would leave all involved worse off as a result. President Trump decided to reduce the steel tariffs against Canada and Mexico in May 2019, opening the possibility of renewing discussions about a new trade agreement. When tariffs against China were raised further, China also responded with tariffs of its own. Although the World Trade Organization (WTO) is committed to reducing tariffs over time, retaliation in the form of ‘countervailing duties’ is permitted.
What is a quota?
An agreement by a country to limit its exports to another country to a given quantity.
What is a non-tariff barrier?
An obstacle to free trade other than a tariff (e.g. quality standards imposed on imported products)
How are quotas and non-tariff barriers a from of protectionism?
An alternative policy that a country may adopt is to limit the imports of a commodity to a given volume. For example, a country may come to an agreement with another country that only a certain quantity of imports will be accepted by the importing country. Such arrangements are known as quotas (or as voluntary export restraints (VERs)).
Domestic producers gain by being able to sell at the higher price, so (as in the case of the tariff) they receive additional surplus. Furthermore, the producers exporting from country A also gain (which, in the case of the tariff, was tax revenue received by the government). As in the case of the tariff, it represents the loss of welfare suffered by the importing country.
Such an arrangement effectively subsidises the foreign producers by allowing them to charge a higher price than they would have been prepared to accept. Furthermore, although domestic producers are encouraged to produce more, the protection offered to them is likely to lead to X-inefficiency and weak attitudes towards competition.
There have been many examples of such agreements, especially in the textile industry. For example, the USA and China had long-standing agreements on quotas for a range of textile products.
There are other ways in which trade can be hampered, one example being the use of what are known as non-tariff barriers (NTBs). These often comprise rules and regulations that control the standard of products that can be sold in a country. It is difficult to quantify the importance of such measures, but the frequency with which disputes arise at the WTO suggests that they have had significant effects on trade.
How does a production subsidy limit international trade?
Another way in which a country may attempt to restrict trade is by subsidising domestic producers to enable them to compete more effectively with imports.
Producers gain from this, receiving the additional producer surplus. However, this needs to be covered by the government, which represents the production inefficiency that was a deadweight loss in the case of the tariff.
The downside of this approach is that these funds need to be raised from elsewhere in the economy, so distorting the allocation of resources in other markets. Although consumers are better off in respect of this product with the subsidy than with a tariff, as taxpayers they may pay the price in other ways. Furthermore, it is not clear that subsidising domestic production in this way provides any better incentives for efficiency than the tariff approach. If governments wish to encourage firms to become more efficient in order to compete, a better approach might be to subsidise education and training or research and development to improve production techniques, and so tackle the problem more directly. Of course, this would depend upon what was causing the inefficiency in the first place.
At the WTO ministerial summit in Nairobi in 2015, it was agreed that developed country members would eliminate all export subsidies immediately, and that developing country members would eliminate them by the end of 2018.
What is a sunset industry?
An industry in decline that needs protection for its displaced workers
What is a infant industry?
An industry that needs protection from international competition in the short run so it can learn to become competitive
What are the advantages and disadvantages of protectionism?
The debate on whether countries should engage in protectionism or allow free trade has a long history, and still does not seem to have been resolved, given the USA’s decision to raise tariffs in 2018 - and the impulse of other countries to respond in kind. Some of the arguments that have been advanced by politicians in favour of protectionism have little grounding in economic analysis.
There may be political reasons for wanting to protect domestic industries. For example, there may be strategic arguments that a country should always maintain an agricultural sector so as not to be over- dependent on imported foodstuffs, as this could be disastrous in the event of war. Such arguments were used in setting up the Common Agricultural Policy in Europe. President Trump’s arguments for imposing a levy on steel imports in 2018 similarly claimed that the USA’s steel industry was suffering from unfair competition, which was a threat to national security.
Some have also argued that domestic industries should be protected because of the impact of high unemployment among workers displaced from declining sectors - so-called sunset industries. This is really an argument about the period of transition to more open trade, as it could also be noted that workers released from those declining sectors could, in time, be redeployed in sectors that are more efficient in comparative advantage terms.
A common line of argument is about the need to protect so-called infant industries. This may be especially important in the context of less developed countries (LDCs) wanting to develop their manufacturing sectors. The argument is that protecting a domestic industry from international competition will allow the new activities to become familiar with the market so that in the longer term they will be able to compete. A problem with both infant and sunset industries is that once protection is put in place, it is difficult to remove. The infants may never grow up and declining sectors may never expire completely.
What are the impacts of protectionism on consumers?
In general, consumers are likely to be worse off as a result of protectionist measures. In the case of a tariff, consumer surplus is lower after a tariff, as consumers must pay a higher price for the good, and will consume less.
What are the impacts of protectionism on producers?
Producers in the domestic economy will gain from protection, as they will receive higher producer surplus (at the expense of consumers). However, their incentives to produce efficiently will be low, so in the long run they may never become able to compete effectively in world markets. The infant industry benefits are rarely delivered.
What are the impacts of protectionism on governments?
When a government imposes a tariff, it gains by the revenue that it raises. This may be valuable for the government of a developing country that faces problems with raising revenue through other forms of taxation because of the lack of an administrative structure. The balance of payments will be affected, as imports will fall after the imposition of a tariff. Whether domestic production will actually rise to compensate will depend upon the elasticity of supply. If home producers are unable to respond by increasing production, then the benefits from the tariff will be lower.
What are the impacts of protectionism on living standards?
For society as a whole, the imposition of a tariff carries a deadweight welfare loss, so overall well-being is lower with a tariff in place.
What are the impacts of protectionism on equality?
Protectionist measures entail a redistribution of resources, from consumers to producers, so there may be an increase in inequality in the society.
How does free trade work?
David Ricardo’s theory of comparative advantage, developed in the early nineteenth century, formed the basis of the arguments for free trade, and still has some resonance today. This suggests that it is possible for countries to gain from trade by specialising in the production of goods in which they have a comparative advantage.
The core idea of free trade is that international trade should be carried out without restrictions in the form of such measures as tariffs, quotas or non-tariff barriers. This has been debated since the nineteenth century, with the proponents of free trade winning the argument until times of recession, which tended to bring out the protectionist arguments.
The free trade argument was widely accepted in the period after the Second World War, and there was a move towards dismantling the structure of tariffs that had been put in place. Successive rounds of tariff reductions were agreed, overseen by the General Agreement on Tariffs and Trade (GATT), which was the precursor of the WTO.
In the twenty-first century, protectionism again came back into fashion, following the recession that followed the financial crisis. Indeed, the idea of free trade is not without its critics, such as economist Ha-Joon Chang.
One line of criticism is historically based. In the Industrial Revolution, Britain led the world in the development of manufacturing industry. Was this based on the principles of free trade? It can be argued that Britain’s success was built on being able to import raw materials from its colonies, but although Britain was keen to import these materials under free trade conditions, it was also ready to restrict the ability of other nations to follow in its footsteps. For example, India was subjected to heavy tariffs on its textile workshops, forcing it to become a source of raw cotton rather than textiles. This protected the Lancashire textile mills.
The South Korean economy went through a period of rapid economic growth from the 1960s. Again, this was facilitated by high subsidies for firms and tariff barriers. There are other examples of the way in which industries have been protected to allow rapid economic growth to take place, often at the expense of potential competing nations.
A second line of argument notes that Ricardo’s analysis rested on the assumption that capital and other factors of production were immobile, providing support for local specialisation. When factors of production are more mobile - as in today’s world - this argument becomes less compelling.
Where there is imbalance of economic power between trading partners, the gains from trade may not be evenly spread between the countries involved. In particular, developing countries have gained less from trade than many developed countries, partly because of actions taken by the developed countries.
There may be strategic reasons for not becoming over-dependent on imports of key goods. Countries may wish to nurture new forms of economic activities and believe that such new industries need some protection from foreign competitors until they have become better able to hold their own.
In the case of the Trump tariffs, there was a move away from free trade because it was perceived that domestic industries were being subject to unfair competition from foreign producers (in particular from China). The retaliation from trading partners reduces the gains made from imposing tariffs, and the danger is that all countries involved will be made worse off.
What is a trading bloc?
Where a group of countries in a region agree to cooperate in international trade through some sort of free trade area or other form of association
What is a free trading area?
A group of countries that agree to remove tariffs, quotas and other restrictions on trade between the member countries, but have no agreement on a common barrier against non-members
What is a customs union?
A group of countries that agree to remove restrictions on trade between the member countries, and set a common set of restrictions (including tariffs) against non- member states
What are the advantages and disadvantages of custom unions?
There are some disadvantages of customs unions. The transactions costs involved in administering the union cannot be ignored, and where there are traditional rivalries between nations, there may be political sensitivities to overcome. This may impede the free working of the union, especially if some member nations are more committed to the union than others, or if some countries have close ties with non-member states.
It is also possible that a geographical concentration of economic activity will emerge over time within the union. This may result where firms want to locate near the centre of the area in order to minimise transportation costs. Alternatively, it may be that all firms will want to locate near the richest part of the market. Over time, this could mean that firms tend to concentrate in certain geographical areas, while the countries that are more remote, or which have smaller populations or lower average incomes, become peripheral to the centre of activity. In other words, over time, there may be growing inequality between regions within the union.
These disadvantages must be balanced against the benefits. For example, it may be that it is the smaller countries in the union that have the most to gain from tapping economies of scale that would not be accessible to them if they were confined to selling only within their domestic markets.
In addition to these internal economies of scale, there may be external economies of scale that emerge over time as the transport and communications infrastructure within the union improves. Furthermore, opening up domestic markets to more intense competition may induce efficiency gains, as firms will only be able to survive in the face of international competition by adopting best practice techniques and technologies. Indeed, another advantage of a customs union is that technology may be disseminated among firms operating within the union.
What is a common market?
A set of trading arrangements in which a group of countries remove barriers to trade among them, including adopting a common set of barriers against external trade and allowing free movement of factors of production
What is a monetary union?
A situation in which countries adopt a common currency
What is an economic and monetary union?
A set of trading arrangements the same as for a common market, but in addition having a common currency (or permanently fixed exchange rates between the member countries) and a common monetary policy
How does structural changes affect trading blocs?
A feature that all of these forms of integration have in common is that they involve the removal of barriers to trade among member countries. It is important to be aware that not all parties will see this as a good thing. In order to benefit from increased specialisation and trade, countries need to allow the pattern of their production to change. The benefits to the expanding sectors are apparent, but it is also the case that industries that formerly enjoyed protection from competition will become exposed to competition, and will need to decline in order to allow resources to be transferred into the expanding sectors. This can be a painful process for firms that need to close down, or move into new markets, and for workers who may need to undergo retraining before they are ready for employment in the newly expanding parts of the economy.
An especially contentious area of debate in the UK concerns the structural change that has taken place in recent decades, in which manufacturing activity has declined and financial services have expanded. This seems to reflect the changing pattern of the UK’s comparative advantage, in which banking, finance and insurance have become a major strength of the economy, whereas the manufacturing sector has found it more difficult to compete with the host of new entrants into this market elsewhere in the world.
