Why are there so many trade disputes around the world economy? Can protectionism ever be justified? This chapter considers the issue of import controls.

Over many years, the world economy has seen a rise in the volume and value of trade. Most countries recognise the long-term benefits of free trade in goods and services between nations although there are disputes about what free trade actually means! Trade is widely regarded as a catalyst for growth both on the demand and supply-side of their economies. But frequently there are trade disputes between countries – as often as not because one or more parties believes that trade is being conducted unfairly, on an uneven playing field, or because they believe that there is an economic or strategic justification for some form of import control.

Whether or not there is ever a fully persuasive justification for protectionist measures from a purely economics vantage point is open to discussion and debate. In this section we consider some of the options for controlling imports; the arguments for introducing them and an evaluation of their economic consequences.

Expanding trade in the global economy All merchandise trade, annual average % change	Trade	Production
1950-63	7.7	5.2
1963-73	9.0	6.1
1973-90	3.8	2.6
1990-01	5.7	2.1
Source: World Trade Organisation

Free trade produces winners and losers - not all countries benefit at the same time from trade particularly those with poor competitiveness. If a country believes that it is not benefiting fairly from participating in free international trade, it is more likely to want to introduce some form of import control or protectionist measure.

What is protectionism?

Protectionism represents any attempt by a government to impose restrictions on trade in goods and services between countries:

• Tariffs - import taxes.
• Quotas - quantitative limits on the level of imports allowed.
• Voluntary Export Restraint Arrangements – where two countries make an agreement to limit the volume of their exports to one another over an agreed period of time.
• Embargoes - a total ban on imported goods.
• Intellectual property laws (patents and copyrights).
• Export subsidies - a payment to encourage domestic production by lowering their costs.
• Import licensing - governments grants importers the license to import goods.
• Exchange controls - limiting the amount of foreign exchange that can move between countries.

Quotas, embargoes, export subsidies and exchange controls are all examples of non-tariff barriers to international trade.

Tariffs

A tariff is a tax that raises the price of imported products and causes a contraction in domestic demand and an expansion in domestic supply. The net effect is that the volume of imports is reduced and the government received some tax revenue from the tariff.

Average import tariffs between OECD countries are around 3 per cent; but tariff peaks reach 506 per cent in the EU, and 350 per cent in the US. The highest tariffs are typically levied on goods from the developing world. Among non-agricultural products, the EU has 135 tariff lines over 15 per cent and about 600 tariff lines between 10 and 15 percent, many in labour-intensive products in which developing countries have a comparative advantage. The USA has 230 tariff lines above 15 per cent, and Australia has nearly 800.

Import Protection in the European Union – selected products

	Average tariff rate (%)	Non tariff barrier %	Anti-dumping duty %	Overall %
Cereals	14.0	5.0		19.0
Meat	11.2	64.8		76.0
Dairy Products	9.7	100.3		110.0
Tobacco	47.3			47.3
Clothing	11.6	19.0		30.6
Footwear	7.4		17.5	24.9

Import Quotas

The Government might seek to limit the level of imports through a quota.  Examples of quotas were found in the textile industry under the terms of the Multi-Fibre Agreement which expired in January 2005 and which led, in 2005, to a trade dispute between the EU and China over the issue of textile imports.

Quotas introduce a physical limit of the volume (number of units imported) or value (value of imports) permitted

Administrative Barriers

Countries can make it difficult for firms to import by imposing restrictions and being 'deliberately' bureaucratic. These trade barriers range from stringent safety and specification checks to extensive hold-ups in the customs arrangements. A good example is the quality standards imposed by the EU on imports of dairy products.

Preferential Government Procurement Policies and State Aid

Free trade can be limited by preferential behaviour by the government when allocating major spending projects that favour domestic rather than overseas suppliers. These procurement policies run against the principle of free trade within the EU Single Market – but they remain a feature of the trade policies of many developed countries within Western Europe. Good examples include the award of contracts to suppliers of defence equipment or construction companies involved in building transport infrastructure projects.

The use of financial aid from the state can also distort the free trade of goods and services between nations, for example the use of subsidies to a domestic coal or steel industry, or the widely criticized use of export refunds (subsidies) to European farmers under the Common Agricultural Policy (CAP) which is criticized for damaging the profits and incomes of farmers in developing countries.

Economic justifications for protectionism

Infant Industry Argument

The essence of the argument is that certain industries possess a potential (latent) comparative advantage but have not yet exploited the potential economies of scale. Short-term protection from established foreign competition allows the ‘infant industry’ to develop its comparative advantage.  At this point the trade protection could be relaxed, leaving the industry to trade freely on the international market. The danger of this form of protection is that the industry will never achieve full efficiency. The short-term protectionist measures often start to appear permanent. 

Protection – a reaction against “import dumping”

The nature of dumping

Dumping is a type of predatory pricing behaviour and is also a form of price discrimination. The concept is used most frequently in the context of trade disputes between nations, where businesses in one or more countries may seek to produce evidence that manufacturers in another country are exporting products at a price below the true cost of production. True dumping according to the definitions employed by the World Trade Organisation is illegal under WTO rules. But it can be difficult, time-consuming and costly to prove allegations of dumping, not least the problems in calculating the production costs of a supplier in their own domestic market.

Export subsidies and dumping in developing countries

Many developing countries have complained about the effects of dumping caused by the system of export refunds (subsidies) offered to producers by the European Union. These subsidies have the effect of reducing the costs of suppliers and allow them to offload their surplus production into overseas markets. This can have a very damaging effect on prices, demand and profits for the domestic producers of developing countries trying to compete in their home markets.

The charity Oxfam has been especially vocal in its criticism of the effects of the trade policies of the developed world in sustaining high levels of poverty in many of the world’s poorest nations. You can read more about their current campaign on trade by accessing this site: http://www.oxfam.org.uk/what_we_do/issues/trade/

Anti-dumping tariffs - recent examples

If a company exports a product at a price lower than the price it normally charges on its own home market, it is said to be “dumping” the product. In the short term, consumers benefit from the low prices of the foreign goods, but in the longer term, persistent undercutting of domestic prices will force the domestic industry out of business and allow the foreign firm to establish itself as a monopoly.  Once this is achieved the foreign owned monopoly is free to increase its prices and exploit the consumer.  Therefore protection, via tariffs on 'dumped' goods can be justified to prevent the long-term exploitation of the consumer.

The World Trade Organisation allows a government to act against dumping where there is genuine ‘material’ injury to the competing domestic industry. In order to do that the government has to be able to show that dumping is taking place, calculate the extent of dumping (how much lower the export price is compared to the exporter’s home market price), and show that the dumping is causing injury. Usually an ‘anti-dumping action’ means charging extra import duty on the particular product from the particular exporting country in order to bring its price closer to the “normal value”.

Externalities, Market Failure and Import Controls

Protectionism can also be used to take account of externalities and dealing with de-merit goods.  Goods such as alcohol, tobacco and narcotic drugs have adverse social effects and are termed de-merit goods. Protectionism can safeguard society from the importation of these goods, by imposing high tariff barriers or by banning the importation of the good altogether.

Non-Economic Reasons

Countries may wish not to over-specialise in the goods in which they possess a comparative advantage. One danger of over-specialisation is that unemployment may rise quickly if an industry moves into structural decline as new international competition emerges at lower costs

The government may also wish to protect employment in strategic industries, although clearly value judgements are involved in determining what constitutes a strategic sector. The recent trade dispute arising from the decision by the United States to introduce a tariff on steel imports is linked to this objective. The US steel tariff was declared unlawful by the WTO in July 2003 and eventually the United States was pressurized into withdrawing these tariffs in the late autumn of 2003.

Tariffs are not usually a major source of tax revenue for the Government that imposes them. In the UK for example, tariffs are estimated to be worth only £2 billion to the Treasury, equivalent to only around 0.5% of the total tax take. Developing countries tend to be more reliant on tariffs for revenue.

Economic Arguments against Import Controls

According to Professor Jagdish Bhagwati, “the fact that trade protection hurts the economy of the country that imposes it is one of the oldest but still most startling insights economics has to offer.”

The folly of protection has been confirmed by a range of studies from around the world.  These indicate that that it has brought few benefits but imposed substantial costs.  Among the main criticisms of protectionist policies are the following:

• Market distortion: Protection has proved an ineffective and costly means of sustaining employment. 

1. Higher prices for consumers: Trade barriers in the form of tariffs push up the prices faced by consumers and insulate inefficient sectors from competition.  They penalise foreign producers and encourage the inefficient allocation of resources both domestically and globally.  In general terms, import controls impose costs on society that would not exist if there was completely free trade in goods and services. It has been estimated for example that the recent tariff and other barriers placed on imports of steel into the US increased the price of every car produced there by an average of $100
2. Reduction in market access for producers: Export subsidies, depressing world prices and making them more volatile while depriving efficient farmers of access to the world market. This is a major criticism of the EU common agricultural policy. In 2002 the EU sugar regime lowered the value of Brazil, Thailand and South Africa’s sugar exports by over $700 million – countries where nearly 70 million people survive on less than $2 a day.

• Loss of economic welfare: Tariffs create a deadweight loss of consumer and producer surplus arising from a loss of allocative efficiency. Welfare is reduced through higher prices and restricted consumer choice.
• Regressive effect on the distribution of income: It is often the case that the higher prices that result from tariffs hit those on lower incomes hardest, because the tariffs (e.g. on foodstuffs, tobacco, and clothing) fall on those products that lower income families spend a higher share of their income. Thus import protection may worsen the inequalities in the distribution of income making the allocation of scarce resources less equitable
• Production inefficiencies: Firms that are protected from competition have little incentive to reduce production costs. Governments must consider these disadvantages carefully
• Little protection for employment:  One of the justifications for protectionist tariffs and other barriers to trade is that they help to protect the loss of relatively low skilled and low paid jobs in industries that are coming under sever international competition. The evidence suggests that, in the long term, tariffs are a costly and ineffective way of protecting such jobs. According to the DTI study on trade published in 2004, since 1997 UK employment in textiles manufacturing has fallen by 45%, in clothing manufacture by nearly 60%, and in footwear manufacturing by around 50% - and this despite the protection afforded to European Union textile manufacturers. The cost of protecting each job runs into hundreds of thousands of Euros for the EU as a whole. Might that money have been spent more productively in other ways? Often there is a huge opportunity cost involved in imposing import tariffs.
• Trade wars: There is the danger that one country imposing import controls will lead to “retaliatory action” by another leading to a decrease in the volume of world trade. Retaliatory actions increase the costs  of importing new technologies
• Negative multiplier effects: If one country imposes trade restrictions on another, the resultant decrease in total trade will have a negative multiplier effect affecting many more countries because exports are an injection of demand into the global circular flow of income. The negative multiplier effects are more pronounced when trade disputes boil over and lead to retaliation.

The diagram below shows the welfare consequences of imposing an import tariff

In a new study of the benefits of global trade and investment published in May 2004, the UK Department of Trade of Industry outlined their opposition to import controls (protectionism)

Protectionist policies rarely achieve their aims. They can be costly to administer and they nearly always provide domestic suppliers with a protectionist shield that encourages inefficiencies leading to higher costs.

Protectionism is a ‘second best’ approach to correcting for a country’s balance of payments problem or the fear of rising structural unemployment. And import controls go against the principles of free trade enshrined in the theories of comparative advantage. In this sense, import controls can be seen as examples of government failure arising from intervention in markets.

Economic nationalism

Economic nationalism is a term that has become used more frequently in recent years. It is used to describe policies which are guided by the idea of protecting a country's home economy, i.e. protecting domestic consumption, jobs and investment, even if this requires the imposition of tariffs and other restrictions on the movement of labour, goods and capital. Economic nationalism may include such doctrines as protectionism and import substitution.

Examples of economic nationalism include China's controlled exchange of the yuan, and the United States' use of tariffs to protect domestic steel production. The term gained a more specific meaning in 2005 and 2006 after several European Union governments intervened to prevent takeovers of domestic firms by foreign companies. In some cases, the national governments also endorsed counter-bids from compatriot companies to create 'national champions'. Such cases included the proposed takeover of Arcelor (Luxembourg) by Mittal Steel (India). And the French government listing of the food and drinks business Danone (France) as a 'strategic industry' to pre-empt a potential takeover bid by PepsiCo (USA).

Further reading on trade and protectionism

• BBC special report on the “Battle over Trade”
• China faces Indian dumping allegations (BBC news – July 2006)
• Foreign lesions (James Surowiecki – The Guardian)
• Guardian special report on fair trade
• OECD international trade and investment research articles
• Oxfam campaign for fair international trade
• Patriotism and protectionism in the European Union (BBC news – March 2006)
• US steel tariffs (2002)
• Why developing countries should liberalise their trade (Globalisation Institute)
• World Trade Organisation – 2006 World Trade Report