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Protectionism & Barriers to Trade

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Protectionism - Import Controls

Trade disputes between countries happen because one or more parties either believes that trade is being conducted unfairly, on an uneven playing field, or because they believe that there is one or more economic or strategic justifications for import controls.

Protectionism represents any attempt to impose restrictions on trade in goods and services. The aim is to cushion domestic businesses and industries from overseas competition and prevent the outcome resulting from the inter-play of free market forces of supply and demand. Protectionism can come in many forms including the following:

  1. Tariffs - a tax that raises the price of imported products and causes a contraction in domestic demand and an expansion in domestic supply – for example, the average import tariff on goods entering the Russian economy is 10%, although there will be higher rates for a number of products
  2. Quotasquantitative (volume) limits on the level of imports allowed or a limit to the value of imports permitted into a country in a given time period (usually one year).
  3. 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.
  4. Intellectual property laws (patents and copyrights)
  5. Technical barriers to trade including product labeling rules and stringent sanitary rules, food safety and environmental standards. These increase product compliance costs and impose monitoring costs on export agencies in many countries. Huge scale vertically integrated transnational businesses can cope with these non-tariff barriers but many of the least developed countries do not have the some technical sophistication to overcome these barriers.
  6. Preferential state procurement policies – where a government favour local/domestic producers when finalizing contracts for state spending e.g. infrastructure projects
  7. Export subsidies - a payment to encourage domestic production by lowering their costs. Soft loans can be used to fund the ‘dumping’ of products in overseas markets. Well known subsidies include Common Agricultural Policy in the EU, or cotton subsidies for US farmers and farm subsidies introduced by countries such as Russia. In 2012, the USA government imposed tariffs of up to 4.7 per cent on Chinese manufacturers of solar panel cells, judging that they benefited from unfair export subsidies after a review that split the US solar industry.
  8. Domestic subsidies – government financial help (state aid) for domestic businesses facing financial problems e.g. subsidies for car manufacturers or loss-making airlines.
  9. Import licensing - governments grants importers the license to import goods.
  10. Exchange controls - limiting the foreign exchange that can move between countries.
  11. Financial protectionism – for example when a national government instructs its banks to give priority when making loans to domestic businesses.
  12. Murky or hidden protectionism - e.g. state measures that indirectly discriminate against foreign workers, investors and traders. A government subsidy that is paid only when consumers buy locally produced goods and services would count as an example. Deliberate intervention in currency markets might also come under this category.

Quotas, embargoes, export subsidies and exchange controls are examples of non-tariff barriers

Tariffs

China joined the WTO in 1991 and since then average import tariffs have been falling on a consistent basis. Our analysis diagram below shows the standard effects of an import tariff on an imported product. The world price before the tariff is Pw and at this price, domestic demand is Qd and domestic supply is Qs.

Because of the tariff, the import price rises to Pw + T. This causes a contraction in demand to Qd2 and an expansion of supply to Qs2. The result is that the volume of imports falls to quantity M. Tariffs have welfare consequences, one of which is that the welfare of consumers who must now purchase the imported product at a higher price has fallen – there is a deadweight loss of consumer surplus. The effects of a tariff on quantities depend on the price elasticity of demand and price elasticity of supply of domestic businesses that have been given a cushion of increased competitiveness by the tariff.

Arguments for Protectionism

  1. Fledging industry argument: Certain industries possess a possible comparative advantage but have not yet exploited economies of scale. Short-term protection allows the ‘infant industry’ to develop its comparative advantage at which point the protection could be relaxed, leaving the industry to trade freely on the international market.
  2. Externalities and market failure: Protectionism can also be used to internalize the social costs of de-merit goods.  Or to correct for environmental market failure in the supply of certain imports.
  3. Protection of jobs and improvement in the balance of payments
  4. Protection of strategic industries: The government may also wish to protect employment in strategic industries, although value judgments are involved in determining what constitutes a strategic sector. This might involve attempting to reduce long-term dependence on certain imports
  5. Anti-dumping duties: Dumping is a type of predatory pricing behaviour and a form of price discrimination. Goods are dumped when they are sold for export at less than their normal value. The normal value is usually defined as the price for the like goods in the exporter’s home market. Recent examples of disputes about alleged dumping have included
    1. India complaining about the dumping of bus and truck tires from China and Thailand
    2. EU shoemakers alleging that Chinese and Vietnamese shoe manufacturers have illegally dumped leather, sports and safety shoes in the EU market
    3. In 2009 EU imposed temporary "anti-dumping" taxes on Chinese wire, candles, iron and steel pipes, and aluminum foil from Armenia, Brazil and China.

In the short term, consumers benefit from the lower prices of the foreign goods, but in the longer-term, persistent undercutting of domestic prices might 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”.

Tariffs are not 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.

Arguments against Protectionism

Market distortion: Protection can be an ineffective and costly means of sustaining jobs. 

  1. Higher prices for consumers: Tariffs push up the prices faced by consumers and insulate inefficient sectors from competition.  They penalize foreign producers and encourage the inefficient allocation of resources both domestically and globally.
  2. Reduction in market access for producers: Export subsidies depress world prices and damage output, profits, investment and jobs in many developing countries that rely on exporting primary and manufactured goods for their growth.

Loss of economic welfare: Tariffs create a deadweight loss of consumer and producer surplus. Welfare is reduced through higher prices and restricted consumer choice.

Regressive effect on the distribution of income: 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.

Production inefficiencies: Firms that are protected from competition have little incentive to reduce production costs. This can lead to X-inefficiency and higher average costs.

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 affecting LRAS.

Negative multiplier effects: If one country imposes trade restrictions on another, the resultant decrease in 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.

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

Economic nationalism

Economic nationalism describes policies to protect domestic consumption, jobs and investment using tariffs and other barriers to the movement of labour, goods and capital

The term gained a more specific meaning in recent years 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 block potential takeover bid by PepsiCo (USA





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