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Trade protection


Trade protection is the deliberate attempt to limit imports or promote exports by putting up barriers to trade. Despite the arguments in favour of free trade and increasing trade openness, protectionism is still widely practiced.

The motives for protection

The main arguments for protection are:

Protect sunrise industries

Barriers to trade can be used to protect sunrise industries, also known as infant industries, such as those involving new technologies. This gives new firms the chance to develop, grow, and become globally competitive.

Protection of domestic industries may allow they to develop a comparative advantage. For example, domestic firms may expand when protected from competition and benefit from economies of scale. As firms grow they may invest in real and human capital and develop new capabilities and skills. Once these skills and capabilities are developed there is less need for trade protection, and barriers may be eventually removed.

Protect sunset industries

At the other end of scale are sunset industries, also known as declining industries, which might need some support to enable them to decline slowly, and avoid some of the negative effects of such decline. For the UK, each generation throws up its own declining industries, such as ship building in the 1950s, car production in the 1970s, and steel production in the 1990s.

Protect strategic industries

Barriers may also be erected to protect strategic industries, such as energy, water, steel, armaments, and food. The implicit aim of the EUs Common Agricultural Policy is to create food security for Europe by protecting its agricultural sector.

Protect non-renewable resources

Non-renewable resources, including oil, are regarded as a special case where the normal rules of free trade are often abandoned. For countries aiming to rely on oil exports lasting into the long term, such as the oil-rich Middle Eastern economies, limiting output in the short term through production quotas is one method employed to conserve resources.

Deter unfair competition

Barriers may be erected to deter unfair competition, such as dumping by foreign firms at prices below cost.

Save jobs

Protecting an industry may, in the short run, protect jobs, though in the long run it is unlikely that jobs can be protected indefinitely.

Help the environment

Some countries may protect themselves from trade to help limit damage to their environment, such as that arising from CO2 emissions caused by increased production and transportation.

Limit over-specialisation

Many economists point to the dangers of over-specialisation, which might occur as a result of taking the theory of comparative advantage to its extreme. Retaining some self-sufficiency is seen as a sensible economic strategy given the risks of global downturns, and an over-reliance on international trade.

In addition to the economic arguments for protection, some protection may be for political reasons.

Methods of protection

There are two types of protection; tariffs, which are taxes, or duties, on imported goods designed to raise the price to the level of, or above the existing domestic price, and non-tariff barriers, which include all other barriers, such as:

Quotas

A quota is a limit to the quantity coming into a country.

With no trade, equilibrium market price in the country will exist at the price which equates domestic demand and domestic supply, at P, and with output at Q. However, the world price is likely to be lower, at P1, than the price in a country that does not trade. If the country is opened up to free trade from the rest of the world, the world supply curve will be perfectly elastic at the world price, P1.

The new equilibrium price is P1 and output is Q1. The domestic share of output is now Q2,compared with Q, the self-sufficient quantity. The amount imported is the distance Q2 to Q1.

Imposing a quota

In an attempt to protect domestic producers, a quota of Q2 to Q3 may be imposed on imports.

This enables the domestic share of output to rise to 0 to Q2, plus Q3 to Q4.

The quota creates a relative shortage and drives the price up to P2, with total output falling to Q4. The amount imported falls to the quota level. It is this price rise that provides an incentive for less efficient domestic firms to increase their output.

One of the key differences between a tariff and a quota is that the welfare loss associated with a quota may be greater because there is no tax revenue earned by a government. Because of this, quotas are less frequently used than tariffs.

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In addition to quotas, other non-tariff barriers include:

Government favouring domestic firms

Countries can protect their domestic industries by employing public procurement policies, where national governments favour local firms. For example, national or local governments may purchase supplies of military or medical equipment from local firms.

Domestic subsidies

Governments may also give subsidies to domestic firms, which can then be used to help reduce price and deter imports. This financial support can also be in the form of an export subsidy, providing an incentive for firms to export.

Health and safety grounds

National governments can also use health and safety regulations to discriminate against imported products, such as banning the import of a product on health or safety grounds, while local producers do not have to pass such stringent tests.

Quality standards

In a similar way, governments can set tough quality standards that may be difficult for overseas producers to meet.

Bureaucracy

Excessive bureaucracy associated with the process of importing and exporting may also restrict trade. For example, goods may be deliberately held-up at ports and airports, and there may be unnecessarily complex and lengthy paperwork associated with international transactions.

Exchange rates

Monetary protection involves countries deliberately devaluing their exchange rate to stimulate exports and deter imports.

Tariffs

Tariffs, or customs duties, are taxes on imported products, usually in an ad valorem form, levied as a percentage increase on the price of the imported product. Tariffs are one of the oldest and most pervasive forms of protection and barrier to trade.

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The impact of tariffs

The imposition of tariffs leads to the following:

Higher prices

Domestic consumers face higher prices, which also means that there is a loss of consumer surplus. However, there is a gain in domestic producer surplus as producers are protected from cheap imports, and receive a higher price than they would have without the tariff. However, it is likely that there is an overall net welfare loss.

Without trade, the domestic price and quantity are P & Q.
If a country opens up to world supply, price falls to P1, and output increases from Q to Q2. As a result, domestic producers’ share falls to Q1 and imports now dominate, with the quantity imported Q1 to Q2.

Tariff diagram

The imposition of a tariff shifts up the world supply curve to World Supply + Tariff.

The price rises to P2, and the new output is at Q3. Domestic producers share of the market rise to Q4, and imports fall to Q4 to Q3. The result is that domestic producers have been protected from cheaper imports from the rest of the World.

Given that domestic consumers face higher prices, they also suffer a loss of consumer surplus. In contrast, domestic producers increase their producer surplus as they receive a higher price than they would have without the tariff.
Increased market share also means that jobs will be protected in the domestic economy.

Welfare loss

However, the reduction in consumer surplus is greater than the increase in producer surplus. Even when adding the tariff revenue (area K,L,M,N) there is still a net loss. The net welfare loss is represented by the triangles X and Y. 

Tariff welfare loss

Distortion

There is a potential distortion of the principle of comparative advantage, whereby a tariff alters the cost advantage that countries may have built up through specialisation.

Retaliation

There is the likelihood of retaliation from exporting countries, which could trigger a costly trade war.

However, in the short run tariffs may protect jobs, infant and declining industries, and strategic goods. Tariffs may also help conserve a non-renewable scarce resource. Selective tariffs may also help reduce a trade deficit, and reduce consumption.