Transcript 22 Free Trade and Protectionism

Free Trade & Protectionism
Ch 22 IB International Economics
Arguments for protectionism
 If international trade is so good why is it that countries
don’t all trade freely?
 Why do they often protect their economies from
imports?
 Here are some of the arguments (some of which are not
valid – evaluation!)
 Protecting Domestic employment
 At any given time in an economy there will be some
industries in decline (sunset industries)
 They cannot compete with foreign competition
 If the industry is large it will cause high levels of
structural unemployment
 Governments often attempt to protect the industry
to prevent the unemployment
 Evaluation – this argument is not very strong;
protecting the industry may just prolong the process of
decline
 Even though there will be short run social costs, it
might be better to let the resources move to other
industries expanding other areas of the economy
 The negative externalities of a rapidly declining
major industry may be so great that government
feels it has to protect
Free Trade: no
barriers to trade put
in place by
governments or
international
organisations
http://www.youtube
.com/watch?v=Y2X
3KPilAt0
Arguments for protectionism
 Protecting the economy from low cost labour
 It is often argued that the main reason for declining
domestic industries is the low cost of labour in
exporting countries
 The economy should be protected from imports
produced in low cost labour countries
 Demands in the US to protect domestic clothing
against cheap Asian imports
 There may be widespread benefits to the economy
from but losses (particularly job losses) in particular
industries
 There is much more job insecurity in the
manufacturing industries of developed countries
who fear losing their jobs to workers in China and
India
 Workers and trade unions lobby for protectionism
 Evaluation
 This argument goes against the whole concept of
comparative advantage
 If the industry is protected consumers will pay higher
prices than they should and production will be
inefficient
Example: In 1998 the
hourly wage for shipbuilding
in the US was $19.19 but
$9.27 in South Korea.
South Korea is now the
largest shipbuilder in the
world. In 2004 South Korea
produced 14,768 large
commercial ships whereas
the US produced only 289
Arguments for protectionism
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Important!!
Protecting the economy from low cost labour
Comparative advantage will change over time
The US may have had a comparative advantage in shipbuilding at one time
As relative factor costs change resources should move freely
Supply side policies that focus on labour markets emphasise the importance
of making labour flexible to adapt to changing economic circumstances
 If governments don’t help create a flexible workforce they will have to
financially help the unemployed caused by increased international
competition
Arguments for protectionism
 Protecting and infant (sunrise) industry
 Many governments argue that new developing
industries do not have the economies of scale
advantages
 Until it can gain EoS it can’t compete
 It needs to be protected until it achieves size
 Evaluation: this argument may not work
for developed countries
 They have access to capital markets to start
off big
 Saudi Arabian government recently
diversified into petrochemical production –
worked with Chevron, BP and Exxon Mobil to
build some of the largest plants in the world
 This argument may be more applicable to
developing countries
 but they may not have the international
political power to impose protectionist
policies without complains and action from
developed countries.
Arguments for protectionism
 To avoid the risks of overspecialisation
 Governments may want to avoid
putting all their eggs in one basket
 The country could become
dependent on export sales of one or
two products
 If demand changes there will be
serious consequences
 The invention of synthetic rubber
had a large negative effect on the
rubber industry in Malaysia
 The oversupply of coffee on the
world market causing falling prices
did the same for Ethiopia
 Evaluation: there are no real
arguments against this view!
Example: the development of the quartz crystal
severely damaged the Swiss wristwatch industry
damaging the economy
Exports of Swiss mechanical watches
plummeted from 40 million in 1973 to only
three million ten years later.
While some Swiss watch companies did
manufacture quartz watches, Japan and Hong
Kong dominated the quartz segment and
decimated the Swiss industry.
Many small- to medium-sized watch companies
in Switzerland closed their doors by the end of
the 1970s. The number of workers in the
industry plunged from nearly 90,000 in 1970 to
47,000 by 1980
Arguments for
protectionism
 Strategic reasons
 It is sometimes argued that
certain industries need to be
protected in case they are
needed in times of war
 E.g. agriculture, steel, power
generation
 Evaluation: A good excuse for
protectionism?! In many cases
it is unlikely that countries will
go to war and that they will be
completely cut off from all
supplies
Arguments for protectionism
Dumping: the practice of selling a
good in international markets at a
 To prevent dumping
 Dumping can ruin domestic producers price that is below the cost of
producing it
 Where countries can prove that their
industries have been severely
damaged their governments are
allowed under international trade
rules to impose anti-dumping
measures to reduce the damage
 Evaluation: it is very difficult to prove
 Countries argue that when the EU
exports subsidized sugar it is
actually dumping because the price
doesn’t reflect the actual costs of
the EU sugar producers
 If dumping happens it is more likely
that there will be a need for talks
between governments rather than
protectionism
 Protectionism may invite
retaliation reducing the benefits
gained by consumers and
Read case study & Answer Q’s P270
producers
Arguments for protectionism
 To protect product standards
 A country might wish to impose safety,
health or environmental standards on
goods being imported into its domestic
market
 This will ensure that products match the
standards of domestic goods
 The EU banned the importing of American
beef because it has been treated with
hormones
 Evaluation: This is a valid argument if the
concerns are valid
 The US don’t believe the EU has a
valid reason as they have no proof that
the hormones are bad for consumers
 They say it is an excuse for
protectionism
 The US retaliated in 1999 by imposing
trade sanctions on $117m worth of
European imports
Arguments for protectionism
 To raise government revenue
 In developing countries where it is difficult
to collect tax governments impose import
taxes (tariffs) to raise revenue
 The IMF estimated that import duties
account for approximately 15% of total
government revenue in developing
countries
 Evaluation: This is not so much an
argument for protectionism but a reason
why it happens
 To correct a balance of payments deficit
 Governments sometimes impose
protectionist methods to reduce import
expenditure and improve the current
account deficit
 Evaluation: This will only work in the short
run and does not fix the actual cause of the
deficit
 Other countries may also retaliate
Arguments against protectionism
 These arguments are really related to the
reasons why countries trade
 In brief these are
 Protectionism raises prices to the
consumers and producers of the
imports
 Leads to less choice for consumers
 Competition would diminish and
domestic firms would become
inefficient (innovation may also be
reduced)
 Comparative advantage is distorted
leading to inefficient use of world
resources
 Economic growth will be reduced
Types of Protectionism
 Before we look at the types of
protectionism we are going to look at
how we illustrate a country that has free
trade (we will use wheat as an example)
 If there is no foreign trade the domestic
farmers would produce Qe tons of wheat
and the price will be Pe
 If we then introduce foreign trade and
the world price is Pw which lower than
Pe the situation changes
 Consumers can now import as much
wheat as they like at the lower price
 The world supply curve is perfectly elastic
because there are so many suppliers (it
doesn’t really matter how much demand
there is it will not affect the price)
 Sworld has to be lower than Pe otherwise
there would be no point in trading
Types of Protectionism
 With free trade the price of what
will be Sworld
 At this price domestic farmers will
only be prepared to supply Q1
tons but the demand will be Q2
 Imports will satisfy the surplus
demand
 Q1Q2 tons of wheat will be
supplied by foreign suppliers
 Consumers get to consume QeQ2
more at the lower price
 Lets now apply some different
types of protectionism
Insert fig 24.1
Types of Protectionism - Tariff
 A tariff is a tax that is charged on an imported
good
 Any tax will cause suppliers to supply less (less
profit to be made)
 The world supply curve will shift upwards (the tax
is not applied to the domestic producers)
 We can see that the price goes up to Pw+t
 At this price domestic suppliers will only supply
Q3
 This is more than before but there is still excess
demand (just less than before)
 Foreign suppliers will supply Q3Q4 which is less
than before
 Domestic producers revenue increases from go to
g+a+b+c+h
 Foreign producers receive Pw+T but they have to
pay the tariff to the government so their revenue
falls from h+i+j+k to only i+j
 The government receives revenue of d+e
 One of the issues is that importers pay a higher
price for the wheat
 They sell the more expensive wheat onto millers
and the flour is used to make cereals etc
 This may cause food inflation
Types of Protectionism Tariff
 Two more things happen
 Firstly because some
wheat is not purchased
there is a dead-weight loss
of welfare
 Q4Q2 tons of wheat are
not now demanded
 Consumers keep the
amount k that they would
have spent on wheat
 There is a loss of consumer
surplus equivalent to f
 This is dead weight loss
Types of Protectionism - Tariff
 Secondly, after the tariff, the wheat
is produced by relatively inefficient
farmers (compared to the foreign
farmers)
 Foreign farmers would produce
this quantity for a minimum
revenue of h
 Domestic producers need a
minimum revenue of h+c
 c represents the inefficiency of
the domestic producers and a
loss of world efficiency (more of
the world’s resources are being
used to produce the wheat than
necessary)
 This is another dead weight loss
of welfare
Complete student workpoint
22.3
Types of Protectionism Subsidies
 A subsidy is an amount of
money paid by the government
to a firm per unit of output
 In this instance government is
giving the subsidy to the firm to
make it more competitive
 The domestic supply curve will
shift downwards reducing the
price
 This means that domestic
producers will supply Q3 wheat
to the market instead of Q1
 foreign supply will decrease
from Q1Q2 to Q3Q2
 Domestic revenue increase
from a to a+b+e+f+g
 Foreign revenue decreases from
b+c+d to c+d
 Government has to pay out
e+f+g
Types of Protectionism Subsidies
 At this tariff Q1Q3 tons of what
are now produced by relatively
inefficient farmers
 Foreign farmers would produce
for revenue b
 Domestic farmers would
produce for b+g
 g represents the inefficiency
(misallocation of world
resources) – dead-weight loss
of welfare
 There is no loss of consumer
surplus because price does not
change
 Consumers are indirectly
affected as governments use
tax revenues to fund the
surplus
 This could lead to higher taxes
and is an opportunity cost –
government could spend the
Complete student
workpoint 22.4 P275
Types of Protectionism - Quotas
 Quotas are a physical limit on the
numbers or value of goods that can be
imported into a country
 The EU imposes quotas on Chinese garlic
and mushrooms
 This has a strange effect on the free trade
diagram
 Let us assume that the government
imposes a quota of Q1Q3
 Domestic producers supply Q1
 Foreign suppliers produce Q1Q3
 There is still excess demand of Q3Q2 at
the price Pw and so the price begins to
rise
 As the price rises importers are not
allowed to supply more
 Domestic producers begin to enter the
market attracted by the high price of
wheat
 The domestic supply curve shifts to the
right above Pw
 Eventually the price settles at Pquota and
the Quantity drops to Q4
Types of Protectionism - Quotas
 Domestic producers now supply Q1 and
Q3Q4 tons of wheat at a price of Pquota
 Their revenue rises from a to a+c+d+f+i+j
 Foreign producers now supply their quota
of Q1Q3 at Pquota
 Their income changes from b+d+c+e to
b+g+h
 This is a fall in income but in theory does
not have to be
 There are two areas of dead-weight loss
of welfare caused by the quota
 Consumer surplus loss of k because
wheat is not purchased
 Q3Q4 tons of wheat are now
produced by relatively inefficient
foreign farmers
 Foreign farmers would produce
for c+d
 Domestic farmers produce for
c+d+j
 J is the loss of world efficiency
Complete student workpoint
24.4
Types of Protectionism – Voluntary export restraints
(VERs)
 VERs are agreements between exporting and
importing countries in which the exporting country
agrees to limit the quantity of exports of a specific
good below a certain level
 China has agreed to limit its export of textiles to South
Africa
Types of Protectionism –
Administrative barriers
 When goods are imported there
are always administrative
processes e.g. paper work to be
stamped etc
 This is called red tape
 These can take time and make it
difficult for exporters
 It can also raise their costs
 Sometimes countries may
designate certain ports of entry
that are difficult to reach and also
more expensive
 This is designed to put off the
exporter
Complete workpoint 24.6 for
homework
Types of protectionism
Health and safety standards and
environmental standards
 This is when restrictions are put on
the types of goods that can be sold in
the domestic market or on the way
they are manufactured
 They may set quality or safety
standards that are hard to meet
 The certification may be very difficult
and expensive to gain
 It is important that government looks
after its people but important that the
country is behaving legitimately
Embargoes
 Complete ban on imports
 US has not traded with Cuba for 50
years
National campaigns
 Marketing campaigns to encourage
people to buy domestic goods
Time for you to do some work!!
Complete the data response question on P280
HL Bit!
 Together we will work
through the example on
P276
Time for you to do some work!!
Complete the higher level paper 3 question on
P279