TRADE POLICY



TRADE POLICY

Protectionism - Any departure from free trade designed to protect domestic industries from foreign competition.

FREE TRADE OR PROTECTION

Most governments accept the proposition that a relatively free flow of international trade is desirable for the health of their individual economies. But should a country permit the completely free flow of international trade, or should it sometimes seek to protect its local producers from foreign competition. If some protection is desired, should it be achieved by tariffs or by non-tariff barriers? Tariffs are taxes designed to raise the price of imported goods. Non-tariff barriers (NTBs) are devices other than tariffs designed to reduce the flow of imports; examples are import quotas and customs procedures that are deliberately more cumbersome than necessary.

THE CASE FOR FREE TRADE

Free trade encourages all countries to specialize in producing products in which they have a comparative advantage. This pattern of specialization maximizes world production and hence maximizes average world living standards

Free trade makes a county as a whole better off, even though it may not make every individual in the country better off.

In today's world, a country's products must stand up to international competition if they are to survive. Over even as short a period as a few years, firms that do not develop new products and new production methods fall seriously behind their foreign competitors. If one country protects its domestic firms by imposing a tariff," those firms are likely to become complacent about the need to adopt new technologies, and over time they will become less competitive in international markets. As the technology gap between domestic and foreign firms widens, the tariff wall will provide less and less protection. Eventually, the domestic firms will succumb to foreign competition. Meanwhile, domestic living standards will fall relative to foreign ones.

Is there a valid case for some protection?

THE CASE FOR PROTECTION

Two kinds of arguments for protection are commonly heard. The first concerns objectives other than maximizing national income; the second concerns the desire to increase one country's national income, possibly at the expense of the national incomes of other countries.

Objectives Other than Maximizing National Income

A country's national income may be maximized with free trade and yet it may still be rational to oppose free trade because of other policy objectives.

ADVANTAGES OF DIVERSIFICATION

For a very small country, specializing in the production of only a few products—though dictated by comparative advantage— might involve risks that the country does not want to take. One such risk is that technological advances may render its basic product obsolete. Another risk, especially for countries specialized in producing a small range of agricultural products, is that swings in world prices lead to large swings in national income.

PROTECTION OF SPECIFIC GROUPS

Although specialization according to comparative advantage will maximize living standards, some specific groups may have higher incomes under protection than under free trade. Of particular interest in Canada and the United States has been the effect that greater international trade has on the incomes of unskilled workers.

Consider the ratio of skilled workers to unskilled workers. There are plenty of both types throughout the world. Compared with much of the rest of the world, however, Canada has more skilled and fewer unskilled people. When trade is expanded because of a reduction in tariffs, Canada will tend to export goods made by its abundant skilled workers and import goods made by unskilled workers. Because Canada is now exporting more goods made by skilled labour, the domestic demand for such labour rises. Because Canada is now importing more goods made by unskilled labour, the domestic demand for such labour falls. This specialization according to comparative advantage raises average Canadian living standards, but it will also tend to raise the wages of skilled Canadian workers relative to the wages of unskilled Canadian workers.

If increasing trade has these effects, then reducing trade by erecting protectionist trade barriers can have the opposite effects. Protectionist policies may raise the incomes of unskilled Canadian workers at the expense of the skilled worker. The conclusion is that trade restrictions can improve the earnings of one group whenever the restrictions increase the demand for that group's services. This is done, however, at the expense of a reduction in overall national income and hence the country's average living standards.

MAXIMIZE NATIONAL INCOME

TO IMPROVE THE TERMS OF TRADE

Tariffs can be used to change the terms of trade in favour of a country that makes up a large fraction of the world demand for some product that it imports. By restricting its demand for that product through a tariff, it can force down the price that foreign exporters receive for that product. For example, a 20 percent U.S. tariff on the import of Canadian softwood lumber might raise the price paid by U.S. consumers by 12 percent and lower the price received by Canadian suppliers by 8 percent (the difference between the two prices being received by the U.S. Treasury). This reduction in the price received by the Canadian suppliers of a U.S. import is a terms-of-trade improvement for the United States (and a terms-of-trade deterioration for Canada). Note that not all countries can improve their terms of trade by levying tariffs on imported goods. A necessary condition is that the importing country has market power.

TO PROTECT INFANT INDUSTRIES

An infant industry is nothing more than a new, small industry. If such an industry has large economies of scale or the scope for learning by doing, costs will be high when the industry is small but will fall as the industry grows. In such industries, the country that first enters the field has a tremendous advantage. A developing country may find that in the early stages of development, its industries are unable to compete with established foreign rivals. A trade restriction may protect these industries from foreign competition while they "grow up." When they are large enough, they will be able to produce as cheaply as foreign rivals and thus be able to compete without protection.

One practical problem with this argument for protection is that some infants "never grow up." Once the young firm gets used to operating in a protected environment, it may resist having that protection disappear.

TO EARN ECONOMIC PROFITS IN FOREIGN MARKETS

Another argument for protectionist policies is to help create an advantage in producing or marketing some product that is expected to generate economic profits through its sales to foreign consumers. If protection of the domestic market, which might include subsidizing domestic firms, can increase the chance that one of the domestic firms will become established and thus earn high profits, the protection may pay off. The economic profits earned in foreign markets may exceed the cost to domestic taxpayers of the protection. This is the general idea behind the concept of strategic trade policy.

FALLICIOUS ARGUMENTS FOR PROTECTION

KEEP THE MONEY AT HOME

This argument says that if I buy a foreign good, I have the good and the foreigner has the money, whereas if I buy the same good locally, I have the good and our country has the money, too. This argument is based on a common misconception. It assumes that domestic money actually goes abroad physically when imports are purchased and that trade flows only in one direction. But when Canadian importers purchase Japanese goods, they do not send dollars abroad. They (or their financial agents) buy Japanese yen and use them to pay the Japanese manufacturers. They purchase the yen on the foreign-exchange market by giving up dollars to someone who wants to use them for expenditure in Canada. Even if the money did go abroad physically—that is, if a Japanese firm accepted a bunch of Canadian $100 bills—it would be because that firm (or someone to whom it could sell the dollars) wanted them to spend in the only country where they are legal tender—Canada.

Canadian currency ultimately does no one any good except as purchasing power in Canada. It would be miraculous if Canadian money could be exported in return for real goods. After all, the Bank of Canada has the power to create as much new Canadian money as it wants (at almost zero direct cost). It is only because Canadian money can buy Canadian products and Canadian assets that others want it.

PROTECT AGAINST LOW-WAGE FOREIGN LABOUR

This argument says that the products of low-wage countries will drive Canadian products from the market, and the high Canadian standard of living will be dragged down to that of its poorer trading partners. For example, if Canada imports cotton shirts from India, higher-cost Canadian textile firms may go out of business and Canadian workers may be laid off. Arguments of this sort have swayed many voters over the years.

Consumers gain when they can buy the same goods at a lower price. If Chinese, Mexican, or Indian workers earn low wages and the goods they produce are sold at low prices, Canadians will gain by obtaining imports at a low cost in terms of the goods that must be exported in return. The cheaper our imports are, the better off we are in terms of the goods and services available for domestic consumption.

EXPORTS ARE GOOD; IMPORTS ARE BAD

Exports raise GDP by adding to the value of domestic output and income, but they do not add to the value of domestic consumption. The standard of living in a country depends on the level of consumption, not on the level of income. In other words, income is not of much use except that it provides the means for consumption.

If exports really were "good" and imports really were "bad," then a fully employed economy that managed to increase exports without a corresponding increase in imports ought to be better off. Such a change, however, would result in a reduction in current standards of living because when more goods are sent abroad but no more are brought in from abroad, the total goods available for domestic consumption must fall.

The living standards of a country depend on the goods and services consumed in that country. The importance of exports is that they provide the resources required to purchase imports, either now or in the future.

CREATE DOMESTIC JOBS

Suppose tariffs or import quotas reduce the imports of Japanese cars, Korean textiles, German kitchen equipment, and Polish vodka. Surely, the argument goes, this will create more employment in Canadian industries producing similar products. This may be true but it will also reduce employment in other industries.

The Japanese, Koreans, Germans, and Poles can buy from Canada only if they earn Canadian dollars by selling their domestically produced goods and services to Canada (or by borrowing dollars from Canada).1 The decline in their sales of cars, textiles, kitchen equipment, and vodka will decrease their purchases of Canadian lumber, cars, software, banking services, and holidays. Jobs will be lost in Canadian export industries and gained in industries that formerly faced competition from imports. The major long-term effect is that the same amount of total employment in Canada will merely be redistributed among industries. In the process, living standards will be reduced because employment expands in inefficient import-competing industries and contracts in efficient exporting industries.

A country that imposes tariffs in an attempt to create domestic jobs risks starting a "trade war" with its trading partners. Such a trade war can easily leave every country worse off, as world output (and thus income) falls significantly. An income-reducing trade war followed the onset of the Great Depression in 1929 as many countries increased tariffs to protect their domestic industries in an attempt to stimulate domestic production and employment. Most economists agree that this trade war made the Great Depression worse than it otherwise would have been.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download