Protectionism Section 3.1

Outline Protectionism The effect of a tariff on imports The effect of tariffs on social welfare Various protectionist methods Arguments in favor of protectionism Arguments against protectionism

Protectionism Barriers to international trade adopted by the government to protect the domestic industry. Protectionist measures include tariff and non-tariff barriers.

Barriers to trade Tariffs Non-Tariff Barriers (NTB) A tariff is a tax on imports. Non-Tariff Barriers (NTB) Non-tariff barriers, unlike tariffs are less direct protectionist measures, which are used to reduce the volume of imports.

The effect of a tariff on imports The imposition of the tariff reduced imports from Qs1-Qd1 to Qs2-Qd2 P S Pw + tariff Pw Sw D Q Qs1 Qs2 Qd2 Qd1 imports

Consumer surplus The consumer surplus is the difference between the maximum price that consumers are willing to pay and the price that they actually pay. P S Pe D Q

Producer surplus The producer surplus is the difference between the minimum price that producers are willing to charge and the price that they actually charge. P S Pe D Q

The effect of a tariff on welfare P S Pw + tariff Consumer surplus Pw Sw D Q Qs1 Qs2 Qd2 Qd1 imports

The effect of a tariff on welfare P S The imposition of the tariff reduces the consumer surplus Consumer surplus Pw + tariff Pw Sw D Q Qs1 Qs2 Qd2 Qd1 imports

The effect of a tariff on welfare Area a: increase in producer surplus due to tariff Area c: government tariff revenue Areas b and d: dead-weight loss to society due to tariff P S Consumer surplus Pw + tariff a c b d Pw Sw D Q Qs1 Qs2 Qd2 Qd1 imports

Non- Tariff Barriers (NTBs) Quotas A limit on the quantity that could be imported. Note that the effects of tarriffs and quotas are different in that no Government revenue is usually produced by Quotas. Thus the domestic welfare loss of a quota is greater

The effects of a Quota ABCD= loss of consumer surplus A= gain in producer surplus BCD is net welfare loss to domestic economy S+ Quota

Quotas (continued) The Government could gain revenue by issuing licenses to importers. Maybe therefore area C could be transferred to the Government. If this is not the case area C is actually the gain in revenue that some importers gain from now getting a higher price for their goods. Thus it is a net loss to the domestic economy

Non- Tariff Barriers (NTBs) Excessive customs formalities Complex and excessive customs formalities delay the imports of goods. VER Voluntary export restraints are bilateral agreements whereby one country voluntarily agrees to restrict the volume of its exports to the other country.

Non- Tariff Barriers (NTBs) Excessive standard requirements These could be health and safety standards, or other standard requirements. In this case, imports are restricted by imposing high standards that could only be met with difficulty by the exporters.

Non- Tariff Barriers (NTBs) Subsidies Subsidies are payments by the government to producers to lower the price of a good or service. Subsidies lower the price of domestic goods and encourage consumers to buy them instead of imports.

The effect of a subsidy given to domestic producers A subsidy reduces imports from Qs1-Qd1 to Qs2-Qd1 Cost of subsidy is shaded area. Blue triangle is welfare loss due to subsidy (the rest is increase in producer surplus P s1 S Pw Sw D Q Qs1 Qs2 Qd1 imports

Domestic firms gain revenue More employment in domestic industry The effect of a subsidy given to domestic producers Domestic firms gain revenue More employment in domestic industry No effects on consumers (Price remains the same) Government spending on the subsidy (opportunity cost) Taxpayers pay for this subsidy Misallocation of resources as more is produced by inefficient domestic producers and less by efficient foreign producers

Arguments for protectionism To support infant industries An infant industry is an industry in its early stages of development. Protecting a newly formed industry through trade barriers will shield it from competition and allow it to mature. For strategic reasons It would be unadvisable to overly rely on food imports as they could be threatened at times of war.

Arguments for protectionism Protect jobs in “sunset industries”. Industries declining will lead to structural unemployment. This process could be slowed down enough for retraining and job creation in other areas. But once there is protectionism it is often politically difficult to reduce this help over time, so large amounts are spent propping up inefficient industries.

Arguments for protectionism To improve the balance of payments The balance of payment is a set of accounts recording the earnings from exports and capital inflows as well as payments for imports and capital outflows. When the outflows of foreign currency exceed the inflows, the balance of payment is in deficit. Protectionist measures reduce the amount of imports and may result in an improvement in the balance of payment.

Arguments for protectionism To avoid overspecialization Producing only those goods in which a country has a comparative advantage in, may result in being too dependent on few goods or services. e.g. Many south American countries were hit hard by the plummeting coffee prices due to their economies’ reliance on this crop.

Arguments for protectionism To prevent Dumping Dumping refers to exporting goods at a lower price than the price for which the good is sold in the home country. Dumping occurs when a good is sold at a price lower than its cost of production protectionist measures could be imposed as an anti-dumping prevention

Arguments against protectionism Protectionism results in a net loss in social welfare The loss in consumer surplus, which results from the higher import prices and the reduced consumption exceeds the gain in producer surplus, which results from the higher price and the increased production and the gain in tariff revenues to the government.

Arguments against protectionism Uncompetitive industries Shielding the domestic industry from competition may lead to a decline in productive efficiency. Domestic firms will not keep up with technological advancements and may become less competitive in international markets.

Arguments against protectionism Retaliation The imposition of tariffs and other forms of protectionism exposes the country to retaliation from trading partners. Exports may decrease as trading partners retaliate by imposing tariffs on the country’s exports.