Free trade and protectionism

INTERNATIONAL
ECONOMICS
FREE TRADE &
PROTECTIONISM

What is free trade?
• Free trade is said to take place
between countries when there are
no barriers to trade put in place by
governments or international
organizations.
• Goods are able to move freely
between countries.

Key Questions - Trade
• If international trade is so good
for all the countries concerned,
why is it that countries do not
trade freely?
• Why do they often protect their
economies from imports?

What is Protectionism?
• Any measured designed to give
local producers of good or service
an advantage over a foreign
competitor.

ARGUMENTS FOR PROTECTION
There are many arguments for protecting local
producers and industries. These include:
• Protecting Domestic Employment
• Protecting The Economy from Low-Cost Labour
• Protecting an infant (sunrise) Industry.
• To Avoid the Risks of Over-Specialization
• Strategic Reasons
• To Prevent Dumping

Protecting Domestic Employment
• At any given time in an economy, there will be
some industries that are in decline (sunset
industries) because they cannot compete with
foreign competition.
• If the industries are relatively large, this will lead
to high levels of structural unemployment and
governments often attempt to protect the
industries in order to avoid the unemployment.
• The negative externalities of a rapidly declining
major industry may so great, the government
feels obligated to provide some protection.

Protecting Domestic Employment
Counter Argument for Free Trade
• The industry will continue to decline and
protection will simply prolong the process.
• Although there will be short-run social costs, it
could be better to let the resources employed
in the industry more into another, expanding
area of the economy.

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 that are produced in
countries where the cost of labour is
very low.

US Clothing Industry Example
• There have been demands in the US to protect
the domestic clothing industry against cheap
imports from Asia, where wages are much
lower.

Manufacturing Industries
• While trade may create many benefits for an
economy as a whole, the cost in terms of job
looses may be concentrated in particular
industries.
• There is much greater job insecurity among
manufacturing workers in developed countries
who fear they will lose their jobs to workers in
emerging markets such as China & India.
• Workers and their trade unions may lobby
vigorously for protection against imported goods.

South Korea – Shipbuilding Industry
• In 1998, the hourly wage for shipbuilding in the
US was $19.19, but in South Korea it was $9.27.
• While cheaper labour is available in other Asian,
countries, South Korean workers were well
educated and could achieve high levels of
productivity.
• Not surprisingly, 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.

• If we protect the economy from low-cost
labour, it will mean that consumers pay higher
prices than they should.
• Production in a protected economy would
take place at an inefficient level.
• The country wishing to export would lose
trade and their economy would suffer.

Comparative Advantage Changes
Over Time
• It should be realized that comparative advantage
changes over time and that a country that has a
comparative advantage in the production of a good at
present may not have that in the future.
• For example, if it quite likely that the US did have a
comparative advantage in shipbuilding at one time.
• As relative factor costs change in different countries, it
is important that resources should move freely as
possible form industries where comparative advantage
is waning, into industries where it is growing.

Counter Argument:
Government supports workers who lose jobs:
• There is some responsibility on governments
to help those workers who have lost their jobs
due to increasing competition, from low cost
foreign labor.
• These supply side policies could include
additional education and training so
retrenched workers can enter new industries.

Protecting an Infant (sunrise) industry
• Many governments argue that an industry that is
just developing may not have the economies of
scale advantages that larger industries in other
countries may enjoy.
• The domestic industry will not be competitive
against foreign imports until it can gain teh cost
advantages of economies of scale.
• Because of this, it is argued that industry needs
to be protected against imports, until it achieves
size where it is able to compete on an equal
footing.

• Most developed countries have highly efficient
capital markets (well as least before the GFC!)
which allows them access to large amounts of
financial capital, even more so since the advent
of globalization. Due to this fact, it can be
argued that there is no basis for the idea that
industries in developed countries will set up in a
relatively small way. They could be able to
benefit from economies of scale with relatively
short period of time.

Counter Argument Example
• The Saudi Arabian government has been
diversifying into petrochemical production in
recent years.
• It has undertaken a number of projects in
partnership with large multinationals such as
Chevron, BP and Exxon Mobil.
• The plants constructed have been among some of
the largest in the world, gaining almost
immediately from economies of scale.

• It is likely that developing countries without
access to sophisticated capital markets, can
use the infant industry argument to justify
protectionist policies.
• However, whether have the international
political power to able to impose protectionist
policies, without complaints and action from
developed countries is debatable.

To avoid the risks of over-specialization
• Governments may want to limit over-
specialization, if it means the country could
become over-dependent on the export sales of
one or two products.
• Any change in the world markets for these
products might have serious consequences for
the country’s economy.
• For example, changes in technology could
severely reduce the demand for a commodity, as
the development of quartz crystal watches did for
the Swiss wristwatch industry, harming the
economy.

• The introduction of new products or changes
in the patterns of demand and supply can
have serious effects on the economies of
developing countries which tend to over
specialize in the production of primary
products without choice.
• For example, the over-supply of coffee on the
world market, caused a fall in price, and had
severe impact on countries like Ethiopia.

• There are no real arguments against this view.
• It does not promote protectionism, it simply
points out the problems that countries may
face if they specialize to a great extent.

Strategic Reasons
• It is sometimes argued that certain industries
need to be protected in case they are needed
at times of war, for example: agriculture, steel
and power generation.
• Steel is needed for many defence items such
as planes and tanks. The steel industry would
argue that it must be protected in order to
stay competitive.

Strategic Reasons
• To certain extent, this argument may be a
valid one, although it is often overstated.
• In many cases, it is unlikely that countries will
go to war, if they do, it also unlikely that they
will be cut off from all supplies.
• Most probably this argument is being used as
an excuse for protectionism.

To Prevent Dumping
What is dumping?
• Dumping is the selling by a country of large quantities
of a commodity, at a price lower than its production
cost, in another country.
• For example, the EU may have a surplus of butter and
sell this at a very low cost to a small developing
country.
• Where countries can prove that their industries have
been severely damaged by dumping, their
governments are allowed under international trade
rules to impose anti-dumping measures to reduce the
damage.
• However, it is very difficult to prove whether or not a
foreign industry is guilty of dumping.

To Prevent Dumping
Counter Argument For Free Trade
• A government that subsidizes a domestic industry
may actually support dumping.
• For example, developing countries argue that
when the EU exports subsidized sugar, it is
actually a came of dumping because the price
doesn’t reflect that actual cost of the EU sugar
producers. Therefore if dumping does occur, it is
more likely that there will be a need for talks
between governments, rather than any form of
protection.

To Prevent Dumping
Counter Argument For Free Trade
• There is always a danger that protectionism
will invite retaliatory actions by foreign
governments and this reduces the benefits
that can be gained by all consumers and
producers in all countries.

To Protect Product Standards
• A country might which to impose safety, health or
environmental standards on goods being
imported into its domestic market in order to
ensure that the imports match the standards of
domestic producers.
• This is a valid argument, as long as the concern
themselves are valid.
• For example, the EU has previously banned the
importing of American Beef, because it have been
treated with hormones.

To Protect Product Standards
• Many of the reasons given for bans when
standards are not reached are considered to be
simply subtle means of protection.
• Where there is a dispute over product standards,
a response by the exporting country might be use
retaliatory policies.
• In the EU-US Beef dispute, the US retaliated
against the EU in May 1999 by imposing trade
sanctions of $117 million worth of imports from
Europe.

To raise government revenue
• In many developing countries it is difficult to
collect taxes and so governments impose
import taxes (tariffs) on products in order to
raise revenue.
• The International Monetary Fund (IMF)
estimated that, on average, import duties
accounted for approximately 15% of total
government revenue for the developing
countries in 2002.

To raise government revenue
• This is not so much an argument for
protectionism, but more a means of raising
revenue.
• In effect, the import duties are actually a tax
on consumers in the country who are buying
the imports.

To correct a balance of payments deficit
• Governments sometimes impose protectionist
measures to attempt to reduce import
expenditure and thus improve a current
account deficit.
• A current account deficit occurs when a
country is spending more on its imports of
goods and services, than it is earning for its
exports of goods and services.

To correct a balance of payments deficit
• This will only work in the short run.
• It does not actually address the actual
problem, because it does not rectify the actual
causes of deficit.
• Also, if countries do this, then it is likely that
other countries will retaliate with protectionist
measures of their own.

ARGUMENTS AGAINST
PROTECTIONISM
• All the counter arguments previously covered
are great arguments for free trade.
• The arguments against protection are really
related to the reasons why countries trade, as
previously studied.

ARGUMENTS AGAINST
PROTECTIONISM
Prices
• Protection may raise prices to
consumers and producers of the
imports they buy.
Choice
• Protection would lead to less choice
for consumers.

ARGUMENTS AGAINST
PROTECTIONISM
Competition
• Competition would diminish if foreign firms
are kept out of a country, and so domestic
firms may become inefficient without the
incentive to minimize costs.
• Innovation may also be reduced for the same
reason.

ARGUMENTS AGAINST
PROTECTIONISM
Comparative Advantage
• Protectionism distorts comparative advantage
leading to the inefficient use of the world’s
resources.
• Specialization is reduced and this would
reduce the potential level of world’s output.

ARGUMENTS AGAINST
PROTECTIONISM
Economic Growth
• For all reasons listed previously, protection
may hinder economic growth.

Free trade and protectionism

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