free trade & protectionism ch 22 ib international economics

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  • Free Trade & ProtectionismCh 22 IB International Economics

  • Arguments for protectionismIf international trade is so good why is it that countries dont 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 employmentAt any given time in an economy there will be some industries in decline (sunset industries)They cannot compete with foreign competitionIf the industry is large it will cause high levels of structural unemploymentGovernments often attempt to protect the industry to prevent the unemploymentEvaluation this argument is not very strong; protecting the industry may just prolong the process of declineEven 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 economyThe 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

  • Arguments for protectionismProtecting the economy from low cost labourIt is often argued that the main reason for declining domestic industries is the low cost of labour in exporting countriesThe economy should be protected from imports produced in low cost labour countriesDemands 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 industriesThere is much more job insecurity in the manufacturing industries of developed countries who fear losing their jobs to workers in China and IndiaWorkers and trade unions lobby for protectionismEvaluationThis argument goes against the whole concept of comparative advantageIf 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 protectionismProtecting the economy from low cost labourComparative advantage will change over timeThe US may have had a comparative advantage in shipbuilding at one timeAs 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 circumstancesIf governments dont help create a flexible workforce they will have to financially help the unemployed caused by increased international competition


  • Arguments for protectionismProtecting and infant (sunrise) industryMany governments argue that new developing industries do not have the economies of scale advantagesUntil it can gain EoS it cant competeIt needs to be protected until it achieves sizeEvaluation: this argument may not work for developed countriesThey have access to capital markets to start off bigSaudi Arabian government recently diversified into petrochemical production worked with Chevron, BP and Exxon Mobil to build some of the largest plants in the worldThis argument may be more applicable to developing countriesbut they may not have the international political power to impose protectionist policies without complains and action from developed countries.

  • Arguments for protectionismTo avoid the risks of over-specialisationGovernments may want to avoid putting all their eggs in one basketThe country could become dependent on export sales of one or two productsIf demand changes there will be serious consequencesThe invention of synthetic rubber had a large negative effect on the rubber industry in MalaysiaThe oversupply of coffee on the world market causing falling prices did the same for EthiopiaEvaluation: there are no real arguments against this view!

    Example: the development of the quartz crystal severely damaged the Swiss wristwatch industry damaging the economyExports 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 protectionismStrategic reasonsIt is sometimes argued that certain industries need to be protected in case they are needed in times of warE.g. agriculture, steel, power generationEvaluation: 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 protectionismTo prevent dumpingDumping can ruin domestic producersWhere 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 damageEvaluation: it is very difficult to proveCountries argue that when the EU exports subsidized sugar it is actually dumping because the price doesnt reflect the actual costs of the EU sugar producersIf dumping happens it is more likely that there will be a need for talks between governments rather than protectionismProtectionism may invite retaliation reducing the benefits gained by consumers and producers

    Dumping: the practice of selling a good in international markets at a price that is below the cost of producing itRead case study & Answer Qs P270

  • Arguments for protectionismTo protect product standardsA country might wish to impose safety, health or environmental standards on goods being imported into its domestic marketThis will ensure that products match the standards of domestic goodsThe EU banned the importing of American beef because it has been treated with hormonesEvaluation: This is a valid argument if the concerns are validThe US dont believe the EU has a valid reason as they have no proof that the hormones are bad for consumersThey say it is an excuse for protectionismThe US retaliated in 1999 by imposing trade sanctions on $117m worth of European imports

  • Arguments for protectionismTo raise government revenueIn developing countries where it is difficult to collect tax governments impose import taxes (tariffs) to raise revenueThe IMF estimated that import duties account for approximately 15% of total government revenue in developing countriesEvaluation: This is not so much an argument for protectionism but a reason why it happensTo correct a balance of payments deficitGovernments sometimes impose protectionist methods to reduce import expenditure and improve the current account deficitEvaluation: This will only work in the short run and does not fix the actual cause of the deficitOther countries may also retaliate

  • Arguments against protectionismThese arguments are really related to the reasons why countries tradeIn brief these areProtectionism raises prices to the consumers and producers of the importsLeads to less choice for consumersCompetition would diminish and domestic firms would become inefficient (innovation may also be reduced)Comparative advantage is distorted leading to inefficient use of world resourcesEconomic growth will be reduced

  • Types of ProtectionismBefore 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 PeIf we then introduce foreign trade and the world price is Pw which lower than Pe the situation changesConsumers can now import as much wheat as they like at the lower priceThe world supply curve is perfectly elastic because there are so many suppliers (it doesnt 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 ProtectionismWith free trade the price of what will be SworldAt this price domestic farmers will only be prepared to supply Q1 tons but the demand will be Q2Imports will satisfy the surplus demandQ1Q2 tons of wheat will be supplied by foreign suppliersConsumers get to consume QeQ2 more at the lower priceLets now apply some different types of protectionism

    Insert fig 24.1

  • Types of Protectionism - TariffA tariff is a tax that is charged on an imported goodAny 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+tAt this price domestic suppliers will only supply Q3This is more than before but there is still excess demand (just less than before)Foreign suppliers will supply Q3Q4 which is less than beforeDomestic producers revenue increases from go to g+a+b+c+hForeign 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+jThe government receives revenue of d+eOne of the issues is that importers pay a higher price for the wheatThey sell the more expensive wheat onto millers and the flour is used to make cereals etcThis may cause food inflation

  • Types of Protectionism - TariffTwo more things happenFirstly because some wheat is not purchased there is a dead-weight loss of welfareQ4Q2 tons of wheat are not now demandedConsumers keep the amount k that they would have spent on wheatThere is a l


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