8.2    InternationalTrade Restrictions

Governments restrict international trade toprotect domestic industries from foreign competition.

Tariffs

·        Atariff is a tax on a good thatis imposed when it is imported.

·        A tariff raises the domesticprice of the good. In the figure, the tariff is equal to $5 per pair of pants,the length of the grey arrow. As a result, the domestic price of a pair ofpants rises from $10 to $15.

·        Thehigher price of a pair of pants decreases the quantity bought in the nation,from 500 million to 400 million in the figure.

·        Thehigher price of a pair of pants increases the quantity produced in the nation,from 100 million to 200 million in the figure.

·        Thequantity of pants imported decreases, from 400 million (= 500 million demanded - 100 million supplied)to 200 million (= 300 million demanded - 200 millionsupplied) in the figure.

·        Thegovernment collects tariff revenue, $1,000 million (=$5 tariff per pants ´ 200 million pants imported)in the figure (which is also equal to area C).

·        Atariff benefits producers and the government, harms consumers, and creates adeadweight loss.

·        Consumers lose consumer surplus, equal to area A + area B + area C + area D.

·        Producersgain additional producer surplus, equal to area A in the figure.

·        Thegovernment collects tariff revenue equal to area C in the figure.

·        Thereis a deadweight loss created from the lost consumer surplus. The deadweightloss is the sum of areas B and D. The deadweight loss indicates thatthe society is made worse off with the tariff.

Import Quotas

·        Animportquota is a quantitativerestriction on the import of a particular good, which specifies the maximumamount of the good that may be imported in a given period of time. An importquota decreases the quantity of imports and thereby decreases the supply of thegood. It raises the domestic price so domestic consumption decreases anddomestic production increases. However the government does not gain any revenue;the person who has the right to import the good gains the revenue.

·        Animport quota benefits domestic producers and the importers, harms consumers,and creates a deadweight loss.

·        Consumerslose because the domestic price rises.

·        Producersgain producer surplus from selling a greater quantity at a higher price.

·        Theimporters earn profit from buying at the lower world price and reselling in theU.S. at the higher domestic price (importer profit would be the same amount asthe government collects in tariff revenue with a comparable tariff).

·        Thereis a deadweight loss created from the lost consumer surplus. The deadweightloss indicates that the society is made worse off with the import quota.

• Provided     that an import quota is set at the same level of imports that would result     from a tariff, the impact on market outcomes is nearly identical, with one     notable difference—a tariff creates government revenue while an import     quota creates profit for the importer.

Other ImportBarriers

·        Health, safety, andregulation barriers:Imports of certain goods, such as food, pharmaceuticals, and toys may beregulated to ensure that they are safe from contaminants or produced undersanitary conditions.

·        Voluntary exportrestraintsresemble import quotas in that imports decrease, as with an import quota, but withvoluntary export restraints the foreign exporter gets the profit from the gapbetween the good’s domestic price and its world price.

ExportSubsidies

Subsidiesare payments by a government to a producer. An export subsidy is a subsidy paidto the producer of goods for export. Such subsidies stimulate production ofgoods and services and consequently make it difficult for other producers tocompete. Export subsidies lead to global overproduction and deadweight loss.

n 9.4       The Case Against Protection

qLandMine: You might have a student (or students) inclass who claim to favor not “free” trade but “fair” trade. This phrase is notonly a common refrain from those who favor free trade but it is also a commonremark made by those who secretly are against free trade. You should tacklethis head on in class because some students find compelling the argument thattrade should only be free if it can be fair. In fact, many politicians say thatthe United States will bring down its tariffs, import quotas, and otherbarriers as soon as our trading partners do. Upon closer scrutiny, it can beseen that this argument does not hold up. If you are engaging in an activitythat is making you worse off, why would you want to make sure that someone elsestops doing the very same thing before you will stop? It’s like the person whodefends high speeding on the freeway by saying “I’ll stop speeding as soon asthe rest of these nuts stop speeding.” But if slowing down is a good thing onits own (saves lives, saves fuel, etc.), then you don’t have to wait forsomeone else to slow down before you are able to enjoy the benefits. Free tradeis no different. If one of our trading partners is able to sell products andservices in our country free of trade restrictions then our consumers will bethe beneficiaries. If that same country does not want to allow its ownconsumers to enjoy the same benefit, this refusal should have no bearing on ourdecision to keep the barriers down. In other words, this is an argument forunilateral free trade. The moral of the story: “beware of the wolf in sheep’sclothing.” The “not free trade but fair trade” argument is simply a pretext forrestricted trade.

·        Argumentsfor protection have varying degrees of credibility:

·        Thenational security argument: There isan argument for protection of some industries, especially those associated withnational defense, to make sure such industries are ready and able to operate inwartime. However, the argument is usually a veiled argument for more widespreadprotectionism because, in a time of war, there is no industry that does notcontribute to national defense. It is more efficient to achieve higherproduction in target industries through the use of subsidies rather than tradebarriers.

·        Theinfant-industry argument: Theso-called infant-industryargumentfor protection is that it is necessary to protect a new industry to enable itto grow into a mature industry that can compete in world markets. The idearelates to changes in comparative advantages change over because of learning-by-doing.However, the infant industries argument only applies if the benefits oflearning-by-doing spill over to other industries. Moreover, historical evidenceindicates that protected industries have a difficult time developing intoglobally competitive industries.

·        Thedumping argument: Dumping occurs when aforeign firm sells its exports at a lower price than its cost of production.Dumping might be used by a firm that wants to gain a global monopoly. However,it is difficult to measure the cost of production so whether dumping is takingplace is difficult to determine. And charging a different export price thandomestic price is not necessarily evidence of dumping because firms often sellgoods and services for different prices in different markets.

·        Saves jobs: The argument thattrade protection saves jobs is flawed. International trade changes the type ofjobs in an economy, but it does not decrease employment in the aggregate because jobs lost in one sector areoffset by jobs created in other sectors.

It is important to point out to studentsthe magnitude of the costs associated with protecting domestic employmentthrough trade restrictions in relation to how much those workers would actuallyearn (as textile workers didn’t get paid anywhere near the $221,000 a year itcost to save their jobs). Identifying how the cost of saving these jobs isgreater than what these jobs actually pay may help reinforce how large the netgains from trade actually are. Moreover, Trade Adjustment Assistance could potentiallybe used to pay extended unemployment benefits and for the retraining andrelocation of displaced workers and those subsidies would be far less than thenet gains from importing in that market. Basically, the losers can becompensated and there would still be gains leftover for our economy.

 

An issue that might confront you in classis the idea that the effectiveness of free trade agreements is based on whetheror not our country will be able to increase its exports. If it can’t or won’tthen the agreement is judged a failure. But let’s hold on a moment. Americanscan’t eat wheat we export to France, we can’t enjoy personal computers we sendto Singapore, and we don’t get the benefits of a pharmaceutical that is senthalf way around the world to South Africa! Imports on the other hand are thegoods and services that our trading partner sells to us. We directly consumeFrench wine and wear bathing suits made in Singapore and give our loved onesdiamond jewelry that came from the mines of South Africa. The bottom line isthat we export so that we can import, not the other way around.

·        Allows us to competewith cheap foreign labor:The argument that trade protection allows us to compete with cheap foreignlabor is flawed. Differences in real wage rates generally reflect differencesin productivity and to think about competitiveness, we must consider bothdifferences in wages and differences in productivity.

·        Brings diversity andstability:The argument that trade protection brings diversity and stability is flawed.Big rich countries are already diversified. And smaller countries can use theproceeds to trade to invest in a variety of other nations and thereby increasediversity.

·        Penalizes laxenvironmental standards:The argument that trade liberalization leads to a “race-to-the-bottom” inenvironmental standards is weak. Many poorer countries have comparableenvironmental standards and should not be targeted. And environmental standardsare positively related to income (they are a normal good). The best way toencourage improved environmental standards is to allow trade and the economicbenefits it brings to poorer countries. But using free trade agreements such asCAFTA to help negotiate policies that avoid irreversible harm to resources suchas rain forests might be useful.

Students might be somewhat familiar withthe terminology of “exploitation” applied to international trade. Have the studentsthink about what “exploitation” means in the context of voluntary trade. If Ibenefit from someone I trade with, did I exploit them? Did they exploit me? Iftrade is voluntary, how did I manage to exploit the person whom I traded with?Is it because I am smarter than the other person? This seems to be thecondescending assumption of those who talk about exploitation of workers indeveloping countries. Indeed, representatives from many developing countries donot see trade as exploitation, but rather see it as a way to improve standardsof living. When these representatives are upset at WTO meetings, it is usuallyabout the trade restrictions rich countries place on imports from developingcountries keeping developing countries poor. Perhaps the best way to improvethe standard of living in developing countries is to open up the U.S. economy(the world’s largest importer) even more and by trading with them more freely.

Why IsInternational Trade Restricted?

Despite argumentsagainst protection, trade is still restricted because key economic interestsbenefit from protection.

·        Rent Seeking: Rent seeking islobbying and other political activity that seek to capture the gains fromtrade. While the benefits from liberalized trade are large in the aggregate,they are widespread across all consumers. Meanwhile, the costs are concentratedon a smaller number of producers. It is in the interests of those who pay thecosts of liberalized trade to undertake a large quantity of political lobbyingto promote protection.