Countries want to win the game of international trade by exporting more than they import. Some countries pursue trade protectionism to do this. In this lesson, you'll learn about the advantages and disadvantages of this strategy and related concepts.
Protecting Your Home Turf From Imports
Meet Cara. She's the leader of a small developing country. The economy of her country is largely based on tourism and the export of basic commodities, such as agricultural products and some precious metals. Cara's country is not nearly as technologically advanced as it needs to be to compete in the global economy.
Due to this problem, her country is suffering a negative balance of trade, which means it imports more goods than it exports. This also means that there's more money going out of Cara's country than coming in to it. Cara wants her country to develop light manufacturing and tech industries, which she hopes will take it from a net importer to a net exporter.
Cara decides to pursue a policy of trade protectionism, which is a policy aimed at restricting imports of foreign goods into a country. She wants to pursue this policy for a couple of different related reasons. First, she wants to improve her country's balance of trade by reducing imports. Secondly, she wants to increase exports by developing more profitable and competitive industries for the global marketplace. Third, in order to accomplish the second goal, she needs to protect her domestic industries from imports that will hinder their growth.
Trade Protection Options
Cara has several tools at her disposal to help protect her country from imports. One tried and true method of trade protectionism is the tariff. A tariff is a special type of tax that is imposed on imports and exports. Tariffs increase the price of imports, which helps protect domestic industries because the imports become more expensive than locally produced products.
Another tactic at Cara's disposal is import quotas. An import quota limits the quantity of specific products that can be imported into the country during a specific period of time. Sometimes import quotas are absolutely fixed. However, sometimes an exporting country can pay extra tariffs for imports that exceed the quota. Like tariffs, Cara can impose import quotas to help the development of her country's infant industries by reducing competition from imports.
But, Cara is not limited just to making life easier for her country's domestic industries by making life more difficult for importers. Cara's government can provide subsidies, which are a direct infusion of cash by a government to a business, for developing industries. Additionally, the government can give tax breaks to developing industries to help reduce costs and increase positive cash flow. Of course, many foreign competitors don't receive each subsidy, or tax break, from their government, which means that Cara's domestic businesses have a competitive advantage.
Cara also has to defend against aggressive and arguably unethical trade practices of exporting countries. One such threat is dumping, which occurs when an exporter sells a high volume of products in a foreign country at a lower price than it charges in its own domestic market. Cara's country can respond by imposing an anti-dumping duty on products it believes are being dumped on its market. An anti-dumping duty is a tariff aimed at imports that are dumped on a market. For example, Cara's country may impose a 100% duty on products dumped on her country's market, which will make the dumped product very expensive in comparison with domestic products.
Advantages and Disadvantages
Cara's policy of trade protectionism has some obvious advantages. Restricting imports helps her country's domestic economy develop new industries that might otherwise be quashed by imports from other countries that have had a head start. These developing industries can add to the country's economic growth, create jobs, increase the overall wealth of the country and lead to a better balance of trade.
But, trade protectionism does have disadvantages. Trade protectionism is not efficient from an economic standpoint. It's more efficient under the concept of comparative advantage for a country to focus its production on those goods for which it has an advantage in production and import those goods that it does not.
Moreover, consumers in the domestic market may also have to pay a premium for a better produced import or be denied the ability to acquire it at all. This may reduce the standard of living of the citizens of Cara's country. Additionally, Cara must remember that the Golden Rule often applies in international trade: Countries subjected to Cara's trade protectionism may retaliate by raising trade barriers against imports from Cara's country.
Integration and Selective Protectionism
Cara may also decide to team up with other countries through economic integration and selective protectionism. Economic integration occurs when a group of countries or a region reduces trade barriers and coordinates certain economic activities. There are various levels of economic integration including trade agreements, free trade areas, customs unions and common markets. The idea is to have some of the benefits of free trade but also keep some level of trade protectionism. It's basically about treating some trading partners better than others.
Cara's country may enter into a trade agreement with another country. These agreements may be between two or more countries. They will address trade issues, such as tariffs and import quotas. Countries that are not part of a trade agreement with Cara's country will be subject to higher tariffs and other trade barriers.
Another option is for Cara to try to form or participate in a free trade area. Members of a free trade area will not be subject to most traditional trade barriers when engaging in trade with other members. Non-members will be subject to trade barriers set up by individual members. The North American Free Trade Agreement (NAFTA) is a good example of a free trade area.
Cara may also try to have her country form or join a customs union. In a customs union, trade barriers between member countries are eliminated just like with free trade areas. However, unlike free trade areas, members of a customs union will develop a unified trade policy regarding non-members.
Cara's country may try to take itself even further along the path to economic integration through a common market or economic union. A common market not only lifts trade barriers between members and provides for a common trade policy, but it also lifts most barriers to the movement of capital, labor and technology among member countries. On the other hand, an economic union is like a common market, but the member countries also maintain a consistent monetary policy, fiscal policy and tax policy. The member countries act as a single economic unit in many ways. The European Union is an example of an economic union.
International Trade Regimes
Cara must also keep in mind the various international agreements and obligations to which her country may be subject. For example, if Cara's country is a signatory to the World Trade Organization (WTO), she will have to abide by the rules and regulations governing trade set forth under it. The World Trade Organization is an international organization that is involved in regulation of international trade. It helps administer international trade agreements and encourages international trade. The new General Agreement on Tariffs and Trade (GATT 1994) is a part of the World Trade Organization regime and governs trade in goods.
Let's review what we've learned. Trade protectionism is a set of policies that a country can pursue in an attempt to limit imports and protect domestic industries. Tools of trade protectionism include tariffs, quotas and anti-dumping duties. Other measures include use of subsidies and tax breaks given to domestic industries to make them more competitive with imports.
Advantages to trade protectionism include the possibility of a better balance of trade and the protection of emerging domestic industries. Disadvantages include a lack of economic efficiency and lack of choice for consumers. Countries also have to worry about retaliation from other countries.
Some countries may decide to move towards a degree of economic integration, where there is a degree of fair trade among member countries and trade barriers still erected against imports from non-members. Levels of economic integration include trade agreements, free trade areas, customs unions, common markets and economic unions. Finally, countries that are parties to the World Trade Organization must be certain to adhere to their obligations thereunder.
Following this lesson, you should be able to:
- Define trade protectionism and describe ways it can be implemented
- Compare the advantages and disadvantages of trade protectionism
- Describe what economic integration is and its levels
- Explain the role of the World Trade Organization