Reasons for imposing trade restriction – individual country perspective

Within the course of International Economics you have learnt that free trade maximizes world output and benefits all nations. In theory, international trade can result in full utilization of natural and social resources and increase the welfare of all nations in trade.

International trade is a bridge for a nation towards prosperity, advancement and civilization. Today, no civilized nation can isolate itself from the rest of the world. Processes of globalization and economic integration have made the world a global village, and international trade plays an irreplaceable role in this process. In this respect, the WTO constitutes international trade policy, including general trade policies, trade rules and regulations of individual nations. International trade policy examines the reasons for and effects of trade restrictions because nations usually impose some restrictions on the flow of goods, services, and factors across their borders.

Despite the theory of international trade explains free trade to be the paretto optima, practically all nations (except for some free trade harbors like Hong Kong, Panama) do impose some restrictions on the free flow of international trade. In order to explain this phenomenon, it is necessary to understand effects of trade restrictions on production, consumption, trade and welfare.

Trade restrictions include tariffs and non-tariff measures. The most important type of trade restriction has historically been the tariff. The WTO/GATT has predominantly been devoted to the tariff reduction negotiations. The only issue discussed in the first 6 rounds of negotiations of the GATT is how to reduce tariff rates.

A tariff is a tax or duty levied on the traded commodity as it crosses a national boundary. An import tariff is a duty on the imported commodity, while an export tariff is a duty on the exported commodity. Import tariffs are more important than export tariffs. Export tariffs are usually applied by developing countries on their traditional exports (such as Ghana on its cocoa and Brazil on its coffee) to get better prices and raise revenues. The main objectives of an import tariff are to protect domestic market or domestic infant industries such as auto industry in Uzbekistan against foreign competition and to raise revenues of the central government of a country.

Tariffs can be ad valorem, specific, or compound. The ad valorem tariff is expressed as a fixed percentage of the value of the traded commodity. The specific tariff is expressed as a fixed sum per physical unit of the traded commodity. A compound tariff is a combination of an ad valorem and a specific tariff.

Tariffs, though generally declined in industrial nations since World War II (with an average nominal tariff rate of 3.8%), are still rendering tremendous effects on production, consumption, trade and welfare in the nation imposing the tariff and on its trade partners. While tariffs are invariably rationalized in terms of national welfare (such as the protection of infant industry or national industries), in reality they are usually advocated by those special groups in the nation that stand to benefit from such restrictions.

In short, consumers pay a higher price for the commodity and producers receive a higher price as a result of the tariff. A tariff leads to inefficiencies, which are referred to as protection cost, because some domestic resources are transferred from the more efficient production of exportable commodities to the less efficient production of importable commodities. Consumers’ welfare has been sacrificed for jobs or employment saved in less efficient industries. Improper tariff rates can only hamper the growth and development of so called infant industry. Auto industry in Uzbekistan is a typical example. It is something beyond economics. If you want to know more about the effects of tariffs, you can refer to partial and general equilibrium analysis of a tariff in International Economics written by Dominick Salvatore.

Nevertheless, tariffs are legal and the only preferred trade restriction in the WTO. This will be discussed in detail later.

Non-tariff trade barriers refer to all the other trade restriction measures other than tariffs, including import quota or licensing (automatic and non-automatic import licensing), voluntary export restraints, technical barriers to trade, sanitary and phytosanitary measures, anti-dumping, subsidies and countervailing measures, customs valuation, pre-shipment inspection, rules of origin, fees and formalities, etc.

Case - effects of non-tariff trade barriers: Voluntary Export Restraints on Japanese Automobiles to the US.

From 1977 to 1981, US automobile production fell by about one-third, the share of imports rose from 18 to 29 percent, and nearly 300,000 autoworkers in the US lost their jobs. In 1980, the Big Three US automakers suffered combined losses of 4 billion $US. As a result, the US negotiated an agreement with Japan that limited Japanese automobile exports to the US to 1.68 million units per year from 1981 to 1983 and to 1.85 million units for 1984 and 1985. Japan “agreed” to restrict its automobile exports out of fear of still more stringent import restrictions by the US. As a result of this agreement, US automakers reaped profits of about 6 billion $US in 1983, 10 billion $US in 1984, and 8 billion $US in 1985. Japan gained by exporting higher-priced autos and earning higher profits. The big loser was the American public, who had to pay substantially higher prices for domestic and foreign automobiles. It was estimated that the agreement resulted in a price 660 $US higher for US made automobiles and 1300 $US higher for Japanese cars in 1984, and the total cost of the agreement to US consumers was 15.7 billion $US from 1981 through 1984, and that 44,000 US automaker’s jobs were saved at the cost of more than 100,000 $US each, 2 or 3 times the yearly earnings of a US autoworker.

As the example above shows, neither tariffs nor non-tariff measures are reasonable or justified to be imposed on because of the high cost of trade protection practice. There are, however, still some fallacious or questionable arguments for trade protection.

Trade restrictions are needed to protect domestic labor against cheap foreign labor.

· Scientific tariff rates could make the price of imports equal to domestic prices and allow domestic producer to meet foreign competition.

· Protection is needed to reduce domestic unemployment and to cure a deficit in the nation’s Balance of Payments or trade deficit.

· Trade restrictions are needed to protect infant industries in developing countries and to acquire a comparative advantage in crucial high-technology industries in developed countries (Strategic Trade Policy).

The first three arguments are to be questions for students. Below, the fourth argument is conferred.

Infant-industry argument: A nation may have a potential comparative advantage in a commodity, but because of lack of know-how and the initial small level of output, the industry will not be set up or, if already started, cannot compete successfully with more established foreign firms. Temporary trade protection is then justified to establish and protect the domestic industry during its “infancy” until it can meet foreign competition, achieve economies of scale, and reflect the nation’s long-run comparative advantage. At that time, protection is to be removed. However, for this argument to be valid,

1) the return in the grown-up industry must be sufficiently high to offset the higher prices paid by domestic consumers of the commodity during the infancy period;

2) there is an objective standard to identify which industry or potential industry qualifies for this treatment;

3) there is a schedule to remove the protection.

Strategic trade policy: A nation can create a comparative advantage (through temporary trade protection, subsidies, tax benefits, and cooperative government-industry programs) in such fields as semiconductors, computers, telecommunications, and other industries that are deemed crucial to future growth in the nation. These high-technology industries are subject to high risks, require large-scale production to achieve economies of scale, and give rise to extensive external economies (a benefit to society at large, say, by training workers who then leave to work in other industries) when successful. Strategic trade policy suggests that by encouraging such industries, the nation can reap the large external economies that result from them and enhance its future growth prospects. Semiconductors (such as computer chips) and steel industry in Japan are a good example. Other examples are the Concorde supersonic aircraft and the Airbus in Europe. However, there are serious difficulties in carrying out this argument: 1) It is extremely difficult to choose the industries that will provide large external economies in the future and devise appropriate policies to successfully nurture them; 2) Since most leading countries undertake strategic trade policies at the same time, their efforts are largely neutralized, so that the potential benefits to each may be small; 3) When a country does achieve substantial success with strategic trade policy, this comes at the expense of other countries and so other countries are likely to retaliate.

All in all, trade production usually increases the commodity price, benefits producers and harms consumers and usually the nation as a whole. For example, it is estimated that removing all quantitative restrictions (QRs) on textile and apparel exports to the US would result in a gain of 11.92 billion $US for the US at 1984 prices. Removing QRs also leads to employment losses in the industry losing the QRs, but these employment losses are matched or more than matched by economy-wide employment gains. Removing QRs on exports of textile, automobiles, and steel to the US leads to a total welfare gain of 20.28 billion $US for the US. Also eliminating all tariffs on industrial products after the above QRs have been removed results in a further gain of 0.6 billion $US for the US. However, since producers are few and stand to gain a great deal from protection, they have a strong incentive to lobby the government to adopt protectionist measures. On the other hand, since the losses are diffused among many consumers, each of whom loses very little from the protection, they are not likely to effectively organize to resist protectionist measures. Thus, there is a bias in favor of protectionism. For example, the sugar quota raises individual expenditures on sugar by only a few dollars per person per year in the US. But with about 250 million people in the US, the quota generates more than 600 million $US in rents to the few thousand sugar producers in the US.