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Saturday, April 7, 2012

Economics

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The distribution of vital natural resources on the earth is unequal. Countries have varying climates, resource endowment and topography which may sustain some (but not all) of the goods and services necessary for survival. Trade compensates for these differences, leading to improvements in allocative efficiency and increased world production, thus allowing individuals to consume a larger and more diverse collection of goods and services. Despite these advantages, trade protection is still common among governments. Trade protection takes the form of tariff and non-tariff barriers. The traditional arguments in favour of protection are critically evaluated and so to are the new protectionist theories which have received fresh attention in the literature recently (Brander and Spencer, 187; Krugman 187; Grilli et al., 10; Salvatore, 187).


Forms of Protection


Tariffs are a tax levied on imports to restrict their inflow by raising their price. Higher prices encourage domestic firms to expand production; thus tariffs also serve as a domestic subsidy. A partial equilibrium analysis of the effects of a tariff is given below.


Figure 1


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Effects of a Tariff


Adapted from Vousden (10, )


Before the tariff, the price of the good is PW; hence the quantity demanded is q5 (Figure 1). The amount of the good produced domestically is q1; therefore this country would have to import q1 to q5. A tariff is imposed represented by Pt-Pw. The domestic price of the good has risen, reducing domestic demand for imports. Quantity demanded falls to q4 while domestic production increases to q. Imports are subsequently reduced to q - q4. Welfare is transferred away from consumers (areas a, b, c and d) to producers in the form of profit (area a) and the government in the form of taxation revenue (area c). The other consumer welfare losses (area b and d) depict the decrease in consumption of imports caused by the increase in price. The tax has distorted choice so that consumers purchase an inferior good that would not have been purchased in the absence of a tax.


GATT has driven down tariff barriers and to maintain protection levels, countries have resorted to non-tariff barriers such as quotas, voluntary export restraints (VERs) and export subsidies. Quotas limit imports by specifying the maximum amount of foreign-produced goods that will be permitted into the country over a specified period of time. Quotas and tariffs have equivalent effects; however, unlike tariffs, quotas do not generate taxation revenue. Instead, profits go to importers (assuming quotas are not auctioned).


Figure


Effect of a Quota


Adapted from Vousden (10, )


Equilibrium occurs at p0 q0 (Figure ). If a quota were imposed at q1 then the quantity demanded would exceed the quantity supplied (pp1), thus providing a profit for the person who has the right to import equal to the area p1, p, a, c. If these quota licences were to be auctioned then this profit would be shared with the government. If the protectionist country were a producer of this imported good then profits would be lower due to the increased domestic supply stemming from higher prices. Quotas directly control imports and are more accurate than tariffs since there less ‘guesswork’ regarding tax rates is involved.


The methods of protection outlined above both have the potential to provoke retaliation or possibly a trade war. Voluntary export restraints (VERs) are used in a similar fashion to quotas but eliminate this factor. A VER involves an agreement by one country to limit their exports to the other. Like the quota, a VER restricts quantity, driving the price of the good upwards. This can achieved through the introduction of an export tax that forces exporters to sell cheaply in the domestic market rather than incur the tax. Unlike the quota, profits that would normally go to the importer would go to the exporting country instead, causing competition for licensing in the exporting country. Harris (185) examines the VER against Japan automobile exports to Europe and the US and suggests that the term voluntary is a misnomer. Such restraints are termed voluntary since exporting countries can modify or remove them at any time; however, VERs are often implemented in response to threats or pressures from the importing country (Jones, 14,).


Export subsidies allow exporters to expand overseas supply. This lowers the price paid overseas, increasing overseas demand, while raising the domestic price and lowing domestic demand. Welfare losses occur do the subsidies distortionary impact on consumer and producer behaviour; however, the magnitude of these effects depend on the size of the country implementing the subsidy. The welfare losses of the subsidy are smaller for a small country than that of a large country. This is because a large country influences the price of its exports. A subsidy will raise the world supply of the exported commodity and lower the demand for it, thus worsening the terms of trade. This is an apparent paradox since the worsening of the terms of trade actually promotes imports.


Despite the disadvantages associated with protection, governments continue to employ tariffs quotas and VERs. Reasons for doing so include assisting infant industry, improving terms of trade, reducing unemployment, fairness, income redistribution, retaliation to overseas protection, assisting developing nation, national safety, defence and correcting for market failure (new protectionism).





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