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Chapter 34

ECO100 Textbook Chapter 34- Trade Policy.docx

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University of Toronto Mississauga
Kalina Staub

Chapter 34- Trade Policy 34.1 Free Trade or Protection? • Tariff- A tax applied on imports of goods/services • Non Tariff Barriers (NTBs)- Restrictions other than tariffs designed to reduce imports (import quotas, customers procedures, etc) The Case for Free Trade • Free trade encourages countries to specialize in producing products in which they have comparative advantage  maximizes world production  maximizes average world living standards • It is possible for free trade to improve everyone’s living standards because larger value of output generated could be divided up so that each individual is better off but not always in practice • Free trade makes the country as a whole better off, even though it may not make every individual in the country better off • As technology gap between domestic and foreign firms widens, the tariff wall will provide less protection so domestic firms must stand up to international competition to survive The Case for Protection • Protection- Any government policy that interferes with free trade in order to protect domestic firms and workers from foreign competition • Arguments for protection:  Promoting Diversification o Decrease a country’s national income o For a small country, specializing in production of only a few products has risks:  Technological advances may render its basic product obsolete  Swings in world prices lead to large swings in national income o By using protectionist policies, government can encourage creation of domestic industries that may otherwise not exist o Cost is the loss of national income associated with devoting resources to production in industries in which there is no domestic comparative advantage o Benefit is that the overall national income and employment become less volatile  Protection Specific Groups o Decrease a country’s national income o Trade restrictions can improve the earnings of one group whenever the restrictions increase the demand for that group’s services o Social and distributed concerns may lead to the rational adoption of protectionist policies; but the cost of such protection is a reduction in the overall national income and the country’s average living standards  Improving the Terms of Trade o Increase a country’s national income o Large countries can sometimes improve their terms of trade (and thus increase their national income) by levying tariffs on some imported goods; small countries cannot o By restricting demand for that product through a tariff, a country can force down the price that foreign exporters receive for that product o The price paid by domestic consumers will probably rise but as long as the increase is less than the tariff, foreign suppliers will receive less per unit  Protection Infant Industries o Increase a country’s national income o Infant Industry Argument- The argument that new domestic industries with potential for economies of scale or learning by doing need to be protected from competition from established, low cost foreign producers so that they can grow large enough to achieve costs as low as those of foreign producers o Trade restriction may protect these industries from foreign competition while they grow up and when they are large enough, they will be able to produce as cheaply as larger foreign rivals and thus be able to compete without protection o Some infants never grow up; once the young firm gets used to operating in a protected environment, it may resist having that protection disappear even though all economies of scale may have been achieved  Earning economic profits in foreign markets o Increase a country’s national income o A country can potentially increase its national income by protecting in fact industries and by subsidizing “strategic” firms; unless carefully applied, however, such policies can end up being redistributions from consumers and taxpayers to domestic firms, without any benefit to overall living standards Invalid Arguments for Protection  • Arguments frequently heard in political debates concerning international trade:  Keep the money at home o Buying a good locally means that the consumer has the good and the country has the money too; common misconception o Assumes that domestic money actually goes abroad physically when imports are purchased and that trade flows only in one direction; if foreign firm accepted Canadian dollars, then it would be because that firm wanted them to spend in the only country where they are legal tender- Canada o Canadian money can buy Canadian products and assets that others want  Protect against low-wage foreign labour o Products of low wage countries will drive Canadian products from the market, and the high Canadian standard of living will be dragged down to that of its poorer trading partners; States that Canada is worse off overall by trading with a poorer country but is this really true? o Canadians will gain by obtaining imports at a low cost in terms of the goods that must be exported in return; the cheaper our imports are, the better off we are in terms of the g/s available for domestic consumption  Exports are good; imports are bad o Exports create domestic income; imports crease income for foreigners; incorrect o Exports raise GDP by adding to the value of domestic output and income, but they do not add to the value of domestic consumption; the standard of living in a country depends on the level of consumption, not on the level of income (income is not of much use except that it provides the means for consumption)  Create domestic jobs o If protectionist policies reduce imports, there will be more employment in Canadian industries but it will also reduce employment in other industries o Decline in sale of imports to Canada for foreign firms will decrease their purchases of Canadian products; jobs will be lost in Canadian export industries and gained in industries that formerly faced competition from imports 34.2 Methods of Protection Tariffs • The initial effect of the tariff is to raise the domestic price of the imported product above its world price by the amount of the tariff • The price received on dom
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