Trade policy: a government’s policy involving restrictions placed on
Protectionism: any government policy that interferes with free trade in order
to protect domestic firms and workers from foreign competition.
34.1 Free Trade or Protection
Tariff: a tax applied on imports of goods or services (purposely designed to
raise the price of imported goods.
Non-tariff barriers (NTBs): restrictions other than tariffs designed to reduce
o I.e. import quotas and customs procedures that are deliberately more
cumbersome than necessary.
Free trade encourages all countries to specialize in producing products in
which they have a comparative advantage.
o This specialization maximizes world production and hence maximizes
average world living standards (measured by the world’s per capita
Free trade makes the country as a whole better off, even though it may not
make every individual in the country better off.
Firms that do no continuously innovate will fall behind foreign competitors
and will succumb to the foreign competition sooner or later.
If one country protects its domestic firms by imposing a tariff, those firms are
likely to become complacent about the need to adopt new technologies, and
over time they will become less competitive in international markets.
Arguments against free trade (other than maximizing national income):
o Advantages of diversification
Countries whose economies are based on the production of
only a few goods face risks such as:
Technological advances that may render their basic
Fluctuations in world prices, which will lead to large
swings in national income.
Pro-tariff argument is that the government can encourage a
more diversified economy by protecting domestic industries
that otherwise could not compete with their foreign rivals.
o Protection of specific groups
Trade restrictions can improve the earnings of one group
whenever the restrictions increase the demand for that group’s
W/o trade restrictions, demand for labour of skilled
workers will increase when the country exports a lot of
product made by the skilled workforce and their wages
will increase (unskilled workers wages will fall). The trade restrictions will, however, cause a reduction
in the overall national income and the country’s average
Social and distributional concerns may lead to the rational adoption of
protectionist policies. But the cost of such protection is a reduction in the
country’s average living standards.
Economists can do three things when presented with arguments for adopting
protectionist measures regarding social and distributional concerns:
o They can ask if the proposed measures really do achieve the ends
o They can calculate the cost of the measures in terms of lowered
average living standards.
o They can see if there are alternative means of achieving the stated
goals at lower cost in terms of lost national income.
Pro-tariffs (maximizing national income):
o Improving the terms of trade
If an importing country has market power (represents a large
portion of demand for a specific product), the imposition of a
tariff can lead to an improvement in the terms of trade (if the
tariff is greater than the caused increase in price to domestic
o Protect infant industries
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.
Once the end result is reached, the protection is then
o Electronics in Taiwan
o Automobiles in Japan
o Commercial aircraft in Europe
o Shipbuilding in South Korea
o Earn economic profits in foreign markets
Strategic trade policy: a policy implemented in an attempt to
help certain firms create an advantage in producing or
marketing some product that is expected to generate economic
profits through its sales to foreign consumers.
I.e. subsidies given to Bombardier.
Opposition to strategic trade policy argue that:
Once all countries implement similar policies, all will
waste vast sums of money trying to break into
industries, which there is no room for most of them. o If one government does not engage in this game,
their citizens will benefit from the importing of
subsidized goods and exporting of their own
Democratic governments that enter the game of picking
and backing winners are likely to make more bad
choices than good ones.
Fallacious arguments for protection:
o Keep the money at home
By purchasing imports, the Canadian money is sold to someone
for the foreign currency who wants to spend the money in
The foreigners are not keeping our money.
It is only because Canadian money can buy Canadian products
and Canadian assets that others want it.
o Protect against low-wage foreign labour
If foreign workers earn low wages and the goods they produce
are sold at low prices, Canadians will gain by obtaining imports
at a low cost in terms of the goods that must be exported in
o Exports are good; imports are bad
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.
o Create domestic jobs
The imposition of tariffs or import quotas in an attempt to
create more employment in Canadian industries producing
similar products as the ones hit with tariffs will reduce
employment in other industries.
Employment will simply be redistributed among
industries and, in the process, living standards will be
reduced because employment expands in inefficient
import-competing industries and contracts in efficient
34.2 Methods of Protection
Tariff (import duty): a tax on imported goods.
The effect of the tariff:
o The domestic price of the imported product is raised by the amount of
the tariff above its world price.
o Imports fall.
o Price rises.
o Domestic producers produce more and sell at the higher price.
Both are beneficial to the producer.
o Consumers are affected in two ways: They consume less of the product.
They pay more for what they do consume.
o The extra amount paid on the remaining imports goes to the
government as tariff revenue.
A tariff imposes costs on domestic consumers, generate benefits for domestic
producers, and generate revenue for the government. But the overall net
effect is negative; a tariff generates a deadweight loss for the economy.
Import quota: a limit set on the quantity of a foreign commodity that may be
imported in a given time period.
Voluntary export restriction (VER): an agreement by an exporting country to
limit the amount of a good exported to another country.
Import quotas and VERs impose larger deadweight losses on the importing
country than do tariffs that lead to the same level of imports.
o Tariffs generate revenue for the government through the higher
prices whereas import quotas simply just have higher prices.
Major difference (refers to the red area above):
o The tariff permits some surplus to be captured by the importing
country. o The quota allows some surplus to be captured by the exporting
Trade-remedy laws: non-tariff barriers that were meant to remedy certain
legitimate problems that arise in international trade.
o They were all too often misused and over time became a potent
means of simple protection.
Dumping: the practice of selling a commodity at a lower price in the export
market than in the domestic market for reasons unrelated to differences in
costs of servicing the two markets.
o If it lasts indefinitely, it can be a gift to the receiving country. Its
consumers get goods from abroad at lower prices than they otherwise
To get rid of unwanted surpluses.
As a predatory attempt to drive competitors out of business.
Most governments have antidumping duties designed to protect their own
industries against what is viewed as unfair foreign pricing practices.
Features that make the antidumping system highly protectionist:
o Any price discrimination between national markets is classified as
dumping and is subject to penalties.
Prices in the producer’s domestic market become minimum
prices below which no sales can be made in foreign markets
(regardless of demand in either market).
o Many countries’ laws calculate the “margin of dumping” as the
difference between the price that is charged in that country’s market
and the foreign producer’s AC.
Foreign producers can be convicted of dumping when the
profit-maximizing price for all producers is below AC during a
slump in the industry.
Domestic producers are given enormous protection.
o Law in the US (not in all other countries) places the onus of proof on
the accused (the accused must prove the cla