restrictions-on-free-trade

Reasons for Restrictions on Free Trade (Protectionism)

• Free trade aims to maximise global output based on the principle of comparative advantage

• However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes

• This is called protectionism and may take the form of limiting imports, limiting exports, boosting exports – or putting administrative barriers in place

Reasons for protectionism

Types of Protectionism

• The most commonly used forms of trade protectionism include tariffs, subsidies, quotas and administrative barriers

Tariffs

• A tariff is a tax on imported goods/services (customs duty)

• Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country

  • This raises the cost of production for domestic firms

  • Firms often pass on the increased costs to consumers in the form of higher prices

  • These higher prices allow some domestic firms to increase their output (law of supply)

• More inefficient domestic firms are now producing at the expense of more efficient firms globally who reduce their output due to the tariff

  • With increased domestic output, employment may increase

Diagram analysis

• World supply (W_s) is considered to be infinite and this supply curve is added to the domestic demand (D_D) and supply (S_D) curves

• The pre-tariff market equilibrium is seen at P_wQ₂

  • Domestic firms supply up to Q₁ at a price of P_w

  • Foreign firms supply the difference equal to Q₁Q₂ at a price of P_w (imports)

• After the tariff is imposed, the world price increases from P_w to P_w+ tariff

• The new market equilibrium is seen at P_w+tariffQ₄ 

  • Following the law of demand, the quantity demanded contracts from Q₂ to Q₄

  • Following the law of supply, the quantity supplied by domestic firms extends from Q₁ to Q₃

  • The level of imports is reduced from Q₁Q₂ to Q₃Q₄

Quotas

• A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry

• This limit is usually set below the free market level of imports

  • As cheaper imports are limited, a quota raises the market price

  • As cheaper imports are limited a quota may create shortages

• Some domestic firms benefit as they are able to supply more due to the lower level of imports

  • This may increase the level of employment for domestic firms

Subsidies to domestic producers

• A subsidy lowers the cost of production for domestic firms 

  • They can increase output and lower prices

  • With lower prices their goods/services are more competitive internationally

  • The level of exports increases

  • The increased output may result in increased domestic employment

Non-tariff barriers

• There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas and subsidies

  • Health and safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries and it effectively blocked the import of southern hemisphere nuts

  • Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size

  • Environmental regulations e.g. in November 2021 new regulations were put in place in the EU and the USA to limit the amount of imports of ‘dirty steel’ – predominantly this is steel produced using coal fired power stations which are prevalent in China

  • Product labelling can be expensive for firms to apply and may limit their desire to sell into certain markets

Impacts of Protectionist Policies

• Protectionist policies have a range of impacts on consumers, producers, governments, living standards, and equality

Tariffs

• The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram

Domestic producers

• Before the tariff domestic producers produced output equal to 0Q₁ and their revenue was equal to P_w X Q₁

• After the tariff was imposed domestic producers produced 0Q₃ and their revenue was equal to P_w X Q₃

• Domestic producer surplus has increased by area 1

Domestic consumers

• Before the tariff domestic consumers consumed Q₂ products at a price of P_w

• After the tariff domestic consumers consumed fewer products (Q₄) at a higher price of P_w+tariff

• Domestic consumer surplus has decreased by areas 1, 2, 3 and 4

Government

• After the tariff is imposed the government receives tax revenue equal to ((P_w+tariff) – P_w) x (Q₄-Q₃) – area 3

Standards of living

• The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices

• Domestic firms who benefit from increased production may increase employees’ wages

  • This would increase the standard of living for employees

Equality

• Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly

The Impact of Quotas, Subsidies and Non-tariff Barriers on Stakeholders