economics

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Protectionism in trade

Some of the benefit of protectionism in trade is the protection of domestic employment and sunrise industry. One type of protectionism is tariff, which is a tax that is charged on imported goods. In this article, the Indonesian government imposed tariff to protect local producers of nails and wire against a spike in imports from China and Malaysia.

One reason of protectionism is to protect domestic employment from foreign low-cost labor. Indonesia's inability to compete with the Chinese products forces at least 10 nail and wire producers to close in 2008, resulting in the dismissal of thousands of workers. In this case, a demand deficient unemployment happens, (as the demand for labor falls when firms cut back on production). As illustrated in Figure A, when the domestic nail firms closes down, there is a fall in aggregate demand for labor (ADL à AD L1), and the number of workers falls from Q e to Q1. In the long run, unemployment has a negative impact to society in the form of poverty and high crime rates. It also affects the economy, as it decreases the potential output and production capacity from 80 percent in 2006 to 30 percent at the end of 2007, and reduces government taxation of income tax. Therefore, the government imposes tariff in order to protect the domestic employment and the economy from the foreign low-cost labor industries.

Another argument for protectionism is to protect domestic industries that may not have the economies of scale advantages, which is any decrease in long-run average costs that happens when a firm alters its factors of production to increase output that larger industries of foreign countries have. Economies of scale such as specialization, division of labor and bulk buying causes larger firms to be more efficient and lowers their unit cost. These advantages put the small domestic nail firms even further behind, and thus the government hopes that the three years tariff implementation will gives the domestic producers to improve their efficiency and be on equal footing with the large Chinese industries.

As illustrated in Figure B, before tariff, the nails are produced at 0Q2, and consumed at Pw. Domestic production is at 0Q1, while imports were Q1Q2. However, when tariff is imposed, S(world) shifts up to S(world)+Tariff (145% of the import value of goods), causing the market prices to rise to Pw+T(145% of import value). As price rises, total Qty demanded falls from 0Q2 to 0Q4. Domestic producers benefit from this, because as their production increase to 0Q3, their revenue increases from g to a+b+c+g+h. Conversely, foreign producers that produce goods at Q3Q4 should receive Pw+T. Yet as they have to pay the tariff for the government, their revenue falls from h+i+j+k to i+j. The government now receives tariff revenue of d+e. Although this raise in government revenue is not really an argument of protectionism, it highlights another benefit of imposing tariff.

However, there is also a limitation to tariff as it creates a dead-weight loss of welfare (shaded). When Q4Q2 is not now demanded, consumers keep the amount k that they would have spent, but there is a loss of consumer surplus f. Therefore the dead-weight loss of welfare exists due to the loss of consumer surplus. Furthermore, after tariff, Q1Q3 are produced by inefficient domestic producers that need minimum revenue of h+c, while efficient foreign producers could produce this quantity for min revenue of h. Thus c is the dead-weight loss of welfare, which is the inefficiency of the domestic producers & loss of world efficiency, as the world's resources are being used to produce more goods than what is necessary.

Furthermore, as foreign firms are kept out of country, protectionism may reduce competition and causes the domestic firms to become inefficient without the incentive to minimize cost or create innovations. As a developing country that is undergoing recession, Indonesia may lack the necessary capital to create innovations and educate their labor force. As opposed to China where the government has high capital reserves, Indonesia's public debt hinder the government for giving subsidies, which is amount of money given to a firm to make it bigger, more competitive, and achieves economies of scale in the long run. Hence Indonesia's industry may not be more productive. Moreover, protectionism could also lead to inefficient use of the world's resources, as reduced specialization would reduce the potential level of the world's output. Therefore, governments should weigh both benefits and disadvantages caused by protectionism, and only set the necessary amount of tariffs.