Is Protectionism The Same As A Restriction On Free Trade Economics Essay

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There are two main traditional tools for protectionism which one must know before evaluating the goodness of protectionism. The first is Tariff, A taxation imposed on goods and services imported into a country. It basically acts as a way to lower the imports and raise the output. Governments generally impose tariffs to raise revenue and protect domestic industries from foreign competition caused by factors like government subsidies, or lower priced goods and services. The second type is quotas. Quota means there is a limit put on the amount of a specific good that can be imported. Quotas are used to prevent other countries from "dumping"; something will be explained later on. However the effectiveness of tariffs in reducing imports depends on the price elasticity of demand for imports. In addition, the imposing of tariffs lead to welfare loss as the consumers pays unnecessarily more than before. Prices could actually be much lower if imports were higher. At the same time, consumers suffer a decrease in consumption due to higher prices, which brings a fall in consumer welfare. However, even in a situation like this, the government still stands to earn from the tariffs imposed. As such, like I said earlier, Protectionism is not always bad. As the question is about whether protectionism is always bad, evaluation and analysis of the arguments for protection would suffice.

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One of the main arguments for protectionism used would be to protect infant industries. In an infant industry, a country may have a comparative advantage but as in many cases the country has arrive in the market a step too late, it cannot actually compete with the foreign industries that have been established from way before as normally they are already operating at much lower costs. At the initial stage of operation, the infant industry will face high initial production costs unless output is expanded sufficiently to reap economies of scale. Therefore, it is necessary to protect the infant industry until it is able to produce as cheaply as foreign industries and thus be able to compete without protection. Japan's automobile industry after the war is a great example of this. Compared to some other industries, the automobile industry did not suffer extensive direct damage from the war. However, with steel and other materials being extremely difficult to procure, production had dropped by 50% by the end of the war. As reconstruction progressed, the production ambitions of automobile and auto parts manufacturers increased. Soon, the Ministry of International Trade and Industry favoured the protection of domestic automobile manufacturers, and this line of thinking set the general tone for government policy. Specifically, MITI set up guidelines (issued in October 1952) aimed at introducing new technologies to Japan through technical collaborations with foreign automobile manufacturers, improving production technologies for passenger cars, and manufacturing automobiles that would be competitive in the export market. The Industry Rationalization Promotion Law adopted in March 1952 marked the first implementation of the new government policy discussed above. Through this law, the automobile, steel, machine tool, and electric communications equipment industries were designated as key industries that ought to be rationalized. The provisions of this law gave those industries tax advantages and also made low-interest government loans available to them. The cost reductions thus gained by the automobile industry, together with improvements in the quality of their product, allowed manufacturers to produce cars with export competitiveness. However, protection for an infant industry is not always good. This form of protectionism should only be a temporary measure. When an industry comes to rely on this too much, it results in low-quality goods, high prices and limited variety of goods. For example, in Brazil, there was an effort to develop a Brazilian personal computer in the late 1960s and early 1970s. The policy was conceived not only to limit the small computer market to national firms but also to stimulate the local production of products and components, which was part of a broader policy of import substitution. Both Brazilian and multinational firms were required to increase the share of domestic content in their products. However, while supporters argued that the policy generated technological competence in Brazilian firms and created employment for researchers and engineers at little cost to industry or Brazil there were detractors who argued that the whole industrial sector suffered from restrictions on access to state-of-the-art electronics and, more generally, that Brazil was delayed in entering the microcomputer culture. Furthermore, in developed countries, a firm with comparative advantage need not be protected; it could simply borrow enough to tide it over its period of infancy. The argument hence is only justifiable for developing countries where capital markets may not be as well developed and so the instruments for borrowing are not well established.

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Another argument for the use of protectionism is to protect declining industries. Industries may decline due to significant changes in demand for a good or a change in comparative advantage. If these industries were allowed to decline quickly, it would lead to massive unemployment which would then be followed by many social problems which would include but is not limited to unemployment, low standards of living, family break-ups, crime, vandalism and depression, especially if these industries were once dominant industries in the economy. Therefore the government needs to protect these industries for a whole to allow workers time to be retrained and re-employed by the other industries. Sometimes industries may decline because they do not have enough profits to afford the necessary investment. However, with some temporary protection, they are able to reorganise, restructure and compete effectively with the foreign firms again. This reason for protection can be justified to prevent rising unemployment is the short run. However such protectionism is not justified in the long run as it will protect inefficiency and ultimately depress the standard of living of a nation. In the long run, it will be better to let the industry decline if it has already lost its comparative advantage and let the nation subsidise retraining and investment in the new efficient industries. In this way, employment is avoided and the consumer does not suffer. One such example of an industry that has been protected for too long is the steel industry of the United States. Since the late 1960s, the US steel industry has been asking for protection from imports and subsidies to help alleviate its troubles. The dominance of the US steel industry seemed to be over by 1970, and domestic steel consumers became increasingly dependent on cheap imports. During the same time, the development of electric furnace technology reduced the barriers to entry in the steel industry and the dominant position of the integrated steel players was challenged for the first time. In the 1980s, the government imposed quotas limiting imports to 20 percent of the US market. The industry was also protected by voluntary restraint agreements on imports. In the late 1990s, the Clinton administration imposed a 12-point plan to protect the domestic industry from the 'dumping' of Japanese steel. Analysts felt that the industry was struggling on account of home-grown problems. Before the government started protecting the domestic steel industry in the late 1960s, the average compensation in the industry was almost equal to the average compensation in the manufacturing sector. In the early 2000s, the average compensation was more than 50 percent higher than that in the manufacturing sector as a whole. This was mainly because the steel industry was highly unionized and the strong trade unions without any threat of foreign competition could negotiate high compensation packages. Thus, far from being of benefit, protectionism was actually responsible for many of the ills of the industry in the early 2000s.

The third purpose of protectionism is to prevent dumping. So what exactly is dumping? Dumping is an informal name for the practice of selling a product in a foreign country for less than either (a) the price in the domestic country, or (b) the cost of making the product. It is illegal in some countries to dump certain products into them, because they want to protect their own industries from such competition. Because dumping will benefit consumers in the importing country, not all instances of dumping are actionable under international rules or domestic law. Rather only dumped imports which are a cause of material injury to a domestic industry in the importing country (or a threat of such material injury) area actionable. Injurious dumping is an internationally recognized unfair trading practice. The GATT, and now WTO, have since 1947 indicated that injurious dumping is "condemned. It simply means that dumping helps to get rid of excess production and if allowed, the cheaper imports will out sell the domestic goods. There will be a decrease in demand for domestic goods and domestics firms will have to close down. This would lead to unemployment in the domestic country. An exporting firm might engage in dumping for various reasons some of which includes but is not limited to maximising overall worldwide profits through practising international price discrimination. Another reason is to use temporary dumping to drive out competitors and to raise the price once it has succeeded in doing so. Prevention of dumping which is temporary used in driving out competitors can be justified. The price of a good would subsequently be raised when the foreign firm becomes a monopoly seller after driving out the domestic producers. But this is not the same for regular dumping as a country can continually import goods at a lower price, this can only be a benefit. The country can channel its unemployed resources to meeting its other needs instead.

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The fourth purpose of protectionism is to maintain home employment and safeguard the interest of workers. In an event of a recession, as said earlier in the introduction, countries tend to place restrictions on imports in order to ensure that income is spent on home produced goods, thus maintaining, if not raising, the level of employment in the home countries. Also, it is often argued that imports from countries where wages are low represent unfair competition and threaten the living standard of the more highly paid worker in the home industries. However, such protectionism may depress the income of the trading partners and reduce their ability to purchase the exports of the country which imposes protectionism, thus reducing their ability to purchase the exports of the country which imposes protectionism, thus reducing unemployment in the export industries. For example, Korean citizens can buy from the United States only if they earn U.S dollars by selling their domestically produced goods and services to the United States. The decline in what they import to the United States will decrease their purchase of American wheat, banking services and basically all United State products. Jobs will be lost in the U.S export industries and gained in industries that formerly faced competition from imports. The effect is that the same amount of full employment will merely be redistributed among industries. In the process, living standards will be lesser as consumers are forced to buy more expensive goods from the inefficient protected local industries and resources are reallocated from the efficient exporting industries to the inefficient import-competing industries. Furthermore, a country that imposes tariffs in an attempt to create domestic jobs risks starting a trade war with its trading partners. Such a trade war can easily leave every country worse off.

The fifth purpose of protectionism is to reduce balance of payment deficit. Balance of payments deficit occurs when international payments are greater than international receipts. This is considered not desirable as a continuous deficit means a continuous depletion of foreign reserves. Hence the government may resort to protectionism by introducing import duties, import quota or exchange control to reduce imports and thus improve the balance of trade and balance of payments. However this policy is to correct the balance of payments deficit can only be taken as a short term measure as the import expenditure is curtailed at the expense of consumer's welfare. This policy may also invite retaliation from the trading partners in the long run and the country concerned may ultimately be subjected to the same balance of payment problems. Trade is a-two way traffic. A country that practises protectionism will also make her trading partners poorer. With poorer trading partners, the country concerned may ultimately face a fall in her exports and the same balance of payments problem. The protectionist policy may be able to reduce the balance of payments deficit in the short run. But it is not a permanent solution as protectionism does not remove the cause of the deficit which is a lack of competitiveness. Often the balance of payment deficit occurs due to lack of competitiveness in areas such as pricing, quality, reliability, delivery, design, ineffective marketing etc. In fact the country concerned should revise and restructure its economy so as to improve her international competitiveness.

The sixth argument for protectionism is that it aids in diversification of industries. It is said that a nation should not be too over-reliant on a few industries as it will lead to greater fluctuation in country's income. This may happen when products they are known for become out-dated due to technological advances. Hence in countries with developing countries that are unable to diversify their industries, a large price swing will lead to large swing in country's income. For example, Venezuela's proven oil reserves are among the top ten in the world. Oil generates about 80 percent of the country's total export revenue, contributes about half of the central government's income, and is responsible for about one-third of the country's gross domestic product (GDP). However if oil prices were to drop rapid and suddenly, Venezuela will then experience fall in export income and it will cause them to go into financial ruin. However this works against the theory of comparative advantage and will lead to higher cost of production and misallocation of resources. But as long as the government can select suitable industries for diversification, protection can be justified in order to achieve a stabilised economy.

However it seems any trade restriction would have a cost be it social, lower standards of living or economical, unemployment rate increase. There may be short-term benefits like in the infant industry argument, but in the long run, it promotes and strengthens inefficiency, thereby causing misallocation of resources. In my opinion, a good solution has to be a long term solution, which leaves protectionism out of the equation and free trade as the prime candidate. Free trade occurs when there are no artificial barriers put in place by governments to restrict the flow of goods and services between trading nations. So actually, there are five main reasons why free trade is a better solution. The first is the increase of production. Free trade enables countries to specialise in the production of those commodities in which they have a comparative advantage. Conversely, protectionist policies that limit trade are inefficient as they reduce total economic surplus. With specialisation, countries then are able to take advantage of efficiencies generated from economies of scale and increased output. International trade increases the size of a firm's market, resulting in lower average costs and increased productivity, ultimately leading to increased production. Free trade increases production efficiencies. Free trade improves the efficiency of resource allocation. The right allocation of resources will lead to more efficient use of resources which leads to higher productivity and thereby increasing total domestic output of goods and services. Increased competition promotes innovative production methods, the use of new technology, marketing and distribution methods. Thirdly, there is obviously more benefits to consumers. Consumers benefit in the domestic economy as they can now obtain a greater variety of goods and services. The increased competition ensures goods and services, as well as inputs, is supplied at the lowest prices. For example in Australia imported motor vehicles would cost 35% more if the 1998 tariff levels still applied. Clothing and footwear would also cost around 24% more. Fourthly, there would be foreign exchange gains. When Australia sells exports overseas it receives hard currency from the countries that buy the goods. This money is then used to pay for imports such as electrical equipment and cars that are produced more cheaply overseas. In fifth place, there would be creation of more jobs and employment. Trade liberalisation creates losers and winners as resources move to more productive areas of the economy. Employment will increase in exporting industries and workers will be displaced as import competing industries fold (close down) in the competitive environment. With free trade many jobs have been created in Australia, especially in manufacturing and service industries, which can absorb the unemployment, created through restructuring as firms close down or downsize their workforce. When tariffs were increased substantially in the period 1974-1984 for textiles and footwear - employment in the sector actually fell by 50 000, adding to overall unemployment. Last but not least, there would be economic growth and the countries involved in free trade experience rising living standards, increased real incomes and higher rates of economic growth. This is created by more competitive industries, increased productivity, and efficiency and production levels. The fact that free trade is efficient suggests an alternative to trade restrictions, however. Because eliminating restrictions on trade increases total economic surplus, in general the winners from free trade will be able to compensate the losers in such a way that everyone becomes better off. Government programs that assist and retrain workers displaced by important competition are an example of such compensation. As the incentive principal reminds us, people are likely to resist policy changes that threaten their incomes. Spreading the benefits of free trade or at least reducing its adverse effects on certain groups reduced the incentives of those groups that inhibit free trade.

In conclusion, Protection is not always bad. I have evaluated arguments for protectionism and found that protectionism can be justified and hence it is rational to use it at certain times. One common theme I found is that protectionism has a cost and the benefits are usually short term. But because of its short-term benefits, one can say for sure that protectionism is not always bad and there will be situations where nations can use protectionism to their advantage even if it is for a short while. Once again, it should be noted that an over reliance or overuse of it can result in negative consequences. Instead of being considered bad, it should be considered inefficient or only as a short term solution. In its place, free trade should be used as a permanent solution.