Trade Restrictions
Despite the existence of opportunities for gains from trade, we frequently observe governments pursuing protectionist policies that serve to restrict trade. Tariffs and nontariff barriers are the principal means for implementing trade restrictions. A tariff is a tax on imported goods imposed by the importing country. Nontariff barriers are other actions restricting trade, including import quotas and voluntary export restraints (VERs).
Let's analyze the impact of a tariff. As we saw early on in the course, a tax imposed on sellers causes an upward shift in the supply curve, since the tax represents an additional cost of bringing the good to market. Hence, a fixed-value tariff imposed by an importing country will cause the supply curve (other countries' export supply) to shift upward in a parallel manner, with the size of the shift equal to the magnitude of the tariff.
An importing country's demand curve for a particular import good will be downward sloping, like virtually all demand curves. The starting point for the demand curve will correspond to the no-trade domestic opportunity cost of the good in question. Putting this demand curve together with the supply curves (with and without tariffs) yields the following diagram.
If you want to see how this process works, STEP BY STEP, click here.
QA and PA are the equilibrium quantity and price in the absence of any tariff. Once a tariff is imposed, the equilibrium quantity falls to QB and the equilibrium price paid by consumers rises to PB. Hence, the tariff restricts the amount of imports and forces consumers to pay a higher price. The price received by producers (exporters from abroad) falls to PB' and the difference between the price paid by consumers and that received by producers (the amount of the tax, T), multiplied by the quantity sold once the tariff is imposed (QB) equals the tax revenue collected by the government (equal to the shaded area in the diagram).
Clearly, consumers lose and foreign producers lose from imposition of a tariff. Domestic producers gain (they will now be able to sell more of the product because the price of the imported substitute has risen), and the government gains in the form of the revenues it collects from the tariff. Understanding who gains and who loses from trade restrictions is critical to understanding the political economy of debates about trade.
Further, as Parkin emphasizes, the import-reducing consequence of a tariff indeed reduces a trade deficit as a first-order effect, but there is also a second-round effect in the form of reduced exports. Hence, the long-term equilibrium effect of a tariff is to reduce the volume of both imports and exports. Overall, then, a tariff (like other trade restrictions) reduces the gains from international trade that are in fact realized.
Now let's examine the impact of nontariff barriers. Because tariffs have generally decreased for most of the past 60 years while nontariff barriers have become more prevalent, these nontariff barriers have become a more serious trade restriction than tariffs.
We'll consider the effects of quotas, which tend to be especially prevalent in textiles and agriculture. An import quota is a restriction on the quantity of a particular good that can be imported.
If you want to see how this process works, STEP BY STEP, click here.
As is evident from the diagram, a quota -- like a tariff -- raises the price to domestic consumers, lowers the price received by foreign exporters, and reduces the volume of imports. However, whereas the difference between the price paid by consumers and that received by producers constituted tax revenue to the government in the case of a tariff, under a quota this amount represents profit to importers who are lucky enough to obtain the restricted number of import licenses (i.e., the rights to import the restricted quantity of the good in question). This often very large potential profit creates competition for import quota licenses and what economists politely refer to as rent-seeking behavior (i.e., bribes and kickbacks to the government officials who distribute the import quota licenses).
The Case Against Protection - Highlights
Parkin reviews a number of arguments that are made in support of protectionist policies, and notes that they are all flawed. Here I want to emphasize two: trade restrictions have been advocated as a means of stimulating the growth of new industries (the infant industry argument), and they have been supported on the grounds that they save jobs.
The infant industry argument was one made by advocates of import substitution policies in Latin America and Africa after World War II and up through the 1970s. However, as we noted much earlier in the course, these policies succeeded only in protecting inefficient producers from the world market, without providing sufficient incentives to grow efficient and be able to compete on world markets. By contrast, the Asian countries that pursued export promotion policies ultimately experienced much more substantial economic growth and development.
The Ross Perot-type argument that trade protection saves jobs is half true. For example, as Parkin notes, protection in textiles has indeed resulted in more textile workers in the U.S. than would exist in a free trade setting. However, this protection has been extremely costly: the U.S. International Trade Commission has estimated that each textile job saved in the U.S. costs over $220,000 per year.
Further, while free trade costs some jobs, it also creates other jobs (in export industries), often at higher pay. Most fundamentally, from the economist's efficiency point of view, free trade brings about a global rationalization of labor and allocates labor resources to their highest-valued activities.
Why Is Trade Restricted?
Given the strength of the arguments in favor of free trade and the weaknesses of the arguments for restricting trade, why is implementing free trade such a hassle? (Cf., WSJ Dec. 3 article on problems confronting the World Trade Organization.) In brief, the answer is that trade restrictions emerge from political considerations, and typically the small number of losers from free trade are much better organized to influence the political process than the large number of gainers.
That is, overall consumption possibilities increase with free trade, but there are some losers (those domestic producers with a comparative disadvantage) as well as domestic gainers (consumers). Thus, while the total benefits exceed the total costs, the losers stand to lose a great deal (their livelihoods) and they will typically lobby heavily to influence the political process so as to provide protection. By contrast, the gainers are more numerous but do not, individually, gain as much as the losers lose. Hence, they are typically not politically organized to lobby against protection.
