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Theories for Trade Protection

Infant Industry Argument
This argument contends that for free trade to be meaningful, trading
countries should temporarily shield their newly developing industries
from foreign competition.

Some truths in the infant industry argument:

Once a protective tariff is imposed, it is very difficult to remove,
even after industrial maturity has been achieved.
It is very difficult to determine which industries will be capable
of realizing comparative advantage potential and thus merit

The argument generally is not valid for mature, industrialized


There may be other ways of insulating a developing industry

from cutthroat competition. Rather than adopt a protective tariff,
the government could grant a subsidy to the industry.
Terms of Trade Argument
In some cases, the terms of trade benefits of a tariff outweigh its costs,
so there is a terms-of-trade argument for a tariff.
The terms of trade argument against free trade, then, is intellectually
impeccable but of doubtful usefulness.
In practice, it is emphasized more by economists as a theoretical
proposition than it is used by governments as a justification for trade
Domestic Market Failure Argument
Theory of the second best
When economists apply the theory of the second best to trade
policy, they argue that imperfections in the internal functioning

of an economy may justify interfering in its external economic

This argument accepts that international trade is not the source
of the problem but suggests nonetheless that trade policy can
provide at least a partial solution.
Strategic Trade Policy

Because of the small number of firms, the assumption of perfect

competition does not apply. There are only a few firms in effective
competition in some industries.

This argument locates the market failure that justifies government

intervention in the lack of perfect competition.
It is possible in principle for a government to alter the rules of the
game to shift these excess returns from foreign to domestic firms.

A tariff is simply a tax (duty) levied on a product when it crosses national

Import tariff v.s. Export tariff
Protective tariff v.s. Revenue tariff

Types of Tariffs
Specific Tariff
Ad Valorem Tariff
Compound Tariff

Effective Rate of Protection (ERP)

the percentage change in the value added in an industry because of
the imposition of a tariff structure by the country rather than the
existence of free trade.

Nontariff Trade Barriers

Import Quota

An import quota is a physical restriction on the quantity of goods

that may be imported during a specific period; the quota
generally limits imports to a level below which imports would
occur under free-trade conditions.
A common practice to administer an import quota is for the
government to require an import license. Each license specifies
the volume of imports allowed, and the total volume allowed
should not exceed the quota.
Import quotas on manufactured goods have been outlawed by
the World Trade Organization.
Tariff-Rate Quota: A Two-Tier Tariff

a tariff-rate quota displays both tariff-like and quota-like

characteristics. This device allows a specified number of goods
to be imported at one tariff rate (the within-quota tariff rate),
whereas any imports above this level face a higher tariff rate
(the over-quota tariff rate).

a tariff rate quota is a two-tier tariff.

Orderly Marketing Agreements

An orderly marketing agreement (OMA) is a market-sharing pact
negotiated by trading partners.
Its main purpose is to moderate the intensity of international
competition, allowing less efficient domestic producers to
participate in markets that would otherwise have been lost to
foreign producers who sell a superior product at a lower price.
A typical OMA consists of voluntary quotas applied to exports.
These controls are known as voluntary export restraints
(VERs); they are sometimes supplemented by backup import
controls to ensure that the restraints are effective.

Domestic Content Requirements

To limit the practice of outsourcing, organized labor has lobbied
for the use of domestic content requirements.
The effect of content requirements is to pressure both domestic
and foreign firms who sell products in the home country to use
domestic inputs (workers) in the production of those products.

Manufacturers generally lobby against domestic content

requirements, because they prevent manufacturers from
obtaining inputs at the lowest cost, thus contributing to higher
product prices and loss of competitiveness.

National governments sometimes grant subsidies to their

producers to help improve their trade position.

Governmental subsidies assume a variety of forms, including

outright cash disbursements, tax concessions, insurance
arrangements, and loans at below-market interest rates.
Two types of subsidies:
a domestic subsidy which is sometimes granted to
producers of import-competing goods;
an export subsidy which goes to producers of the goods
that are to be sold overseas.

Dumping is recognized as a form of international price


It occurs when foreign buyers are charged lower prices than

domestic buyers for an identical product, after allowing for
transportation costs and tariff duties. Selling in foreign markets
at a price below the cost of production is also considered
Commercial dumping is generally viewed as sporadic, predatory,
or persistent in nature. Each type is practiced under different

The Logic of Free Trade

Many of us like the idea of being self-reliant
Defects of self-sufficiency explain why most people do not choose it
Principle applies not just to individuals, but also to groups of individuals

What would happen if residents of your state switched from a policy of open
trading with other states to one of self-sufficiency?

It would make no sense to insist on the economic self-sufficiency of each of

Indias states and territories
What is true for states is also true for entire nations
Long-term goal of WTO is to remove all barriers to exports and imports

Why Some People Object to Free Trade

Given the clear benefits that nations can derive by specializing and trading
Why would anyone ever object to free international trade?
Despite benefit to nation as a whole, some groups within the country, in
short-run, are likely to lose from free trade
Even while others gain a great deal more
Instead of finding ways to compensate the losers
Often allow them to block free-trade policies

The Impact of Trade in the Exporting/Importing Country

When opening of trade results in increased exports of a good

Producers of the good are made better off
Consumers of the good in exporting country will be made worse off
When opening of trade results in increased imports of a product
Domestic producers of the product are made worse off
Consumers of the good in importing country are better off

Attitudes and Influence on Trade Policy: The Anti-Trade Bias

Distribution of gains and losses create a policy-bias against free trade

Those who benefit from trade in a specific product either have little
incentive to lobby for it (consumers of imports)
Or have limited power to influence policy (producers of exports)

But one constituency harmed by trade has both a powerful incentive to

lobby and ability to influence policy
Domestic producers threatened by imports
Antidotes to this policy bias
Multilateral Agreements
Two or more countries agree to trade freely in many goodsor
even all goodssimultaneously
World Trade Organization
By setting standards for acceptable and unacceptable trade
restrictions, and making rulings in specific cases, WTO has some
power to influence nations trade policies
Industries as Consumers
Term can apply to any buyer of a product, including a firm that
uses it as an input
How Free Trade Is Restricted
When government decides to accommodate opponents of free trade
It is apt to use tariffs or quotes to restrict trade
Tax on imported goods
Can be a fixed dollar amount per physical unit or a percentage
of goods value
In either case, effect in tariff-imposing country is similar
Both countries, as a whole, are worse off

Tariffs reduce volume of trade and raise domestic

prices of imported goods

In the country that imposes the tariff, producers

gain and consumers lose

World as a whole loses, because tariffs decrease

volume of trade and therefore decrease gains from

Government decree limiting imports of a good to a specified maximum
physical quantity
Because goal is to restrict imports, a quota is set below the level of
imports that would occur under free trade
General effects are same as a tariff
Reduce quantity of imports and raise domestic prices

While both tariffs and quotas help domestic producers

They reduce benefits of trade to the nation as a whole
However, a tariff has one saving grace
Increased government revenue

Groups who suffer from trade with other nations have developed a number
of arguments against free trade
Together, these arguments form a position known as protectionism
Belief that a nations industries should be protected from free
trade with other nations

Myths about international trade

A high-wage country cannot afford free trade with a low-wage country
High-wage country will either be undersold in everything and
lose all of its industries, or else its workers will have to accept
equally low wages and equally low living standards
Low-productivity country cannot afford free trade with a highproductivity country
Former will be clobbered by latter and lose all of its industries
In recent times, Americas unskilled workers have suffered because of
ever-expanding trade between United States and other countries

Sophisticated Arguments for Protection

Strategic trade policy and support for infant industries are controversial

Opponents stress three problems

Once government assistance to an industry is accepted
Special interest groups of all kinds will lobby to get the
Whether it benefits general public or not
When one country provides assistance to an industry by keeping out
foreign goods, other nations may respond in kind
If they respond with tariffs and quotas of their own, result is a
shrinking volume of world trade and falling living standards
If subsidies are used to support a strategic industry, and another
country responds with its own subsidies, then both governments
lose revenue
Neither gains the sought-after profits
Strategic trade policy assumes that government has information to
determine which industries, infant or otherwise, are truly strategic and
which are not

Sophisticated Arguments for Protection

Arguments help to remind us of conditions under which free trade is most
beneficial to a nation
Production is most likely to reflect principle of comparative advantage
When firms can obtain funds for investment projects
When they can freely enter industries that are profitable
Thus, free trade, without government intervention, works best when
markets are working well

May partly explain why United States has for decades been among the
strongest supporters of free trade ideal

Using the Theory: The U.S. Sugar Quota

United States has protected U.S. sugar producers from foreign competition
since 1930s
Since 1980s protection has been provided in the form of a price
If U.S. sugar prices fall below 22, government will buy the
sugar at that price

May not sound like a lot

But in the rest of the world, people and businesses can buy sugar for a
lot less
Government decides how much foreign sugar it will allow in each year free of
any tariff
All sugar beyond the allowed amount faces a heavy tariff of about 16
a pound
Sugar producers benefit
Sugar consumers are hurt substantially

Taxpayers pay a cost for the sugar quota

Because as part of its price support program, U.S. government must
occasionally buy excess sugar from producers

Hurts the poorest countries in the world that rely on sugar as an important
source of export revenue
Sugar quotas harm to these countries has been estimated at about
$1.5 billion per year
Why do we bear these costs?
Because of lobbying by groups who enjoy highly concentrated benefits
NTBs: Import quotas
Quotas are a restriction on the quantity of a good that may be imported in
any one period (usually below free-trade levels)
Global quotas restrict the total quantity of an import, regardless of origin
Selective quotas restrict the quantity of a good coming from a particular

Tariff-rate quota
The tariff-rate quota is a two-tiered tariff
A specified number of goods (up to the quota limit) may be imported at
one (lower) tariff rate, while imports in excess of the quota face a
higher tariff rate

The tariff-rate quota is a two-tiered tariff

A specified number of goods (up to the quota limit) may be imported at
one (lower) tariff rate, while imports in excess of the quota face a
higher tariff rate

Orderly marketing agreements

Market sharing pact signed by trading partners
Intended to protect less efficient domestic producers
Usually involve voluntary export restraints, or export quotas
Recent trade negotiations have restricted the use of these agreements