Lecture 34

LESSON – 34 Non Tariff Trade Barriers and New Protectionism Learning outcomes After studying this unit, you should be able to: Define Free Trade Know Non tariff Trade Barriers and Protectionism Arguments for free trade and protectionism Know the demerits of protectionism Identify the fall and rise of protectionism

Free Trade Versus Protection Free trade refers to the trade that is free from all artificial barriers to trade like tariffs, quantitative restrictions, exchange controls, etc. Protection, on the other hand, refers to the government policy of according protection to the domestic industries from foreign competition. There are a number of arguments for and against both free trade and protection. ARGUMENTS FOR FREE TRADE The important arguments in favour of free trade are as follows: (i) Free trade leads to the most economic utilisation of the productive resources of the world because under free trade each country will specialise in the production of those goods for which it is best suited and will import from other countries those goods which can be produced domestically only at a comparative disadvantage. (ii) Under free trade, division of labour occurs on an international scale leading to greater specialisation, efficiency and economy in production. (Iii) As there will be intense competition under free trade, the inefficient producers are compelled either to improve their efficiency or to quit. (Iv) Free trade helps to break domestic monopolies and free the consumers from exploitation. (v) Free trade benefits the consumers.in different ways. It enables them to obtain goods from the cheapest source. Free trade also makes available large varieties of goods. (v i) Further, under free trade there is no much scope for corruption which is rampant under protection. ARGUMENTS FOR PROTECTION Theoretically speaking, free trade has certain virtues, as we have seen above. But, in reality, government are

encouraged to resort to some manner of protective measures of safeguard the national interest. There are a number of arguments put forward in favour of protection. Some of these arguments are very valid while some others are not. We provide below the gist of the popular arguments for protection. (i)

Infant Industry Argument The infant industry argument advanced by Alexander Hamilton, Frederick List and others asserts that a new industry having a potential comparative advantage may no_ get started in a country unless it is given temporary protection against foreign competition. An established industry is normally much more stronger than an infant one because of the advantageous position of the established industry like its longstanding experience, internal and external economies, resource position, market power, etc. Hence, if the infant is to compete with such a powerful foreign competitor, it will be a competition between unequals and this would result in the ruin of the infant industry. Therefore, if a new industry having a potential comparative advantage is not protected against the competition of an unequally powerful foreign industry, it will be denying the country the chance to develop the industry for which it has sufficient potential. The intention is not to give protection for ever but only for a period to enable the new industry to overcome its teething troubles. The policy of protection has been well expressed in the following words: "Nurse the baby, Protect the child and Free the adult". The infant industry argument, however, has not been received favourably by some economists. They argue that an infant will always be an infant if it is given protection. Further, it is very difficult for a government to identify an industry that deserves infant industry protection. "The infant industry argument. boils down to a case for the removal of obstacles to the growth of the infants. It does not demonstrate that a tariff is the most efficient means of attaining the objective." J (ii)

(iii)

Diversification Argument It is necessary to have a diversified industrial structure for an economy to be strong and reasonably self-sufficient. An economy that depends on a very limited number of industries is subject to many risks. A depression or recession in these industries will seriously affect the economy. A country relying too much. on foreign countries runs a number of risks. Changes in political relations and international economic conditions may put the country into difficulties. Hence, a diversified industrial structure is necessary to maintain stability and acquire strength. It is, therefore, advised to develop a range of industries by according protection to those which require it. Improving the Terms of Trade It is argued that the terms of trade can be improved by imposing import duty or quota. By imposing tariff the country expects to obtain larger quantity of imports for a given amount of exports, or conversely, to part with a lesser quantity of exports for a given amount ofimports. But the terms of trade could be expected to improve only if the foreign supply is inelastic. If the foreign supply is very much elastic a tariff or a quota is unlikely to improve the terms of trade, there is also the possibility that the

foreign countries will retaliate by imposing counter tariffs und quotas. The validity of this argument, is therefore, questionable. (iv) Improving Balance of Payments This is a very common ground for protection. By restricting imports, a country may try to improve its balance of payments position. The developing countries, especially, may have the problem of foreign exchange shortage. Hence, it is necessary to control imports so that the limited foreign exchange will be available for importing the necessary items. In developing countries, generally, there is a preference for foreign goods. Under such circumstances it is necessary to control unnecessary imports lest the balance ofi payments position become critical. (v) Anti-Dumping Protection is also resorted to as an anti-dumping measure. Dumping, certainly, can do harm to the domestic industry; the relief the consumers get will only be temporary. It is possible that after ruining the domestic industry by dumping, the foreign firms will obtain monopoly powers and exploit the home market. Sometimes, dumping represents a transmission of the recession abroad to the home country. These factors point out the need to protect domestic industries against dumping. (vi) Bargaining It is argued that a country which already has a tariff can use it as a means of bargaining to obtain from other countries lower duties on its . exports. It has been pointed out, however, that the bargaining lever, instead of being used to gain tariff concessions from foreign powers, may be employed by others to extract additional protection from the home government. (vii) Employment Argument Protection has been advocated also as a measure to stimulate domestic economy and expand employment opportunities. Restriction of imports will stimulate import competing industries and its spread effects will help the growth of other industries. These, naturally, create more employment opportunities. This method of employment generation, however, has some problems. First, when we reduce imports from foreign countries employment and income will shrink abroad and this is likely to lead to a fall in the demand for our exports. Secondly, the foreign countries will be tempted to retaliate in order to protect their employment. (viii) National Defense Even if purely economic factors do not justify such a course of action, certain industries will have to be developed domestically due to strategic reasons. Depending on foreign countries for our defense requirements is rather foolish because factors like change in political relations can do serious damage to a country's defense interest. Hence, it is advisable to develop defense and other industries of strategic importance by providing protection if they cannot survive without protection. (ix) Key Industry Argument It is also argued that a country should develop its own key industries because the development of other industries and the economy depends a lot on the output of the key industries. Hence, if we 40 not have our own source of supply of key inputs, we will be placing ourselves at the mercy of the foreign suppliers. The key industries should therefore be given protection if that is necessary for their growth and survival.

The arguments mentioned above have been generally regarded as 'serious'. There are, however, a number of other arguments also which have been branded as 'nonsense', 'fallacious', 'special interest', etc. Common among them are the following: (x) Keeping Money at Home This argument is well expressed in the form of a remark falsely attributed to Abraham Lincoln: "I do not know much about the tariff, but I know this much: When we buy manufactured goods abroad we get the goods and the foreigner gets money. When we buy the manufactured goods at home we get both the goods and the money". As Beveridge rightly reacted, this "...argument has no merits; the only sensible words in it are the firsteight word." The fact that imports are ultimately paid for by exports clearly shows that the 'keeping money at home' argument for protection has no sense in it. (xi) The Pauper Labour Argument The essence of this argument is that if in the home country the wage level is substantially high compared to foreign countries, the foreign producers will dominate the home market because the cheap labour will allow them to sell goods cheaper than the domestic goods and this will affect the interests of the domestic labour. This argument does not recognize the fact that high wages are usually associated with high productivity. Further, labour cost differences may not be a determining factor. (xii) Size of the Home Market It is argued that protection will enlarge the market for agricultural products because agriculture derives large benefits not only directly from the protective duties levied on competitive farn1 products of foreign origin but also, indirectly from the increase in the purchasing power of the workers employed in industries similarly protected. It may be pointed out against this that protection of agriculture will harm the non-agriculturists due to the high prices of agricultural products and the protection of industries will harm agriculturists and other consumers due to high prices encouraged by protection. (xiii) Equalisation of Costs of Production Some protectionists have advocated import duties to equalise the costs of production between foreign and domestic producers and to neutralise any advantage the foreigner may have over the domestic producers in terms of lower taxes, cheaper labour, or other costs. "This argument allegedly implies a spirit of 'fair competition', not the exclusion of imports. When, however, by reason of actual cost structure or artificial measures, costs of production become identical, the very basis of international trade disappears. The logical consequence of this pseudoscientific method is the elimination of trade between nations. Thus, the equalisation of costs of production argument for protection is utterly fallacious and is one of the most deceitful ever advanced in support of protection. (xiv) Strategic Trade Policy Strategic trade policy which advocates protection and government cooperation to certain high-tech industries in the developed countries is somewhat similar to the infant industry argument applied to the developing countries. The argument is that government support should be accorded to gain comparative advantage in the high technology industries which are crucial to the future of the nation such as semiconductors, computers,

telecommunications, etc. It is also argued that State support to certain industries become essential to prevent market monopolisation. For example, outside the former Soviet Union, only three firms build large passenger jets. If European governments do not subsidise the Airbus Industries, only the two American companies, Boeing Company and Mc-Donnell-Douglas Corporation, will remain. The oft cited examples of industries developed with the support of the strategic trade policy include the steel industry in Japan in the 1950s, semiconductors in the 1970s _nd 1980s, and the development of the supersonic aircraft, Concorde, in Europe in the 1970s and the development of the Airbus aircraft in the 1980s. As Salvatore observes, while strategic trade policy can theoretically improve the market outcome in oligopolistic markets subject to extensive economies and increase the nation's growth and welfare, even the originators and popularisers of this theory recognise the serious difficulties in carryingl it out. The following difficult\es are pointed out/ in particular. First, it is extremely difficult to choose the wimiers (i.e. choose the industries that will provide large externaly economies in the future) and devise appropriate policies to successfully n\lrture them. Secondly, since most leading nations undertake strategic trade policies at the same time, their efforts are largely neutralised so that the potential benefits to each may be small. Thirdly, when a country does achieve substantial success with strategic trade policy, this comes at the expense of other countries (i.e., it is a 'beggar-thy-neighbour' policy) and so, other countries are likely to retaliate. DEMERITS OF PROTECTION The following defects are generally attributed to protection: (i) Protection is against the interest of consumers as it increases price and reduces variety and choice. (ii) Protection makes producers and sellers less quality conscious. (iii) It encourages domestic monopolies. (iv) Even inefficient firms may feel secure under protection and it discourages' innovation. (v) Protection leaves the arena open to corruption. (vi) It reduces the volume of foreign trade. (vii) Protection leads to uneconomic utilisation of world's resources, FALL AND RISE OF PROTECTIONISM The period of over two-and-a-half decades until the early 1970s witnessed rapid expansion of the world output and trade. World trade, in fact, grew much faster than the output. After the Second World War, there was a progressive trade liberalisation until the early seventies. Thanks to the efforts of GATT, the "tariff reductions in the industrial countries continued even after this. The average levels of tariff on manufactures in industrial countries is now about 3 per cent compared to 40 per cent in 1947.

Although the period until the early 1970s was characterised by trade liberalisation in general, there were several exceptions. In the developed countries, heavy protection was given to the agricultural sector through import restrictions and domestic subsidies. Further, in manufactured goods, textiles and clothe ing were subject to heavy protection. There was also protection associated with regional trade agreements like the EEC. Imports to developing countries were in general highly restrictive due to reasons such as balance of payments problems and the need to protect infant industries. In the industrial countries, anti dumping and counterveiling duties began to assume more importance since the mid-sixties. The overall trend in the industrial countries, however, was one of liberalisation. This trend was reversed in the seventies. Since about the mid-seventies, protectionism has grown alanllingly in the developed countries. This has taken mainly the fonn of non-tariff barriers (NTBs). The main reason for the growing protectionism in industrialised countries is the increasing competition they face from Japan and developing countries like, for example, the South-East Asian countries. Due to the fact that the competition has been very severe in the case of labour intensive products, the import competing industries in the advanced countries have been facing the threat of large retrenchments. Several other industries, like the automobile industry in the US, have also been facing similar problems. The demand for protection has, therefore, grown in the industrial countries in order to protect employment. Protective measures have also been employed to pressurise Japan and the developing countries to open up their markets for goods, services and investments of the industrial countries. As mentioned earlier, the NTBs affect the exports of developing countries much more than those of the developed ones. In other words, the main target of the developed country import restrictions in the last two decades, or so, has been the developing countries. By 1987, NTBs were estimated to have affected almost a third of OECD imports from developing countries.4 While developing countries as a group now face tariffs .10 per cent higher than the global average, the least developed countries face tariffs 30 per cent higher-because tariffs remain higher on the goods with greatest potential for the poorest countries, such as textiles, leather and agricultural commodities. Labour intensive products like textiles, clothing and footwear are among the most highly protected imports. The restriction on the textiles and clothing, which account for nearly one-fourth of the developing country exports, has been' exercised mainly by the MultiFibre Arrangement (MFA) which denies the developing countries an estimated $ 24 billion a year in terms of export earnings. Tariff escalation (i.e. increase in tariffs with the level of processing) is yet another important factor which discourages developing countries' manufactured goods. For example, while the tariff on raw sugar is less than 2 per cent, it is around 20 per cent for processed sugar products. The tariff escalation discourages the developing countries' graduation as exporters of manufactured goods from commodity exporters. Tariff escalation affects a wide variety of products such as jute, spices, vegetables, vegetable oils, tropical fruits beverages, etc.

As the industrial countries face more competition, they increase protectionism. This encourages one to think that they wanted free trade only as long as they enjoyed a dominant position; when their dominance is challenged they increase the trade barriers giving one or another reason. One should not be surprised if tomorrow they restrict the imports from developing countries arguing that the cost advantage of the developing countries is because of the 'injustice' done to the labour by paying wages lower than that in the US or other industrial countries! Ironically, industrial countries are increasing trade restrictions while the developing countries are liberalising trade. Trade restrictions prove costly not only for the affected exporting country but also for the importing country restricting the trade. The consumers often pay a heavy price for protection. It is estimated that overall the American consumers pay as much as $ 75 billion a year more for goods on account of import fees and restrictions-a sum roughly equivalent to about a sixth of the US import bill. In Canada every dollar earned by workers who continue to hold their jobs because of protection of the textile and clothing industries costs society an estimated $ 70. In the United States, consumers paid $ 1,14,000 a year for each job saved in thc steel industry.7

POINTS TO PONDER: Free Trade Meaning: Free trade refers to the trade that is free from all artificial barriers to trade like tariffs, quantitative restrictions, exchange controls, etc.

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Protection Meaning: Protection, on the other hand, refers to the government policy of according protection to the domestic industries from foreign competition.

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Arguments for Free Trade

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Arguments for Protection

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Demerits of Protection Protection is against the interest of consumers as it increases price and reduces variety and choice. Protection makes producers and sellers less quality conscious. It encourages domestic monopolies. Even inefficient firms may feel secure under protection and it discourages' innovation. Protection leaves the arena open to corruption. It reduces the volume of foreign trade.

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Questions for self assessment: 1. Give a brief and critical account of the arguments for protection. 2. Present your views on protection vs liberal trade in respect of a developing country like India. 3. What are the advantages and disadvantages of free trade for a developing economy? 4. What, in your opinion, is the right trade strategy for India in the emerging international economic environment? 5. Review the trade liberalisation in India and its impact and implications. 6. Write notes on the following: (i) Infant industry argument. (ii) Strategic trade policy. (iii) "When we buy manufactured goods abroad we get the goods and the foreigner gets money. When we buy the manufactured goods at home we get both the goods and the money". Discuss. (iv) Trends in trade liberalisation. SUGGESTED READINGS Ellsworth, P.T. and 1. Clark Leith, The International Economy, London: Macmillan Company. Haberler, Gottfried, The Theory of International Trade, London: William Hodge Co. Johnson, Harry, G., Aspects of the Theory of Tariffs, London: George Allen and Unwin. Salvatore, Dominick, International Economics, New York: Macmillan Publishing Co. Towle, Lawrence, W., International Trade and Commercial Policy, New York: Harper and Bros. Wells, Sidney J., International Economics, London: George Allen and Unwin Ltd.