Unit 4: The Global Economy

Arguments for protectionism

1) Protection of infant industries (An argument usually used by LEDCs)

Industries that are in their early stages need time to grow and enjoy economies of scale. When such industries are faced with competition from more efficient firms abroad, they may not be able to compete and may have to close down. Hence, governments should protect infant industries from foreign competition. However, the long lasting support given by the government to the infant industries may lower the efficiency of the firms and cause resource misallocation.

2) National security (An argument usually used by MEDCs)

When a country imports most of its goods from other countries, it faces a high risk in the case of war as it can’t produce its own weapons and food. Therefore, the government should protect industries such as aerospace, food and national defence for strategic reasons. E.g. The government protects industries of strategic importance to the economy thereby reducing the economy’s reliance on other countries’ provisions.

3) Protection of domestic jobs

Domestic firms face more competition from foreign firms with free trade. As a result, demand for local products drops, forcing domestic firms to shut down. This causes unemployment and the domestic government might intervene to protect local jobs and industries. If the domestic products are more expensive than imports because of higher production costs, we have to understand the reason for higher production cost. If domestic products are with higher quality (though higher cost at the same time), it may not have to fear competition from imports. However, if the higher cost is due to production inefficiency by domestic firms, then this means the country could have obtained goods overseas with lower prices, so production by other countries should be done for a more efficient resource allocation.

4) The maintenance of health, safety and environmental standards

Trade barriers are set to ensure the imports pass the health and safety standards so that citizens gain access to safe products. Firms often argue that it is unfair to directly compete with countries producing products at a lower environmental standard, as firms may need to exploit the environment to lower production costs thereby becoming more competitive.

However, these standards often become a pretext for developed countries to impose protectionist measures on goods from developing countries.

5) Anti-dumping and unfair competition

Dumping is when firms sell products overseas at a price lower than the average cost or domestic prices, i.e. selling less than the ‘fair value’. The WTO allows countries to act against dumping when dumping causes a loss to domestic firms. However, it is hard to prove dumping takes place. The government has to calculate the extent of dumping and show that dumping is causing a loss to the domestic economy.

6) Reducing the balance of payments deficits

Protectionist measures aim to reduce import volume and spending, hence making it possible to reduce the balance of payments deficits so that foreign reserves need not be depleted. However, if trading partners retaliate, the amount of exports will be lower, and the effect on trade deficit is uncertain.

7) A source of government revenue

To many developing countries, tariffs are an important source of revenue as their tax systems are usually less effective and informal sectors are usually large.

8) Economically less developed country (LEDC) diversification

Governments of LEDCs might want to limit over-specialisation as it means that their countries might become over-dependent on the export of only a few products, meaning that changes in the world markets for those products would have serious consequences for the country’s economy.

Developing countries tend to specialise in the production of primary products, leading to issues when new products are introduced. For example, the invention of synthetic rubber had a negative effect on Malaysia’s economy, which was dependent on the export of rubber.

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Arguments against protectionism

1) Misallocation of resources

Local firms face less competition and have lower incentives to be efficient under protection by the government. This lowers productive efficiency. In addition, the imposition of protectionist measures result in a deadweight loss to society, causing resource misallocation.

2) Danger of retaliation

Imposition of protectionist measures may trigger retaliation from trading partners by implementing similar measures. Both countries face a cut in the demand for their exports and both countries lose. However, it might be hard for LEDCs to retaliate by granting subsidies on export industries as they lack the funds to do so.

3) Higher prices for consumers

Consumers have to pay a higher price for imports that can be obtained with lower prices; this may lower the quantity and quality of goods and services they enjoy and lower their standard of living.

4) Increased costs of production

Firms have to pay a higher price for imported raw materials and this raises the production cost. There is pressure for inflation. If the firms are engaged in export-oriented business, a higher price also reduces export competitiveness. The export sectors may also be hurt.

5) Less choice

Protectionism limits consumers’ choices, as they are limited to goods that are produced domestically and cannot import goods from abroad. For example, around 12% of the UK’s imports in 2020 are computers, which consumers would not be able to get without free trade.

6) Domestic firms lack the incentive to become more efficient

When domestic firms are shielded from competition from abroad by protectionism, they have less of an incentive to become more efficient. They therefore do not reduce costs, and may also reduce innovation.

7) Reduced export competitiveness

This lack of incentive to improve efficiency may also lead to firms becoming less competitive in the export market, as the prices of those firms’ goods will be higher than those of their international competitors.