4.1.6 Restrictions on Free Trade

• Protectionism


  The act of guarding a country's industries from foreign competition, by imposing restrictions on free trade
• A country employs several protectionist measures

  Trade deficit would reduce
• Infant industries


  • Relatively new and need support
  • Protectionism is usually short term until the industry develops, at which point the industry can trade freely
  • Based on the concept of new industries facing high start-up costs, which fall as the industry develops
• Purpose of protectionism


  To help the industry survive by providing support
• Protectionism


  • Can be used to correct market failure
  • Can deal with demerit goods and protect society from them
• Reasons for protectionism


  • Protect domestic jobs and avoid them being offshored
  • Retaliation against trade barriers imposed by other countries
• Types of restrictions on trade

  • Tariffs
  • Quotas
  • Subsidies to domestic producers
  • Voluntary export restraints (VERs)
  • Embargoes
  • Excessive administrative burdens ('red tape')
• Tariffs


  Taxes on imports to a country
• Tariffs


  Quantity demanded of domestic goods increases, whilst the quantity demanded of imports decreases
• Tariffs


  Result in higher prices for consumers and a loss in consumer surplus
• Quotas


  Limit the quantity of a foreign produced good that is sold on the domestic market
• Quotas


  Lead to a rise in the price of the good for domestic consumers, so they become worse off
• Subsidies to domestic producers

  Makes domestic goods relatively cheap compared to imports
• Subsidies to domestic producers

  Encourages domestic production to increase, as shown by a right shift in the supply curve, and the average price falls
• Voluntary export restraints (VERs)

  When two countries make an agreement to limit the volume of exports to one another over a period of time
• Embargoes


  The complete ban on trade with a particular country
• Excessive administrative burdens ('red tape')

  Increases the cost of trading, and hence discourages imports
• Impact of protectionist policies

  • Distort the market and lead to a loss of allocative efficiency
  • Prevent industries from competing in a competitive market and there is a loss of consumer welfare
  • Consumers face higher prices and less variety
  • Firms have little or no incentive to lower their costs of production
  • Impose an extra cost on exporters, which could lower output and damage the economy
  • Tariffs are regressive and are most damaging to those on low and fixed incomes, which could increase income and wealth inequality
  • Taxes could raise more revenue for the government, which could be used to redistribute income to the poor or improve public services
  • Risk of retaliation from other countries, so countries might become hostile
  • Could lead to government failure