Trade Policies and Protectionism

Tariffs, Quotas, Embargoes, and More!

Hi All,

Welcome to this week’s edition of A-Level Economics Weekly.

Our focus is on Trade Policies and Protectionism, a topic that highlights the tension between the efficiency gains of free trade and the strategic role of government intervention in managing trade flows. Understanding protectionism is vital not only for exams but also for developing a nuanced perspective on current economic debates, from Brexit to the US-China trade war.

In this edition, we’ll delve into:

1. Why countries turn to protectionist measures.

2. The various forms of protectionism, including tariffs, quotas, and subsidies.

3. The economic, social, and political consequences of these policies.

4. How to construct high-level evaluation points for essays and exams.

By the end, you’ll have a thorough understanding of protectionism’s mechanics and its trade-offs, ready to tackle any essay question or class discussion with confidence.

---

Why Do Countries Use Protectionist Policies?

Protectionism is often adopted to address challenges posed by global trade. While the principle of comparative advantage suggests that specialisation and free trade lead to greater global efficiency, the real world introduces complications. Here are the primary reasons countries adopt protectionist policies:

1. Safeguarding Domestic Industries:
   Many governments use protectionist policies to protect domestic industries from foreign competition. This is particularly true for:

   • Infant industries, which lack the economies of scale to compete globally. Temporary measures, such as tariffs or subsidies, provide these industries with breathing space to grow and become competitive.

   • Strategic industries, such as defence or energy production, which are deemed too important to be dependent on foreign suppliers.

2. Addressing Unemployment:
   In sectors facing heavy foreign competition, such as steel or textiles, protectionist measures can prevent job losses. This is particularly important in regions where such industries dominate the local economy.

3. Correcting Trade Imbalances:
   Persistent trade deficits—where imports exceed exports—can lead to a depletion of foreign currency reserves and increased national debt. By restricting imports, protectionism can help narrow the trade deficit and stabilise the domestic economy.

4. Preventing Dumping:
   Dumping occurs when foreign firms sell goods below their production costs to gain market share, often driving domestic competitors out of business. Anti-dumping tariffs level the playing field, ensuring fair competition.

5. Political and Strategic Reasons:
   Protectionism can also be used as a tool of diplomacy or economic coercion. For example, sanctions and trade restrictions can be applied to pressure rival nations or achieve political goals.

---

Forms of Protectionism

Protectionism takes many forms, each with its own implications for consumers, producers, and governments. Let’s explore the most common methods:

1. Tariffs:
   Tariffs are taxes on imports that raise the price of foreign goods, making them less competitive compared to domestic alternatives. While tariffs protect domestic industries and generate government revenue, they also lead to higher prices for consumers and potential retaliation from trading partners.

2. Quotas:
   Quotas restrict the quantity of a good that can be imported. Unlike tariffs, quotas do not generate revenue but still limit competition for domestic producers. For example, the EU’s Common Agricultural Policy imposes quotas on agricultural imports to protect European farmers.

3. Subsidies:
   Governments may provide financial assistance to domestic producers, reducing their costs and making them more competitive internationally. For instance, the UK has provided subsidies to its renewable energy sector to foster growth and innovation.

4. Administrative Barriers:
   Bureaucratic hurdles, such as stringent safety standards or complex customs procedures, can act as non-tariff barriers, discouraging imports. These measures are often justified on grounds of protecting public health or the environment but can also be used strategically.

5. Exchange Rate Manipulation:
   By devaluing their currency, countries make exports cheaper and imports more expensive. This form of protectionism has been a contentious issue, particularly in the US-China trade relationship.

6. Embargoes and Sanctions:
   These are extreme forms of protectionism, often used for political purposes. For instance, the US embargo on Cuba aimed to isolate the Cuban economy for decades.

---

Tariffs in More Detail

Among all the protectionist measures, tariffs stand out as the most widely used and significant tool for governments seeking to influence trade. A tariff is essentially a tax imposed on imported goods, designed to make them more expensive than domestically produced alternatives. This price adjustment encourages consumers to purchase local products, shielding domestic industries from foreign competition.

The diagram included below illustrates the effects of a tariff on the market for a good. Let’s break it down step by step:

Understanding the Diagram

1. Pre-Tariff Market:

   • Without a tariff, the supply curve of imports is denoted as S (no tariff).

   • At the world price of £1.20, domestic producers supply 20 million units, while the remaining demand (from 20 to 60 million units) is met by imports.

2. Imposing a Tariff:

   • A tariff increases the price of imported goods, shifting the supply curve to S + Tariff.

   • The new price rises to £1.60, reducing the quantity of imports and increasing domestic production.

3. Impact on Stakeholders:

   • Domestic Producers: Benefiting from higher prices, they increase output from 20 million to 30 million units.

   • Foreign Exporters: Suffer as imports fall from 50 million to 20 million units.

   • Consumers: Pay a higher price (£1.60 instead of £1.20), reducing their overall welfare.

Economic Effects of a Tariff

1. Government Revenue:
   The shaded area between £1.20 and £1.60 in the diagram represents the revenue generated by the government. This is calculated as the tariff per unit (£0.40) multiplied by the quantity of imports (20 million units). Tariffs can thus provide a significant source of revenue, particularly in developing countries.

2. Deadweight Loss:
   Tariffs introduce inefficiencies into the market. The triangular areas on either side of the government revenue represent the deadweight loss—the reduction in total economic welfare due to higher prices and reduced trade volumes.

3. Redistribution of Wealth:

   • Domestic producers gain from the higher prices, while consumers bear the cost.

   • This redistribution often disproportionately affects low-income households, as they spend a larger share of their income on goods impacted by tariffs.

4. Global Implications:

   • Tariffs can trigger retaliation from trading partners, escalating into trade wars.

   • They disrupt global supply chains, particularly in industries like automotive manufacturing, where parts are sourced internationally.

Why Are Tariffs So Popular?

Despite their drawbacks, tariffs remain the most frequently used form of protectionism due to their simplicity and effectiveness in achieving short-term goals:

1. Political Appeal:
   Tariffs are often politically popular as they are seen to "protect jobs" and "support local businesses." This makes them a go-to tool during election cycles or in times of economic uncertainty.

2. Flexibility:
   Tariffs can be adjusted relatively quickly compared to other policies, allowing governments to respond to economic shocks or geopolitical tensions.

3. Revenue Generation:
   For many developing countries, tariffs provide a vital source of government funding, especially when other forms of taxation are difficult to implement.

By analysing the effects of tariffs in detail, as shown in the included diagram, we gain a clearer understanding of why they are the cornerstone of protectionist policy. While they achieve the immediate goal of shielding domestic industries, the broader economic consequences—higher consumer prices, reduced global trade, and deadweight loss—highlight the trade-offs inherent in such measures.

---

Consequences of Protectionism

Protectionist policies have far-reaching implications for all stakeholders in the economy:

1. For Consumers:
   Protectionism often leads to higher prices, as tariffs or quotas limit access to cheaper foreign goods. Consumers face reduced choice and a decline in their overall welfare.

2. For Domestic Producers:
   In the short term, protectionist policies shield domestic industries from competition, boosting profits and employment. However, in the long term, these measures can reduce incentives for innovation and efficiency, leading to stagnation.

3. For Governments:
   While tariffs generate revenue and subsidies support key industries, these measures can also strain public finances and provoke retaliation from trading partners, escalating into trade wars.

4. For the Global Economy:
   Protectionism disrupts global supply chains, increases costs, and reduces trade volumes. During the Great Depression, the Smoot-Hawley Tariff Act of 1930 triggered a wave of retaliatory tariffs, deepening the global economic crisis.

5. For Equity:
   Protectionist policies can disproportionately affect lower-income households, as they spend a larger share of their income on goods that become more expensive due to tariffs.

---

Evaluation Points

To write high-quality essays on protectionism, it’s important to present balanced arguments. Consider these points:

• Dynamic Effects: While protectionism may address short-term goals, such as preserving jobs, it often hampers long-term growth by reducing competition and efficiency.

• Impact on Developing Economies: Protectionism in developed countries (e.g., agricultural subsidies in the EU) often harms producers in developing nations who cannot compete on a level playing field.

• Alternatives to Protectionism: Supply-side policies, such as investment in education and infrastructure, may achieve similar objectives without distorting trade.

• Political Considerations: Protectionism is often politically popular, especially in election cycles, as it appeals to workers in struggling industries. However, its economic costs may outweigh its benefits.

---

Looking Ahead

Next week, we’ll dive into Exchange Rate Policies, exploring how countries manage their currencies to influence trade and economic stability. This topic builds directly on this week’s discussion, helping you connect the dots between trade, protectionism, and monetary policy.

---

Best,
Sam

A-Level Economics Weekly

p.s. here’s the link to my A-Level Economics flashcards, if you’re interested: https://www.brainscape.com/packs/aqa-a-level-economics-year-2-19107711