4.4 Trade policies and negotiation

Protectionism

Measures taken by a country to restrict international trade

Trading bloc

Where a group of countries in a region agree to cooperate in international trade through some sort of free trade area or other form of association 

Tariffs

A tax imposed on imported goods

Quotas

An agreement by a country to limit its exports to another country to a given quantity 

Trade creation

The replacement of more expensive domestic production or imports with cheaper output from a partner within the trading bloc 

Trade diversion

The replacement of cheaper imported goods by goods from a less efficient trading partner within a bloc

World Trade Organisation

A multilateral body now responsible for overseeing the conduct of international trade

Economic integration

The process by which the economies of different countries become more closely linked, e.g. through free trade agreements or common currencies. 

Free Trade Area

A group of countries that agree to remove tariffs, quotas and other restrictions on trade between the member countries, but have no agreement on a common barrier against non-members

Customs Union

A group of countries that agree to remove restrictions on trade between the member countries, and set a common set of restrictions (including tariffs) against non-member states e.g European Union

Common market

A set of trading arrangements in which a group of countries remove barriers to trade among them, including adopting a common set of barriers against external trade and allowing free movement of factors of production 

Monetary union

A situation in which countries adopt a common currency 

Economic union

A set of trading arrangements the same as for a common market, but in addition having a common currency (or permanently fixed exchange rates between the member countries) and a common monetary policy

Reasons for protectionism

-Protect infant industries

-Employment protection

-Raising tax revenues for government

-Response to chronic trade deficit

-Response to export ‘dumping’

-Environmental reasons

Arguments against protectionism

-Risk of retaliation

-Higher prices for consumers

-Regressive effect on income inequality

-Higher cost of production for firms which import resources (cost-push inflation)

-Potential creation of a shadow market

-Barrier to entering market reduces contestability and increases monopoly power

Advantages of free trade

-Firms can exploit economies of scale

-Lower prices for consumers

-Increased choice for consumers

-Increased competition encourages more innovation

Disadvantages of free trade

-Vulnerability to external shocks if overly dependant on imports

-Structural unemployment

-Environmental impact

-Income inequality

Tariff diagram

-Import tariffs are a form of protectionism

-Tariffs aim to protect domestic industries from overseas competition by increasing the relative price of imports, thereby causing a fall in import demand.

-Thus a higher proportion of domestic demand will be met from domestic suppliers

-Tariffs can also generate tax revenues for the governments who levy tariffs. Indeed for many developing countries, import tariffs are an important source of tax revenues

-A reduction in the quantity of imports as a result of the import tariff may also improve a nation’s trade balance

Quota diagram

-A quota places a quantity limit on the volume of imports of a product that can come into a country

-The quota has an indirect effect on market price by creating an artificial scarcity

-A quota caps the volume or quantity of imports

-The effect of a quota is to create excess demand for imports for a given level of domestic demand

-The quota therefore pushes up the market price

-The higher market price incentivizes domestic producers to increase their supply / enter the market

-Domestic supply + the quota is the new domestic supply curve

Impact of import quota on firms

Domestic producers benefit from the cap on imports – increases the market price and makes it more profitable for them to stay in / enter the market

Quota is a barrier to trade, might encourage domestic firms to become less productively efficient

Some producers affected by scarce supply of higher quality overseas imports used in their production process – hurts their competitiveness

Impact of import quota on consumers

Consumers likely to face a higher price in the market because of limit on import products. Less competition in the market might also affect the quality of products available – impact on utility 

Consumers who work for domestic firms may benefit from higher employment

Impact of import quota on government

Improved balance of payments from the reduction in imports and an expansion of GDP from the increase in domestic production

No immediate tax revenues from an import quota - a contrast with an import tariff

Non-tariff barriers

-Intellectual property laws e.g. patents

-Technical barriers to trade including labelling rules and sanitary standards

-Preferential state procurement policies – where government favour local producers when finalizing contracts for state spending e.g. infrastructure projects or purchasing new defence equipment

-Domestic subsidies – government help for domestic businesses

-Financial protectionism – e.g. when a government instructs banks to give priority when making loans to domestic businesses

-Managed exchange rates – government intervention in currency markets to affect relative prices of imports and exports