Economics Grade $$12$$: Protectionism and Free Trade

Key Terminology in International Trade

• Export promotion: Refers to specific measures taken by the government to increase both the quantity and the variety of goods and services that are exported to other countries.
• Import substitution: Involves measures undertaken by the government to replace goods that were formerly imported with locally produced goods and services.
• Dumping: The practice of selling goods in a foreign market at a price lower than the cost of production in the country of origin.
• Embargo: An official government ban on trade with a particular country.
• Sanction: A penalty imposed by one or more countries upon another country, often for political or economic reasons.

Fundamentals of Export Promotion

• Core Concept: Export promotion involves providing incentives to encourage local businesses to produce goods specifically for export. It is an outward-looking policy focused on international competitiveness and expanding the presence of local businesses in foreign markets.
• Primary Objectives and Reasons:
  • Economic Growth: It aims to achieve significant export-driven economic growth.
  • Productive Capacity: The policy improves a country's productive capacity by leading to the establishment of new businesses and enlarging existing production capabilities.
  • Scale and Employment: Since export markets are significantly larger than local markets, large-scale production takes place. This mass production leads to job creation and provides opportunities for economies of scale, specialization, and division of labor.
  • International Competitiveness: Mass production results in a lower cost per unit, allowing local producers to be more competitive in international markets.
  • Resource Optimization: It ensures the optimal use of resources, particularly in the refining and processing of natural resources.
  • Industrial Performance: It serves as a catalyst for improving the performance of both manufacturing and service industries.

Methods and Approaches of Export Promotion

Export promotion is facilitated through direct and indirect subsidies, incentives, and trade neutrality.

Direct Subsidies

• Definition: A payment made to domestic producers who export their goods abroad. These are described as direct because they result in actual government expenditure.
• Mechanism: These are often cash grants paid as financial support to increase production levels.
• Impact: Directly subsidized businesses can produce at a lower cost, explore new overseas markets, and increase their international competitiveness.

Indirect Subsidies

Indirect subsidies do not result in direct government expenditure but involve exemptions or discounts given to exporting firms. Their effect is similar to direct subsidies as they allow firms to increase capacity at a lower cost.

• Tax Rebates: Tax refunds provided to exporting businesses based on a portion of the taxation they have already paid, which is then redirected toward production for foreign markets.
• Tax Exemptions (Concessions): Tax discounts provided on the profits earned by exporting businesses to support increased production.
• Refunding on Import Tariffs: Companies that use imported machinery or equipment to produce goods for export are refunded the import duties (tariffs) paid on that equipment.
• Government Surety: An interest rate discount formal agreement between an exporting business, the government, and a commercial bank. Capital is provided at a lower interest rate to the business at the expense of the government.
• Trade Neutrality: These are subsidies paid by the government to local exporters that are equal in value to the import duties imposed on them. This reduces the producer's costs and increases productive capacity.

Incentives and Support Programs

• Purpose: To improve producer efficiency and enable exporters to ship a greater volume of domestic goods, thereby driving economic growth.
• Export Market and Investment Assistance (EMIA): A government-formed program specifically designed to promote the export of South African products and encourage foreign investment.
• Department of Trade, Industry and Competition (DTIC): This department pays for various benefits extended to exporters.
• Specific Benefits Provided:
  • Free advisory schemes and business intelligence.
  • Provision of information on export markets free of charge.
  • Conducting research on new markets on behalf of local exporters.
  • Provision of cheap freights, low-cost storage, and subsidized marketing and advertising.
  • Concessions on transport charges (e.g., transport from the interior to harbors) to reduce the cost burden.
  • Export credit and export credit guarantees to facilitate access to required capital.

Advantages and Disadvantages of Export Promotion

Advantages

• Market Expansion: Allows producers to supply large international markets, creating opportunities for mass production.
• Reduced Unemployment: Increased productive capacity raises the demand for labor, serving as a mechanism for poverty alleviation and increasing government tax revenue via income and consumer spending.
• Price Reduction: Economies of scale achieved through larger markets lead to lower prices, increasing the standard of living as consumers can buy more with their income.
• Currency Stabilization: Exporting earns foreign currency, creating an inflow (injection) into the economy. As foreign currencies are exchanged for the Rand, the value of the domestic currency increases.
• Balance of Payments (BoP) Improvement: High levels of exports reduce trade deficits in the current account, helping to resolve balance of payment disequilibrium.
• Economic Diversification: Incentives attract new businesses, leading to a wider variety of goods produced locally.

Disadvantages

• Price Distortion: Subsidies make goods appear cheaper than their actual production cost, meaning prices do not reflect true economic costs. This can lead to state intervention focusing on international relations rather than profit maximization.
• Price Wars: If foreign competitors are not subsidized, unfair competition occurs, which can lead to price wars that drive competitors out of the market and reduce consumer choice.
• Dumping Allegations: Local exports might be viewed as dumping in foreign markets. This can lead to retaliation through high tariffs according to World Trade Organisation (WTO) provisions.
• Market Dependency: Local firms may become overly dependent on government support and may fail to survive if subsidies are withdrawn.
• Production Inefficiency: Incentives can lead to complacency, causing producers to lose the drive for creativity and innovation in cutting costs.
• Retaliation: Foreign governments may retaliate by imposing their own tariffs and quotas, eroding the spirit of free trade.

Fundamentals of Import Substitution

• Definition: The replacement of previously imported goods with locally manufactured goods and services. It is a key part of South African international trade policy.
• Forms of Import Substitution:
  • Forced: Occurs when a country is sanctioned or excluded from international trade and must produce goods internally to survive.
  • Voluntary: Occurs when a country chooses to improve its own industrial base by producing goods that were previously imported.
• Reasons for Implementation:
  • Diversification: Reduces reliance on foreign countries by expanding domestic manufacturing.
  • Industrialization: Develops new industries, increases tax revenues, and creates jobs.
  • BoP Correction: Helps rectify high deficits on the Balance of Payments by decreasing the outflow of money for imports.
  • Resource Utilization: Encourages using domestic natural resources to produce goods for local consumption rather than just relying on raw resource exports.

Methods of Import Substitution

Tariffs and Quotas

• Tariffs (Import duties, excise duties, or import taxes): Taxes on imported goods designed to protect local producers, provide government revenue, and discourage imports by making them more expensive. Types include:
  • Specific tariffs.
  • Ad valorem tariffs.
  • Composite tariffs.
• Import Quotas: Physical limits on the quantity of a good that can be imported to reduce foreign supply and influence the price of imported goods. These can be general or discriminatory.

Controls and Trade Diversion

• Foreign Exchange Control: The central bank rations foreign currency. Without access to foreign exchange, importers cannot purchase goods from the rest of the world.
• Trade Diversion Measures:
  • Import Deposits: Requiring importers to make a cash deposit equal to a fixed percentage of the value of ordered goods.
  • Administrative Obstacles: Using time-consuming paperwork, customs delays, and certificate delays to discourage importing.
  • Quality Standards: Imposing high health, safety, environmental, or copyright standards that act as protective measures if domestic producers are exempted.
• Physical Control: Imposing a complete trade embargo or ban on certain goods due to quality concerns or societal harm.

Advantages and Disadvantages of Import Substitution

Advantages

• Employment: Increased local production creates demand for labor.
• BoP Improvement: Reduces leakages from the economy as money stays within the country.
• Independence: Promotes self-sufficiency and reduces dependence on other nations.
• Economic Diversity: Encourages the establishment of new businesses and increases the variety of locally produced goods.
• Ease of Implementation: Measures like tariffs and quotas are relatively simple to execute.

Disadvantages

• Capital Constraints: Emerging economies like South Africa are often capital-poor and rely on imported machinery. Import substitution may increase the need for imported capital goods even as it reduces consumer good imports.
• Isolation: Protection from international competition can make local businesses unable to compete on a global scale.
• Higher Costs: Lack of competition often leads to inefficiency, resulting in higher prices and lower quality for local consumers.
• Retaliation: Other countries may respond with bans, sanctions, or tariffs on South African exports.
• Inefficient Production: Dependency on government protection decreases the drive for efficiency and innovation.

The Desirable Mix: Protectionism and Free Trade

• Relationship: Import substitution and export promotion are not opposites. Historiography shows many industrialized countries used import substitution initially to protect domestic industries before transitioning to export-oriented policies.
• Dual Strategy: A country can combine both strategies. However, evidence suggests countries focused on export promotion have recently outperformed those focused strictly on import substitution.
• Trade Protocols: These are agreements that set the rules of trade. They increase trade volume while simultaneously restricting it through established rules.
• Trade Blocs: These utilize both free trade (among members) and protectionism (against non-members).

Levels of Economic Integration

• Economic Cooperation: Combined action by two or more governments to promote mutual interests.
• Economic Integration: The removal of trade barriers to allow the free flow of goods, services, and factors of production.
• Stages of Integration:
  • Free Trade Areas: Members remove restrictions among themselves but set their own policies for non-members.
  • Customs Union: Members remove restrictions among themselves and apply a common set of restrictions against non-members.
  • Common Market: A customs union that also allows the free movement of labor, capital, and money. People can live and work anywhere within the market borders.
  • Economic and Monetary Union: The highest level where members adopt a single currency, a single central bank, a common monetary policy (e.g., interest rates), and uniform fiscal/tax policies.

Questions & Discussion

Impact of Trade on the Economy

• Export Promotion and BoP: It increases export volume and foreign currency inflow. If exports grow faster than imports, trade deficits are reduced.
• Increase in Imports: Rising imports cause trade deficits, distort the balance of trade, and can devalue the national currency.

Impact of Export Promotion on Local South African Industries

• Positive Impacts:
  • Access to larger markets leads to more income.
  • Benefits from economies of scale due to high-quantity production.
  • Minimized average production costs allow for competitive international pricing.
  • Government incentives (e.g., transport concessions) increase profit margins.
  • Encourages innovation to maintain a competitive advantage.
• Negative Impacts:
  • Financial incentives may decrease the drive for creative efficiency.
  • Subsidies create a false sense of security by distorting the actual cost of production.
  • Businesses without financial support struggle to compete.
  • Retaliation from foreign countries through tariffs and quotas can close off markets.

Evaluation of South African Trade Policy (Import Substitution)

Successes

• Industrial Growth: Promoted the initiation of local industries and redirected resources toward domestic production.
• Capital Formation: Increased profits positively impacted savings and investment.
• Employment: Bolstered industrialization in labor-intensive sectors using modern technology.
• Stability: Increased resilience to global economic shocks.
• Urbanization: Expanded industries to meet increased demand for local goods.

Failures

• Efficiency: Lack of external competition negatively affected the growth and efficiency of infant industries.
• Market Distortions: Failed to meet some domestic needs, leading to the emergence of black (illegal) markets.
• Financial Strain: Forced the government to spend heavily on subsidies, leading to inflation.
• Drain on Talent: Capital and entrepreneurial talent often migrate toward countries with a comparative advantage.
• Import Persistence: Total imports were not significantly reduced because the country still needs to import specialized products, intermediate goods, and capital (loans) to produce locally.

Essay Component Specifics

• Introduction: Export promotion is the use of incentives and subsidies to encourage domestic manufacturers to increase their productivity to sell into foreign markets ($2\,marks$).
• Conclusion: Given the negative impacts of free trade, it is critical to protect smaller developing economies against uneven competition from developed economies ($2\,marks$).
• Scoring Metrics:
  • Main Body: Reasons, methods, and disadvantages ($26\,marks$).
  • Additional Part: Evaluation of success ($10\,marks$).
  • Discussion Questions ($8\,marks$).