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Economics of Trade Restrictions

Excerpt from Gaining from International Trade, International Business

Despite the potential benefits from free trade, almost all nations have erected trade barriers. Tariff, quotas, and exchange-rate controls are the most commonly used trade restricting devices.

A tariff is nothing more than a tax on imports from foreign countries. The tariff benefits domestic producers and the government at the expense of consumers. Since they do not pay the tariff, domestic producers will expand their output in respond to the higher (protected) market price. In effect, the tariff acts as a subsidy to domestic producers.

An import quota, like a tariff, is designed to restrict foreign goods and protect domestic industries. A quota places a ceiling on the amount of a product that can be imported during a given period (typically a year). As in the case of tariffs, the primary purpose of quotas is to protect domestic industries from foreign competition.

In many ways, quotas are more harmful than tariffs. With a quota, foreign producers are prohibited from selling additional units regardless of how much lower their costs are relative to those of domestic producers. In contrast to a tariff, a quota brings in no revenue for the government. While a tariff transfer revenue from U.S. consumers to the Treasury, quotas transfer these revenues to foreign producers, who are granted licenses (quotas) to sell various amounts in the U.S. market. Clearly, this right to sell at a

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premium price (since domestic price exceeds the world market price) is extremely valuable. Thus, foreign producers will compete for the permits. They will hire lobbyists, make political contributions, and engage in other rent-seeking activities in an effort to secure the right to sell at a premium price in the U.S. market. AS a result, removal of a quota is often even more difficult to achieve than a tariff reduction.

Some countries fix the exchange-rate value of their currency above the market rate and impose restrictions on exchange-rate transactions. At the official exchange-rate, the countrys export goods will be extremely expensive to foreigners. As a result, foreigners will purchase goods elsewhere, and the countrys exports will be small. In turn, the low level of exports will make it difficult for domestic residents to obtain the foreign currency required for the purchase of imports. Such exchange-rate controls both reduce the volume of trade and lead to black-market currency exchanges. In deed, a large blackmarket premium indicates that the countrys exchange-rate policy is substantially limiting the ability of its citizens to trade with foreigners. While exchange-rate controls have declined in popularity, they are still an important trade barrier in many less-developed countries.

Why do nations adopt trade restrictions? There are three major arguments for protecting certain domestic industries from foreign competitors: national-defense, infant-industry, and anti-dumping arguments.

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According to the national-defense argument, certain industriesaircraft, petroleum, and weapons, for exampleare vital to national-defense and therefore should be protected from foreign competitors so that a domestic supply of necessary materials would be available in case of an international conflict.

Advocates of the infant-industry argument hold that new domestic industries should be protected from older, established foreign competitors. As the new industry matures, it will be bale to stand on its own feet and compete effectively with foreign producers, at which time protection can be removed.

Dumping involves the sale of goods by a foreign firm at a price below cost or below the price charged in the firms home-base market. Dumping is illegal and if a domestic industry is harmed, current law provides relief in the form of anti-dumping duties (tariffs imposed against violators).

English in Foreign Trade