PPT - Free Trade & Protection

The concepts of absolute and comparative advantage, including the sources of comparative advantage

Comparative Advantage

• Countries gain from trade when they produce (specialise in) goods and services for which they have a comparative advantage
  • Comparative Advantage has lower opportunity cost and is concerned with what can be done with the resource endowment

Competitive Advantage

• Producers develop an advantage over their competitors in international markets
• Concerned with advantages created, not given
• Contributions:
  • Comparative Advantage
  • Free Trade
  • Foreign Investment
  • Workforce
  • Non-price competitiveness
  • Strong institutions
• Detractions
  • AUD
  • Regulated economy
  • High direct taxes
  • Labour supply
  • High wages and low productivity
  • Lack of economies of scale

The gains from specialisation and trade using the demand and supply model, the Production Possibility Frontier (PPF) model and the concept of opportunity cost

Meaning of Free Trade

• The absence of government intervention of any kind in international trade, so that trade takes place without any restrictions (or barriers) between individuals or firms in different countries
  • Protectionism is the opposite of free trade

Specialisation

• Occurs when an individual, firm, or country concentrates production one one or a few goods and services
  • Countries that do not trade cannot specialise as they must produce all goods and services
  • Specialisation is possible because of the uneven distribution and quality of resources between nations
  • Differences in the distribution of resources in terms of quantity and quality will affect the cost of supplying goods a

Absolute Advantage

• A country is said to have an absolute advantage in the production of a good or service if it can produce a greater quantity of that good with the same quantity of inputs
  • According to the theory of absolute advantage, if countries specialise in and export the good in which they have an absolute advantage, the result is increased production and consumption in each country
  • However there are some assumptions of the theory
    1. The world consists of two countries
    2. Each country produces and consumes 2 goods
    3. Resources are perfectly mobile - they can be shifted between industries with no displacement cost
    4. Transport costs are not considered

Demand & Supply Model

• The demand and supply model may be used to determine the relative price of a good which is the same as opportunity cost
• By comparing the domestic price of a good with the world price we can determine whether a country has a comparative advantage
• If the domestic price is lower than the world price, then the country must be relatively more efficient at producing this good

The benefits of trade liberalisation

• Free Trade refers to the absence of government intervention of any kind in international trade, so that trade takes place without any restrictions (barriers) between individuals or firms in different countries

The Benefits

1. Economic Growth: increase real incomes and living standards
2. Efficiency: increases efficiency through greater competition
3. Productivity: increases productivity through efficient resource allocation
4. Consumer Gain: consumers gain through lower prices and increased market access
5. Domestic Producers: domestic producers gain through lower input prices as they can import
6. Economies of scale: enable greater specialisation which allows economies of scale

Types of protection, including tariffs, subsidies, quotas

• Trade Protection involves government intervention in international trade through the imposition of trade restrictions (barriers) to prevent the free entry of imports into a country or to protect the domestic economy from foreign competition

• Three Types

  • Those that increase the domestic price of a foreign product, such as a tariff
  • Those that provide domestic producers with a cost advantage, such as a subsidy
  • Those that impose a quantitative restriction on imports, such as a quota

Tariffs

• A tariff is a tax that is imposed on imported good
• Consumers' loss more than offsets the gain to producers and the government.
  • The higher the tariff, the greater the protection afforded to the domestic producers since imports would contract which domestic production would increase
  • If a tariff is increased to the equilibrium, then tax revenue falls to zero as the domestic industry is completely protected (Q3-4 is ZERO)

Subsidies

• No adverse effects to consumers - they pay the same price and purchase the same quantity of the good
  • This is why subsidies may be preferred to tariffs
  • However consumers pay an indirect burden due to the subsidy being paid through government tax revenue
• Because of area ABC causing a deadweight loss, there is still a welfare loss to society.
  • Thus there is still an invisible loss
• Sample Paragraph
  • A subsidy is a payment from the government to producers to decrease the cost of production of a good. In Scenario X, the subsidy has increased supply from Sd to Ss. The world price for Good X is indicated at W where imports (which are perfectly elastic) are at W. Quantity consumed is at Q2, and Quantity produced domestically is at Q1. Thus imports are between Q1 and Q2. With the introduction of the subsidy, quantity produced domestically has increased to Q3 and so imports have decreased (as consumption is constant at Q2). Area A + B is the cost of the subsidy, and area A only is the increase in producer surplus as a result of the subsidy. This means B is a deadweight loss that has introduced inefficiency in the market. There are no adverse effects on consumers as price is constant, though they pay an indirect price/burden through the fact that their taxes are used on the subsidy - money which could be used elsewhere.

Arguments for protection

• Protection refers to any action by the government designed to give the domestic producer an artificial advantage over a foreign producer
  • It seeks to increase domestic production in the industries and decrease the consumption of imported goods and services
  • Those that benefit form the protection include the owners and workers in the protected industries and sometimes the government in the case of tariff revenue
  • Protection does, however, impose a cost/burden on the economy
    • The industries given protection will expand their use of resources that could be used in other sectors of the economy
  • Production in non-protected industries will fall
  • Consumers are also disadvantaged since they will have to pay higher prices for both domestic and imported goods and the quantity of goods they consume will also decrease
  • that is, the losses from protection always outweigh the gains

Arguments

• Anti-Dumping Argument - where a producer/nation produces and then dumps a product in another nation's market - at a price which is lower than the cost of production
  • this drives the domestic producer out and allows the foreign producer to actually make money
  • Also the product could be illegal in the country of production
• Infant industry Argument
  • Infant/undeveloped industries have higher costs, so they may be protected
    • Mature foreign firms are able to sell at lower prices so infant industries are priced out
  • This is considered one of the strongest arguments for protection
  • Protection must be temporary
• Diversification Argument
  • If you specialise you are putting your eggs in one basket - if the industry is destroyed, there are massive impacts
    • this often applies to developing countries such as Cuba with sugar/bananas
• Strategic trade policy
  • Closely related to infant industry
  • Argument calls for protection of high technology industries to help them achieve economies of scale
    • It is argued that these industries (semiconductors, etc.) are always growing and must be protected
  • JAPAN + PROTECTION = SEMICONDUCTOR OMG
  • Used by US/EU
• National Security /Defence Argument
  • Certain industries are essential for defence
  • In times of war, a country should not rely on imports
    • 'unfriendly' nations shouldn't specialise
• Balance of Payments Deficit
  • We want to be in a trade surplus to minimise leakages
    • If M > X, protection could resolve this short-term
    • However, other countries could retaliate reducing our exports
  • So this is a short-term solution at best
• Protection of Domestic Jobs
  • As the name implies- a shift towards imports decreases domestic production and thus employment
  • Protection will increase domestic production and thus employment

Anti-Arguments

• Anti-Dumping
  • What may be perceived as dumping may not necessarily be dumping - think Temu
• Infant Industry*
  • Industries may not have a a strong enough incentive to become efficient because of the protection provided
  • Hard to choose infant industry - that is, those we know will succeed
• Diversification
  • Only really applies to developing countries
  • Selection/Identification
• Strategic Trade Policy
  • Identification of industries
  • Selecting policy - also it is likely many countries will protect, which means no country has any real comparative advantage
• National Security/Defence Argument
  • Irrelevant industries (such as steel) can argue for this - it is hard to filter out relevant industries
  • This argument is also non-economic, more military

Steps to writing Protection Questions

• What would happen without
• What would happen with
• Why it won't work

It is important to note that all forms of protection cause harms to world trade and are inefficient

The impact of tariffs and subsidies using the demand and supply model on trade, market efficiency and the macroeconomy