Consumers pay more with protectionism too. Without a system of competitive
pricing, domestic companies are free to raise their prices without raising
the quality of their goods. Put more simply, when a business is without
competition then the consumer is without options.
Businesses suffer from protectionism as well, though theirs is more
of a head-in-the-clouds brand of suffering. Government support often
builds corporate complacency, which in turn could lead a business to
believe that it has a nice safety net set up behind it. In the event
of strong foreign competition, these businesses might not have the resources
necessary to survive on their own.
Finally, trade protectionism limits consumer access to foreign goods
and non-domestic companies that offer unique products and services are
also subject to the aforementioned restrictions.
Foreign businesses and domestic consumers face the greatest disadvantages
of trade protectionism. Businesses face unfair restrictions while their
domestic competitors are offered financial boons, and consumers end
up paying higher prices for a limited variety of products that aren't
always worth their cost.
- The Advantages for Free Trade
Free trade is a trade policy that allows traders
to transact business without any sort of interference or intervention
from the government. It is believed that free trade leads to mutual
benefits for both the trading partners. It differs from other forms of trade in that there is no creation
of artificial prices, or a false demand and supply of products. In a
protectionist trade economy, government intervenes in the form of subsidies,
taxes, tariffs, etc to lower prices of goods or adjust supply of products.
Free trade overcomes all this and gives a true picture of the actual
demand and supply. To understand how free trade creates a better market
and trade environment, let’s take a look at its benefits. There are
at least 10 advantages to free trade.
Increased
Production and Efficiency. In 1776 Adam Smith stated,
"If a foreign country can supply us with a commodity cheaper than
we ourselves can make it, better buy it of them with some part of the
produce of our own industry, employed in a way in which we have some
advantage." Smith's comment states the largest advantage of free
trade:
1. Countries that specialize
in creating commodities where they have the comparative advantage will
increase their production, instead of focusing on products or industries
in which other countries have the comparative advantage. What is comparative
advantage? In economics, comparative advantage refers to the ability of
a party to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one
country is more efficient in the production of all goods (absolute advantage in all goods) than the other,
both countries will still gain by trading with each other, as long as
they have different relative efficiencies. As a result, this explains
that by specializing in goods where countries have a lower opportunity
cost, there can be an increase in economic welfare for all countries.
Free trade enables countries to specialize in those goods where they
have a comparative advantage.
2.
Economy of scale. When countries specialize
in certain goods that they can produce, they can take advantage of economy
of scale and produce these goods at lower average costs. This is more
useful to industries where the fixed cost of production is very high
or where the investment required is very high. By specializing in such
products, the industry can ultimately gain from economy of scale and
lower production costs. This would transfer to the consumer as lower
prices for the finished goods.
3. Production efficiencies.
Free trade improves the efficiency of resource allocation. The more
efficient use of resources leads to higher productivity and increasing
total domestic output of goods and services. By increasing production,
countries increase their efficiency. By specializing, countries better
allocate their resources and purchase cheaper resources from other countries.
4. Increases healthy competition. When demand increases from
abroad, industries will respond to the demands by reducing costs and
increasing efficiency. This will prevent the creation of monopolies
within the domestic market, which lead to high prices. Thus free trade
brings about a healthier competition within the domestic industry. Because
free trade leads to a global market, consumers benefit from the competition
and variety brought to the market. When other countries produce some
items cheaper, than the consumer purchases products for less.
5. Increase of innovation.
Another benefit to consumers is increased innovations. As free trade
expands, competition also expands. To stay competitive, companies must
seek ways to create the comparative advantage. This leads to increased
innovation that improves products.
6.
Employment. Although free trade may cause jobs in one particular industry to wind up overseas,
jobs in the exporting and importing sides will increase. When productivity
increases in importing and exporting, wages also tend to rise.
7. Increases economic growth.
Trade is the greatest factor that leads to economic growth. When the
trade occurs as a result of true demand and supply, the economic growth
that occurs also truly reflects the increase in economic welfare. Thus,
free trade brings about increased economic growth, which means better
and more jobs; better standards of living; etc.
8.
Foreign Exchange Gains and Decreased Poverty. When a country purchases
a product from another country with money, they essentially send the
exporting country non-interest IOUs in exchange for real goods. The
exporting country, though, must use the money within the
country that imported the products. For example, the United States purchases
steel from China with U.S. money at the current market value. China
will later use the U.S. money to purchase computer programs from the
United States at the future market value. Countries that open their
trade barriers to allow free trade have the chance to enter the global
market, which will increase income for the country. In the 1990s, developing
countries that lifted trade restrictions tended to grow three times
faster than countries that restricted trade.
9.
Increased Export. Countries with stringent trade restrictions often
cause animosity with other countries. Therefore, the country with the
restrictions also limits its own ability to export. When a country removes their
trade restrictions, other countries are more willing to accept the exports.
10. Effective use of raw
materials. Free trade not only brings about economic growth but also
effectively uses raw materials, especially highly valuable and highly
limited raw materials. For instance, the Middle East is a rich source
of oil, but there isn’t much else in these countries. Trade is what
ensures that this limited resource is distributed to different countries
that lack this resource and the Middle East, in turn, gets the products
necessary for their day-to-day living and business.
11. Lesser cost of living.
When governments add tariffs and taxes to protect their interests, it
leads to the industries selling products at a higher cost. This leads
to higher costs of living. On the other hand, free trade does away with
government interventions such as subsidies, tariffs, and taxes. This
ensures that the products and services are efficiently produced and
at a lower cost. This transfers to lesser prices for products and thereby
lesser cost of living.
12. Good government and peaceful
international ties. Free trade prevents the need for protectionist government
policies. It is such policies that lead to corruption among the government
officials. Thus, a free trade economy promotes healthier governance.
A healthy government also works towards a healthier economy. This ensures
smoother and healthier trade and political relationships between countries.
Thus, free trade leads to healthier domestic governance and peaceful
international ties.
Disadvantages of Free trade
Unrealistic
Policy. Free trade policy is based on the assumption of laissez-faire
or government non-intervention. Its success also requires the pre-condition
of perfect competition. However, such conditions are unrealistic
and do not exist in the actual world.
Non-Cooperation of Countries. Free trade policy works smoothly if
all the countries cooperate with each other and follow this policy.
If some countries decide to gain more by imposing import restrictions, the system
of free trade cannot work.
Economic Dependence. Free trade increases the economic dependence
on other countries for certain essential products such as food, raw
materials, etc. Such dependence proves harmful particularly during wartime.
Unbalanced
Development. Free trade and the resultant
international specialization lead to unbalanced development of national
economy. Under this system, only those sectors are developed in which
the country has a comparative advantage. Other sectors remain undeveloped.
This results in lop-sided development.
Dumping. Free trade may lead to cutthroat
competition and dumping. Under dumping, goods arc sold at very cheap
rates and even below their cost of production in order to capture the
foreign markets.
International Monopolies. Free trade may lead to international monopolies.
It encourages the establishment of multinational corporations. These
corporations tend to acquire monopoly position and thus harm the interest
of the local people.
Reduction in Welfare of Certain Groups.
While free trade tends to maximize world production of goods and services,
it may simultaneously hurt the welfare of certain group in every country.
Under free trade, the output of those commodities in which the country
has comparative advantage tend to increase to meet the export demand,
and the output of goods in which the country has comparative disadvantage
contracts due to pressure from import competition. Thus, the real income
of the groups engaged in the export industries will rise and real income
of those engaged in the import competing industries will fall.
With the removal of trade barriers, structural
unemployment may occur in the short term. This can impact upon large
numbers of workers, their families and local economies. Often it can
be difficult for these workers to find employment in growth industries
and government assistance is necessary.
Increased domestic economic
instability from international trade cycles, as economies become dependent
on global markets. This means that businesses,
employees and consumers are more vulnerable to downturns in the economies
of our trading partners, eg. Recession in the USA leads to decreased
demand for Australian exports, leading to falling export incomes, lower
GDP, lower incomes, lower domestic demand and rising unemployment.
International markets are not a level playing
field as countries with surplus
products may dump them on world markets at below cost. Some efficient
industries may find it difficult to compete for long periods under such
conditions. Further, countries whose economies are largely agricultural
face unfavorable terms of trade (ratio of export prices to import prices)
whereby their export income is much smaller than the import payments
they make for high value added imports, leading to large CADs and subsequently
large foreign debt levels.
Developing or new industries
may find it difficult to become established in a competitive environment with no short-term protection
policies by governments, according to the infant industries argument.
It is difficult to develop economies of scale in the face of competition
from large foreign TNCs. This can be applied to infant industries or
infant economies (developing economies).
Free trade can lead to pollution and other environmental
problems as companies fail to include
these costs in the price of goods in trying to compete with companies
operating under weaker environmental legislation in some countries.
Pressure to increase protection during the GFC. During the global financial
crisis and recession of 2008-2009, the impact of falling employment
meant that protection pressures started to rise in many countries. In
New South Wales, for example, the state government was criticized for
purchasing imported uniforms for police and firefighters at cheaper
prices rather than purchasing Australian made uniforms from Australian
companies. Similar pressures were faced by governments in the United
States, Britain and other European countries.
THE PRACTICAL PART
Why Free Trade Is Far More Preferable Than Protectionism
on the USA example
Free
Trade vs Protectionism
The
financial meltdown of 2008 and the resulting deep recession have brought
enormous pressure upon the governments of the many nations of the world
including the United States. The world economy has
been remarkably slow in recovering from this sharp downturn. The resulting
unemployment, slow GDP growth, and continuing depressed housing markets
stubbornly persist. Politicians often look for quick fixes during these
times of severe economic distress. Protecting domestic industries sounds
like the the logical action to take under these conditions. Unfortunately
these same politicians do not consider the long term implications of
protectionism. They need to examine history, macroeconomics, and foreign
policy before making these hugely momentous decisions. All policy actions
have reactions and thus they often have dire consequences. Often these
consequences create much more damage than the initial problem ever did.
In this analysis I will describe the four main types of protection that
a country may provide to an industry or the economy itself. They are
tariffs and quotas, industry subsidies, currency manipulation, and import
product regulations. Furthermore I will present both the benefits and
the dangers of each of these forms of protectionism. Finally I will
attempt to give a full global picture of why free trade is a far more
preferable long term policy than protectionism.
Let us start with the most common forms of protectionism which are tariffs and quotas.
Pure free trade exists when countries trade with one another without
placing any barriers upon any of their trading partners. In other words
all nations would be trading on a level playing field. However many
nations decide to protect one or more of their industries by placing
tariffs on imports from other countries within that industry. They may
also place quotas limiting imports relating to that industry. Tariffs
make imports more expensive compared to the products of the domestic
industries. Quotas overtly limit imported products from other nations.
These forms of protectionism are often instituted to protect a developing
domestic industry or a declining one. Third world developing nations
use these mechanisms to allow their infant industries to grow and solidify.
Unfortunately many of these nations become addicted to these methods
and fail to remove them when the protected industry matures. Some political
leaders in the developed world feel political pressure to save a domestic
industry of theirs when it is declining. This is usually because companies
in the developing world are gaining ground on them quickly due to wage
cost advantages. These countries are still poor so their wages are naturally
much lower at this point. This type of protection is usually futile
due to these vast wage differences. It is also counterproductive to
trade in general. The Smoot-Hawley tariff was passed by the U.S. Congress
in 1930 during the height of the Great Depression to protect primarily
their agricultural industry. The tariffs were record highs at the time
and it sparked a worldwide trade war that further exasperated an already
decimated world economy. The U.S. also negotiated quotas with Japan
on steel and automobiles in the 1980's to protect these declining industries.
They were successful but only to the extent that they left extremely
shrunken domestic industries for those products. The lesson to be learned
from this is that negotiation works. Unilateral trade actions often
spark trade wars which hurts everyone involved very badly.
Another form of protectionism utilized by many countries is industry
subsidies. This method is generally used to help fledgling industries
grow or to protect mature industries from unfavorable market conditions.
Giving help to a growing industry
is a norm for most countries whether they are developed or not. Developing
nations do it to establish new industries and to grow their economy.
Developed countries normally utilize this method to move off declining
industries and establish more advanced industries such as biotechnology
or alternative renewable energy. Sometimes these developed nations use
this method as protection for an aging or vital industry. The United
States provides very large subsidies to its farming industry. These
subsidies were first implemented during President Franklin Roosevelt's
administration as part of his New Deal during the Great Depression.
Prices for farming crops had fallen to rock bottom levels and farmers
were going bankrupt in record numbers. The U.S. food supply was now
being threatened and something needed to be done. The Roosevelt administration
instituted a number of programs and subsidies that allowed farmers to
stay in business and make a livable income. This worked very well and
has continued to be used to ensure a stable farming economy. Unfortunately
these programs have become institutionalized and farm subsidies are
now the norm. My belief is that they should only be used as a backstop
to ensure that farmers do not go bankrupt and not to ensure a certain
income level for farmers. This is a prime example of a misuse of industry
subsidies. The proper use of subsidies is to employ them to meet vital
national needs such as developing a cutting edge industry or ensuring
that a national security requirement is met.
The third major form of protection that nations use to aid their industries
is currency manipulation. All nations perform currency manipulation
at one time or another. Most nations have a broad range in which they
feel it is safe for their currency to
fluctuate without damaging their economy. Any fluctuations beyond this
are usually deemed a threat to their economy and the government will
take action to bring that currency back into the acceptable trading
range. A strong currency favors cheap imports, lower inflation, and
lower interest rates. A major disadvantage is that your exports are
are more expensive hurting most of your domestic industries. Conversely,
a weak currency aids your domestic industries greatly but could lead
to higher interest rates and higher inflation. The major problem regarding
currency manipulation occurs when a nation conducts this method with
the goal of obtaining a competitive trade advantage over other nations.
The prime example of a country employing this form of protectionism
currently is China. The Chinese economy is overwhelmingly driven by
their export industries. Their economy would begin to stall without
the component of consistently rising export levels. This growth is critical
to the retention of power for the Chinese Communist Party government.
Of course the Communist name is misleading in this case because the
Chinese economy is now actually a Capitalist economy. The problems the
Chinese government is faced with involve the lack of democracy as well
as the fact that their country has a population of 1.3 billion people
and growing rapidly. They need to maintain the growth of their economy
to support China's massive population. There is also a large group of
their citizens that remain in poverty. This is additionally critical
for the ruling Communist party due to the fact that their populace does
not have elections as an outlet for their frustrations. Therefore the
Chinese government employs currency manipulation as a means to keep
their export industries strong and to maintain a huge trade surplus.
This in turn allows the government to use the funds from this surplus
to buy up dollars on the open currency market. This is the mechanism
that the Chinese government uses to keep the Chinese Yuan value low
relative to the U.S. dollar and other world currencies. It not only
helps their export industries but it hurts the export industries of
other countries making it a very unfair trading practice. They are not
the only offender of this sort but they are certainly the most prominent
and blatant practioner.
Finally we turn to import
product regulations. As with the other three forms of protectionism,
regulating imports can be a double edged sword. This method is key to
ensuring that the products imported into a nation are up to the quality
standards that the receiving nation holds for its own domestic products.
Some nations, especially developing ones, look the other way in regards
to ensuring high quality standards for the products of their exporting
industries. Their main priority is usually facilitating the rapid growth
of their industries rather than maintaining the safety and quality of
their products. China has been implicated in several scandals regarding
dangerous export products in recent years. One was a recall of poisonous
pet food in 2007. Another example is an ongoing problem with sub-standard
dry wall that is damaging many homes in the United States. The Chinese
government has begun punishing these industrial malefactors severely
when these instances of gross neglect or incompetence are found. This
is an attempt to uphold China's industrial reputation before it substantially
hurts its exports. There is still a lot of improvement that needs to
be done. The U.S. and all other countries must remain vigilant and take
action against offenders such as this to ensure that these practices
are halted. Developing countries already have a substantial advantage
in regards to labor costs. Taking shortcuts on quality should never
be allowed both for safety reasons and trade fairness. This is the proper
and necessary use for import product regulations. Unfortunately some
nations utilize extraordinarily onerous regulations on imports as a
means of excluding them from their country. These nations use this method
to effectively block certain imports from entering their country much
like tariffs and quotas operate. They get the benefit of this result
without appearing to be protectionist. The bottom line is that regulations
should be used for the protection of their nation's citizenry and not
for the promotion and protection of their domestic industries.
I have now outlined the four
major forms of protectionism. My belief is that all nations will become
more prosperous in the long run as more trade protections are dropped
and trade becomes freer. Of course nations do not operate within a utopian
world. Some countries are marvelously wealthy with a myriad of resources.
Others have been poor for centuries due to geography, wars, nature,
or government corruption. These are the major reasons for a nation's
poverty though by no means the only ones. Therefore different governments
have different problems and pressures. Developing countries have fledgling
industries to nurture while developed ones have jobs in declining industries
to preserve. I believe protection should only be given in three situations
and even then only on a limited basis. The situations are aiding a brand
new industry to start up and develop, protecting an industry that is
vital to national security, and the using of regulations strictly to
exclude dangerous products from entering one's country. All other trade
problems should be handled through in depth trade negotiations. People
lose their lives when nations enter into shooting wars. People lose
their jobs when nations enter into a trade war. No one wins in either
of these types of wars. Nations close down their trade markets during
a trade war shrinking the field for everyone. Trade negotiations are
the most optimal way to settle trade disputes. This is true in state
diplomacy among nations just as it is with trade negotiations. The North
American Free Trade Agreement (NAFTA) is an excellent example of successful
trade negotiations that have benefited all nations involved. Now it
is true that some U.S. jobs have been lost primarily in older low-tech
industries. Conversely lower market barriers have expanded the market
share of our hi-tech industries which greatly expanded job creation
in these areas which represent our future. This is the model of economic
progress we should be striving for all over the world. The World Trade
Organization (WTO) embodies this. The WTO is an outgrowth of the General
Agreement on Tariffs and Trade (GATT) which was a set of trade rules
agreed upon by many nations in 1947. It was negotiated under the auspices
of a United Nations conference on trade. There were eight rounds of
negotiated agreements under GATT which each time substantially lowered
tariffs and other barriers among the participating nations. GATT was
replaced by the WTO in 1993. The major difference between the two is
that the WTO is an actual institutional negotiating body and not simply
a set of agreements. The WTO and smaller trade negotiations such as
the one that resulted in NAFTA are the best mechanisms to open up all
trade markets and expand the world economy. Our world is a much smaller
one now due to the incredible advances in communications and transportation.
These are wonderful developments which if handled correctly and openly
among nations should result in a more prosperous and peaceful world.
I know this sounds like a "Pollyanna" viewpoint especially
with all the tumult going on in the world presently. Yet think about
how the idea of democracy has been spreading like wildfire in the Middle
East. Dictatorial tyrants are quaking in their boots. Practically instantaneous
information transmission via the internet has sparked this. It has also
given the tools to millions of entrepreneurs around the world to start
up companies and grow them. Barriers among nations are coming down by
way of this information phenomenon without any input of world governments.
I hope to see them get onboard this train and continue to negotiate
to tear down protectionist barriers on the road to free trade. We are
inevitably moving in that direction anyhow. Let us accelerate this process
and make this a better world for all.