Arguments for Trade Protection
Lecture 8

Externalities

1. Distortions - causes a gap between private and social benefits (or costs)

• Causes

  • Government policies such as taxes, subsidies, price controls, quotas, etc.

  • Market failure

    • Positive or negative externalities

    • Monopoly - a monopolist's reduces supply to cause the market price to rise, and he or she earns long-run economic profits

2. Externalities – failure to include all costs and/or benefits

1. Negative externality - an individual's or firm's action harms others without their consent

   • Property rights are not defined well

   • Not all costs are registered, therefore supply function understates the true cost of production

   • Example: A polluting firm

     • A firm supplies Q* which sell for P* and freely pollutes

     • Pollution is a social cost to society, Social Marginal Costs (SMC)

     • Government can force the firm to include pollution costs, causing the supply function to shift left

     • Gov. imposes taxes, regulations, pollution permits, etc.

     • Taxes are efficient in this case

   • Equilibrium price increases while quantity supplied decreases

   • This is efficient because firm pays all costs including pollution

   • Firms still pollute, but less

   • Note – Countries impose a tariff against countries that have lax environmental laws

   • Example - leakages - U.S. relocate manufacturing to China, because China has little environmental regulations

A Polluting Firm Pollutes the Environment

2. Positive externality (or spillover effects) - an individual's actions generate benefits for nonparticipating parties

   • Demand functions understates the true value of output

   • Called Social Marginal Benefits (SMB)

   • From the viewpoint of efficiency, too few units may be produced

   • Example: Inoculations - people getting inoculated help prevent the spread of diseases

     • People who are not inoculated also benefit

     • Government can subsidize inoculations, bringing the market price down

3. Gov. imposes trade barriers that generate Social Marginal Benefits (SMB)

   • Compare the gains from SMB to the deadweight loss

   • Examples of expanding domestic industry

     • Creates knowhow and management specialization

     • High cost spur technological innovation

     • Protect national defense

     • Help a disadvantaged group

     • Create national pride

     • Reduce training costs for displaced workers

4. Note – author says a production subsidy is more effective than a tariff

   • Tariffs generate revenue

   • For gov. to pay a subsidy, another market has to be taxed

Infant Industry Argument

1. American Alexander Hamilton (1755-1804)

   • U.S. came into existence in 1791

   • Hamilton stated we need to protect U.S. industries

   • U.S. industries were young and needed to thrive and grow

   • Imposed tariffs on imports

   • Gives U.S. gov. revenue

2. German Friedrich List (1789-1846) – exiled from Germany for his views

   • State action was needed to promote education, technology, and industry

   • Promotes heavy industry

   • Industries require more mental abilities than in agricultural

3. Import substitution - a country helps develop a domestic industry that substitutes for imported products

   • Mercantilistic policy – restrict imports and keep exports the same

   • Worked for the U.S.

   • Failure for Brazil, Mexico, Turkey, and other Latin American countries

   • Benefits

     • Low risk to establish business, because market is already there

     • Could encourage foreigners to invest in country to avoid trade barriers

   • Problems

     • Government has problems picking winners and losers

     • Fosters monopolies; restricts competition

     • A smaller market means firms cannot gain economies of scale in production

     • Difficult to remove protection; protected industry will resist

     • Gov. may own or control industry; could foster corruption

     • No focus on exports

       • Exports are a source foreign revenue

       • Many governments borrowed to finance current spending

       • Many governments could not control their spending

       • Mexico and Latin American countries had a crisis in late 1980s and early 1990s

4. Economics

   • Similar to the economics of a tariff

   • Over time, a country’s supply function would increase and shift right, if the theory is valid

Dying Industry Argument

1. Free trade causes one or more industries to go in decline

2. The country does not have a comparative advantage in these industries

3. Regional effects – industries tend to be located in specific regions

   1. Regions go into economic decline

   2. Labor, capital, and land have trouble moving to new industries

   3. People complain loudly to politicians in their region

   4. Politicians help pass tariffs to protect region and garner votes

4. Product Life Cycle - country produces a high-tech good and then loses its comparative advantage

   • Country starts producing a high-tech product

   • Country exports this product

   • A foreign country begins producing product

   • Country loses its comparative advantage

   • Foreign country begins exporting product

   • The United States lost its electronics, radios, computers, cars, TV sets, etc.

Government Revenue

1. Government Revenue

   • Government needs the revenue from tariffs and export taxes

   • Country may be low income with high tax evasion

   • Government (i.e. customs) can easily monitor border crossings and ports, and collects tax revenue

   • Note – export taxes hinder exports, because taxes cause a higher price

   • Government needs the money

2. National Defense and National Security

   • An ancient argument

   • Mercantilistic policy

   • Government fosters specific industries that are critical to the country

   • Types

     1. Weapons – many countries manufacture their own guns and weapons

     2. Stockpile critical resources, like metals and petroleum

     3. Protect agricultural industries for food security

Politics

1. Tariff escalation – tariffs become greater with products that have more manufacturing

1. Example

   • Raw materials tend to have no or little tariffs

   • Intermediate goods tend to have higher tariffs

   • Finished products like clothes, cars, etc. have the highest tariff

2. Government is protecting a manufacturing industry

3. Company can circumvent a tariff by producing product within country using imported parts; reduces impact of a tariff

4. Strengthens the North-South Dilemma

5. Countries

   • Asian tigers and Japan have little natural resources; import raw materials for their factories

   • China has natural resources; growing so fast that it also imports massive amounts of resources

2. Politics - trade protection are tied to politics

1. Large companies may produce the finished products

   • Campaign contributions

   • Lobby political leaders

   • Companies can bribe politicians for trade protection

2. Russia and other corrupt countries

   • Bureaucrats impose trade barriers for products (and prevent entry of foreign firms into country)

   • Create monopolies

   • Monopolists can pay high bribes to bureaucrats

3. Manufacturing adds significant value to products

   • Example – taking silicon and creating computer chips

   • The high value of chips can support high wages

4. The squeaky wheel gets the grease

   • People harmed by free trade complain to politicians

   • Book - democratic governments are more likely to pass trade protection

   • Not true – dictatorships can move faster

     • The dictator wants a new law; thus, the law quickly comes into existence

     • Many dictators do not use free markets

     • Dictators expand their military and increase their power base

     • Democracies – laws can be challenged by courts, etc.