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Restricted and Preferential Trade




The infant industry argument. Some industries in a coun­try may be in their infancy, but have a potential compar­ative advantage. This is particularly likely in developing countries. Such industries are still too small to have gained economies of scale; their workers are inexperienced; they lack back-up facilities, such as communications networks and specialist suppliers. They may have only limited access to finance for expansion. Without protection, these infant industries will not survive competition from abroad.

Protection from foreign competition, however, will allow them to expand and become more efficient. Once they have achieved a comparative advantage, the protec­tion can then be removed to enable them to compete internationally.

Similar to the infant industry argument is the senile industry argument. This is where industries with a potential comparative advantage have been allowed to run down and can no longer compete effectively. They may have consider­able potential, but be simply unable to make enough profit to afford the necessary investment without some tempor­ary protection.

To reduce reliance on goods with little dynamic potential.

Many developing countries have traditionally exported prim­aries: foodstuffs and raw materials. The world demand for these, however, is fairly income inelastic, and thus grows relatively slowly. In such cases, free trade is not an engine of growth. Instead, if it encourages countries' economies to become locked into a pattern of primary production, it may prevent them from expanding in sectors like manufactur­ing that have a higher income elasticity of demand. There may thus be a valid argument for protecting or promoting manufacturing industry.

A country may engage in dumping by subsidising its exports. Alternatively, firms may practise price discrimination by selling at a higher price in home markets and a lower price in foreign markets in order to increase their profits. Either way, prices may no longer reflect comparative costs. Thus the world would benefit from tariffs being imposed to counteract such practices.

It can also be argued that there is a case for retaliating against countries that impose restrictions on your exports. In the short run, both countries are likely to be made worse off by a contraction in trade. But if the retaliation persuades the other country to remove its restrictions, it may have a longer-term benefit. In some cases, the mere threat of retalia­tion may be enough to get another country to remove its protection.

Methods of restricting trade

Tariffs (customs duties). These are taxes on imports and are usually ad valorem tariffs: i.e. a percentage of the price of the import. Tariffs that are used to restrict imports are most effective if demand is elastic (e.g. when there are close domestically produced substitutes). Tariffs can also be used as a means of raising revenue, but in this case they are more effective if demand is inelastic. They can also be used to raise the price of imported goods to prevent 'unfair' com­petition for domestic producers.

Quotas. These are limits imposed on the quantity of a good that can be imported. Quotas can be imposed by the government, or negotiated with other countries which agree 'voluntarily' to restrict the amount of exports to the first country.

Exchange controls. These include limits on how much foreign exchange can be made available to importers (finan­cial quotas), or to citizens travelling abroad, or for invest­ment. Alternatively, they may take the form of charges for the purchase of foreign currencies.

Import licensing. The imposition of exchange controls or quotas often involves requiring importers to obtain licences. This makes it easier for the government to enforce its restrictions.

Embargoes. These are total government bans on certain imports (e.g. drugs) or exports to certain countries (e.g. to enemies during war).

Export taxes. These can be used to increase the price of exports when the country has monopoly power in their supply.

Subsidies. These can be given to domestic producers to prevent competition from otherwise lower-priced imports. They can also be applied to exports in a process known as dumping. The goods are 'dumped' at artificially low prices in the foreign market. (This, of course, is a means of artificially increasing exports, rather than reducing imports.)

Administrative barriers. Regulations may be designed to exclude imports. For example, in Germany all lagers not meeting certain purity standards are banned. Taxes may be imposed that favour local products or ingredients.

Procurement policies. This is where governments favour domestic producers when purchasing equipment (e.g. defence equipment).

The world economy seems to have been increasingly forming into a series of trade blocs, based upon regional groupings of countries: a European region centred on the European Union, an Asian region on Japan, a North American region on the USA and a Latin American region. Such trade blocs are examples of preferential trading arrangements. These arrangements involve trade restric­tions with the rest of the world, and lower or zero restric­tions between the members.

Although trade blocs clearly encourage trade between their members, many countries outside the blocs complain that they benefit the members at the expense of the rest of the world. For many developing economies, in need of access to the most prosperous nations in the world, this represents a significant check on their ability to grow and develop.

Types of preferential trading arrangement

There are three possible forms of such trading arrangements.

Free trade areas

A free trade area is where member countries remove tariffs and quotas between themselves, but retain whatever restrictions each member chooses with non-member countries. Some provision will have to be made to prevent imports from outside coming into the area via the country with the lowest external tariff.

Customs unions

A customs union is like a free trade area, but in addition members must adopt common external tariffs and quotas with non-member countries.

Common markets

A common market is where member countries operate as a single market. Like a customs union, there are no tariffs and quotas between member countries and there are common external tariffs and quotas. But a common market goes fur­ther than this. A full common market includes the follow­ing features.

A common system of taxation. In the case of a perfect common market, this will involve identical rates of tax in all member countries.

A common system of laws and regulations governing pro­duction, employment and trade. For example, in a perfect common market, there would be a single set of laws govern­ing issues such as product specification (e.g. permissible artificial additives to foods, or levels of exhaust emissions from cars), the employment and dismissal of labour, mergers and takeovers, and monopolies and restrictive practices.

Free movement of labour, capital and materials, and of goods and services. In a perfect common market, this will involve a total absence of border controls between member states, the freedom of workers to work in any member country and the freedom of firms to expand into any member state.

The absence of special treatment by member governments of their own domestic industries. Governments are large purchasers of goods and services. In a perfect common market, they should buy from whichever companies within the market offer the most competitive deal and not show favouritism towards domestic suppliers: they should oper­ate a common procurement policy.

The definition of a common market is sometimes extended to include the following two features of economic and monet­ ary union.

A fixed exchange rate between the member countries' cur­rencies. In the extreme case, this would involve a single currency for the whole market.

Common macroeconomic policies. To some extent, this must follow from a fixed exchange rate, but in the extreme case it will involve a single macroeconomic management of the whole market, and hence the abolition of separate fiscal or monetary intervention by individual member states.

Most countries have not pursued a policy of totally free trade. Their politicians know that trade involves costs as well as benefits. In this section, we will attempt to identify what these costs are, and whether they are genuine reasons for restricting trade.

Although countries may sometimes contemplate hav­ing completely free trade, they usually limit their trade. However, they certainly do not ban it altogether. The sorts of questions that governments pose are (a) should they have freer or more restricted trade and (b) in which sectors should restrictions be tightened or relaxed? Ideally, coun­tries should weigh up the marginal benefits against the marginal costs of altering restrictions.

 

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