THE WELFARE CONSEQUENCES OF TARIFFS AND QUOTAS; EVALUATION OF THE POTENTIAL JUSTIFICATION FOR PROTECTIONISM MEASURES
The Welfare Consequences of Tariffs and Quotas: Evaluation of the Potential Justification for Protectionism Measures
Occasionally both tariffs (tax that adds to the cost of imported goods) and import quotas (a restriction placed on the quantity of particular good that a country can import) are used to control the quantity of foreign products that can enter a country’s domestic markets. Several arguments have been raised regarding reasons for protecting domestic markets against foreign traders. Nonetheless, protectionism is characterized by several welfare consequences. The arguments for protectionism can be categorized into economic and non-economic. The economic arguments mostly focus on national welfare. On the other hand, arguments for non-economic protectionism are based on national interests. This paper evaluates the potential justifications for protectionism measures.
Protectionism Improves National Welfare by Preventing International Price Discrimination
Sometimes goods might be sold overseas at prices that are below their production cost and below market price in the domestic market. Cassimatis (2007) argues that, through international price discrimination, import competing industries might be forced to exit the market. Ideally, it is costly to re-establish industries after they have been forced to close down. Although not common in modern times, governments might be justified to effectively set prices of goods that are not domestically produced (imported goods) (Cassimatis 2007). These measures would prevent dumping: the process of exporting goods by a country to another country at a price lower than its normal price.
International price discrimination leads to several forms of dumping: this can include predatory dumping which refers to temporary sale of goods at a lower price abroad in order to drive foreign industries out of business; thereafter raising prices abroad in order to take advantage of the resultant monopoly power (Cassimatis 2007). Similarly, tariffs and quotas prevent sporadic dumping which involves occasional sale of goods at lower prices abroad than domestically in order to drop off an unexpected and temporary surplus of a commodity without reducing the price of goods in domestic markets (Cassimatis 2007). The World Trade Organization (WTO) has since supported protectionism to prevent international price discrimination; this is on the basis that tariffs and quotas rectify trade distortive effect of dumping and re-establishes fair trade (Cassimatis 2007). Therefore, tariffs and quotas should be imposed on goods imported from other countries especially if domestic industries are able to foster welfare that is being impacted negatively by dumping. However, such taxes should be imposed at a percentage rate that is calculated to counteract the dumping margin.
Protectionism Increases National Welfare through Full Employment
Countries can only maximize their welfare if its entire production factors are fully employed. However, countries which have large-scale unemployment would not be able to use the factors of production effectively. Those supporting domestic employment protection cite increased competition from imported goods can threaten domestic employment (Beiske, Cai, Murray and White 2007). For instance, domestic employers might fire workers or shift production abroad in order to cut costs of production. This will result to higher unemployment and less happy nationals. Under such cases, established foreign companies might decide to bring in cheap labor and certain goods that are produced cheaply (Beiske, Cai, Murray, and White 2007). However, even in the absence of foreign companies, domestic companies will produce goods until they reach the comparative advantage point.
Nonetheless, those Advocating for tariffs and quotas on imports asserts that any welfare distortions resulting from protectionism would be of secondary significance. Therefore, the consumers would not loss anything for consuming domestic goods, instead of foreign goods (Vangrasstek 2010). However, based on a close look on how tariffs affect prices, such argument does not hold. According to Investopedia (2011), tariffs and quotas increase the price of imported goods. This is because domestic producers will not need to reduce their prices because they do not face competition from foreign goods. As a result, domestic consumers might be forced to either pay higher prices or forgo important goods thereby leaving them unhappy.
The graph below illustrates the effects of trade in the absence of tariffs and quotas. In the figure, DS indicates domestic supply and DD shows domestic demand. The price of domestic goods is at price P, while the price for foreign goods is at P–. At a lower price p–, consumers will consume quantity QW, but since the domestic industries can only produce up to Qd, the country is supposed to import QW-Qd worth of goods in order to meet full demand.
Price without the influence of tariff and quotas
Source: (Investopedia 2011).
Whenever tariffs and quotas are enacted, they increase prices and limit the quantity of imports thereby negatively affecting consumer welfare. The figure below indicates price increases from the non-tariff price P* to P–. Investopedia (2011) indicates that, domestic industries often take advantage to produce the goods and Qd move rightward. Similarly, QW shifts to the left. Overall, imports are reduced, domestic production increased, and prices increased. Therefore, tariffs and quotas force consumers to spend more on goods which they could otherwise obtain at a fair price. Therefore, protectionism leads to loss of desired foreign varieties of goods which is equivalent to real income loss.
Price Under Effect of Tariffs and Quotas
Source: (Investopedia 2011)
Protectionism Increases National Welfare through Infant Industry protection
Studies indicate that, if an industry has large economies of scale, its costs and prices will be high before the industry grows (Bernitz and Ringe 2010). However, as the industry grows, its costs and prices will decline. Owing to such argument, small industries should be protected. From Bernitz and Ringe (2010) point of view, when newly developing industries are exposed to competition, they might not be competent. Therefore, Bernitz and Ringe (2010) suggest the use of import substitution industrialization (ISI) strategy in order to protect infant industries. The ISI strategy involves levying taxes on imported goods in industries in which the government wants to foster growth.
Although tariffs create domestic markets for domestically produced goods, it also increases prices of imported goods thereby limiting consumer freedom of choice. Itō and Krueger (1993) support the need to protect infant industries from being forced out of market by more competitive foreign industries ISI decreases unemployment and allows developing countries move from agricultural products to finished goods. Although such arguments justify protectionism, infant industries protection is also associated with some drawbacks. First and foremost, if an industry develops without facing any competition, it might end up producing low quality goods. As a result, the subsidies required to keep the state-protected industries growing will not achieve the desired impacts.
Studies conducted by Nadakavukaren and Schefer (2010) indicate that, protectionism harms both consumers and businesses through higher prices for goods. For instance, if the price of steel is inflated through tariffs, consumers will be required to pay more for products which are made from steel and producers pay more for steel that they use to make such goods. Therefore, although to some extent protectionism protects infant industries, the tariffs and quotas In response to these concerns regarding the impacts of infant industry protection, Nadakavukaren and Schefer (2010) suggests that, instead of barring foreign imports through tariffs and quotas, governments will be better off considering to offer technical assistance such as labor training or education as opposed to protection.
Non-Economic arguments for Protectionism
Protectionism has also been recommended on political and social grounds. Eichengreen and Pak (2012) argue that, protectionism assists countries to maintain their traditions. For instance, Canadians believes that, tariffs can assist them to maintain a separate nation with identities that are different from those of the United States. As far as the role of protectionism in fostering national traditions is concerned, protectionism can be viewed as a matter of national pride. Similarly, some countries use national pride and cultural identity to justify their protectionism economic policies (Eichengreen and Pak 2012). For instance, in Australia’s political history, both Labor and Coalition governments have employed cultural identity and national pride arguments to justify economic protectionism policies.
It is important to note that, cross-border flows of knowledge, films, and other cultural goods and people are not new phenomena. Beiske, Cai, Murray, and White (2007) assert that, indigenous people have continuously struggled to maintain their identity and culture against forces of foreign economic investment. There are various factors which make protection of national traditions less important. These include increased spread of culture by settlers by design or failing to respect indigenous culture, the free flow of films, and increased international labor migration (Beiske, Cai, Murray, and White 2007). Such factors render national identity challenging to foster alongside fostering consumer welfare. Beiske, Cai, Murray, and White (2007) affirm that, it is difficult for governments to legislate the link between traditions and trade. This is because the former is a concept used in most cases to further countries’ own economic and political interests. Some critiques have contented that, traditional protectionism which is the intervention of a State in trade in the defense of its local culture, is merely economic protectionism in disguise.
Protectionism also fosters national defense. Bernitz and Ringe (2010) noted that, Britain requires an experienced merchant marine industry that would be used in case of war. Such industry (defense) can be fostered through protectionism policies. This argument concurs with Bernitz and Ringe’s (2010) suggestion that, developed countries should employ tariffs and quotas in order to protect industries that such countries deems strategically important. These industries include those supporting national security. In most cases, defense industries are vital to state interests thus they are justified to enjoy significant levels of protection. For instance, while both the United States and Europe are industrialized, they are very protective of their defense-oriented industries.
Summary and Conclusion
Tariffs and quotas have varied impacts on consumers and countries as a whole. From an economic perspective, protectionism harms national welfare by forcing consumers to spend more on commodities they could otherwise buy at lower prices without the effects of quotas and tariffs. Although protectionism protects infant industries, it does so at a cost. That is, developing countries end up producing low quality goods and selling them at high prices. This translates into loss of real income for consumers. Instead of protecting infant industries from foreign competition, the government should consider supporting these industries technically through free or subsidized labor training. On the other hand, protectionism prevents dumping thereby hampering companies from exploiting consumers through monopoly. As far as traditional values are concerned, it a matter of national pride and therefore cannot be universally justified. Similarly, protectionism safeguards important industries such as defense. Therefore, although protectionism has some benefits, from consumer’s point of view, protectionism leads to more harm.
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