4.1.6 Restrictions on Free Trade

• Free trade aims to maximise global output based on the principle of comparative advantage
• However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes
• This is called protectionism & may take the form of limiting imports, limiting exports, boosting exports - or putting administrative barriers in place
  
  

Reasons for Protectionism

Reason	Explanation
Infant industries	To protect new firms that would be unlikely to succeed at start-up due to the level of global competition. Once established support is removed
Sunset industries	Similar to above, but at the other end of the life cycle, these firms are on their way out & the government chooses to support them to help limit the economic damage that would occur if they closed abruptly
Strategic industries	Industries such as energy, defence & agriculture are essential to self-sufficiency & security. Being reliant on other countries for these creates vulnerabilities for a nation
Dumping	Dumping is anti-competitive & can harm a country's industries
Employment	When firms outsource production to other countries or certain industries are experiencing structural unemployment governments will step in to protect jobs
Current Account deficit	When imports > exports the amount of money leaving the country to support foreign firms is greater than that entering to support domestic firms. Protectionism aims to correct this imbalance
Labour/environmental regulations	Many countries offer cheap labour & low-cost production due to poor environmental regulations. Protectionism can help apply pressure to bring about change in these countries

• The most commonly used forms of trade protectionism include tariffs, subsidies, quotas & administrative barriers
  
  

Tariffs

• A tariff is a tax on imported goods/services (customs duty)
  
  
• Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country
  • This raises the cost of production for domestic firms
  • Firms often pass on the increased costs to consumers in the form of higher prices
  • These higher prices allow some domestic firms to increase their output (law of supply)
    
    
• More inefficient domestic firms are now producing at the expense of more efficient firms globally who reduce their output due to the tariff
  
  • With increased domestic output, employment may increase
    
    

A tariff raises the price of the world supply from Pw to Pw + tariff. This reduces the quantity of imports from Q₁Q₂ to Q₃Q₄

Diagram Analysis

• World supply (W_s) is considered to be infinite & this supply curve is added to the domestic demand (D_D) & supply (S_D) curves
• The pre-tariff market equilibrium is seen at P_wQ₂
  • Domestic firms supply up to Q₁ at a price of P_w
  • Foreign firms supply the difference equal to Q₁Q₂ at a price of P_w (imports)
• After the tariff is imposed, the world price increases from P_w to P_w+ tariff
• The new market equilibrium is seen at P_w+tariffQ₄ 
  • Following the law of demand, the quantity demanded contracts from Q₂ to Q₄
  • Following the law of supply, the quantity supplied by domestic firms extends from Q₁ to Q₃
  • The level of imports is reduced from Q₁Q₂ to Q₃Q₄
    
    

Quotas

• A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry
  
  
• This limit is usually set below the free market level of imports
  
  • As cheaper imports are limited, a quota raises the market price
  • As cheaper imports are limited a quota may create shortages
    
    
• Some domestic firms benefit as they are able to supply more due to the lower level of imports
  • This may increase the level of employment for domestic firms
    
    

Subsidies to domestic producers

• A subsidy lowers the cost of production for domestic firms 
  • They can increase output & lower prices
  • With lower prices their goods/services are more competitive internationally
  • The level of exports increases
  • The increased output may result in increased domestic employment
    
    

Non-tariff barriers

• There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas & subsidies
  • Health & safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries & it effectively blocked the import of southern hemisphere nuts
  • Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size
  • Environmental regulations e.g. in November 2021 new regulations were put in place in the EU & the USA to limit the amount of imports of 'dirty steel' - predominantly this is steel produced using coal fired power stations which are prevalent in China
  • Product labelling can be expensive for firms to apply & may limit their desire to sell into certain markets
    
    

• Protectionist policies have a range of impacts on consumers, producers, governments, living standards, & equality
  
  

Tariffs

• The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram
   

A tariff impacts domestic producers, consumers, foreign producers & the government

Domestic producers

• Before the tariff domestic producers produced output equal to 0Q₁ & their revenue was equal to P_w X Q₁
• After the tariff was imposed domestic producers produced 0Q₃ & their revenue was equal to P_w X Q₃
• Domestic producer surplus has increased by area 2
  
  

Domestic consumers

• Before the tariff domestic consumers consumed Q₂ products at a price of P_w
• After the tariff domestic consumers consumed fewer products (Q₄) at a higher price of P_w+tariff
• Domestic consumer surplus has decreased by areas 1, 2, 3 & 4
  
  

Government

• After the tariff is imposed the government receives tax revenue equal to ((P_w+tariff) - P_w) x (Q₄-Q₃) - area 3
  
  

Standards of living

• The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
• Domestic firms who benefit from increased production may increase employees' wages
  • This would increase the standard of living for employees
    
    

Equality

• Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly
  
  

The Impact of Quotas, Subsidies & Non-tariff Barriers on Stakeholders

Stakeholder	Quota	Subsidies	Non-tariff
Domestic Producers	Increases their output Raises the selling price Increases their revenue	Decreases costs of production Increases output Increases international competitiveness	Limits foreign competition Protects levels of outputs May increase selling price & revenue
Foreign Producers	Decreases their output Compared to a tariff, those firms who manage to export in the quota receive a higher price for their sales	Makes it harder for them to compete with domestic firms	Acts as a disincentive to sell into foreign markets Costs of meeting the non-tariff barriers may significantly reduce profit margins
Consumers	Results in higher prices & less choice	Lowers prices	May reduce choice/variety in a market
Government	They do not receive any tariff revenue (as there is no tariff) They may receive higher tax revenue at the end of the financial year when domestic firms pay their corporation tax	This costs the government the amount of the subsidy There is an opportunity cost associated with every subsidy provided	They may lose some credibility with the WTO Enforcing the non-tariff barriers may be difficult or expensive
Standards of Living	Reduces for consumers as higher prices erode the purchasing power of their income	Improves for consumers as they benefit from lower prices - their income goes further	Less choice & higher prices erode standards of living Product labelling information may improve decision making & quality of life
Equality	Improves for domestic firms but worsens for foreign firms	Domestic firms can compete more equally	May help improve equality e.g. environmental standards help create equal production inputs which results in equality in the costs of production