Protectionism and Trade Blocs

Instruments of protection

Protectionism is the use of barriers to restrict imports and shield domestic producers from foreign competition. A tariff is a tax on imports; for a small country trading at a given world price it raises the domestic price by the full amount of the tariff, so domestic output rises, consumption falls and imports fall. The government collects revenue on the remaining imports, producers gain surplus, and consumers lose more surplus than the sum of those two gains: the difference is the deadweight loss, made up of a production-inefficiency triangle and a consumption-distortion triangle. An import quota is a physical limit on the quantity imported; it raises the domestic price like a tariff, but the revenue equivalent (quota rent) goes to whoever holds the import licences, often foreign exporters, unless the licences are auctioned. An export subsidy is a payment per unit exported which raises the price domestic producers receive and makes exports artificially cheap abroad. Embargoes, exchange controls, product standards and bureaucratic procedures are non-tariff barriers.

Arguments for and against

Arguments for protection: the infant industry argument (temporary protection until economies of scale are reached), protection against dumping (selling abroad below cost), strategic or sunset industries, protection of employment, correcting a balance of payments deficit, raising government revenue. Arguments against: higher prices and lower consumer surplus, resources retained in industries without comparative advantage, inefficiency because firms are shielded from competition, retaliation and trade wars, and the fact that most stated aims can be achieved more cheaply by other policies.

Trade blocs

A free trade area removes tariffs between members, each keeping its own external tariff. A customs union adds a common external tariff. A common market adds free movement of labour and capital. An economic and monetary union adds a single currency and coordinated policy. Joining a bloc causes trade creation when high-cost domestic production is replaced by cheaper imports from a member, and trade diversion when cheaper imports from a non-member are replaced by dearer imports from a member because of the common external tariff.