Trade Protection: Reasons, Types, Advantages and Disadvantages

What’s it: Trade protection is a government policy to limit the flow of exports and imports of goods and services. Protection takes various forms, such as import tariffs, subsidies, quotas, labeling, product safety, and health requirements. The aim is to protect the domestic economy’s interests, such as protecting local producers from import competition.

Protectionism is the enemy of free trade. Critics say such a policy would only result in an inefficient allocation of resources at the global level. It may benefit one party, but costs to the other. Instead of supporting domestic economic development, protection resulted in a less competitive industry because it depended on government support.

Trade protection reasons

Even though many oppose it, countries in the world still practice it. Their motives range from protecting the domestic economy to retaliating for similar practices in other countries.

Next, I will try to detail the reasons why a country imposes trade protection.

Prevent unfair competition

Trade protection can be a form of retaliation against partner countries. Producers in partner countries may adopt anti-competitive practices such as dumping.

Dumping is a practice whereby their producers export at a lower price than their domestic market price. Because they are cheaper than they should be, domestic companies have to face unfair competition from imported goods. To prevent harmful effects, the government implements protection by imposing anti-dumping rates.

In this case, protection is a form of self-defense rather than attacking partner countries.

Save domestic jobs

Increased imports reduce opportunities for domestic job creation. The import increases supply and raises pressure on domestic producers.

Domestic buyers may prefer imported products to local products. Imported products are cheaper because of the economies of scale of the producers. Also, they may offer more exciting features.

As a result, domestic companies are unable to compete, and their position is threatened. Some may be closed, while others are still operating but under pressure. That, in turn, reduces labor absorption.

Conversely, low imports should create more jobs for domestic workers. When imports are low, domestic producers increase their output to meet increasing demand from consumers. They invest in capital goods and recruit new workers.

Save the environment and consumers.

Imported products may fail to meet product safety requirements. It poses serious harm to both the environment and the health of consumers. In this case, protection helps to limit the damage caused by high imports.

Domestic producers may demand fair treatment between domestic products and imported products. If they have to follow these standards, then foreign producers must meet them too. They then lobbied the government to apply the same standards.

Protect emerging industries

This is what we often call the infant industry argument. The infant industry is an industry that is just growing and requires a friendly environment to thrive.

The government protects the industry for several reasons. They are strategic for national interest because they create many jobs and contribute significantly to national security, such as the technology industry. Or, they have a long production chain, so growing them will grow other industries.

The infant industry is vulnerable to competitive pressures for imported products. For this reason, the government tries to support it through protection. Governments may reduce protection when the industry becomes globally competitive.

Protect mature and strategic industries

Protection is not only for new industries but also for those that have reached a mature stage. They are strategic because they absorb a lot of labor and have a long production chain.

The United States has implemented such protection. In the 1980s, it imposed import restrictions on Japanese auto products to protect its domestic industry.

The government may impose strict protections. I mean, the goal is to make sure the industry stays alive. The government may also impose loose protection, which allows the industry to decline slowly to avoid a shock effect on the unemployment rate.

Types of trade protection

Trade protection takes many forms. The following is the list:

• Import tariffs
• Quota
• Subsidy
• Currency devaluation
• License
• Voluntary export restraints

Import tariffs

Import tariffs are taxes on imported goods’ prices. The government may impose a tariff as a percentage (ad-valorem tariff) or a fixed nominal (specific tariff), for example, $ 100 per tonne.

Tariffs directly increase the price of imported goods when they enter the domestic market. As prices go up, it is less attractive to domestic buyers. The government expects they will switch to domestic products.

Import quota

Import quotas limit the quantity of imported products entering the domestic market. A decrease in import quotas directly reduces supply on the domestic market. As a result, domestic prices tend to rise.

The effect of the price increase would have been minimal if domestic producers could increase output by the quantity lost by quotas.

The reduced supply of imports reduces competitive pressures on the domestic market. Domestic producers should take the opportunity to increase production and sales.

Subsidy

Subsidies help reduce production costs and selling prices. Thus, when they sell products abroad, the price will be more competitive.

Subsidies can take forms such as tax breaks, soft loans, selling price subsidies, or direct payments.

Subsidies are essential for countries that rely on exports. The most common example is agricultural subsidies.

Subsidies work better than tariffs because of reducing production costs. Producers can increase their exports and production. That will ultimately create more jobs and income for the domestic economy.

During the implementation of policies, the government should encourage producers to increase efficiency through economies of scale or automation. That way, unit costs slowly fall. When they are more competitive, the government then reduces subsidies.

However, unlike tariffs, subsidies increase government spending. Since most of the government’s revenue comes from taxes, the taxpayers actually contribute to the subsidies, not the government.

Currency devaluation

Devaluation is a deliberate attempt by a country to reduce its currency exchange rate against other currencies. In other words, it is a purposeful depreciation.

Typically, this policy is adopted by countries with a system of fixed exchange rates. If the exchange rate floats freely, devaluation is futile because the exchange rate moves according to supply and demand in the market.

Devaluation is a powerful way to boost exports as well as reduce imports. Currency devaluation makes imported goods more expensive for domestic buyers.

On the contrary, it makes the prices of domestic goods cheaper when they enter the international market. Therefore, they are becoming more competitive, driving demand by overseas buyers. As a result, exports increase.

However, devaluations are susceptible to retaliation from aggrieved countries. If the retaliation gets more intense, it leads to a currency war.

License

To send goods from abroad, the government issues an import license. To reduce imports, the government can tighten licensing.

Furthermore, the license also applies to exports. When tightening the granting of export licenses, the government tries to limit the outflow of domestic goods. The aim is to avoid shortage and price hikes in the domestic market.

Voluntary Export Restraints

Voluntary export restraints (VERs) work in reverse with import quotas. Under conventional quotas, the importing country issues the policy. In contrast, under VERs, the exporting country takes the policy.

Exporting countries are willing to restrict goods, leaving their country for several reasons. They may avoid retaliation from partner countries. Or, it is a deal for another lucrative trade agreement. For example, a partner country reduces its tariff if the exporting country is willing to impose VERs.

Trade protection pros and cons

In general, the advantages of trade protection are reflected in the motives I have discussed above. When a country tries to grow strong in a new industry, protection will reduce competition pressure. It provides opportunities for companies in new industries to build a competitive advantage.

Trade protection offers more growth, employment, and income opportunities for the domestic economy. Imports reduce such benefits because production is outside the country. When import pressure is lower, domestic producers should increase their production and competitiveness. That will ultimately create more jobs and income for domestic households. An increase in income encourages consumption and encourages higher economic growth.

But critics argue that trade protection will only benefit one party but harm the other. That leads to inefficiency in resource allocation

Protection is detrimental to domestic consumers. They have to bear a higher price. Also, they have fewer choices. Some imported products may offer features that they cannot get from domestic products.

Also, protection makes domestic producers lazy. They become very dependent on government policies to support their competitiveness in the international market.

A decrease in the intensity of competition also has the potential to weaken the domestic industry. Without competition, there is no incentive to be more innovative and more efficient.

Finally, protectionism triggers strong retaliation from partner countries. That can lead to a trade war, which can damage the economy. Not only the countries involved, but it also harms other countries. The most recent example is the trade war between China and the United States, driving the global economy into uncertainty.