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What’s is: Trade restriction refers to the various barriers that make the flow of goods and services between countries immobile. If the barriers come from government policies, we call it trade protection.
Trade restrictions affect the demand for and supply of goods and services on international markets. Specifically, trade protection prevents market forces from operating freely to determine the equilibrium quantity and price. As a result, protection results in an inefficient allocation of resources on a global scale.
Trade restrictions may still exist today, but they are much less than before. The increasing role of multinational companies and international institutions (such as the WTO) erodes these barriers.
Also, the establishment of regional economic integration in various countries contributes to reducing trade barriers between member countries. Not only goods and services, but such integration also allows factors of production (such as capital and labor) to flow freely among member countries.
Reasons for trade restriction
Without barriers, international trade allows for the efficient allocation of resources. Goods, services, and production factors flow freely to various countries.
Proponents argue that free trade brings prosperity to society because people have a greater choice of products to meet their needs. Workers also move easily to countries that offer better opportunities. And for companies, the market for their products is broader, not only domestic.
However, the free flow of services and factors of production may not be suitable for some countries. For that, they impose trade restrictions. Specifically, some reasons why a country imposes restrictions on trade are:
- Protecting established domestic industries from foreign competition. If foreign goods and services easily enter the domestic market, it increases domestic competition.
- Keeping infant industries until they become mature and internationally competitive. Some countries want to make sure their strategic industries thrive. Such industries usually contribute to national security, employment, technology, or value chains with various other industries.
- Securing domestic employment and income. Imports benefit foreign producers as money flows from domestic to them. Besides, when imports increase, they will increase production. It creates jobs and income in their country but not domestically.
- To generate government revenue, the government obtains a source of income other than individual or business taxes by imposing import tariffs.
- Retaliating for similar restrictions imposed by trading partners. Countries do not like unfair trade practices by their partner countries, for example, dumping. Hence, it is in their interest to get even with the partner country.
Types of trade restrictions
Trade restrictions can take many forms, including:
- Import tariffs
- Import quota
- Embargo
- License requirements
- Standardization
- Subsidy
Import tariffs
Import tariffs are taxes on imported goods from abroad. The tariff’s effect is to increase the price of imported products when they enter the domestic market.
Tariffs can take the form of:
- Ad-valorem tariff. The value is based on a certain percentage of the original price of the imported product. Although the percentage is fixed, if the price changes, the nominal import tariff will also change.
- Specific tariff. It is based on a fixed nominal. An example is $100 per tonne of the imported product.
As the price of imported products rises, domestic buyers may be less interested in buying them. The hope is that they will switch to domestic products.
Import tariffs benefit domestic producers by reducing their competitive pressure and allowing them to capture higher sales.
Furthermore, for the government, tariffs are a source of income. The higher the tariff, the greater the government revenue.
However, tariffs also raise another problem. Domestic consumers bear a higher price. They may not want to switch to domestic products because they can only get some features from imported products.
Import quota
Import quotas limit the quantity of goods entering the domestic market, essentially creating a cap on the amount that can be imported. This directly reduces supply. Imagine a store with a limited stock of a popular item.
In this scenario, if domestic producers cannot compensate by increasing their own output to meet the remaining demand, quotas create shortages. This is because there’s an excess demand for the limited supply, leading to a situation where people want to buy more than what’s available.
As a result, the price of domestic goods inevitably rises. This can be beneficial for domestic producers who face less competition from imported goods and can potentially charge higher prices. However, domestic consumers are the ones who bear the brunt of this strategy. They have to deal with higher prices due to the market shortage and may have fewer choices of products available.
Embargo
An embargo is a political decision to stop transactions with individual countries, including export or import activities. Embargoes may only apply to some products or include all goods and services.
Embargoes are often for political rather than economic reasons. For example, the United States banned arms sales to Indonesia from 1999 – 2005 because it considered Indonesia to have committed human rights violations in the East Timor case.
Embargoes are more likely to come from economically strong countries such as the United States than from developing countries. It becomes a form of political punishment to isolate a country.
License
Some countries use import or export licenses to restrict trade. To ship foreign goods into the domestic market, importers must obtain a license.
The government can limit the granting of import licenses. For example, the government may not issue licenses for certain products from certain countries for specific purposes.
Meanwhile, export licenses reduce shipments of goods abroad. They are usually used to restrict trade in certain products or to keep domestic prices from rising.
Producers may be more interested in selling abroad at a higher price. They then increased their exports. An increase in exports reduces supply in the domestic market. If, at the same time, producers do not compensate by increasing production, it is likely to lead to a shortage, pushing prices up.
Standardization
Standardization refers to establishing specific requirements that products must meet before they can be sold in a particular market. These standards can encompass various aspects, such as health, environmental safety, and even local content requirements.
Think of it as a set of criteria a product needs to pass to be deemed fit for the market. Governments can strategically use standardization to limit imports. They can raise these standards to a level where fewer imported products qualify, effectively reducing the number of foreign competitors in the domestic market.
While this might seem like a good way to protect domestic industries, it can also have unintended consequences. By making it harder for foreign products to meet the stricter standards, the variety of choices available to domestic consumers shrinks.
Subsidy
Subsidies work in reverse with import tariffs. Instead of imposing import duties, the government provides grants to domestic producers to encourage exports.
Subsidies can take many forms, including reduced production costs, cheaper access to credit, or subsidies on the price of goods exported.
Subsidies make domestic goods more competitive when entering international markets. Manufacturers charge low prices for their export products.
The source of subsidy payments is tax revenue. So, indirectly, it is not the government that pays taxes but the taxpayers. Households or businesses may not use the product.
Pros and cons of trade restrictions
Trade restrictions, like government policies that limit trade between countries, are a complex issue with both potential advantages and disadvantages. While they’re often implemented to safeguard domestic industries, they can also have unintended consequences for consumers and the overall economy. Let’s delve deeper into the pros and cons of trade restrictions.
Benefits of trade restrictions
Nurturing infant industries: Imagine a young sapling – it needs protection and care to grow strong enough to withstand harsh winds. Similarly, new industries, often called “infant industries,” may require temporary shelter from fierce foreign competition. Trade restrictions like import tariffs and quotas can provide this breathing room, allowing domestic companies to develop their skills, technologies, and production efficiencies. Once they’re established and competitive, these restrictions can be eased, allowing them to compete on the global stage.
Safeguarding domestic jobs: In today’s interconnected world, intense competition from countries with lower labor costs can threaten domestic jobs. Trade restrictions can act as a buffer, making imported goods more expensive and encouraging consumers to buy domestic products. This can incentivize businesses to hire locally, supporting domestic employment and fostering a sense of economic security.
National security considerations: Certain goods and technologies are deemed crucial for national security. These might include strategic materials, advanced weaponry, or cutting-edge communications equipment. Governments may use trade restrictions to control the import and export of such goods, ensuring they don’t fall into the wrong hands and potentially compromise national security.
Drawbacks of trade restrictions
Higher prices for consumers: Think of a grocery store with limited options. Trade restrictions like tariffs and quotas act like an invisible hand, limiting the variety of imported goods available. This often leads to higher prices for consumers, who have fewer choices and may end up paying more for products that might be of lower quality compared to what they could get in a free trade environment.
Reduced innovation and efficiency: Competition is a powerful driver of innovation. When shielded from the pressure to compete with foreign companies that offer better or cheaper products, domestic producers may have less incentive to innovate and improve their own offerings. This can lead to stagnation in the long run, hindering overall economic efficiency and potentially harming domestic industries in the future when they eventually face global competition.
Deadweight loss: Imagine a delicious pie! Trade restrictions are like putting a smaller plate on it, leaving less pie for everyone to enjoy. By limiting trade, both countries involved miss out on potential gains from specialization and efficient production. One country might be better at producing textiles, while another excels in making electronics. Free trade allows them to focus on their strengths and exchange goods, creating a bigger economic pie for everyone to benefit from. Trade restrictions shrink this pie, leading to a phenomenon called deadweight loss, where everyone loses out on potential gains.
