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, it had been 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 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. By imposing import tariffs, the government obtains a source of income other than individual taxes or business taxes.
- 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
- License requirements
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.
Tariff 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.
For domestic producers, import tariffs bring benefits to them. That reduces the competitive pressure on them. It also allows 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.
Quotas limit the quantity of goods entering the domestic market. Quotas reduce supply. If domestic producers cannot compensate by increasing output, quotas create shortages (excess demand). As a result, the price of domestic goods rises.
Domestic producers benefit from less pressure on imported goods. But, for domestic consumers, they have to bear higher prices as the market faces a shortage.
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, it may 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.
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. The government may not issue licenses for certain products from certain countries for specific purposes.
Meanwhile, export licenses reduce shipments of goods abroad. It is usually 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 can take many forms, including standards for health, environmental safety, and local content requirements. To limit imports, the government can raise standards and reduce the number of products that fulfill them.
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.
Negative effects of trade restriction
Trade restrictions benefit one party and raise costs for the other. The main problems caused by trade restrictions are higher prices for consumers, lower quantities of supply, and deadweight losses.
Trade barriers increase costs and selling prices. For example, when tariffs apply to consumer products, domestic buyers have to pay more. If that applies to imports of raw materials and capital goods, production costs will be more expensive. Manufacturers are likely to pass the increase in costs to the selling price of the product.
Under free trade, consumers have access to more products. The supply of some products such as luxury goods relies on shipments from abroad because they are not produced domestically. Therefore, they have more choices, either in terms of price or quality.
Imposing trade restrictions will only have the opposite effect. It reduces domestic consumer choices.
For example, the imposition of tariffs makes the selling price of goods more expensive and less competitive. Importers see these conditions as unfavorable, making them less interested in importing goods.
The effect of the restriction on supply is more apparent in the case of import quotas. Quotas reduce the quantity of goods that enter the domestic market.
Reduced supply not only raises prices, but also reduces options for domestic buyers. Some imported products may have features or qualities they cannot find from domestic products.
Damaging future competitiveness
Trade restrictions were initially intended to protect domestic industries. However, sometimes, instead of becoming more competitive and efficient, such protection makes domestic producers lazy to innovate. Their competitiveness has not improved over time. And, they become very dependent on government protection.
Such situations do not lead to prosperity and better conditions. It actually leads to increased monopoly power, political lobbying, bureaucratic corruption by domestic companies.
Domestic firms have less incentive to invest in technological advances or research and development. Because there is little incentive to provide superior products, the quality of products in the economy decreases over time.