Protectionism

Protectionism - How Tariffs Work

• When businesses, jobs and incomes are threatened, it is very tempting for governments to try and protect sectors that are vulnerable to competition from abroad. The obvious way to do this is to control imports. This can be done using tariffs or quotas or a combination of measures. These are the elements of protectionism, which can be used to keep businesses going and preserve jobs when competition is a problem.
• Tariffs are usually intended to protect sales of domestic products from competitive important substitutes. The substitute may or may not be a good one.

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• Tariffs can be used in a range of circumstances:
• - they can protect specific industries or sectors from foreign competitors. Many developed countries want to protect their agricultural sectors.
• - tariffs raise tax revenue; if demand for the relevant import is inelastic, people will continue to buy it even thought the price is higher; the government will collect taxes that can be used to fund public expenditure.
• - tariffs can be used to deter dumping. This occurs when the exporter is selling the product at a price below the cost of production. Consumers are often pleased to be able to get a very cheap import but a business that is competing with dumped imports will usually feel very aggrieved.

Tariffs and Elasticity

• When tariffs cause prices to rise, demand may be price inelastic. This means that many customers will simply buy the imported item anyway and pay the higher price. This leaves them with less money to spend on other things. Tariffs on cars or video games may help domestic manufacturers to increase sales revenue - the protection means they can charge a higher price and probably sell more too. Businesses, their employers and their shareholders will be happy. But if that leads to people having less money to spend on meals out, restaurant owners and their employees will be unhappy.

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• Tariffs have a range of consequences that may not be obvious when they are introduced:
• - consumers have to pay higher prices for imports. If their demand for the product concerned is price inelastic, many will continue to buy the import. Higher prices reduce their purchasing power and their demand for other products.
• - when country A uses tariffs to cut imports, sales fall in the exporting country, B. Businesses there will reduce output, making some employees redundant. Incomes in country B will fall; businesses and individuals will have less money to spend on imports. Even if country B does not retaliate, it will cut back on buying country A's exports.

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• - tariffs reduce competition. Inevitably, businesses that are protected have little incentive to produce efficiently. With tariffs in place they can relax a bit. Overtime, they may lose the capacity to strive for efficiency, cut costs and sell at keen prices. Ultimately, their customers will be the losers.
• Trade protection can have very serious consequences and can turn a recession into a depression. Domestically produced goods may have imported components. Tariffs on these would rise prices, making the domestic producer less competitive both in the home market and in export markets. Such unintended consequences would be hard to avoid.

Quotas

• Quotas set a physical limit on imports of individual products. If demand is at a low level anyway, they will make no difference. But if demand is high, the price will be pushed up. Consumers will pay a higher price for a smaller quantity than they would ideally like to buy.
• Exporters who are faced with quotas may in fact make increased profits from the higher prices they can charge when quantity is restricted. This will happen if there are few domestically produced competing products, i.e. good substitutes. The more price inelastic demand is, the more the price is likely to rise when a quota is imposed. Quotas almost always inhibit competition, leading to inefficiency.

Other Trade Barriers

• There are other kinds of protectionist policies, besides tariffs and quotas:
• - using subsidies to help a domestic industry can help it to compete. They may finance investment that raise productivity and cuts costs. Or they may simply allow the business to survive recession and continue in easier times.
• - keeping the exchange rate undervalued is a form of protection. The US government has sometimes accused China of manipulating its exchange rate to keep it low and strengthen Chinese exporters' competitiveness.
• - safety standards can be used to protect domestic industries. Government legislation can be framed in such a way as to create rules that give an advantage to the domestic producer.

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• Any measure that restricts trade involves preventing some people from buying the cheapest or best-value supplier. So trade protection will always lead to lower real incomes in the long run. The problem is that industries do decline when competing imports become available and decline is painful. Some employees do lose their jobs and the value of shareholders' investments will fall too. Both groups will lobby the government, seeking protectionist measures.
• Businesses and people suffer from competition can become very vocal and sometimes get popular support for their efforts to get protection.