Okay, so let's say that you are a domestic producer who is losing out to foreign competitors
because you have the comparative disadvantage in production relative to that foreign producer.
You've gone to the government to ask for help in the form of trade restrictions, but what
type of restriction will be put into place?
Let me walk you through the various tools that could be used, and how each would affect
not only the market, but the players in that market.
Let’s start with the tariff.
A tariff, by definition, is a tax on traded goods.
Technically, this could mean a tax on imports (which we'll be examining more detail), or
on exports -- but in the US, we tend to think of tariffs only in terms of the taxes on imported
goods, intended to make the foreign imports less attractive to US consumers.
In fact, export taxes are unconstitutional in the United States.
Think about it: what was one of the major gripes of the colonists under British rule?
Taxation without representation, right?
Like the Boston Tea Party, where colonists who objected England taxing their exports,
dressed as natives and dumped a shipment of tea into Boston Harbor.
Anyway, when discussing tariffs, let's stick to analysis of taxes on imported goods.
The tax on imported goods makes those goods more expensive, and consumers purchase domestic
goods instead.
Are there any other effects of such tax?
When examining the effects of any policy, I like to ask the question, “Who wins, and
who loses as a result of this policy?”
But in order to do that, I’d like to imagine for a moment what the domestic economy would
look like with no trade.
Let's say that we're looking at the domestic market for steel, with no trade.
We've got the domestic demand for steel, the domestic supply of steel, and the resulting
equilibrium price and quantity in the steel market.
Now, suppose we open up this market to foreign competition.
Who will win as a result of free trade, and who will lose?
Since we’re discussing protectionist policy in this video, I'm going to assume that the
domestic steel producers are at a productive disadvantage vis-à-vis their foreign counterparts;
i.e., the foreign producers can sell their steel at lower price, PF, than the domestic
no-trade equilibrium price, P*.
To compete, domestic producers will have to offer this price as well.
But what is the quantity supplied at this new, lower price?
For our domestic producers, it's pretty low.
But how many domestic consumers will want to purchase at this price?
A lot.
And how do we make up the gap between the large amount our consumers want to buy at
PF and the small amount that our producers are willing to provide at this price?
We’ll need to fill the gap with imports, or steel purchased from foreign producers.
So compared to a situation of no trade at all, who wins (and who loses) with free trade?
On the winning side, we have our domestic consumers, who can now purchase lots of steel,
at lower prices than before, and clearly foreign producers benefit, because they’ve now expanded
their sales into our market.
On the losing side, we clearly have the domestic steel producer, who sells much less product
than before, at a much lower price, and therefore also workers in the steel industry, where
wages and jobs will be declining.
So this producer, facing losses under free trade, goes to the government and lobbies
for assistance in the form of a tariff (T) on incoming goods, so that the price of the
imported steel will actually be PF plus this new tariff, T.
Now this tariff won't be so high as to close off trade altogether -- much as our producers
might like that -- but the tariff-inclusive price will end up somewhere between the free
trade price, PF, and the no trade price P*.
So going from a situation of free trade to a situation of restricted trade, who wins
and who loses?
Compared to free trade, there will be a larger quantity supplied in the domestic market at
this higher price, also meaning more jobs and better salary, so domestic industry wins
as a result of the tariff.
You could also say the government wins, because it gets the tax revenue on any imports that
come in, or the tariff “T” times that gap, [quantity demanded minus quantity supplied]
-- whatever's being imported into the country.
Who loses?
Well, any domestic consumers are now facing higher prices, and as a result, have a decreased
quantity demanded.
At the higher price, notice the gap between the domestic quantity demanded and the domestic
quantity supplied is smaller than it was under free trade, meaning that imports are declining,
so the foreign producer loses out.
The second type of trade restriction is a quota.
Where the tariff was something of an indirect restriction, giving domestic consumers the
incentive to buy the domestic product rather than the foreign product, the quota is a very
direct restriction, putting limits on how much of the foreign product is allowed into
our market.
This could be either a quantity limit (say, only 1000 units imported), or a value restriction
(for example, allowing only $1 million worth of the product to be imported).
It looks something like this: if we start from a position of no trade at all, we have
the domestic demand and supply.
Now if we allow free trade, we add the foreign supply to our supply.
This drives the price down, leading to a situation for domestic producers that you saw earlier:
lower price, and diminished sales.
Now, what if the domestic producer goes to the government requesting protection in the
form of a quantity quota, say, 100 units would be allowed into our market?
Watch what happens to supply: the total supply of the product -- that is, our supply plus
the foreign product that’s being allowed in -- is not as large as the total supply
under free trade.
This means the price is now higher, so the quantity supplied by domestic producers is
larger than it would be under free trade, while imports of foreign goods are now smaller.
Who wins?
Domestic producers, domestic workers, and possibly the government, if it earns revenue
by selling quota licenses.
Who loses?
Domestic consumers and foreign producers.
Note that although tariffs and quotas are very different tools, the end result of the
restrictions is the same.
In fact, for every tariff, there is a tariff-equivalent quota.
Due to trade agreements (which I’ll get into in the next episode, GATT/ WTO), tariffs
and quotas have actually declined in use over the years.
But let me ask you this: if you're a domestic industry whose livelihood is being threatened
by foreign competition, but your government has signed an agreement not to use tariffs
or quotas, does that mean you won't ask for any protection?
No; it just means that you'll try to lobby for some other form of restriction.
For example, when an agreement was made to reduce the number of quotas around the world,
voluntary export restraints (or VERs) became more popular.
With a VER, the foreign government “volunteers” to restrict its own exports into our market.
If that sounds pretty much like you quota to you, that's because it is just like a quota.
The only difference is in whose government establishes the restriction.
Why would government restrict its own country's exports?
Because we ask them to.
In 1992, George Bush Sr. had his infamous dinner with the Japanese prime minister.
What made the news was the fact that President Bush became ill at dinner; what got lost was
that the trip was actually to get the Japanese government to agree to stop selling so many
car parts in our market.
They said no.
Another type of restriction that’s used is health and safety regulations.
Sometimes you can clearly tell that a health and safety regulation is -- or isn't -- about
health and safety.
Other times, a regulation is more of a gray area that could require international intermediation.
For example, in the 1980s, the Japanese government said that only Japanese producers could properly
engineer and manufacture skis that were safe on Japanese snow.
Yeah - that one never went into effect.
In the 1990s in the US, it was found that several types of Chinese-produced crayons
being sold in the US had high lead content, and the US government refused to allow any
more imports of those crayons until they were reformulated.
That seems like a pretty clear health and safety concern, because small children, who
are the primary users of crayons, like to eat crayons.
But what about more recent concerns about genetically modified foods, for example, sometimes
referred to by the media as “Frankenfoods”?
For instance, in the US people don't want just steak, but they want a nice, BIG, juicy
steak.
How you get a bigger, juicier steak?
By having bigger cows!
And so, cattle are injected with hormones.
Now, US scientists say that this beef is perfectly safe, and that foreign countries are using
concerns about health and safety associated with this product as an excuse to block trade.
The foreign governments say that there really hasn't been enough time to evaluate the long-term
health effects, so they won't buy US beef because it's a health and safety concern.
In the end, who's right?
To mediate such disputes, the World Trade Organization (formerly GATT) was created -- but
you'll hear more about that in the next episode.
NEXT TIME: GATT/ WTO TRANSCRIPT00EPISODE 36: TYPES OF TRADE RESTRICTIONS