Friday, August 28, 2009

Protection

The term protection refers to a policy whereby domestic industries are to be protected from foreign competition. The aim is to impose restrictions on the import of low priced produces in order to encourage domestic industries producing high priced products. The domestic industries may be protected by imposing import duties which raise the price of foreign goods by more than the price of domestic goods. Or they may be protected by quotas or other non-tarrif restrictions which make imports of cheap foreign goods difficult or impossible. Or the domestic industries may be paid subsidies or bounties to enable them to compete with cheap foreign goods.

Arguments for Protection:

Haberler has divided the arguments for protection into two groups economic and non-economic. These are discussed as under.

A. Economic Arguments: The economic arguments given in favour of protection are:

1. Terms of Trade arguments: Terms of trade arguments is given to correct disequilibrium in the balance of payments of a country. It is argued that imposition of a tarrif on imports improves the rate at which the country’s exports are exchanged for imports. This means that a tarrif improves its terms of trade because the foreign exporter is forced to pay some part of the import duty. The extent to which a country can improve its terms of trade by imposing import duty will depend upon relative demand and supply elasticities at home and abroad. A country which imports a large quantity of a particular commodity (i-e demand is less elastic) will be in a better position to impose a tarrif duty and improve its terms of trade them a country which imports a small quantity of a given commodity (i-e demand is elastic).

However there are certain adverse effects on the tarrif imposing country, first, the terms of trade may be improved but the volume to trade of the tarrif-imposing country is reduced. Second the imposition of tarrif increases the price of the imported commodity to the domestic consumer. Third it may lead to retaliation by the other country. Thus too high a tarrif leads to the reduction in consumer’s satisfaction, mal allocation of domestic resources with the reduction in the volume of trade, and retaliatory tarrifs harm the economics of both the countries.

2. Bargaining argument: It is argued that the imposition of tarrif’s is necessary to bargain in trade negotiations with other countries. Since international trade is based on reciprocal basis, tarrif is used as a weapon to persuade or dissuade the other country to lower its tarrif wall. Thus the fear of the tarrifs may induce countries to give reciprocal concession to each other. Cut the bargaining argument for protection is not sound on many counts. First tarrif as a weapon for bargaining may lead to retaliation on thee part of the other country, thereby harming both the countries. Second vested interest may be created in the country which may be so powerful that they may not allow reduction in tarrif and reciprocal bargaining. So the bargaining arguments for protection are fallacious one.

3. Anti-dumping argument: Protection is advocated against the practice of dumping. Dumping means selling a product in a foreign market at a lower price than in home market, after taking into account transport and other costs of transfer. Dumping aims at flooding a foreign market with low priced commodities. As a result the import competing firms are ruined. To protect such firms, a high tarrif is imposed. This will raise the price of the product in the importing country and removes the threat of dumping.

4. Diversification argument: Another argument advanced in support of protection is to diversify the domestic industries. It means that there should be a balanced growth of the economy so that all the sectors of the economy develop side by side. For this purpose agriculture and manufacturing industries should be protected from foreign competition. This is a valid argument for experience has shown that the countries which are not developed in balanced way are affected more by international economic disturbances. Therefore they should diversify and become self sufficient by protecting their industries. But it is not possible to diversify completely.

5. Infant industry argument: The infant industry argument is the oldest and the most accepted argument for protection. This argument “rests on the assumption that the country has a latent comparative in the industry or group of industries to be protected”. It is therefore argued that if industries in their infancy are not protected from established foreign producers, they can not develop to enjoy the comparative advantage. For this they must attain optimum size so as to operate most efficiently and competitively and to produce at lower cost. Protection is also needed to facilitate the flow of resources into infant industries, even though consumers have to bear the burden of higher prices temporarily. Economic justification lies in that the social returns will exceed the private returns from investment in such industries. The argument runs that infant industries require time to undergo the process of learning by doing to become competitive in the long run. Therefore they should be protected.

6. Socially important or Key industries argument: Protection should be given to socially important industries such as agriculture, iron and steel, heavy electrical, machine making heavy chemicals etc. There is no dispute over this argument because the development of Key and other socially important industries under protective tarrifs is out of the principal aims of trade policy in a country.

7. Employment argument: A usual argument for protection is that it is a cure for unemployment. The imposition of a tarrif reduces imports and encourages employment directly in import competing industries. This in turn generates employment in other industries dependent upon this import-competing industry and may even spread to import substitution industries. According to Prof. Haberler unemployment in one single industry can be reduced by a tarrif on the competing imports provided the demand for its products is not completely elastic and its products compete with similar imported products. But this does not mean the total unemployment will be diminished. The critics argue that tarrif is not likely to reduce unemployment because a restriction of imports will lead to a reduction of exports. While unemployment may be reduced in import competing industries, it will increase in export industries. As pointed by Keynes “If a reduction of imports cause almost at once a more or less equal reduction of exports obviously a tarrif … would be completely futile for the purpose of augmenting employment”. But Keynes gave two arguments to show that a protective tarrif might lead to increase in employment provided exports are maintained at the old level. First if the tarrif imposing country lends to foreign countries, its exports can be maintained at old level, and the increase in employment in the import competing industries will not be offset by reduction in employment in export industries – second exports can be maintained at the old level, if subsidies are given to export industries out of the reserve from import duties.

But critics do not agree with Keynes on the adoption of these methods. They argue that lending to other countries would divert capital resources from home investment which would reduce domestic investment, thereby reduction total employment in the country. On the other hand the grant of subsidies to export industries would lead to retaliation by other countries which would levy anti dumping duties. Thus it is not possible to increase employment by imposing protective tarrif.

8. Balance of Trade argument: The balance of trade argument is based on the notion that a country should impose tarrifs to have a surplus of exports over imports. Such a surplus brings bullion into the country. But this is not corrective view because if all countries follow the same rule, none would gain. Moreover, a surplus of exports over imports can not continue over the long run. An inflow of gold would raise prices and an outflow would lower prices. Thus in the long run, exports must equal imports. Moreover the balance of trade argument in this case is not valid these days because there are no free movements of gold among countries.

9. Pauper labour argument: It is argued that goods produced by workers getting high wages in one country can not compete with goods produced by low-wage workers in the other country. Therefore high wage domestic goods should be protected from low wage imported goods by imposing tarrifs.

This argument is based on two unrealistic assumptions. First, the prices of goods are determined by wage rates alone and second, labour is the only factor of production. But the fact is that goods are manufactured by a combination of factors. Labour is combined with land and capital. It is only in the labour intensive goods that low paid can have a cost advantage over high paid labour is therefore fallacious to argue that high wage country is at a disadvantage in the production of all types of commodities.

10. Keeping money at home argument: This is also one of the fallacious arguments for protection. This argument suns as follow “When we buy manufactured goods abroad we get the goods and foreigner gets the money. Where we buy manufactured goods at home we get both the goods and money”. This argument is illogical because if every country were to follow this rule, there would be no international trade and benefits of it would not accuse to any country of the world. A country buys goods from another country because the latter offers them at lower prices than the domestic manufacturers. Buying goods produced by domestic manufacturers would therefore mean loss to the consumers. Moreover in international trade domestic currency can not be used for making payments to foreigners. Infact goods pay for good and payments if any are made in the international currency. Thus as pointed out by Beveridge this argument has no merits.

11. Expanding home market argument: This is a corollary to the above argument of keeping money at home. According to this argument protection should be given to new industries and the workers engaged in them would create a good market for other domestic products. This would expand the home market for all domestic products including agricultural commodities. This is again a fallacious argument because the home market would expand at the expense of foreign market for exports. When imports are restricted by the imposition of tarrif duties, exports also decline because the other countries would retaliate. Moreover domestic producers will charge higher prices for products of domestic industries and the consumers will be the losers.

12. Equalisation costs of production argument: Protection to domestic industries is advocated for equalising costs of production of domestic and foreign products. If for example, the domestic costs are higher than foreign costs by 25 percent an import duty of 25 percent should be imposed on foreign products. Thus costs of production of both domestic and foreign products are equalised and they can compete on equal terms. Such policy would lead to giving protection to the least efficient industries with highest costs of production. It thus “discriminates in favour of inefficiency producers against efficient ones, and against the general body of consumers”.

B. Non Economic Arguments: There are two important non-economic arguments for protection which are described as under.

1. Defence argument: A country should adopt the policy of protection from the stand point of national defence. If a country is dependent on other countries for its requirements of agricultural and industrial products, it will be very harmful for its national interest in times of war. The argument runs that it is no use amassing wealth and becoming richer, if the country is not in a position to defend its freedom. As aptly put by Adam Smith “Defence is better than oputence”. Therefore a country should be self sufficient as far as possible even if it involves an economic loss in the production of certain commodities which are needed for national defence. In particular protection for national defence refers to self sufficiency in arms and ammunitions and other related industries. But complete self sufficiency as an argument for national defence does not carry much force for it will lead to inefficiency in domestic industries and loss of the gains from international trade. Thus industries which are directly and indirectly needed for the manufacture of arms and ammunition and other war materials should be developed under protection.

2. Preservation argument: Protection is advocated to preserve the special ethos of the nation and certain classes of the population or certain occupation. It is argued that these would tend to disappear under free trade and their preservation is desired on political and social grounds. This argument is put forth to safeguard the interests of the agriculturists. The imposition of agricultural duties on the import of farm products is beneficial for the farmers who would be assured fair prices for their products. They would thus become prosperous. The prosperity of peasantry is essential for it forms the back bone of every nation. Therefore agriculture should be protected from foreign competition at all costs to preserve the special ethos of the nation.

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