Policies To Mitigate The Costs Of Globalisation

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1) Trade policies:

a) protectism

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protectionism refers to the partial or complete protection of domestic industries from foreign competition in domestic markets

solves:

current account deficit

exposure to increased competition from the global economy

vulnerability to external shocks

structural unemployment

protectionism can take the following forms:

a) Tariffs

b) import quotas

c) exchange controls

d) physical controls

e) exploitation of differences in technical regulations and standards

f) preferential state procurement policies

g) bureaucratic administrative regulations covering import procedures

h) voluntary export quotas/restraints (VERs)

i) subsidies to domestic producers (export promotion)

import controls like tariff and quotas can be adopted to switch expenditure from imports to domestically produced goods. they limit imports to correct trade deficit

or govts can encourage domestic production by subsidies

a) Tariffs

taxes levied by the government on imports of a particular good are called tariffs

they can take 2 forms:

- specific: a fixed amount imposed per unit of the good imported

- ad valorem: which is a fixed percentage of the px of the pdt

let us consider the effect of a tariff in the case of a small country which is too small a buyer of the pdt in the world to influence the world px of the good (by varying its dd for imports). it is thus a px taker. hence the world ss curve is horizontal as ss is perfectly px elastic

(diagram)

in the case of autarky (economic independence/self-sufficiency), production would occur at the intersection of the domestic demand and supply curves

however, there are gains for trade instead of autarky. let us observe how much of a good a small country gets to consume with trade, both in the absence of a tariff and after the imposition of a tariff

before the tariff:

as mentioned, the small country is a price taker. hence it will take the world px, Pw

at Pw, total consumption by the small country is at Qd

out of this Qd units consumed, Qs was produced domestically. this is the qty of goods that domestic producers would be willing to supply at the world px.

since Qd units were consumed but Qs was produced domestically, the remaining qty QsQd is imported

After the imposition of the tariff:

upon the imposition of the tariff (which acts as a tax on imports), the world supply curves upwards to world supply + tariff (intuitively it becomes more expensive to buy from the world now)

and the px increases to Pw+t

due to higher world px, domestic producers are now incentivised to increase their Qs to Q1 which is greater than Qs

at the same time, the higher world px Pw+t means that consumers in the small country would now reduce their Qd from Qd to Q2. imports are also reduced from QsQd to Q1Q2

evaluation:

welfare effects of a tariff:

gains:

-producers: because the tariff raises the px if the good from Pw to Pw+t and guarantees the domestic producers a bigger market, domestic sellers are better off as seen by the gain in producer surplus area A

-govt: govt also gains as the rev collected by the govt from the imposition of the tariff is shown by area C (however, this part will be spent on manpower resources such as extra custom officials and administrative officers to enforce and administer the tariff. This socially unproductive use of resources increases the deadweight loss of the tariff)

losses:

consumers: domestic buyers are worse off because of the higher px which forces then to cut down on the Qd of the good. the loss in consumer surplus is seen by areas A+B+C+D

effectiveness of a tariff:

the effectiveness in controlling imports is however dependent on the px elasticity of home dd for imports (which must be elastic) and the px elasticity of domestically produced import substitutes (which must also be elastic)

for tariffs to be effective at curtailing imports, home dd for imports must be px elastic, such that when the px of the good increases, there will be a mtp decrease in Qd for imports from Qd to Q2. as such, import expenditure will decrease

domestic supply of import substitutes must be px elastic for the tariffs to be effective in curtailing imports. if so the higher px would mean that there would be more than proportionate increase in Qs of the good from Qs to Q1. As such export revenue would increase

if domestic ss of import to substitutes were to be px inelastic then it means that domestic output cannot be increased as easily even with the higher pxs as an incentive to domestic producers

b) import quotas

refers to a limit in the qty of a good that is produced abroad and sold domestically

an absolute quota fixes a limit on the amount of imports. it prevents the consumers from getting the imported goods once the quota is exhausted.

it is thus an effective instrument for restricting the volume of imports.

the power of import quotas has diminished because foreign manufacturers have started building plants in the countries to which they had previously exported to in order to avoid such regulations

eg: many japanese car manufacturers such as toyota have set up production plants in the US to produce cars for the north american market

a tariff quota sets a fixed limit on the amount of imports, beyond which a higher rate of duty is imposed. it does not absolutely prevent goods from crossing the frontier of a country as the importer could obtain units beyond the quota by paying a tariff for the extra units. the effectiveness of tariff quotas is dependent on the elasticity of dd for imports

c) exchange controls/foreign exchange restrictions

it is possible to restrict imports by the exchange control method. this requires 2 or more foreign currencies held by individuals to be surrendered to the govt, so that all requirements of foreign exchange have to be obtained from the govt through a license

thus the govt can decide the volume of imports and the priorities for imports

the disadvantage of such a measure is to restrict the spending power of the consumers and consequently, a lower SOL of the country

d) physical controls

a complete ban, an embargo (imposed for political and not economical reasons) may be placed on the imports or exports of certain goods. such measures are not desirable because they prevent trade altogether and are often difficult to enforce

i) subsidies to domestic producers (export promotion)

promote export of its domestically produced goods

subsidies and tax rebates to exporters: however this might encourage inefficient producers to continue producing. they might be too dependent on govt subsidies that they become less competitive in the global market

ss-side policies: improving quality of its goods or reducing its px via R&D or increasing productivity of workers through training. this policy might be costly but it helps the country to retain or regain its competitiveness in the world market in the LR

Economic arguements for protectionism:

1) to protect infant industries (more applicable to less developed countries)

infant industry is a newly established industry. because it is new it lacks the business goodwill of its more established competitors to realise its potential comparative advantage

at the same time it tends to produce at a higher per unit cost due to its smaller scale in production. this makes it even less competitive on a global scale

in a case like this a country may benefit in the LR if such an industry is allowed to develop. it can then eventually become efficient enough to develop its efficiency to the point where it would be able to compete woth the foreign competitors without any protection.

in the SR consumers will be faced with higher pxs of domestic goods however in the LR there will be gains in the form of lower pxs of these goods as the industry comes of age and other indirect benefits like increased employment and income.

if the LR gains outweighs the SR losses then the country should offer protection to firms in an infant industry

limitations:

protection could result in complacency and they will remain as perpetual infants. protection enables them to survive despite being inefficient and inward-looking

thus economis welfare decreases due to inefficiency amd higher pxs of domestic goods

it is also difficult to identify the industries that have the potential to enjoy EOS. identifying the wrong industries for protection may prove to be costly as it leads to LT loss of consumer welfare and misallocation of resources

2) protect domestic industries and safeguard home employment

trade restrictions may be used esp in times of recession to protect domestic firms and jobs

as import penetration rises domestic firms can come under increasing pressure to maintain sales and the less successful ones will have to lay off workers and some may completely shut down. this can result in considerable structural unemployment

govts in developed countries may bow to the pressure of trade unions to impose trade sanctions on imported goods that are in direct competition with the domestically produced goods

limitations:

could create a beggar thy neighbour effect. protectism results in a fall in income and purchasing power for its trading partners. this will harm the domestic country herself as it eventually results in the fall in their demand for her exports causing a fall in AD leading to a multiple decline in the domestic country's income and output and worsening the recession

3) Protection against low wage foreign labour

4) protection against unfair foreign competition

economic arguements against protectionism

1) economic inefficiency

curb the progress of international trade

protecting the high cost domestic firm would only perpetuate the problems of inefficency and misallocation of resources as firms produce goods that they dont have a comparative advantage in

(use tariff diagram to illustrate welfore loss)

2) does not solve the root cause of the problem

do little or nothing about the underlting causes of the trade deficit or structural unemployment but simply attempt to solve the problem by cutting off imports

3) Beggar-Thy-Neighbour effect leading to retaliation leading to decrease in world trade

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