Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

abel197

theory of commercial policy-ba 2020-21

FREE TRADE

MEANING
Free trade policy refers to a trade policy without any tariffs, quantitative restrictions and other
devices obstructing the movement of goods between countries
...
Jagdish Bhagwati define free
trade policy, "as absence of tariffs, quotas, exchange restrictions, taxes and subsidies on
production, factor use and consumption"
...
Lipsey gives very simple definition "A world of
FREE TRADE would be one with no tariffs and no restrictions of any kind on importing or
exporting
...
"
Thus the policy of free trade means simply complete freedom of international trade without any
restrictions on the movement of goods between countries
...
Import
duties can be levied for revenue and not for protection even under free trade
...
Thus a country following the free trade policy
levies import duties which are lower than the cost advantage enjoyed by the lowest cost foreign
good
...
Of the modern economist
Haberler2 advanced the following arguments in favour of free trade
...
Maximization of Output
...
This maximizes the output of all the participating
countries because all gain from trade which, in turn, increases the real national income of the
world economy
...

2
...

Free trade leads to international specialization and geographical and territorial division of labour
...

As a result, the existing resources in each trading country are employed more productively and the
resource allocation becomes more efficient
...
Optimization of Consumption
...
This, in turn, has the effect of raising their standard of living
...
High Factor Incomes
...
They can move from one place
to another and between countries in order to earn more
...
There is increase in the real income of the
world economy and of its participant countries
...
Educative Value
...
International competition encourages
home producers to sacrifices leisure in order to increase productivity, for this, they innovate and
bring improvements in organization and methods of production
...
Wide Markets
...
As the demand for goods is not confined to
one country but to a number of countries, the entire world becomes the market for all types of
goods
...

7
...

Under free trade each country specializes in the production of a few commodities, and the firms or
industries are of the optimum size so that the cost of production of each commodity is the
minimum
...

8
...

Free competition and trade encourage nations to produce the best and the cheapest products in
order to gain more
...

9
...

Free trade encourages the development of the means of transport and communications not only
within countries but also among countries
...
The development of internet, E-Mail and E-Commerce has been possible due to more
freed trade globally
...


Promotes International Co-operation
...
International organizations like WTO arrange to
solve trade problems and promote international co-operation
...


Policy for Economic Development
...

THE CASE AGAINST FREE TRADE
The policy of free trade, with all its advantages noted above, was abandoned after the Great
Depression by the countries of the world
...
Laissez Faire and Perfect Competition do not exist
...
But these conditions do not exist in the present day world
...

2
...

Under the policy of free trade, some industries expand in which the country possesses
comparative advantage but other industries are not developed
...

3
...

There being no restrictions on the movement of goods under free trade, substandard and harmful
commodities are likely to be produced and traded
...
Trade
restrictions on the import of such commodities become necessary
...
Cut-throat Competition and Dumping
...
This led to cut-throat competition in the world market under free trade
...

5
...

Free trade leads to the emergence of international monopolies and local monopolies
...

6
...

This policy led to the exploitation and colonization of countries during the 19th and early 20th
centuries
...
Economic Dependence
...
Such a
country has to depend on the imports of varied types of consumers and capital goods, raw
materials, etc
...
Trade Cycles
...
But the danger of depression is more as was the case of the Great Depression of the
1930s and 2008
...

PROTECTION
MEANING

The term protection refers to a policy whereby domestic industries are to be protected from
foreign competition
...
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, the domestic industries may be paid subsides, or bounties to
enable them to compete with cheap foreign goods
...

A
...

1
...

The terms of trade argument is given to correct disequilibrium in the balance of payments of a
country
...
This means that a tariff improves its terms of trade
because the foreign exporter is forced to pay some part of the import duty
...

A country which imports a large quantity of a particular commodity, whose demand is less elastic,
will be in a better position to impose a tariff duty and improve its terms of trade than a country
which imports a small quantity of a given commodity whose demand is elastic
...
Here the world welfare will decline with a departure from free trade

theory of commercial policy-ba 2020-21

because the home country's gains in welfare are more than offset by the losses of welfare
occurring in other countries
...
Tariff by the home country reduces
demand for the foreign good on the world market
...
Tariff therefore has the potential to increase home welfare,
although foreign welfare will fall as the commodity terms of trade of foreign countries decline
...
However, there are certain adverse
effects on the tariff imposing country,
First, the term of trade may improve but the volume to trade of the tariff-imposing country is
reduced
...

Third, it may lead to retaliation by the other country
...

2
...

It is argued that the imposition of tariffs is necessary to bargain in trade negotiations with other
countries
...
Thus the fear of retaliation may
induce countries to give reciprocal concessions to each other
...
Anti-dumping Argument
...
Dumping means selling a product in a
foreign market at a lower price than in the home market
...
As a result, the import competing firms are ruined
...
This will raise the price of the product in the importing
country and removes the threat of dumping
...
Diversification Argument
...
For this purpose, agriculture and manufacturing industries should
be protected from foreign competition
...
Therefore, they should diversify and become self-sufficient by protecting their
industries
...
Infant Industry Argument
The infant industry argument is the oldest and the most accepted argument for protection
...
If
industries in their infancy are not protected from established foreign producers, they could not
attain the optimum size so as to operate most efficiently and competitively and to produce at lower
costs
...

Further, there may be "imperfection of the information flow" to infant industries in the form of
difficulty to borrow funds for investment, knowledge of infrastructure facilities, labour market,
etc
...
The economic justification of this
argument lies in the fact that social benefits exceed private benefits from investment in such
industries
...
Therefore, they should be protected
...
If it is protected by providing all types of facilities, such as subsidies, heavy
import duties on foreign goods, etc
...
It may
lead to external economies for all firms within the industry in the form of lower costs of
production through the availability of trained labour force, advanced production techniques,
research facilities, etc
...
When they attain adulthood, protection can be withdrawn and then they should
be left free to face foreign competition
...
Moreover, protection leads to its expansion and a lowering of costs and
prices which, in turn, benefits industries using the products of the protected industry
...

For protection to be profitable, it should be able to pay back the losses incurred due to protection
during the infancy period
...
It is then that the tariff should be withdrawn and at the same
time the increase in community welfare should be more than compensate for the loss in the earlier
years so that there are net benefit to the community
...
Difficult Decision
...
It is difficult to select genuine infant industries because it requires "forecasting the
potential cost structure of an industry, and its established competition
...
Lack of Reliable Criteria
...
But it is difficult
to decide about this due to the lack of any reliable criteria
...
Vested Interests
...

4
...

Even if a part of the industry is able to stand upon its feet some less efficient firms are always stay
behind the shelter of tariffs which make it difficult to remove the duties
...
Monopoly Profits
...
They, therefore, bribe the legislators and corrupt the general politics of the
country
...
External Economies do not exist
...
He has shown that alleged possibilities of external
economies under infant industry protection are vague, muddled and doubtful
...
LDCs can have
potential comparative advantage in one particular commodity
...
As a
result, such an industry cannot be developed in the face of foreign competition
...
Such protection is justified so long as the industry does not develop in size
and efficiency to such a level as to compete with foreign competitors
...

Unless an industry becomes capable of competing with foreign producers, protection should not
be removed
...
But
the experience is that once protection is given to an industry, it likes to remain an infant industry
for ever
...
Sunset Industries Argument
...
Some established
labour-intensive industries such as producing steel products, textiles, clothing, footwear, etc
...
This argument implies that sun is setting on such industries of Europe which should be
granted temporary protection so that they may be able "to re-equip and regain-competitiveness"
...

7
...

Protection should be given to socially important industries such as agriculture or strategically
important industries as iron and steel, heavy electrical, machine making, important chemicals, etc
...

8
...

The imposition of a tariff reduces imports and encourages employment directly in import
competing industries
...
But a restriction
of imports will lead to reduction of exports
...

9
...

Tariffs help in restricting the imports of unnecessary goods and try to reduce the balance of
payments deficit
...
The
expansion of the import-substitution and export sectors, in turn, raises employment and income in
the country
...
Consequently, more employment and income are

theory of commercial policy-ba 2020-21

generated
...

10
...


Tariffs are used to generate revenue for the government
...
But if governments depend more on
tariffs as a source of revenue, it may lead to some negative side-effects
...
On the contrary, in the case of
highly elastic demand, tariffs may stop trade altogether and reduce the government revenue
Similarly, taxes (duties) on exports reduce the sales of exports and foreign earnings, thereby
creating balance of payments difficulties
...
But the tariff rates should not be so high as to become prohibitive and harmful for the
country
...


Domestic Distortions Argument

The domestic distortions argument for tariff is based on the fact that the domestic factor and
commodity markets in an economy do not work under fully competitive conditions
...
Market
failures or distortions are due to monopolies, the problem of externalities, wage differentials, trade
unions, government activities or regulations
...


Conservation of National Resources Argument
...
Therefore, protection to such exhaustible national resources as coal, manganese,
mica, iron, etc
...
This is
done by restricting their exports through high export duties
...


Pauper Labour Argument
...
Therefore, high-wage domestic
goods should be protected from low-wage imported goods by imposing tariffs
...


Keeping Money at Home Argument
...
When we buy the manufactured goods at home we get both the
goods and the money
...

15
...
This would expand the home
market for all domestic products including agricultural commodities
...


Scientific Tariff, or Equalizing Costs of Production

Protection is advocated for equalising costs of production or prices of domestic and foreign products
...
Thus the price of both domestic
and foreign products are equalised and they can compete on equal terms
...
Non-Economic Arguments
1
...

A country should adopt the policy of protecting its industries from the standpoint of national
defense
...
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 defense in particular
...
Thus
industries which are directly and indirectly needed for the manufacture of arms and ammunitions
and other war materials should be developed under protection
...
Preservation Argument
...
It is argued that these would tend to disappear under free trade
and their preservation is desired on political and social grounds
...
The imposition of agricultural duties on import of
farm products is beneficial for the farmers who would be assured fair prices for their products
...
The prosperity of the peasantry is essential for it forms the
backbone of every nation
...
Patriotism or Nationalism Argument
...
This
is what Gandhiji advocated in his swadeshi movements
...

NEED FOR PROTECTION IN LDCs

Various arguments have been put forth in support of the policy of protection in LDCs
...
Capital Formation
...
So the rate of capital
formation is low
...
As traded goods become more expensive
...
This
increase in savings is, in turn, utilized for importing capital goods
...
Foreign Investment
...
In order to escape import controls the foreign manufacturer may set up a branch or
subsidiary of his firm alone or in collaboration with local enterprise
...
Revenue
...

4
...

This argument in favour of protection gives enough inducement to LDCs in accelerating their pace
of industrialization
...
The argument is that 'infant' industries need
protection from foreign competition till they attain adulthood
...

4
...

LDCs have unfavourable terms of trade in relation to the developed countries
...
If an LDC imposes tariffs that bring about a fall in import prices or rise in export prices, its
terms of trade are improved
...

5
...


theory of commercial policy-ba 2020-21

Another argument for protection in LDCs is the establishment and development of new industries
...
These external economies
result in a divergence between private profit and social benefit
...
Factor Redistribution
...

Due to underemployment in "rural areas, wages tend to be low in agriculture as the marginal
product of labour is negligible or zero
...
As a result, there is a gap
in prices and costs between agriculture and industry
...
Since
agriculture is less productive than industry, real income can be raised by factor redistribution
through a policy of protection in LDCs
...
Balance of Payments
...
Such countries are prone to serious balance of payments difficulties to fulfill
the planned targets of development
...
This is due to increase in imports and
decline in exports
...

8
...

LDCs follow the policy of planned economic development
...
This requires the importation of essential raw
materials and capital goods in place of unnecessary consumer goods
...

9
...

The majority of LDCs have won their freedom from the colonial rule after much struggle
...
These require a
policy of protection in order to diversify their economies so that they become self-sufficient
through all-round development and have self-sustaining growth
...

Tariff imposition assists in the growth of infant industries, in industrial diversification, in
attracting foreign capital, in securing more revenues, in promoting factor redistribution, in

theory of commercial policy-ba 2020-21

enlarging the size of the market, in raising the domestic saving and investment, in off-setting the
balance of payments deficits, in improving the terms of trade and in creating external economies
...

The cost of protection is very high for the nations
...
Protection is against the interest of consumers as it increases price and reduces variety and

choice
...
Protection makes producers and sellers less quality conscious
...
Protection encourages domestic monopolies
...
Even inefficient firms may feel secured under protection and it discourages innovation
...
Protection open the way for corruption
...
Protection reduces the volume of foreign trade
...
Protection leads to uneconomic utilization of the world's resources

---