International Trade and Comparative Advantage
? In spite of the strong theoretical case that can be made for free international trade, every country in the world has erected at least some barriers to trade. Trade restrictions are typically undertaken in an effort to protect companies and workers in the home economy from competition by foreign firms. A protectionist policy is one in which a country restricts the importation of goods and services produced in foreign countries. The India, for example, uses protectionist policies to limit the quantity of foreign- produced sugar coming into country.
In general, protectionist policies imposed for a particular good always reduce its supply, raise its price, and reduce the equilibrium quantity. Protection often takes the form of an import tax or a limit on the amount that can be imported, but it can also come in the form of voluntary export restrictions and other barriers. Tariff rates on dutiable imports have fallen dramatically over the course of history. A tariff is a tax on imported goods and services. A tariff raises the cost of selling imported goods. It thus shifts the supply curve for goods to the left.
The price of the protected good rises and the quantity available to consumers falls. Protectionist policies reduce the quantities of foreign goods and services supplied to the country that imposes the restriction. As a result, such policies shift the supply curve to the left for the good or service whose imports are restricted. In the case shown, the supply curve shifts to S2, the equilibrium price rises to P2, and the equilibrium quantity falls to Q2. One of the most common protectionist measures now in use is the antidumping proceeding.
A domestic firm, faced with competition by a foreign competitor, files charges with its government that the foreign firm is dumping, or charging an unfair price. Under rules spelled out in international negotiations that preceded approval of the World Trade Organization, an unfair price was defined as a price below production cost or below the price the foreign firm charges for the same good in its own country. While these definitions may seem straightforward enough, they have proven to be quite troublesome.
A quota is a direct restriction on the total quantity of a good or service that may be imported during a specified period. Quotas restrict total supply and therefore increase the domestic price of the good or service on which they are imposed. Quotas generally specify that an exporting country’s share of a domestic market may not exceed a certain limit. In some cases, quotas are set to raise the domestic price to a particular level. A quota restricting the quantity of a particular good imported into an economy shifts the supply curve to the left, as in.
It raises price and reduces quantity. An important distinction between quotas and tariffs is that quotas do not increase costs to foreign producers; tariffs do. In the short run, a tariff will reduce the profits of foreign exporters of a good or service. A quota, however, raises price but not costs of production and thus may increase profits. Because the quota imposes a limit on quantity, any profits it creates in other countries will not induce the entry of new firms that ordinarily eliminates profits in perfect competition.
Voluntary export restrictions are a form of trade barrier by which foreign firms agree to limit the quantity of goods exported to a particular country. Although such restrictions are called voluntary, they typically are agreed to only after pressure is applied by the country whose industries they protect. A voluntary export restriction works precisely like an ordinary quota. It raises prices for the domestic product and reduces the quantity consumed of the good or service affected by the quota. It can also increase the profits of the firms that agree to the quota because it raises the price they receive for their products.
In addition to tariffs and quotas, measures such as safety standards, labeling requirements, pollution controls, and quality restrictions all may have the effect of restricting imports. Many restrictions aimed at protecting consumers in the domestic market create barriers as a purely unintended, and probably desirable, side effect. These standards tend to discourage the import of foreign goods, but their primary purpose appears to be to protect consumers from harmful chemicals, not to restrict trade.
But other nontariff barriers seem to serve no purpose other than to keep foreign goods out. The conceptual justification for free trade is one of the oldest arguments in economics; there is no disputing the logic of the argument that free trade increases global production, worldwide consumption, and international efficiency. But critics stress that the argument is a theoretical one. In the real world, they say, there are several arguments that can be made to justify protectionist measures.
One argument for trade barriers is that they serve as a kind of buffer to protect fledgling domestic industries. The desire to maintain existing jobs threatened by foreign competition is probably the single most important source of today’s protectionist policies. Some industries that at one time had a comparative advantage are no longer among the world’s lowest-cost producers; they struggle to stay afloat. Cost cutting leads to layoffs, and layoffs lead to demands for protection. The model of international trade in perfect competition suggests that trade will threaten some industries.
As countries specialize in activities in which they have a comparative advantage, sectors in which they do not have this advantage will shrink. Maintaining those sectors through trade barriers blocks a nation from enjoying the gains possible from free trade. A further difficulty with the use of trade barriers to shore up employment in a particular sector is that it can be an enormously expensive strategy. That shifts the supply curve slightly to the left, raising prices for countries consumers and reducing their consumer surplus.
The loss to consumers is the cost per job saved. One reason often given for the perceived need to protect Indian workers against free international trade is that workers must be protected against cheap foreign labor. This is an extension of the job protection argument in the previous section. From a theoretical point of view, of course, if foreign countries can produce a good at lower cost than we can, it is in our collective interest to obtain it from them. But workers counter by saying that the low wages of foreign workers means that foreign workers are exploited.
This objection, however, fails to recognize that differences in wage rates generally reflect differences in worker productivity. Further, we have seen that what matters for trade is comparative advantage, not comparative labor costs. When each nation specializes in goods and services in which it has a comparative advantage measured in the amounts of other goods and services given up to produce them then world production, and therefore world consumption, rises. By definition, each nation will have a comparative advantage in something.
Exports restrictions are the limitations on the goods and services exported to foreign country by the government. These limitations are imposed to prevent a shortage of goods in the domestic market when it is more profitable to export. As a part of foreign policy for a example as a competent of trade sanctions. Government also promotes exports by making following incentives policies under EXIM policy like Duty Entitlement Passbook (DEPB), Export Promotion Capital Goods, Special Economic Zones (SEZ’s) etc.