Gains+of+Trade+versus+Protectionism

=__**Gains of Trade versus Protectionism**__= by: Bhoomi Wadhwa


 * Benefits of Free Trade: **

- It allows specialization of scarce resources, since factor endowments differ between countries - The increased specialization permits trading nations to achieve higher levels of output, thus higher levels of consumption. - Through trade, countries can consume combi nations of goods outside their production possibilities frontier. - Free trade decreases the power of domestic monopolies by exposing them to international competitive forces. - The increased level of competition increases efficiency and lowers prices of domestic firms. - It stimulated growth by increasing productive resources, accelerating technological change and spurring competition. - If real incomes rise then saving rises, increasing the availability of domestic funds for investment. - It may permit domestic firms to achieve economies of scale by increasing the size of the markets in which they sell their products (especially significant for small nations) - Diffusion and transfer of technology and ideas across borders becomes faster. - It presents consumers with a greater variety of goods to choose from.

__ Absolute Advantage: __ A country has absolute advantage in the production of a good if it can produce more of it with the same resources (or if it can produce a unit of it with fewer resources). __ Comparative Advantage: __ - Each country should specialize and export those goods that it can produce at relatively lower cost. - A country has comparative advantage in the production of a good if it can produce it at a lower opportunity cost.

Assumptions used to derive the principle of comparative advantage: - Constant costs of production reflected in the linear production possibility curves - Perfect factor mobility within each country (but immobility between countries) - No transport costs - Perfect competition in all markets - Free trade

Criticisms of principle of comparative advantage: - Costs of production need not be constant. They may be decreasing, in which case the gains from specialization may be even greater. Increasing returns to scale in production and the resulting economies of scale are very often the case in the real world. - Labour and the other factors of production suffer from both occupational and geographical immobility. It may not be costless or even possible for a country to specialize. Real adjustment costs, such as unemployment for certain regions or groups, will result when a country responds to a shift in its comparative advantage. - Transportation costs in the real world do exist and depending on the weight to value ratio will decrease the scope of foreign trade opportunities. Note though that transport costs have dramatically decreased since the advent of the container in shipping. - Perfect competition is not common at all. Large firms with monopoly power and scale economies dominate world trade. - Trade barriers are also a reality which prevents world trade flows from reflecting comparative advantage conditions among nations.

Factors determining the relative costs of production and thus c omparative advantage - the quantity and quality of factors of production available. - Movements in the exchange rate (the price of a currency expressed in terms of another) can affect comparative advantage. - Changes in the relative inflation rates affect export competitiveness. - Export subsidies can be used to create an artificial comparative advantage for a country’s products. - Non-price factors can lead to the creation or the loss of comparative advantage.

**__ Protectionism: __** Non-economic arguments in favor of protectionism: - To ensure that a country is self-sufficient in the production of crucial goods in case of a war. - To restrict imports of illegal drugs and other harmful substances. - To put pressure on and weaken politically unfriendly countries. - To preserve a way of life of cultural identity as part of a broader social strategy. - To ensure that certain safety and health standards are met. However, such standards may be a pretence through which domestic producers are protected. Economic arguments in favor of protectionism: - To protect domestic jobs and declining industries - To improve a trade deficit - To assist certain industries in their initial stages of development - To help industries facing dumping from abroad - The strategic trade policy argument - To provide a government with revenues

__ Forms of Protectionism: __ Protectionism can take various forms. The most common forms are: tariffs, quotas, voluntary export restraints, subsidies, regulatory barriers, etc.

Tariffs: A tax imposed on imports. - it is the most common form of protectionism. - May be specific or ad valorem. - A tariff will tend to raise the price and domestic production while lowering the amounts consumed and imported.  Quotas: A quantitative restriction on the volume of imports - it increases the domestic price and domestic production and reduces domestic consumption and the quantity of imports. Voluntary Export Restraints: A form of protectionism that is a slightly different version of quotas. VERs are agreements between an exporting and an importing country limiting the maximum amount og exports in a given period.

Subsidies: - They lower production costs of firms and thus artifically increase their competitiveness. - Subsidies will decrease imports and may even lead to exports.

Regulatory barriers: - may be technical, administrative, or any kind of ‘red tape’ - include product standards, sanitary standards, pollution standards. - The standards are set to protect domestic producers rather than domestic consumers by making it more difficult and thus costly for foreign firms to comply. Anti-Dumping duties: - domestic firms may file a complaint that foreign firms are dumping their goods in their market. - A duty (tax) is automatically imposed that raises the foreign firms’ price until the issue is investigated.

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