Free trade and Protectionism

Free trade(Laissez- Faire Policy)

• Adam Smith supported free trade without any
restrictions.
• The policy of laissez faire is the corner stone of free trade
• It is the policy allowing individual activities (esp. in
commerce) to be conducted without government
control.
• Free trade concept is based on market mechanism which
is controlled by the forces of demand and supply,
government should not interfere and should provide
infrastructure which is necessary for market expansion.
Benefits of international free trade(Habeler)
• Provision of material means indispensible for economic
development of developing countries
• Helps in dissemination of technical knowledge, ideas for importation
of know-how, skills and entrepreneurship
• Leads to international movement of capital especially from the
North (developed countries) to the South (developing countries)
• Serves as the best anti-monopoly policy and guarantee for
maintenance of healthy competition
• Results in division of labour on an international scale leading to
greater specialization, efficiency and economy in production
• Benefits the consumers by providing large variety of goods at the
cheapest prices
 Protectionism
• Free trade existed for a long time as it was a tool for countries to expand their
trade throughout the world.
• But some countries like Germany favored strategic protective measures in
their national interest by restricting free trade by imposing trade barriers.
• These barriers were governmental policies and measures that obstructed the
free flow of goods and services across national borders.
• Objectives behind imposing trade barriers –
a. To protect domestic industries from foreign companies
b. To guard against dumping
c. To promote indigenous research and development
d. To conserve foreign exchange resources of the country
e. To make the balance of payments position more favorable
f. To curb conspicuous consumption and mobilize revenue for the government
 TRADE BARRIERS

Tariff barriers Non-tariff barriers

 Tariff barriers (fiscal controls)
• Tariff is a financial levy imposed by the importing country on
goods so that countries can protect their domestic industries
producing the same goods or for the general interest of the
national economy.
• Tariff is usually less restrictive than other methods of control
like quantitative restrictions and hence are preferred more by
organizations like GATT.
• Tariff barriers may be classified as –
a. Export duties
b. Import duties
c. Transit duties
 Classification of tariffs on the basis of the purpose they serve

Revenue tariff Protective tariff Countervailing &

Anti-dumping duties
 Classification of tariffs on the basis of quantification

Specific duties Ad-valorem duties Compound duties

flat sum per levied as a fixed when the commodity is
physical unit of percentage of the subject to both specific
the commodity value of the and ad-valorem duties
imported or commodity
exported imported or
exported
 Impact of tariff
• Protective effect- an import duty likely increases the price of the imported goods,
which in turn would decrease imports and increase the demand for domestic goods
• Consumption effect- increase in prices due to import duty would also stand to
reduce the consumption capacity of the people
• Redistribution effect- if the import duty causes an increase in the price of the
domestic goods, it would lead ton redistribution of income between the consumers
and producers in favor of the producers
• Income and employment effect- because of the switch from imported goods to
domestic goods, it would cause an expansion of domestic income and employment
• Competitive effect- domestic industry obtains monopoly and gets the power to
compete with foreign companies
• Terms of trade effect- in a bid to maintain the previous level of imports to the tariff
imposing country, if the exporter reduces the prices, the tariff imposing country
would get their imports at a cheaper price; thus improving the terms of trade of the
country imposing the tariff
• Balance of payments effect- tariffs by reducing the volume of imports may help the
country to improve its balance of payment sposition
Non-tariff barriers (quantitative restrictions)

• NTB’s fall in two categories-

a. Which are generally used by developing countries to
prevent foreign exchange outflows or those which
result from their chosen strategy of economic
development. Eg. – import licensing, import quotas,
etc.
b. Which are mostly used by developed countries to
protect domestic industries which have lost
international competitiveness and are politically
sensitive for governments to these countries.
 Forms of NTB’s
• Voluntary export restraints: VER’s are bilateral arrangement instituted to restrain the rapid
growth of exports of specific manufactured goods. They are highly discriminatory and fall
outside the jurisdiction of GATT Rules.
• Administrative Protection – wide range of Bureaucratic government action:
1. Safeguards: Safeguard actions which under GATT Article XIX enable countries to undertake
temporary restrictions against ‘influxes’ threatening the viability of domestic industries, have
become a common form of administered protection.
2. Health and product Standards
3. Custom procedures
4. Licensing
5. Environment protection laws
6. Quotas: restriction on volume of export and import by licensing .

Merits: Quotas are more effective than tariffs . They are more precise and their effects are
more certain. They are more flexible, easily imposed, and more easily removed instruments of
commercial policy than tariffs.

Demerits: effects of quotas are more vigorous and arbitrary and they tend to distort
international trade more than tariffs. Tends to restrict competition by helping importers and
exporters to acquire monopoly power.
 Objectives of protectionism
• Infant industry: Nurse the Baby, protect the
Baby and free the child
• Diversification: Economy that depends on a
very limited number of industries is subject to
many risk. Diversified industrial structure