Although countries as a whole benefit from free trade with other economies, there are some segments of an economy that lose as a result of free trade. For example, as was mentioned earlier, India has a comparative advantage in textile production over the United States while the United States, has a comparative advantage in, say, producing software. As a whole, the United States is better off letting India produce textiles and trading for our software. Clothing consumers in the United States benefit by getting less expensive clothing, as well as experiencing a net gain in software jobs compared to what would be the case without trade.
But, there are losers. United States textile manufacturers and their employees are hurt by the increased competition from foreign textile plants. These losses from free trade are often more visible than the gains. On the nightly television news we can see laid-off textile workers demonstrating in front of closed textile plants in the Northeast and South. They are protesting against job loss, foreign competition, and free trade. It is much harder to show the monetary savings to millions of clothing consumers in the United States and the increased jobs in seemingly unrelated industries.
Net losers from free trade are likely to want protection from free trade. They are likely to appeal to Congress and other public officials for such protection. As a result, a host of measures designed to impede free trade have been enacted. Let us look at some of the main policy tools that are used to restrict trade.
A tariff is a tax on imported goods. Many imported goods have tariffs placed on them and some of these tariffs are very high. Tariffs on many goods exceed 20 percent (blue jeans, small pickup trucks, shoes, some food items, and more). The effect of tariffs is to reduce competition from foreign producers in order to protect U.S. firms. Like any tax, tariffs also raise revenues for the government.
An import quota limits the amount of a good that can be imported from another country. So-called mandatory quotas are imposed against the will of an exporting country. The threat of a trade ban, tariffs, or quotas by one country can often induce a country to voluntarily restrict the amount it exports. These so-called voluntary export restrictions (VERs) are fairly widespread and can be costly to domestic consumers. For example, some of the best-known quotas were the voluntary export restrictions on Japanese automobiles during the 1980s.
One feature of trade restrictions is that they raise the price of both foreign and domestic goods for domestic consumers. For example, the VERs on Japanese cars have been estimated to increase the price of Japanese cars to U.S. consumers by an average of more than $1,000. In addition, they raised the price of domestically produced cars by an average of over $500. The tariff on Japanese small trucks is estimated to have increased prices by even more!
How can a tax or restriction on foreign goods raise the price of domestic goods? Let us continue with the example of VERs on Japanese automobiles. Import restrictions will result in a decreased supply of Japanese automobiles in the United States. This will raise the price of Japanese cars in the United States. But for most automobile consumers, Japanese cars are substitutes for domestic automobiles. Recall from an earlier lecture that an increase in the price of a substitute will increase the demand for a good and, as a result, raise its price. Because of the relative price increase in Japanese cars due to trade restrictions, the demand for a domestically produced car increases and so does the price of that car. Thus, just because you buy American does not mean you are not adversely affected by trade restrictions!
There are other types of trade restrictions employed to protect domestic producers. There are non-tariff barriers that are aimed at reducing trade. For example, there are government procurement regulations, technical standards, and domestic content rules that prohibit the use of certain imported goods.
Export subsidies are government subsidies paid to domestic firms to encourage exports. By receiving subsidies, domestic producers are able to sell their products more cheaply abroad than the producers within the importing country. A related concept is dumping, which occurs when firms sell products in foreign countries for less than the cost of making the products. This can result from the presence of large export subsidies or, supposedly, when one country wishes to drive foreign producers out of a given market. The problem with the concept of dumping is that determining the actual costs of production is difficult to do. It is probably the case that actual dumping is much more rare than is portrayed by policy-makers, who are anxious to enact trade restrictions in order to satisfy some constituents hurt by foreign competition.
For much of its history, the United States has been a high-tariff nation. The highest tariffs were those in effect during the Great Depression following the passage of the Smoot-Hawley tariff. Some economists argue that the decline in trade that resulted was one of the causes of the depression of the 1930s.
In 1947, the United States and 22 other nations agreed to reduce barriers to trade and establish an organization to promote liberalization of trade. This is the General Agreement on Tariffs and Trade (GATT). In the years since its signing, there have been rounds of trade talks resulting in significant reductions and eliminations of trade barriers. Yet some sectors of the U.S. economy have, at different times, still received special protection.
Another significant trend of recent decades has been increasing economic integration. This occurs when two or more nations join to form a free trade zone. In 1991, the European Community (EC, or the Common Market) became the largest free-trade zone in the world by forming the European Union (EU). In the years since, the countries have dropped all tariffs and trade barriers, allowed free movement of citizens among member countries, and have worked toward the establishment of a common currency, the euro.
In 1988, the United States signed a free trade agreement with Canada, which was later extended to include Mexico. This is called the North American Free Trade Agreement (NAFTA), which went into effect in 1994. Most economists agree that NAFTA has increased trade and employment opportunities on both sides of the border.
To further explore the economic impact of trade barriers, try the following Active Graph exercise:
and try the following Smart Graph exercise: