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Home > Economics > The global economy > Features of the global economy: the reasons for protection

Outcomes
Overview
Content
Review exercises
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Outcomes

HSC Topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

H1	demonstrates understanding of economic terms, concepts and relationships
H3	explains the role of markets within the global economy
H7	evaluates the consequences of contemporary economic problems and issues on individuals, firms and governments
H8	applies appropriate terminology, concepts and theories in contemporary and hypothetical economic contexts.

Being up to date and aware of contemporary issues

This tutorial is based on 2002 information and this should be kept in mind as you read it. Students of Economics need to be aware of what is happening in the Global Economy today and should, for instance, keep up to date with changes in the level of tariffs and other trade barriers.

After completing this tutorial you may wish to do some research on the current situation for Australian sugar exporters; looking at whether trade has actually been liberalised for this industry or whether barriers continue to be imposed.

For current information on trade protection you are advised to scroll down to the section MORE at the bottom of this page and to visit the websites such as that of the Australian Government Department of Foreign Affairs and Trade.

Overview

Globalisation and trade liberalisation are worldwide phenomena that have significantly changed Australia’s trading environment over the past 25 years. Traditionally, Australia has used various forms of protection, such as tariffs, to raise the price of imports and keep domestic industries competitive. This added to the cost of living as everybody paid extra to support these industries.

However, since the 1980s Australia and many of the world economies has faced substantial reductions in trade barriers.

In Australia, the average tariff levels have decreased from 36 percent in 1968–9 to approximately 9 percent in 2001. The reductions in trade barriers has contributed to a stronger industrial base, increased productivity and allowed better access to international markets for exporting industries.

Despite the economic arguments for free trade countries have historically given protection in some form to import competing and exporting industries.

Content

1. What is protection?

   Protection can be defined as any actions by national governments that will give an artificial competitive advantage to domestic producers over foreign producers.

2. Arguments for protection

   There are a number of arguments that have been put forward to justify protection of domestic industries. These are also arguments against free trade.

   There are two economic arguments. These are:

   1. protection of infant industries
   2. prevention of dumping

   Other arguments involve social and political points of view. These include:

   3. protection of domestic employment
   4. defence and self-sufficiency
      
      

   1. Protection of infant industries

      In simple terms, an infant industry (also known as a sunrise industry) is one in the early stages of development and has not yet become established in the domestic market. Infant industries usually have high costs per unit of output and are at a cost disadvantage compared with more established overseas industries.

      These industries may need protection in the short-term to enable the development of economies of scale to promote efficiency, to reduce costs and to become internationally competitive.

      Governments tend to provide new industries with direct assistance for a limited time and avoid the long-term problems of higher prices for consumers and misallocation of resources of inefficient industries. However these industries often remain inefficient in the long term due to the lack of international competition.

   2. Prevention of dumping

      Dumping occurs when foreign producers are able to sell their products at a price lower than those of the domestic market. There are a number of reasons for foreign firms following this practice.

      • to dispose of surplus stocks
      • to establish increased market share in the domestic economy.

      Supported by subsidies, overseas companies production costs are lower, giving them a competitive advantage. In the long-term dumping can force efficient domestic producers out of business, causing a loss of productive capacity and increasing unemployment.

      Dumping is one area that protection can be justified, as the only gains are lower prices for consumers in the short term.

   3. Protection of domestic employment

      This popular argument suggests that domestic industry should be protected from cheap imports to create higher levels of domestic demand and employment. In economics this argument has little support.

      Restricting free trade distorts the allocation of resources from the more efficient to less efficient industries. Employment levels will be maintained in the protected industries at the expense of the more efficient areas of the economy.

      In the long run protection will lead to lower levels of domestic output, falling incomes and lower levels of economic growth.

      The effect of free trade on employment can be seen in the textiles, clothing and footwear industry where many clothing firms either closed down or moved their production offshore. Although widespread unemployment was created in these industries, overall employment levels increased, especially in the more efficient exporting industries.

   4. Defence and self-sufficiency

      There are some countries that put forward non-economic arguments for the protection of certain industries. For example a country may wish to reduce dependence on imports and increase its self-sufficiency in industries such as communication, shipbuilding, transportation and defence capabilities that are important to the security of the country. These goods and services are produced domestically even though they could be purchased more cheaply from international markets.

      These arguments are based on social and political reasons and not economic theory. Self-sufficiency may then come at the expense of higher living standards gained from free trade.

3. Other arguments to support protection

   1. Diversification

      The diversification argument is used because a country wants to become more flexible and be able to adjust quickly to changes in global demand. Developing countries especially use this argument because they have a narrow export base and need protection to develop new manufacturing industries. Diversification would help spread the risk and make the economy less susceptible to sudden changes in demand and price decreases of commodities.

      The problem is that scarce resources are being diverted into industries that may not be able to survive once protection is removed.

   2. Cheap foreign labour

      This argument suggests that domestic producers should be protected from countries where cheap labour creates an unfair competitive advantage. One of the main reasons why international trade takes place is because of the differences in factor endowments between countries.

      The problem is not that foreign labour is cheap but that domestic labour is being used to produce goods that can be obtained cheaper from overseas. In this case the goods should be imported to take advantage of the greater efficiencies in the foreign country. The argument for protection is therefore based on absolute advantage instead of comparative advantage.

      Social groups may put forward ethical arguments about not buying products from countries that may use prisoners or child labour.

Review exercises

Exercise 1

Drag & drop activity     Flash version      HTML version

Exercise 2

Case Study

1. Outline one reason why the Egyptian government would consider increasing the level of tariffs on sugar imports.

   Answer

2. How will the Australian economy benefit from the reduction in Egyptian sugar tariffs?

   Answer

More

The Department of Foreign Affairs and Trade web site has a section for students to work through, with activities to help enhance the understanding of trade liberalisation.

The World Trade Organisation provides articles that can help us to understand the reasons for developing countries using protectionist policies.

Visit The Centre for Trade web site and read the information on the benefits of free trade. This web site also contains some very current information on global trade issues.