Protection (Cambridge (CIE) O Level Economics)

Revision Note

Reviewed by: Jenna Quinn

Reasons for Protection

Free trade aims to maximise global output through national specialisation
However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes
This is called protectionism and may take the form of import tariffs, export subsidies, the use of quotas or embargoes
Trading partners may retaliate to any methods of protectionism and they should be carefully considered before any implementation

Reasons for Protectionism

Reason	Explanation
Infant industries	To protect new firms that would be unlikely to succeed at start-up due to the level of global competition Once established support is removed
Sunset industries	Similar to above, but at the other end of the life cycle, these firms are on their way out and the government chooses to support them to help limit the economic damage that would occur if they closed abruptly
Strategic industries	Industries such as energy, defence and agriculture are essential to self-sufficiency and security Being reliant on other countries for these creates vulnerabilities for a nation
Dumping	Dumping is anti-competitive and can harm a country's industries
Employment	When firms outsource production to other countries or certain industries are experiencing structural unemployment governments will step in to protect jobs
Current Account deficit	When imports > exports the amount of money leaving the country to support foreign firms is greater than that entering to support domestic firms Protectionism aims to correct this imbalance
Labour/environmental regulations	Many countries offer cheap labour and low-cost production due to poor environmental regulations Protectionism can help apply pressure to bring about change in these countries

Methods of Protection

The most commonly used forms of trade protectionism include tariffs, subsidies, quotas, embargoes and administrative barriers

1. Tariffs

A tariff is a tax on imported goods/services (customs duty)
With the price of imports higher, domestic firms find it easier to compete and increase their market share as consumers switch from buying imports to buying domestically produced goods/services
Less efficient domestic firms are now producing at the expense of more efficient international firms

**A tariff increases the costs of production for domestic firms, resulting in a shift of the supply curve from S1 → S2**

Diagram analysis

The pre-tariff market equilibrium for plantains is seen at P₁Q₁
After the tariff is imposed, costs of production for domestic firms increase (as they pay the tariff when the plantains enter the country) - the supply curve shifts from S₁ → S₂
The new market equilibrium is seen at P₂Q₂
- Following the law of demand, the quantity demanded contracts from Q₁ to Q₂
- The price increases from P₁→ P₂
Tariffs are one of the most widely used forms of protectionism and their impact on stakeholders can be evaluated as follows

An Evaluation of the Use of Tariffs To Protect Domestic Firms

Stakeholder	Explanation
Domestic producers targeted by the government action e.g. steel manufacturers	Before the tariff domestic manufacturers are less competitive and produce less After the tariff was imposed the targeted domestic manufacturers increase their output These firms may need more workers to produce the extra output and so unemployment in that industry falls
Domestic producers who have to pay higher prices e.g. car manufacturers who use steel for production	Before the tariff domestic manufacturers are able to purchase the raw materials at cheaper prices After the tariff, the costs of production of domestic manufacturers increase resulting in a fall in output These firms may require fewer workers and so unemployment in several related industries may rise
Foreign producers	Tariffs decrease demand for their products and so their output falls With less supply from efficient foreign producers, the global allocation of resources is now more inefficient
Domestic consumers	Before the tariff domestic consumers consumed more products at lower prices After the tariff domestic consumers consumed fewer products at higher prices The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
The Government	After the tariff is imposed the government receives tax revenue from each unit imported

Examiner Tips and Tricks

One of the most common misconceptions about tariffs is who pays them. The tariff is not paid by the foreign exporting firm. It is paid by any domestic firms that are importing. They pay the tariff to their own government when the goods cross the border.

Quotas, Subsidies, Embargoes and Administrative Barriers

2. Quotas

A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry
This limit is usually set below the free market level of imports
- As cheaper imports are limited, a quota raises the market price
- As cheaper imports are limited a quota may create shortages
Some domestic firms benefit as they are able to supply more due to the lower level of imports
- This may increase the level of employment for domestic firms

An Evaluation of the Use of Quotas To Protect Domestic Firms

Stakeholder	Explanation
Domestic Producers	Increases their output Raises the selling price Increases their revenue
Foreign Producers	Decreases their output Compared to a tariff, those firms who manage to export in the quota receive a higher price for their sales
Consumers	Results in higher prices and less choice
Government	They do not receive any tariff revenue (as there is no tariff) They may receive higher tax revenue at the end of the financial year when domestic firms pay their corporation tax
Standards of living	Reduces for consumers as higher prices erode the purchasing power of their income
Equality	Domestic firms can compete more equally

3. Subsidies to domestic producers

A subsidy lowers the cost of production for domestic firms
- They can increase output and lower prices
- With lower prices their goods/services are more competitive internationally
- The level of exports increases
- The increased output may result in increased domestic employment

An Evaluation of the Use of Subsidies To Protect Domestic Firms

Stakeholder	Explanation
Domestic Producers	Decreases costs of production Increases output Increases international competitiveness
Foreign Producers	Makes it harder for them to compete with domestic firms
Consumers	Lowers prices
Government	This costs the government the amount of the subsidy There is an opportunity cost associated with every subsidy provided
Standards of living	Improves for consumers as they benefit from lower prices - their income goes further
Equality	Domestic firms can compete more equally

4. Embargoes

An embargo is a complete ban on trade with a certain country usually as the result of political fall out e.g. the USA ran an embargo for many decades on Cuban products

An Evaluation of the Use of Embargoes To Protect Domestic Firms

Stakeholder	Explanation
Domestic Producers	Increases output due to less foreign competition
Foreign Producers	They are unable to legally trade with the country running the embargo They lose sales and profits They may go out of business or need to reduce their number of workers
Consumers	Prices will rise - and in some cases the product may no longer be available at all
Government	The government has to spend money enforcing the embargo

5. Administrative barriers

There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas and subsidies
- Health and safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries and it effectively blocked the import of southern hemisphere nuts
- Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size
- Environmental regulations e.g. in November 2021 new regulations were put in place in the EU and the USA to limit the amount of imports of 'dirty steel' - predominantly this is steel produced using coal fired power stations which are prevalent in China
- Product labelling can be expensive for firms to apply and may limit their desire to sell into certain markets

Last updated: 27 June 2024

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