Submitted By: Zain Saleem

Roll No. : F18BA138

Section: Afternoon ‘A’

Subject: Macro Economics

Submitted To: Sir Latif

 Protectionism and Free Trade

What is Protectionism?
Protectionism is the practice of following protectionist trade policies. A protectionist trade policy
allows the government of a country to promote domestic producers, and thereby boost the
domestic production of goods and services by imposing tariffs or otherwise limiting foreign
goods and services in the marketplace. Protectionist policies also allow the government to protect
developing domestic industries from established foreign competitors.

Types of Protectionism:
 Tariffs: A tariff is a tax imposed by a government on goods and services imported from
other countries that serves to increase the price and make imports less desirable, or at
least less competitive, versus domestic goods and services. Tariffs are generally
introduced as a means of restricting trade from countries or reducing the importation of
specific types of goods and services.
 Quotas: A quota is a government-imposed trade restriction that limits the number or
monetary value of goods that a country can import or export during a period. Countries
use quotas in international trade to help regulate the volume of trade between them and
other countries. Countries sometimes impose them on specific products to reduce imports
and increase domestic production. In theory, quotas boost domestic production by
restricting foreign competition.
 Subsidies: A subsidy is a payment by government to domestic producers. With relation
to protectionism, governments employ two kinds of subsidies. The first is a domestic
subsidy that provides domestic suppliers with funds to help reduce prices. By providing
money to local businesses to help keep prices down, it makes them more competitive
against imports. The second is export subsidy where government funds domestic
suppliers to export their goods. In other words, government is paying so that its domestic
firms export to other nations. The aim is generally to reduce consumption at home and
protect consumers.
 Standardization: Product safety and high volumes of low-quality products or
materials are typically top concerns when enacting product standards. Product standard
protectionism can be a barrier that limits imports based on a country’s internal controls.
Some countries may have lower regulatory standards in the areas of food preparation,
intellectual property enforcement, or materials production. This can lead to a product
standard requirement or a blockage of certain imports due to regulatory enforcement.
Overall, restricting imports through the implementation of product standards can often
lead to a higher volume of product production domestically.

Arguments in favor of Protectionism:

  Infant or Fledging industry Argument:
Certain industries have a possible comparative advantage but have not yet exploited
sufficient economies of scale to bring their unit costs down to competitive levels. Short-
term protection might allow an infant (or fledgling) industry to develop a cost advantage
at which point protection could be relaxed, leaving an industry to trade more freely on the
international market. Of course, the risk is that these controls become semi-permanent.

 Protection of Strategic Industries:

A government may wish to protect employment and investment in strategic industries,
although value judgments are involved in determining what a strategic sector is.

 Correct balance of payments disequilibrium:

As demand for imports is dampened and exports promoted. This makes the domestic
output appear to be more competitive.

 Prevent dumping:
It is where economies sell goods in overseas markets at a price below the cost of
production. Domestic consumers pay more than those buying overseas. Such low prices
are part of a policy to destroy rivals in export markets.

 Prevent labor exploitation in developing economies:

This is really a moral argument as it rests on making imports more accurately reflect their
true cost of production. However, it might also reduce imports from some of the poorest
economies in the world.

 Developing country to diversify:

This is like the infant industries argument. Many developing countries are heavily
dependent on exports of primary commodities. This can leave them very exposed to
changes in international commodity prices. If they want to diversify and develop new
export revenue streams, they may need to protect these new industries from full exposure
to international competition for a while.

 Source of government revenue:

This is where protectionism takes the form of a tariff, apart from reducing demand for
imports via the impact of a higher price, this will also raise revenue for the government,
like any other tax. The revenue raising function will be most successful where the
demand for imports is price inelastic.

What is Free Trade?

A free trade agreement is a pact between two or more nations to reduce barriers to imports and
exports among them. Under a free trade policy, goods and services can be bought and sold across
international borders with little or no government tariffs, quotas, subsidies, or prohibitions to
inhibit their exchange.
How a Free Trade Agreement Works?
In the modern world, free trade policy is often implemented by means of a formal and mutual
agreement of the nations involved. However, a free-trade policy may simply be the absence of
any trade restrictions. A government does not need to take specific action to promote free trade.
This hands-off stance is referred to as “laissez-faire trade” or trade liberalization. Governments
with free-trade policies or agreements in place do not necessarily abandon all control of imports
and exports or eliminate all protectionist policies. In modern international trade, few free trade
agreements (FTAs) result in completely free trade.

History:
Early Era:
The notion of a free trade system encompassing multiple sovereign states originated in a
rudimentary form in 16th century Imperial Spain. American jurist Arthur Nussbaum noted that
Spanish theologian Francisco de Vitoria was "the first to set forth the notions (though not the
terms) of freedom of commerce and freedom of the seas". Vitoria made the case under principles
of jus gentian. However, it was two early British economists Adam Smith and David Ricardo
who later developed the idea of free trade into its modern and recognizable form.
Modern Era:
Most countries in the world are members of the World Trade Organization] which limits in
certain ways but does not eliminate tariffs and other trade barriers. Most countries are also
members of regional free trade areas that lower trade barriers among participating countries. The
European Union and the United States are negotiating a Transatlantic Trade and Investment
Partnership. Initially led by the United States, twelve countries that have borders on the Pacific
Ocean are currently in private negotiations around the Trans-Pacific Partnership which is being
touted by the negotiating countries as a free trade policy. In January 2017, President Donald
Trump pulled the United States out of negotiations for the Trans-Pacific Partnership.
Features:
 Trade of goods without taxes (including tariffs) or other trade barriers (e.g. quotas on
imports or subsidies for producers).
 Trade in services without taxes or other trade barriers.
 The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws)
that give some firms, households, or factors of production an advantage over others.
 Unregulated access to markets.
 Unregulated access to market information.
 Inability of firms to distort markets through government-imposed monopoly or oligopoly
power.
 Trade agreements which encourage free trade.
Arguments in favor of Free Trade:
 Advantages of Specialization:
Free trade secures all the advantages of international division of labor. Each country will
specialize in the production of those goods in which it has a comparative advantage over
its trading partners. This will lead to an optimum and efficient utilization of resources
and, hence, economy in production.

 All-Round Prosperity:
Because of unrestricted trade, global output increases since specialization, efficiency,
etc., make production large scale. Free trade enables countries to obtain goods at a
cheaper price. This leads to a rise in the standard of living of people of the world. Thus,
free trade leads to higher production, higher consumption, and higher all-round
international prosperity.

 Competitive Spirit:
Free trade keeps the spirit of competition of the economy. As there exists the possibility
of intense foreign competition under free trade, domestic producers do not want to lose
their grounds. Competition enhances efficiency. Moreover, it tends to prevent domestic
monopolies and free the consumers from exploitation.

 Accessibility of Domestically Produced Goods and Services:

Free trade enables each country to get commodities which it cannot produce at all or can
only produce inefficiently. Commodities and raw materials unavailable domestically can
be procured through free movement even at a low price.

 Greater International Cooperation:

Free trade safeguards against discrimination. Under free trade, there- is no scope for
cornering raw materials or commodities by any country. Free trade can thus promote
international peace and stability through economic and political cooperation.

 Free from Interference:

Free trade is free from bureaucratic interferences. Bureaucracy and corruption are very
much associated with unrestricted trade. In brief, restricted trade prevents a nation from
reaping the benefits of specialization, forces it to adopt less efficient production
techniques and forces consumes to pay higher prices to produce protected industries.