Protectionism

We have now seen our first two reasons for restriction on free trade:

We assume the world supply curve is always a flat, horizontal line. That means that, world supply is perfectly elastic.

And so

First of all, restrictions on free trade can prevent dumping.

Dumping happens when firms aggressively cut their prices, below average variable costs, in a foreign country. Dumping drives prices so low that domestic producers can’t compete, forcing them out a market.

But restrictions on free trade may prevent dumping by foreign firms. For instance, a tariff would increase the price of dumped goods, meaning that foreign firms won’t be able to undercut domestic firms!

Second, restrictions on free trade can protect domestic employment.

Cheap foreign imports reduce demand for domestic goods, decreasing derived demand for domestic labour, increasing domestic unemployment.

By restricting free trade, like with a quota, consumers can’t buy as many cheap foreign imports…so they have to demand domestic goods from domestic firms, who employ domestic workers! Keeping domestic employment high.

But governments might also restrict free trade to protect infant industries.

For instance, in 2006, the Malawian government launched their Agricultural Inputs Subsidy Programme. Through the Agricultural Inputs Subsidy Programme, the Malawian government would subsidise the cost of fertilizers for Malawian tobacco farmers – meaning they would pay for some of the fertilizers.

This reduced costs for the farmers, meaning they could afford to sell their tobacco for lower prices!

Malawi’s subsidy to domestic producers was a type of restriction on free trade: the more Malawi subsidized the cost of fertilizers for Malawian farmers, the cheaper it became for them to produce tobacco plants in Malawi.

And the cheaper it is to make Malawian tobacco, the more Malawian consumers will switch to cheaper domestic goods and reduce the number of goods they import. That means that Malawi’s fertilizer subsidies restricted free trade.

Malawi’s fertilizer subsidy wasn’t popular with all Malawians – after all, it was the taxpayers money that was funding these subsidies! Also, the subsidy wasn’t popular with other African countries, as it meant that Malawian farmers could produce tobacco for a lower cost than them!

But, the Malawian government had an important reason for providing the fertiliser subsidies: they wanted to protect Malawi’s tobacco industry, which was still an infant industry!

Malawi’s tobacco industry was still a baby, it was too young to compete all by itself in the global economy.

In lots of other countries that produce tobacco, like Brazil, tobacco industries are so large that tobacco producers benefit from massive economies of scale, which occur when…

Economies of scale occur when increased production reduces a firm’s long run average costs.

For instance, in Brazil, tobacco farms are huge, and use lots of high tech machinery to harvest tobacco leaves quicker, and ship them out faster!

But Malawians, on the other hand, had not been farming tobacco for very long. That meant that Malawian farmers were not yet big enough to benefit from the same economies of scale that Brazil did – Malawian farmers still picked tobacco leaves slowly, by hand!

So compared with Brazil’s tobacco industry, the Malawian tobacco industry had high production costs.

And these high production costs would force Malawian farmers to charge higher prices for their tobacco, meaning they would not be very competitive in the global economy.

So Malawi’s tobacco industry was still a baby, it was too young to compete all by itself in the global economy – and that meant that Malawi’s tobacco industry was an infant industry!

Therefore, the Malawian government introduced the Agricultural Inputs Subsidy Programme to protect their infant tobacco industry – to allow Malawian tobacco farmers to produce their tobacco at lower costs, giving them time to grow and eventually benefit from economies of scale too!

So our third reason for restricting free trade is to protect infant industries.

Infant industries are industries which do not benefit from economies of scale – like Malawi’s tobacco industry, in which farmers still picked tobacco leaves by hand!

When an industry does not benefit from economies of scale, their production costs will be high compared with industries that do benefit from economies of scale – like Brazil’s tobacco industry. High production costs lead to higher, less competitive prices, meaning infant industries can’t compete with larger industries – so Malawian farmers could not compete with Brazil’s tobacco industry!

But restrictions on free trade, like Malawi’s fertilizer subsidy for Malawian farmers, reduce production costs for infant industries. And with reduced production costs, producers can afford to sell their products for lower prices – so Malawi’s tobacco farmers could afford to sell their tobacco for less!

So in summary, a country might use a trade barrier to protect infant industries…

Infant industries are industries which do not benefit from economies of scale. When an industry does not benefit from economies of scale, their production costs will be high compared with industries that do benefit from economies of scale. High production costs lead to higher, less competitive prices, meaning infant industries can’t compete with larger industries!

But restrictions on free trade reduce production costs for infant industries. And with reduced production costs, producers can afford to sell their products for lower prices!

In 2006, the Malawian government wanted to protect their new tobacco industry – and they used a fertilizer subsidy to domestic producers to do it!