Q: Explain the different methods of protection available to governments and discuss their effects on

the domestic economy.

Protection refers to government policies that give domestic producers an artificial advantage over
foreign competitors. There are a range of different methods of protection available to governments,
including tariffs, quotas and subsidies. Protection methods such as local content rules and export
incentives may also be used by governments. Although different methods have different effects on
the domestic economy, they are all implemented to protect domestic producers from the intensely
competitive foreign producers. However, many economists have refrained from the idea of
protectionism as its continued implementation reduces trade, productivity, economic growth
potential and living standards, whilst also slowing the process of free trade and globalisation.

Tariffs are taxes on imports that protect domestic industries by increasing the price of imports.
Tariffs enable domestic producers to supply their goods at a competitive price to those of foreign
producers, enabling them to supply a larger quantity of the good. This stimulates domestic
production and employment, thus maintaining the standard of living in a nation. Tariffs also
generate government revenue, which can be used to improve infrastructure, or fund education and
healthcare. Figure 1 shows how the implementation of tariffs causes a decrease in the number of
imports from Q0Q3 to Q1Q2. Domestic demand decreases from Q3 at world price to Q2 after the
tariff, and domestic supply increases from Q0 at world price to Q1 after the tariff. Australia, for
example, has an average tariff of 5% for passenger motor vehicles, to protect their local motor
vehicle industry. However, tariffs cause a reallocation of resources as more domestic resources are
attracted to the protected industry, which may not be as efficient as foreign producers. Consumers
are also forced to pay a higher price, which redistributes income away from consumers to local
producers. There may also be a retaliation effect, with other countries imposing tariffs on goods that
are exported to them in response to the tariffs on imports, which contributes to slowing
globalisation. For these reasons, Australian tariffs decreased from approximately 20% in 1990 to
2.3% in 2018. Thus, tariffs are taxes on imports that protect domestic producers, but cause a
reallocation of resources.

Figure 1: a diagram showing the

Quotas are restrictions on the volume of imported goods into the domestic market. They enable
domestic suppliers to gain a greater market share, and also protect domestic employment by
enabling domestic producers to supply a greater quantity of the good. As seen through Figure 2, the
quota restricts the number of imports from QQ1 to Q2Q3. This increases domestic supply from Q to
Q2 but decreases domestic demand from Q1 to Q3, because of the price increase from P to P1.
Unlike a tariff, government revenue is not generated through the implementation of a tariff, and as
consumers have to pay a higher price for goods, this decreases domestic demand and results in
decreased economic growth. Similar to a tariff, it can also precipitate retaliation, which can result in
lower exports for the country that initiated the import quota. Countries may also use a system of
tariff quotas where goods imported to the quota pay a standard tariff rate, and goods imported
above the quota pay a higher rate. This was done by Australia to protect their textiles and footwear
industry. Therefore, quotas are a form of protection that guarantee local producers market share,
but they do not generate government revenue.

Figure 2: A diagram depicting the economic effects of implementing a quota.

Subsidies are cash payments from the government to businesses to encourage production of a
good/service and influence the allocation of resources in an economy. They help domestic producers
in reducing their costs of production; therefore, allowing them to compete more easily with
imported goods. For example, Australia currently subsidises fuel use on non-public roads with the
Fuel Tax Credit Scheme for businesses, increasing the international competitiveness of mining
companies. Figure 3 shows the effects of a government-implemented subsidy on the domestic
market. As seen through the graph, the domestic supply curve shifts to the right, causing an increase
in quantity supplied from Q to Q1 and a decrease in price from P to P1. As consumers enjoy lower
prices and higher quantity of goods, domestic demand increases from Q to Q1. The government
experiences the cost in a subsidy, as they are supplying money to businesses from their own
revenue. This means that governments have to reallocate their budget resources and may have to
divert spending away from merit goods which will increase the quality of life towards more essential
sectors such as education and healthcare. Consequently, subsidies reduce the production costs of
businesses and cause decreased market prices, however they impose direct costs on the
government.
Figure 3: A diagram portraying the economic effects of a subsidy.

Local content rules specify that goods must contain a minimum percentage of locally made parts. In
return for guaranteeing this, a tariff may not be implied. In the past, when motor vehicles were
produced in Australia, manufacturers were allowed reduced tariffs on car components so long as
they complied with local content rules. Export incentives give domestic producers assistance and
encourage businesses to penetrate global markets or expand their market share. This assistance
comes in the form of grants, loans and technical advice and is less focused on protectionism, and
more focused on capturing foreign markets to achieve higher economic growth and employment.
For instance, Australia has a program called the Export Market Development Program (EMDP) that
repays companies up to 50% of their export promotion costs, and provides general assistance to
local manufacturers looking to expand globally. Thus, local content rules and export incentives are
methods designed to specifically aid local manufacturers, with minimal impacts on consumers and
the government.

In conclusion, governments can utilise many protection methods such as subsidies, quotas, tariffs,
local content rules and export incentives to protect and promote their domestic producers. The
different methods have different impacts on government revenue and consumer demand, however
they all allow for increased domestic supply within a market. However, protection may cause a loss
of dynamic efficiency as domestic firms become reliant on protection and have limited incentive in
order to be internationally competitive. For these reasons, governments must carefully consider the
type and level of protection they will set in the economy.