Chapter 9

International Trade
trade or foreign trade means trade between
ional trade
Internatio
countries. In other words, it is the
anoe of goods or services between two or
exchang more countries. The
with
branch of economics
which deal foreign trade is International Economics.

latermational Economics deal with the economic and financial transactions nations.
among
Itanalyses the flow of goods, services, payments and money between a nation and the rest
af the world. The policies which
regulate these policies and their effect on economic
welfare of the nation are also coming under International Economics. More specifically, it
deals with international trade theory, international trade policy, the balance of payments
and foreign exchange markets.

Advantages and disadvantages of foreign trade

The following are the important advantages of foreign trade.

1. Optimal use of natural resources: International trade helps each country to make
optimum use of its natural resources. Each country can concentrate on production of those
goods which are advantageous to them. Therefore, wastage of resources is avoided.

2. Availability of all types of goods: It enables a country to obtain goods produced all over
the world. The country may not be producing these good because of their technological
problems or because of higher cost when it is produced in the domestic country.

3. Specialisation: Foreign trade leads to specialisation as the country produce only those
goods, where the production of such goods has certain advantages. The country can enjoy
the benefits of division of labour

4. Advantages of large-scale production: Due to international trade, goods can be

produced for home consumption as well as for export. This enables country to produce in
large scale and enjoy the benefits of largescale production.

5. Stability in prices: International trade helps to avoid wild fluctuations

making the goods freely available all over the world.

6: Establishment of new industries: The

importing of machinery and technology enable
the country to start new industries.

131
 Trade
Industrial Economics and Foreign

7. Increase in efficiency: Due to international competition, the producers in a countr

attempt to produce better quality goods and to minimize the cost. This increases efficiene
ency
and productivity.
8. Development of the means of transport and communication:

International trade requires the best means of transport and communication. Because of
facilities.
this, countries develop better transport and communication
9. International co-operation and understanding: The people of different countries
come in contact with each other. Commercial integration amongst nations of the world
encourages exchange of ideas and culture. It creates cooperation, understanding, cordial
relations among various nations.

10, Discouragement to Monopolies: International trade discourages the formation of

monopolies in a country. If certain business units raise the prices through monopoly
practices, the government imports those goods to reduce the prices in the country.

11. Better Employment Opportunities: As the Foreign trade expands, it creates jobs and
provides better employment opportunities for the people both in and outside the country.

Disadvantages
1. A threat to domestic industries: International trade has an adverse effect on the

development of home industries. It poses a threat to the survival of infant industries at

home. Due to foreign competition and unrestricted imports, the upcoming industries in the
country may suffer.

2. Economic dependence: Underdeveloped nations have to rely on developed countries

for their economie growth. Such dependency often results in economic exploitation.
3. Misuse of natural resources: Constant and excessive exports can exhaust the natural
resources in a country. If not controlled the country may suffer in the long run.

4. Endangers independence: Foreign trade encourages slavery. It impairs the econome

independence of the poor nations.

5. Import of harmful goods: Through international trade harmful goods

imported and it may adversely affects health and well being of the people.
6. Evil Effects of Dumping: Sometimes, certain countries use international trade to u mp
t h e i r goods on other countries with a view to cheapen the value o f t h e other country > Egoods.

132
 International Trade
an al Defence: It Is argucd that a nation which depcnds on
7AgainstnationalDefe
foreign sources
Aga s
supplylacks defence
during the war. During war, they may not be able to import goods.

Theories
if International Trade
Absolute Advantage Theory
ing to
cording Adam
to Adam Smith the basis of international trade is absolute cost advantage.
A o r

there are two commodities and two countries which produce these commodities.
Suppose

Ane country is efticient production of one commodity and thus it has an absolute
in the
an absolute
adantage in the production of this commodity. The other country has
the production of the other commodity. Then the countries will specialise
advantage over
which they have an absolute advantage. They will export
and produce that commodity upon
utilised in the most
commodity to the other country. By this process resources are
this both
will increase. From this mutual trade
efficient way and output of both the countries
the countries will benefit.

The absolute advantage theory can be explained

with the help of an example.
UK
USA
labour 10
Number of Units of wheat per unit of
8
Labour 3
Number units of cloth per unit of
over the production
of wheat over
USA has an absolute advantage
In the above example UK can
one unit of labour. But
UK. Because it is able produce
10 units of wheat with
over the production of cloth.
units. Similarly, UK has an absolute advantage
produce only 5 and export cloth to
and export wheat to UK and UK will produce
Hence, US will produce
from international trade.
US. Both the countries will gain

to specialisation
and division of labour. But according to
This kind of production leads
the market. When there is
division of labour is limited to the size of
Adam Smith
for division of labour because size of the market
international trade, there is ample scope
only
Adam Smith theory of absolute advantage explain
increases substantially. However,
narrow in its scope.
one aspect of trade. It is too

Comparative Advantage Theory

Comparative cost advantage theory was developed by David Ricardo in 1857. Later it was
refined by JS Mill, Marshall and others. According to Ricardo, even in the case of a country
for which there is no absolute advantage for both the commodities, it can gain from

133
 Industrial Economics and Foreign Trade

international trade. In this situation, the country should specialise in the production and
export of the commodity in which its absolute disadvantage is smaller and import th.
the
commodity in which its absolute disadvantage is greater. In other words, a country should
specialise in the production of that commodity in which it is more efficient and leave tha
production of the other commodity to the other country.

The Ricardian theory is based on the following assumptions.

1. There are only two countries and two commodities

2. There are no barriers in international trade

3. There is no transport cost
4. Labour is the only component of cost of production
5. There is perfect competition and full employment
6. Labour is homogeneous
7. Labour is
perfectly mobile within the country
7. Goods are exchanged according to the relative amount of labour embodied in them.
Ricardo in his two commodity, two country model taken cloth and wine
and
as commodities
England and Portugal as two countries.
Country No. of units of labour No. of units of labour
Per unit of cloth Exchange ratio
per unit of wine
England 100 120 l wine = 1.2 cloth

Portugal 90 80 I wine = 0.88 cloth

The above example shows that

both the
Portugal has an absolute advantage
in the production o
commodities. However,
with ratio of the cost of cloth comparisona
of the ratio of the cost of wine
production
production in these two countries reveals that Portugal nas s a
higher advantage in the production of wine.
Hence it will specialise in wine
produce wine. At the same time, England has a productionaand
and it will produce cloth.
England
comparative advantage in cloth produc
cloth from England. Both the
can
import wine from Portugal and Portugal can ort
countries have mutual inpo
gain from trade as explainea elow.
o
In the absence of trade, one unit
of wine
units of cloth in Portugal. When trade takescommands 1.2 units cloth in England and
place, Portugal will gain if it can get ything
a
134
 International Trade
RR
morethan 0.88 units cloth for one unit of wine.
of clot
units of
more uhing less than 1.2 unts of cloth. Similarly, England will gain if it has to
sacrifice

sacri1.2 unts of Therefore, any exchange ratio between 0.88

a n d1 . 2 u n t cloth for oneuunit of wine will
of cloth
bring a gain for both the countries.
and

Criticism

i a t of
Most
the assumptions of the theory are its limitations. The
riticisms against comparative cost theory.
following are the important
1. Labour is not the only element of cost.

Exchange ratio is not always fixed according to the cost ratios. Demand and supply play
an important role in fixing the price.

3. The assumption of full employment and perfect competition are not valid.

4. The assumption of free trade (trade without barriers) is highly unrealistic.

5. According to Graham if one country is very small and other country is big complete
specialisation may not be possible. The big country cannot sell its entire surplus to the small
country
6. The theory of comparative cost gives the limit within which exchange ratio will be fixed.
lt does not say how the exact point within these limits is determined.

The Heckscher-Ohlin Theorem or Factor Endowment Theory

The factor endowment theory was originally developed by Eli Heckscher in 1919. Later in
1935 it was refined by his student Bertil Ohlin. Hence the theory is popularly known as
Heckscher-Ohlin Theorem. It is a two-country two-commodity model. The following are
the important assumptions of the model.

.There is perfect competition in the factor market

and product market.
2. Factors of production are perfectly mobile within the country but immobile between the

countries.
3. Factors production are homogeneous.

4. There is full employment.

5. There is free trade between countries.

6. There is no transport cost.

7. Technology remains the same in both countries.

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 Industrial Economics and Foreign Trade

The classical theory showed that the basis of international trade was comparative cost
differences. But it did not explain the reason for comparative cost differences, The
Heckscher-Ohlin theorem tried to explain the causes of comparative cost differences that
exist internationally. According to the theorem, the differences in comparative advantage
among nations is mainly due to the differences in relative factor abondance or factor
endowments.
Heckscher-Ohlin theorem can be stated as follows. A country will produce and export that
commodity whose production requires the intensive use of the nation's relatively abundant
and cheap factor and import the commodity whose production requires the intense use of
relatively scarce and expensive factor. In other words, relatively labour abundant country
will export the relatively labour-intensive commodity and import the relatively
capital
intensive commodity.

In the Heckscher-Ohlin theorem factors of production are considered as abundant or scarce

in relative terms and not in absolute terms. For example, a country will be considered as

capital abundant only if the ratio of capital to other factors is higher when compared to
other countries.

Country A Supply of labour = 50

Supply of capital 40
Capital-labour ratio = 0.8

Country B Supply of labour = 16

Supply of capital 20
Capital-labour ratio = 1.25

In the above example, country A has more

capital in absolute terms but country B is
endowed with or abundant in capital because the ratio of capital to labour is high in country
B.

Factor Price Equalisation Theoremn

Factor price equalisation theorem is a
corollary of Heckscher-Ohlin theorem. It was proved
by Paul Samuelson and hence it is called
Heckscher-Ohlin-Samuelson theorem.
The theorem state that free
international trade will equalise factor
relatively and prices between couni
absolutely and this serve as a substitute for international factor mobility. In
a country, international trade increases the
demand for
specialisation takes place on the basis of factor endowments orabundant factors becaus
abundance. Thereforc, the
136
 International Trade
of the abundant
he abunda
factors increase.
nd hence their
creases and Similarly, the demand for the
prices alsO decrease. scarce factors
Thus,
d e c r

a large
proportion of when a
contaninga
aa
the
relatively abundant and
country export goods
A a lar
ontaining large proportion of scarce chcap factors and import
onta
Comt

factors, it may act

as goods
movements
and lead to factor
price substitute for
inter-regional
factor
equalisation.
Merits of Heckscher-Ohlin theory
Heck obccher-Ohlin theory provides a more
foreign trade.
comprehensive and satisfactory explanation for
2.a Heckscher-Ohlin theory explain the reason for
comparative cost differences between
nations in terms of factor endowments.

Heckscher-Ohlin theory is formulated within the framework of the general

equilibrium.
4 The Heckscher-Ohlin theory highlights the role of relative of factors in
prices
determining the trade flow.

5. Heckscher-Ohlin theory highlights the impact of trade on product and factor prices.
Effects of International Trade

According to Heckscher-Ohlin theorem, international trade has the following effects.

1. Equalisation of factor prices: Since specialisation takes place according to factor

endowments, it equates factor prices between countries.

2. Equalisation of Commodity prices: International trade leads to the movement of goods

abundant to where they are scarce. This would
from those areas where they are arcas

equalise the commodity prices.

Balance of Payments
record of all economic transactions of a nation with
Balance of payments is a systematic
time. Usually, time period is taken as one year.
the rest of the world for a specific period of
is to inform the governments regarding the
The main purpose of balance of payments
nation and to help in the formulation of policies
international currency position of the
is also useful to banks, firms and individuals who
accordingly. Balance of payments
or indirectly involved in
international trade and finance.
directly
It is obvious that during a period of time millions of transactions take place between one

all these transactions cannot appear

nation and with the rest of the world. Therefore,
statement. As a summary statement, balance of
individually in the balance of payment
payments aggregates all these transactions under different heads.

137
 Foreign Trade
and
Industrial Economics

of Payments
Balance of Trade and Balance
and balance of trade. Balance
to distinguish between balance of payments
lt is meaningful the exporting and inmporting
transactions which are
involved in
of trade includes only those various kinds services of
It docs not include invisible items such as
ofvisible items (goods). etc. On the other hand
interest and dividend
payment of
(shipping. banking, insurance), item. Therefore, balance of
includes both visible and invisible
balance of payments
balance.
payments gives a bctter picture of a country's external

Components of Balance of Payments

system. That means
accounting follows double-entry book-keeping
Balance of payments debit entry ofequal
size. Therefore, balance
cach transaction will result in a credit entry and
total
amount of debit will be equal to amount
of payments will always balance. That is, total added to balance the
item called errors and omissions will be
of credit. Sometimes, an

balance of payments.

following heads:
transactions are classified under the
Usually, international
Account
1. Current Account 2. Capital Account 3. Unilateral payments

4. Official Reserve Assets Account

Current Account
Current account consists of two major items i) merchandise (visible) exports and imports

ii) invisible exports and imports.

Merchandise exports and imports: Merchandise exports, that is sale of goods abroad

credit items and merchandise imports, that is purchase of goods from abroad are
debit
are
items. Merchandise exports and imports are the most important international transactions
of most of the countries.

Invisible exports and imports: Invisible exports are credit entries and imports are debit
entries. Invisible exports mean sale of services like transport, insurance, foreign tourist
expenditure in the home country and interest received on loan and dividend on investment
abroad etc.
Invisible imports include purchase of services like transport and insurance, tourist

expenditure abroad and payment on foreign loans and foreign investments etc.

138
 International Trade
CapitalAccount

account includes short term and long-term capital transactions.

+ol
The
capital.
Capital inflows
ing as Credit entries and capital outflows as debit entries. For example, when a
m invest 100 million in India, there will be an entry under credit for India and
Japanesefim inve
ntry under debit for Japan. However, the payment for capital services like interest on
2n e n t r y

n and dividend payments for investment are included in current account. The following
loan.

e the three major items coming under capital account.

are

Loans and borrowings - It includes all types of loans from both the private and public

sectors located
in foreign countries.

Investments These are funds invested in the corporate stocks by non-residents.

various investments in real estates,

The flow of funds from and to foreign countries through
monitored through the financial account. This
business ventures, foreign direct investments etc is
of domestic assets and domestic
account measures the changes in the foreign ownership
ownership of foreign assets

Unilateral Transfers Account

Such
of an item from one person to another.
Unilateral Transfer means the one-way transfer
of anything in return. This is important
an
without any expectations
one-way transfers are
account. The following
In a broader sense it is a part of current
tem of balance of payments.
unilateral transfers.
are the important items coming under
home country.
from immigrants to their
Payments or remittances

Humanitarian aid.
aid is from developed or prosperous
another. Usually, the
Aid by one country to
nations.
nations to less developed
institutions.
charitable
Contribution to

international agencies.
Membership payment to
could be from a person, business
or
another. This gift
Gift from one county to

government.
The official reserve account
The official reserve account is a capital account. It is the foreign currency
subdivision of the
and is used to balance
and securities held by the government, usually by its central bank,
trade surplus
the payments from year to year. The official reserves increases when there is a

139
 Industrial Economics and Foreign Trade

and decreases when there is a deficit. Sometimes the central bank will use it to intervene in
the foreign exchange market to set the exchange rate to some desired level.

Balance of Payments Disequilibrium - Deficit

The balance of payments is in disequilibrium when it shows a surplus or deficit. When the
demand for foreign exchange exceeds the supply of foreign exchange, there is deficit in
balance of payments. There are a number factors responsible for a disequilibrium or a
deficit in balance of payments.
Economic Factors
The following are the important economic factors which lead to balance of payment
disequilibrium.
i) Development disequilibrium: Largescale development expenditure may increase the
purchasing power of the people and they demand more imported items. Besides, developing
countries may import capital goods like machinery and equipment for their economic
development. This also increase their import bill and result in a deficit.
ii) Cyclical Disequilibrium: Cyclical fluctuation create and boom and depression. When
there is boom import may increase more than export and it create a deficit in balance of
payments.

ii) Secular Disequilibrium: In developed countries disposable income and

demand will be very high. Wages may increase and the
aggregate
production cost also increases. This
may result in high prices. Higher aggregate demand and
higher prices lead to larger imports
and deficit in the balance of payments.

Political Factors
Political instability in a country may
adversely affect the capital flows and investments. It
may lead to large capital outflows and less investment in the domestic
create a deficit in balance of
country. This may
payments.
Social factors

Changes in tastes, fashion etc. may change consumption habits of the

affect export and import as well as balance of people and this may
payments.
Correction of Disequilibrium or Deficit
When there is deficit in the balance of
payments, it has to be corrected. The following are
the important measures to correct a balance of
payments disequilibrium.
140
 International Trade
atic
1 .Automatic Correction: When there is
will try to correct it
economy will disequilibrium
a
in the balance
aple,
For example, when there is
automatically with the help of demand
of
payments, the
a
deficit, or the demand for supply mechanism.
Nchange rate will be
get adjusted forcign exchange exceeds it
supply
e domestic currency. This willaccordingly
of the and there will be a
increase the exports and
fall in the external
correct the deficit.
Deliberate Measures: The three deliberate
measures are a)
trade measures and c) Miscellaneous measures Monetary measures b)
Monetary measures The important monetary measures are
i) Monetary contraction or
expansion: Expansion or contraction of money supply can
affect the balance of payments position.
When there is a deficit, a contraction of
money
supply will decrease the purchasing power of the people and hence the
aggregate demand
as well as the
price level falls. This reduces the imports. When there is a fall in the price in
the domestic economy, it encourages
export. Thus, deficit will be corrected.
ii) Devaluation: It means a deliberate reduction in the value ofa currency by reducing the
official rate at which it is exchanged for another currency. When there is a deficit in the
balance of payments, devaluation of the currency encourages export and discourages
import. Devaluation makes the domestic goods cheaper for the foreigners and foreign
goods expensive for the people in the home country.
ii) Exchange control: Under exchange control, the government or the central bank will
have the complete control over the foreign exchange earning of the country. The
government will keep the entire foreign exchange earnings and this helps the government
to control imports.

Trade Measures Trade measures are export promotion and import control.

i) Export promotion: Export can be encouraged by abolishing export duty, giving export
facilities for export-oriented production.
subsidy and by providing
ii) Import control: Imports can be discouraged by increasing import duties, through import
quotas import licensing etc.

Miscellaneous Measures Miscellaneous measures include encouragement of

etc.
1oreign investment, promotion of tourism
Devaluation
Devaluation means a deliberate reduction of the value of the domestic currency in terms of

foreigncurrencies. A country which laces a serious problem of deficit in the balance of

payments may resort to devaluation. This will stimulate their export and discourage import.

141
 Industrial Economics and Foreign Trade
of Indian
The working of devaluation can be explained with the help of the devaluation
rupee in 1966.
Indian Rupee
Before devaluation the exchange rate $1= Rs. 4.76. Devaluation of the
was
rate became $1
57.56 against dollar. Then the exchange
=

was 36.5 per cent and it was

became costly. Before devaluation, foreign commodity

a
Rs.7.5. After devaluation import
the same commodity
which cost S1 Abroad cost Rs.4.76 in India. But, after devaluation
became costier in India.
cost Si abroad but Rs.7.5 in India. Thus, imported goods
devaluation a commodity
became cheaper after devaluation. Before
Similarly, export
cost only $0.64 for the foreigners. This
which cost Rs.4.76 in India and $1 abroad now
market and encouraged export.
made Indian goods cheaper in the foreign
Limitations of Devaluation

reactions of other countries. If they

retaliate by
1. The success of devaluation depends on

devaluation will not be successful.

devaluing their currencies,
same rate or at a higher
rate of
in the domestic country increases at the
2. If prices
increase export or decrease import.
devaluation, it will not will not
also depends on the elasticities
of demand for export
3. The s u c c e s s of devaluation depends
Marshall-Lerner condition devaluation
will be successful only
and import. According to the
domestic country is
of elasticities of demand for exports and imports of the
if the sum
greater than one.
the extent
country's export due to devaluation,
increase in the demand for a
4. In spite of an available for export.
increase in exports depends on the exportable
surplus or the quantity
of

Devaluation and Elasticities of Demand for Exports and Imports

 International Trade

Versus Protection
Trade

ree
restrict imports or exports. In other words, it refers
trade policy that does not
de is a
-a trade policy

from all artificial barriers to trade like, tariffs, quota restrictions,

Fre
tothe trade that is free
the to international
the case of free trade the free market idea is applied
o control etc.
exchange

on the other hand is the policy of protecting domestic

industries against
ection
rade. Protection on

tariffs, subsidies, import quotas etc. It affects mainly the

en competition by
means
of measures. They
Government-levied tariffs are the chief protectionist
ofacountry.
importsof country
products, making them more expensive than domestic products.
ice the price of imported
raise

for Free Trade

Arguments
favour of free trade
are the important arguments in
The following
economic utilisation of
utilisation of resources: Free trade leads to the most
it is
1, Better
utilised in the production
of those goods for which
The resources will be
resources.
best suited.
will specialize in
free trade Each country
of labour and specialisation: Under to large
2. Division
it has a comparative
advantage. This leads
those goods in which
the production of
division of labour and efficiency.
scale production,
inefficient firms
under free trade and hence
intense competition
3. Efficiency: There is their efficiency.
survive. Therefore,
firms try to increase
cannot
domestic monopolies by providing
trade jeopardise
practices: Free
4. Dampen monopoly
at lowest price.
internationally available goods
to avail all types
enables the
consumers

goods: Free trade

5. Wide variety of

internationally
available goods at cheapest price.
bureaucratic interferences and
trade is free from
and red-tapism: Free
6. Avoid corruption related decisions.
in taking trade
and delay
hence it avoids corruption economic
and division of labour leads to
Largescale production
7. Economic growth:
growth.
Free Trade
Arguments Against
become available
Because of free trade, imported goods
1. Threat to domestic industries: between domestic
unfair and cut-throat competition develops
at a cheaper price. Thus, an
domestic industries are wiped out.
industries. In the process,
and foreign

147
 Industrial Economics and Foreign Trade
2. Harmful commodities: a country may have to
change its consumption habits. Because
of free trade, even harmful commodities
(drugs, etc.) enter the domestic market. To prevent
this, restrictions on trade are required to be imposed.
3. The Unfair-Competition Argument: It is that free trade leads to
argued competition
among unequals. Developing countries cannot fairly compete with the developed
countries.
Their cost conditions may be different.

4. Job outsourcing leads to unemployment: Free trade allows businesses to move their
production to a place where it is cheaper to produce. In countries where labour or
production costs are high, the firms may outsource their work and this may lead to loss of
employment domestic economy.

5. Degradation of environment: Emerging developing economies often may not have

sufticient environment protection laws. Free trade leads to depletion of timber,
minerals,
and other natural resources because of their over exploitation.
6. Poor Working Conditions: Multi-national companies may outsource jobs to emerging
developing countries without adequate labour protections. As a result, women and children
often may involve in factory
jobs in sub-standard conditions.
Arguments in Favour of Protection
When the domestic industries are threatened
by foreign competition, nations may resort to
protectionism to safeguard national interest. The following are the important
favour of protection. arguments in

1. Infant industry
argument: This argument says that when a new
industry is launched,
it must be
protected from
foreign competition. Already established companies will have
certain advantages like economies of scale,
to compete with such a
experience, market power etc. If the infant is
foreign competitor, it will be competition between
that will lead to the destruction of the infant unequals and
industry. That doesn't mean that it has to be
protected for ever, but only during the blooming stage.
Nurse the baby, Protect the child and Free the According to protection policy
adult". But some economists criticised that
if protection is given to an infant, it will
remain as an infant forever.
2.Strategic and Key industry argument: It is argued that a
country should develop is
own strategic and key industries. This is because
the development of other industries and
the development of the economy needs the output of these industries. Hence, we have to
protect and develop such industries.
148
 International Trade
National
anal DefenDefence: If we depend on other nations for defence
because if they deny it at times when it is most urgent itequipment
it will be a
hness
olishness becaus will be a threat to the
ity of
of the nation. Hence defence industries should be
the nation
security protected and developed.
iversification: A diversified industrial structure is necessary to maintain stability in
and to strengthen the economy.
the economy

5. Terms of trade argument: When a country protects its industries by imposing tariffs
or quotas, it will restrict the imports and improve the terms of trade.

6. Improving balance of payments: When imports are restricted through protection

policies, it will help to mprove the balance ofpayments.

7. Anti-Dumping: Through dumping a foreign company may sell its product at very low
in the home country and this may ruin the domestic industries. Once they get a
prices
harmful in the
monopoly over the product, they will increase the price and hence it will be
long run. By protective measures, a government can prevent dumping.

8. Employment argument: Restricting imports by way of protective measures encourages

production in the home country and it will create more employment opportunities in the
home country.
from the home
Keeping money at Home: When a commodity imported, money
9. is
when imports are restricted through protection,
country is going abroad. On the other hand,
can be kept in the honme country itself.
money
10. Equalisation of costs of production: Imposition of import duties increases the price
it will equalise the cost of the commodity in the
of foreigngoods and thus it is argued that
But critics say that cost differences is the vey basis
home country and in the foreign market.
of international trade.

that protection will enlarge the market for

11. Size of the home market: It is argued
because of the increase in the price of the farm
agricultural products. This will happen
from countries as well as the increase in the purchasing power
foreign
products imported
of the workers who engage in the industrial sector by way of protection.

Arguments Against Protection

1. Protection is against the interest ofthe consumers as it increases the price of the
imported products. Further, consumers are denied the opportunity for enjoying

variety goods.
2. It discourages competition and hence compromises efficiency.
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 Industrial Economics and Foreign Trade

3. It encourages the growth of domestic monopolies because of the

foreign competition.
weakening of
4. Protection discourages innovations and cost reduction.

5. It leads to uneconomic utilisation of world's resources.

6. Protection may lead to trade wars and international conflicts

among trading nati ons.
When one country takes protective measures, others may retaliate.

Trade Barriers
Trade barriers refer to the government policies and measures which
restrict the free flow
of goods between the countries. Broadly, trade barriers are divided
into two groups. They
are tariff barriers and non-tariff barriers.

Tariff Barriers

Tariff barriers are duties or taxes

imposed by the government of a country on its imports or
exports. Tariff is an important measure of protection. But,
involvement of WTO countries are
recently, because of the
reducing tariffs.
On the basis of origin and destination of goods, tariffs can be classified in to the
following three categories.
i) Export duties: These are taxes levied on
goods originated in the duty levying country
(home country) and destined for some other
countries.
) Import duties: These taxes
imposed on goods originated abroad and destined for the
are
duty levying country (home country).
1) Transit duty: These are taxes imposed on
these goods crossing the boarders of a country Du
goods are originated from and destined for some other countries.
Based on the
quantification of tariffs, these can be classified as
1) Specific duties: It is a fixed amount of duty
exported or imported. imposed on each unit of the conm dity
1) Aa-valorem duties:
These
commodity imported or exported. duties the
are levied as a fixed percentage of the valuc

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 International Trade
n d du
ii)Cormpound duties: When specific and ad-valorem duties
compound duties.
are imposed on a commodity
as
known
is
an
Based o n the application of Tariffs between different
countries, tariffs may be
classified as

Cinale-column tariff: Under this type of tariff system, a uniform tariff is imposed on
1) Sr
similar product irrespective of the country from which they areimported.
simi

Double-column tarift: In this type two rates are imposed on some commodities or all
commodities.

i Triple-column tariff: In this system three rates of tariffs -general, the intermediate and
preferential- are levied.

Based on the purpose they serve, tariffs can be classified as

i) Revenue tariff: When raising revenue is the only motive of imposing a tariff, it is called
revenue tariff. Generally, this type of tariff rates will be low.
intention to protect domestic
ii) Protective tariff: This type of tariff is imposed with an

industries. Usually, the rates will be high.

tariffs are imposed on those
i) Countervailing and Anti-Dumping tariffs: Countervailing
the foreign governments. When foreign
commodities which are heavily subsidised by
anti-
market at price lower than its cost of production,
goods are sold in the domestic
dumping duties are imposed.

Effects of Tariff

The following are the effects of tariff on the economy.

become costlier. Hence, the
Protective effect: When an import duty is imposed, imports
i)
increase and it will protect the domesticindustries.
demand for domestic goods will
increase the revenue of the government if it does not
ii) Revenue effect: A tariff will
completely stops the imports.
tariff will increase the demand for domestic goods. Hence
ii) Income and employment: A
it will increase production, employment and income in the home country.

iv) Balance of payments effect: Tariff may help to improve the balance of payments as its
restrict the imports.

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 Industrial Econ

increase the price ofsthe commodities and

duty Will
effect: An import
vConsumption
capacity of the people.
reduce the buying
hence it will
protects the domestic industries oand
effect: An import duty hence it may
vi) Competitive This can lead to inefficiencies
in the economy.
reduce competition
vi) Redistribution effect: If the import duty increases the price of a domestically produced
favour of the producers
redistribution of income in
nroduct, it leads to a

The effects oftariff in general can be explained with the help of the following agram.

In thediagram, in the
absence of foreign SL
D
trade domestic
demand curve DDI
and supply curve SS1
intersect at point M.
The equilibrium price
is P and the quantityy
demanded and
P2
supplied is Q B
P1
Suppose, foreign A
supply is perfectly
elastic at price P1.
Then under free
trade, supply in the
economy can be
represented by the
straight line PIB. Q1 Q3
Q4 a2
Under free trade, the
total
domestic producers and theconsumption will be Q2 and of this Ql out will be by
quantity Q1Q2 will be supp
Suppose the government imported.
to P2. At P2
price
imposes a tariff equal to PIP2. Pl
domestic demand falls to This increases the
increases from Ql to Q3. The Q4. Because of the rise in prte.r
by import. remaining part of the domestic
price u
and Q3Q4 will he met
demand Q

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 International Trade

se trade tithe total

free
trade surplus is DPIB. But under protection it decreases to
consumers

in consumer's surplus is PIP2GB and this is distributed in a number

Under
The total loss
DP2G
The tariff per
rsThe
ofways.
unit is PlP2 and total import is Q3Q4. Therefore, the government

a total
revenue of CEFG from import duty.
willget
from Pl to P2. Hence, the producers
Recause
Becau ofthe imposition of the tariff, price increased
PIP2CA. This is transfer of income from consumers to
t
get
additional benefits of a

the redistributive effect of tariff.

producers and it is
ACE represents the sum of
from Q1 to Q3.
Because of the tarifi domestic supply increases
is the protective effect of the tariff. Similarly,
additional cost per unit of output This GFB.
and hence the loss in consumer's surplus is
consumption decreases from Q2 to Q4
This is the consumption effect.
effect and
of the tariff is the sum of protective
The actual loss to the economy because
redistributive effects
The revenue effect (CEFG) and
consumption effect (ACE + GFB).
one group to another group.
a transfer of income from
only
(PIP2C) are

Non-Tariff Barriers (NTBs)

Its impact is more on developing
Recently, non-tariff barriers are gaining popularity.
NTBs
different types of NTBs. Hardcore
developed countries. There
are
countries than
Variable levies, Multi-Fibre Agreement restrictions
include, Voluntary Export Restraints, technical barriers, minimum pricing
Others include
and non-automatic licensing.
surveillance.
regulations and price
restriction
voluntary export restraint (VER) is a trade
Restraints: A
1.Voluntary Export
is allowed to export to another country.
an exporting country
on the quantity of a good that
are highly discriminatory and the
This limit is self-imposed by the exporting country. They
WTO is taking efforts to eliminate such restrictions
wide range of a
2. Administered Protection: Administered protection encompasses
bureaucratic government actions. The important measures under administered protection

include

a) Safeguards: A safeguard is a temporary import restriction that a country is allowed to

impose on a product if imports of that product are increasing so as to cause, or threaten to
cause, serious injury to a domestic industry that produces a similar or directly competitive
product.

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 Industrial Economics and Foreign Trade

b) Health and product standards: The developed countries fix

fix certain has certain health and
standards which hinder the exports of developing countries because of
use of product
added cost or
technical requirements.
e)Customs Procedures: Customs procedures of many countries act as a trade i
example, frequent changes in customs procedures of Japan acted as a barrierto ev

d Licensing: Many countries use licensing as a measure to restrict trade. esnoel n

imports.
ially
e) Monetary controls: Monetary controls are also employed to regulate imnore
example, RBI in 1990s took several measures which include a 25 percent interest
For
st rate
surcharge on bank credit for imports.

f)Environmental protection laws: Many countries framed environment protection laws

to restrict imports. For
example, the US congress has passed legislation to prohibit the
import of shrimp harvested with commercial fishing technology on the argument that it will
threaten the survival of turtles.

g Foreign Exchange Regulations: In some countries, the State monopolise foreign

exchange and hesitate to release foreign exchange for imports.
Demerits of NTBs
NTBs are lesstransparent, difficult to identify and it is impossible
They are unfair because they do not treat
to quantify its impacts.
exporters equally.
Quantitative Restrictions or Quotas
A quota represents a ceiling or limit on the volume of
are the exports or imports. The following
important types of import quotas.
1.The tariff or custom
quota: Under this system, import of a commodity up to a d
quantity is allowed to be imported duty-free or at a special low rate of duty. But imports
excess of this fixed limit are
charged a higher rate of duty. The tariff quota thus
the features of a taritf with those
of quota.
como
2. The UnilateralQuota: Under this system, a
country places an absolute n the
import ofa commodity during a given
foreign governments.
period. It is imposed without
prior negola
h

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 International Trade
3. The Bilateral Quota: Under this
importing country and the exportingsystem, quotas are set through
country.
negotiation between tne
4. The Mixing Quota: It is a
type of
proportion of domestiC raw materialsregulation which requires
producers to utilise a certan
domestically. It thus sets limits on along
with imported parts to produce finished goods
the
imported and used in domestic production.proportion of foreign-made raw materials to be

5. Import Licensing: Under this,

from the proper authorities for
prospective importers required to obtain a licence
are

are generally distributed

importing any quantity within the specified quotas. Licences
among established importers keeping in view their share in the
country's import trend.
Effects of quotas
The following are the important economic effects of quotas
1. Price effect: As
quotas restrict imports and domestic supply, it increases prices in the
domestic economy.
2. Consumption effect: Since quotas raises the price, it reduces consumption.
3. Balance of
payments effect: As quotas restrict imports, balance of payments position
will be improved.

4. Protective effects: Quotas restrict imports and guard domestic industries from foreign
competition.
5. Revenue effect: When quotas are administered
by means of a license, government can
get some revenue in the form of license fee.

6. Redistributive effect: If price increases because of

quota restrictions, there will be some
redistribution of income in favour producers.

Effects of quotas can be explained with the help of the following diagram similar to
the case of tariff.

155