Theories of protectionism:
Economists have always acknowledged the benefits of international trade. Gains from trade arise due to specialisation in production along lines of comparative advantage, leading to efficient allocation of scarce resources within nations. Gains also arise from exchange between countries, with each country exporting the goods, which it produces relatively most efficiently and importing goods at a cost lower than that of domestic production.
Therefore, trade can potentially be welfare improving for the world as a whole. Yet, in practice, trade bamers restricting the cross-border flow of goods and services, are erected by virtually every trading nation in the world. What justifies the use of protectionist measures, given the many benefits of free trade?
Our analysis indicates that tariffs lead to more efficient outcomes compared to non-tariff bamers like quotas, as in addition to restricting the flows of imported goods, tariffs also impose a price discipline on domestic firms.
Further, while the government directly benefits from tariff revenues, the quota rent may be completely dissipated in wasteful rent-seeking activities, leading to a social loss.
Our discussion highlighted another important point. In many cases, conventional trade restrictions like tariffs and quotas are giving way to newer, more indirect measures like imposition of health and safety standards. When viewed in the context of countries' commitments to move towards a more fret and fair world trade, this tendency appears opposite in spirit to the very principle embodied in multilateral organisations like the WTO.
After understanding the various instruments of protectionism, we showed that large countries especially stand to gain by imposing protectionist measures like import tariffs, as they can affect the world price and hence their terms of trade by restricting imports. However, the notion of gains arising from imposition of the optimum tariff applies only to large economies, for smaller nations cannot influence the world price through their actions. Moreover, given that tariff imposition by one country may lead to retaliation by other trade partners, it is not clear to what extent the notion of optimum tariffs can be used in reality, by large countries to improve their terms of trade situation.
Another theoretical argument justifying trade protection rests on the effects of market failures in the domestic economy. In case of domestic market failures, often the outcome can be improved, by imposing trade restrictions. For instance, granting protection to certain industries may result in marginal social benefits that enhance social welfare.
Other common justifications for trade protection include the infant industry argument, which makes a case for granting protection to new industries, especially in developing countries, till they are mature and able to compete with established firms from developed countries. However, there is a tendency for such protection, once granted, to be continued indefinitely and the absence of competition may breed inefficiencies in the industrial structure.