Methods of Protection (HSC SSCE Economics): Revision Notes

Methods of Protection

Most countries use some form of protectionist measures to shield their domestic industries from foreign competition, despite living in an era of relatively free global trade. Over time, there has been a shift from traditional protectionist tools like tariffs and subsidies towards less obvious measures such as administrative barriers and industry assistance programs.

Tariffs

What is a tariff?

A tariff is a tax imposed by the government on imported goods. By raising the price of imports, tariffs make domestically produced goods more competitive in the local market.

How tariffs work

The diagram above illustrates how tariffs affect a market. Consider the following key points:

• The supply curve (S) and demand curve (D) represent domestic supply and demand
• At the free trade price $P$, consumers demand quantity $Q_1$, domestic producers supply quantity $Q$, and imports equal $Q$ to $Q_1$
• When a tariff equal to $PP_1$ is imposed and fully passed to consumers, several changes occur:
  • Consumer demand contracts to $Q_3$
  • Domestic supply expands to $Q_2$
  • Imports fall to $Q_2$ to $Q_3$
  • The government collects tariff revenue shown by the shaded area $ABCD$

Economic effects of tariffs

Impact on domestic production and employment

When tariffs are introduced, domestic producers can supply a greater quantity of goods at higher prices. This stimulates local production and creates employment in the protected industry. However, this comes at a cost to economic efficiency.

Consumer welfare effects

Consumers face higher prices and can purchase fewer goods when tariffs are imposed. This represents a redistribution of income from consumers to domestic producers. Economic modelling by the Productivity Commission suggested that for every $1.00 increase in Australian tariff revenue, economic activity would fall by $0.64. GDP would decline by over 1%, equivalent to around 100,000 lost jobs, and the average household would lose approximately $1,500 per year in income.

Risk of retaliation

Tariffs can trigger retaliation from trading partners. When one country imposes a tariff, affected countries may respond with their own trade barriers. For instance, after Australia imposed a 144% tariff on Chinese steel imports in 2014 as an anti-dumping measure, China retaliated by imposing tariffs on several Australian exports, including barley (74% in 2018) and wine (over 200% in 2020).

Quotas

What is a quota?

An import quota is a restriction on the volume of a particular good that can be imported over a specified time period. Quotas are primarily used to protect domestic production, though they may also limit the entry of undesired goods. For example, in 2018 Australia implemented a quota system for hydrofluorocarbons (HFCs) used in refrigeration due to environmental concerns.

Quotas guarantee domestic producers a share of the market by physically limiting the quantity of imports.

How quotas work

The diagram above shows the market effects of an import quota. The key points are:

• At the free trade price $P$, consumers demand $Q_1$, domestic producers supply $Q$, and imports equal $Q$ to $Q_1$
• When the government restricts imports to $Q_2$ to $Q_3$, this creates scarcity
• The reduced supply pushes the price up to $P_1$
• At this higher price, domestic supply expands to $Q_2$
• Overall consumption falls to $Q_3$

Economic effects of quotas

Production and employment effects

Similar to tariffs, quotas stimulate domestic production and employment in the protected industry by guaranteeing local producers a share of the market. For instance, the European Union imposes an import quota allowing no more than 7,150 tonnes of high-quality beef imports. This provides certainty for European producers who can supply any demand exceeding this limit, even if their production costs are higher than overseas competitors.

Resource reallocation

More resources flow into the protected industry, drawn away from other sectors where production and employment consequently fall. This represents an inefficient allocation of resources from an economy-wide perspective.

Consumer impacts

Consumers pay higher prices and have access to fewer goods. This transfers income from consumers to domestic producers in the protected industry and results in lower overall economic growth.

Retaliation risk

As with tariffs, imposing quotas can invite retaliation from countries whose exports are reduced. This can result in lower exports for the country that initiated the quota.

Subsidies

What is a subsidy?

A subsidy is a cash payment from the government to businesses to encourage production of a good or service. Subsidies enable domestic producers to reduce their selling prices and compete more effectively with overseas producers. They are designed to influence the allocation of resources in the economy.

How subsidies work

The diagram illustrates the effect of a subsidy on a market. When a subsidy is provided to producers:

• The supply curve shifts rightward from $S$ to $S_1$
• This results in a lower market price (from $P$ to $P_1$)
• The quantity produced and sold increases from $Q$ to $Q_1$
• The vertical distance between $S$ and $S_1$ represents the per-unit subsidy amount

Businesses can sell a higher quantity of their product in both domestic and global markets at lower prices.

Economic effects of subsidies

Stimulating production and employment

Subsidies enable domestic producers to supply greater quantities of goods, thereby stimulating production and employment in the protected industry.

Resource allocation impacts

More resources are attracted to the protected industry, leading to reallocation away from other sectors where production and employment decline.

Consumer benefits and indirect costs

Consumers benefit from lower prices and access to more goods because the subsidy shifts the supply curve rightward. However, consumers still pay indirectly through higher taxes needed to fund the subsidies.

Local content rules

Local content rules mandate that goods must contain a minimum percentage of locally manufactured parts. In exchange for guaranteeing a certain percentage of local production, imported components may enter without tariffs.

Australia has a longstanding requirement that the majority of free-to-air television content broadcast from 6:00 am to midnight must be locally produced (currently a minimum of 55%). In 2023, the Australian Government announced plans to introduce local content requirements for streaming services such as Netflix, Stan and Binge as part of its Revive National Cultural Policy.

Export incentives

Export incentive programs provide domestic producers with assistance including grants, loans, or technical advice (such as marketing or legal information). These programs encourage businesses to penetrate global markets or expand their market share.

The popularity of export incentives has grown considerably as nations have shifted focus from protecting import-competing businesses to capturing foreign markets as a strategy for achieving higher economic growth and employment.

Overall economic effects of protectionism

Beyond the impacts on individual domestic economies, protectionist policies have broader consequences for the global economy.

Reduced global trade

Protectionist policies reduce the overall level of trade between nations. For any individual economy, this means exports and imports represent a smaller share of national output. A Boston Consulting Group report for the B20 group of business leaders estimated that major economies imposing protectionist policies following the COVID-19 pandemic could reduce global economic output by as much as $10 trillion by 2025 compared to what it would otherwise reach.

Lower living standards and economic growth

Overall, protectionist policies reduce living standards and constrain global economic growth by shielding inefficient producers. A major 2019 International Monetary Fund study titled "The Macroeconomic Consequences of Tariffs" examined the tariff policies of 151 countries over 50 years. The study concluded that countries raising tariffs experience:

• Lower output
• Weaker productivity
• Increased unemployment
• Increased inequality

Reduced specialisation and efficiency

Protectionist policies make it more difficult for individual economies to specialise in production where they are most efficient. Businesses are less able to achieve economies of scale, resulting in lower profits and dividends. With reduced competitive pressures, prices for goods and services rise. This leads to slower economic growth in individual countries.

Disproportionate impact on developing economies

The negative economic impact of protectionist policies tends to be larger relative to the size of economies for developing countries, which are often excluded from access to the markets of advanced economies. The World Bank has highlighted that increased trade helps reduce global poverty. Between 1990 and 2017, developing economies increased their share of global exports from 16% to 30%, while the number of people in extreme poverty globally fell from 36% to 9%.