Reasons for Protection (HSC SSCE Economics): Revision Notes

Reasons for Protection

What is protection?

Protection refers to government policies that give domestic producers an artificial advantage over foreign competitors. The main methods of protection include tariffs (taxes on imports), import quotas (limits on quantities) and subsidies (financial support to domestic firms).

Despite the economic benefits of free trade, most countries have historically used some form of protection to help local producers compete against foreign firms. Understanding why governments choose to protect certain industries is crucial for analysing trade policy decisions.

Infant industries

The rationale for protecting new industries

New industries face significant challenges in their early years. They typically operate on a small scale with relatively high costs compared to established competitors in other countries. The infant industry argument suggests that these new industries need temporary protection to:

• Build production capacity
• Establish market presence
• Achieve economies of scale (lower average costs through increased production)
• Develop the efficiency needed to compete globally

Many emerging economies have used this approach to develop new industries in recent decades.

The credibility test

The key test for whether infant industry protection is economically justified is whether the protection is removed over time. Without a clear exit strategy, protected industries have no incentive to become efficient enough to compete without government support.

Problems with the infant industry argument

Historically, many industries protected as "infants" have continued to rely on government assistance for decades. National airlines in the global aviation industry are a prime example of this problem. The infant industry argument has been used to justify support for many industries that would never have become internationally competitive.

For this reason, economists are generally skeptical when businesses seek protection based on infant industry claims. Today, when governments do support new industries (such as battery manufacturing for electric vehicles), they tend to use direct financial assistance for limited time periods rather than ongoing trade barriers.

Prevention of dumping

What is dumping?

Dumping occurs when foreign firms sell goods in another country's market at unrealistically low prices—specifically, below the price charged in their home market. This practice may be used to:

• Dispose of large production surpluses
• Establish market position in a new country
• Drive out local competitors

Why dumping is harmful

While consumers benefit from lower prices in the short term, these prices are usually temporary. Local firms that could normally compete with foreign producers may be forced out of business, causing:

• Loss of productive capacity
• Higher unemployment
• Reduced competition in the long run

Economist support for anti-dumping measures

Using protectionist methods to prevent dumping is the only reason for protection that is widely accepted by economists. However, the World Trade Organization (WTO) has recently questioned whether some countries might be unfairly accusing efficient low-cost foreign producers of dumping. There are concerns that countries may be abusing "anti-dumping" processes simply to protect their domestic industries from legitimate competition.

Anti-dumping measures in practice

Since the WTO was formed in 1995, member countries have lodged more than 6500 anti-dumping complaints. By 2023, around 4500 anti-dumping measures (such as special duties) were legally in force. The sectors most affected include base metals, chemicals, plastics, resin and rubber.

Australia has been quite active in this area, ranking sixth in the world with over 375 complaints initiated. The table below shows which countries have been most active in both initiating anti-dumping measures and being targeted by them.

Protection of domestic employment

The popular argument

One of the most politically popular arguments for protection is that it saves local jobs. The logic appears straightforward: if local producers are shielded from cheaper foreign imports, demand for locally produced goods will increase, creating more domestic employment. This argument gains strongest public support during recessions when unemployment is rising, even though technological change and automation often play a more significant role in job losses than international trade.

Why economists reject this argument

Despite its political appeal, there is little support among economists for protecting industries to preserve employment. Protection distorts the allocation of resources in an economy, shifting production away from efficient industries towards less efficient ones. This misallocation of resources is likely to lead to:

• Higher unemployment in the long run
• Lower economic growth rates
• Reduced international competitiveness

The retaliation problem

If one country protects its industries, other countries may retaliate with similar protectionist policies. The net result could be:

• Higher employment in less efficient protected industries
• Lower employment in more efficient export industries that face new barriers abroad
• Overall reduction in economic welfare for all countries involved

This demonstrates why employment protection through trade barriers is generally considered an ineffective policy approach.

Defence and national security

Non-economic justifications

Countries sometimes have strategic rather than economic reasons for retaining certain industries. Major powers typically want to maintain their own defence industries to ensure that during conflicts they can produce necessary military equipment. This represents a legitimate national security concern that goes beyond pure economic efficiency.

Recent examples of security-based restrictions

National security concerns have expanded beyond traditional defence industries in recent years:

The challenge for Australia

The disruptions to "just in time" global supply chains caused by the pandemic led governments and businesses to reconsider how to prepare for future crises. This presents particular challenges for Australia because of:

• High integration with global supply chains
• Heavy reliance on imports
• Limited domestic manufacturing capacity

Rising barriers to trade

The past decade has marked the end of a long period of expanding free trade that stretched back to the post-Second World War era. While many countries have experienced backlash against globalisation for decades, a new era of "deglobalisation" and rising protectionism has emerged in response to:

• Vulnerabilities in supply chains exposed during COVID-19
• Disruptions caused by the war in Ukraine
• Growing geopolitical tensions

An International Monetary Fund (IMF) report in 2023 estimated that increasing fragmentation in world trade could ultimately cost the global economy 7% of its output.

Changing priorities

While the basic principles of free trade remain widely embraced and global tariff levels remain relatively low, governments have become more concerned about:

• Dependence on other economies
• Vulnerability to overseas developments
• Supply chain resilience

Governments are now focusing on improving supply chain resilience through:

• Increasing inventories
• Expanding local production capacity through subsidies
• Prioritising security interests over pure comparative advantage

Beyond protectionist trade policies, deglobalisation may also involve greater restrictions on migration and foreign direct investment, plus weaker commitment to international cooperation.

US-China decoupling

At the heart of deglobalisation is the "decoupling" between the United States and China. In 2023, President Biden introduced:

• Export restrictions limiting China's access to semiconductor chips and technology
• $11 billion in grants and subsidies to support green technology transitions in rural areas

These measures aim to strengthen national security and reduce risks from the interdependent US-China economic relationship. The Boston Consulting Group estimates these measures will decrease trade between the US and China by $63 billion by 2031.

Other arguments for protection

Wage differentials and labour standards

Some economists argue that producers should be protected from competition with countries that use low-cost labour. They contend that labour costs are artificially low in many developing economies because of:

• Weak labour standards
• Restrictions on workers' rights to form unions
• Low workplace safety standards

This argument suggests that allowing such imports creates unfair competition for producers in countries with higher labour standards.

Modern slavery and forced labour

Growing awareness of modern slavery in global supply chains has led governments to prohibit trade in goods produced using forced labour, including:

• Prison workers
• Child labour
• Other forms of coerced work

Environmental factors

Countries sometimes block trade in goods because of environmental concerns. Overseas producers may be able to produce items cheaply because they:

• Operate with less environmental responsibility
• Do not comply with the tougher environmental standards in advanced economies
• Contribute more to pollution and climate change

In recent years, some countries have proposed introducing "carbon tariffs" on goods produced in countries making slower progress on reducing carbon emissions. These measures aim to prevent "carbon leakage" where production simply shifts to countries with weaker environmental standards.