Arguments for Protection Chap 9, “International Economics” Written by Pugel Presented by M, Kim

 Import protection is good for the country. Why do most countries have policies that limit imports?  Import protection is good for the country. Int'l Finance

A tariff or NTB to imports of a product can: GOOD TEXT TEXT TEXT TEXT Increase employment and other resources Decrease domestic consumption Increase government revenue Increase domestic production Alter the distribution of income or well-being in the country Extra good Extra good Extra bad Extra good Desire Int'l Finance

1. The ideal world of first best 2. The realistic world of second best 3. Promoting domestic production or employment 4. The infant industry argument Int'l Finance

First-best world --- All private incentives aligned perfectly with benefits and costs to society as a whole. Price (P) =buyers’ private marginal benefit (MB) = Social marginal benefit (SMB) =Sellers’ private marginal cost (MC) = Social marginal cost (SMC) Int'l Finance

MB & MC The domestic demand curve represented not only marginal benefits of an extra bicycle to its private buyer but also the extra benefits of another bicycle to society as a whole. The domestic supply curve represented not only marginal cost of an bicycle at home but also the marginal cost to society as a whole. Int'l Finance

Government Policies toward Externalities Two basic approaches for government policy: 1. optimistic approach: tax-or-subsidy approach 2. Pessimistic approach: property-rights approach Int'l Finance

If SMC>MC=P=MB=SMB, as in the pollution case? levy a tax of (SMC-SMB) raising the price If SMB>MB=P=MC=SMC, as in the training case? pay a subsidy of (SMB-SMC)  decision makers recognize the full social returns Int'l Finance

The Specificity Rule It is usually more efficient to use the government policy tool that acts as directly as possible on the source of the distortion separating private and social benefits or costs. identify the specific source of the problem and intervene directly at this source. Int'l Finance

Ex: paper mills polluting rivers Tax all production of paper  make less paper Subsidize the installation of a particular waste-treatment device  too narrow Taxes or quantitative limits on the amount of pollution discharged is likely to be better policies to use. Int'l Finance

Although a barrier against imports can be better than doing nothing in a second-best world, some other policy instrument is usually more efficient than a trade barrier in dealing with a domestic distortion. Int'l Finance

Promoting Domestic Production or Employment Proposed reasons that protection is good for the country: 1. Local production of this product produces spillover benefits because other firms and industries benefit from production know-how or management techniques introduced by the firms in this industry 2. Employment in this industry imparts new worker skills and attitudes, and some workers carry these when they switch jobs to work for other firms and industries. Int'l Finance

The Infant Industry Argument A temporary tariff is justified because it cuts down on import while the infant domestic industry learns how to produce at low enough costs. Eventually the domestic industry will be able to compete without the help of a tariff. Difference: protection is needed only for a while. Int'l Finance

How valid is the infant industry argument? Four conclusions There can be a case for some sort of government encouragement. A tariff may or may not be good. Some form of government help other than a tariff is a better infant industry policy than a tariff. It is hard for a government to know which industries to support, because it is difficult to predict which industries can reduce their costs enough in the future to create net national benefits. Int'l Finance