What trade barriers can governments put in place? As Figure 4.3 shows, there are three types of trade barriers:

Figure 4.3

Trade Barriers

• Tariffs and subsidies. The most common trade barrier is a tariff, a tax imposed on an imported good or service, such as a U.S. tariff on imported French wine. Governments prefer to impose tariffs because they raise tax revenues. The opposite of a tariff is a subsidy, in which a government makes payments to domestic producers. In the United States, subsidies are provided to a wide variety of businesses, including many agricultural businesses. A subsidy can take many forms. It can be a direct cash grant or a tax concession or a low-interest loan.

• Quotas and embargoes. A quota is a limitation on the amount of an import allowed to enter a country. For example, a U.S.-imposed quota on French wine might limit the quantity of it that can be imported to 10,000 cases per day. The most heavy-handed government trade barrier is an embargo, a total restriction on an import (or an export). For example, the United States has imposed an embargo on most goods traded with Cuba. Embargoes are ­usually tools designed to achieve a political goal. In the case of Cuba, the U.S. embargo began in the 1960s when Fidel Castro adopted a one-party communist system. The embargo has been used as a tool to pressure Cuba to adopt a more democratic system of government.

• Administrative trade barriers. Several other types of trade barriers can be lumped under the heading of administrative trade barriers—government rules designed to limit imports. One example is a local content requirement, which is a requirement that some portion of a good be produced domestically. This usually drives up the cost of an import. Administrative trade barriers might also require an import to meet some technical standard or bureaucratic rule, effectively shutting out the import from a domestic market. For example, the EU has banned the importation of all animal meats in which steroids were used to stimulate growth. This decision has heavily impacted the U.S. beef and dairy industries. Although administrative trade barriers can be legitimate, they may be designed purely to protect domestic producers from international competition.

Who benefits and who suffers from trade barriers? Without a doubt, trade barriers benefit domestic producers and their workers but hurt domestic consumers. Trade barriers increase costs to foreign companies or restrict the supply of imports, driving up prices and reducing sales in the domestic market. As a result, higher-priced imports increase the demand for domestically produced substitute goods or services. This higher demand also increases the domestically produced product’s price, although it simultaneously increases domestic sales.

Because domestic firms are selling more at higher prices, they are more profitable. This profitability also creates more job security for their employees. The undesirable outcome, however, is that both imports and domestically produced substitute products are now more expensive. Domestic consumers lose, whereas domestic producers and their workers gain. Trade barriers also hurt consumers because the overall quantity, variety, and quality of products are lower as a result of curtailing foreign competition.

What are common arguments in favor of protectionist trade barriers? Four main arguments for and against trade barriers are as follows:

• National security. The national security argument states that certain industries critical to national security should be protected from foreign competition. For example, the United States wouldn’t want to become dependent on another nation for a component critical to the nation’s defense. Critics of this argument point to the fact that few industries seeking protection fall into this category.

• Infant industry. The infant industry argument states that an undeveloped domestic industry needs time to grow and develop to compete in the global economy. Once the industry has grown and is more competitive, protection from foreign competition will no longer be necessary. Opponents of this view argue that, in practice, it can be difficult to determine whether an industry legitimately holds the promise of becoming competitive. In addition, these people argue that rarely do infant industries ever “grow up.” Instead, governments continue to protect them at the expense of consumers.

• Cheap foreign labor. The cheap foreign labor argument centers on lower wages paid to workers of foreign companies. This issue has become a growing concern. How can domestic companies compete with these low wages? Critics of protecting a nation’s workers against cheap labor argue that a company’s costs of production can be lower even when it pays its workers twice as much if the productivity of the workers is at least twice as high. If a country wants to maintain high wages in a global marketplace, it needs to find a way to increase the productivity of its labor force, not impose trade barriers.

• Threat of retaliation. The threat of retaliation (or the bargaining chip) argument says that if a trading partner increases its trade barriers on your exports or fails to reduce trade barriers when you reduce yours, then an uneven playing field is created. For example, domestic companies are often adversely affected if a foreign firm is dumping its product. Dumping refers to selling a product at a price below its cost in a foreign country to drive competitors there out of business so you can take over the market. Dumping can be difficult to prove, however, and even harder to stop. One way to stop it is for a government to threaten to impose higher trade barriers on the imported product being dumped—in other words, to use trade barriers as a bargaining chip. The problem with this tactic, critics argue, is that it can result in a trade war if the exporting country raises its trade barriers in response. A trade war is likely to harm the economies of both countries.

How do economists feel about protectionist trade barriers? Most economists believe that the best way to address the concerns of those industries and their workers whose livelihoods are threatened by foreign competition is not to impose protectionist trade barriers. Instead, these displaced individuals need to be equipped with the education, training, and skills necessary to smooth their transition into a line of business or work in which the nation has a comparative advantage and demand is rising. Although all governments have protectionist trade barriers in place, they have been working to reduce them because they believe the economic benefits of doing so generally outweigh the costs. This helps explain the recent trend toward freer trade and greater globalization. Table 4.1 summarizes the economic benefits and costs of free trade and protectionism for a nation.

Table 4.1

Economic Benefits and Costs of Free Trade and Protectionism for a Nation

What groups are working to promote free trade? Countries realize that unilaterally reducing their trade barriers puts their businesses at an unfair disadvantage. The key for realizing the mutual benefits of international trade is to get all countries to lower their trade barriers simultaneously, which was the reason for creating organizations such as the General Agreement on Tariffs and Trade and the World Trade Organization.

The General Agreement on Tariffs and Trade (GATT) was created in 1948 with 23 member nations and grew to 123 member nations by 1994. Although GATT was not an organization with any real enforcement powers, its eight rounds of negotiated agreements or treaties successfully reduced tariffs and other obstacles to the free trade of goods. Thereafter, the amount of global trade increased dramatically, as did world economic growth.6 However, GATT was not as successful in terms of reducing trade barriers on services, protecting intellectual property rights, or enforcing agreements among member nations. As a result, the World Trade Organization (WTO) replaced GATT in 1995.

The WTO has strengthened the world trading system by extending GATT rules to services and increasing the protection for intellectual property rights. But, perhaps most significantly, the WTO has taken on the responsibility for ­arbitrating trade disputes and monitoring the trade policies of member ­countries.7 The WTO operates as GATT did—on the basis of consensus—when settling disputes. However, unlike GATT, the WTO doesn’t allow losing ­parties to ignore the ­arbitration reports of the WTO. The WTO has the power to enforce its decisions. Figure 4.4 shows which countries are members of the WTO.

Figure 4.4

Countries in the WTO

Can more be done to promote free trade? Advocates of free trade argue that much more can be done to reduce trade barriers. The first round of WTO meetings were derailed by antiglobalization protestors. The meetings were relaunched a few years later with the goal of curtailing dumping, reducing trade barriers, protecting intellectual property rights, and reducing government barriers on foreign direct investment.8 That round of talks was slated to last three years but started and stopped over the next fifteen years. It has been far more difficult than anyone imagined to reach concrete results.

What problems can result from free trade? WTO protests reflect an ongoing concern that free trade encourages firms to shift their production to countries with low wages and lax labor standards and that the exploitation of workers in low-wage countries contributes to the gap between the rich and the poor. Environmentalists are also concerned that free trade encourages companies to move their production to countries that allow the firms to pollute the environment and emit unlimited amounts of greenhouse gases that contribute to global warming. Environmentalists highlight the fact that the economic benefits and costs of free trade are not the only costs and benefits it results in. Important social, ethical, political, and environmental concerns also need to be considered.

What are regional free-trade agreements? Many nations have been so eager to achieve the higher standards of living associated with free trade that they have struck out on their own by creating their own regional free-trade agreements. Let’s look at some of the most powerful regional free-trade agreements.

The European Union

The oldest and largest free trade area in the world is the European Union (EU). The EU can trace its roots to 1957 with the creation of the European Economic Community (or Common Market), which consisted of six founding countries. Although many obstacles had to be overcome, such as the concern over the potential loss of national sovereignty, the EU now includes 28 countries, as shown in Figure 4.5. Its success is as a result, in large part, of its demonstrated commitment to the free flow of goods, services, capital, and people across borders in Europe.

Figure 4.5

The European Union

Figure 4.5 Full Alternative Text

The success of the European Union has not been without controversy. In 2016, after the pressures of large-scale immigration movements, the United Kingdom voted in referendum to leave the European Union. This “Brexit,” or British Exit, was a close vote with certain areas like London and Scotland firmly voting to remain in the EU. The procedure for the withdrawal from the EU and the long-term implications will be understood over the next several years. The immediate impact was a sharp drop in the value of the British pound as the world financial markets reacted.

The EU accounts for approximately one-third of the world’s total production. It is the largest exporter in the world and the second-largest importer.9 In 1999, the EU also surpassed all other free-trade areas with respect to economic integration by adopting a common currency—the euro. The euro is currently used by 18 of the 28 countries in the EU and has become a major currency in global financial markets.10 The EU is likely to continue to grow as other countries, particularly those in Eastern Europe, apply to join the organization.

The EU’s economic power and political clout has a huge influence on international businesses worldwide. For example, some international businesses have been motivated to invest in production facilities within the EU to hedge against any potential trade barriers. The EU has also established many legal, regulatory, and technical standards for imports to the EU market. In addition, the EU’s antitrust rulings have significantly affected U.S. businesses.