Why Do Governments Protect their Domestic Firms - Coursework Example

Running Head: Why do Governments Protect their Domestic Firms? WHY DO GOVERNMENTS PROTECT THEIR DOMESTIC FIRMS? Name: Unit: Professor: Submission Date WHY DO GOVERNMENTS PROTECT THEIR DOMESTIC FIRMS? Introduction Governments all over the world strive to ensure their national economies flourish. The governments take all the possible measures to ensure their national economic growth and development. One of the ways in which governments deem viable in attaining these long-term goals is the protection of local industries. The less developed domestic industries are termed as ‘infant’ to mean that they have not fully developed or are not ‘mature’ enough to compete with the well-developed foreign industries in the international market (Melitz 2004 p.177). For this reason, economists argue that local industries should be protected against unfair competition from foreign industries. Government planners can use various measures to protect the domestic firms from unfair foreign competition (Brenner 1993 p.103). The most popular trade protection measures include government subsidies for domestic production, quotas, tariffs, embargo and administrative barriers (Melitz 2004 p.177). Governments may offer subsidies inform producer goods, loans, and also lump-sum payments to encourage domestic industries to compete favorably with imports.For example, firms that produce liquid biofuels in the United States receive direct subsidies from the government for every ethanol gallon they produce. Quotas involve setting physical limits for the quantity of a commodity that is to be imported in a country at a particular time. An example is the Organization of Petroleum Exporting Countries (OPEC) quota that limits the production of the commodity to control its price in the market (Melitz 2004 p.178). Tariffs involve imposing some taxation on imported goods. For example, cheese from Scotland faces a valorem tariff before entering the United Sates to increase its price, therefore, increasing domestic consumption of the product. Embargo involves prohibition of trade with a given country to isolate the country and subject it to difficult economic times for it to accept certain terms of trade. For instance, the United States imposed embargo on Cuba in 1999 banning foreign subsidiaries of its companies from trading with Cuba. The ban was due to Cuban nationalization of American-owned oil producing companies. Administrative barriers involve rules and legislations to burr certain trade practices (Brenner 1993 p.105, Dunn 2009 p.26). The various measures of domestic firms’ protection are adopted by different governments for varied reasons. However, trade protection has been an issue of contention among economists, socialists, and political bigwigs over a long time. Some support the idea of trade protection while others criticize the same arguing that free trade is more beneficial than trade protectionism. The various reasons for trade protection are discussed below. The arguments for and arguments against are as follows. Arguments for Domestic Firms’ Protection Various arguments have been put forward to emphasize the importance of domestic industry protection. The economic point of view advances two arguments for the protection of domestic industries. The first one is the protection of infant domestic industries, and the second is prevention of dumping. The infant industries incur high costs of production per unit of output. For this reason they are at a cost disadvantage contrary to their well-established international counterparts. Therefore, the economists argue that the infant industries should be protected against unfair foreign competition. However, the critics of this view argue that protection of infant industries eliminates competition and makes the industries remain inefficient in the long run due to lack of international competition (Lu & Ma 2011 p.72). Dumping causes influx of low quality, low priced products in the domestic markets from the international markets. The foreign market participants undertake this unscrupulous practice to dispose of surplus products or increase the market share in the domestic market. These lowly priced products may cause loss of productive capacity due to unfair competition. For example, the United States accused South Korea and other eight countries of dumping steel products to its domestic markets in 2014. It imposed tariffs to protect the domestic market from the dumped steel products. This view of domestic industry protection is justified, and government can counter dumping effects by providing subsidies and supporting local industry development (Prusa 2001 p.592) The other two arguments revolve around social and political standpoints. They are the protection of domestic employment and country’s self-sufficiency status. The social aspect of this view advocates protection of domestic industries to create employment. The suggestion is that local industries should be protected against cheap imports so as to increase domestic demand and enhance the creation of employment opportunities locally. This view is, however, least supported by economists because the creation of domestic employment opportunities through domestic industry protection maybe at the expense of efficient production due to lack of competition (Krugman 1987 p.134). The political view of domestic industry protection advocates for a country’s self-defense and self-sufficiency. This is a non-economic argument for the protection of domestic industries. It advocates for the reduction of dependence on imports to enhance self-sufficiency in domestic industries. It also advocates for the promotion of defense capabilities important to the country’s security (Lu & Ma 2011 p.72). Further, a modern argument is based on diversification of the domestic economy. It is composed of two arguments that masquerade as one; the exports argument and the imports argument. The exports argument urges protection against imports to facilitate diversification of exports and, therefore, increase income from exports to overseas markets. The import argument argues that import protection enables diversification of the domestic economy and facilitates economic growth and development (Lu & Ma 2011 p.72). Finally, some economists argue that free trade may cause prevalence of unfair competition. They, therefore, advocate for trade protection to protect the domestic market against excessive international competition. The developed world has its production subsidized hence lower production costs and lower prices. When their products enter the domestic market, they are lowly priced interfering with the demand of locally manufactured products. In this connection, the critics of free trade also associate it with inequality and poverty. They argue that free trade causes income inequalities that also increase poverty incidences in certain countries due to the dominance of the economy by imported products making it incapable of producing for domestic sustenance (Dunn 2009 p.23). Arguments against Domestic Firms’ Protection Free trade and trade protectionism are two incompatible goals. Despite the many benefits of free trade, some state governments advocates for trade protectionism (Fouda 2012 p.351). However, most countries reconcile the two aspects of trade, partially protecting some domestic industries and partially allowing some aspects of free trade. Free trade has its benefits discussed as follows. First and foremost, free trade allows access to wide variety of commodities. A country can never be self-sufficient in everything (Fouda 2012 p.352). Some countries are well endowed with certain resources and others may lack the same resources. The uneven distribution of resources, therefore, does not leave any room for trade protectionism. Further, a country may be consuming more than it produces. In this case, a country needs to source additional products to satisfy its citizens, a situation that calls for free trade (Fouda 2012 p.352). It is also important to understand that diversification of trade through free entry and exit of international products creates a broad range of choices for customers (Dunning 1998 p.10). This improves the standards of living for the customers in the particular country (Curtin, Garvey, Silver & Berkowitz 2007 P.2). Economists have argued that protectionism causes deadweight loss. They claim that the benefits accruing from free trade surpass those from trade protectionism by a big margin. The argument is that free trade compared to trade protectionism is many times better in improving societal welfare and creating greater opportunities of prosperity (Fouda 2012 p.352). Free trade creates competition that enhances improvement in efficiency and innovation in production (Porter 1990 p.75). The efficiency in production translates to more economic growth and development. With economic growth, people’s welfare and living standards are improved, and the country gains a competitive edge in the international market (Aghion, Antras&Helpman 2007 p.13). International free trade expands a country’s market base. The country can sell surplus production in the international market. Through trade, the country can generate foreign income. This creates wealth that can be invested back in the domestic economy, therefore, promoting economic growth and development. Conclusion Trade protection may take different forms including domestic government subsidization, the imposition of quotas, tariffs or import duties, and customs, embargoes and legislative barriers. Governments adopt the trade protection measures for various reasons. The aim of trade protectionism is to protect domestic infant industries, prevent dumping, preserve domestic employment opportunities, attain self-sufficiency, ensure the security of a country and diversify the domestic economy as argued by economists. However, the benefits of trade protectionism do not outweigh those of free trade. Free trade ensures the provision of a wide range of products at low prices to local citizens, therefore, improving their living standards and welfare. Free trade also eliminates the deadweight loss created by trade protectionism. It enhances international peace and reduces inter-states wars by promoting peaceful coexistence and strong relationships based on trade. Further, free trade poses healthy competition to the domestic firms making them more effective and innovative in the production of goods and services. Lastly, free trade broadens the country’s market base. In a nutshell, free trade is more beneficial to an economy than trade protectionism. References Aghion, P., Antras, P. &Helpman, E.2007.Negotiating Free Trade, Journal of International Economics 73(7), 1-30. Brewer, T. L.1993.Government policies, market imperfections, and foreign direct investment.Journal of International Business Studies, 24(1): 101-120. Curtin, J.F., Garvey, J.E., Silver, C.N. & Berkowitz, J.E. 2007. Benefits of Trade; Costs of Protectionism, Journal of Economic Perspectives, 12(1), 1-30. Dunn, B. 2009. Neither Free Trade nor Protection but International Socialism: Contesting the Conservative Antinomies of Trade Theory, Marxist Interventions, 1, 23-45. Dunning, J. H.1988. The eclectic paradigm of international production: a restatement and some possible extensions. Journal of International Business Studies, 19(1): 1-31. Fouda, R.A.N. 2012. Protectionism and Free Trade: A Country’s Glory or Doom? International Journal of Trade, Economics and Finance, 3(5), 351-357. Krugman, P. R.1987. Is free trade passé?.The Journal of Economic Perspectives, 1(2): 131-144. Lu, Y., Ma, J. 2011. Free trade or Protection: A Literature Review on Trade Barriers, Research in World Economy, 2(1), 69-78. Melitz, M.J. 2004. When and how should Infant Industries be protected? Journal of International Economics 66 (5), 177-196. Porter, M. E. 1990. The competitive advantage of nations.Harvard Business Review, 68(2): 73-93. Prusa, T.J. 2001.Spread and Impact of Anti-dumping, Canadian Journal of Economics, 34(3), 591-612. Read More