Free trade

• Free trade  occurs when there are no artificial barriers put in place by governments to restrict the flow of goods and services between trading nations.

• When  trade  barriers,  such  as  tariffs  and subsidies  are  put  in  place,  they  protect domestic  producers  from  international competition  and  redirect,  rather  than  create trade flows.

Advantages of free trade Increased production• Free trade enables countries to specialise in the production of those commodities 

in which they have a comparative advantage.

Production efficiencies• Free trade improves the efficiency of resource allocation. 

Benefits to consumers• can now obtain a greater variety of goods and services.

Foreign exchange gains

Employment 

Economic growth

Disadvantages of free trade

• Structural unemployment may occur in the short term.

A  longer-lasting  form  of  unemployment  caused  by  fundamental shifts in an economy. Structural unemployment occurs for a number of reasons – workers may lack the requisite job skills

• Increased domestic economic instability from international trade cycles, as economies become dependent on global markets. 

• Countries with  surplus products may dump  them on world markets at below cost. 

• Developing or new industries may find it difficult to become established in a competitive environment.

• Free trade can lead to pollution and other environmental problems 

Protectionism

•   It  represents  any  attempt  to impose restrictions on trade in  goods  and services.

• Tariffs

• Quotas 

• Voluntary Export Restraint Arrangements –  where  two  countries  make  an agreement  to  limit  the  volume  of  their  exports  to  one  another  over  an  agreed period of time.

• Technical barriers to trade Food safety and environmental standards

• Preferential state procurement policies –  where  a  government  favour local/domestic  producers  when  finalizing  contracts  for  state  spending  e.g. infrastructure projects

• Export subsidies - a payment to encourage domestic production by lowering their costs. 

Arguments for Protectionism

• Fledging industry argument Short-term  protection  allows  the  ‘infant  industry’  to  develop  its comparative  advantage  at  which  point  the  protection  could  be relaxed,  leaving  the  industry  to  trade  freely  on  the  international market.

• Externalities and market failure: Protectionism can also be used  to internalize  the  social  costs  of  de-merit  goods.   Or  to  correct  for environmental market failure in the supply of certain imports.

• Protection of jobs and improvement in the balance of payments

• Protection of strategic industries: The government may also wish to protect employment in strategic industries.

• Political argument: One common political argument for government intervention  is that  it  is necessary for protecting  jobs and  industries from unfair foreign competition. 

• Anti-dumping duties:  Dumping  is  a  type  of  predatory  pricing behaviour  and  a  form  of  price  discrimination.  Goods  are  dumped when they are sold for export at less than their normal value. 

Arguments against Protectionism

• Higher prices for consumers.

• Reduction in market access for producers.

• Loss of economic welfare: Tariffs  create  a  deadweight  loss  of consumer  and  producer  surplus.  Welfare  is  reduced  through higher prices and restricted consumer choice.

• Regressive effect on the distribution of income: Higher prices that result from tariffs hit those on lower incomes hardest.

• Production inefficiencies

• Trade wars

There is the danger that one country imposing import controls will lead to “retaliatory action” by another leading to a decrease in the volume of world trade. 

• Negative multiplier effects:  If  one  country  imposes  trade restrictions on another, the resultant decrease in trade will have a negative multiplier effect affecting many more countries because exports are an injection of demand into the global circular flow of income

• Second best approach: Protectionism  is  a  ‘second best’ approach to correcting for a country’s balance of  payments  problem  or  the  fear  of  structural unemployment.

•   Import  controls  go  against  the  principles  of  free trade. 

• In  this  sense,  import  controls  can  be  seen  as examples  of  government  failure  arising  from intervention in markets.

POLICY LAGS

Time lags that occur between the onset of an economic problem and the full impact of the policy intended to correct the problem.

Policy lags come in two broad categories--inside lag (getting the policy activated) and outside lag (the subsequent impact of the policy).

The three specific inside lags are recognition lag, decision lag, and implementation lag.

The one specific outside lag is termed impact lag.

Policy lags can reduce the effectiveness of business-cycle stabilization policies and can even destabilize the economy.

Policy lags, especially inside lags, are often different for monetary policy than for fiscal policy.

For example, should a business-cycle contraction hit the economy on January 1st, stabilization policy cannot correct the problem by January 2nd.

INSIDE LAG

Inside lag is the time it takes between the actual onset of a problem and the launching of the corrective action by government.

The wheels of government often spin slowly and deliberately.

Three types of inside lag occur.

RECOGNITION LAG

Before any policy action can be pursued, the existence of the actual problem must be identified.

It takes time to collect and analyze economic data. Unemployment and inflation data are usually available only a month or so after the fact.

That is, the unemployment rate for January is usually available in February.

Production and income data are reported quarterly and have an even longer lag.

Gross production data for January, February, and March is seldom available until May.

DECISION LAG Once government policy makers have identified the

problem, they need to decide on a suitable course of action, and then pass whatever legislation, laws, or administrative rules are necessary.

For example, if a business-cycle contraction is identified, Congress is likely to debate over an expansionary fiscal policy use of increased government spending or decreased taxes.

But will the spending go for purchases or transfer payments? If it goes for purchases, then what types of goods or services are purchased? If taxes are decreased, which taxes are cut and who receives the extra income? These decisions could take days, weeks, or months.

IMPLEMENTATION LAG After a particular policy has been selected, steps then need to

be taken to implement the policy.

For any change in spending, the appropriate government agencies need to be contacted.

More often than not, this involves a change in budget appropriations.

The affected agencies then need to actually make changes in their spending.

The act of spending is not instantaneous.

Most agencies require competitive bids to identify product suppliers before they can make the expenditures.

Inside lags are likely to take several months.

A best case scenario involves at least two months. One month to recognize the problem and another month to select and implement the appropriation policy.

A more likely scenario is three to six months of inside lags.

OUTSIDE LAG

The outside lag is the time it takes after a policy is selected and implemented by appropriate government entities, before it works its magic on the economy.

Such magic is not instantaneous. The principal outside lag is termed the impact lag.

IMPACT LAG

This lag is the time it takes any change initiated by a government policy to impact the producers and consumers in the economy.

A key part of the impact lag is the multiplier.

An initial change in government spending, taxes, the money supply, interest rates must work through the economy, triggering changes in production and income, which induces changes in consumption, which causes more changes in production and income, which induces further changes in consumption.