Government Intervention into Trade

Kenneth R. Szulczyk

Free Trade

• Law of Absolute Advantage• Not in notes

– Countries specialize in goods that it can produce the cheapest

– Then trade goods with other countries

– World production increases– Free trade increases the wealth of all

countries

Free Trade

• What if a country can produce the ALL products cheaper than other countries?

• This country could still benefit from free trade

• However, we need another law

Free Trade

• Law of Comparative Advantage

• Country specializes in the production of products that it has the greatest relative advantage

• Country produces products relatively more cheaply

• Then trade products with other countries

Free Trade

• Country A produces everything cheaply– That country specializes in production that

has the lowest relative costs

• Country B specializes in another product that it has the relative lowest costs

• Countries A and B can still trade

Free Trade

• Important Assumption– Country A does not have the resources to

produce all products– Trade allows Country A to consume more

Free Trade

• A country opening its borders to free trade

• Adjustment process– The competitive industries expand– The inefficient industries contract

• Unemployed workers• Lower tax collections

Government Intervention

1. Protect an Eroding Comparative Advantage– Country A has a relative advantage in

producing and exporting a product.  – Country B comes along and gain the

comparative advantage, taking trade away from Country A.

Government Intervention

2. Achieve Domestic Policy Goals

• Free trade can bankrupt inefficient industries, – Causes unemployment– Lower tax collections– Government may impose trade restrictions to

keep inefficient industries in business.

Government Intervention

3. Protect National Security

• Some commodities– Natural gas and petroleum– Many Asian countries, like Japan, have little

energy resources– Are vulnerable, if imported energy is blocked

Government Intervention

4. Protect “Infant Industry”

• A country's industry may be relative new

• Could not compete with foreign industries. 

• Government protects an industry, in order for the industry to become large enough to compete. 

Government Intervention

• When the United States became independent of England

• The new U.S. government restricted trade– Encourage the growth of U.S. industries.

• Most manufacturing was in Europe at that time• England wanted to manufacture all goods and

sell the goods to the United States– Causes an inflow of money into England– Creates jobs

Government Intervention

5. Protect National Health

• Government restricts trade of a product, if the product may be harmful. 

• For example, Europe does not import beef from the United States.  – Europeans claim beef contains growth

hormones, which are harmful to humans.– They may be right!

Government Intervention

6. Government Protects or Retaliates Against Policies of Other Trading Countries

• One country imposes a trade restriction.  • Other countries may retaliate against that

country.  • For example, one country weakens its currency

– Boost its industries– Other countries may weaken their currencies to nullify

the first country

Government Intervention

7. Correct Foreign Exchange Rate

• Government views its currency as being either too strong or too weak. 

• Government imposes trade restrictions to correct the currency problem.  

Government Intervention

• Usually Asian countries want their currencies to be weak. 

• A weak currency – Boosts a country's exports– Decreases its imports– Causes its industries to expand and create

jobs.

Government Intervention

• A strong currency makes a country's exports expensive and its imports cheap

• I have no ideal why the U.S. government pursues a strong dollar.  The United States is losing industries to China and other countries.

Government Intervention

8. Balance-of-Payment Problems• Balance of payments is the total inflow minus the

total outflow of money into a country • The problem is when more money flows out than

in.  – Usually the central bank or government has to finance

the outflow, if it is large.  – Government can impose trade restrictions to reduce a

balance-of-payment problem.

Government Intervention

• United States – not in notes– U.S. has large trade deficit– U.S. dollars flow out and products flow in.– Foreign countries increase U.S. dollar

holdings

– Some countries are worried about U.S. trade deficits (and U.S. government debt)

– U.S. currency has to depreciate

Government Intervention

9. Generate Revenues for the Government

• Government can impose – Import tariffs– Export taxes – A government may have better control over its

ports• Easier to collect than income taxes 

Government Intervention

10.  Prevent export of technology – not in notes

• Some countries ban or restrict exports of technology

• These countries do not want other countries to benefit from technology– Become future competitors

Conclusion

• Government wants to export products to foreign countries– Expands industries and creates jobs– More money flows into country than out  

• However, government wants to restrict imports

Conclusion

• Government could lie and make one of the above claims in order to protect its industries