Types of Trade Restrictions

Trade restrictions are government policies that limit the free exchange of goods and services between domestic entities and foreign countries. They include tariffs, import quotas, voluntary export restraints (VER), subsidies, embargoes, domestic content provisions, and capital restrictions.

Different trade restrictions are discussed below:

Tariffs

A tariff is a type of tax that imposes additional costs on imports. Tariffs primarily aim to protect the domestic industries that produce similar goods and reduce the trade deficit.

Intuitively, the economic impact of tariffs is reduced demand for imported goods due to increased prices above the free trade price.

We need to define “small” and “large” countries in the context of tariffs. A small country is the price taken in the world market and has no influence on the world market price. On the other hand, a large country is the larger importer of goods and influences the world market price.

When a larger country applies tariffs, the exported decreases the price of the good to retain the market share. Consequently, the terms of trade are altered such that income is redistributed from the exporting country to the importing country.

As such, a larger country can elevate its welfare through tariffs if its trading partner does not retaliate and the resulting deadweight loss is lower than the benefit of improving terms of trade. However, global welfare still experiences a dip.

In summary, the effects of tariffs include:

• Loss of consumer surplus due to price increase.
• Domestic producers gain producer surplus due to higher prices for their products.
• Gain of the revenue by the government.

Import Quotas

Import quotas refer to the regulations that restrict the amount of a specific good that can be imported within a specific period of time. For instance, an import license states the quantity of goods that can be imported.

The effect of quotas is uncertain since foreign producers can increase the prices of their goods to make higher profits (quota rent).

Voluntary Export Restraints (VER)

The government of the exporting nation creates this type of restriction to limit the export of goods to its trading partner. As such, VER allows the quota rent to be captured by the exporting country.

Compared to quotas, VER is imposed by the exporting country, while the importing country imposes quotas. Voluntary export restraints lead to the deterioration of welfare in the importing country.

Export Subsidies

Export Subsidies involve governments providing payments to companies for each unit of a product they export, aiming to boost export activities.

However, export subsidies disrupt the functioning of the free market and sway the trade away from the comparative advantage, reducing welfare. Consequently, there have been countervailing duties, such as tariffs imposed by importing nations on subsidized exports.

When an export subsidy is in place, exporters are motivated to prioritize selling in the higher-priced export market due to the subsidy, leading to a shift away from the domestic market. As a result, this shift causes an increase in prices within the domestic market.

Similarly, if a large country increases exports, the world price declines. As such, the net effect of both large and small county is negative, with large countries experiencing a higher decline.

Capital Restrictions

Capital restrictions refer to measures a government or central bank takes to control the flow of capital. This could be capital flowing in and out of the economy. Controls include taxes, tariffs, volume restrictions, etc., whereas regulations include foreign exchange, tax regulation, credit regulation, and investment restrictions.

They have similar effects as trade restrictions – protect domestic industries – but capital restrictions can slow growth, and more restrictions can mean higher domestic prices for goods.

Controls are useful when they enable a government to deal with currency exchange rates and interest rates. The government benefits from tariffs since they are a type of revenue (tax).

Industries benefit from reduced competition since import prices are high. On the flip side, consumers do not benefit because the increase in import prices means higher prices. The most apparent difference between trade restrictions and capital restrictions is that trade restrictions limit access to a wide range of goods and services. In contrast, capital restrictions limit access to financial markets.

Other Restrictions

• Domestic content provisions specify that some proportion of the value added or components used in production should be of domestic origin.
• Embargo is a government order that restricts trade or commerce with a specified country or the exchange of specific goods. Embargoes are typically enacted due to unfavorable political or economic circumstances between nations.

$$ \begin{align*} & \textbf{Summary of Effect of Trade Restrictions} \\ & \textbf{on Producer and Consumer Surpluses} \end{align*} \\
\begin{array}{l|l|l|l|l}
& \textbf{Tariff} & { \textbf{Import} \\ \textbf{Quota} } & {\textbf{Export} \\ \textbf{Subsidy}} & \textbf{VER} \\ \hline
\textbf{Impact on} & {\text{Importing} \\ \text{Country}} & {\text{Importing} \\ \text{Country}} & {\text{Exporting} \\ \text{Country}} & {\text{Importing} \\ \text{Country}} \\ \hline
{ \text{Producer} \\ \text{Surplus}} & \text{Increases} & \text{Increases} & \text{Increases} & \text{Increases} \\ \hline
{\text{Consumer} \\ \text{Surplus}} & \text{Decreases} & \text{Decreases} & \text{Decreases} & \text{Decreases} \\ \hline
\text{Price} & \text{Increases} & \text{Increases} & \text{Increases} & \text{Increases} \\ \hline
{\text{Domestic} \\ \text{Consumption}} & \text{Decreases} & \text{Decreases} & \text{Decreases} & \text{Decreases} \\ \hline
{\text{Domestic} \\ \text{Production}} & \text{Increases} & \text{Increases} & \text{Increases} & \text{Increases} \\ \hline
\text{Trade} & {\text{Imports} \\ \text{decrease}} & {\text{Imports} \\ \text{decrease}} & {\text{Exports} \\ \text{decrease}} & {\text{Imports} \\ \text{decrease}}
\end{array} $$

$$ \begin{align*} &\textbf{Summary of Effect of Trade Restrictions on} \\ &\textbf{Government Revenue and National Welfare.} \end{align*} \\
\begin{array}{l|l|l|l|l}
& \textbf{Tariff} & { \textbf{Import} \\ \textbf{Quota} } & {\textbf{Export} \\ \textbf{Subsidy}} & \textbf{VER} \\ \hline
{\text{Government} \\ \text{Revenue} } & \text{Increases} & {\text{Mixed} \\ \text{(depends on} \\ \text{whether quota} \\ \text{rents are} \\ \text{captured by} \\ \text{the importers} \\ \text{or exporters)} } & \text{Decreases} & \text{No change} \\ \hline
{\text{National} \\ \text{Welfare} } & {\text{Decreases in} \\ \text{small countries} \\ \text{and increases} \\ \text{in the larger} \\ \text{country.} } & { \text{Decreases in} \\ \text{small countries} \\ \text{and increases} \\ \text{in the larger} \\ \text{country.} } & \text{Decreases} & \text{Decreases} \end{array} $$

Question

Which of the following is least likely a consequence of open trade?

1. Increasing unemployment.
2. Strengthening the economies.
3. Increasing the choices of goods to buy from.

Solution

The correct answer is A.

Open trade strengthens economies, creates jobs, and increases the choice of goods and services from which one can choose. As such, it does not increase unemployment.