Arguments for and against protection

ARGUMENTS FOR AND AGAINST PROTECTION Fachhochschule Bremen ISGM III International Economic Relations Wintersemester 2002−2003 issued by: Bremen, 10.01.2003 • Introduction: − Defining the limits of free trade and free import; − Defining policies that could be implied instead of barriers and tariffs; 2. Incentive Distortions: − Definition and explanation; − Policies for finish these distortions; 3. The Specificity Rule: −Definition and explanation; −Is better to establish barriers against imports than using some other policies? 4. A Tariff to Promote the Domestic Production: − Concept 5. The Public revenue: − Concept; − Against; 6. The Optimal Tariff: − Concept; − Terms of Trade; − Against; 7. The Infant Industry: − Concept; − Against; 8. The Dying Industry: − Concept; − The Adjustment Assistance; 9. National Security: − Concept; − Against; 10. Protect Culture: − Concept; −Against;

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11. Protect a Favoured Industry: − Concept; − Against; 12. Retaliation: − Concept; − Problems; 13. Pauper Labour: − Concept; − Problems; 14. Fairness: − Concept; − Problems; 15. Patriotism: − Concept; − Problems 16. Summary of Arguments For and Against Protection; 17. The Practical Case: Aerolineas Argentinas; −.Introduction; − The Problem; − Conclusion; 18. Personal Point of View;

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Introduction To understand whether the barriers are good or bad, it should be first defined in what conditions trade barriers can generally exists. Assuming that we are living in a second best world, we have to accept that there are good arguments for protection, but usually is better to use some other policies than barriers to imports. The governments have to look for the best policies for their nation and as good as possible for the world as a whole. The Incentive Distortions In a first−best world there are not incentive distortions under free trade, which are gaps between the private and social benefits or costs of any activity, but we are living in a second−best world were is unrealistic to think that these distortions do not exist. It's unrealistic to think that in our society the benefits and the costs are perfectly balanced. There are always externalities that broken the balance. The first case is, for example the case of a paper mill that do not reckon the harm he is doing to the river. The buyers of paper didn't pay this damage and so the Social Marginal Cost is greater than the price of the paper. The second case, is when the Social Marginal Benefits are bigger than the price, with the example of these companies that training their employers and they are going benefit because they are learning these knowledge and skills and also the normal salary. Then, what should do the society to finish these distortions? There are two theories. The pessimist about the government availability to cure distortions say that it's better to create new private property institutions than using taxes or subsidies. The optimist theory (1) is the theory we will follow. This theory says that a wise 2

government should eliminate the distortions with taxes or subsidies. In the case of the river, the government should levy a tax of the different between the Social Marginal Cost and the Social Marginal Benefit to bring they two in line. If the problem is the training incentive case, let the government pay a subsidy to the companies of SMB−SMC. But the question we have to do is: could trade barriers help to cure distortions in the domestic economy? If there are distortions in the economy of a country, perhaps cutting their imports could help it. *(1)developed by A. C. Pigou The Specificity Rule It's clear that there is no a magic procedure to keep these distortions, every case have his owns particularities. We couldn't say neither that every case is different and don't do anything. The conclusions we draw are: • Doing something (by the government) is better than doing nothing. • A tariff may or may not help. • Some other forms of interventions is in general better than imposing tariffs. The specificity rule is a rule that we can use in most of the cases. It say: Intervene at the source of the problem. It is usually more efficient to use those policy tools that are closest to the sources of the distortions separating private and social benefits or costs(2). It is clear what does it mean. If we have a problem with the crime, since crime is caused by people we could think that reducing the whole population through sterilisation laws or taxes on children could be good for attack this distortion. But these way is total inefficient. The good ways were greater law enforcement or programs to reduce unemployment for example. Suppose that we use different sources such as oil, coal, renewable resources, and nuclear power to produce electricity. Firms combine electricity with other inputs like labour, capital, and raw materials to produces goods and services. Oil Coal Renewable Nuclear Labour Capital Electricity Materials Goods and services *(2) from the book of International Economic Relations by P. Milde Now suppose that we want to discourage the production of coal because of its effect on environment. The most stupid policy would be to impose a tax on all goods and services to raise their costs. This would lower the quantity demanded for them, lowering in turn the conditional demand for electricity, and finally demand for coal. We have been able to lower the production of coal and, in the process, have managed to do a lot of damage. We have lowered the demand for all kinds of inputs and all kinds of energy sources. For example, as a result of our policy the production of electricity by renewable will also go down. But we didn't really want this to happen. A better policy would be to move towards the source of the problem. So let's climb one step on the ladder and tax electricity production. This may not do too much damage to labour and capital employment. However, it will still lower the production of non−coal resources, something we don't necessarily want to happen. Therefore, the best policy is to directly tax coal production. (3) 3

A Tariff to Promote Domestic Production: • Concept: One of the most used reasons to establishing tariff is the excuse of promote the domestic production. It is one of the most popular arguments for the protection, because it tries to make grow up the national production in damage of the foreigners competitors. The question is: would it be better to cut the importation of our country by using tariffs, or in opposite, subsidise our companies and try to do them more competitive in the market place? The specificity rule induce to use the policy tools that are closest to the problem. Then, each government have to look which measure could help better to restore the distortions of the country. But it's clear, that until we know the facts of each situation, all that we can say is that the tariff might prove to be better or worse than doing nothing. The Public Revenue: • Concept: It is true that tariffs generate revenue and they are often the easiest taxes to administer. Historically countries have used tariffs as their first revenue raising method. In such nations the import tariff becomes a crucial source, not of industrial protection but of public revenue. • Against: However, there are a lot of other taxes that take the same revenue, and they are not so bad for the economy. *(3)example taken by Internet The Optimal Tarif: • Concept: these argument can be use only in large countries (those that are able to influence the world price). A tariff causes a fall in the world price of the imported good. This fall in price benefits the importing nation, and the benefit may be larger than the DWL. This is often called the Terms of Trade argument. • Terms of Trade: it is the relative price of a country's exports compared to its imports. An improvement in the terms of trade is a rise in this relative price. A worsening in the terms of trade is a fall in this relative price. The optimal tariff is used to improve the terms of trade by lowering the world price of imports and thus increasing the relative price of exports compared to imports. Also called the monopoly argument for tariffs because a nation restricts buying a good in order to change prices in its favour (which is roughly analogous to what a monopoly firm does by restricting its supply).

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• Against: This policy makes the home country better off by making the rest of the world worse off. Since this policy hurts others it will probably result in retaliation, and even if it does not, it is not nice. Infant Industry Argument • Concept: New industries have high costs because they haven't learned yet to produce. Industries often reduce their costs through learning−by−doing. Given time, new industries in a nation will bring their costs down. So the argument is give new firms or industries a chance to get efficient (economies of scale) and be competitive. However, because initially they have high costs, they can't compete under free trade with foreign firms that are relatively well established. A tariff in this case permits production and fosters learning. • Against: a production subsidy will create the same benefit without distorting the market (without raising the price to consumers) like a tariff does. A production subsidy therefore generates a smaller DWL. The three conclusions we can take are: • There can be a case for some sort of government encouragement; • A tariff may or may not help; • Some other form of help is a better infant industry policy than the tariff; Dying Industry Argument • Concept: In this case we have to discus above the same issues and results than in the Infant Industry debate. The thinking is that foreign competition may be killing the domestic industry. The theory say that we can leave an industry and use their resources in other kind of industry, but in the second−best world these is an unreal think. There is too the question that leaving an industry is costly. The protectionist arguments can be validity in the same cases as before (Promote the Domestic Production and Infant Industry).There is , then, no reasons to make imports more expensive to consumers as long as one can help producers directly. • The Adjustment Assistance: Is a policy used by the U.S. government since early 1960's, that give financial aids to relocate and retrain workers for reemployment in other sectors. Theoretically could be a good idea, but it is more a politic tool than a economic solution. National Security • Concept: often articulated as a national defense argument, it means use of a tariff to protect military capability. The idea is, to consume the goods of our country to promote the national industry and so, in the case of war we don't have to buy the products in a foreign country and our industries have the capacity to produce all the goods that our country need. We want tariffs to reduce the dependence on international resources.

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• Against: The National Security argument fail to follow the specificity rule. If a country blocks his imports in peacetime, he doesn't stockpile goods for use in wartime. Instead, it merely makes us buy and use up more home−productive capacity by encouraging the domestic industry. Yet, the industry will probably install only as much capacity as it seems adequate to meet peacetime needs, not any extra emergency capacity. If that capacity has to be created, it is best to subsidised directly. Protect Culture • Concept: Protect important elements of culture from being lost due to international influence or competition. For example, France has protected their domestic film industry from international competition. • Against: Is trade policy the best way to protect culture? It depends of each country and each situation. Protect a Favoured Industry • Concept: This is probably the main reason countries have tariffs. Why are certain industries favoured? Industries can be favoured for many reasons including political, historical and economic. It is often very painful when industries collapse and tremendous hardship can result from international competition. We can restrict trade to protect an industry and help those who are hurt by trade. But also, protection can be obtained through political lobbying whether or not it is needed. • Against: Again there are better ways to help people who are hurt through trade, ways that create less DWL. Retaliation • Concept: If another country is using tariffs or other forms of protection, we should retaliate by using tariffs ourselves. • Problems: If countries are too small to affect world prices a tariff will unambiguously harm them (small country tariff result), regardless of whether other countries are using tariffs. It is true that a large country may benefit by using a tariff, but if so, this too is true whether or not other countries are using tariffs. A nation cannot undo an effect from a foreign tariff by having one of

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its own. • Retaliation for your own sake does not make sense. But, retaliation can be used as a way to enforce international agreements. The threat of retaliation, as a last resort, provides the ultimate enforcement tool of WTO rules, etc. Pauper Labour • Concept: it is believed to be difficult to trade with countries that have relatively low wages (how to compete?) and a fear that trade will lower domestic wages (perhaps to the level of those abroad). • Problems: This argument ignores productivity (why foreign wages are low productivity low). Productivity differences allow for competition between low and high wage countries Fairness • Concept: Unfair for domestic producers to compete with foreign producers who have advantages (national resources, etc.). Often said that the playing field is not level. We need to erect barriers to offset the advantages of foreign producers. • Problems: the argument imagines that the country is like a firm, but the nation should care about all its citizens, not one single firm. It imagines trade as a zero−sum game (but it is not). There are gains from trade even if one nation has an advantage over another. This ignores comparative advantage. Patriotism • Concept: purchasing goods from home country is more patriotic, or to knowing that some good is produced within our own country can be taken as an object of national pride. • Problems: if people purchased only domestic goods this would imply no trade and no trade makes a country worse off. In fact, it may be inefficient to buy from home; and again, countries benefit by trading according to comparative 7

advantage. Summary on Arguments For and Against Protection: • Valid arguments for tariffs exists. These arguments rely on some type of distortion, or gap, between private and social costs or benefits. • In the second−best world, a tariff may be better than doing nothing. But very often some other policy is better than a tariff in responding to the distortion. • The specificity rule is important for selecting the best policy response to a distortion. • Why nations and voters choose tariffs and protection is a complex issue. Ideas from political economy offer some insights into the popularity of certain trade policies, and the unpopularity of others. • The two mains arguments against protection are: • Retaliation: protectionist policies often result in the protectionist country also facing high tariffs from other nations. • There exist better policies to forward the particular policy goals. Direct subsidies to production instead of tariffs. PRACTICAL CASE: AEROLINEAS ARGENTINAS INTRODUCTION: Argentina became democratic in 1986, before lived a dictatorial regime and in the end of the Malvinas´ War a democratic process introduced a new democratic government with Raul Alfonsin as a new president. His government restored human rights and political but he failed in the economics and his administration ended with hyperinflation and the Argentineans claimed for a new president. His successor, Carlos Menem was elected with not the majority of the Argentineans but he won the elections and introduced an aggressive program of privatisation and reformed banking system, deregulated prices, implemented currency board and introduced a liberalised trade. At the very beginning the economy suffered a growth but he left a country worse that he had found and in 1999 President Fernando de la Rua inherited a country with a debt of 50 per cent of GDP a high fiscal deficit and 14 per cent unemployment and the first thing they made was raised taxes, so the poorest part of the citizen suffer a big economical crisis . In 1989 the Carlos Menem´s government decided to transfer Aerolineas Argentinas to the Spanish government whose as well as Entel, YPF(yacimientos pretoliferos fiscales), and the process of liberalised was one of the most aggressive in the modern Era. The argentine government allowed to the Spanish companies operate in Argentina and some banks, telecommunication's companies, railroads and so on , The Spanish Government bought these companies and Spain stood their own companies as Iberia, Repsol with protection and only with the introduction of Spain in the UE these flags−companies became private. Nowadays Argentina has an important economic crisis, Argentina is in the MERCOSUR block trade and has a trade partner with Brazil. They work together as economies of scale .Spain is the forth country which have more investment and trade with Argentina Argentina has adopted external tariffs of 0−20% since the introduction of MERCOSUR in January 1995 with trade with third parties, tariffs of 10% to capital goods of 15% to most intermediate products and 20% to finished goods. (4) 8

However Argentina in the Menem government had trade with countries depending of the relationships and these trades seemed strange because when Menem´s government transferred Aerolineas Argentinas and let the Spanish government invested in others sectors, countries like US were able to invested more and more efficiency Spain is a democratically country since 1976, before lived more than 30 years under military regime with fascist dictator Franco. In 1976 after demands for democratisation Adolfo Suarez became Prime minister and in 1977 centrist coalition won the first democratic elections and a new democratic constitution is agreed and introduced in 1978 • In 1979 negotiations on the entry of Spain to the EEC began; • In 1986 Spain became a member of the European Community by referendum; • The peseta is replaced by the Euro in 2002;(5) Before Spain was part of the E U there was no agency or authority or countries that had control power to Spanish citizens so that means. Only Spanish laws, slated by the Government who was elected , had the control over the Spanish population and imposed by a constitution dated in 1978 , Since 1986 Spain belongs to the EEC , Spain is free from control of laws of other countries that doesn't belong to the Union. But some trades with the Sudamericans countries still remain. The Spanish government debt last year was 67% of its GDP. However the percentage is still high the government has been successful of decreasing this percentage over the course of the last recent years.(6) Spain is a country which bought more than sold but the tourism equalised these numbers Its entry into the European Community was followed by a dismantling of restrictions on international capital flows Since 1993 the transfer of both money and goods within the EU, was liberalised., but before the most of the industries and all the public sector was handle only for the government In 1986 after joining the EU , Spain began to open its economy, a privation program that reduced the size of the government,. and now there is an important transfer from the public sector to a private investment As a result of that process of privatisation Spain enjoyed economic growth and job creation, the unemployment decreasing 7% in two years, but the economy has not grown as the government thought Now the government consumes 18´26% of the GDP but now there is a big controversy because the privatisation could bring the end of the public health system and other services like the education, transport,... The privatisation's impact that was imposed with the entry of the C E E on the Spanish economy didn't help all the citizens to start a business. The economy may be growth due the profits of the privations but they are not profits that benefit the Spanish citizens directly, . Their amounts are not higher than before and people don't want to risk their money because the border from come without problems to the end of the each month is smaller. Most of the political and institutions in Spain are stable and the democratic sistem and the legal system are also stable but democracy is still young in Spain and needs time to become total stable. *(4Argentina economic policy analysis

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*(5)&(6)Spain economic policy analysis THE PROBLEM AEROLINEAS ARGENTINAS Aerolineas Argentinas was sold to Spanish government in latest 80´ Carlos Menem ,the second Argentinean democratic president convinced the former Spanish president , also the second democratic president in Spain,Felipe Gonzalez, to carry the flag airlines of Argentina, Aerolineas Argentinas, in those years the air company had small debts and small problems but was the fifth most important airlines in the world ,and the argentine president agreed with his political reforms of privatisation convinced the Spaniard to buy Aerolineas Argentinas and left the country without the flag− waving airlines Carlos Menem had a controversy privatisation and the country at those time Was an infant government and as others politics he tried to take benefit for himself and his government over the interest of the country He not only imposed tariffs nor gave subsidised to reform the company, he sold the company and worse at all he sold the flag company to a foreigner country The flag airlines is a National Pride and for the Argentineans that company was one of the symbols of the nation A own airlines is also important for the national defence and now the airports and the flag airline company belongs to another country and worse with the liberalised process in Spain the company belongs to a private foreigner companies When Aerolineas Argentinas was sold to the Spanish government the debt was less than today even less compared with the value of the money in those years. . In 1990 the company was sold because the debts and the former government didn't do anything to invest in the company which was and have to be really important for the nation, then the company could have been saved with a wise protection or with correct investment or reforming the airlines and encouraging the services but instead of that, they sold the company and now is really difficult to bring it back. Now there is a big problem with the Spanish government and the airlines which could be an important institutional problem because the country is bankruptcy and the airlines has a losses of 30 million dollars every year and seem not be a good possibility to reform the company and the Spanish government had already made an effort to invest the company, but it failed . The new owner of Aerolineas Argentina's seem to be a tourist group which is Marsans and Air−Europa and nowadays the airlines doesn't operate that means that the company produced nothing and there are so many strikes for the employers and everyday there are shouts against the new sale of the airlines, the Spanish and Argentines government and so on. The crisis in Argentina is going up and everyday seem to be worse and the government has many problems to protect the wealth ,education, and all the economical institutional system.. The government of Carlos Menem acted badly and without wise and may be was a fraudulent government which have loans for the FMI and many foreigner investments whose didn't take profit. As the specific rule says doing something is always better than do nothing (7)and the government of Carlos Menem did nothing, well they did, but may be was the worse for the country. A year ago the group Iberia sold the Argentines company to Spanish government which was the owner of the 10

company, because when the Spanish airline was liberalised get the argentineas which before belongs of the government The future of the airlines is in the air, but the interested buyers, Air Comet, Marsans, Air plus, are waiting, but the main shareholder is considering to closing the company, and that means a big social cost, but the Spanish group said that they will not fired workers in two years if they accepted all the new rules The closing of the airlines could lead to the loss of 7000 jobs and the country now cannot handle this important social lost. That is a blow to the Argentine economy already mired in recession. The protests have struck a chord outside of the industry. Dozens of Argentine pop stars and celebrities have held a concert to support the workers. (8) The crisis has also created tension between Argentina and Spaniard and that could be a new rise of voices that claimed against the Spanish companies the Argentines want to make a boycott to the Spanish companies The president of Argentina has called to do more to help the airline, but he described the privatisation as disastrous Even that the Spanish government injected 1´5 billion dollars into airlines with is more than Spain received for the privatisation of Iberia As the actual president of Argentina said the privatisation made Menem was a completely disaster and when a country liberalised their market and let investors from other countries do what they want in the country, and take back the money and the investment to their countries when they want and without penalisation, is really difficult to change it and protect the country again, more if the country is submit in a devastating crisis like Argentina has at the moment *(7)the specificity Rule *(8) www.freeessays.cc CONCLUSION: In our point of view the sale of Aerolineas Argentinas to the Spanish government was a completely disaster for some many reasons: First at all the liberalisation of the publics sectors as electricity, telephone, airlines ,railroads,...was wrong and was not in a good time. Argentina had just become a democratic country and an infant government whose found a country still so young and with weak markets, was no intelligent enough to make the right reforms We think that they had to do, first at all , protect the country make the sources stronger and think in the social interest because was a country which had had great reform of the human right already, and in this case and without the support of the strong block we think that the best had been to protect the industry, subsidising or imposing tariffs but the last was to sell the companies and liberalised all the sector A strong protection had been in our point of view, the best solution and when they had found a block and get stability they could open the market and start to liberalised the sector, although in the sudamericans countries the political stability is not strong at the moment, and if we compared for example the liberalised and privatisation of the Iberia to compared with the case of Aerolineas Argentinas, we think that in this case our 11

politics, that may be are fraudulent as the Argentina's but the Spanish acted better and wiser and protected the flag airlines as the other sector until entry in the EU, and then have more power, because the EU is a powerful block Perhaps the stability and the place where are two countries was basic and the support the Spanish received to being member of the UE was fundamental. So we think that each case is different and before protected or not we have to take a look of some important points like the political, social, geographical, the belonging of a strong group,....and in the case of Argentina was more difficult that the case of the Spain when both liberalised their economical system We think that may be putting trade barriers at the beginning as the Spanish government made or subsidising the air sector had been better than just put it on sale, and even worse sold the company for private interest as we though an the most of Argentine people think because now is really difficult to bring the companies back Bibliography:

• The most of the theoretical information was taken out from the book used in International Economic Relations by P. Milde; • http://listproc.ucdavis.edu/class/200205/ecn160a−102/att−0050/01−NOTE−10__Protectionist_Arguments_.DO • http://pages.stern.nyu.edu/~rlevich/f1999/Chap−9.pdf • www.mkeever.com • www.freeessays.cc • www.pts.org • www.amricanexpress.com • www.lavanguardia.es • www.elpais.es

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