Protectionism and Free Trade Economics Grade 12 Notes and Study Guide

Protectionism and Free Trade Economics Grade 12 Notes and Study Guide. Protectionism refers to government policies and regulations (such as restrictive quotas and tariffs on imported goods), which are designed to benefit local producers of goods and services in their competition with imported goods, thus helping them to survive. you can See Discuss in detail the arguments in favour of protectionism (Protectionism and Free Trade)

Free trade occurs where government creates very few barriers to international trade. This allows the free flow of goods and services into the country from any other country that can produce these goods cheaper, better, or in the required volumes.

PROTECTIONISM AND FREE TRADE GRADE 12 NOTES – ECONOMICS STUDY GUIDES

Overview

5.1 Key concepts

These definitions will help you understand the meaning of key Economics concepts that are used in this study guide.

5.2 Export promotion

5.2.1 Definition
Export promotion involves providing incentives to encourage local businesses to produce goods for export.
5.2.2 Reasons for export promotion
Some of the reasons for export promotion are:

• The country achieves significant export-led economic growth.
• Export promotion enlarges the production capacity of the country.
• Export markets are much bigger than local markets.
• More workers will be employed.
• Prices will be reduced.

5.2.3 Methods of export promotion
Methods used to support export promotion include:

• Incentives: The government supplies information on export markets, research on new markets, concessions on transport charges, export credit, etc. in order to stimulate exports.
• Subsidies: These include direct and indirect subsidies:
  • Direct subsidies: Cash payments to exporters.
  • Indirect subsidies: Refunds on import tariffs and general tax rebates.
• Trade neutrality: Subsidies equal in size to import duties, are paid.
  Neutrality can be achieved through trade liberalisation.

5.2.4 Advantages of export promotion
The advantages of export promotion include:

• There are no limitations to size and scale of market.
• Production is based on cost and efficiency.
• There is increased domestic production.
• Exchange rates would be realistic.

5.2.5 Disadvantages of export promotion
The disadvantages of export promotion include:

• The real cost of production is reduced by subsidies and incentives.
• Incentives and subsidies reduce prices and force competitors out of the market. This leads to a lack of competition.
• Export promotion results in increased tariffs and quotas by powerful overseas competitors.
• Export promotion results in the protection of labour-intensive industries by developed countries.

5.3 Import Substitution

5.3.1 Definition
Import substitution is part of South Africa’s international trade policy. It occurs when locally produced goods replace goods that had previously been imported. This has a positive impact on the balance of trade.
5.3.2 Reasons for import substitution
Reasons for import substitution include the following:

• Diversification: when goods that were previously imported are produced locally domestic manufacturing expands and an economy becomes less reliant on foreign countries.
• Industrialisation is promoted: the development of new industries to produce previously imported goods can increase tax revenues and create jobs.
• Balance of payment problems: if the deficit on the BoP is too high, a decrease in imports can help to rectify this.
• Trade: developing countries’ reliance on natural resources as a basis for growth and development limits their ability to grow. If these resources are used to produce goods and services which can be used domestically or exported, economic growth might be increased.

5.3.3 Methods of import substitution
The government imposes certain measures to restrict the amount of imports into the country and to support local industries. Restrictive measures used to reserve the domestic market for local manufacturers are:

• Tariffs: Customs duties or import duties are taxes on imported goods. They can be ad valorem (based on the value) or specific to certain goods. Prices of imported goods increase for domestic consumers, and they tend to shift demand from imports to domestic products (goods).
• Quotas: Limits are put on the supply of goods and services. Supply is reduced and prices rise. Foreign enterprises benefit if demand for their products remains high.
• Subsidies: They enable relatively high cost domestic enterprises to undercut more efficient foreign enterprises in the domestic market.
• Exchange control: Government reduces imports by limiting the amount of foreign exchange made available to those who wish to import.
• Physical control: A complete ban or embargo is imposed on the import of certain goods from a particular country.
• Diverting trade: Monetary deposits, time-consuming customs procedures and high-quality standards are imposed to make the importing of goods more difficult.

These are commonly called ‘barriers to trade’ or ‘methods of protection’.
5.3.4 Advantages of import substitution
Some of the advantages of import substitution are:

• Increased employment: More local workers are employed. This stimulates the economy and GDP increases.
• More choice: Available foreign exchange can be used for other imports, thus increasing choices.
• Diversification: By producing more goods locally, the range of available goods increases, and the country becomes less vulnerable to foreign actions and conditions.

5.3.5 Disadvantages of import substitution
Some of the disadvantages of import substitution for the local economy are:

• Capital and entrepreneurial talent: This is drawn away from comparative advantage.
• Technology borrowed from abroad: This may be unsuitable for local production.
• Competitiveness of certain sectors decreases: Where comparative advantages exist.
• Import substitution leads to demand for protection: This demand comes from industries that provide inputs to local industries.

5.4 Protection

Many economists argue for protection, especially for developing countries. Many other economists insist that free trade is the best way to regulate markets. Governments often choose a mix of selected protectionist and free trade policies that suit the particular conditions of their country.
5.4.1 Definition of protection
A trade policy whereby the state discourages the importing of certain goods and services in order to protect local industries against unequal competition from abroad
5.4.2 Arguments in favour of protection

• Industrial development: Some developing countries are well suited to establishing certain kinds of industries. Free trade makes it difficult for these countries to compete with countries with wellestablished industries.
• Infant industries: Newly established industries find it difficult to survive because of high average costs of production which are higher than those of well-established foreign competitors.
• Stable wage levels and higher standards of living: A country with high wages has a view that the standard of living will be undermined if cheaper goods are imported from countries with low wages.
• The protection of job opportunities: If local industries cannot find profitable markets because of cheaper imports, production may decrease and this will lead to more unemployment.
• Economic self-sufficiency and strategic key industries: In times of conflict, cut-off or friction between countries occurs. Protection should be granted, especially to key industries to ensure the availability of these key products.
• Dangers of dumping: Some countries sell their surplus goods in a foreign country at lower prices than it cost them to produce the goods. Local producers cannot compete, and their factories may close.
• Stabilise exchange rates and balance of payments: Traders buy in the cheapest markets and sell in the most expensive ones. Countries export primary products and import manufactured goods, causing disrupted balance of payments and exchange rates.
• Protection of natural resources: Free trade can easily exhaust natural resources, therefore protection is needed to protect local industries and indigenous knowledge systems so that they can survive. The South African government has taken steps to protect Rooibos tea as natural resource and safeguard indigenous knowledge that allows the hoodia plant to be used for medicinal purposes.

5.5 Free trade

5.5.1 Definition of free trade
When producers and consumers are free to buy goods and services from anywhere in the world without the interference of government.
5.5.2 Arguments in favour of free trade

• Specialisation: The theory of comparative advantage shows that world output can be increased if countries specialise in what they are relatively best at producing. If each nation does what it does best, everyone will enjoy lower prices and higher levels of output.
• Economies of scale: Free trade allows economies of scale to be maximised and thus unit cost are reduced. Economies of scale are a source of comparative advantage.
• Choice: Free trade allows consumers the choice of what to buy from the whole world, and not just what is produced domestically. Consumers’ welfare is thus increased because some consumers at least will prefer to buy foreign goods rather than domestic goods.
• Innovations: Free trade increases competition and this encourages innovation in goods and processes.
• Improves global efficiency: Under free trade, resources are allocated more efficiently as markets expand, because each country specialises in its most effective production.
• Free trade leads to greater world production of traded goods, leading to an increase in economic welfare.
• Free trade leads to mutual gains from international trade to all countries.

5.6 A desirable mix of protection and free trade

5.6.1 Import substitution and export promotion
The strategies of Import substitution and export promotion should not be regarded as unavoidable opposites. Many countries started out by protecting their domestic industries and then applied export-orientated policies only after a considerable length of time. Import substitution almost inevitably leads to export promotion.
5.6.2 Protection and free trade
Regionalisation, in the form of trade blocks, makes use of free trade and protection. Member countries pursue free trade with one another but apply trade restrictions outside their block. (Free trade area, e.g. NAFTA and Custom unions, e.g. Mercusor)
5.6.3 Globalisation
Restrictive practices, whether they relate to imports or to exports have the same effect – they reduce the potential volume of world production that would be possible if there was complete free trade and only those goods for which countries had comparative advantage were produced. To pursue this objective of free trade, an independent facilitator was required. The WTO is such a facilitator.
5.6.4 Economic integration
Some of these trade protocols that focus on economic integration are:

• Free trade areas (FTAs) – Member countries agree to the removal of all tariffs. Each member country is still permitted to maintain its own level of trade protection against non-member countries.
• Customs unions – Member countries agree to the removal of all tariffs. However, in a custom union, member countries all set and maintain the same external restrictions on non-member countries.
• Common markets – Are a form of economic integration that satisfies all the requirements of a customs union but also allows for the free movement of factors of production between member countries.
• Economic unions – Meet all the requirements of a common market, but go further which results in member countries establishing a single authority responsible for joint economic policy making, a single monetary system, one central bank, a unified fiscal system and a common foreign economic policy.

5.7 Evaluation of South Africa’s trade policies

5.7.1 Export promotion and import substitution
South Africa’s export promotion policy unfolds as follows:
Export promotion

• 1970’s – measures such as cash grants, tax concessions on export turnover and profits and rail freight concessions were introduced in order to reduce costs for manufacturers of goods with export potential.
• 1980’s – some quotas were removed and replaced with tariffs. Export subsidies were introduced. A list of importers that needed approval replaced a list of imports that did not need approval.
• 1985 – When the US banks refused to roll over import guarantees, South Africa declared a debt standstill and unilaterally restructured the payment of its foreign loans. The rand depreciated substantially and surcharge of 10% on imports was introduced. This led to the effective protection rate increase from 30% to 70%.
• 1990’s – the General Export Incentive Scheme (GEIS) was introduced for the purpose of encouraging the production of valueadded exports. For the first time the official policy stance was one of export-orientated industrialisation.

South Africa’s Import substitution policy unfolds as follows:

Import substitution

• Tariff protection – in 1910 the Cullinan Commission was appointed to investigate the feasibility of establishing a domestic manufacturing industry in South Africa. Tariffs were introduced by the Customs Tariff Act of 1914 and provided protection for local manufacturing industries. In 1925 a new act was implemented and the ‘South Africa first campaign’ was introduced. South Africa thereby introduced an official inward-looking policy.
• The Second World War – Iscor (now Arcelor Mittal) was established as a strategic industry in 1928, in time to take advantage of the opportunities brought about by the Second World War. The SWW stimulated manufacturing and industrial development in general. This was because SA was isolated from many imports and had to produce many products itself.
• Export ready – After the SWW it was accepted that import substitution was the best policy to enhance economic growth. Sasol was established in 1955 to produce oil from coal. From the mid-1960’s, import substitution reached a mature phase when manufacturing increasingly focused on intermediate and capital production. Domestic demand was the main stimulus. However large markets were essential for these goods and necessitated exports. South Africa was ready for an export promotion policy. SA manufacturing sector’s contribution to GDP increased from 5,8 in 1912 to 31,1% in 1981. Import substitution had indeed been successful.

5.7.2 Protection and free trade
The Customs Union Agreement of 1910 was the origin of the Southern African Customs Union (SACU). This is one of the world’s oldest customs unions. The members of the SACU are: South Africa, Lesotho, Namibia, Botswana and Swaziland. The Common Monetary Area (CMA) – made up of South Africa, Lesotho and Swaziland – was replaced with the Multilateral Monetary Area (MMA) in 1992 and was joined by Namibia. Various protocols have been signed with the African Union (AU) and Southern African Countries, including the Southern Africa Development Community (SADC) and the Africa Free Trade Zone (AFTZ). Since 1994 South Africa also made significant progress towards strengthening bilateral ties with its main trading partners and free trade areas (FTAs). They include the EU, Asian Free Trade Area (AFTA), Asian countries – in various combinations and BRICS.
5.7.3 Trade liberalisation
South Africa’s economic policy bias towards exports as a major stimulant of economic growth was further entrenched after 1994. An agreement was reached with GATT (WTO) in terms of what trade had to be liberalised as from January 1995. South Africa’s offer to the WTO consisted of a five year tariff reduction period. More than 100 tariff categories were reduced to six categories.
South Africa’s average tariff declined from 11,7% in 1994 to 5% in 2011.