In this article we will discuss about Protection of Trade:- 1. Meaning of Protection 2. Arguments in Favour of Protection 3. Arguments against Protection 4. Protection and Underdeveloped Countries 5. Forms or Methods.
Meaning of Protection:
Protection means protecting the home industries from foreign competition. The term protection refers to the policy of encouraging the home industries by giving subsidies to the home producers and by imposing duties on the foreign goods by raising their prices relative to those of domestically produced goods. In the general sense, protection may refer to the commercial policy of protecting the national interests through restrictions on the international trade.
According to J.L. Hanson, protection means “the imposition of duties on imports in order to protect home producers of these commodities by making foreign produced goods and exempting native goods of a similar character, with the intention of preventing the markets of the country concerned.” According to the Penquin Dictionary, “protection is the imposition of tariffs of quotes to restrict the inflow of imports.”
The mercantilists were the first to state their arguments in favour of protection. They advocated the theory of balance of trade, according to which a nation could only gain through foreign trade if it had excess in the value of exports over imports.
But, this view was strongly criticised by the classical economists. The modern idea of protection as a means of stimulating economic growth was first developed by the American economist Alexander Hamilton in 1791.
Later on, other Americans like Henry George, Mathew Carey, etc. also supported the idea. In Germany, the policy of protection was advocated by Frederich List in 19th century. After the World War I, particularly after Great Depression, almost all the countries of the world have abandoned free trade policy in favour of the policy of protection.
Arguments in Favour of Protection:
The theory of comparative advantage shows that total world output will be maximum when there are no restrictions on international trade. But, on the contrary, in practice, the countries of the world have adopted the policy of protection in one from or the other.
Many arguments have been given in favour of protection.
These arguments may be broadly classified into:
(A) Economic arguments and
(B) Non-economic arguments.
(A) Economic Arguments:
The main economic arguments given in favour of the policy of protection are discussed below:
I. Infant Industry Argument:
Infant industry argument is one of the important valid arguments given in favour of protection. The credit of advancing this argument goes to List in Germany, Hamilton in America and J. S. Mill in England. According to this argument, infant industries (i.e, newly or late starting industries) during the initial stages of their development are not strong enough to compete with the long-established foreign industries.
The operational cost of the infant industries is very high. Such an industry needs to be fully protected by the government from foreign competition. By imposing a tariff on imports, the government raises the domestic price and helps the home producers to cover their high costs and thus grow under protection.
The essential features of infant industry argument are as follows:
(i) The basic idea behind the infant industry argument is to bring a country in the same stage of development as its trading partner. Free trade among unequal’s is neither possible nor desirable. As List writes, “A child or a boy in wrestling with a strong man can scarcely be victorious or even offer steady resistance.”
(ii) Protection should be given temporarily only in the initial stages. It should be withdrawn once the industry becomes mature enough to compete internationally. According to List, “baby is to be nursed; child is to be protected; and the grown up young one is to be left free.”
Similarly, J.S. Mill writes that “It is essential that the protection should be confined to such cases in which there is good ground of assurance that the industry which it fosters will after a time be able to dispense with it.”
(iii) The infant industry arguments is not against free trade policy. It favours free trade based on potential (or long run), and not present, comparative advantage. A country might have potential comparative advantage in the development of certain industry, but, at present, it is not able to realise its true comparative advantage under free trade because other countries have already well-established that industry. Such a country must give protection to this industry in the early stages so as to make it folly competitive under free trade in future.
(iv) The infant industry argument is based on the realistic conditions of unrealised internal and external economies of scale. Protection tends to equalise competitive conditions and make available to the new firm the unrealised internal and external economies.
It helps the firm to grow up to its optimum level (i.e., realisation of internal economies); it helps to reduce costs of all firms by creating a trained labour force or by spreading knowledge of production techniques (i.e., realisation of external economies).
(v) List advocates discriminating protection. Protection should be given only to those selected industries which are potentially capable of becoming economically viable units.
(vi) Infant industry argument can be developed into the generalised form of infant country arguments’. Industrialisation requires the creation of necessary infrastructure, growth of sizable labour force with the requisite attitudes and skills, and increase in the quantity and quality of scarce resources. Protection helps the infant or newly developing country to industrialise itself.
(vii) Infant industry argument, and particularly the more general infant country argument, is frequently used to speed up the process of industrialisation in less developed countries through protection.
The infant industry argument has been criticised on the following grounds:
(i) It is difficult to determine which particular industry has the potential comparative advantage and deserves protection.
(ii) Once protection is given, vested interests are created and it becomes impossible to withdraw it.
(iii) Protection may lead to political corruption. All types of industries, whether economically justified or not, start claiming for protecting.
(iv) Under protection, an infant industry tends to remain infant. Protected industries generally become negligent and develop a tendency to depend more and more on government assistance.
(v) Protection weakens the efficiency of the firm and results in higher price and poor quality of the product.
Despite these defects, infant industry argument for protection has wide scope of application, particularly in the less developed countries. What is needed is to grant discriminating protection and ensure maximum efficiency in the protected industries.
II. Diversification of Industries Argument:
List and other economists advocated protection with the purpose of diversifying the industries of a country. The basic idea behind this argument is that a country should have a variety of sources of production and employment and excessive specialisation (or over dependence on one industry) is dangerous both politically as well as economically.
Politically, excessive specialisation leads to too much dependence on foreign trade which is risky and undesirable during war time. Economically, dependence on a few industries may result in serious economic dislocation in times when such industries pass through adverse circumstances.
Thus, in order to have- (a) national self-sufficiency and (b) smooth and balanced growth of the economy, it is necessary to bring about a diversification of industries through protection.
Diversification argument may be criticised on the following grounds:
(i) It is not possible for a country to attain complete self- sufficiency. Even the most advanced countries, like U.S.A., U.S.S.R., do not possess all types of resources necessary for self-sufficiency.
(ii) This argument cuts the very root of the principle of comparative advantage as the basis of international trade.
(iii) This argument may lead to abandonment of international economic relations.
(iv) Complete isolation is neither desirable nor possible in the present-day world.
III. Employment Argument:
Protection reduces imports, stimulates economic activity and increases employment. This argument was very popular during 1930’s (i.e., the period of Great Depression). Expansion of employment occurs through two effects, i.e., the multiplier effect and the acceleration effect-
(a) Imports form a leakage in the domestic income stream. When imports are reduced through protective measures and exports are maintained, foreign trade multiplier operates which leads to an increase in income and employment by a multiple of reduced import expenditures.
(b) There will be expansion of employment and income in other sectors. The overall increase in employment and income needs more capital. Hence investment in capital goods will rise which will further stimulate investment, income and employment through acceleration effect.
The employment generation argument has the following limitations:
(i) The employment expansion argument is based on the assumption that there exists excess capacity in the economy.
(ii) Protection can be an effective device for expanding employment only if exports can be maintained at the previous level and there is no reduction in exports through retaliation by other countries. But the assumption of no retaliation is highly unrealistic in practice.
(iii) Since imports pay for exports, therefore curtailment of imports through tariff will lead to an equal reduction in exports. Thus, additional employment created in the protected industries will be neutralised by the reduction in employment in export industries due to fall in exports,
(iv) If the demand for imports is highly inelastic, protection will not be able to reduce imports appreciably and thus will fail to have the desired employment expansion effect,
(v) Less developed countries face widespread disguised unemployment which cannot be removed through protection.
IV. Terms of Trade Argument:
Protection (or imposition of tariff) improves a nation’s terms of trade and secures for it larger gains from international trade. By imposing tariff duty on imports, a country improves the rate at which its exports are exchanged for imports from abroad. When a country imposes tariff duty, its willingness to take imports is reduced.
It means for any quantity of exports, it requires larger quantity of imports, or putting it another way, it is willing to offer less of exports for a given quantity of imports from abroad. The result is an improvement in the tariff imposing country’s terms of trade; tariff reduces the home country’s offer of exports for imports.
The terms of trade argument is also known as the foreigner pays the duty argument. The terms of trade will improve for the tariff imposing country if the foreigners are made to pay for the duty. Imposition of tariff raises the price in the imposing country which reduces the demand for imports from abroad.
Reduced demand compels the producers in the exporting country to lower the price in order to reduce the foreign supply to match the reduced demand in the imposing country. The extent to which the terms of trade improves and the extent to which the foreigners are made to pay the duty depends upon the extent to which the price rises in the importing country and falls in the exporting country.
If the demand for foreign good in the home country is elastic and if the supply of the foreign producers is inelastic, then there will be a greater price rise in the importing country and a greater price fall in the exporting country.
Main defects of the terms of trade arguments are given below:
(i) Tariffs will improve the terms of trade only when the foreign offer curve is less elastic. The terms of trade will, however, not improve in case of poor countries which generally face elastic foreign offer curves.
(ii) The gains in the terms of trade through tariff duty are secured only at the cost of other countries. Thus, other countries will also retaliate by imposing tariffs on their imports. The process of retaliation and counter-retaliation will benefit none and will turn the policy of protection self-defeating.
(iii) Imposition of tariff may improve the terms of trade, but such restrictions will curtail the world output in absolute terms.
(iv) Tariffs higher than the optimum level will be detrimental to the national economic welfare. An optimum tariff is that which maximises the gains from the improved terms of trade minus the loss from the reduced volume of trade.
Although the terms of trade may continue to improve at tariff levels even above the optimum tariff, the resultant reduction in the volume of trade will more than offset this improvement. This will lower the welfare level of the country.
(v) Tariffs increase the prices of the imported goods and are against the interests of the consumers.
V. Balance of Payments Argument:
Achievement of favourable balance of payments or removal of disequilibrium in balance of payments is another argument put forward in favour of protection. The basic idea is that country which faces deficit in balance of payment should impose tariffs to have an excess of exports over imports.
This will enable the country to earn more foreign exchange. The balance of payments argument which became popular since 1930’s has special relevance to the less developed countries whose developmental programmes put strain on limited foreign exchange resources.
Tariff as a method of correcting disequilibrium in the balance of payments is superior to devaluation. Devaluation adversely affects the terms of trade and may lead to flight of capital. But, tariff, on the other hand, avoids such unfavourable consequences.
VI. Bargaining Argument:
The policy of protection is adopted to increase the bargaining power in trade negotiations. International trade is based on reciprocal basis. Tariff can be used as an instrument of bargaining, i. e., force the other countries to lower their tariff duties. Thus, through protection, a country can obtain favourable terms for its exports from other countries.
The bargaining argument has the following drawbacks:
(i) Tariff as a method of bargaining may lead to retaliation by other countries. In this way, it is harmful to both the countries.
(ii) If a country is dependent on imports for basic commodities, the tariff rise may be inflationary. The resultant adverse internal developments and the depressing effects on exports may more than offset any gain in bargaining.
(iii) The bargaining argument ignores the possibility that a country may use non-tariff concessions to obtain tariff concessions from its trading partners.
(iv) Bargaining mentality should be aimed at elimination of the loss from tariffs. But, in reality this mentality may be wrongly used to get as much as possible from other countries, while giving up as little as possible.
(v) The bargaining argument is not a wise and desirable argument. Arguing that protective tariff should be imposed in order to use it to bargain with is just like arguing that one should contract a disease in order to enjoy it being cured.
VII. Anti-Dumping Argument:
Protection is used as a means to prevent the foreign producers from resorting to dumping. Dumping means selling in a foreign market at a price below that received in the home market. Discrimination between the home and foreign price is the essential feature of dumping.
Dumping aims at flooding the foreign markets with cheap goods with a view to capturing these markets. Dumping has harmful effects in the country in which it occurs; it disturbs or even ruins the import competing firms. In order to protect the home industry from dumping high tariff is imposed. This would raise the price in the importing country and would avoid the threat of dumping.
VIII. Self-Sufficiency Argument:
Another goal of protection is to attain national self-sufficiency and protect the country from outside disturbances. In this sense, protection- (a) makes the country economically independent; (b) promotes industrialisation through diversification of industries; (c) saves the economy from undesirable effects of fluctuating world prices; (d) avoids shocks of world depressions; and (e) minimises economic disruptions from wars.
IX. Revenue Argument:
Protection is also advocated on fiscal basis. Tariffs are a good source of revenue to the government. The revenue argument has two merits- (a) The imposition of tariff duties not only provides protection to the domestic industries, but also brings revenue to the state, (b) Whole or part of tariff duty will be paid by foreigners.
The relative shares of the tariff paid by the foreign producer and the domestic consumer depend upon the elasticity of supply of the foreign producer and the elasticity of demand of the domestic consumer. If the demand is more elastic and the supply is more inelastic, the greater share of the tariff will be paid by the foreigners.
X. Correcting Distortions Argument:
Since a tariff affects a country’s internal price structure and allocation of resources, it can be used to correct distortions in the domestic economy which prevents the attainment of gains obtained in a situation of competitive free trade equilibrium. Important distortions of the economy are monopolies, trade unions, external economies or diseconomies (i. e., social benefits or cost not reflected in private prices), government regulations, etc.
XI. Capital Accumulation Argument:
Protection can be used as a method to promote capital formation by increasing saving ratio in the country. A tariff increases the domestic saving ratio in three ways- (a) by improving terms of trade; (b) by attracting foreign investment; and (c) by increasing compulsory saving (through reduction in consumption).
XII. Basic Industry Argument:
Development of basic and key industries, such as iron and steel industry, petroleum industry, etc. is a precondition for industrialisation. Such industries also need protection from foreign competition.
XIII. Retaliation Argument:
Sometimes, protection is adopted as retaliatory measure. If one country levies tariff against another, the latter will levy similar tariff against the former in retaliation.
XIV. Conservation of Resources Argument:
Protection is needed to conserve national resources. Therefore, duties or other restrictions should be imposed on the export of minerals and raw materials.
XV. Maintaining High Wage Argument:
Policy of protection is recommended to protect domestic workers from low-wage foreign competition. A high-wage (or high-cost) country competes with a low-wage (or low-cost) country in international trade. Thus, the rich countries where higher wages are paid will be at disadvantage when they import cheaper goods from, and export costlier goods to, the low-wage poor countries.
By adopting the policy of protection, these rich countries are able to protect the higher living standard of their workers and to compete with the low-wage countries in the international trade.
Maintaining high wage argument is defective on the following grounds:
(i) Labour is not the only factor of production and the prices of the commodities are not determined by wage rates alone. Production of goods is the joint result of various factors, such as, Land, labour, capital etc.
(ii) High wage does not necessarily mean high cost of production. Higher wages may be paid due to higher productivity of labour and higher productivity of labour tends to lower the unit cost of production.
XVI. Size of Home Market Argument:
Another argument in favour of protection is that it enlarges the size of the national market for domestic production by keeping out imports. The people who would have previously purchased the imported goods would now purchase the domestic goods. But, this argument is also misleading because it ignores the fact that imports pay for exports. If protection enlarges the domestic market for import- competing goods, it also reduces the foreign market for our exports.
XVII. Equalising Cost Argument:
The policy of protection is advocated in order to equalise costs of production at home and abroad so that no country has an unfair advantage in the production of a commodity. If a country enjoys comparative cost advantage in the production of a commodity and is able to sell abroad at lower price, then this advantage should be eliminated by other countries through imposing tariff duties.
The elimination of differences in costs internationally will lead to the elimination of unfair competition from abroad. The drawback of this argument is that the elimination of all international differences in costs and prices would mean elimination of all gains from trade and, in fact, the trade itself.
XVIII. Keeping Money at Home:
Protection helps in keeping money or wealth at home. When a country imports from abroad, its people get goods and the foreigners get money. If imports are restricted and the people spend their money on domestically produced goods, they get goods and also retain money at home. Thus, it is preferable to keep money or wealth at home by preventing imports through protection. In this way, the country will have the cake and eat it too.
This argument is criticised on the following grounds:
(i) It is based on the wrong mercantilist identity of money and wealth. Real wealth lies in physical goods and services, and not in money; money is only worth what it can buy.
(ii) The money which we send abroad by purchasing imported goods will be ultimately used by foreigners to pay for our exports. In this sense, reduction of imports will lead to reduction in export.
(B) Non-Economic Arguments:
Protection is also advocated on the following non-economic arguments:
I. Defence Argument:
Tariffs are necessary in order to develop national defence industries. Though economically such industries may be unjustified, but their existence and development is of critical importance particularly in war times. National security is even more important than economic prosperity. As Adam Smith says, “Defence is better than opulence.” Thus, the defence industries must be developed behind the wall of protection.
II. Nationalist Argument:
Protection is also justified on the nationalist ground. The spirit of patriotism requires that every citizen of the country should prefer homemade (swadeshi) goods to imported goods. Such nationalist feelings give a good boost to the development of domestic industries and necessitate restrictions on imports through protective measures as well as encouragement to import substitution.
III. Preservation Argument:
Protection is also advocated in some countries to preserve certain classes of population or certain occupations. For example, agriculturists and farming occupation should be preserved on political and social grounds. The basic argument is that the agriculturist community is the backbone of the society and, therefore, the interests of agriculturists should be preserved by imposing tariff duties on the import of cheap food grains. In England, for instance, ‘Corn Laws’ imposed tariff in 1819 on the import of wheat.
IV. To Check Import of Harmful Goods:
Tariffs may be imposed to check the import of harmful and socially undesirable goods. The consumption of certain commodities such as alcoholic beverages, tobacco, etc. is detrimental to the health of the people. Therefore, the import of such goods should be restricted.
Arguments against Protection:
Critics also point out certain dangers of protection.
The important arguments against protection are given below:
i. Uneconomic Use of Resources:
Protected industries are generally those in which a country has less comparative advance. Thus, protection leads to the development of economically less efficient industries and shifting of natural resources of the country from more productive occupations to less productive occupations.
ii. Producers Become Lethargic:
Protection makes the home producers lethargic. In the absence of competition from abroad, the home producers do not bother to reduce the cost of production in their units and make them more efficient.
iii. Check on Industrial Growth:
Protection once given to an industry is taken as a matter of right and thus cannot be easily removed. Protection tends to become a permanent feature and the protected industry continues to be considered as an infant industry.
iv. No Cure for Unemployment:
Protection may not prove to be a successful method of generating employment. The creation of employment because of the expansion of the protected domestic industries may be offset by the reduction in employment due to the resultant decline in exports.
v. Loss to Consumer:
The ultimate burden of protection falls on consumers. Protection results in restriction on cheap imports and raising of domestic prices. The consumers suffer from these effects.
vi. Unequal Distribution of Income:
Protection encourages unequal distribution of income and wealth. Under protection, the rich (producers) become richer because of high profits in the protected industries and the poor (consumers) become poorer because of higher prices.
vii. Creation of Monopolies:
Tariff is considered the mother of trusts. In the absence of foreign competition, the domestic producers combine to reap higher profits.
viii. Encouragement to Corruption:
Protection may lead to political corruption. The producers of the protected industries, instead of paying their attention to improve the efficiency of these industries, use their money and energies to bribe the legislators for the continuation of protection to their industries.
ix. Loss of Revenue:
There may be a loss of revenue to the government due to protection. Imposition of tariffs reduces imports and, as a result, the revenue from custom duties falls.
Imposition of tariffs by one country often leads to the similar retaliation action by other countries. This results in tariff war among the trading countries and spread of international hatred.
xi. Other Drawbacks:
Other drawbacks of the system of protection are summarised below:
(i) Protection is inefficient for the world economy because it results in reduction of world output and world consumption levels.
(ii) Protection leads to fall in international trade.
(iii) Protection leads to the overvaluation of exchange rate.
(iv) Protection alone is not sufficient for economic development.
(v) Indiscriminate protection is always harmful.
(vi) Excessive restriction on import of consumer goods generate inflationary pressures in the country.
The discussion of relative merits and demerits of free trade and protection leads to the following broad conclusions:
(i) Free trade, on the basis of traditional comparative advantage theory, is not a realistic commercial policy in the actual world, particularly in the underdeveloped countries.
(ii) Protection is indispensable- (a) for influencing a country’s relations with the rest of the world, and (b) for developing and diversifying the domestic economy in accordance with the potential comparative advantage.
(iii) Permanent and blanket protection is neither desirable nor justified. It involves high and unnecessary costs. Selective and skillful use of protection can avoid the drawback and adverse effects of protection.
(iv) Protection is the second-best method of achieving the domestic objectives because it imposes distortions of its own, which more direct methods will avoid.
(v) Protection means interference with the optimum pattern of world trade; it makes the world worse off. Therefore, the cost of every departure from free trade should be carefully examined and, wherever conditions allow, unnecessary restrictions on trade should be avoided.
Second-Best Nature of Protection:
Protection is used as method- (a) to influence a country’s relations with other countries and (b) to influence the domestic economy. International objectives of protection include improving terms of trade and achieving favourable balance of payments.
Domestic objectives include industrialisation, diversification of industries, increasing employment, removing domestic distortions, increasing government revenue and other non-economic objectives. It should be noted that protection is only the second-best method of dealing with domestic objectives.
While dealing with the domestic objectives, the following implications of protection are to be kept in mind:
(i) Protection is not possibly the first-best method to achieve the domestic objectives. It is necessarily the second-best policy because it not only helps correcting distortions in the domestic economy, but also introduces distortion of its own (i. e., a consumption cost). The first-best method is that which directly deals with the domestic objectives and does not have undesirable side effects of protection. Thus, protection is inferior to a more direct method; tariffs and quotas which protect the industries are inferior to subsidies which promote industries.
(ii) In practice, however, the second-best policy of protection is preferred to the direct measures due to political and administrative considerations.
(iii) While imposing a protective tariff, the additional distortions which this tariff introduces must be weighed against the distortions corrected by it.
(iv) A small tariff is better than free trade because gains due to correcting the distortions are larger than the additional distortion in the form of consumption.
(v) A moderate-to-large tariff may be either better or worse than no tariff at all.
Protection and Underdeveloped Countries:
It is now generally believed that the traditional comparative advantage theory of international trade is not a realistic theory for poor and less developed countries and is not relevant under dynamic conditions. Free trade is not an appropriate commercial policy when the objective is to accelerate economic development. In fact, the underdeveloped countries have special reasons to follow the policy of protection.
Important among them are as follows:
I. Industrialisation Argument:
The main objective of the under developed countries is to have accelerated development through industrialisation, and for industrialisation the adoption of protective policies is essential.
There are many reasons why an underdeveloped country wants to industrialise and hence calls for the adoption of protection:
(i) The economies of the underdeveloped countries are heavily dependent upon production and export of primary products. The cyclical fluctuations and swing in the balance of payments of the primary producing countries tend to be more marked than in manufacturing countries.
(ii) As per capita world income rises, its declining proportion is diverted to food and other raw materials. The underdeveloped countries which depend heavily upon the export of food and raw materials face a long-term deterioration in their terms of trade. By creating demand for industrial products through protection, these countries can diversify their economies and thus avoid the effects of deterioration in their terms of trade.
(iii) Foreign trade has not proved an engine of growth for the underdeveloped countries. Trade of these countries has grown more slowly than that of the developed countries. The factors like growth of synthetics, changes in the consumer tastes, and restrictive policies against the imports from the underdeveloped countries have forced these countries to concentrate on import substitution rather than export promotion. Protection may be used as a means to develop export industries.
(iv) Marginal productivity of labour being higher in manufacturing industry than in agriculture, a transfer of labour from agricultural sector to industrial sector will raise the marginal productivity in agriculture and average productivity in the economy as a whole as a whole. Therefore, the underdeveloped countries need to be industrialised and protective measures should be adopted to achieve this aim.
II. Infant Economy Argument:
Infant industry argument in favour of protection becomes stronger and more relevant to the underdeveloped countries when this argument is considered in its broader sense, i. e., in terms of infant country argument.
In other words, instead of applying the infant industry argument to one industry or group of related industries, we should apply this argument to a whole sector (i.e., to the industrial sector) of the underdeveloped economy.
By definition, and underdeveloped economy is that which is not reaping full gains from its potential (long-term) comparative cost advantage. Protection will not only help an underdeveloped country to develop those industries in which it has potential comparative advantage, but will lead to a better distribution of world output and resources.
When protection is given to many (instead of one) infant industries, the gains from internal and external economies of scale and from the training up of a skilled labour force will also be greater.
III. Capital Formation Argument:
An important argument for protection in underdeveloped countries is that the policy of protection can increase the saving ratio and capital accumulation in these countries.
This is done in three ways:
(i) By imposing the tariffs, an underdeveloped country will improve its terms of trade and thus will make the foreigner pay the duty. In other words, for the same amount of the real resources embodied in the exports, the country will be able to get larger volume of imports.
(ii) Tariffs may be so designed as to attract direct foreign investment. In other words, tariff duties in the underdeveloped countries should aim at not only prohibiting the importation of the finished products, but encouraging the imports of necessary machinery and raw materials.
(iii) Saving ratio in the underdeveloped economies might be increased by imposing selective import restriction to reduce the consumption of certain commodities, such as imported luxuries. The reduction in consumption of imports is equivalent to an increase in disposable income and this increase may be channelled in capital formation.
IV. Underemployment Argument:
Most of the overpopulated underdeveloped countries face the problem of widespread underemployment or disguised unemployment. Underemployment exists when the marginal productivity of labour is zero or even negative. In other words, a part of labour force can be removed from farms without any fall in the total agricultural output.
In fact, where the marginal productivity is negative, the total agricultural output may increase by removing labour to other productive areas. Protective industrialisation may improve the allocation of resources. Tariffs help in transferring labour from rural areas (i.e., agricultural sector) to urban areas (i. e., industrial sector) and thus tend to reduce the problem of underemployment.
V. Other Reasons:
Some other reasons for adopting protective policy in underdeveloped countries are as follows:
(i) The underdeveloped countries, during the process of economic development, face the problem of adverse balance of payments. Protection restricts the non-essential imports, helps in creating an excess of exports over imports and thereby serves as a method of correcting the adverse balance of payments.
(ii) Accelerated economic development in the underdeveloped countries needs concerted planned efforts. Planned economic development is not possible under the conditions of free trade. Protection helps in implementing the strategies and policies of and attaining the targets of planning in the country.
(iii) For both political (defence) and economic reasons, the underdeveloped countries cannot depend upon other countries for all types of goods. They need to be self-sufficient in the production of various essential goods and the goods of strategic importance. Protective measures are required to achieve the objective of self-sufficiency in the country.
In short, it is true that free trade has little relevance to the conditions prevailing in the underdeveloped countries of today. These countries cannot develop their economies without adopting the policy of protection. But, protection should not be permanent and indiscriminate.
Selective and judicious use of the policy of protection will enable an underdeveloped country- (a) to reduce its exposure to the fluctuations of the international markets, and (b) to develop and diversify its economy on the basis of potential comparative advantage.
Forms or Methods of Protection:
The following are the important forms or methods of protection which a country can adopt in its commercial policy and the selection of the method depends upon the purpose in hand:
Tariff or import duty is a tax on imports. According to I. Walter, “A tariff is a charge levied on goods as they enter a country by crossing the nation customs frontier.” P.T. Ellsworth defines tariff as “a schedule of duties leveled upon the importation of commodities into a given nation from abroad.” A tariff is different from a transit duty which is imposed on commodities passing through country. Generally the aim of tariff is to reduce imports by raising their price.
Tariffs can be of three types:
(i) Special tariffs constitute a fixed monetary duty per unit of the imported commodity. For example, Rs. 30,000 per automobile may be charged as tariff on the imported automobiles.
(ii) Ad Valorem tariffs are levied as percentage of the total value of the commodity as it enters the country, including its cost and transportation charges. For example, 300% of the total value of the imported color T. V. may be charged as tariff.
(iii) Sliding scale tariffs are imposed in relation to the price of the commodity; when the price falls, tariff is reduced and when the price rises, tariff is increased. Sliding scale tariff maybe specific i.e., according to the number of commodities) or ad valorem (i. e., according to the value of the commodity).
II. Import Quotas:
Import quota is a quantitative restriction on imports. It constitutes an absolute limit on the physical quantity or the value of goods and services that may be imported over a given period of time, say, a year or a month.
Import quotas aim at controlling and regulating imports to protect the home industries from foreign competition and to remove disequilibrium in the balance of payments. While tariffs indirectly reduce imports, quotas have direct and physical control on imports.
Import quotas are of different types:
(i) Tariff Quotas:
Under the tariff quota system, a fixed quantity of a commodity is allowed to be imported free or on a low duty. But, when the imports exceed this limit, higher import duties are charged. Thus, tariff quotas combine both the tariff and quota systems.
(ii) Unilateral Quotas:
Unilateral quota is fixed unilaterally without taking the exporting countries in confidence; an absolute limit is autonomously fixed on commodities imported. Unilateral quotas may be global or allocative. (a) Under the global or non-discriminatory quota system, the permitted quantities can be imported from any country of the world, (b) Under the allocative or selective or discriminatory quota system, the permitted quantities can be imported from a particular country or group of countries.
(iii) Bilateral Quotas:
Under this system, quotas are fixed after entering into bilateral agreements with the exporting countries. Bilateral quotas are also called agreed quotas.
(iv) Mixed Quotas:
Under this system, the domestic producers are asked to use a minimum proportion of domestic inputs along with the imported inputs. Protection is thus provided not only to the domestic producers, but also to the domestic suppliers of inputs.
(v) License Quotas:
Under this system, licenses are also issued to the importers along with fixation of quotas. The authorities give licenses to limit the permitted quantities to be imported by a few selected importers. The licenses maybe issued either on the basis of ‘first come first served’ or on the fulfillment of some import requirements.
III. Import Restrictions:
Various forms of restrictions on imports are also used to reduce imports and encourage domestic production, (a) Sometimes import of certain commodities is prohibited by law to protect the home industries, (b) A country may refuse to permit the importation of vegetables, flowers, meats, etc., on the health grounds, (c) A country may instruct the customs officials to check every item and ensure the correctness of the commodities. The delays and damage to goods caused by such regulations may reduce imports.
IV. Exchange Control:
Exchange control, i.e., controlling and rationing foreign exchange, is also used as a protective method. Under the exchange control system, the government has full control over the foreign exchange resources and foreign exchange business of the country.
The importers are allotted foreign exchange at the official rates and according to set priorities to enable them to make payments for the imported goods. In this way, through effective exchange control, the volume of imports can be reduced.
Discrimination refers to the system of- (a) differing tariffs or quotes on imports of goods; or (b) differing exchange control practices; or (c) multiple exchange rates applied to different countries. Thus, under this system, preferential treatment is given to certain countries and commodities against others by making discrimination in trade and exchange controls. Such discriminatory arrangements reduce international trade, create trade blocks and lead to retaliation.
Subsidy is a financial help given by the government to the domestic producers to make them more competitive in the international markets. When the cost of production of the domestic producers is very high and they cannot face the foreign competition, the government can help them in the form of cash incentives, tax concessions, making up the loss, etc.
Subsidies do not restrict imports directly, but indirectly discourage them. They reduce the domestic prices, increase demand for domestic goods and thus reduce imports. Subsidies also have favourable effect on domestic Income and employment.
VII. State Trading:
Under the system of state trading, the government gets control over the entire foreign trade in its own hands. In this way it becomes easier for the government to regulate foreign trade according to the requirement of the country.
The government may employ the method of state trading- (a) to import only the socially necessary goods and to check the non-essential imports; (b) to secure favourable terms from the foreign exporters and to utilise the gains from international trade for public welfare; and (c) to promote the exports of the country.
The policy of devaluation, i.e., lowering the value of the home currency in terms of foreign currency, may be adopted as a method of protection. Devaluation reduces imports by making them dearer and encourages exports by making them cheaper.
9. Boycott of Foreign Goods:
The imported goods maybe boycotted within the country by arousing the spirit of nationalism among the people. This provides natural protection to the domestic industries.