Globalisation refers to the process of increased integration between nations as traditional barriers separating economies are broken down, leading to the formation of a global economy. A key aspect of the move towards globalisation in recent decades has been reducing protectionism. Protection refers to any type of artificial advantage that a government gives to its domestic industries. There are a number of different types of protection, including embargoes, subsidies, quotas, export incentives, voluntary export restraints and local content rules, although the most common form is the tariff (a government tax on an import). The removal of protection results in free trade, which occurs when there are no restrictions to the free movement of goods and services between economies. There are a variety of reasons for which nations reduce protection levels, mostly focused on achieving increased efficiency and productivity levels, and this can have a number of impacts on the domestic and global economy.
The main reason for reducing levels of protection ties in with David Ricardo’s Law of Comparative Advantage. This law arises because of differences in factors of production (land, labour, capital, enterprise): as countries differ in both the quality and quantity of the resources at their disposal, a country may lack the appropriate factor endowment to produce desired goods. Free trade enables these goods to be obtained. Ricardo’s law of Comparative Advantage states that, even if one country has an absolute advantage in producing all goods over another, each country will gain from trade providing each specialises in the production of that good in which it has a comparative advantage, or lower opportunity cost, in producing. If a country produces to its comparative advantage, the LRASC (long run average supply curve) will move to the right. It will also lead to reduced costs of production as nations move towards economies of scale.
As illustrated above, reducing protection will increase the technical efficiency of an economy’s industries, lowering average costs of production. It will also increase allocative efficiency as resources are allocated to more efficient producers. This will raise income levels and increase efficiency and productivity, and promote structural change. International competitiveness will improve as domestic businesses face greater competitive pressures from overseas producers. It encourages innovation and the spread of new technology and production processes around the world. Reduced levels of protection will also lead to higher living standards and higher rates of economic growth as a result of lower prices, increased production of goods and services and greater consumer choice. Comparative advantage is still promoted by the World Trade Organisation (WTO) as the primary reason for all countries to embrace freer trade and international specialisation.
A second reason for reducing protection levels is pressure from the global economy. The main institution encouraging free trade is the WTO, and economies face considerable pressure from the WTO to lower its trade barriers. Nations also face pressure from other economies, which may retaliate to high protection levels by implementing protectionist policies themselves, thereby restricting access to overseas markets.
Reduced levels of protection have a dramatic impact on the domestic economy, an effect which can be illustrated using the tariff diagram shown below. A tariff, the most common form of protection, is a government imposed tax on an import. It makes the import more expensive, giving domestic producers a greater market share.
If a tariff of PWP1 is removed, it will have a number of impacts on the domestic economy. The government will lose revenue of abcd. The quantity of imports will increase from Q1Q2 to Q3Q4 while domestic supply will contract from OQ3 to OQ1, reducing domestic production and employment. The price of the good will drop from P1 to PW, meaning inflationary effects are reduced. This forces domestic industries to become more competitive and provides them with incentive to innovate and use new technologies. Domestic demand will expand from OQ2 to OQ4. Consumers pay less, redistributing income aed from producers to consumers and raising the standard of living. Resources in the domestic economy are better allocated, moving away from inefficient industries towards more productive and competitive industries. Thus, the dynamic, technical and allocative efficiency of the domestic economy increases.
The impact of reduced protection on domestic economies can be further analysed by examining a specific economy such as Australia. Historically, Australia was one of the most highly protectionist countries in the world. However, in 1973, Australia began to shift away from this protectionist strategy, when the Whitlam government announced a 25% across the board tariff cut. In 1988, under the Hawke government, Australia initiated a comprehensive program of tariff reductions. Tariffs declined rapidly in the 1990s, and since this time the Howard government has pursued a slower trade schedule for tariff reductions. For example, tariff levels for the passenger motor vehicle and TCF industries were frozen between 2000 and 2005. Australia’s reduction in protection levels have gone well beyond those required by international trade agreements, such as that of the WTO. Between 1968 and 2004, tariffs in Australia decreased from 36% to 4.5% (although some industries such as the motor vehicle and textile industries remain more heavily protected). As a result, Australia is now one of the most open economies in the world, and is one of its most vocal free trade advocates. The government aims to remove all tariffs by 2010.
This has had a number of positive impacts for Australia, most significantly, that it has promoted structural change. Structural change is the process of change in the pattern of production in an economy over time. It results in products, process and whole industries disappearing and new ones emerging. Since embracing free trade, inefficient industries (such as our electronics manufacturing sector) have virtually died out, meaning Australia can become highly specialised in those industries which we are most competitive, such as agriculture, mining, minerals and elaborately transformed manufactures.
This has boosted the long term efficiency of our firms and industries. Reduced protection levels and structural change has increased international competitiveness, as it has meant the Australian economy can produce goods and services at lower costs, increasing overseas demand for exports and reducing consumer reliance of imports. It has also meant a greater variety of products for consumers, as companies previously unable to compete in the local market due to protection can now compete. Within Australia, the number of car models available for purchase has risen from 75 in 1985 to 250 today. With this has also come cheaper prices for goods, bringing higher standards of living and improved customer service.
Reduced protection levels in Australia has also led to higher productivity growth: Australia’s productivity growth during the 1990s averaged 3% (as opposed to 2% in the 1980s), largely a result of reduced protection levels. Australia’s economic growth rates have also been high, averaging over 3% for much of the 1990s (above OECD average) and currently standing at 2.5% for 2005-06. Embracing free trade has meant that our trade flows have changed dramatically; our trade dependence has increased 10% since 1968, indicating that X and M are now a greater proportion of aggregate demand, where AD = C + I + G + (X – M). Our exports as a component of GDP increased from 10% in 1980 to 22% in 2004, a direct result of the specialisation caused by trade liberalisation. The removal of protection also has a significant effect on the current account deficit (CAD). One protection is removed, volumes of imports rise, contributing to a short-term deterioration in the CAD as cheaper or higher quality imports reduce demand for local products. In the long term, however, the increased competitiveness of Australian firms in the global market will reduce the CAD as export flows increase. Embracing free trade has therefore had positive extensive long term impacts on the domestic economy.
However, reducing protection levels may also have a number of negative impacts on a domestic economy such as Australia. Firstly, domestic ‘infant industries’ may not be able to establish themselves in the world market as they are unable to compete against large foreign competitors. These industries will be unable to expand their economies of scale and reduce their costs of production sufficiently to compete. Secondly, reducing protection levels may result in ‘dumping’, whereby overseas producers supply a product in a domestic market at unrealistically low prices, either to dispose of large production surpluses or to establish a market position in another country. This could harm domestic producers, who may be forced out of business, causing a loss in the country’s productive capability and higher unemployment levels.
Low prices benefit consumers in the short term, but are usually only of a temporary nature – foreign producers will put up their prices once local competition is eliminated. Thirdly, it is argued that free trade results in increased levels of structural unemployment, as local producers are no longer shielded from competition with cheap foreign imports. However, this argument has no economic validity: the law of comparative advantage demonstrates that this should correct itself in the long term as resources are redirected within the domestic economy to areas of production in which it has a comparative advantage. In the long run, this will lead to greater efficiency and higher levels of employment. It is for these reasons that many domestic governments continue to provide protection despite the benefits coming from international specialisation and free trade.
In terms of the global economy, reduced protection levels have had an extensive impact on increasing trade liberalisation and global integration. World trade has increased to 25 times its 1950 level, enabling countries to access goods and services they would otherwise not be able to afford and increasing global productivity and growth levels. These increasing trade flows have broken down traditional barriers, meaning that the world economies are becoming increasingly integrated. This has led to the formation of one global economy and the convergence of the international business cycle. As a result, investment flows have expanded sevenfold since 1970, the role of TNC’s has become far more important, and technology has also been allowed to spread more easily.
The emergence of the WTO in 1995 has been a result of the growing importance of trade in the global economy. The WTO now plays a key role in formulating and negotiating free trade agreements. Reduced protection has increased the importance of these agreements as the numbers of bilateral, regional and multilateral agreements have increased. Australia, for example, has agreements with New Zealand, Singapore, US and Honk Kong as well as being a member of the APEC and ASEAN forums.
However, free trade has also had a number of negative impacts on the global economy. The most significant of these is the increased inequality between developed and developing countries. There is no doubt that global inequalities have become worse over the past century, and though it is difficult to assess exactly to what extent this is a result of globalisation and free trade, it is clear that reducing protection is a key cause of inequality. This is largely due to the fact that the benefits of free trade agreements are often not accessible to developing nations because of the substantial cost in implementing international agreements and lodging appeals against other countries’ protectionist measures. Regional trade blocs such as the EU and NAFTA exclude poorer nations from gaining access to profitable global consumer markets.
It is estimated that if Africa, East Asia, South Asia and Latin America were each able to increase their share of exports by 1%, resulting gains in income could lift 128 million people out of poverty. Furthermore, protection levels tend to have been reduced in areas such as manufacturing: this has little benefit to developing countries, which tend to rely more on export commodities. In contrast, global protection levels remain high in the agricultural sector, severely affecting developing countries and exacerbating inequality. The WTO has failed to make progress on issues of development in the Doha Round of trade negotiations. Though the Doha round made it easier for developing countries to obtain cheap pharmaceuticals, agricultural protection remains high and the recent trend towards bilateral and regional free trade agreements has been accelerated. This has done little to help smaller developing economies from accessing rich countries’ markets, and has therefore entrenched global inequalities.
Reduced protection can also result in environmental degradation. Overseas producers may be able to produce some items cheaply because they do not have to comply with the environmental standards in advanced economies. However, some progress was made on this issue at the 2001 WTO Doha Ministerial Conference, in which the members of the WTO agreed to include environmental standards on the negotiation table for the Doha trade round. This means countries are able to impose import restrictions on goods produced using environmentally damaging practices.
In conclusion, reduced protection levels have had enormous impacts on both the domestic and global economies. As protection levels continue to decrease under pressure from the WTO, the competitiveness, efficiency and productivity of both domestic and global economies will continue to increase.