Protection is advocated by List and other economists to diversify the industries of a country, when there is unbalanced economy as a result of excessive specialisation. Excessive specialisation leads to overdependence of a country on other countries.
This is dangerous, politically as well as economically. Politically, in times of war, imports from foreign countries become difficult and people have to suffer hardships. Economically there is a danger of serious economic dislocation in case adverse circumstances affect these few industries on which the country is dependent.
Thus, in order to bring about a harmonious and balanced growth of all industries and self-sufficiency, it is necessary to bring about a diversification of industries through protection.
This argument seems to have merits of its own in these days of tension when it advocates rational self-sufficiency. However, it has been criticised on the following counts:
1. All countries, even highly industrialised countries like U.S.A. and the former U.S.S.R., do not possess all types of natural resources and in adequate quantities to be self-sufficient. Thus, there is practical difficulty for any country to be completely self-sufficient.
2. It cuts at the very root of the principle of comparative cost advantage and relative specialisation as a basis of international trade.
3. Complete isolation is not possible in the modern world.
4. Hence, the diversification argument in favour of protection is weak. Further, it should be noted that protection in any case should not mean complete abandonment of international economic relations.
‘Promotion of Employment’ and Protection Theory of Trade
It is believed that imposition of tariff leads to expansion of employment and incomes. The belief was extremely popular in the thirties – the period of the Great Depression, when cyclical unemployment prevailed throughout the world.
Tariff was then regarded as a fairly practicable means of lessening the cyclical unemployment prevailed throughout the world. Tariff was then regarded as a fairly practicable means of lessening the cyclical unemployment. Imposition of tariff restricts certain imports so that, some money is saved in the domestic economy which will be spent upon the purchase of the products of protected home industries. As the protected industries expand, employment therein, increases and income of the community increases.
This generation of income will have a ‘multiplier effect.’ There will be an expansion of employment and income in other sectors of the economy as well. The overall arise in output will require more capital.
Hence, net investment in capital goods industries will rise, which will stimulate further investment, employment and income through ‘acceleration effect.’ Hence, the final increase in employment and incomes is greater than that initially generated by the expansion of protected industries. Moreover, tariffs may even attract foreign capital – as producers abroad, seeing their market threatened, may set up a plant within the country. Therefore, the existence of unemployment in an industry usually is considered a very good reason for the imposition of a tariff.
Free traders, however, express doubt about the practicability of the employment argument. In their view, since exports pay for imports, a curtailment of imports through tariff will cause an equal diminution in exports.
Thus, the additional employment that has materialised in the protected industries by curtailing imports may be neutralised by an equal volume of unemployment in the export industries as a result of the shrinkage. This view of free traders, however, is erroneous. First of all, the curtailment of imports due to tariff is not necessarily followed by a decline in exports.
If a country has a monopoly in the export of certain commodities, it will not contract in spite of tariff duties. And even if there is retaliation by the other countries, at least some time elapses, before a temporary expansion in employment and income are effected in the country. Secondly, even if exports decline it may not necessarily lead to a contraction of the exporting industries, when home consumption increases as a result of saving that has been realised due to restriction on imports. Hence, tariffs will have a favourable effect on the level of employment and income in the country at least in the short run.
‘Balance of Payments’ and Protection Theory of Trade
Since World War II, tariff duty has been advocated as one of the most effective implements to correct disequilibrium in the balance of payments. Restrictions on imports through tariffs may become inevitable in a country if it does not possess sufficient reserves of gold or foreign exchange to make disbursement with the surplus country.
Compared to devaluation, as a means of correcting disequilibrium in the balance of payments, tariff seems to be better, since unlike devaluation it will not have any side repercussions. Devaluation may not only deteriorate the terms of trade but generally speaking it may not be a very effective measure in the case of underdeveloped countries.
This is because their demand for foreign goods is inelastic, so that, the volume of imports will not fall and this will not boost up exports proportionately as their exports also have less elastic demand. In these circumstances, import is to be checked by tariff duties to improve the balance of payments situation. Import controls through tariff duty only suppress disequilibrium if they are retained on a long-term basis.
‘Terms of Trade’ Protection Theory of Trade
For correcting disequilibrium in the balance of payments, tariff duty can be used as an instrument for making the terms of trade more favourable to the country.
The terms of trade can be improved by making foreigners pay whole or part of the tariffs. For, the imposition of tariff duty will lead to a rise in the price of the importing country and a fall in the price of the exporting country and if the demand for the commodity is elastic, then the price in the exporting country will fall to a greater extent.
Thus, the burden of tariff duty is borne by the exporting (foreign) country. Hence, tariff duty moves to more favourable terms of trade for the importing country. This will, however, depend upon the extent to which the price rises in the importing country and the extent to which it will fall in the exporting country.
If tariff duty is imposed, the price will rise in an importing country and fall in an exporting country. If the demand for the commodity of the exporting country is elastic, its price will fall to a greater extent. If the demand for it is elastic, a small rise in the price will lead to a greater fall in demand. If the supply of the commodity is more elastic, the price will rise to a lesser extent. But if the domestic supply is inelastic, then the price will rise to a larger extent.
‘Retaliation’ and Protection Theory of Trade
Tariff is also a weapon to beat down foreign duties that affect a country’s exports. Tariff so imposed is called ‘retaliation.’ A country surrounded by neighbours who have all armed themselves with tariff weapons cannot afford a liberal trade policy.
In these circumstances, the country following a free trade policy is in a weak bargaining position because it has no duties to impose and it cannot offer any concessions to its neighbours to induce them to lower their tariff upon its exports. This one-sided free trade is harmful, and there will be no alternative for the country but to arm itself with tariff weapons, i.e., to retaliate.
Danger of retaliation is that, it is indulged in by both sides and trade in both directions shrinks.
‘Revenue’ and Protection Theory of Trade
Protection is also advocated on fiscal grounds. Tariffs are a very good source of revenue to a government, especially because it is the foreigners who pay tariff duties. In India, customs duties have been a very productive source of state revenue.
Tariffs are regarded as a superior source of revenue on the following counts:
1. Tariffs kill two birds with one stone as these provide revenue to the state as well as protection to home industries.
Free trader protagonists, however, argue that these two objectives of tariffs, viz., to provide revenue and protection, are inconsistent. Tariffs which yield more revenue will afford less protection and vice versa.
It may be pointed out here that the yielding of revenue is a by-product and not the basic consideration for imposing tariffs. Thus, tariffs usually provide protection plus some revenue.
2. Usually, tariff duty will be borne wholly or partly by the foreigners. The relative share of the tariff paid by the foreign exporters and domestic importers is determined by the elasticity of supply of the former and the elasticity of demand of the latter.
If the demand is perfectly elastic, and the supply is perfectly inelastic, the full amount of tariff will be borne by the foreigner. And in the case of a relatively elastic demand, with a relatively inelastic supply, a major part of the tariff duty will be paid by the foreigner, But, in an underdeveloped country where demand for import is inelastic, and the supply of the foreign exporter is elastic, a large part of the tariff will be borne by the domestic importer.
The ‘Pauper Labour’ and Protection Theory of Trade
Protection is sometimes advocated, especially in industrially advanced countries, in order to safeguard the interest of labour. It is argued that in the absence of protection, there will be unhealthy competition between countries having dear labour economy and those having cheap labour.
The product of high wage labour of these countries will be undersold by the ‘pauper labour’ countries. Thus, in the advanced countries where the people enjoy high real wages, it is often felt that their standard of living will be undermined if cheap goods are imported from low wage countries. Hence, to protect a country’s high standard of living and maintain high wages, tariffs become essential to meet competition from a pauper labour country.
This argument, however, overlooked two points:
(i) Labour is not the only factor of production. Dear labour does not necessarily mean higher cost of production. When capital-intensive technique is adopted, productivity being very high, the average cost may be reduced considerably. Labour-intensive technique, on the other hand, adopted by pauper labour country may have low productivity, and as such, high cost of production. When capital-intensive technique is adopted, productivity being very high, the average cost may be reduced considerably. Labour-intensive technique, on the other hand, adopted by pauper labour country may have low productivity, and as such, high cost of production.
(ii) Industrially advanced countries pay high wages not only because labour is scarce, but because it is more efficient and productive. Thus, high wages are no bar to low cost of production. Cheap labour does not necessarily imply low cost of production. For, had the pauper labour argument been correct, the low wage nations of Asia and Africa should have swept away their competitors in the western countries in the world market.
‘Conservation of National Resources’ Argument of Protection
Carely, Patten and Jevons have argued that protection is essential to conserve the national resources of a country. This argument is particularly applicable to countries which export minerals and other essential raw materials. For instance, Jevons feared that England’s export of coal would cause exhaustion of her coal-fields. Therefore, coal exports should be restricted by imposing high export duties.
The same argument is applicable to the Union of South Africa with her gold mines and to India with her manganese and mica deposits.
If a country exhausts its exportable raw materials, it loses the benefit of manufacturing. Therefore, by restricting exports through high tariffs, national resources should be conserved for the benefit of the country itself.