What are the Protection Methods of Foreign Trade?

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In this article, we will discuss the following protection methods in brief:

(i) Price Discrimination or Dumping;

(ii) Subsidies;

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(iii) International Cartels; and

(iv) International Commodity Agreements.

1. Price Discrimination or Dumping:

Discriminatory monopoly pricing in foreign trade is described as It implies different prices in the domestic and foreign markets. Haberler defines dumping as “the sale of a good abroad at a price which is lower than the selling price of the same good at the same time and in the same circumstances at home, taking account of differences in transport costs.” Under dumping, a producer possessing monopoly in the domestic market for his product charges a high price to the domestic buyers and sells it at a low competitive price to the domestic buyers and sells it at a low competitive price in the foreign market. A reverse dumping is followed if a producer charges a low domestic price and high foreign price for the product.

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The rationale behind dumping is that it enables the exporter to compete in the foreign market and capture the market by selling at a low price, even sometimes below costs and to make up for the deficiency in sales revenue by charging high prices to the home buyers (taking advantage of monopoly power in the home market). In fact, the higher domestic price serves to subsidise a segment of the foreign price which helps considerably in promoting exports.

The export earnings may, however, be made available to promote the growth of home industries, which otherwise would not have been possible. Moreover, by resorting to dumping, when the producer is able to widen the size of foreign markets for his product, his investment risks are minimised and when he has to launch large scale production he can reap the economies of large scale resulting in costs minimisation. Eventually, in the long run, it may become possible for him to sell goods at cheaper rates in the domestic market as well.

Dumping, in essence, implies price discrimination. The success of international price discrimination, however, depends on the following conditions:

1. The producer must possess a degree of monopoly power at least in the home market.

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2. There must be clearly defined separate markets. In international trade, markets are clearly differentiated into home and foreign markets. In fact, in international trade, markets are separated by space, difference of customs, nationals, languages, currencies, etc.

3. It should not be possible for the buyers to resell the goods from a cheaper market to the dearer one. In foreign trade, of course, the distance, transport cost element and the customs prevent this tendency.

4. Price discrimination is profitable only when two different markets have different elasticities of demand. It is meaningless to resort to price discrimination if two separate markets have identical demand curves, because under such conditions the total sales receipts will not be affected by shifting the uniform price policy.

Micro theorists presume that price discrimination or dumping maximises the total profit of the exporter. According to micro economic analysis, a monopolist in order to maximise profit will tend to equate combined marginal revenue of two markets with the marginal cost of his product. As Stigler puts, under dumping, the producer with a marginal revenue in the home market and foreign market set equal to marginal cost, and with price related to marginal revenue by the equation MR = P (1 – 1/e), where e is the elasticity of demand, different prices will be set in both the markets to derive maximum profits.

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The basic theorem in this regard may be stated: A low price will be charged in a market with more elastic demand (e > 1) and a high price will be set for the market with an inelastic demand (e < 1).

Dumping by a foreign competitor is obviously condemned by the domestic producer when the foreign competitor captures their market by selling below cost price.

Hence, competing home producers strongly react to any suspicion that a foreign exporter has resorted to dumping. As an anti-dumping measure, thus, a tariff wall has to be erected by the country concerned.

There are, however, two major forms of dumping-persistent and sporadic. Persistent dumping is adopted on a long-term basis, in the context of different market conditions in the two countries.

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Its basic goal is to facilitate large-scale production. Under persistent dumping, importers benefit by low-price imports; so unless there is the infant industry argument, there is no need for a protective tariff in such case. Persistent tariff, however, is harmful to the exporting country as it exploits domestic consumers for the sake of foreign buyers. But if export promotion is to be given priority and dumping facilitates economies of large-scale production, there is no valid reason for resentment against such dumping.

Sporadic dumping is occasionally adopted, especially to dispose of a casual stock. Further, sporadic dumping may be either predatory or intermittent. Predatory dumping is adopted to ruin rival firms and to achieve monopoly power by selling even at a loss in the foreign market.

Once the object is realised, predatory dumping is immediately followed by a price rise. Similarly, intermittent dumping is adopted to maintain a foothold in the market, or to develop goodwill in a new market. Since sporadic dumping is harmful to both the local producers as well as consumers in effect, it must be prevented through a protection tariff. The duty so imposed must be high enough to equalise the selling price of the dumped goods with that of domestic goods.

2. Subsidies:

Protection to home industries is also granted by giving subsidies to the domestic producers. Especially when the cost of production is high and domestic producers are incapable of either competing with foreign goods or sell goods at a cheaper rate, the government may give them subsidies in the form of tax exemption, development rebate or tax remittance or a segment of the cost of production may also be borne by the state.

Further, in order to encourage exporters, they may be given export bounties. Export bonuses or bounties in effect artificially bring down the domestic price of goods to be exported, hence exporters will be in a position to sell them at low prices in the foreign market, thereby, stepping up exports. Generally, all subsidies and bounties tend to reduce imports and increase exports, but eventually they cause diversion of resources from more efficient to less efficient uses.

To counteract the export subsidies of a foreign government, the importing country may impose import duties and thereby, convert subsidies of the exporting country into customs revenue (for the importing country).

3. International Cartels:

An international cartel is formed by producers in the same line of production in two or more countries, agreeing to regulate production and sales for monopolistic ends. Haberler defines international cartels more precisely as “a union of producers in a given branch of industry, of as many countries as possible, into an organisation to exercise a single planned control over production and price and possibly to divide markets between the different producing countries.” Thus international cartels are a sort of monopoly combines to eliminate competition in the foreign markets. Cartel members usually form an organised association through explicit agreements which would ensure them higher profits than would be possible otherwise.

Indeed, the scope of cartels is wide enough covering metals and minerals, and manufactured goods like chemicals, dyestuffs, pharmaceutical products and electrical goods.

The main inducing factor behind the formation of cartels is the fear of cut-throat competition and desire for monopoly control. Further, when productive capacity is found to exceed current demand, international cartels have been formed as an attempt to share a diminished market.

Professor Krause points out the following important objects of cartels:

1. To achieve control over prices Cartels resort to price-fixing above .competition price and reap high monopoly profits.

2. To impair the quality of product. When cartels are formed, buyers will have no safeguards against low quality, since hardly an opportunity is made available to the buyers to choose between different varieties.

3. To make allocation of trade territories and thereby to acquire and maintain a monopolistic position by each cartel member in their respective allocated- markets.

4. To restrict supply, assigning quotas to each cartel member.

5. To deliberately retard technological change until the existing plants and productive facilities have been fully depreciated.

International cartels seem to have the following merits:

1. Due to business combines, large-scale output is made possible, so goods may be sold at cheaper rates through cartels.

2. Cartels tend to eliminate wasteful competition also.

3. Cartels can solve the problem of excess capacity.

However, the cartels have the following drawbacks:

1. They tend to reduce international trade on account of restricted output and high price policy.

2. International cartels may also mean underutilisation of the world’s resources and manpower, in view of lack of competition and the system of production quotas followed by the cartel members.

Since international cartels are not governed by impartial international machinery in favour of the consumer’s interest in general, it is utmost desirable that cartels must be prevented by all means. For breaking up the cartels, it is necessary to adopt unilateral action through anti-thrust measures by a country, coordinated with such international actions.

4. International Commodity Agreements:

International commodity agreements basically pertain to government-sponsored international cartels. They are inter-governmental arrangements relating to the production and trade of certain basic raw materials and agricultural goods.

Especially, there have been agreements made by countries in respect of coffee, sugar and wheat trade. Unlike private cartels, under international commodity agreements, arrangements are made by governments binding a large number of independent producers who otherwise may not be in a position to untie with one another to carry out the restrictive practices.

Furthermore, unlike cartels, commodity agreements recognise consumers’ interest in determining supply and price policies. There is no restriction on output, nor incidence of high prices and low quality.

Usually, international commodity agreement are inter-governmental agreements between leading producer countries, as an outcome of deliberate governmental policy.

To illustrate such as agreement, let us refer to the International Wheat Agreement evolved in 1933. It provided for production and export controls. It was, however, modified and extended in 1953,1956,1959 and 1962. The basic minimum and maximum prices laid down in the 1962 Agreement were $1.62’/2 and $2,021/2 per bushel. Further, each importing country within the Agreement had agreed to purchase wheat from the subscribing exporting countries, not less than a specified percentage of its annual aggregate quantum.

This Agreement was, however, criticised on the ground that it was meaningless when the proportion of total wheat covered was too small to establish positive market stability.

International commodity agreements have, in general, been opposed on the count that they constitute an obstacle to the effective operation of free market forces.” Further, it also involves the chance of their becoming a ready device for restricting output and raising price.

Professor Krause, however, expresses some hope for the commodity agreements if they conform to certain standards such as (i) recognition of consumer interests, (ii) elimination of excess capacity, j i.e., provision for shifting production from high-cost regions to low-cost regions and (iii) Increase of income and consumption through economic prosperity.

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