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Features of the global economy: methods of protection

Subsidies, quotas, voluntary export restraints, local content rules, export incentives

This tutorial was written by
Ken Edge
Head Teacher Social Science
Cardiff High School

Outcomes
Overview
Content
Review exercises
More

Outcomes

HSC topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

Being up to date and aware of contemporary Issues

Students of Economics need to be aware of what is happening in the Global Economy today and should, for instance, keep up to date with changes such as new trade agreements between nations or the imposition of new export restraints or incentives. In 2010 the Global Economy was dominated by the global financial crisis, global recession and their ongoing effects. This crisis commenced in the United States financial sector. It initially led to a worldwide shortage of credit for business, and falls in asset prices, such as homes and commercial property. This decline in asset values promoted an international recession. Unemployment began to rise, banks and financial institutions went bankrupt and banks ceased lending to many businesses. As a result consumption and investment fell. This meant that international trade fell for the first time since the Second World War. Leading exporting countries, especially Japan, faced a very large decline in exports. As a result their economies went into recession. A recession is defined as a fall in Gross Domestic Product (GDP) in two consecutive quarters (e.g over six months).

Government around the world increased spending to help keep consumers spending and so promote economic growth via the multiplier effect. Many governments came under pressure to encourage consumers to purchase domestic made products. In 2009 the International Monetary Fund (IMF) predicted that international gross domestic product (the entire world economy)  would fall in 2009 – 2010 by 1.2.%.

Students are advised to scroll down to the section MORE at the bottom of this page and to visit the websites such as that of the Australian Government Department of Foreign Affairs and Trade.

After completing this tutorial, students may wish to do their own research on the current situation of the global wine industry and on Australia's wine exports to the United States. This 2008 data can be accessed from the Austrade site at http://www.austrade.gov.au/Wine-to-the-USA3932/default.aspx . Students may also wish to explore the sugar industry as well as what access to U.S. markets Australian and New Zealand lamb exporters have currently.

The Austrade website contains information on Australian exports at http://www.austrade.gov.au/Country/default.aspx .

Overview

Despite the fact that trade liberalisation has produced gains for some countries, others have experienced social problems, loss of income and increasing unemployment. This has led to an increase in pressure on many governments to use a variety of methods to protect industry from international competition. Protection can however have a very negative impact on an economy.

The Australian Department of Foreign Affairs and Trade estimated the cost of protection in OECD countries in 2005 to be US$280 billion a year. Rather than importing cheaper and high quality foods from Australia, the OECD countries subsidised their own agricultural producers and, as a result, European consumers paid much more for their food. This disadvantaged Australia’s efficient and low cost farmers. As a result, European consumers could have purchased (imported) Australian foods and agricultural products at a much lower price, and Australian farmers’ income would have been higher.

In one OECD country the cost to consumers to save a single job was estimated by the WTO to be about US$600 000 per annum back in 1991. Protection redirects resources towards inefficient producers that could be used in more efficient businesses and industries. Removal of protection means that displaced workers could be absorbed by the more efficient producers, or employed in exporting industries and businesses developing new products.

This tutorial examines the main forms of protection used by governments to protect industry and analyses the impact on the domestic and global economy.

Content

1. Subsidies

   Subsidies are cash payments made to domestic producers by the government. A subsidy enables producers to reduce their costs of production and compete more favourably with foreign competitors.

   The effects of a subsidy:

   

   Cloze Activity     Flash version     HTML version

   Case study
   With subsidies a redistribution of income occurs because the government uses the revenue from taxpayers to subsidise the protected industry. Taxpayers’ income is transferred to the local producers and consumers of the subsidised goods. In effect, valuable resources are being directed into inefficient industries at the expense of more competitive areas of the economy. The global economic impacts of subsidies are illustrated in this case study.

   Open markets and the environment: the global fish market
   
   A major focus of international organisations such as the WTO has been on how subsidies and other barriers to trade cause excessive resources use and waste.
   
   In the global fish market, trade protection has led to over exploitation of resources and environmental degradation.
   
   Whilst the global marine fish catch has remained constant over the decade 1999-2009, most of the world’s fish stocks are over exploited, resulting in a decline in the net stock of fish, known as ‘fish capital’. Although regulations control the total amount of fish caught, government subsidies, especially for fuel for fishing vessels, encourage too much fishing and fish resource exploitation. The World Bank has estimated that the same amount of fish could be caught by halving the world’s fishing fleet – indiciating an inefficient industry propped up by subsidies.
   
   A World Bank Study on the world fishing industry is available at: http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTARD/0,,
   contentMDK:21930578~pagePK:148956~piPK:216618~theSitePK:336682,00.html
   
   Global demand for fish continues to grow while the world’s fish resources are undergoing alarming rates of depletion. The World Trade Organization (WTO) continues to work to encourage a reduction in subsidies in order to conserve fish stocks. In June 2006 the WTO negotiating group on rules met to discuss fisheries subsidies. The debate focused on key questions such as which kinds of protection contribute to overcapacity and overfishing and how to provide special and differential treatment (SDT) for developing countries. By 2009 no real action had been taken.
   
   Subsidies to protect domestic fishing industries in many countries around the world have significantly contributed to the loss of fish stocks.
   
   Subsidies are used to reduce vessel fuel costs enabling long range harvesting and encourage fleet construction to increase productive capacity.
   
   With trade liberalisation (reduction in trade barriers) in the global market, artificial incentives would be reduced/removed, less capital would flow into the sector and fish harvesting levels would fall.
   
   The removal of subsidies may not ensure the sustainable use of fish resources; however, it removes an economic instrument hampering sustainable fish management.
   
   Sources:
   
   Australian Department of Foreign Affairs and Trade, Trade Outcomes and Objectives Statement 2001.
   
   Technical Centre for Agricultural and Rural Cooperation ACP-EU. Email: info-agritrade@cta.int
   
2. Quotas
   
   A quota is a legally imposed limit used to control the quantity of a good that can be imported into a country over a given period of time.
   
   The effects of a quota:
   
   
   From the above diagrams:
   1. Figure 2 shows the domestic supply and demand curves (DdDd and SdSd) for hockey sticks with free trade.
      • With free trade the world and domestic price for hockey sticks is OP.
      • At OP consumers demand is OQ, the quantity supplied by domestic producers is OQ₂ and imports are Q₂Q.
        
        
   2. Figure 3 shows the effect of the government imposing a quota to decrease imports from Q₂Q to Q₁Q₃.
      • The domestic price of hockey sticks will rise from OP to OP₁ and will benefit holders of the import licenses and domestic producers.
      • Domestic supply increases from OQ₂ to OQ₁.
      • Domestic consumers now face the higher price of 0P1 and the availability of hockey sticks has fallen from 0Q to 0Q3.
        

   The effects of imposing a quota are similar to that of a tariff, (click here for information on tariffs) however there are a number of important differences.

   • Unlike tariffs the government does not receive any revenue, however the government raises revenue when it sells import licences.
   • The imposition of the quota has decreased supply and increased the price of imports. Domestic producers will benefit as they become more price competitive and increase market share.
   • Quotas on imports are often more effective in providing protection for domestic producers than tariffs because once the import quota has been filled further imports are prohibited, and producers are guaranteed a share of the domestic market.
   • Quotas are more effective at limiting consumer purchases of imported goods with inelastic demand. With tariffs consumers can choose to pay the higher price. However, with quotas, once all the imported goods are sold consumers are forced to purchase the domestically produced good or go without.
   
   
   Countries may also use a combination of tariffs and quotas. Such combinations are known as tariff-quota systems. Import producers pay the standard rate of tariff up to the quota amount, and any imports above the quota are paid at a higher rate.
   
   Many countries have quotas on sugar. The United States, for example, has a quota on the amount of sugar that can be imported from Australia. In the negotiations over the Australia United States Free Trade Agreement this quota was increased, enabling Australian producers to export more sugar to the United States.
   
   Australia is a highly efficient sugar producer, the second lowest cost producer in the world. Australian sugar producers do not receive any tariff or non-tariff protection against imports, due to successive microeconomic reform measures to liberalise trade and encourage efficiency in the industry. Australia exports around 80% of its sugar production, our second largest export crop, mostly at the world price. Australia exports around 4 million tonnes of sugar a year, generating over 40,000 jobs both directly and indirectly.
   
   
3. Local content rules
   
   This method of protection requires that certain products contain a minimum percentage of domestically produced components. The remaining components can be made up of imports and may attract zero tariffs. Domestic industries that supply the component parts will benefit from increased output and employment under this form of protection.
   Australia has used local content rules in the motor vehicle industry. This means that to qualify for protection for making cars in Australia, Australian car manufacturers must include a certain percentage of car components made in Australia (85%).
   
   
4. Export incentives
   The government can provide domestic producers with specific assistance when competing in foreign markets. Assistance can take the form of tax concessions and export incentives. The export market development grant (EMDG) scheme, for example, provides financial assistance to small and medium sized businesses in developing their export markets.
   
   Tax cuts enable domestic producers to reduce costs and thus domestic consumers will benefit from reduced prices. In Australia the Trade Commission (Austrade) was formed in 1986 to help export orientated companies compete in overseas markets.
   
   Case study
   
   
   Protecting Australia's Car Industry: Making it Competitive at the Same Time.
   
   The Australian Government has been steadily reducing tariffs on imported cars and providing subsidies to make the Australian industry more internationally competitive and efficient. The Australian car industry is now the nation’s sixth largest export earner, the largest manufacturing export earner and is a major employer, with almost 70,000 workers. The Australian car industry is also important because cars are not only produced in Australian, but designed and planned in Australia.
   
   In 2008 a review of Australia's car manufacturing was carried out by Steve Bracks: the Brack's Review. The inquiry recommended that the Australian Government invest heavily in making cars in Australia.
   
   The background to the report was the global economic crisis, the collapse of new car sales, and the looming collapse of the large United States car makers GM and Chrysler. Even Toyota, the most efficient car producer in the world, made great losses in 2008/2009. In Australia Mitsubishi closed a car plant in Adelaide resulting in the loss of almost 5000 jobs.
   
   The Australian government committed to $6.2 billion in Government investment over the next 13 years, in making cars in Australia. One of the key aspects of these subsidies is Government investment in green cars that use less fuel. The Bracks review also recommended that the tariffs on imported cars should still continue to fall from 10% to 5% by 2010.
   
   According to the Brack's review 'It is new investment which is the lifeblood of this industry and the establishment of the Green Car Fund in particular will help reposition the industry's investments for the lower emission vehicles of the future.' Such subsidies have the impact of lowering the costs of cars made in Australia, so that Australian domestic car sales can compete with lower priced cars imported from overseas.
   
   
5. Voluntary export constraints:
   
   Voluntary export constraints (VERs) involve agreements between national governments and foreign suppliers to restrict the exporting of certain products to an importing country. Foreign producers may enter into such an agreement to avoid the imposition of tariffs and quotas on these products. Japan has been the leader in voluntarily limiting the number of car exports to many countries such as the United Kingdom and the United States.

Review exercises

Exercise 1

Changes in US chops lamb import quotas and agricultural protection

1. The United States removed its tariff-rate quota on lamb exports in 2001, after a dispute with Australia and New Zealand which was settled by a World Trade Organsiation ruling that the quota was illegal, leading to a negotiated agreement regarding the issue. The quota was imposed in July 1999 and was intended to make smaller US lamb producers more competitive against imports.
   
   Under the tariff-quota, Australia and New Zealand faced a tariff of 9 per cent on exports of up to 35 million kilograms, and a 40 per cent tariff on exports in excess of that.
   
   The 2001 agreement gave Australian lamb producers unrestricted access to the US lamb market. The Trade Minister Mark Vaile indicated the agreement was negotiated in Mexico City with the US administration during a WTO meeting.
   
   
2. In January 2005 Australia and the United States signed a free trade agreement. An important aspect of this agreement was the end of US tariffs on the import of Australian lamb and sheep meat products. As a result between 2005 and 2006 sheep meat and lamb exports to the US rose by 20% to reach a total of $350 millionAUD of exports of lamb to the US.

Exercise 2

True and False Quiz     Flash version     HTML version

Exercise 3

Global sugar industry reforms needed

The Global Alliance for Sugar Trade was formed in 1999 as an international coalition of sugar producers committed to removing protectionist sugar policies.

In a press release on the World Trade Organisation (WTO) ruling on European Union (EU) sugar subsidies (31 October 2005) the Australian Minister for Trade highlighted the fact that European export subsidy entitlements to sugar producers totalled 499 million Euros annually.

In the United States sugar costs consumers twice the world price due to generous subsidies and restrictions on imports.

These trade distorting policies have reduced world sugar prices to very low levels and unfairly affected the income of many efficient sugar producing countries such as Australia. The Australian Federal Government’s 2004/2005 budget reflected this problem with the domestic sugar industry receiving $444.4 million to fund reform and restructure activities to secure a sustainable future for Australia's sugar industry (through the 'Sugar Industry Reform Package 2004').

The Cairns Group is supporting the Global Alliance’s priorities to eliminate price and export subsidies in the sugar industry as part of the need for further global agricultural trade liberalisation. A number of negotiations to reduce agricultural protection, especially in the developed world such as the EU and the US, were conducted at the Doha round of talks in which the Cairns group of countries were key players. However, the Doha round of trade talks ended without agreement to cut agricultural protection in the developed countries.

Australia and the United States signed a free trade agreement that came into force on January 1, 2005. The free trade agreement did not include sugar and the US quota – tariff remained. US domestic sugar producers were protected from cheaper priced and high quality Australian sugar. However, in 2006 the US agreed to a 52,000 tonne increase in the amount of Australian sugar (quota) that could be exported to the United States.

Source: Adapted using material from a media release, Department of Foreign Affairs and Trade.

1. Use the Internet to gather up-to-date information to respond to this question.
   The Cairns Group (formed in 1986) has played an important role in liberalising world trade in agriculture. Access the Internet site for The Cairns Group and briefly outline their main objectives. Answer
   
   
2. What are the objectives of the Global Alliance for Sugar Trade Reform? Answer
   
   
3. How have subsidies and price support schemes by the USA and the European Community affected the Australian Sugar Industry? Answer

More

The World Trade Organisation web site has a section on current programs and media releases. Complete a review of an article related to protection.

For students who are interested in exploring these issues the Australian Department of Foreign Affairs and Trade home page has a section on media releases and global issues. Select an article and review the main points.

The Institute for International Economics is a good source of materials on international institutions and international economic issues.

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