Discuss whether the use of protectionist policies can ever be justified during a period of worldwide recession or whether governments should follow Chinese Premier Wen Jiabao’s advice to adopt a policy of greater free trade. [N2013 25]

Protectionism refers to the imposition of economic policies aimed at restricting trade between countries, designed to protect domestic businesses and workers from foreign competition, while free trade refers to the exchange of goods and services across international boundaries. Recently, governments have been adopting protectionist measures in the belief that this would offset the impacts on their economies from the worldwide recession. Fundamentally, the question is: during a period of worldwide recession, can protectionism be justified, or should governments adopt a policy of free trade, to address the macroeconomic problems of rising unemployment and lack of economic growth? This economics paper argues that, while some would argue that protectionist policies can be justified during a worldwide recession, governments should still follow Premier Wen’s economic advice to pursue a policy of greater international free trade.  

There are many methods used by various countries to protect their economies, but fundamentally these methods either discourage imports or encourage a country’s own exports.  For example, a tariff is a tax levied on imports, where a specific tariff is levied as a fixed charge per unit while an ad valorem tariff is levied as a fraction of the value of a unit. A tariff raises import prices, hence causing consumers to switch from imports to locally produced goods. An import quota is a direct restriction on the quantity of imports. The quota is typically enforced by issuing licenses to a group of individuals or firms. The quota directly reduces the availability of imports, hence pushing up prices of imported goods. Per unit output subsidies can be given to help local producers lower their production costs, which enable them to better compete with more efficient foreign producers. These methods, among others, arguably can protect the domestic economy during a period of recession. 

On the one hand, it can be strongly argued that protectionism can be justified on grounds of employment protection. Protectionism arguably helps the economy against both demand-deficient and structural unemployment. First, during a period of recession, protection may be used to reduce demand-deficient unemployment, where there is insufficient AD to fully utilise the unemployed resources in the economy, because imports are discouraged while exports are encouraged, which theoretically boosts AD, shifting it to the right. Furthermore, trade restrictions are sometimes imposed during an economic downturn to reduce cyclical unemployment. For example, under trade union pressure, governments may decide to curb imports that are in direct competition with domestically-produced goods in order to preserve the jobs in these industries. 

Second, protectionism can also be given to declining sunset industries to slow down their contraction, thus allowing more time for labour to be retrained and re-channelled to other growing sunrise industries. This reduces the degree of structural unemployment, which can be defined as the unemployment arising from the mismatch of skills in the industry as the structure of the economy changes. Many developing countries, especially China, and developed economies, such as Singapore, face structural unemployment as the production structure of the economy as well as demand conditions change and mature. Hence, protectionism can be justified through employment protection. 

However, there are many limitations of protectionism in addressing a situation of worldwide recession. First, protectionism creates a “beggar-thy-neighbour” effect whereby the exports, output, and employment of its trading partners are reduced, which in turn curbs the exports, output, and employment of the country initiating the protectionist measures. Secondly, with protectionism, trading partners are likely to “retaliate” and impose their own import restrictions, again further causing the initiating country’s exports, output, and employment to subsequently suffer even more. For instance, China may face countermeasures if it were to implement protectionist measures on the USA, which would not benefit both countries. 

Furthermore, although the initial intention may only be to offer temporary protection to help smoothen the adjustment and reallocation of resources, protection is politically difficult to remove, once it has been put in place. Vested interests are created and the industries concerned will inevitably resist any removal of trade barriers. In the long run, the country might end up having resources being locked in inefficient ‘sunset’ industries, hence depriving its expanding ‘sunrise’ industries of precious economic resources. For instance, this occurred in Latin America after WWII under the system of Import Substitution Industrialisation, as contrasted with the success of the East Asian countries which pursued Export Oriented Industrialisation. All these limitations reduce the usefulness of protectionism in addressing a situation of worldwide recession. 

On the other hand, other than the limitations of protectionism, international trade might in fact help a country tide a recession. First, developing economies sometimes lack sufficient domestic demand to enable full utilisation of resources. Trade allows such countries to overcome domestic demand constraints by giving them access to larger world markets. With additional demand coming from exports, greater utilisation of otherwise unemployed resources raises output, income, and employment. For instance, Singapore, a small and open economy, depends upon trade as an engine of growth for her national income and employment. Furthermore, rising export demand further stimulates investments, causing the AS to shift outwards faster. These investments, for example in infrastructure facilities like ports and storage warehouses and export industries, in fact allowed Singapore to expand its export sector. Seen from these perspectives, trade arguably acts as an engine of growth as it enables both AD and AS to increase faster than under autarky, and therefore possibly contributes to a country’s long run sustained economic growth.

Second, accompanying the development of merchandise trade would be the development of services like shipping and airfreight, air travel, banking and finance, and tourism. With time, a developing economy experiences structural change and becomes less dependent on merchandise trade and manufacturing, instead diversifying into services, thus becoming more like a developed economy. For instance, countries like Singapore have developed from a third world to a first world country by experiencing structural change from international trade. Therefore, governments like China should also pursue a policy of free trade to benefit from economic diversification, maturation, and structural change, which could arguably ameliorate the impacts of recession. 

In conclusion, while protectionism can be politically expedient and may even ameliorate unemployment – both demand-deficient and structural unemployment – in the short run, it should not be used as an active policy to address recessions. This is because of the limitations of protectionism as well as the foregone benefits of international trade as an engine of growth that can also provide fundamental structural change to the economy, which would put it in good stead when the world economy recovers. Alternatively, large economies like China could also encourage local, domestic demand through the use of expansionary monetary and fiscal policies, and that could drive their economic growth during periods of recession, because they have the option to depend on domestic demand, whereas smaller and more open economies like Singapore would have to depend on international trade and globalisation to drive their economies. Thus, in the final analysis, the policy options taken to address the problems really depend on the countries involved, but to a large extent international trade is a much better policy than protectionism.

JC Economics Essays: This economics essay is a sample answer to an adapted economics question from the H2 Economics A Level paper, November 2013. The response was co-written by two economics lecturers for a tutorial class, in order to teach about protectionism and international trade for the A levels examination. However, this particular economics essay is only one possible response to the question - what could be done differently? Furthermore, how would you improve upon this answer, what real world examples could you use to buttress your arguments, and what can you do to improve this essay? Remember to think through the answers and how you can make economics arguments better. Thanks for reading and cheers. 

Should governments always intervene when free markets fail to allocate resources efficiently? [15]

It should be recognized that free markets often fail due to allocative inefficiency, and there are various ways where governments can intervene to improve the outcome of resource allocation. However, governments should not always intervene as there are instances where intervention results in a less desirable outcome. This essay thus aims to analyse the pros and cons of the various ways of government intervention, and instances of government failure.

Yes, governments should intervene to improve the efficiency of free markets. Firstly, government policies to bring down the output level to the socially optimal output level can be divided into two categories, one market-based and another of direct control. A per unit output tax of the good raises production cost, thus reducing the output to the socially optimal outcome when there are negative externalities or demerit goods.

[Insert diagram for tax]

By imposing a per unit tax equivalent to MEC, MPC shifts to the left, thus bringing the output level down to Qs, coinciding with socially optimal output level. Hence, there should be intervention as it allows allocative efficiency to be achieved. 

On the flipside, an output subsidy would lower production costs, thus raising production to an output level coincidental to the socially optimal outcome, bettering the situation where there are positive externalities or merit goods.

[Insert diagram for subsidy]

By giving an output subsidy equivalent to MEB, MPC is shifted to the right, thus bringing the output level forward to Qs, the socially optimal level. Thus, allocative efficiency is similarly achieved.

While controlling output directly is a faster and more straightforward method, some may argue for the use of emission charges in the case of negative externalities as it advocates specific actions to cut down on the externalities which seem to some as a more long term solution. For example, in the case of pollution, emission charges induce firms to directly reduce pollution by the addition of a filter or the switch to less polluting production methods. However, there are limitations to such a policy as it gives high administrative costs due to the difficulty faced in monitoring emissions as compared to output.

When market-based policies fail to work, it may be sensible for the government to intervene with direct controls. An output ban could be used to forcefully bring down the output level to the socially optimal one. 

[Insert diagram on total ban]

An output ban will be advisable in the case where MEC is so large that the socially optimal output occurs at Qs = 0. In this case, a ban will be allocatively efficient. However, it should be noted that in a case where the MEC is relatively small, government intervention is not advisable as the outcome is even more allocative inefficient. As seen in the diagram above, when the government does not intervene, the area of welfare loss is smaller than when the government chooses to impose a total ban where quantity will be brought to zero. Hence, output bans are very extreme and thus governments should only intervene with a ban if MEC is large.

Another form of direct control would be direct free provision by the government to bring the output level to one that is socially optimal.

[Insert diagram on free provision]

For free provision, the MEB is so large that the socially optimal outcome occurs at Qs. Thus output has to be subsidized to such a large extent that the price of the good effectively becomes zero.

However, just like an output ban, free provision is very extreme and should only be used when the extent of MEB is very large. 

Where MEB is relatively small, MPC needs to be shifted to the right in order for socially optimal outcome to be achieved. Therefore, if the good was to be provided for free, the good will be over-consumed, resulting in a deadweight loss, implying that the outcome is worse than before intervention. Hence government should not intervene. 

In conclusion, despite substantial pros brought about by government intervention, the government should not always intervene as there will bound to be cases of government failure when the extent of intervention required is wrongly judged as seen from the examples above. Furthermore, the extent of administrative costs of some of the methods of intervention outweighs their benefits, translating to the view that the government should not always intervene.

JC Economics Essays - H1, H2, H3 Economics Essays - tutor's comments: While there is a lot of good economics material in this generally well written essay, the main problem is that it could have addressed the examination question more directly and targeted the answer better to the economics question specifically. Having said that, there are some saving graces to this economics essay. There is great use of varied economics diagrams, a lot of explanation, solid economic reasoning, and generally good application of economic principles and ideas, concepts, and logic. These save the essay quite a lot. However, better use of essay technique and more direct answering of the question would be great and would raise the grade achieved - also, lots of economics examples should also have been used. What other ways could be used to improve this essay? Think of how you could make this economics paper even better than it already is. 

“Protectionism is better than free trade.” Discuss the validity of this statement. [25]

Adapted from an actual H2 'A' Level Economics Examination

Introduction to Protectionism

What is protectionism? Protectionism is the government policy of imposing economic policies aimed at restricting international trade between countries, designed to protect domestic producers and workers from foreign competition brought about by trade. International trade, on the other hand, is the free and competitive exchange of goods and services across international boundaries. 

There are many methods of protectionism, namely, import tariffs, import quotas, subsidies, voluntary export restraints, foreign exchange restrictions, physical barriers such as making it difficult to clear unnecessary and bureaucratic custom checks and technical barriers such as differences in technical and safety standards to justify the prevention of foreign goods from being imported. Import tariffs are either levied as a fixed amount of charge per unit or levied as a fraction of the value of a unit. Thus, tariffs artificially raise import prices and reduce the quantity demanded of imports. 

What Economics diagram should be applied here? Based on the description below, what is the likely diagram here?

By examining the concept of protectionism through import tariffs, assuming that the country is a price taker as it is too small to affect world markets and prices, a small country can import as much as it wants at world price, Pw. Sw is the supply of imports and is infinitely price elastic at Pw. At Pw, domestic production is at Q1 while domestic consumption is at Q4. Thus, there is a shortage, DC, is solved by importing the goods to satisfy consumption. When there is a tariff on imports, the world supply curve shifts upwards from Sw to SW+t, with the area between Sw and SW+t being the tariff. Domestic production has now increased from Q1 to Q2 while domestic consumption has fallen from Q4 to Q3. The volume of imports has shrunk from Q1Q4 to Q2Q3. Before the tariff, consumer surplus was ACPw and producers’ surplus at ODPw.  The presence of the tariff caused the consumers’ surplus to fall from ACPw to ABPw. Therefore there is a welfare loss, a deadweight loss in area (2+4). This shows that protectionism results in a loss in welfare to society. [Tutor's Note: this is a very detailed analysis of a diagram. Always try to give analysis of diagrams that you draw in an examination.]

The Theory of Comparative Advantage

International trade operates on the basis of the theory of comparative advantage, where a country produces a good that it can produce at a lower opportunity cost compared to other countries, given its factor endowments. Here, it is assumed that the factors of production are perfectly immobile between countries and from one sector to another within countries as well as that the transportation costs of goods and services are negligible. Referring to figure 2, we use a hypothetical example between USA and Mexico’s comparative advantage. 

Figure 2 refers to two different economies, both depicting differently shaped PPCs (Production Possibilities Frontiers). How would you draw this Economics diagram?

Thus, international trade, as can be seen from the diagram, specifically by the theory of comparative advantage, enables consumers to enjoy higher consumption possibilities. 

Benefits of International Free Trade

Other benefits of international or free trade include lower prices and better product quality, greater product variety, developing countries being able to enjoy technical transfers, trade being an engine of growth for an economy and providing economic diversification. 

Firstly, countries that trade freely will enable domestic firms to face competition from foreign imports. If it is the case of intra-industry trade, it will pressure domestic firms to become more efficient and innovate new methods of production to increase efficiency, reduce cost of production and ultimately pass down the lower cost to consumers in the form of lower prices as well as better quality products from innovation in a bid to differentiate their products from rival foreign imports. If it is a case of inter-industry trade, it enables consumers to enjoy goods that the country are enable to produce due to the lack of factors of production required to produce the particular product, thus increasing product variety. For example, in Singapore, due to the tropical climate, we are not able to produce apples but owing to free trade, we are able to import apples from other temperate countries like New Zealand and USA and as a result, able to enjoy greater product variety, i.e.: enjoy a wider range of fruits, ranging from not only tropical fruits but also fruits grown in temperate climate.

Free Trade is also an engine of growth for the country. Developed and small economies like Singapore lack sufficient domestic market. Trade then exposes Singapore firms to a larger world market and enable us to fully utilise resources that are otherwise unemployed. This in turn increases output, income and employment, shifting both the AD and AS outwards. 

Limitations of International Trade

However, while free trade and specialisation may seem ideal, there are also some limitations. 

Free trade using comparative advantage may mean that in the event firms in other countries become more efficient at producing the product the first country has as a comparative advantage, the first country will become less competitive and lose its comparative advantage, which may lead to an economic crisis for the country since the country is largely dependent on the trade of this particular good. It makes the situation worse since the country is only adept at producing the particular product at a lower opportunity cost compared to other country, its initial focus on producing this good would mean that most of its workers are only trained in producing this good, leading to a case of structural unemployment when the country loses its comparative advantage. This has a somewhat similar result when the country is faced with supply problems from its sole supplier who specialise in supplying the raw materials.  This not only affect the livelihood of the people, as well as cost-push inflation due to a spike in prices of goods stemming from shortage of raw materials to manufacture the goods.  Trade restrictions due to natural disasters and war could also affect a country that depends on international trade via comparative advantage theory and thus is not independent. 

In this light, protectionism may seem like a better solution despite it causing a welfare loss as explained earlier in the tariff diagram. As countries need to protect its strategic industries and be self-sufficient to prevent the above situation from occurring and thus debilitating the country’s economic progress. Some examples are the agriculture and defence related industries. 

Furthermore, protectionism enables the country to protect domestic infant industry to better develop the economy of the country in future. New domestic industries have the potential to develop a comparative advantage in a certain product. However, due to high start up costs and a lack of economies of scale due to smaller scale of production compared to giant foreign firms, prices of the domestic goods are less price competitive compared to foreign imports. Thus, protection enables infant industries to grow and become internationally competitive in future before the protectionist measures are taken away. Nevertheless, such an argument may not be foolproof because firstly, it is difficult to identify the correct new industries which have potential to develop a comparative advantage and also politically difficult for the government to remove the protectionist measure from an infant industry which have grown up. Also, with protectionist measures, it reduces the domestic firms’ incentive to be efficient and respond to consumers demand or to reduce average costs, thus, these infant industry may never develop and build a comparative advantage in the world market because the firms are assured of being protected by the government if it does not grow.  For example, Malaysia protects its national car firm, Proton. It has been under protection from the Malaysia government and has not improved in technology unlike other Japanese car firms. 

Protection of declining industries can be another reason for protectionism as stated earlier how a country could lose its comparative advantage and be entrapped in serious structural unemployment as workers are only equipped with skills to manufacture to previous product that used to be a comparative advantage to the country. This gives time for workers to learn a new skill and find a new job in a new industry, mitigating structural unemployment. However, critics say that such protection is not perfectly viable because overtime, these declining industries are protected for too long and never change and adjust, creating a burden to the country’s economy as well as adversely affect the standard of living of the consumers as they are denied access to cheaper foreign imports. For example, Singapore used to be labour intensive but owing to the decline of the primary and manufacturing sector in Singapore, it quickly decline, go through training and move into the tertiary industry quickly without protectionist measures. 

Other reasons for protectionism includes protection from unfair foreign competition and raising employment in domestic firms and improving trade position of the country. 

Evaluation/ Conclusion

In conclusion, although both protectionism and free trade and specialisation has both its pros and cons, free trade is ultimately better because protectionism only serves as a temporary measure to problems caused by free trade , with many arguments for protectionism debatable in the long run. Welfare losses stemming from protectionism are also borne by consumers as consumers would have benefited from increased trade and suffer from retaliation if protectionist measures were imposed. Instead, countries should take a pro-trade stance and use macroeconomic policies like supply-side policies, improving education and retraining, better infrastructure to develop infant industries and strategic industries as well as ensure smooth transition out from structural labour rigidity from declining sectors.     

JC ECONOMICS ESSAYS: Economics tutor's comments: A more direct approach to this economics question on protectionsim would be to directly tackle the statement: first, in what cases would protectionism be better than free trade? Then, second, write the anti-thesis: how is free trade better? Finally, conclude with an evaluative statement with a justification for the viewpoint. However, this economics essay does a more exploratory and discussion-based kind of approach, which makes for an interesting reading, but may not be the most time effective or efficient strategy in an Economics examination. How would you rearrange these economics content and materials to make the essay address the question more directly, clearly, and efficiently? As a quick reminder, also remember to draw relevant economics diagrams and also to think of how you could make the essay better. What can you learn from the strengths of this economics paper, in a similar vein? Do think through the essay as you read and reflect on it. Thanks for reading and cheers!

(b) How far would the knowledge of demand elasticities be useful to a govt in devising policies that discourage the use of private cars? [15]

(b) How far would the knowledge of demand elasticities (PED, YED, XED) be useful to a government in devising policies that discourage the use of private cars? [15]

To discourage the use of private cars, there are a few policies that the government can implement. The government can implement policies to curb car ownership, curb car usage, or encourage the use of public transport. This paper argues that the knowledge of demand elasticities is useful to help governments in terms of car ownership, car usage, and public transport strategies, and to a large extent this knowledge is quite useful for helping the government make good decisions to tackle road congestion.

Firstly, car ownership can be reduced through a variety of measures. Car ownership can be discouraged by taxing the purchases of new cars, thus making them more expensive, thereby reducing the quantity demanded. Taxes shift the supply curve of cars to the left, thus reducing the equilibrium quantity demanded. Alternatively, an equivalent policy is to set a quota below the free market equilibrium quantity. A quota is a mandatory number of cars that limits the car population. By controlling car ownership, the population growth of cars is curbed and with a smaller car population, there will indirectly be fewer cars on the road.

Alternatively, car usage can be controlled directly using road pricing whereby motorists are charged for using congested roads. For example, in Singapore we have ERP. Electronic Road Pricing is a road toll system that reduces the usage of cars. This reduces the number of cars on that road, hence lowering the extent of traffic congestion.

Finally, lowering the fares or improving the quality and accessibility of public transport, for instance, lowering the fares of SMRT trains or raising the quality of SBS buses, encourages people to switch away from driving private cars to using public transport, hence reducing the usage of cars and traffic congestion in the process.

The knowledge of PED, YED, and XED are quite useful in helping governments devise policies to discourage the use of private cars. PED can be applied here. If demand is price elastic, a low tax rate is able to significantly reduce the quantity demanded. Hence an indirect tax is a suitable policy to curb car usage or ownership. However, if the demand is price inelastic, a very high tax rate is required to significantly reduce the quantity demanded. Hence indirect taxes are likely to be politically unpopular because the imposition of a very high tax rate can result in the government being perceived as being more interested in raising revenue rather than in curbing car usage. Hence a quota is probably politically more acceptable because the government is perceived to be controlling the quantity directly rather than trying to raise revenue. However if the government were to auction off the quota permits, they might again be accused of trying to raise revenue rather than fight traffic congestion.

YED can also be applied here. Knowing the income elasticity of demand enables the government to estimate the extent of the change in demand in response to a change in income. So as income rises with economic growth, the government is then be able to better determine how much car taxes should be raised so as to prevent car population and usage from rising. If the demand for cars is income elastic (i.e. normal luxury), car ownership and usage taxes have to be raised frequently and/or substantially as the country experiences economic growth. Again, the government might be seen as being more interested in raising revenue than in curbing traffic congestion so indirect taxes are likely to be politically unpopular while a quota is likely to be politically more acceptable.

Cross elasticity of demand (XED) measures responsiveness of the demand for a good to a change in the price of another good. It is calculated by taking the percentage change in the demand for the good over the percentage change in the price of the other good. XED can be applied here as well. Since public transport are substitutes to private cars, knowing the cross elasticity of demand for cars with respect to the price of a public transport enables the government to know whether cutting public transport fares is an effective way of curbing car usage. Alternatively, by improving the quality and accessibility of public transport, this makes it a closer substitute to private cars, hence raising the cross elasticity of demand between the two goods. Hence, for a given reduction in the price of public transport, there is a greater impact in curbing the demand for car usage.

In conclusion, knowing the various demand elasticities is to a certain extent quite useful in helping a government decide on which policy to choose. However, it is probably less useful in helping the government decide how much to tax or what fares to charge for public transport. This is because elasticity figures are estimated based on pass data, so they are not fully applicable to the current context as economic conditions tend to change over time. Hence, all elasticity figures should be considered carefully.

JC Economics Essays - Tutor's Commentary: This essay paper was written under exam conditions, and is still well structured, much like the companion complementary part (a). However, as usual, the usual questions apply: how can I make this essay better? How can I use an economics diagram to make this paper better? It has a good structure and is well crafted, yes. May I use this approach in my other Economics essays, or is this only applicable to this type of questions or only to elasticities? A quick word of advice here: please do not swot/ mug/ memorise Economics essays - try to understand the underlying structure, pattern, and system of writing, and always think to yourself - how can I make this essay better and more structured? Why do I prioritise the points this way? Why do I write like this? And how can I be better than I am already? Think hard and you will succeed.