Unit 4 : Protectionism 30 Marks

Evaluate the significance for the UK balance of payments on current account of increased use of protectionist policies (30)

The Current Account is an account which measures the level of imports and exports within the UK and lets the government know whether they are in Surplus        (Imports< Exports) or Deficit (Exports< Imports). The main factors on the Current Account are (in decreasing order): Trade of goods, Trade of services, Investment Income and Balance Transfers. Currently, the UK faces a huge balance of trade deficit.

Protectionism is where the UK will try to reduce the amount of imports entering the country for various reasons. Hence, reducing the huge trade deficit they are already facing and also to protect employment and domestic industries.

The first form of protectionism is tariffs. These are taxes places on imports entering the UK. If tariffs are successful they will reduce the number of Imports because they increase the price of goods entering the country and this will tend to discourage consumers from buying the goods because of the inflated prices. DIAGRAM OF TARIFFS INCLUDED HERE. As you can see from the diagram, the tariffs will reduce the quantity of imports and will reduce consumer surplus as price increases and less people are prepared to charge high prices for the good. The reduction of imports will improve the UK balance of payments on the current account and reduce the huge trade deficit.

The second form of protectionism is Quotas. Quotas work by completely restricting the amount of goods entering a country to a certain level for example the UK may only allow 100,000 Cars from America enter the economy per year, no more than that is allowed. Unlike tariffs, Quotas do not let the government gain any additional revenue as the goods are not being taxed, they are merely being restricted from entering the country. INCLUDE DIAGRAM HERE. The diagram above shows how the quota level which is perfectly inelastic completely restricts the quantity of goods entering the country thus increasing price and also reducing consumer surplus. This form of protectionism again reduces imports as less foreign goods enter the country and this reduces the UK’s trade deficit.

Other forms of protectionism are non-tariff barriers. The first one is red-tape and administration costs. These are when a country makes it difficult for goods to enter the country such as health and safety checks and a lot of paper work which will waste a lot of time. These are very difficult to prove and countries will do it to reduce the amount of imports entering the country. The UK would definitely do it because they are facing a huge trade deficit and will try any method to stop imports from entering the country.

Another form of protectionism tends to be controversial - embargos. An Embargo is where a country completely bans the importing of a certain product. For example, due to poor political relationships, America decided to place an embargo on all goods from Cuba. If the UK placed an embargo on goods for certain products, this form of protectionism completely stops the importing of certain products so reduces the number of imports entering a country leading to a reduction in the trade deficit to the UK.

Eval. Tariffs do not place a stop to importing of products, it merely reduces the price of the good and so should deter the number of imports entering the UK. Therefore, the effectiveness of tariffs depends on the elasticity of the product being taxed. For example, oil is a highly inelastic product as nearly everyone in the UK relies on oil for heating, electricity, manufacturing and of course transportation. Therefore, a tariff placed on oil may not be effective in reducing the quantity of imports and hence may not lead to a reduction in the trade deficit faced by the UK.

Eval. Quotas I believe, are very effective at reducing the trade deficit faced by the UK. Unlike tariffs, they will definitely lead to a reduction in imports because it places a limit to the number of imports and hence I believe is one of the most effective ways of reducing the quantity of imports. Quotas have high significance in trying to reduce imports but they do have their disadvantages: they may lead to retaliation by other countries. Other countries may in fact, place Quotas on UK exports entering their countries and thus the UK’s exports may reduce as a result. The overall effect, may not lead to a reduction in the trade. Thus, their aim of reducing their trade deficit by using Quotas may back fire and therefore is government failure.

Eval. I believe red tape and administration work are not very significant ways of trying to reduce imports. Although, time consuming, imports may not be reduced if the goods being imported are highly important for example a firm in the UK may need a highly specialised piece of machinery to enhance efficiency and thus will go through the time consuming work just to help them in the long run. Thus I believe red tape is not an effective form of reducing imports and also it may again lead to retaliation although it is of course hard to prove.

Eval. Embargos will definitely lead to a reduction in the UK’s balance of trade deficit however, embargos are not placed on goods to help improve the UK’s balance of trade deficit. They are placed on goods to try and improve consumer welfare by reducing the imports of de-merit goods and goods which will lead to negative externalities such as Cuban cigars. So, embargos I believe, will not be used by the UK as an effective way of reducing the quantity of imports entering and will be used for other reasons. Hence, in my opinion, it is not an effective way of improving the UK’s balance of trade deficit.

Overall, I believe that tariffs and quotas are the only significant ways of reducing the UK’s balance of trade deficit and in my opinion the UK should start thinking about increasing its exports rather than reducing their imports if they want to remain competitive and improve their massive trade deficit.