Just a few days ago President Trump raised the import tariffs for steel and aluminium. He hopes that such a measure will revive the steel and alumina industry in the USA. Many do not believe this is so and instead fear a global trade war in which all will lose. We will see what happens. Below we are taking a look at what it in fact means to trade in a global market.
Free trade is promoted and expected to benefit parties at both ends of the supply chain. International agreements are made to enhance the trade between countries. A free trade zone of 26 African countries, including Ethiopia, has been agreed upon for example. It is hoped that the deal will ease access to markets within the region and strengthen the bloc’s bargaining power when negotiating international deals. Analysts say the agreement will help intra-regional trade and boost growth.
Some other examples are the North American Free trade Agreement (NAFTA), European Union (EU) and Asian Pacific Economic Cooperation (APEC). As is so often the case though, there are two sides of the coin. Free trade creates benefits indeed but it also destroys. It gives and takes away. By increasing competition, free trade lowers the price of imported goods and raises the demands for quality goods, produced locally. Sales will increase and profits will rise. It is clear that consumers of imported goods and producers of exported goods are benefiting. But some groups are harmed as well. Domestic producers of goods that are imported as well are the most obvious group to loose out. Their market share declines and their profit falls. This is when governments sometimes intervene and come to protect domestic producers by passing protectionist legislation. There are several forms of such legislation like tariffs, quotas and qualitative trade restrictions.
Tariffs are taxes on goods moving across borders. They can be imposed on imports, exports or on goods in transit. The tariff on imports is the more common one. They tend to raise the price of imported goods and thereby protect domestic industries from foreign competition. They also generate income for the government. The foreign seller may however lower the prices to offset any tariff increase. As a result, the government continues to earn income from the import tariffs but there is little additional protection for the domestic producers.
Quotas are limits on the amount of goods that can be imported into a country. Quota’s increase prices by directly restricting trade. This is a form of protection for domestic producers. Once the quota has been reached, goods no longer enter the market, even if the sellers lower their price. It is the consumer now who loses most. Instead of imposing quotas, countries also make agreements to share markets by limiting foreign export sales.
Then there are the so called non tariff barriers, which include a wide range of charges, requirements and restrictions such as surcharges at border crossings, licensing regulations, performance requirements, government subsidies, health & safety regulations, packaging and labelling regulations, and size & weight requirements. These kind of barriers are the most difficult as they are subject to interpretation. And do they protect domestic producers or discriminate foreign producers? Restrictions dealing with public health and safety are certainly legitimate, but the line between social well being and protection is a fine one.
Are US automobile safety standards unfair to foreign car makers? Are chickens slaughtered in the US unfit for the European market because a different process is used to clean them? Governments also subsidise local producers, which can make it very difficult to foreign producers to enter the market. This happens most in the agriculture sector, where West European and the US farmers receive subsidies from their governments. As a side effect they dump their under priced overproduction on weaker markets, making it very difficult for domestic farmers to compete against below production prices.
Because of the harmful effects of protectionism, the General Agreement on Tariffs and Trade (GATT) was formed in 1948. Through regular trade rounds or negotiations, GATT served as the major forum for the liberalization and promotion of non discriminatory international trade between participating countries. In practice this resulted in bargaining among countries to lower their tariffs. GATT policy was for countries to replace non tariff barriers by tariffs, assuming that non tariff barriers do more harm to trade than tariffs. Tariffs reduce uncertainty and are clear, so they are easier to negotiate. During its existence GATT effectively reduced trade restrictions and minimized price distortions. It also reduced qualitative trade barriers, curtail dumping (that is selling abroad at a cost lower than the cost of production) and discouraged government subsidies.
GATT was replaced in 1995 by the World Trade Organization (WTO), which continues to pursue tariff reductions as well as liberalization of trade in agriculture and services. The WTO is the global watch dog for free trade.
WTO also faces new challenges, which comprise of foreign investment policies, competition and labour standards. Although most countries want foreign investment, some still set terms of entry for foreign investors. And while many countries favour labour standards, such as a ban on child labour and freedom for trade unions, others argue that low labour costs are the basis of most of their exports. To be a member of WTO will obviously be of benefit to tackle some of the barriers faced in exporting goods. To become a member of WTO also requires that policies and practices are conform global standards.
President Trump took a unilateral decision, against the advice of many of his own experts. Unilateral decisions and measure are seldom beneficial in the end. He expects it will be easy to win a threatening global trade war. Instead it may end up in a LOSE-LOSE for all. To quote his own words: “We will see what happens”.