• Unit3:Free Trade and Trade Protectionism

    Key unit competence: Learners will be able to analyse the impact of free
    trade and trade protectionism in an economy.

    My goals

    By the end of this unit, I will be able to:

    ⦿ Distinguish between free trade and trade protectionism.

    ⦿ Discuss the impact of free trade and trade protectionism on an economy.

    ⦿ Identify the objectives and tools of commercial policy in Rwanda.

    ⦿ Evaluate the impact of free trade on Rwanda’s economy.

    ⦿ Analyse the need for trade protectionism in Rwanda and the likely

    ⦿ Assess the tools of trade protectionism.

    ⦿ Choose the appropriate trade system for economic development.

    Activity 1

    Suppose Rwanda trades with the rest of the world freely and easily without any hindrance. Agree together as a whole class over 2 sides, (opposing and proposing sides), debate on the motion that; “Free trade should be adopted between or among countries if they are to gain more
    from international trade”.


    3.1 Meaning of Free Trade

    Free trade refers to the unrestricted purchase and sale of goods and services between or among countries without the imposition of constraints such as tariffs, duties, and quotas. It is a policy followed by some international markets in which countries’ governments do not restrict imports from, or
    exports to other countries. In this case, government does not discriminate against imports or interfere with exports by applying some tariffs (to imports) or subsidies (to exports).

    According to Adam Smith, the term “free trade” is used to denote “the system of commercial policy which draws no distinction between domestic and foreign commodities and, therefore, neither imposes additional burdens to the latter, nor grants any special favour to the former”.

    In other words, free trade implies complete freedom of international trade exchange. In this situation, there are no barriers to movement of commodities among countries and exchange can take its perfect natural course.

    3.1.1 Advantages of free trade

    Free trade is the term given to trade between nations that takes place without the imposition of barriers in the form of tariffs, quotas or other measures by governments or international organisations. Free trade is
    generally considered by economists to be beneficial to interntional trade by encouraging competition, innovation, efficient production and consumer choice etc. Its advantages include among others the following:

    • Greater welfare: Free trade avails consumers in a particular country  with a wider choice of goods, as     they find imported as well as domestic  goods on display in the shops. Thus Free trade permits large varieties  of consumption goods and improves consumer’s welfare.

    • Domestic businesses may also have a chance to reduce costs by buying   imported raw materials from    abroad or importing new technology  without restriction.

    • Both individuals and businesses may have access to imported products  that do not exist on the domestic market and would not be available  without international trade.

    • Comparative cost advantage: Free trade is the natural outcome  of comparative advantage. It permits an allocation of resources,  and manpower in accordance with the principle of comparative
       advantage which is just an extension of division of labour i.e. it boosts  specialisation between or among countries involved where countries  may boost their production by specialising in those industries for which  their opportunity cost is lower than for their competitors.

    • By engaging in free trade, countries may then export those goods or  services that they are most efficient in producing and import the items  which other countries may produce more efficiently.

    • By concentrating on certain industries, it may be possible for countries  and the firms operating in their territory to build up economies of scale   that lower their costs and boost productivity.

    • Generally, larger organisations may compete more efficiently on the   international market by keeping control over their costs of production  and managing their supply chain to reduce transport and inventory

    • Competition: Free trade increases competition as domestic industries   must compete with foreign firms in the same industry as well as other  firms in their own country. This compels domestic industries to look for  ways to keep costs down by operating more efficiently and gives them
      an incentive to innovate and look for improved products, processes  and marketing methods.

    Thus, this constant search for new ideas and technology induces domestic producers to become more alert and improve their efficiency which enables them to compete on the international market.

    • More factor earnings: Under free trade, factors of production will   also be able to earn more, as they will be employed for better use i.e.  optimally utilised. Hence, wages, interest and rent will be higher under
       free trade than otherwise.

    • Cheaper imports: Free trade procures imports at cheap rates thus   favouring customers through       reduced prices in the market.

    • Enlarged market: Free trade widens the size of the market as a result   of which greater specialisation and a more complex division of labour  becomes possible. This brings about optimum production with costs   reduced everywhere, benefiting the world as a whole.

    • Restricted exploitation: Free trade prevents growth of domestic    monopolies and consumer’s exploitation from abroad.

    • Free trade encourages the development of efficient entrepreneurs in  given countries due to fear of competition, in order to maintain and  improve their methods of production and this reduces their costs of

    • It promotes international cooperation among countries and mutual  understanding. This helps to improve on the atmosphere of peace and good will in the world hence increasing the volume of international trade.

    • It widens tax base in the economy as a result of variety of goods and services produced and exchanged.

    • It reduces administrative costs of protectionism such as enforcing  quotas, foreign exchange control, subsidies etc.

    • It eliminates possibilities of trade malpractices like smuggling with its  negative effects e.g. reduction in government revenue through taxes.

    • It increases employment opportunities since there is free movement  of factors of production.

    3.1.2 Disadvantages of free trade

    • Free trade involves some risks for a country because the international  market conditions are out of the control of any government and are often unpredictable and liable to fluctuation.

    • As the terms of trade change, a particular industry in a country can fall into decline, resulting in factory closures and unemployment. The labour market is not fully flexible, and workers may have difficulty
     retraining for other industries or moving to other locations to find work. Structural unemployment may therefore cause problems for a country’s economy.

    • A country may become too dependent on the export of a particular commodity; this leaves the economy vulnerable to fluctuations in the price of that commodity. This is often the case with former colonies
    that were compelled to cultivate a limited number of crops such as cereals or mine for a particular metal.

    • The price of agricultural products or minerals on the global market  fluctuates greatly with changes in  international supply and demand  which are outside the control of the producer countries.

    • The distribution of income between or among countries may be more uneven as a result of free international trade, because some countries will take advantage of natural resources, skilled workforce
    or economies of scale to sell their goods and services internationally on favourable terms.

    • Within each particular country, free international trade may increase the gap between rich and poor because those who benefit most from international trade may be the rich elites who own the main assets of the country.

    • For individual firms trading internationally, the business risks are   increased. They are exposed to the risk of falls in demand as a result of  changes in taste or fashion and problems resulting from the introduction  of new technology or more efficient processes by their international
      competitors. Credit risks can be high and the cost of borrowing may  increase unexpectedly, making such firms uncompetitive.

    • Countries often need to become part of a larger trading bloc to obtain  favourable terms of trade internationally, but such economic benefits may come at the cost of a loss of sovereignty, as important decisions  affecting the national economy are made by the international trading
      bloc rather than by its individual members.

    • The inflow of international goods into a country may cause other  problems such as an erosion of the national culture.

    • A country with unfavourable BOP finds it difficult to overcome this  situation under free trade.

    • Free trade may encourage interdependence and discourage self-reliance  or sufficiency. But in the matter of defence each country should have  self -reliance and self- sufficiency as far as possible.

    • Competition induced under free trade is unfair and unhealthy. Backward  countries cannot compete with advanced countries. i.e. Local infant  industries are out-competed by cheap imported products from abroad   since they cannot compete favourably with MDCs.

    • Free trade may worsen terms of trade for LDCs as it may prove  advantageous to developed and technologically advanced countries.

    • It reduces tax revenue from imports and exports since there are no  tariffs on them.

    • It may lead to importation of undesirable commodities in the country  which have adverse effects on consumers since there is no check on  production and trade of various harmful goods. This undermines the  health conditions of local people.

    • It leads to dumping of out dated and poor quality commodities and  reconditioned technology into the country.

    • It may encourage brain drain and capital outflow/flight from LDCs  to MDCs.

    3.2 Trade Protectionism

    Activity 2

    1. Use the library or the internet or any other economics source and  make more research on international trade, and using the acquired  knowledge, analyse the following scenario;
      Rwanda exchanges different commodities between and among  different countries all over the world.

    However, it is not all the time, that she exchanges with other countries at her wish. At times there are restrictions on her imports and exports e.g. through tariffs, quotas, standardisation measures,
    border checks, embargos/sanctions, total ban, import and exportmlicenses, bureaucratic delays etc. This limits the number of commodities entering or leaving the country respectively. Basing
    on the above scenario, discussion the following:

    (a) What economic term is given to international trade with restrictions?

    (b) Why do you think countries need to restrict their trade with  others?

    (c) Identify examples of trade barriers mentioned above that  can be imposed on international trade.

    (d) What other policy measures can countries use to restrict trade with other countries in international trade?


    3.2.1 Meaning of trade protectionism

    Trade protectionism refers to the different forms of barriers imposed on international trade to influence the flow or volume of commodities exchanged. It is a commercial policy of safe guarding the national interests through restrictions on international trade. It is used to regulate the inflow
    and outflow of commodities between or among countries involved in international trade so as to allow fair competition between imports and goods and services produced domestically.
    The doctrine of protectionism contrasts with the doctrine of free trade, where governments reduce as much as possible the barriers to trade.

    3.2.2 Reasons for trade protectionism

    • To protect infant industries against unfair competition from low cost  products from abroad. Infant industries normally produce at high costs  and their products are of poor quality and thus need to be protected   from cheap and high quality import goods.

    • To discourage dumping through tariffs on cheap and expired commodities into the country.

    • To increase employment opportunities at home by reducing imports and stimulating domestic demand for local products which contains local industries in operation so that they can keep providing employment.

    • To reduce external economic dependence and promote self-sufficiency e.g. through establishment of import substitution industries to produce formerly imported commodities to ensure self-reliance in the economy.

    • To increase government revenue through import and export duties, of which revenue can be used to finance government programmes.

    • To prevent importation of undesirable commodities and thus protect   the health of citizens. e.g. ban of certain drugs, food staffs etc. on health grounds.

    • To check imported inflation by increasing tariffs or prohibit importation  of commodities facing hyper inflation.

    • To encourage full utilisation of domestic resources especially for  import substitution industrial strategy.

    • To improve on the BOP position of a country i.e. restrictions may be   imposed on imports in order to reduce them and improve BOP of a  country because it would reduce foreign exchange expenditure abroad  thus improving the BOP position of a country.

    • For security purposes e.g. a country may impose restrictions like  embargo or total ban on importation of strategic commodities like  firearms, military hardware etc. to maintain security in the country.

    • For retaliation purposes i.e. countries impose restrictions to retaliate  against other countries restrictions on her exports.

    • For political purposes e.g. discrimination in favour or against certain  political groups.

    3.2.3 Tools of protectionism (Barriers to Foreign/ International Trade)

    Tools of protection are normally grouped into 2 namely;

    (a) Tariff barriers and

      (b) Non-tariff barriers

    (a) Tariff barriers to trade

    These are restrictions in form of taxes on imports and exports. They are at
     times called customs duties. They are divided into;

        (i) Import duties: these are taxes imposed on goods and  services imported into the country.

        (ii) Export duties: these are taxes imposed on goods and  services exported to other countries.

    (b) Non-tariff barriers to trade

    These are non-tax restrictions or regulations in international trade, they include quotas, import or export licenses, standardisation/quality control, total ban, sanctions, etc.
    A variety of policies/tools, both tariff and non-tariff, have been used to shelter home industries, in order to achieve protectionist goals. These include among others the following:

    Custom duties or tariff

    Tariffs are taxes imposed on imported and exported goods and services. Tariff rates usually vary according to the type of goods imported/exported. When tariffs are imposed on the import of commodities, they discourage import and raise their prices to domestic consumers thus lowering the
    quantity of goods imported, to favour local producers.

    When they are imposed on the export of commodities, they discourage exports and make the goods available for home producers. With floating exchange rates, export tariffs have similar effects as import tariffs. However, since export tariffs are often perceived as ‘hurting’ local industries, while
    import tariffs are perceived as ‘helping’ local industries, export tariffs are seldom implemented.

    Tariffs or custom duties may be specific or ad-valoram. When a tariff is based on weight, quantity or other physical characteristics of imported goods, they are called specific. The duty is called ad-valoram when it is based on the value of the goods. Such a duty is fixed as percentage of the foreign or
    domestic valuation of imported goods.

    Import and export prohibition

    The government of a country by law may totally ban the importation or exportation of certain commodities for health reasons or for promoting the growth of certain industries in the country. For instance, when foot and mouth disease attacks cattle, the government totally prohibits the import
    of beef from that country.

    Exchange rate manipulation

    Exchange control implies the government regulations relating to buying and selling of foreign exchange. Under the system of exchange control, all exporters are required to surrender their claims on foreign exchange to the central bank of the country in exchange for domestic currency at the rate
    fixed by the government. The government then allots the foreign exchange among the licensed importers. Exchange control may be resorted for correcting an adverse balance of payments or for protecting home industry or for conserving foreign resources or for maintaining the exchange rate at a predetermined parity.

    A government may intervene in the foreign exchange market to lower the value of its currency by selling its currency in the foreign exchange market. Doing so will raise the cost of imports and lower the cost of exports, leading to an improvement in its trade balance. However, such a policy is only effective in the short run, as it will most likely lead to inflation in the country, which will in turn raise the cost of exports, and reduce the relative price of import.


    These are physical quantities of commodities that are supposed to be exchanged per period of time. It can be import or export quotas. In order to reduce imports, the government of a country may restrict the total imports of a given commodity to a specified amount or specify the maximum amount
    of a commodity which can be imported from each producing country. When the total amount of goods to be imported is determined, the government then issues licenses for their import. This device of restricting imports is applied as an alternative to custom duties, for example, they are put on imports to reduce the quantity and therefore increase the market price of imported goods. The economic effects of an import quota are similar to that of a tariff, except that the tax revenue gained from a tariff will instead be
    distributed to those who receive import licenses.

    Preferential treatment

    The government of a country may give preferential treatment in the rate  of taxes to some of the countries. The granting of preferential treatment results in the formation of trade blocs. The countries which are not giving preferential treatment impose high tariffs in relation to the goods of the
    discriminating countries, international trade is thus hindered.

    Import monopolies

    When the government of a country takes responsibility of importing all the commodities herself, we say the government has import monopolies.

    Import licenses.

    Another barrier which restricts the import of goods from abroad is the import license. If the government of a country allows the import of foreign commodities to the licensed importers, the trade is very much brought under control. This method is adopted for curtailing/limiting imports and for the
    use of discrimination between goods and countries.

    Export subsidies

    Export subsidies are often used by governments to increase/foster exports by providing financial assistance to locally manufactured goods. Subsidies help to either sustain economic activities that face losses or reduce the net price of production exports. Export subsidies have the opposite effect
    of export tariffs because exporters get payment, which is a percentage or proportion of the value of the exports. Export subsidies increase the amount of trade, and in a country with floating exchange rates, have effects similar to import subsidies.


    This is an extreme form of trade barrier. Embargoes prohibit imports from a particular country as a part of the foreign policy. In the modern world, embargoes are imposed in times of war or due to severe failure of diplomatic relations. A voluntary export restraint This is restriction set by a government on the quantity of goods that can be exported out of a country during a specified period of time. Often the

    word voluntary is placed in quotes because these restraints are typically implemented upon the insistence of the importing nations.

    Anti-dumping legislation

    Supporters of anti-dumping laws argue that they prevent “dumping” of cheaper foreign goods that would cause local firms to close down. However, in practice, anti-dumping laws are usually used to impose trade tariffs on foreign exporters.

    Political campaigns advocating domestic consumption

    This for example involves encouraging citizens to consume their home made commodities e.g. the “Buy Rwandan” campaign in Rwanda, which could be seen as an extra-legal promotion of protectionism.
    Employment-based immigration restrictions Such as labour certification requirements or numerical caps on work visas.

    Direct subsidies

    Government subsidies (in form of lump sum payments or cheap loans) are sometimes given to local firms that cannot compete well against imports. These subsidies are purported to “protect” local jobs, and to help local firms adjust to the world markets.

    Administrative barriers

    Countries are sometimes accused of using their various administrative rules (e.g. regarding food safety, environmental standards, electrical safety, etc.) as a way to introduce barriers to imports.

    3.2.4 Advantages/arguments for trade protectionism

    Activity 3

    International trade between or among countries is restricted as seen in Activity 2 of this unit. Agree as a whole class, on opposing and proposing sides, and debate on the motion that;
    “Trade protectionism should be adopted between or among countries if they are to gain more from international trade”.


    The main arguments which are advanced to support the policy of protectionism are as follows:

    (i) Protectionism reduces unemployment: It has been claimed that   the use of tariffs discourages imports  and raises their prices to the  domestic consumers. This leads to diversion of demand for goods
       produced at home. The home industry is encouraged and thus more  employment is provided for the home population.

    (ii) Preserves certain class of population or certain occupation: The  government of a country on political or social grounds may favour  protectionism for preserving certain classes of people or certain
         occupations, for instance, the agrarian population is generally  more submissive and loyal to the government than the industrial population. If government wishes to preserve this class of people,
         then it will levy heavy import duties on foreign agricultural raw materials thus encouraging them to take more interest in farming.

    (iii) Diversification of industries: Protection brings about a balanced  economy in the country, if it is given to those industries which do  not possess natural superiority. Under free trade, a country will
          specialise in the production of those commodities in which it has a  relative price advantage over other countries. A country can specialise  completely in one or few goods at the most. This means the country  will put all ‘her eggs in one basket’, if war breaks out or the export  prices of the goods go down, then it will face severe hardships.

    (iv) It assists new industries: A newly established industry is just like a  newly born baby. As the baby cannot grow up unless it is nursed and well protected, similarly, an infant industry cannot face the blast of
          foreign competition unless it is given full protection till it grows to  its full structure. Thus protectionism protects infant industries against  unfair competition from low cost imported products.

    (v) Protectionism guards against dumping: Protectionism discourages dumping of cheap and at times substandard or expired goods in the country. If a foreign firm enjoying a monopolistic power or other
         advantages resorts to dumping with a view to capturing foreign  markets, then the other countries must protect their industries by  levying high protective duties on foreign goods. As selling of goods

         under cost (dumping) in other countries is temporary and spasmodic  in nature, the anti-dumping duties should also be temporary. If  dumping is permanent, then higher tariffs should be imposed
         permanently on foreign products.

    (vi) Keeps money at home: Protectionism is also advocated on the grossly  fallacious argument of “keeping money at home”. When we buy  manufactured goods abroad, we get the goods and the foreigners get the money. When we buy the manufactured goods at home, we
          get both the goods and the money.

    (vii) Protectionism increases government revenue: Protectionism is also  advocated on the ground that it raises revenue for the state through  import and export duties. If prohibitive high tariffs are imposed on
           the import of foreign goods, then they may not be imported at all  and the government would not be able to collect the revenue at all.  On the other hand, if a moderate protection duty is levied, then it
            may serve both the purposes of collecting revenue and protecting  industries.

    (viii) Protection helps in checking imported inflation by putting sanctions  or even total ban on commodities from countries affected by inflation.

    (ix) Protectionism conserves national resources: Protection is essential  for preserving the natural resources of a country. The unchecked  trade often leads to exhaustion of mineral resources which are very  vital for the development of the country.

    (x) National defense: Protectionism has been advocated for on the ground   that in times of war or any other emergency, an entire dependence on  foreign goods which are very essential for defense or consumption  purposes is very dangerous. It is stated, therefore, that a country must build up her own iron and steel Industry and develop farming
         industry even if these involve an economic loss to the country.

    (xi) It reduces shortages in the home country by restricting exportation of  certain commodities and favouring importation of such commodities  which are scarce in the country.

    (xii) It encourages full utilisation of domestic resources: If imports  are discouraged and demand for domestic goods is encouraged, it  encourages domestic producers to use the available idle resources
          in order to increase production to meet the domestic demand.

    (xiii) It checks on the production and consumption of harmful products in   the economy: High import duties on certain imported commodities  or their total ban discourages inflow of such commodities on health and moral grounds which improve the standards of living of the  citizens of the protecting countries.

    3.2.5 Dangers of protectionism

    • Market distortion and loss of allocative efficiency: Protectionism can  be an ineffective and costly means of sustaining jobs.

    • It may lead to trade diversion in case trade protectionism is in form of  regional integration i.e. shifting  from a cheap source to a high source  of imports.

    • It may lead to inflation due to high import tariff especially if imports   have inelastic demand.

    • Trade barriers between countries can spoil the relationship between  them.

    • It encourages smuggling which reduces government revenue and  smuggled goods are always  expensive.

    • It promotes monopoly i.e. protected domestic industries will become monopolies and create the items of monopoly e.g. low output, inefficiency etc. due to lack of competition.

    • Over protectionism leads to inefficiency whereby local producers   will produce local quality goods and charge high prices thus cheating  customers.

    • Higher prices for consumers: Tariffs push up the prices for consumers  and insulate inefficient sectors from genuine competition. They penalise foreign producers and encourage an inefficient allocation of
     resources both domestically and globally.

    • Reduction in market access for producers: Export subsidies depress  world prices and damage output, profits, investment and jobs in many  lower-income developing countries that rely on exporting primary and  manufactured goods for their growth.

    • Loss of economic welfare: Tariffs create a deadweight loss of consumer  and producer surplus. Welfare is reduced through higher prices and  restricted consumer choice since imports are restricted and consumers  may end up consuming low quality and expensive commodities. The
      welfare effects of a quota are similar to those of a tariff – prices rise  because an artificial scarcity of a product is created.

    • Extra costs for exporters: For goods that are produced globally, high  tariffs and other barriers on imports act as a tax on exports, damaging  economies, and jobs, rather than protecting them. It leads to high production costs thus high prices for domestic final goods due to the  fact that LDCs normally import raw materials and spare parts.

    • Regressive effect on the distribution of income: Higher prices from  tariffs hit those on lower incomes hardest, because the tariffs (e.g. on  foodstuffs, tobacco, and clothing) fall on products that lower income,
       families spend a higher share of their income.

    • Production inefficiencies: Firms that are protected from competition  have little incentive to reduce their production costs. This can lead to  inefficiency and higher average costs.

    • Trade wars: There is a danger that one country imposing import  controls will lead to retaliatory action by another leading to a decrease  in the volume of world trade. Retaliatory actions increase the costs of
        importing new technologies affecting long run average supply.

    • Negative multiplier effects: If one country imposes trade restrictions on  another, the resultant decrease  in trade will have a negative multiplier   effect affecting many more countries because exports are an injectionn  of demand into the global circular flow of income.

    • Second best approach: Protectionism is a second best approach to correcting a country’s balance of payments problem or the fear of  structural unemployment. Import controls go against the principles of
      free trade. In this sense, import controls can cause government failure.

    • It may lead to scarcity inflation especially if there are high taxes on   imports. This limits supply of goods and services in the country and  it results into high prices for the few commodities available.

    • It may lead to limited inflow of skilled labour into the country if they  are highly taxed.

    3.3 Commercial Policy

    Activity 4

    Rwanda, has developed a policy towards international trade in order to improve her domestic industrial welfare because she wants to gain more from its trade. Use the library, the internet, or any other economics source to research on international trade and thereafter present the following
    in your class discussion.

    (a) What economic term is given to such a policy?

    (b) What are the objectives of such a policy in Rwanda?

    (c) What policy tools have been adopted in Rwanda to improve  her domestic industrial or commercial welfare?

    (d) What benefits and costs have the Rwandan economy faced  as a result of such a policy?


    3.3.1 Meaning of commercial policy

    A commercial policy or trade policy or international trade policy refers to all measures regulating the external economic relations of a country, that is, measures taken by a territorial government which has the power of assisting or hindering the exports or imports of goods and services”. It is a set of
    rules and regulations that are intended to change international trade flows, particularly to restrict imports.

    OR a set of measures adopted by the government of a country towards international trade aimed at improving domestic industrial and commercial welfare.

    In modern times, the commercial policy of every country is generally based on the encouragement of exports and discouragement of imports. The exports are encouraged by giving preferential freight rates on exports; consular establishments subsidised merchant marines etc. The imports are
    hindered by erecting the tariff wails, exchange controls, quota system, buy at home campaign etc.

    Every nation has some form of trade policy in place, with public officials formulating the policy which they think would be most appropriate for their country. Their aim is to boost the nation’s international trade. The purpose of trade policy is to help a nation’s international trade run more smoothly,
    by setting clear standards and goals which can be understood by potential trading partners. In many regions, groups of nations work together to create mutually beneficial trade policies.

    Trade policy can involve various complex types of actions, such as the elimination of quantitative restrictions or the reduction of tariffs. According to a geographic dimension, there is unilateral, bilateral, regional, and multilateral liberalisation.

    According to the depth of a bilateral or regional reform, there might be a free trade area (wherein partners eliminate trade barriers with respect to each other), a customs union (whereby partners eliminate reciprocal barriers and agree on a common level of barriers against non-partners) or
    a free economic area.

    3.3.2 Objectives of commercial policy

    The main objectives of commercial policy are:

    • To increase the quantity of trade with foreign nations.

    • To preserve, the essential raw materials for encouraging the  development of domestic industries.

    • To stimulate the export of particular products with a view to increasing  their scale of production at home.

    • To prevent the imports of particular goods for giving protection to infant   industries or developing key  industry or saving foreign exchange, etc.

    • To restrict imports for securing diversification of industries.

    • To encourage the imports of capital goods for speeding up the economic
       development of the country.

    • To restrict the imports of goods with a view to correct the unfavorable balance of payments.

    • To assist or prevent the export or import of goods and services for
       achieving the desired rate of exchange.

    • To enter into trade agreements with foreign nations for stabilising the
       foreign trade.

    3.3.3 Arguments for commercial policies

    There are three proposed arguments offered as explanation for why nations adopt commercial policies:

    1. The national defense theory

    According to this argument, certain industries such as weapons, aircraft, and petroleum are vital to a nation’s defense. Therefore, proponents of this theory argue that these domestic industries should be protected from foreign competitors so that there is a domestic supply on hand in case of an international conflict. No country would like to be dependent on another country when it comes to weapons.

    2. The infant industry theory

    Under this argument, it is believed that new domestic industries should be protected from foreign competition so that they will have a chance to develop. Ideally, as the new industry matures and becomes able to compete favourably with other producers on its own, the protections will be removed.
    It is intended to help a new domestic industry develop without being immediately crushed by already established foreign industries.

    3. The anti-dumping theory

    Dumping is simply the selling of a good in a foreign country at a lower price than it is sold for in the domestic market. It is an illegal practice and current laws provide relief in form of tariffs imposed against the violators. Proponents of this argument believe that if dumping is allowed, foreign
    producers will temporarily cut prices and drive domestic firms out of the market ans use their monopoly to exploit consumers. Anti-dumping legislation is implemented to prevent this.

    3.3.4 Arguments against commercial policy

    Increased cost to consumers

    One of the most important disadvantages of trade restrictions is that they drive up the price of goods in a country where trade barriers artificially raise the prices of imported products. The apparent effect of trade barriers is to prevent jobs from being lost to foreign competition, which is an argument
    used by many special interest groups to justify various types of trade barriers.

    In the long run, however, trade barriers force consumers to pay higher prices, since products that could otherwise be made cheaply overseas take more resources to produce domestically.

    Increased costs to domestic suppliers

    Price hikes due to trade barriers don’t just affect consumers. It also puts a strain on firms which supply raw goods and commodities to domestic industries. Without trade barriers in place, such firms can rely on the law of comparative advantage. This would cost them more to try to find a certain
    raw material in their own country than it would to buy from some country rich in a particular commodity. Trade barriers artificially raise prices on foreign commodities, making it less profitable to buy from other countries.

    Less competition

    Trade barriers lessen foreign competition, leading to fewer product choices for consumers. The fact that trade restrictions make it more costly to purchase goods from abroad, the domestic industry faces less competition from foreign markets. In the short term, this can save jobs in select domestic
    industries. However, in the long run, it leads to customers having fewer choices in the products they buy. It also gives producers less incentive to create high-quality products available to the public.


    Over time, one country’s policy of trade restrictions may lead to similar measures taken by foreign governments, who may lose out in the international trade game because they can’t export products for a profit. This cuts down on economic efficiency and competition on a global scale.

    3.3.5 Instruments/tools of commercial policy

    The main instruments or tools which are now days used for achieving the objectives of commercial policy are as follows:

    (1) Tariffs or custom duties

    Tariffs or custom duties may be defined as a schedule of duties/taxes authorised by territorial government to be imposed upon a list of commodities that are exchanged. Tariffs are generally classified into three classes. (a)
    Transit duties, (b) Import duties, (c) Export duties.

    (a) Transit duties are those taxes which are levied upon merchandise passing through the country and consigned for another country. Transit duties are levied for raising money for the government.

    (b) Import duties are those taxes which are levied on the goods brought
    into the country. Import duties are chiefly levied for revenue or for protection purpose or for both.

    (c) Export duties are those taxes which are imposed on the merchandise
       sent out of the country. Export duties, like import duties, are also imposed for raising revenue and to     restrict the export of certain raw materials as a way of encouraging the development of domestic
    industries. Custom duties may be discriminatory with respect to commodities of
    countries or it may be non-discriminatory. When a country is pursuing a discriminatory tariff policy, it may give:

    (a) Preferential treatment by levying lesser custom duties upon the merchandise of some of the   countries. (Or);

    (b) Enter into an agreement with other countries for ensuring fair and equal treatment to the imports or exports of each member country.
    (c) Join a common market where the merchandise of member countries
        are allowed free entry but the goods of other countries are subjected to tariffs.

    (2) Bounties/subsidies on exports

    In order to promote the export of a particular industry or the export of specified commodities, a government sometimes gives bounties on exports. The bounties or subsidies may be direct or indirect. When subsidy is paid in cash from the public treasury, the bounty is said to be direct and when low
    freight rates are charged on the goods to be exported or they are exempted from taxes, etc., the bounty or subsidy is said to be indirect.

    (3) Direct restrictions on imports

    The government may totally prohibit the importation of certain commodities into the country with the intent of increasing foreign exchange or for protection of domestic industries or for discouraging the use of particular commodities because they are injurious to health. The government may
    regulate the imports by means of quotas. Under quota system, the maximumamount of a commodity which can be imported during a particular period is fixed by the government. In recent years, governments of most countries are employing the import quota system because:

    (i) It is very flexible and can be adjusted by the administrative authorities without resorting to legal action.

    (ii) The home producers know in advance the total quantity of goods to be imported during a particular period, so they can regulate their output accordingly.
    It arouses less resentment than the custom duties from the consumers.

    (4) Trade agreements

    The government of a country may enter into trade agreements with other countries for the exchange of goods. The trade agreements may be bilateral or multilateral. When two countries make a trade agreement for the exchange of goods, the agreement is said to be bilateral. When more
    than two countries enter into, trade agreement for ensuring fair and equal treatment to the imports and exports of the member countries, the agreement is called multilateral.

    (5) Beggar-my-neighbour policy

    This is an economic policy through which one country attempts to remedy its economic problems by means that tend to worsen the economic problems of other countries.

    (6) Economic integration

    This is the economic cooperation of countries in the same region so as to improve gains from trade among themselves.

    (7) Devaluation

    This is the legal reduction in the value of a county’s currency in respect to other countries’ currencies. This is done to increase the demand for exports as they become cheap and reduce that of imports since they become expensive.

    (8) Import substitution strategy

    This is where a country establishes domestic enterprises to produce most of her requirements at home and participate less in international trade. This is done with the intent of reducing import expenditure.

    (9) Foreign exchange control

    This is the regulation of inflow and outflow of foreign exchange e.g. by fixing the foreign exchange rate.

    (10) Basic infrastructure policy

    This involves expansion and improvement of domestic infrastructure to promote domestic production.

    Unit assessment

    1. (a) Distinguish between barriers and non-tariff barriers to trade.

    (b) Explain the various tools used to restrict international trade in your country.

    2. (a) Why do some countries adopt protectionism as an international trade policy?

    (b) Examine the problems that may arise from protectionist policies.

    3. (a) What is trade liberalisation?

     (b) Would you advocate for trade liberalisation, why?


    ཀྵཀྵ Anti-dumping duty: A tariff imposed to restrict the importation of goods that are below standard.    (dumping)

    ཀྵཀྵ Beggar-my-neighbour policy: This a policy adopted by a country to benefit its own economy but harmful to other economies e.g. import restriction, devaluation etc.

    ཀྵཀྵ Drawback: This occurs when a duty imposed on certain imports not destined for domestic consumption and subsequently exported, is refunded. This repayment of duty is what is called drawback.

    ཀྵཀྵ Effective tariff rate: A tax charged on any imported commodity expressed as a percentage of the value added by the exporting country.

    ཀྵཀྵ Export quota: The maximum amount of the product that may be exported in a given period of time.

    ཀྵཀྵ Free Trade: Trade in which goods can be exported or imported without any form of restrictions by the   state.

    ཀྵཀྵ Import quota: This refers to the maximum amount of the product that may be imported in a given period of time.

    ཀྵཀྵ Nominal rate of tariff: A tax charged on any commodity expressed as a percentage of the price of the commodity.

    ཀྵཀྵ Non-tariff barriers: Devices other than tariffs that are devised to reduce the flow of imports e.g. quotas, total ban, sanctions etc.

    ཀྵཀྵ Tariff war: This refers to the competitive use of tariff by countries to change the pattern of  international trade in an endeavor to gain individual advantage.

    ཀྵཀྵ Tariffs: These are taxes or duties imposed on goods imported or exported either for revenue purposes or for protection or both.

    ཀྵཀྵ Trade barriers: Any number of protectionist devices by which governments discourage imports. Tariffs and quotas are the most visible barriers, but in recent years, non-tariff barriers
    such as burdensome regulatory proceedings, have replaced more traditional measures.

    ཀྵཀྵ Protectionism: Advocacy of policies designed to protect domestic industries from foreign competition, usually in the form of tariffs, import quotas, or export subsidies.

    ཀྵཀྵ Quota: A quota is a legal restriction on the quantity of a good that may be imported or exported.

    Unit summary

    • Free trade

    • Meaning

    • Advantages and disadvantages

    • Trade protectionism

    • Meaning

    • Reasons for trade protectionism

    • Tools of trade protectionism

    • Dangers of trade protectionism

    • Commercial policy

    • Meaning

    • Objectives

    • Tools of commercial policy

    Unit2:Terms of TradeUnit4:Balance of Payment (BOP)