Free trade

Free trade occurs when there are no

artificial barriers put in place by
governments to restrict the flow of goods
and services between trading nations.
When trade barriers, such as tariffs and
subsidies are put in place, they protect
domestic producers from international
competition and redirect, rather than
create trade flows.

Advantages of free trade

Increased production
Free trade enables countries to specialise in the production of those
commodities in which they have acomparative advantage.
Production efficiencies
Free trade improves the efficiency of resource allocation.
Benefits to consumers
can now obtain a greater variety of goods and services.
Foreign exchange gains
Employment
Economic growth

Disadvantages of free trade

Structural unemployment may occur in the short
term.
A longer-lasting form of unemployment caused by
fundamental shifts in an economy. Structural unemployment
occurs for a number of reasons workers may lack the
requisite job skills
Increased
domestic
economic
instability
from
international trade cycles, as economies become
dependent on global markets.
Countries with surplus products may dump them on world
markets at below cost.

 Developing or new industries

may find it difficult to become
established in a competitive
environment.
Free trade can lead to pollution
and
other
environmental
problems

Protectionism

It represents any attempt to

imposerestrictions on tradein
goods and services.

 Tariffs
Quotas
Voluntary Export Restraint Arrangements where two
countries make an agreement to limit the volume of their exports
to one another over an agreed period of time.
Technical barriers to trade
Food safety and environmental standards
Preferential state procurement policies where a government
favour local/domestic producers when finalizing contracts for state
spending e.g. infrastructure projects
Export subsidies- a payment to encourage domestic production
by lowering their costs.

Arguments for
Protectionism
Fledging industry argument
Short-term protection allows the infant industry to
develop its comparative advantage at which point the
protection could be relaxed, leaving the industry to
trade freely on the international market.
Externalities and market failure: Protectionism can
also be used to internalize the social costs of de-merit
goods. Or to correct for environmental market failure in
the supply of certain imports.
Protection of jobsand improvement in thebalance
of payments

 Protection of strategic industries: The government

may also wish to protect employment in strategic
industries.
Political
argument:
One
common
political
argument for government intervention is that it is
necessary for protecting jobs and industries from unfair
foreign competition.
Anti-dumping duties: Dumping is a type of predatory
pricing behaviour and a form of price discrimination.
Goods are dumped when they are sold for export at less
than their normal value.

Arguments against
Protectionism
Higher prices for consumers.
Reduction in market access for producers.
Loss of economic welfare:Tariffs create a deadweight
loss of consumer and producer surplus. Welfare is
reduced through higher prices and restricted consumer
choice.
Regressive
effect
on
the
distribution
of
income:Higher prices that result from tariffs hit those on
lower incomes hardest.
Production inefficiencies

 Trade wars
There is the danger that one country imposing import
controls will lead to retaliatory action by another
leading to a decrease in the volume of world trade.
Negativemultiplier 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 injection of demand into the global circular flow of
income

 Second best approach:Protectionism is

a second best approach to correcting for
a countrys 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 be seen
as examples of government failure arising
from intervention in markets.

POLICY LAGS

Time lags that occur between the onset of an

economic problem and the full impact of the policy
intended to correct the problem.
Policy lags come in two broad categories--inside lag
(getting the policy activated) and outside lag (the
subsequent impact of the policy).
The three specific inside lags are recognition lag,
decision lag, and implementation lag.
The one specific outside lag is termed impact lag.

Policy lags can reduce the effectiveness of

business-cycle stabilization policies and can even
destabilize the economy.
Policy lags, especially inside lags, are often
different for monetary policy than for fiscal policy.
For example, should a business-cycle contraction
hit the economy on January 1st, stabilization
policy cannot correct the problem by January
2nd.

INSIDE LAG

Inside lag is the time it takes between the actual

onset of a problem and the launching of the
corrective action by government.
The wheels of government often spin slowly and
deliberately.
Three types of inside lag occur.

Before
any policy action
can be pursued, the existence of
RECOGNITION
LAG
the actual problem must be identified.
It takes time to collect and analyze economic data.
Unemployment and inflation data are usually available
only a month or so after the fact.
That is, the unemployment rate for January is usually
available in February.
Production and income data are reported quarterly and
have an even longer lag.
Gross production data for January, February, and March is
seldom available until May.

DECISION LAG

Once government policy makers have identified the

problem, they need to decide on a suitable course of
action, and then pass whatever legislation, laws, or
administrative rules are necessary.
For example, if a business-cycle contraction is identified,
Congress is likely to debate over an expansionary fiscal
policy use of increased government spending or decreased
taxes.
But will the spending go for purchases or transfer
payments? If it goes for purchases, then what types of
goods or services are purchased? If taxes are decreased,
which taxes are cut and who receives the extra income?
These decisions could take days, weeks, or months.

IMPLEMENTATION LAG

After a particular policy has been selected, steps then need to be

taken to implement the policy.
For any change in spending, the appropriate government agencies
need to be contacted.
More often than
appropriations.

not,

this

involves

change

in

budget

The affected agencies then need to actually make changes in their

spending.
The act of spending is not instantaneous.
Most agencies require competitive bids to identify product suppliers
before they can make the expenditures.

Inside lags are likely to take several months.

A best case scenario involves at least two months.
One month to recognize the problem and another
month to select and implement the appropriation
policy.
A more likely scenario is three to six months of
inside lags.

OUTSIDE LAG

The outside lag is the time it takes after a policy

is selected and implemented by appropriate
government entities, before it works its magic on
the economy.
Such magic is not instantaneous. The principal
outside lag is termed the impact lag.

IMPACT LAG

This lag is the time it takes any change initiated by a

government policy to impact the producers and
consumers in the economy.
A key part of the impact lag is the multiplier.
An initial change in government spending, taxes, the
money supply, interest rates must work through the
economy, triggering changes in production and income,
which induces changes in consumption, which causes
more changes in production and income, which induces
further changes in consumption.