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Trade Barriers

How governments can protect domestic economies

What are Trade Barriers?

Trade barriers are legal measures put into place primarily to protect a nation’s home economy. They typically reduce the quantity of goods and services that can be produced and consumed in an economy. Such trade barriers take the form of tariffs or taxes and generally benefit governments, domestic producers, and national interests at the expense of consumers.

 

Trade Barriers

 

Why do trade barriers exist?

Trade barriers usually exist to protect domestic producers or to further political agendas. Other reasons for the implementation of trade tariffs and barriers include:

 

Anti-dumping provisions

The term “dumping” is used here to describe the way that foreign producers can “dump” their products onto the home market at much lower prices than what domestic producers offer. There are two possible reasons why a foreign producer may choose to dump their products into another economy. Firstly, it may just be the case that the goods can be produced at a significantly lower cost abroad due to lower input costs such as labor or raw materials compared to the home market. In such a case, the foreign company is still able to realize profits despite advertising lower prices than domestic producers.

Secondly, dumping can be a deliberate predatory move carried out by large multinationals to gain market share. Such large organizations are able to bear taking losses in the short-term due to their larger cash reserves and greater liquidity, compared to smaller players. The goal is to force competitors to shut down by driving the market price below what domestic producers can bear. Following the demise of home producers, the foreign entity will be able to adopt monopoly pricing and see its profits rise.

A prime example of this is in the oil industry, where OPEC is able to produce oil at a lower cost than other organizations, flooding the world market with cheap oil. The practice jeopardizes the profitability of competing oil suppliers, an effect that is compounded by OPEC’s ability to supply the market with large quantities of oil and drive the price down even further.

To prevent such events, governments can put in places trade tariffs that will raise the prices of dumped goods and protect domestic suppliers. Should the tactic not be aggressive enough, governments can impose sanctions against certain companies and ban them from doing business in the home country altogether.

 

National defense suppliers

Just like most developed industries, the defense sectors of many nations rely on a worldwide network of suppliers to build and maintain national defense mechanisms. However, it is important for nations not to become overly reliant on other nations when it comes to the supply of artillery, ammunition, planes, boats, etc. It is because, in the case of an international conflict, the supplying economy could easily cease to supply the enemy with national defense goods, thus jeopardizing the home nation’s ability to protect itself.

To prevent such situations, governments may place trade tariffs on foreign-made national defense systems in a bid to make them less attractive to domestic national defense providers. While the practice may force domestic suppliers to pay more for goods, it will prevent them from becoming overly reliant on foreign suppliers.

 

Trade Barriers

 

Early-stage industries

Industries that are still in their early stages are particularly vulnerable to dumping. While a certain industry may be very developed in a given nation, that same industry may just be starting up in newer economies. Such industries are comprised of much smaller players that cannot afford to compete on price with a foreign entity.

If the industry holds the promise of becoming a major economic contributor in the future, governments are incentivized to protect the industries by imposing trade tariffs on predatory foreign players. Conversely, governments can reactively subsidize the domestic market in order to allow them to compete on price.

 

More resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

  • Globalization
  • Gross National Product
  • Purchasing Power Parity
  • Supply and Demand

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