(2013) A Level H2 Econs Paper 2 Essay Q6

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6. On 14 October 2011 Premier Wen Jiabao of China called for joint international efforts to combat rising trade protectionism, which he said was damaging the world economy amid on-going global economic turbulence.

Source: China Daily, 15 October 2011

Discuss whether the use of protectionist policies can ever be justified during a period of worldwide economic recession or whether governments should follow Premier Wen’s advice and adopt a policy of greater free trade. [25]

Why use of protectionist policies can be justified during a period of worldwide economic recession

Increase home employment

1. In times of recession, there may be massive unemployment as a result of the fall in demand.

2. Government could take action to protect industries through the provision of subsidies, so that exports can remain competitively priced → increase in (X-M) → increase in AD → increase real NY → higher economic growth → firms hire more factor inputs such as labour to produce the higher level of output → lower unemployment

Why use of protectionist policies cannot be justified during a period of worldwide economic recession

Retaliation

1. When countries allow / implement protectionism policies (think that protectionist policies are ‘ok’), they may end up affecting their trading partners who may suffer from lower export sales.

2. Their trading partners may take steps to protect their own industries and in this sense ‘retaliate’ by imposing protectionists policies of their own  This will now affect the country since exports now lose competitiveness as they are more ‘expensive’ in the other countries due to protectionists measures, such as tariffs, being imposed.

3. A trade war such as that between US-China occuring from 2018 - 2022 could occur, affecting both countries negatively

Beggar-thy-neighbour

1. When a country imposes protectionist measures, it affects the demand for the trading partner’s exports. Trading partner will experience a fall in (X – M) → fall in AD → fall in RNY (via k process)

2. A fall in incomes implies a decrease in purchasing power → trading partner will buy lesser imports from the country

Increased cost of production

1. Countries may be importing intermediate inputs and raw materials from other countries, which are cheaper.

2. The imposition of protectionists policies against trading partners, will increase the costs of local producers importing such input  COP increases for local producers. Export competitiveness may fall as a result → fall in (X – M).

3. Local consumers will also experience a fall in SOL as they are able to buy less, given the higher prices.

Should governments follow Premier Wen’s advice and adopt a policy of greater free trade

Explain the theory of comparative advantage

1. The theory of comparative advantage suggests that countries should specialise in goods that they have a comparative advantage in, export these goods & import goods that they do not have a comparative advantage in

2. By doing so, both countries will be able to consume beyond their Production Possibility curve and benefit from trading

3. Thus, the theory of comparative advantage suggests that free trade is beneficial for countries and governments should follow Premier Wen’s advice

The below numerical illustration shows the benefits of free trade & specialisation

A country such as the USA would have absolute advantage in the production of most goods as compared to Vietnam due to higher technology and better quality of work force. However, the theory of comparative advantage states that countries can still benefit from trade and specialisation even though one country may have absolute advantage in all goods, which in this situation, appears to be the case for the USA.

Given that countries have different factor endowments, their respective opportunity costs differ. Vietnam with relatively more labour resources would have comparative advantage in labour intensive goods such as textiles. World output can increase, and countries can enjoy a higher consumption of all goods by exporting goods they have a comparative advantage in and importing goods they have a comparative disadvantage in. This can be illustrated with the use of numerical examples.

Given that 2 units of resources are divided equally between textiles and car production, USA can produce 100 units of textiles and 50 units of cars, while Vietnam can produce 80 units of textiles and 10 units of cars. The total production of textile and cars are 180 units and 60 units respectively.

Even though US has absolute advantage in production of both textiles and cars, it only has comparative advantage in the production of cars, since its opportunity cost of producing 1 unit of car is 2 units of textiles which is lower than that of Vietnam with 8 units of textiles. Conversely, Vietnam has a comparative advantage in the production of textiles. Thus, US should specialise in the production of cars and Vietnam in textiles. However, it should be noted that the country with absolute advantage in both goods should partially specialise and not fully, for output to increase.

Hence, if US puts 0.3 unit of resources to textile and 1.7 unit to car production, and Vietnam allocates all 2 units to the production of textile, US will produce 30 units of textiles and 85 units of cars while Vietnam can produce 160 units of textiles. This will increase total output of textiles and cars to 190 and 85 respectively. Thus, world output of both rises after specialisation.

To benefit from specialisation, countries must trade, and will only benefit from trade if the Terms of Trade (TOT) lies between the 2 countries’ domestic opportunity costs. In this case, terms of trade of 1 car should be between 2-8 units of textiles. Thus if TOT is 1 unit of car to 5 units of textiles, US will benefit because it can now get 5 textiles in return for 1 car, which is higher than the 2 textiles it could get before trade because its opportunity cost was 1 car to 2 textiles. Vietnam will also benefit because it only needs to sell 5 units of textiles to get 1 unit of car now, since it needed to give up 8 units of textiles to produce 1 car before trade.

Therefore, with trade, both US and Vietnam are now able to enjoy higher consumption of the goods.

Specialisation and trade enable countries to consume beyond its Production Possibility Curve (PPC), thus increasing standard of living.

Strategic reasons (food, military security)

1. Yet, beyond the theory of comparative advantage, there are compelling reasons for countries not to fully encourage free trade

2. There are specific industries that a government may consider protecting and developing domestic industries for

3. Food security would be a reason why a country may opt to protect domestic industries to boost production in order to ensure that a country produces a minimum level of agricultural goods for self-sufficiency.

A similar case may be made for military goods such as arms and ammunition

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