MCQs and Answers

The main objective of the under developed countries is to have ac­celerated development through industrialisation, and for industrialisation the adoption of protective policies is essential. There are many reasons why an underdeveloped country wants to industrialise and hence calls for the adoption of protection.

(i) The economies of the underdeveloped countries are heavily dependent upon production and export of primary products. The cyclical fluctuations and swing in the balance of payments of the primary producing countries tend to be more marked than in manufacturing countries.

(ii) As per capita world income rises, its declining proportion is diverted to food and other raw materials. The underdeveloped countries which depend heavily upon the export of food and raw materials face a long-term deterioration in their terms of trade.

By creating demand for industrial products through protection, these countries can diversify their economies and thus avoid the effects of deterioration in their terms of trade.

(iii) Foreign trade has not proved an engine of growth for the underdeveloped countries. Trade of these countries has grown more slowly than that of the developed countries.

The factors like growth of synthetics, changes in the consumer tastes, and restrictive policies against the imports from the underdeveloped countries have forced these countries to concentrate on import substitution rather than export promotion. Protection may be used as a means to develop export industries.

(iv) Marginal productivity of labour being higher in manufacturing industry than in agriculture, a transfer of labour from agricultural sector to industrial sector will raise the marginal productivity in agriculture and average productivity in the economy as a whole as a whole.

Therefore, the underdeveloped countries need to be industrialised and protective measures should be adopted to achieve this aim.

An important argument for protection in underdeveloped countries is that the policy of protection can increase the saving ratio and capital accumulation in these countries. This is done in three ways:

(i) By imposing the tariffs, an underdeveloped country will improve its terms of trade and thus will make the foreigner pay the duty. In other words, for the same amount of the real resources embodied in the exports, the country will be able to get larger volume of imports.

(ii) Tariffs may be so designed as to attract direct foreign investment. In other words, tariff duties in the underdeveloped countries should aim at not only prohibiting the importation of the finished products, but encouraging the imports of necessary machinery and raw materials.

(iii) Saving ratio in the underdeveloped economies might be increased by imposing selective import restriction to reduce the consumption of certain commodities, such as imported luxuries.

The reduction in consumption of imports is equivalent to an increase in disposable income and this increase may be channeled in capital formation.

The following are the important forms or methods of protection which a country can adopt in its commercial policy. The selection of the method depends upon the purpose in hand.

1. Tariffs:

Tariff or import duty is a tax on imports. According to I. Walter, “A tariff is a charge levied on goods as they enter a country by crossing the nation customs frontier.” P.T. Ellsworth defines tariff as “a schedule of duties levied upon the importation of commodities into a given nation from abroad.”

A tariff is different from a transit duty which is imposed on commodities passing through country. Generally the aim of tariff is to reduce imports by raising their price.

Tariffs can be of three types:

(i) Special tariffs constitute a fixed monetary duty per unit of the imported commodity. For example, Rs. 30,000 per automobile may be charged as tariff on the imported automobiles.

(ii) Ad Valorem tariffs are levied as percentage of the total value of the commodity as it enters the country, including its cost and transportation charges. For example, 300% of the total value of the imported color T.V. may be charged as tariff.

(iii) Sliding scale tariffs are imposed in relation to the price of the commodity; when the price falls, tariff is reduced and when the price rises, tariff is increased. Sliding scale tariff may be specific i.e., according to the number of commodities) or ad valorem (i.e., according to the value of the commodity).

2. Import Quotas:

Import quota is a quantitative restriction on imports. It constitutes an absolute limit on the physical quantity or the value of goods and services that may be imported over a given period of time, say, a year or a month.

Import quotas aim at controlling and regulating imports to protect the home industries from foreign competition and to remove disequilibrium in the balance of payments. While tariffs indirectly reduce imports, quotas have direct and physical control on imports.

Import quotas are of different types:

(i) Tariff quotas:

Under the tariff quota system, a fixed quantity of a commodity is allowed to be imported free or on a low duty. But, when the imports exceed this limit, higher import duties are charged. Thus, tariff quotas combine both the tariff and quota systems.

(ii) Unilateral Quotas:

Unilateral quota is fixed unilaterally without taking the exporting countries in confidence; an absolute limit is autonomously fixed on commodities imported. Unilateral quotas may be global or allocative. (a) Under the global or non-discriminatory quota system, the permitted quantities can be imported from any country of the world, (b) Under the allocative or selective or discriminatory quota system, the permitted quantities can be imported from a particular country or group of countries.

(iii) Bilateral Quotas:

Under this system, quotas are fixed after entering into bilateral agreements with the exporting countries. Bilateral quotas are also called agreed quotas.

(iv) Mixed Quotas:

Under this system, the domestic producers are asked to use a minimum proportion of domestic inputs along with the imported inputs. Protection is thus provided not only to the domestic producers, but also to the domestic suppliers of inputs.

(v) License Quotas:

Under this system, licenses are also issued to the importers along with fixation of quotas. The authorities give licenses to limit the permitted quantities to be imported by a few selected importers. The licenses may be issued either on the basis of ‘first come first served’ or on the fulfillment of some import requirements.

3. Import Restrictions:

Various forms of restrictions on imports are also used to reduce imports and encourage domestic production, (a) Sometimes import of certain commodities is prohibited by law to protect the home industries, (b) A country may refuse to permit the importation of vegetables, flowers, meats, etc., on the health grounds, (c) A country may instruct the customs officials to check every item and ensure the correctness of the commodities. The delays and damage to goods caused by such regulations may reduce imports.

4. Exchange Control:

Exchange control, i.e., controlling and rationing foreign exchange, is also used as a protective method. Under the exchange control system, the government has full control over the foreign exchange resources and foreign exchange business of the country.

The importers are allotted foreign exchange at the official rates and according to set priorities to enable them to make payments for the imported goods. In this way, through effective exchange control, the volume of imports can be reduced.

5. Discrimination:

Discrimination refers to the system of (a) differing tariffs or quotes on imports of goods; or (b) differing exchange control practices; or (c) multiple exchange rates applied to different countries.

Thus, under this system, preferential treatment is given to certain countries and commodities against others by making discrimination in trade and exchange controls. Such discriminatory arrangements reduce international trade, create trade blocks and lead to retaliation.

6. Subsidies:

Subsidy is a financial help given by the government to the domestic producers to make them more competitive in the international markets. When the cost of production of the domestic producers is very high and they cannot face the foreign competition, the government can help them in the form of cash incentives, tax concessions, making up the loss, etc.

Subsidies do not restrict imports directly, but indirectly discourage them. They reduce the domestic prices, increase demand for domestic goods and thus reduce imports. Subsidies also have favourable effect on domestic income and employment.

7. State Trading:

Under the system of state trading, the government gets control over the entire foreign trade in its own hands. In this way it becomes easier for the government to regulate foreign trade according to the requirements of the country.

The government may employ the method of state trading (a) to import only the socially necessary goods and to check the non-essential imports; (b) to secure favourable terms from the foreign exporters and to utilise the gains from international trade for public welfare; and (c) to promote the exports of the country.

8. Devaluation:

The policy of devaluation, i.e., lowering the value of the home currency in terms of foreign currency, maybe adopted as a method of protection. Devaluation reduces imports by making them dearer and encourages exports by making them cheaper.

9. Boycott of Foreign Goods:

The imported goods may be boycotted within the country by arousing the spirit of nationalism among the people. This provides natural protection the domestic industries.

A tariff is a tax on imports. The economic significance of a tariff is that (a) tariff causes the domestic price of the imported goods exceed its foreign price, or, in other words, the price a domestic purchaser pays for an imported good exceeds the amount the foreign exporter receives by the tariff payment; and (b) tariff causes the domestic relative price of imports in terms of exports to exceed the foreign relative price or terms of trade.

All other economic effects of tariff follow from these basic facts about tariffs. These facts are further classified below:

(i) If the tariff is a specific tariff, i.e., a fixed duty imposed on each unit of imported good, then the domestic price of the imported good (Q_m) is equal to foreign price (P_m) plus specific tariff (t_a)

(ii) If the tariff is a ad valorem tariff, i.e., the tax levied as a percentage of the price of the imported good, then the domestic price of the imported good (Q_m) consists of the price paid to the foreigner (p_m) plus the ad valorem tariff rate (t_a).

The application of the theory of comparative advantage explains that tariffs are inefficient for the world as a whole. They cause the production and consumption levels of the world as a whole to fall.

1. Effect on World Production:

Tariff causes the domestic relative price of imports in terms of exports (q) to exceed the foreign relative price (p). The fact q > p means that the marginal rate of transformation of exportables for importables (MRT_xm) is greater at home.

In other words, more exports must be sacrificed to produce one more importable at home than abroad. This further implies that the world can produce more of either of both goods if (a) the home country shifts its resources from producing importable; (b) the rest of the world does the opposite; and (c) international trade increases.

2. Effect on World Consumption:

Tariff causes the domestic relative price of imports in terms of exports to exceed the foreign relative price (i.e., q>p). This means that the marginal rate of substitution of exports (MRS_xm) of each domestic consumer exceeds marginal rate of substitution of exports for imports of each foreign consumer.

In other words, each domestic consumer is willing to sacrifice more of exports to obtain one more import than each foreign consumer would require to supply it. Thus, the consumers in both the countries can be made to increase their consumption levels by trading more.

The conclusion that tariffs are inefficient for the world as a whole does not mean that it is not beneficial to the imposing country.

The truth is that the tariff imposing country receives both favourable and unfavourable effects through the imposition of a tariff and it is also likely that the favourable effects outweigh the unfavourable effects.

But, the important implication of overall harmful effect of tariff on the world economy is that if a country gains from a tariff, it is at the expense of the rest of the world.