Background Paper 16 1996-97 Free Trade or Protectionism?: Australia's History and the Arguments For and Against


Index
Tas Luttrell
Foreign Affairs, Defence and Trade Group
24 June 1997

Contents

Major Issues Summary

Introduction

The Australian Experience

A Retreat From Free Trade?

Methods of Protection

Structural Adjustment

Effects of a Tariff

Arguments in Favour of Protection

Protection against Cheap Foreign Labour
National Defence
Preservation of Particular Classes or Occupations in the Population
The 'Optimum Tariff' Argument
Infant Industries
Real Wages and Immigration
Protection of Employment
Balance of Payments
A More Balanced and Self-Sufficient Economy
Other Arguments

Arguments Against Protection

Protection Taxes Exporters
Net Loss of Income
Loss of Employment
Reducing Protection Improves Productivity
Greater Opportunities for Exports of Goods and Services

Conclusion

Endnotes

Appendix 1: Restraints on Trade

Major Issues Summary

The question of whether Australia should continue its program of trade liberalisation is once again under close scrutiny. Yet most industries in Australia now have minimal levels of tariff protection. Of the two remaining industry groups with substantial tariff protection, one, the Automotive Industry, has recently been reviewed by the Government and the other, Textiles, Clothing and Footwear, is about to be reviewed. The political attention given to the outcomes of these two inquiries shows that they have taken on an importance which goes beyond the economic significance of the industries, substantial as that is.

In reality, apart from the two industry groups just mentioned, the argument about changes in tariff protection concerns variations of a few per cent in tariff levels over a period of several years. Variations in the value of the Australian dollar are likely to have greater effect on the financial planning of industry over this period.

The debate on trade liberalisation, in many cases, has become a focus for issues arising in other areas of national policy. Continuing high levels of unemployment have placed both expectations of solution and accusations of blame, on what is seen as a result of trade policy. In fact, a whole range of other issues are involved, such as the social effects of structural adjustment. Important as they are, detailed examination of these issues are beyond the scope of this paper. Whatever the policy decisions in those areas might be, Australia has a continuing responsibility to make trade policy decisions consistent with its international commitments.

Australia has made a commitment in the Asia Pacific Economic Co-operation group (APEC), to establish a regime of free trade and investment by 2010. The decisions on protection levels for the Automotive and TCF industry groups will be read against that commitment and the other APEC members will be concerned at any indication that Australia's resolve to continue trade liberalisation is weakening.

Two main themes in the debate have been the speed of Australia's liberalisation process and the proposal that before proceeding with its own liberalisation program Australia should wait to see evidence of reciprocal concessions from its trading partners.

In the argument over the relative benefits for Australia from a liberalised trade regime by comparison with a protective regime, the balance of opinion is strongly in favour of continued liberalisation. In addition, the world trade scene has changed so much and the globalisation of industry has proceeded so far that it would not be practicable to 'turn back the clock' and return to reliance on protection.

The consensus of opinion therefore suggests that Australia should proceed with liberalisation. The timing is not subject to any outside pressure other than the commitment to 2010 but there are advantages to be gained in increased efficiency and progress in restructuring the economy, which suggest that the process should not be slowed unduly.

Australia's export industries carry the main burden of protection as they cannot pass on their increased costs. It is these industries which are growing strongly as tariff levels fall; this is particularly true of products which have undergone substantial manufacturing processes (the so-called 'elaborately transformed manufactures').

The call for reciprocity is emotive rather than economic. In terms of its overall output and income, Australia will be better off even if it liberalises alone. The question is how that wealth will be distributed. That problem has been at the core of the protection/trade liberalisation debate for many years.

Australia's major challenge today is to produce an assistance package which will:

  • not interfere with the trade liberalisation process;
  • address the unemployment problem;
  • minimise the disruption to industry in the transition period; and
  • most importantly, assist those people who have been disadvantaged by economic change and especially those with particular employment disabilities.

It is essential for Australia's reputation and leadership in groups such as APEC, the Cairns Group and its commitments in the World Trade Organization, that its policies demonstrate a continued commitment to trade liberalisation.

Introduction

Each generation has the tendency to consider its problems unique. In the debate on tariff protection, however, there is little that is new. The following comment from the Tariff Board in 1931-32 reveals that while the personnel may have changed, the problems and arguments remain the same:

The Board has constantly had in mind that the prevailing very serious unemployment is bad for the financial, physical and moral condition of the community, and in all its deliberations has regarded it of vital importance that remunerative work should be found for the people. Nevertheless, the imposition of high rates of duty for the benefit of one industry, resulting in seriously higher costs to other secondary or to primary industries, may cause some additional employment in the one, but resultant unemployment in the others. The maximum employment of our people is largely dependent upon the successful expansion of our export industries... The establishment of new industries or the extension of existing industries which need the application of excessive rates of duty tend to add to costs and retard progress and employment.(1)

Since colonial times Australian governments have wrestled with the question of the level and form of industry assistance. This is often characterised as free trade versus protectionism. In the nineteenth century, duties were mainly applied for revenue purposes although protectionist sentiments were present. After Federation, and for most of this century, the proponents of protection held sway but in the last fifteen to twenty years the world trading scene has altered dramatically and the tide of change is now flowing very strongly in the direction of trade liberalisation.

The long debate in Australia over tariff protection is as much a political issue as an economic one. While this paper is confined mainly to the economic aspects, it acknowledges the importance of the political side of the discussion. The paper notes the need for government policy to take particular account of what could be called the 'social costs' of reductions in tariff protection-labour market problems, housing, schools, the general disruption of the lives of people whose work prospects are affected.

A major part of this paper recounts the process by which tariff policy in Australia changed from the wide-ranging protection of industry under McEwen to the Keating Government's promise to achieve a free trade regime by 2010.

As part of this process of change, Australia is in the process of restructuring its industrial base and reducing or eliminating the protective walls which had been built around the manufacturing sector in the period up to the 1970s.

There has been a vigorous, sometimes acrimonious, debate about the merits of the liberalisation process and the pace of reform, which has been revitalised by the recent decision on protection for the passenger motor vehicle industry post-2000 and the impending decision on protection for the textiles, clothing and footwear industries.

An important issue in recent months has been an apparent weakening of the resolve to continue Australia's trade liberalisation. All of the major parties have made statements which indicate less certainty than before about the completion of the APEC program. The recent debate and final decision on protection for the Automotive Industry has highlighted the changed thinking in this area of policy.

The paper reviews arguments in support of tariff protection, with the greatest emphasis on the reasons which have been used in the Australian debate. Those arguments are balanced by a review of the arguments in favour of free trade (or, at least, trade liberalisation).

World wide the arguments for and against tariff protection have taken on a new urgency and importance in recent years. This has occurred because of the major changes in protective regimes, particularly tariffs, brought about through the activities of the General Agreement on Tariffs and Trade and its successor the World Trade Organization (WTO) and the agreements reached within the Asia Pacific Economic Co-operation conference (APEC), the European Union and other regional trading groups.

The changes have sprung from a widespread belief among economists and policy makers that trade liberalisation benefits countries individually and the world economy as a whole. From the perspective of policy makers there is no doubt that free trade in the rest of the world is a good thing. The major problem remaining, and the reason protectionism has flourished for so long, is that although free trade is believed to offer overall benefits, it can be detrimental at least in the short term to some sectors and individuals in a society. Lowering of protection therefore has domestic consequences which may be considered more important than the purely economic benefit. Since protection offers financial advantages to a protected sector there is also an understandable reluctance by such sectors to see any reduction of that advantage.

Trade liberalisation, the reduction or elimination of barriers to trade, brings with it the necessity for structural adjustment in the economy. Even in an economy which begins with low tariffs and few non-tariff barriers, some structural changes will be necessary, albeit small. For an economy like Australia which began the process with some parts of its economy highly protected, the problem assumes much greater dimensions, although many of the problems can be ameliorated in a rapidly growing economy.

One of the problems still facing the world community, and of great importance to Australia, is the search for an equitable and effective method of dealing with the negative effects of structural adjustment brought about by economic change, including trade liberalisation. So far international negotiations have been focussed on the immense task of removing or reducing trade barriers. Except for the special effort to give development assistance to developing countries, international bodies have mainly left the task of dealing with structural adjustment to individual governments. Realistically, of course, this is an area where governments will be loath to allow international involvement to any great extent and it will remain a national problem (the European Union being an exception).

The paper also reviews briefly the methods of protection which are commonly used and offers comments on the costs involved in the alternate policies of protection and trade liberalisation. It notes the need to address the social costs of policy decisions and concludes with a comment regarding the effect that a weakening of Australia's resolve on trade liberalisation could have on its international image and influence.

The Australian Experience

Australia's economy began the 1960s with a highly protected industrial sector secure behind a double wall of high tariffs and import licensing.(2) The first crack in that wall was the removal of import licensing from all but a few products in February 1960. This was followed during the 1960s by a radical change in the thinking of the Tariff Board.

Until the appointment of G.A. Rattigan as Chairman of the Tariff Board, the tariff making process had broadly complied with the views of the then Minister for Trade, John McEwen. McEwen was a staunch supporter of tariff protection for industry and, strangely for a Country Party Minister, was seen 'by manufacturers as their voice in Government'.(3)

'McEwenism' was based on the idea of 'all-around protection'. He envisaged a system of assistance to all producers, rural and manufacturing, in the form of subsidies, tariffs, bounties and tax concessions. The McEwen policy on tariff protection- 'The maintenance of full tariff protection which increases Australian prices substantially above those elsewhere, only while the protected industry operates efficiently and in particular establishes export markets',- was only acceptable to the rural sector because it was balanced by a rural policy based on 'policies of compensation designed to offset the added costs of export industries from tariff protection.'(4)

Under Rattigan, the Tariff Board changed its approach and developed an independent viewpoint, which differed considerably from McEwenism. Encouragement came from the Vernon Committee Report in 1965 which questioned the basic approach to tariff making in Australia when it said:

... we are satisfied that there is no case for the indiscriminate application of tariff protection... The Board should ... consider whether particular tariffs are likely to hamper the economic operation of other industries to such an extent that disadvantages outweigh any gain from them.(5)

Although the Government of the day did not implement the bulk of the Vernon Committee recommendations, the Tariff Board employed some of the principles set out by the Committee in its approach to tariff protection. In 1967 the changed thinking in the Tariff Board was reflected in a policy statement by Rattigan which criticised the ad hoc approach of previous years, as described in the 1958-59 Annual Report of the Tariff Board under the chairmanship of Alan Westerman. This criticism also directly challenged McEwen because the latter had extensively quoted from that Annual Report in March 1967.

The essence of Rattigan's approach was to take an economy-wide approach to tariff setting in an effort to minimise misallocation of resources. The Vernon Committee's proposal for a central 'benchmark' tariff level was refined into a three tiered structure designed to indicate high (50 per cent), moderate (25-50 per cent) or low (below 25 per cent) protection.(6)

The Board's Annual Reports in 1966-67 and 1967-68 expanded on the new approach with discussion on the use of effective rates of protection in assessing tariff levels (i.e. rates which take into account any duties applicable to a product's imported inputs). Effective rates would be used to determine where an industry stood in the three tiered structure envisaged by the Board.

In its 1968-69 Annual Report, the Board suggested that individual industries should be examined in a sequence based on the existing levels of protection and beginning with the more highly protected industries. The main purposes of the review were to clarify the meaning of the terms 'economic and efficient' in the context of industry protection, to establish a methodology for determining which industries should be considered high cost by Australian standards, and to establish the conditions under which the Board would regard activities as economic or uneconomic. The report noted that industries requiring a high level of protection would need to produce 'greater offsetting benefits' to generate equivalent levels of real wealth to those needing less protection.(7)

In January 1971 the Government announced a long-term review of the tariff in response to the Tariff Board's urging. The then Minister for Trade and Industry, Doug Anthony, in elaborating on that decision in April 1971 broadly accepted the Board's proposed methodology. The Minister restated the Government's attitude to protection and its view of the Government/Tariff Board relationship:

The Tariff Board is an advisory body and has never been anything else. The decisions and the responsibility rest with the Government... It believes that reasonable and adequate protection should be given to worthwhile industries, taking into account all relevant considerations... the economic worth of an industry to the nation requires a judgement on whether the benefits derived by the community from the existence of that industry outweigh or otherwise the costs to the community of providing adequate protection to it. More generally, the maintenance of a competitive industrial structure is of central importance to the Government both for promoting sound economic growth and for the most efficient use of the nation's resources.(8)

In 1972, the Government referred to the Tariff Board the so-called 1000 Items reference, which was a very broad reference asking the Board to examine protective levels on tariff items across a range of industry groups. This was to both provide information for the forthcoming Multilateral Trade Negotiations and also to identify areas of excess protection.(9)

The transformation of the Tariff board into the Industries Assistance Commission was a significant change in the tariff-fixing process. The Commission was made responsible to Prime Minister Whitlam, a move designed to make it more difficult for governments to limit or bypass its advice. The three main reasons given for the creation of the Commission were:

  • improving the allocation of resources;
  • because of its independence it could be expected to provide disinterested advice; and
  • to facilitate public scrutiny of government policies.(10)

Then, in July 1973, the Whitlam Government took the unusual step of introducing an overall 25 per cent cut in tariff levels. The reasons given for this step were:

The justification... is the excessive level of inflation which now prevails... Inflation can be offset by an increase of supply of goods in Australia. The most readily available source of supply of goods is imports from overseas. Whilst it is expected that imports will increase in the next few months, because of the high level of tariffs the increase would be insufficient to help combat inflation. Consequently the Government has decided to reduce tariffs so that imports may increase in the short term to help meet inflationary pressures in Australia...

The increased imports may affect production and employment in Australia. A tribunal is being established to immediately hear appeals from any firm or company which may be seriously affected by imports...

The decision represents a major step towards implementing the Government's objective of support for moves to liberalise international trade-moves which in the long term can only strengthen the economies of the trading countries of the world...(11)

In the decade from 1974 to 1983, tariff levels continued to fall in many industries as the tariff review proceeded. However, the period also saw the reappearance of import quotas and an increased use of anti-dumping duties. An assessment by the Industries Assistance Commission, the successor to the Tariff Board, in its Annual Report for 1984-85 noted that although tariffs had fallen by about 40 per cent on average, this had been achieved by removing or decreasing protection for lightly protected industries, while increasing protection for heavily protected industries through the use of non-tariff measures.

The Treasurer's Economic Statement of 25 May 1988 announced that as part of the program of general reductions in protection, tariff rates would be reduced to standardised levels for all industries except textiles, clothing and footwear (TCF), motor vehicles and some industries where tariff levels were already phasing down. The program was to phase ad valorem tariffs (i.e. those based on a percentage of the value of the product-see Appendix 1), or their specific rate equivalents, which were then above 15 per cent, down to 15 per cent. Similarly, rates of 15 per cent or less but above 10 per cent would phase to 10 per cent. The reductions were planned in five steps from 1 July 1988 to 1 July 1992, with a minimum annual reduction of 1 per cent.(12)

As the 1988 reduction program neared its end a further plan was announced on 12 March 1991, in the 'Building a Competitive Australia' statement. All general tariff rates of 15 or 10 per cent would be phased down over four years to reach a single rate of 5 per cent in 1996. For motor vehicles, duty rates would be phased down from 35 per cent to 15 per cent by 2000. Similarly, for TCF products tariff rates were to phase down to a maximum of 25 per cent by 2000; quotas would be removed two years early, in 1993, and bounties would be abolished in 1995, to be replaced where appropriate by tariffs.(13)

A Retreat From Free Trade?

In contrast to earlier decades, Australia has joined other countries in promoting liberalised world trade. In agriculture it has been a leader, it was Australia's initiative which led to the establishment of the Cairns Group in 1986, during the Uruguay Round negotiations. The initiative sprang from Australia's concern that agriculture would once again be left out of consideration in the GATT multilateral trade talks as it had been in earlier GATT rounds.

Australia had continuing concerns about the effects of the European Union's subsidisation of agricultural products and America's efforts to combat that policy with retaliatory export subsidies (which often seemed to hurt the non-subsidising agricultural exporters more than the EC). These problems, when added to concern over Japan's barriers to agricultural imports, led Australia to propose a joint lobbying effort by countries which were being disadvantaged by these policies.

Although Australia was involved in all of the GATT Multilateral Tariff Negotiation Rounds, the key tariff decisions were taken outside those talks. Even the Uruguay Round which ended in 1994 had been pre-empted by Australia's unilateral tariff reductions which had in most cases already reached tariff levels below the levels bound in the GATT/WTO negotiations. Australia's promise in APEC, for free trade and investment by 2010, while not legally binding as are GATT/WTO Agreements, is nevertheless a public government commitment. Failing to live up to that commitment would damage Australia's international credibility and weaken its standing, e.g. as a prime mover in APEC and a leader of the Cairns Group of agricultural fair traders.

Australia was also a major force in establishing the APEC group. At Heads of Government and Ministerial meetings of the group Australia has continued to encourage APEC towards the ultimate target of free trade.

The concessions and commitments offered in APEC are offered unilaterally. There is no formal bargaining process as in WTO negotiations and no formal balancing of offers (at least until free trade is reached). The unique features of APEC (compared for example with the GATT/WTO arrangements) have been the lack of a large bureaucratic structure, the lack of formal and enforceable agreements and the absence of a dispute settlement mechanism. The basic principles are open regionalism and concerted unilateralism. Agreement has been reached, with strong pressure from Australia, that liberalisation should be comprehensive, i.e. no exclusions.

APEC has already achieved more than many of its detractors considered likely. Those achievements are demonstrated by the wide ranging offers in Individual Action Plans presented by each member at the meeting in the Philippines last year.

Consequently, Prime Minister Howard's introduction of the idea of reciprocity into discussions on APEC was surprising and considered by many to be a disturbing development. The press release announcing the Government's decision on the Productivity Commission Report on the Automotive Industry stated that: 'There will be a review in 2005 which will take account of our APEC commitments and progress on market access.'(14)

This followed an earlier comment in a speech to the Metal Trades Industry Association, Annual National Dinner on 21 October 1996, when Mr Howard said:

... I think industry is entitled to say well, we have done our part, we have borne the brunt of reduced protection, but have we seen sufficient matching of that reduced protection in the area of reduced business costs and in the area of reciprocation from our trading partners. I think most people would have to acknowledge that the answer is probably no to both those questions... I can understand the desire of Australian industry to say to Government: "Well, we have engaged in a lot of give-ups, we'd like a few give-ups in return". And I want to say to all of you tonight that I do understand that.

The ALP response to the debate over motor vehicle policy since March 1997, has been equally surprising. The Whitlam and Keating Labor Governments had overseen a dramatic reduction in Australia's protection levels, culminating in Keating's agreement at APEC in 1994 to eliminate tariff barriers by 2010. In Opposition, Labor has taken a different position. Recent statements appear to show an intention to delay the reduction in tariffs on motor vehicles and review the situation in 2004:

...and start to use any particular movement as bargaining coin, in terms of lowering other people's barriers against ourselves.(15)

The Australian Democrats have called for a different approach to Australia's tariff system:

Democrats believe that any future tariff cuts should be directly linked with those undertaken by other countries... the Australian Government should be producing reports which compare Australia's tariff levels with those of its trading competitors.(16)

The Australian Democrats have called for an immediate stop to tariff cuts, arguing that their retention will save $A2 billion for use in export manufacturing and service industries; they say that Australia has already satisfied its World Trade Organization obligations; they claim 200,000 Australians are without a job because of reductions...(17)

The Greens have also shown deep suspicion of Australia's international trade commitments, particularly the World Trade Organization (WTO). They propose greater self-reliance and less trade dependency for Australia and have expressed concern at the job losses which they blame upon the WTO Agreements. The policy of the just formed One Nation party goes even further, with Ms Hanson quoted in the press recently as saying that her party would restore tariff protection if necessary to revitalise Australian industry.(18)

On 5 June 1997, the Government announced that tariff rates for passenger motor vehicles will be frozen at 15 per cent from 2000 to 2004 and will then be reduced to 10 per cent on 1 January 2005. A review will be carried out in 2005 which will take account of APEC commitments and progress on market access. In an article on the Government's decision in the Australian newspaper Paul Kelly commented:

It is one thing to point to Indonesia's or Malaysia's high tariffs. But it is folly to use this as an argument against our own liberalisation... Such thinking merely weakens ourselves, a point Bob Hawke understood when he declared in 1985: 'We have to break loose from the notion, inherent in the negotiation framework, that one's own trade liberalisation is a concession granted to others.'(19)

The suggestion that future steps in the liberalisation process might be tied to reciprocal arrangements, threatens to undermine the very features which have made APEC different from other multilateral and regional forums. It is the absence of legalistic and confrontational bargaining which has allowed APEC to proceed so quickly-if these unique features are removed, APEC would lose its dynamism and become nothing more than a poor cousin to the WTO.

Methods of Protection

Import-competing industries can be assisted by import restrictions, which require no budgetary outlays and are less open to public scrutiny than the use of direct subsidies. The benefits provided to producers by quotas particularly are difficult to quantify and do not come under annual budget scrutiny-consequently, there is less criticism from taxpayers and consumers. If a tariff is used or quotas are sold there is also the side benefit of additional revenue raised. Appendix 1 lists the common types of protective measures, divided into the two main groups: tariffs and non-tariff barriers.

It has been a worrying trend in world trade in recent years that as tariff levels drop and quotas are removed, governments have turned to other ways to restrict import competition.(20) Criticisms have been levelled at a number of countries in the WTO for such things as the way quarantine legislation is applied, their use of anti-dumping controls or the application of standards legislation.

An industry whose international competitiveness is declining has an inclination to seek steadily increasing protection. The level of protection, however, is only one of a variety of changes which could be affecting that industry. The effects of technical change, for example, are generally more important than the reduction of trade barriers. In a situation where changes are occurring, it is better to facilitate change than to resist it.

Structural Adjustment

The issue of structural adjustment is a continuing one for any economy. Industries will not grow evenly and demand for different goods will also grow at varying rates, influenced by changes in income and spending patterns. This is a normal feature of the growth process. The International Labour Office commented:

Structural change is an integral part of the process of economic growth; indeed, absence of such alteration in the organisation of economic activity is evidence that development is not taking place.(21)

In addition to its own internal pressures for change, an economy is also subject to external pressures such as new products or production methods, new resource discoveries, immigration, capital inflows or new competitors. Relevant changes in the economic environment, of course, can originate from either domestic or foreign government policy. Changes in government policy, of course, can occur either at home or overseas. Structural change brought about by economic growth can be offset by these other factors, particularly government intervention, and this can reduce growth rates below their potential.(22)

Australia's efforts to compensate companies and individuals affected by structural change have not been particularly successful. One comment about the policies introduced in the 1970s indicated that:

...[the] practical effect was to subsidise firms in regional centres to continue production and maintain employment, rather than encourage restructuring.(23)

The Study Group on Structural Adjustment, chaired by Sir John Crawford, reported to the Government in 1979 that: '... the Australian economy has been able to absorb substantial adjustment with little associated unemployment.'(24) Predictably, the group found that: 'Adjustment problems are more likely to occur when the size of industries shows an absolute decline or when changes occur during periods of high unemployment.'(25) the group also suggested, however, that:

...any general program of tariff reductions should not be implemented while unemployment stays above, say, five per cent.(26)

This, unfortunately, is the position in which Australia finds itself now. Unemployment is high, economic activity is sluggish, and there is strong pressure for the structure of industry to change to deal with the new international trade situation.

The challenge is to establish a program of assistance which actually does what its name implies, i.e. to assist people placed in difficulty by economic change, whether the changes are in tariff protection or not. Clearly, the first step must be to tackle the unemployment problem-success in structural adjustment is unlikely if displaced workers have nowhere to go and if labour market programs can offer them no long term prospects.

Not all the pressures for structural adjustment come from reductions in protection. Capital, management skills and technology are easily transferable between countries to take advantage of the best available conditions and the globalisation of industry is based on that flexibility. This can play a major role in determining the employment level, through the modern trends of downsizing and outsourcing which have had more effect on employment than tariff reduction.

Effects of a Tariff

This section introduces consideration of the effects of a tariff on various sectors of the economy. It highlights the fact that the effects can be seen right across the economy; they are not confined to the industry being protected and those closely related to it. Discussion of the effects of a tariff leads into an analysis of the various arguments which have been advanced for and against protection, concentrating on those arguments which have been important in the Australian context.

The most obvious effect of a tariff is to make imports of the product involved dearer to domestic consumers and to discourage them from buying imports in preference to a similar local product.

Introduction of a tariff provides an incentive to increase or sustain domestic production and, incidentally, to provide additional government revenue from the tariff payments. There will also be a transfer of income from consumers to producers as market prices rise and the prices and incomes of the inputs used in domestic production will also rise. There can be a slight improvement in the terms of trade.(27)

Tariffs tend to draw in resources from the unassisted sector to the assisted sector of the economy. While this may appear to increase employment, generally it will lead to employment 'shuffling' out of unassisted industries and into assisted industries. There is little, if any, evidence around the world that trade barriers raise the general level of employment.

The exchange rate may be appreciated by trade barriers, but on the other hand it may lead to reduced capital flows as capital is redirected to more open economies, and this will lead to a depreciated currency.

The cumulative effect of these changes is to encourage production of the protected product domestically, with a positive effect on employment in the protected industry, but at the expense of domestic consumers, unprotected industries (especially export industries) which bear the higher costs, and overseas trading partners.

Encouragement of an individual industry or sector also carries its price. Unless total employment is increased-which is unlikely-employment in the protected sector is likely to increase but other sectors will lose the resources now being attracted to the protected sector. This situation is exacerbated by the fact that the industry losing resources in this situation is likely to be a more efficient user of those resources than the protected industry (or the protected industry would have attracted the resources without the need for a tariff).

Arguments in Favour of Protection

Although most of those who have examined the indirect as well as the direct effects of trade barriers consider that free trade offers the most efficient allocation of resources, the use of protection as a part of trade and industry policy continues to be supported by decision makers. Those who are directly affected always have more incentive to plead their case than those who share only in the 'general interest'.

The arguments used to support protectionist policies are numerous and this section examines the most common of those arguments, particularly those frequently used in the debate over the protection of Australian industry.

Protection against Cheap Foreign Labour

This argument is often used to claim that Australian industry is being unfairly disadvantaged by imports of products from countries with 'cheap' labour. The reasoning is that a country with relatively high wages cannot compete with the output of countries with very low labour costs and should be protected from loss of market share.(28)

The problem with this argument is that it also suggests that countries with higher wage structures than Australia would also be seeking protection against Australian products exported to them. The fact that this does not happen is explained by the concept of comparative advantage-i.e. that countries export the goods that they can produce relatively most efficiently.(29)

American economist Paul Samuelson is quite scathing about the cheap labour argument. He notes that the important determinant in trade is comparative advantage, not absolute advantage and describes trade as, in the end, two-sided barter. Even if one country can produce everything more cheaply than another in terms of resources, trade can still be mutually profitable.

National Defence

A country may decide not to rely too heavily on imports of certain key commodities and manufactured products, so as to be self-sufficient in times of national emergency. Such a decision may (in fact, almost certainly will) involve an economic cost but the risk of isolation in wartime may be considered to outweigh such economic considerations.

This has always been a powerful argument in Australia (often in concert with other arguments) because of the long sea routes between this country and the major manufacturing centres of America and Europe. (30) It is perhaps less persuasive now in the era of expanding capabilities of air transport and increased effectiveness of precision munitions. Stockpiling is an alternative strategy which is used extensively by modern defence forces.

Preservation of Particular Classes or Occupations in the Population

This is an argument used almost exclusively in connection with agricultural protection-to ensure the preservation and maintenance of the capacity and lifestyle of the farming sector of the economy.

The argument has been used in the past in conjunction with the national defence argument, e.g. to support protection of the sugar industry in Northern Australia to retain population in the tropical areas of Queensland.(31)

The 'Optimum Tariff' Argument

This theory argues that there is an optimum tariff level at which gains to national income are maximised. A modest tariff may improve the terms of trade for a country which accounts for a large part of world demand for the product.

The theory has little relevance to Australia. The only area where the terms of trade effect would be likely to have any relevance to Australia would be as an exporter of some products-but our experience in trying to change the world wool price is hardly encouraging.

Infant Industries

The infant industries argument suggests that long-term economic growth is increased through short-term protection of new areas of manufacturing. Protection provides encouragement to entrepreneurs to risk their capital in the years before the industry can become self-sufficient. It is therefore an argument for temporary assistance only, but it really relies on a judgement that politicians and public servants can judge future profitability better than the capital market.

Experience world-wide suggests that infant industries rarely grow up. Some people suggest that such assistance has been effective in East Asia but others believe that it was the export orientation of industry which was crucial in those countries.

One local example of an infant industry which 'grew up' was the cotton industry. The industry established with 'infant industry' protection but has now shed virtually all of the assistance it had at the beginning.

Real Wages and Immigration

This theory is based on the belief that protection raises real wages or allows a larger work force to be employed at a given wage. A side effect of the theory is the belief that it attracts immigrants by increasing the demand for labour and that the resultant population growth provides a general stimulus to economic growth.

This argument has been an important influence in Australian tariff-making, especially in the periods after the two World Wars when rapid population growth was seen as a high priority. It was the basis of one of the Brigden Report's main findings in 1929:(32)

'The advantage of protection is in the maintenance of a larger population than could have been expected at the same standard of living without the protective tariff. It is not an advantage to every part of the population nor has it produced the maximum income per head.'(33)

The Vernon Committee in 1965 agreed: 'Protection, by providing a wider range as well as a larger number of employment opportunities and, probably, by sustaining urban wages, has no doubt increased the attractiveness of Australia for migrants.'(34)Nevertheless, there are more efficient ways, through taxes and social security, to redistribute income if that is the policy objective. There are also more efficient ways to attract migrants if that is the objective.

Protection of Employment

This theory also relates to real wages and the idea that protection allows a higher level of employment to be maintained at a given wage. Usually it is used to support protection for a particular industry or region-the equivalent of taxing all the other industries or regions.

The argument has been influential in Australia in times of sustained unemployment. However, only measures which increase aggregate demand or increase productivity can be successful in dealing with widespread unemployment.(35) To the extent that protection increases aggregate demand, employment may be increased but it is unlikely to do this because of its indirect effects.

Balance of Payments

This theory was perhaps more relevant under the system of fixed exchange rates established at the Bretton Woods conference after World War II. Even with fixed exchange rates protection was unlikely to affect the balance of trade; it was more likely to affect the amount of trade. With flexible exchange rates there is even less likelihood of effects on the balance of trade.

A More Balanced and Self-Sufficient Economy

A theory which argues that, despite the costs to national income, the economy needs to maintain a balance which:

  • protects against threats to sources of supply
  • allows the economy to be less specialised and less vulnerable to changes in commodity markets.

This theory has a long history of support in Australia. There was a view that without protection for manufacturing in Australia, the economy would consist mainly of farms and mines. That view of the economy overlooked the growing importance of services (more than two-thirds of GDP) and the fact that protection reduced the variety of export industries.(36)

Manufactured exports have increased rapidly with the reduction of tariffs. This is especially true of exports of the more complex manufactured goods (the so-called substantially transformed manufactures) which increased by 17 per cent in 1995-96 and have increased their share of total merchandise exports from 17 per cent in 1990-91 to 23 per cent in 1995-96.(37)

Other Arguments

There are other arguments which are used from time to time. Essentially, they consist of two types:

  • those where the beneficiaries of a change are concentrated in a few companies or industries and the benefits to them are easy to demonstrate or quantify, but the costs of the change are dispersed and much harder to identify, e.g. the decision to protect a single industry when the costs will affect the whole range of export industry; and
  • the opposite case where the losers from a particular policy are easy to identify and the benefits are dispersed and difficult to link to individuals, e.g. the decision to remove protection from a single industry, where the costs to that industry are obvious but the benefits to consumers and export industries are diffused.

Arguments Against Protection

Paul Samuelson wrote that:

Indeed, there is essentially only one argument for free or freer trade, but it is an exceedingly powerful one; namely, unhampered trade promotes a mutually profitable international division of labour, greatly enhances the potential real national product of all countries, and makes possible higher standards of living all over the globe.(38)

Arguments for trade liberalisation have recently been supported by indications that rapid unilateral trade liberalisation has not adversely affected Australia's economic growth by comparison with the OECD countries. Growth in Australia's output in the 1990s has been well above the OECD average. Inflation is near the OECD average after being well above that average for twenty years and Australia became a net exporter of services for the first time in 1995-96.(39) The table below sets out a comparison of growth rates in gross domestic product for OECD countries for 1988-1996.

Economic Growth - Annual Average Age for Calendar Years 1987 to 1996

Protection Taxes Exporters

Increases in costs caused by tariffs are ultimately borne by industries unable to pass the costs on-importantly the export industries. These industries, competing on the world market, are restrained in their response to rising costs by the need to stay competitive with world price levels. Most other economic sectors are able to pass on cost increases to consumers or pass on their higher living costs to employers. On the other hand, farmers and exporters of manufactured goods and services have no control over world prices.

Net Loss of Income

Protection causes loss of income through increased prices to consumers. Households have less to spend on other goods and services. Protection also reduces national income because of lost opportunities-an invisible loss which does not show up in national accounts. Opportunities are lost because protection inhibits investment, research and development and innovation in the unassisted sectors of the economy.

Loss of Employment

Although it may preserve or increase employment in the protected industries, protection costs jobs in unprotected industries. Protection of some industries increases costs and reduces profitability in other industries-which respond by employing fewer people.

Reducing Protection Improves Productivity

There is considerable evidence that international competition has significantly improved productivity in the traded goods sector of the economy. For a high labour cost economy like Australia there is encouragement to improve management and concentrate on the production of higher quality, more innovative products to offset labour costs-the increase in Australia's exports of elaborately transformed manufactures reflects this.

An example may be found in the recent Industry Commission report on the Automotive Industry. The report comments that:

The threat of competition from imports has generated productivity changes throughout the Australian automotive industry and its supplier base. Many participants acknowledged this has helped spur performance.(40)

The Victorian Government in its submission to the inquiry also noted the positive effects of reduced protection:

The industry has responded positively to its changed competitive environment, most notably the decline in tariff protection by developing a strong export base and realising other improvements in innovation, research and development and productivity.(41)

Another example is found in the response of the Textiles, Clothing and Footwear industries to the changes in their levels of tariff protection and elimination of quotas. A report by independent consultants for the TCF Future Strategies Committee commented:

Significant restructuring was required before the Australian industries would be capable of being internationally competitive... On the whole, substantial elements of the industries have seized the opportunity and restructured. These now form the basis for further development of the industries into a fully internationally competitive sector.(42)

Greater Opportunities for Exports of Goods and Services

As more countries move to liberalise their trade and foreign investment regimes the opportunities for Australians will grow. However, the argument for free trade suggests that even if liberalisation is undertaken alone, there are substantial benefits to be gained in productivity and resource allocation. Alan Oxley neatly summed up the argument for free trade in his book The Challenge of Free Trade when he wrote:(43)

... If there are no barriers to trade, products can be imported to be sold if there is a market for them. Increase the price of an import by taxing it-with a tariff- or making it scarce-restricting the number that can be imported by a quota-and the import cannot play its proper role in helping to set a market price.

Economies that are open to all imports receive the cheapest available goods. These will be either the imported good or the domestic good which has been priced to compete with the imported competition. This reduces costs to consumers who then, of course, have more funds available for other purposes. Open economies are also best for countries that want to export. The cost of components will be the world price. This is essential in order to manufacture products for export which are internationally competitive.

Conclusion

It is apparent from the arguments set out above, that strong cases have been mounted for both sides of the Protection v Free Trade (or Trade Liberalisation) question. While there are a number of strong arguments for both sides, however, the weight of logical argument is heavily on the side of trade liberalisation.

One aspect which is often overlooked in the debate (by advocates of both sides) is that both courses have costs. In the case of protection, the cost lies in higher prices paid by consumers; in effect a subsidy from consumers to the protected industry. These costs continue as long as the protective regime is in place. The higher the tariff level, or the more restrictive the quota, the higher is the subsidy. Conversely, the gains at each successive phase of lowering tariffs may be proportionately less, unless there are accompanying gains in economies of scale-the benefit, for example, from reducing motor vehicle tariff rates from 45 per cent to 22.5 per cent may be much greater than those from a further reduction from 22.5 per cent to Free.

Lowering protection also carries its costs, although in this case they are transitional and decline over time as the restructuring process proceeds. As competition increases some industries contract or disappear. When this happens quickly it may be difficult to move resources from one industry or location to another, particularly the labour force. To allow restructuring to proceed at a reasonable pace, therefore, assistance is necessary for both the industries affected, employees who are disadvantaged and new entrants to the workforce who may need further training.

If Government policies are implemented to retrain and/or relocate the workforce and to provide incentives and encouragement for the establishment of internationally competitive industries, it would be possible to minimise the social and economic costs of restructuring. Such policies would need to ensure that the economy could continue to move steadily towards international competitiveness without protective barriers. The policies would also need to take account of the needs of employees with particular re-employment disabilities, e.g. age or language barriers. The task, unfortunately, is neither easy nor inexpensive.

There are powerful economic arguments in favour of trade liberalisation but decisions on protection levels for industries such as motor vehicles and the textiles, clothing and footwear group are not made in economic isolation. The Government must weigh up many closely related factors such as the current unemployment level, the possible disruption of employees' lives if protection is removed, likely future investment decisions by capital owners and the likely responses by trading partners.

The Government must also take into account the responsibilities of Australia's leadership roles in the Cairns Group and APEC and its commitments in the WTO. Australia's active role in these bodies in recent years has built up an expectation among the members that Australia will remain fully committed to trade liberalisation and especially to the achievement of free trade and investment by 2010. Removing some products from our APEC commitments could encourage other countries to remove other products-particularly agriculture-from their commitments, with negative effects for Australia.

Endnotes

  1. Tariff Board Annual Report 1931-32, para. 2, 'Tariff Reductions and Employment'.
  2. Import Licensing is a method of applying an absolute limit to imports of a particular product -without a licence the product cannot be imported. Licensing differs from the use of tariff quotas in that tariff quotas do not apply an absolute ceiling on imports. Once the quota level is reached, a very high rate of duty is applied which does not prohibit imports but discourages them.
  3. Leon Glezer, Tariff Politics: Australian Policy-making 1960-1980, Melbourne University Press, 1982, p. 200.
  4. ibid., p. 202.
  5. Vernon Committee Report, vol.1, Commonwealth Government Printer, May 1965, p. 367.
  6. Glezer, op. cit. P. 93.
  7. Tariff Board Annual Report 1968-69, pp. 4-5.
  8. Mr Anthony, Minister for Trade and Industry, Hansard, House of Representatives, 28 April 1971, p. 2136.
  9. Mr Edwards (Berowra), Hansard, House of Representatives, 5 December 1973, p. 4319.
  10. Glezer, op. cit., p. 112.
  11. Joint Statement by the Prime Minister, E.G.Whitlam, and the Minister for Overseas Trade and Secondary Industry, Dr J. Cairns, 18 July 1973; also in Hansard, House of Representatives, 21 August 1973, pp. 167-170.
  12. Economic Statement May 1988, Statement by the Treasurer, Hon. P.J. Keating, 25 May 1988, AGPS, pp. 121-125.
  13. Building a Competitive Australia, Ministerial Statements, 12 March 1991, AGPS, pp. 3.3-3.10.
  14. Joint Statement by the Prime Minister, John Howard, the Treasurer, Peter Costello, and the Minister for Industry, John Moore, 5 June 1997.
  15. Transcript of doorstop interview, the Hon K.Beazley, Leader of the Opposition, Commonwealth Offices, Sydney, 6 June 1997.
  16. 'Democrats call for policy shift', Report by AAP, 11 June 1997.
  17. 'Australia: Democrats want freeze on tariff cuts', Mark Skulley, Report by AAP, 11 April 1997.
  18. 'Australian race row MP wants tariffs back', Reuters News Service, 11 June 1997.
  19. 'Tariff freeze frees lethal genies', Paul Kelly, Australian, Wednesday, June 11, 1997, p. 13.
  20. Australia's Business Challenge: South-East Asia in the 1990s, Report by the East Asia Analytical Unit, Department of Foreign Affairs and Trade, and Austrade, AGPS, 1992, p. 62.
  21. Quoted in Industries Assistance Commission, Structural Change in Australia, June 1977, AGPS, Canberra, p. 7.
  22. ibid., p. 7.
  23. Glezer, op. cit., pp. 190-191.
  24. Study Group on Structural Adjustment, Report, vol.1, March 1979, AGPS, Canberra,
    p. 3.5.
  25. ibid., p. 3.5.
  26. ibid., p. 40.
  27. Paul A. Samuelson, Economics, 6th edn, McGraw-Hill, New York, pp. 688-689.
  28. David Greenaway and Christopher Milner, Protectionism Again ...?, Hobart Paper No. 4, Institute of Economic Affairs, London, 1979, pp. 16-17.
  29. Walter Goode, Dictionary of Trade Policy Terms, Centre for International Economic Studies, University of Adelaide, 1997, p. 49.
  30. Reitsma, Trade Protection in Australia, University of Queensland Press, St Lucia, 1960, p. 150.
  31. ibid., p. 153.
  32. The Brigden Committee was established to prepare a report on the economic effects of the Australian Tariff.
  33. Quoted in Reitsma, op. cit. p. 74.
  34. Vernon Committee Report, op. cit., p. 362.
  35. Anderson and Garnaut, op. cit., pp. 31-32.
  36. ibid., p.34.
  37. Composition of Trade: Australia, 1994-95 and 1995-96, Department of Foreign Affairs and Trade, p.2 and p.1.
  38. Samuelson, op. cit., p. 684.
  39. 'Omen of serious national malaise', Financial Review, 17 June 1997, p. 17.
  40. The Automotive Industry, Report, vol. 1, Industry Commission, Report No. 58, 26 May 1997, p. 140.
  41. ibid., p. 141.
  42. Review of the Textile, Clothing & Footwear Industries Development Strategy, Final Report, Werner International Inc., October 1994, p. II.1.
  43. Alan Oxley, The Challenge of Free Trade, Harvester Wheatsheaf, Sydney, 1990, p. 194.

Appendix 1: Restraints on Trade

Types of Tariffs

  • Ad valorem tariff
calculated as a percentage of the value of the goods cleared through Customs,
e.g. 10 per cent
  • Specific duty
expressed as a fixed monetary amount per physical unit or per weight of unit of an imported product,
e.g. $1 per kg
  • Compound duty
contains elements of both ad valorem and specific duties,
e.g. 10 per cent of the value and $1 per kg
  • Alternative duty
  • Involves either and ad valorem or a specific duty,
    e.g. 10 per cent or, if higher, $1 per kg
  • Tariff quota duty
Tariff rate applicable to a quota of imports, with a higher rate charged on imports in excess of the quota; the quota and tariff may be defined in terms of quantity or value.

Non-tariff barriers (NTBs)

Non-tariff barriers consist of two broad types of measures:

  • Quantitative restrictions (QRs)
    • Export restraints: arrangements between importers and exporters, whereby the latter agree to limit exports in order to avoid the imposition of mandatory restrictions by importing countries
    • Non-automatic licensing: the practice of requiring, as a condition for importation, a licence which is not granted automatically and which may be issued on a discretionary basis or depend on specific criteria
  • Price control measures (PCMs)

(Source: the OECD Observer, no. 203, December 1996/January 1997, p. 28)

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