Essay, Trade: Protectionism and FTAs

The bilateral CSFTA signed between China and Singapore has enhanced Singapore-based companies’ access to the vast Chinese market and further boosted bilateral trade and investment relations. The CSFTA is also the first comprehensive bilateral FTA concluded by China with an Asian country, covering areas ranging from trade in goods and services, to investment and economic cooperation, among others.

Source: IE Singapore, March 2012

a. Explain why some countries continue to implement protectionistic policies. (10)

b. Discuss the extent by which appropriate policy responses would differ between China and Singapore in the run-up to the full implementation of the CSFTA. (15)

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a) def Protectionism refers to government action through its policies to restrict or restrain a country's trade, and particularly imports through measures such as tariffs, quotas, and legislative barriers.

infant industry

A frequent argument for protectionism is the so called infant industry argument. Infant industries usually start off small, and will die before they reach a certain size where they can enjoy economies of scale, adequate infrastruture, and the appropriate trained labour force.

For instance, Airbus in its beginning stages received massive support from European governments to build up its capabilities in order to compete with Boeing from the US.

Protectionists claim that infant industries need to be protected from competition for a certain amount of time, so that the industry can eventually compete in the world market effectively. Subsidies and tariffs on imports are used to ensure the infant industry can compete initially.

evalThe drawback of relying on this argument is that it can be very difficult in reality to take away protections once it is given, and is likely to breed inefficiencies in protected industries.

avoiding structural unemployment

Structural unemployment may result from a structural change in the economy which loses its comparative advantage in certain industries. For example, the car industry in the US has claimed that they require protection from cheaper and presumably more efficient Japanese firms.

In the figure below, an imposition of a tariff raises the world price and reduces imports from Q1-Q2 to Q3-Q4. Local production increases from Q1 to Q3.

eval Protectionistic measures which aim to slow down structural unemployment does not address the structural change in the economy. General Motors eventually went bankrupt in the US despite government support. It is vital for the government to focus on other policies such as retraining to deal with structural change.

correct current account deficit

Countries may also implement protectionist measures in an attempt to correct a balance of payments deficit caused by a current account deficit.

Protectionist measures such as tariffs or quotas will reduce the amount spent on imports, which will improve the current account.

eval However, the economic justification for doing so is weak, as persistent current account deficits are usually due to underlying economic fundamentals, such as an overvalued currency which encourages imports and makes exports too expensive. It would be better to address these root causes directly.

conclusion Most justifications for protectionism tend to be framed as a benefit only for a section of the economy. Overall, protectionism leads to higher prices for households and may also lead to retaliatory actions by trading partners. Hence, protectionism should be justified more on the basis of politics rather than economics.

b) Discuss the extent to which appropriate policy responses would differ between China and Singapore in the run-up to the full implementation of the CSFTA. (15)

intro The FTA is likely to lead to increased trade and economic growth by increasing export demand, as shown by national income increasing from Y1 to Y2 in the figure below.

supply side policy thesis Both countries would implement supply side policies to increase the export capacity of the country in the long run. For example, both countries would invest in the labour workforce through training and education in order to raise productivity levels.

antithesis Singapore would be likely to focus its supply side policies in its export facing high tech manufacturing industries.

On the other hand, China would be likely to focus its supply side policies on labour intensive industries in which it has a comparative advantage, such as textiles manufacturing and other low tech industries.

inequality thesis Both countries would experience an increase in inequality as the gains from trade would go the most to workers in export facing industries. To alleviate widening income inequality, both countries would find redistributive policies such as transfer payments to the lower income appropriate.

antithesis China is likely to face a bigger problem of income inequality as the disparity between the rural and city areas is high. China would focus on improving the transport and education infrastruture to ensure that more citizens can benefit from trade, while Singapore would focus more on training for low skilled workers.

fiscal policy

Increased trade between both countries would lead to increased mutual economic dependence. This is likely to be more true for Singapore, which would see more volatility in the economic cycle due to fluctuations in Chinese import demand. As such, fiscal policy would be appropriate for Singapore during periods of weak Chinese demand (for example during recessions).

Given an initial increase in government spending, households employed by firms which contract for the government will earn higher income. These households will in turn spend a proportion of this higher income in consumption, which further increases the factor income of those in consumer facing industries, who then go on to spend so on and so forth until withdrawals equals injections.

The figure below illustrates the multiplier effect, where the initial injection (vertical distance between AE1 and AE2 leads to a more than proportionate increase in income Y2-Y1).

eval As China is not as trade reliant on Singapore, it is unlikely that China will be severely impacted in the event of a Singaporean recession. Fiscal policy may also be of limited use in Singapore's case due to a high import leakages and a low multiplier.

To conclude, the FTA will be likely to deepen the economic relationship between Singapore and China, and appropriate policies will be introduced to maximise the potential benefits of the FTA. Due to differences in the size and openness of the two economies, the specific focus of these policies will differ largely.

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