Discussion: Improvement of overall economic welfare and the economic welfare of an individual factor of production through Protectionism

Table of Contents

1. Introduction

2. Protectionism - definition, argumentation and actions
2.1 Arguments in favour of protection
2.2 Measures for Protectionism
2.3 Effect of protection policy on economic welfare
2.3.1 Effect of a tariff
2.3.2 Effect of a quota on imports
2.3.3 Effect of a production subsidy

3. Part a) Improvement of the overall economic welfare through protectionism
3.1 Theories
3.1.1 Indifference Curves and where they derive from
3.1.2 Offer curves and the terms of trade
3.2 The terms of trade argument for protection
3.2.1 Optimum Tariff
3.2.2 Assumptions
3.2.3 Retaliation
3.3 Strategic Trade Theory
3.4 Conclusion

4. Part b) Improvement of welfare of an individual factor of production
4.1 Theories
4.1.1 Edgeworth Box
4.2 Heckscher-Ohlin Model
4.2.1 Assumptions
4.2.2 Heckscher Ohlin Theorem
4.2.3 Factor price Equalisation Theorem
4.2.4 Stolper Samuelson Theorem
4.2.5 Rybczynski Theorem
4.3 Tariff and the impact on the owners of a scarce factor
4.4 Validity of Heckscher Ohlin Model
4.5 Specific Factors Model and influence on imposing a tariff
4.6 Conclusion

5. Summary

6. Appendix (Explanation of words)

7. References

8. Other Models and their impact on protectionism

1. Introduction

Protectionism could improve a country's welfare but on the other hand diminish it.

The aim of this assignment is to give a detailed explanation on how protectionism could improve the overall economic welfare of a country and an individual factor of production. In the first section I would like to give a short overview of the theories underlying protectionism. I name all circumstances under which a domestic industry could improve its economic welfare by imposing protection. Further on I will describe how possible it is that a country can really set the right rate of protectionism.

In the second part I show how protectionism can improve the welfare of an individual factor of production. I give a detailed description of the essential theories. In addition it is shown how potential it is that a specific factor of production can profit from a protectionist policy. In conclusion the ideas raised in this essay will be summarized. To round up the whole picture I would like to give a short outlook how important protectionism is in today's economies.

2. Protectionism - definition, argumentation and actions

Protectionism is a restriction to trade between countries internationally.¹

2.1 Arguments in favour of protection

There are several arguments that can be used to support the policy of protectionism. The textbook for International Economics classifies the argumentation into three mayor groups.

1. Increase the overall welfare of an economy by

a) Terms of Trade argument

By using an optimum tariff it is assumed a country can increase its overall economic welfare. This argument will be explained later in this assignment.

b) Reduction of aggregate unemployment

this argument states that during times of high unemployment a tariff could shift the demand to domestic products. Hence production will grow and the industry will hire more labour. The unemployment rate will decrease and workers will also have more money to spend.

But this argument is very questioned by economics in terms of validity. There might be also a job loss in export industry and this one might be larger than the job gain.

Another important issue is that consumers will be restricted in the goods they are able to purchase. The tariff forces them to buy "home-made" products even though they might be better off with foreign goods.

2. Benefits for and individual industry or scarce factor of production

a) Tariff to increase employment in special industry

On the one hand this argument is also based on the same theory as mentioned above. It is also an argument, which is mainly used to argue in favour of protectionism, but is does not really hold its ground. It is true that jobs can be lost in industries which are not competitive in the world market for example Germany's Textile industry. But when these old industries are going down others will come into place (for example high tech). Countries, which have a comparative advantage in labour intensive products like textiles, will be better of trading these goods. But developed countries like the US might have a comparative advantage in the high tech industry. So jobs might be lost in the short run there will be also a huge gain in other industries.

b) Tariff to benefit a scarce factor of production

This argument is based on the Heckscher Ohlin Model and the factor endowment theory and will be described later on in this essay.

3. Increase welfare for the world as whole

a) To Protect Infant Industries

A country might have a comparative advantage in one sector but cannot build it up due to strong international competition. Tariffs or other measures might help this particular industry to grow strong and the country could develop a comparative advantage. But it is necessary to remark here that young industries usually never ask for help. Often old industries with a prestige standard are the ones asking the government to intervene.

Other arguments:²

Protection during current currency overvaluations

This is the last argument Case and Fair name in favour of protectionism. A currency might be artificially too strong against other countries and the products of this country might become not wanted on the world market. Temporarily protection might help to overcome this state. But the authors note that it is very difficult to set the "proper" rate of protectionism and to ascertain the "right" exchange rate.

Protectionism as an argument for National Security and Independency from other countries Politicians argue that some industries might be vital to national defence. Due to this argument the steel industry profits a lot from protectionism. Also it is argued that a country should not depend too much on other countries especially in essential products like food or fuel. Even though this might be true in some cases it is still a question of logic how far protectionism should go.

2.2 Measures for Protectionism

There are two different ways a government can impose protectionism:

1. Tariffs

"A tariff is a tax imposed on goods and services traded across national borders and can be applied to either imports or exports."³ Mainly tariffs are placed on imports.

2. Non-tariff barriers

A non-tariff barrier is any other action, which restricts trade. This could be for example a quota or a voluntary export restraint. A quota restricts the amount of the good that is allowed to be imported into the domestic country. Other non-tariff barriers can be export (production) subsidies or health and safety requirements that will influence international trade.⁴

2.3 Effect of protection policy on economic welfare

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2.3.1 Figure 1: effect of a tariff (source)

A tariff - as a tariff on imports is an import duty that assigns a fixed amount of money on each unit imported.⁵

In the above diagram the triangle ABC signifies the production dead weight loss to society, the triangle DEF the consumer dead weight loss to society and the rectangle BCFE the government revenue.

To impose protectionism to increase the overall economic welfare of a country the government must know if the increase in the overall welfare will be larger than the consumer and production dead weight loss to society. One way to equalize this effect is to reinvest the earned tariffs into the country's economy.

2.3.2 Effect of a quota on imports

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Figure 2: Effect of a quota on imports (Macroeconomics (966) & International Economic relations (229))

The same effect as a tariff has a quota on imports. For example in figure two the amount of cars Japan is allowed to import into Australia is restricted. Originally a car would cost $ Aus 3.000 (po). But due to the quota Australians are willing to buy the car for $Aus 6.000 (p1).

Japan on the other hand is offering the car for $2.000 (p2). Importers profit massively from the quota (see picture for quota profit). But as well on production and consumption side there is a loss as shown in the next diagram. Consumers have to pay more for cars and importers earn more money because they are able to buy the car for $ Aus 2.000 and sell them for $ Aus 6.000.

2.3.3 Effect of a production subsidy

The government can also impose protectionism by subsidising the production of a specific industry.

A subsidy is a grant or payment made by the government to producers e.g. export incentive grants, dairy industry stabilization payments. A subsidy lowers the market price below the factor cost.⁶ Hence consumers have to pay less for a certain product. The costs for subsidies are paid by the government which will uses tax money to do so.

3. Part a) Improvement of the overall economic welfare through protectionism

By naming all circumstances - how can a country improve its overall economic welfare by protecting a domestic industry? How likely is it that each of the circumstances exist?

As already mentioned above there are two ways to increase overall economic welfare - either by Job Protection or with the Terms-of Trade Argument to. Terms of trade Argument will be the basis for answering question 1.

But at first it is necessary to give a short summary of the fundamental theories.

3.1 Theories

3.1.1 Indifference Curves and where they derive from

To fully explain the theory of offer curves and how a country can improve its economic welfare it is necessary to give a short explanation of indifference curves.

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The basis for the indifference curve is a two-commodity world. Indifference curves show the various consumption combinations of the two goods that provide the same level of satisfaction to the consumer. It is not possible to measure exactly the welfare achieved by one indifference curve but one can say that the welfare is greater between two indifference curves (IC1 and IC2 see diagram). A country's indifference curve indicates the level of satisfaction (or welfare) achieved by a country. Indifference curves are always downward sloping and convex to origin. The points A, B and C give the same level of satisfaction to the country (or to a consumer). But the country will reach a higher level of satisfaction at point D because it can consume more of good x and y.

Figure 3: Indifference Curve for a nation (Appleyard/Field I nternational Economics)⁷

3.1.2 Offer curves and the terms of trade

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Offer curves show a country's willingness to trade. They indicate the quantity of imports a country is willing to buy and the quantity of exports it is willing to sell on the world market at all possible relative set of prices.⁸

Figure 4: Offer Curve for one country Figure 5: Offer curves for two countries combined (Lecture Notes)⁹

The first figure shows the offer curve for one country for various terms of trade.

The next diagram combines the offer curves of two countries (I and II) under free trade. At point A there is equilibrium. Country I is willing to import the same amount of good Y that country II is willing to export. And it is also willing to export the same amount of good X that country II is willing to import.

Higher Terms of Trade (TOT') symbolize higher set of prices and on the other hand lower Terms of Trade (TOT'') signify lower set of prices.

Under free trade the amount of exports and imports will fix the level of the terms of trade to equilibrium. Because it is assumed that both countries cannot influence the prices for its products (X and Y) the market will shift to equilibrium (A).

3.2 The terms of trade argument for protection

The textbook argues that the national welfare can be enhanced by a restrictive trade policy. But it also shows that the domestic economy can only enhance its welfare on expense of the other country.

It further elaborates that setting an "optimum" tariff will raise the ratio of price for exports (good X) to the price of imports. By imposing the tariff the domestic industry reduces the demand for the foreign good on the world market and the price for this good will fall and the price ratio for exports to imports will hence increase.¹⁰

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The two diagrams above explain this argumentation. In the first diagram (Figure 4) both countries trade under equilibrium. Point A signifies the equilibrium under free trade. If country I sets a tariff it will shift its offer curve to the left as shown in the next diagram because it is now less willing to trade with country II. Shifting its offer curve means that it will export less of good X (shift from x1 to x2) and import less of good Y (shift from y1 to y2) because of an increase in prices due to the optimum tariff. The optimum tariff can be either a tax on import (good y) or a tax on exports (good x).

The terms of trade improve for country I from TOT to TOT' which means that it can buy more of good y in exchange for good x.

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By shifting the offer curve and ending up with higher terms of trade country I moves to a higher indifference curve but also brings country II on a lower indifference curve. This means that country I is better off but on the expense of country II.

But what also must be considered is that country can now import less than before. So it gains from the raise I prices but looses in terms of import quantities.¹² This shows how important it is to set the optimum tariff.

3.2.1 Optimum Tariff

The optimum tariff rate is the rate that maximizes the country's welfare.¹³ As discussed before a tariff can bring a country on a higher indifference curve and hence increase its welfare. The textbook claims that the optimum tariff is there where the "positive difference between the gain from better prices and the loss from reduced quantity of imports is at maximum."¹⁴

The rate for an optimum tariff is defined by the following equation:¹⁵

tI* defines the optimum tariff rate for country I

eII defines the elasticity of the offer curve from country II

The optimum tariff is clearly related to the foreign country's offer curve and it's elasticity. The offer curve must be inelastic to set an optimum tariff. If the offer curve of country II is unit- elastic the optimum tariff could not be set. If the offer curve is elastic the domestic country will not gain at all. The foreign country could engage in trade with other countries to offset the tariff.

So to make my point clear the following assumptions must hold. And to set an optimum tariff the foreign country's offer curve must be inelastic.

3.2.2 Assumptions

- The domestic country is a large country that can influence the world price of products (terms of trade).
- The other (foreign) country is passive and does not seek retaliation, which means that it does not react on the tariff and has an inelastic offer curve.
- Country I must know the offer curves for both countries so that it can set the optimum tariff and foresee the consequences as mentioned above.¹⁶

Setting an optimum tariff is also called "beggar-my-neighbour" policy because the domestic country does only increase its welfare on the expenses of the foreign country.¹⁷ If the assumptions mentioned above do not hold than the foreign country might seek retaliation or if possible trade with other nations. I already explained above what might happen when the second choice takes place.

The next paragraph explains shortly what will happen when the foreign country retaliates with a tariff of its own.

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3.2.3 Retaliation

Figure 8: Retaliation of country II (Lecture Notes)¹⁸

Diagram 6 shows what can happen if country II is not passive and seeks retaliation. After the shift of the offer curve country II is now on a lower indifference curve. It will now try to equalize this effect by imposing protectionism as well. This implicates a shift of the offer curve of country II. Country II will now be on a higher indifference curve but again on the expense of country I.

If both countries "play this game long enough" they will make themselves worse off than before because every time they will be shifted on a lower indifference curve.

What it boils down to is that the consumer will be able to buy less and less for its money and the country can import less and less every time a shift of the offer curve takes place and will therefore lower its level of satisfaction. Hence the overall economic welfare will decrease.

3.3 Strategic Trade Theory

To complete the picture it is worth mentioning that nowadays governments often use a new protectionist policy called strategic trade policy to influence trade between nations. I do not want to go into very detail. But the basic behind it is that the domestic government is manipulating the behaviour of the domestic firm by subsidising or taxing exports (or doing both). Through the manipulation it will favour the domestic industry for higher profits and revenues.

Strategic Trade Theory assumes that the foreign government is passive and does not retaliate. Domestic companies must be domestically owned. The government following this strategy must also have a very good insight view on markets and behaviours of companies. By stating this it is already clear how difficult it is to pursue this strategy.

3.4 Conclusion

As shown in the theory of offer curves and optimum tariff a country can improve its overall economic welfare by imposing protectionism. But it is important that the assumptions mentioned before hold.

If they are not valid a country can be worse off than before and not improve its economic welfare at all.

It also must be considered what an effect a tariff can have on society regarding the dead weight loss on consumer and production side. The government must carefully judge if the policy of protectionism generates a bigger increase in the overall economic welfare than the loss through the measures of protectionism.

One way is the reinvestment of the government revenue into the economy.

It also must be considered that the assumptions might be very unrealistic in today's economy. There are very view economies, which dominate the world market. And on the other hand why should a country not seek retaliation?

A good example for a dominating economy is the OPEC (by seeing as OPEC as one entity). Due to its mayor oil reserves the countries of OPEC are able to dominate the world price and make themselves better off.

But this policy has also a negative flavour. Every time OPEC was increasing the price of oil other countries invested in alternative energy reserves like natural gas, solar energy and energy from wind and water. By investing in these alternative solutions they become less dependent on the oil reserves of the OPEC states. In the long run profits of OPEC might decrease because they will not be able to dictate the price anymore.

4. Part b) Improvement of welfare of an individual factor of production

As mentioned in the introduction for protectionism there are two arguments that answer the questions. A tariff might be used to improve a particular industry but also the welfare of a scarce factor of production. By using the Heckscher Ohlin Theorem it will be shown how imposing protectionism can increase the welfare of an individual factor of production. Using the Specific Factors Model I will further elaborate on the negative side effects of protectionism and the impact on a scarce factor of production!

4.1 Theories

4.1.1 Edgeworth Box

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Figure 9: Model of Edgeworth Box for two industries (steel and cloth) (Appleyard/Field)¹⁹

The Edgeworth Box explains either production of different industries (in diagram 6 steel and cloth) or the consumption of two different products (steel or cloth). It describes the different factor endowments for the production and measures the total amount of the two factors in one country (in this example capital and labour).

The steel industry uses relatively intensively capital and the cloth industry relatively intensively labour. This particular Edgeworth Box shows the total amount of labour and capital available in a country and how these factors can be combined in the production of cloth and steel. For example at point D a great amount of cloth is produced but hardly any steel. On the other hand at point A the economy is producing a lot of steel but very few cloth. The production efficiency locus is the curve, which signifies the most efficient combination of the production factors (capital and labour).²⁰

4.2 Heckscher-Ohlin Model

The Heckscher Ohlin Model assumes that on industry is using relatively intensively one factor of production. For example in the Diagram 8 - the steel industry is using relatively intensively capital but relatively non-intensively labour. This assumption has a mayor impact on the Heckscher Ohlin Model and the effect of protectionism on an individual factor of production.

4.2.1 Assumptions

According to our textbook there are 9 different assumptions for the Heckscher Ohlin Model:²¹

1. There are 2 countries, 2 homogenous goods, and 2 homogenous factors of production whose initial levels are fixed. These levels are relatively different for each country.
2. There are identical technologies in each country. That means that both countries have the same isoquants (see at the end).
3. Production constantly returns to scale for both goods in both countries, which means that industries do not profit from mass production to reduce their costs per unit of output.
4. The two goods have different factor intensities as mentioned above.
5. Taste and preferences are the same in both countries
6. There is perfect competition.
7. Factors of production (like labour and capital) are perfectly mobile within each country but not between countries.
8. The Heckscher Ohlin Model considers no transportation costs.
9. There are no policies restricting the trade between the two countries and interfering with the market determination of process and output quantities.

At this point I would like to give a short explanation. The whole essay is about protectionism and not free trade. But the Heckscher Ohlin Model regards Free Trade as a basic assumption. In my further discussion it will be clear why I used the Heckscher Ohlin Model to show the benefits protectionism can have.

4.2.2 Heckscher Ohlin Theorem

The Heckscher Ohlin theorem explains that a country will export the good that uses relatively intensively its relatively abundant factor of production and will import the good that uses relatively intensively its relatively scarce factor of production.²²

The Production Possibility Frontiers between the two countries differ as result of the different factor endowment.

Both countries will shift to a point of equilibrium and the price for products will soon equalize between the countries.

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Diagram 10 shows the Edgeworth Boxes for two different countries. Country I uses capital relatively intensively in its production in comparison to country II which uses relatively intensively labour (factor endowment).

The Production Possibility Frontiers for both countries would look like the following diagram:

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Figure 11: Production Possibility Frontiers for two different countries (lecture notes)²³ Assuming that preferences are identical country I will export steel and country II will export cloth. Hence country I will have a comparative advantage in steel and country II in cloth.

4.2.3 Factor price Equalisation Theorem

²⁴ Different relative sets of prices are the basis fro trade. Under free trade prices will adjust until they are equalized between countries. This has a mayor impact on factor prices. If both countries reached the point of equilibrium as mentioned above the will face the same product prices. Both having the same isoquants and a production of constant return to scale all relative and absolute costs will equalize as well. This can only happen when factor prices are equalized.

4.2.4 Stolper Samuelson Theorem

²⁵ The Stolper-Samuelson Theorem explains the impact on income distribution if factor price equalisation takes place. With full employment both before and after trade takes place, the increase in the price of the abundant factor and the decrease in the price of the scarce factor due to trade implies that

- Owners of scarce factor will find their real income falling and hence themselves worse off
- And owners of the abundant factor of production will find their real income rising and will be better off.

To go more into detail, Heckscher Ohlin assumes that there is perfect competition. This implies that the change of product prices due to free trade will equal the average change in input prices as well.²⁶

Following the example from above and assuming that country I is the home country price for

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Figure 12: Influence on Product and Factor Prices (lecture notes)²⁷

clothing will fall (to world price) because it will import it cheaper from country II. On the other hand the price for steel will go up (to the world price). Hence the price for the factor that is used relatively intensively in the production of the imported good (cloth) will decrease meaning wages will fall. This also means that the price for the factor that is used relatively intensively in the production of the exported good (steel) will increase. But the price for steel will rise less than the interest rate for capital will rise because the production of steel includes at least a little bit of labour (see picture) and wages do decline. Also the price of clothing will fall less than the wage rate because even the production of clothing requires some capital.

According to the Stolper Samuelson Theorem owners of labour will be worse off and owners of capital will be better off.

4.2.5 Rybczynski Theorem

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Figure 13: Rybczynski Theorem (small country case) (lecture notes)²⁸

The Rybczynski theorem explains growth in the economy. It assumes that a country is a small country but the factor ratio for each industry is fixed. In diagram 12 this would mean that the ratio of capital to labour is fixed for both the capital as well the labour intensive product.

But now more labour comes into the economy for example by foreign workers moving into the country. Because the country is small prices for goods and also for the factors will not change. And because the capital/labour ratio is fixed the production of the capital intensive good must decline a bit (from y1 to y2) because there is also capital needed for the production of the labour intensive product.²⁹

But in general the country will be better off because it will be able to produce more and offer more on the world market.

Large country assumption:

On the other hand if the country is large enough to influence world prices growth could also bring a country on a lower indifference curve and make the country worse off.

4.3 Tariff and the impact on the owners of a scarce factor

Getting back to figure 12 and the Stolper Samuelson theorem if a tariff is now levied on the imported good (clothing) which uses relatively intensively the scarce factor of production (labour) the price for the imported good (clothing) will rise. Wages will rise as well and owners of the scarce factor of production (labour) will be better off than without the tariff. But this tariff has a mayor impact on the well being of the whole nation. Because by levying a tariff on clothing consumers have to pay higher prices for clothing as well. Also factor price equalisation cannot take place between countries.

4.4 Validity of Heckscher Ohlin Model

The Heckscher Ohlin Model explains very well trade with primary goods but there are several problems in real life because a lot of the assumption will never be realised in practice. For example there are already different product prices due to:

- Transportation costs between countries
- There is no perfect competition like Adam Smith envisioned it.
- There might be goods, which will never be traded even though a country might have a comparative advantage in trading them.
- A lot of countries have unemployed resources and factors are not perfectly mobile within countries.
- Factors of production are not homogenous.
- Technology is not identical everywhere.
- Also the income effect is not clearly settled in the Stolper Samuelson Theorem because in real life factors of production cannot be separated so clearly. For example one household might have labour as well as capital to offer. This household can in the long run still profit from the Factor Price Equalisation even though wages will decline.³⁰

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4.5

Specific Factors Model and influence on imposing a tariff

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Figure 14: Specific-Factors Model (Salvatore)³¹

In this discussion the Specific Factors Model also plays a mayor role. The specific factors model considers three factors of production, two are specific to each industry and one can move freely between industries. For example: capital, land and labour - capital can be only used in the production of Good X, land only in the production of good Y but labour is used in both industries (X and Y). I will use in this example cars (symbolised in the diagram by X) and food (symbolised in the diagram by Y).

OD signifies the labour used in the car industry and O'D' the amount of labour used in the food industry. ED is the wage rate.

When a country opens to trade Price for cars increases. There is a shift of the Value of marginal product (VPML) of labour from VPMLx to VPML'x because VPML is described by Marginal Product of Labour (MPL) * Price for a certain good.

Wages will rise from ED to E'D'. Because of the rise in wages labour will shift from the food sector to the car sector. But since wages rise less than the price for the price for cars, wages will fall in terms of cars but will rise in terms of food. The absolute wage rate will rise (ED to E'D').³²

The textbook also describes that the Specific Factors Model might also be more realistic in real life than the Heckscher Ohlin Model. If a tariff is levied on an imported good like food (in the model above) the return to capital in the import-competing industry (food) will rise, the return to capital in the export industry (cars) will fall and the money wage will rise (as explained above).³³

Appleyard and Field conclude that the impact on real wages surely depend on the consumption patterns of the worker, either towards the imported good or the exported.

4.6 Conclusion

If the Heckscher Ohlin model would really prove its validity in practice than the economic welfare of a scarce factor of production could be improved by setting a tariff on imports. But this would happen on the expense of the overall economic welfare of the country. As stated before it is very unlikely that all assumptions and circumstances of the Heckscher Ohlin model function in practice. Appleyard and Field state that Heckscher Ohlin very well explains the trade with primary goods and that in the long run factor price equalisation might take place.

If a government imposes a tariff it must carefully consider the consequences and the real revenue. It does not make sense to support a scarce factor of production if the whole economy "suffers" from it.

By using the Specific Factors model it is even clearer that consumption patterns also reflect the consequences of a tariff. Workers might profit from protectionism but they also could loose depending on their consumption choices.

5. Summary

The question of the essay was how first a country increase its overall economic welfare and secondly the welfare of an individual factor of production by imposing protectionism. The first part was answered with the terms of trade argument. By setting an optimum tariff a country can improve its overall welfare. But certain assumptions must hold. As pointed out above its not always likely that the assumptions hold in real life.

A good example for the possibility was named with the OPEC nations. But also OPEC had its negative side effects.

In the second part of the assignment it was shown how a nation could improve the economic welfare of an individual factor of production (or scarce factor of production) by levying a tariff. Using the Heckscher Ohlin Model and the Specific Factors Model it was clearly stated how an individual (scarce) factor of production could gain from protectionism. But as already said it is very unlikely that all the assumptions required by the Heckscher Ohlin Model hold its ground in real life. It is also not clearly stated who would really gain from a tariff. To bring my argumentation to a conclusion a country as a whole as well as an individual factor of production could gain from protectionism but real life often proves it wrong.

International Economics' Discussion reacts very much in favour of free trade and critics the new protectionism which is also very much described by Strategic Trade Theory. I found a lot bad examples for protectionism in past and toady's nation's policies. Examples are Argentina, Europe, US, Japan and India.

To prove my statement I would like to give a short explanation about Argentina and how its economy developed over the last century.

At the beginning of this century Argentina was counted as one of the richest nations in the world. This had several reasons like rich agriculture, peace in the country and low taxes. There were no mayor restrictions to trade and the movement of people and capital and profited from a vast stream of immigrants from all over the world. The economy was highly efficient and people were well educated.

After World War I the government started to interfere into the economy, which accelerated even more, with the great depression. To put it in a nutshell the government under Juan Peron nationalized companies, raised taxes, enforced price control and inflated the currency. The results of this policy are obviously. Higher prices and shortages adding to an increasing bureaucracy and brought Argentina over the years from one of the richest nations to one of the poorest! By following a very protectionist strategy the government harmed the country drastically.³⁴

To make my point clear protectionist policy brought Argentina from "riches to rags". And Argentina is not the only bad example for protectionism and it's harmful consequences. Even though the purpose of the essay was to prove how a country could improve by imposing protectionism, reality clearly shows that only in few cases it had good effects.

6. Appendix (Explanation of words)

- Isoquant is the concept that relates output to the factor inputs. An isoquants shows the various combinations of two inputs (for example capital and labour) that produce the same level of output.³⁵ Isoquants are downward sloping and convex to origin. They are used in the model of the Edgeworth Box.

- Isocost line shows the various combinations of the factors of productions that can be purchased by a firm for a given total cost at given input prices.³⁶

- Production Possibility Frontier shows all possible combinations of the quantities of the goods that a nation could produce if its resources were fully and efficiently employed.³⁷

- Terms of Trade defines the rate of which two goods are exchanged for each other.

7. References

Mc Taggart, Douglas; Findlay, Christopher and Parkin, Michael. 1996, macroeconomics, Addison-Wesley Publishing Company

Hodgson, John S. and Herander, Mark G. 1983, International Economic Relations, Prentice-Hall, Inc., Englewood Cliffs, New Jersey

Case, Karl E. and Fair, Ray C. 1989, Principles f Economics, Prentice-Hall, Inc.

Appleyard, Dennis R. and Field, Alfred J., JR. 1998, International Economics, Irwin/McGraw-Hill

Salvatore, Dominick 1998 International Economics, Prentice Hall, Sixth Edition

Applegate, Craig 2000. Lecture Notes, University of Canberra Jim Powell 1997. Protectionist Paradise? Freedom to Trade (Refuting the New Protectionism), CATO Institute, Centre for Trade Policy Studies 2000, Massachusetts [Online] www.freetrade.org/pubs/freetotrade/freetrade.html

Hudgins, Edward L. 2000. The Fundamental Freedom to Trade, Freedom to Trade (Refuting the New Protectionism), CATO Institute, Centre for Trade Policy Studies 2000, Massachusetts [Online] www.freetrade.org/pubs/freetotrade/freetrade.html

Miller, Vincent H. and Elwood, James R. 2000. Free Trade versus Protectionism, INTERNATIONAL

SOCIETY FOR INDIVIDUAL LIBERTY, San Francisco [Online] Internet Resources for International Economics and Business http://grove.ship.edu/INTNTL/index.html

8. Other Models and their impact on protectionism

To complete the picture of trade theories I would like to give a short summary on the following models. The following models loosen a lot of the assumption from the Heckscher Ohlin Model.

But they strongly argue that a country could still gain from free trade even though not all of the assumptions from the Heckscher Ohlin model hold.

Linder Model

The Linder Model is demand oriented and not like the Heckscher Ohlin Model supply oriented and applies strongly to the production of manufactured goods. Linder assumes that the consumer taste is strongly influenced by the level of income. He concludes that trade will be more intensive between countries with similar per capita income (therefore similar taste) than between countries with dissimilar income distribution.

Kemp Model

The Model releases the assumption that there is a constant return to scales (see Heckscher Ohlin). Two countries can profit from the economies of scale and both gain from trade even though the have the same Production Possibility Frontier and same taste and preferences.

Krugman Model

Krugman also introduces the economies of scale and monopolistic (not perfect) competition in his model Labour is the only input for production. When a country is exposed to International Trade the demand for a certain product will rise because there are now more consumers on the market. On the other hand the consumption per capita will decrease. Prices will decline because economies of scale will be set into place. The real wages for workers will increase because real wages are defined by the ratio of Wage to prices (W/P). And because the P/W ratio is declining real wages are rising. In the long run all companies will run a Zero Sum Profit. But there are a lot of benefits from this model:

- Real wages are rising
- Prices are declining
- Total output is rising
- And there is a greater diversity in products to choose from.

[...]

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¹⁹ Appleyard, Dennis R. and Field, Alfred J., JR. 1998, International Economics, Irwin/McGraw-Hill

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²² Appleyard, Dennis R. and Field, Alfred J., JR. 1998, International Economics, Irwin/McGraw-Hill

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²⁴ Appleyard, Dennis R. and Field, Alfred J., JR. 1998, International Economics, Irwin/McGraw-Hill

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²⁶ Applegate, Craig 2000. Lecture Notes, University of Canberra

²⁷ Applegate, Craig 2000. Lecture Notes, University of Canberra

²⁸ Applegate, Craig 2000. Lecture Notes, University of Canberra

²⁹ Applegate, Craig 2000. Lecture Notes, University of Canberra

³⁰ Appleyard, Dennis R. and Field, Alfred J., JR. 1998, International Economics, Irwin/McGraw-Hill

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