Most people have engaged in some sort of trade, whether it was buying something on the foreign market or trading a candy bar for a toy on the playground as a kid. Oftentimes, no one cares how much you buy or sell abroad as long as you pay the appropriate taxes and fill out the correct forms. Sometimes, the government cares and sets regulations to influence trading. Usually, it has pretty good reasons for its regulations and the paperwork is not there to simply be a nuisance to importers and exporters. We promise! Maybe this explanation can shine some light on those trade policies. Keep reading for a definition, different types of trade policy, and more.
Trade Policy Definition
Let's get right into the trade policy definition. A trade policy is set in place by a government and affects the number of goods and services a country exports and imports. Policy-makers might want to employ a trade policy to benefit the domestic market and its industries.
A trade policy is a government policy that affects the number of goods and services a country exports and imports.
Free trade is when there are no government restrictions on trade.
Protectionism is when governments set trade restrictions to help domestic industries.
In an economy, there is a spectrum of trade policies. On one end there is free trade and on the other end, there is protectionism. Under a free trade policy, there is no or very little government intervention in a country's trading practices. Under protectionism, the government regulates the trade flowing in and out of a country to protect domestic industries and limit its reliance on other countries. Most countries are not one or the other but are located somewhere on this spectrum.
Fig. 1 - Spectrum of Trade Policies
Why would a government want to interfere in trade? Under trade regimes like free trade, where there is little to no government intervention, the domestic economy will tend to specialize, meaning it focuses on only producing what it is good at and allocates its resources as such. The problem is that smaller industries will shrink and die out, to which people who work in those industries will be opposed. The government then steps in to help the affected industry by using some instrument of trade policy.
Now, if trade policy is used to restrict trade, like under protectionism, the domestic producer may benefit but the consumer pays the price. Protectionism is associated with increasing the price of the good the policy protects because it creates a shortage of that good in the domestic market.
Foreign Trade Policy
Foreign trade policy as it relates to the international market should follow any agreed-upon principles decided by multiple nations that are part of international organizations like the World Trade Organization (WTO) and the International Monetary Fund (IMF). These organizations were created to support international trade in a fair and sustainable way that benefits all nations involved.
While trade policy is usually set by a nation's government, if the policy is too drastic or is devastating to another nation's economy, the WTO will step in as a mediator to keep the peace and come up with a solution. An example of this type of situation is when the Trump Administration placed around $200 billion worth of tariffs on Chinese imports during the presidency.1 The WTO stated that the tariffs were in violation of global trade body rules because they were only against China and it could not be proven that the domestic industry benefited from the tariffs.1
Foreign trade policies are meant to reduce barriers between trading nations, produce non-discriminatory trading practices, and make the trading process more transparent through the use of international organizations like the WTO.
Types of Trade Policy
In the US, we see several types of trade policies. There are trade policies that affect which goods and services can be imported and how much. There are others that affect exports, currency exchange rates, or tourism. The job of trade policies though is to regulate imports and exports to the benefit of the domestic economy.
An import is a good or service that is manufactured or provided in another country and sold domestically.
An export is a good or service that is manufactured or provided domestically but sold in another country.
Trade Policy: Imports
There are several reasons why a government would want to establish trade policies for importing goods and services. First, under free trade, imports are seen to benefit the economy because they increase the selection of goods available to the consumers, lower prices, improve economic efficiency, and create global price stability.
A trade policy that supports imports could be a free trade agreement between two or more nations that allows for goods from one country to be imported into the other without restrictions like tariffs or quotas. This would keep domestic prices low and stable by increasing the supply available. A trade policy might also restrict imports. For example, if the US steel industry were to suffer from low prices due to foreign steel being more affordable, the government might step in to help them out. It could set a quota limiting the total amount of steel that can be imported or impose a tariff that charges the importer a percentage of the value of the steel.
Trade Policy: Exports
Exports benefit the domestic economy first and foremost because they bring money and foreign currency into the country. Exporting also expands the consumer base that is available to producers, which is important for increasing profits. A trade policy that benefits exports could be a deal between two countries where Country A will only sell its wheat to Country B as long as Country B agrees to offer border and transport protection from neighboring enemy countries.
A situation where the government may employ a more protectionist trade policy on exports is if there is a natural resource that is being depleted or the domestic population is not able to consume the good because it is all being exported. When foreign prices for a good, let's say corn, are more profitable than what domestic consumers are able to pay, producers will want to export their corn to raise their profit margins. This causes a shortage in the domestic market for corn. The government can restrict the amount of corn that is exported to benefit the domestic consumer.
Do you think you know everything there is to know about imports and exports? We are willing to take a guess that you could learn something you did not know from either of our explanations on them. Have a look:
- Export
- Import
Instruments of Trade Policy
Most of the instruments of trade policy will sound familiar. They are tools that the government uses to implement the trade policy it has decided to use based on its economy's needs. Let's take a look at the major instrument of trade policy.
| Instrument of Trade Policy | Definition |
| Tariff | A tariff is a tax on an imported good or service. There are several types of tariffs such as an ad Valorem tariff which is a tariff based on the value of the good that is being imported. A specific tariff is a fixed per-unit rate that the importer pays on each item. A tariff is used to restrict imports since it raises the price of foreign goods. |
| Import Quota | An import quota is a restriction on the amount of a good or service that can be imported in a set time frame. Under an absolute quota, once the limit is reached no more of the good can be imported. Under a tariff-rate quota, once the quota limit is reached, all goods after that are subject to higher tariff rates.A quota is used to restrict imports by limiting the quantity allowed in. |
| Export Subsidy | An export subsidy is money paid by the government to exporters of a good. Export subsidies can be specific meaning that it pays the exporter for every unit exported or they can be ad Valorem where the government pays the subsidy as a percentage of the good's total value. An export subsidy encourages the export of goods which increases domestic prices. |
| Voluntary Export Restraints (VER) | A VER is an export quota that restricts the quantity of a good that can be exported to another country. They are typically set in place after the importing country requests them. They want to avoid having the importing country set mandatory trade restrictions on the exporting country. A VER is not good for the domestic economy and it is good for the country that is importing the goods. Countries would prefer this voluntary and amiable solution to one that is more inflammatory like a quota or tariff. |
| Local Content Requirements (LCR) | A LCR is a trade policy that mandates that a portion of the goods that producers manufacture be produced domestically. This serves the purpose of reducing a country's dependence on international trade and provides opportunities for domestic production. |
| Other Trade Policies | There are other trade policies such as export credit subsidies, red-tape barriers, and government procurement that serve to benefit the citizens of the nation, be it economically or by protecting their health. |
Table 1. Types of Instruments of Trade Policy
Table 1 goes over the various types of trade instruments that governments use to exact their trade policies. One instrument is favored due to its relative simplicity, the benefits it provides the government in the form of revenue, and that it is a tried and true method of trade. The oldest instrument of trade is a tariff. They have also been used as a form of discipline for nations that the domestic country feels have wronged them through unfair trading practices, political slights, human rights abuses, etc. However, tariffs do cause local prices to increase and may also cause retaliation from exporting countries that rely on the trading relationship with the importing country that set the tariff.
Did you know... That we really only grazed the surface of all these instruments of trade policy? Here are some explanations that will go into more detail:
- Tariff
- Quota
Importance of Trade Policy
So, what is the importance of trade policy? Well, trade in general is vital to the economic well-being of a nation. It provides the citizens of a nation with a greater selection of goods, opens the country up to a larger consumer base where they can sell their goods, keeps prices more stable and insulates the country from a disaster such as a failed crop, and brings in revenue that the country would not be able to generate without trade. Solid trade policies are what keep all of this trade running smoothly and efficiently. Trade policies also support the domestic markets by influencing prices through the regulation of imports and exports. Trade policies that lean towards free trade are the preferred route taken by economists because they theorize that the economy will always strive toward equilibrium and efficiency. Protectionist policies are frowned upon since they disrupt what free trade is trying to achieve because they interfere with the natural flow of the global economy.
Trade Policy - Key takeaways
- A trade policy is a government policy that affects the number of goods and services a country exports and imports.
- Trade in general is vital to the economic well-being of a nation, and trade policies are what keep international trade running as smoothly as it can.
- The two types of trade policies are import and export trade policies.
- There are five main instruments of trade that governments frequently utilize to implement trade policy.
- There are international organizations like the IMF and the WTO that work to support international trade in a fair and sustainable way that benefits all nations involved.
References
- Jamey Keaten, World Trade Organization rules U.S. tariffs on China are illegal, Sept 2020, https://www.pbs.org/newshour/world/world-trade-organization-rules-u-s-tariffs-on-china-are-illegal
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