Barriers to Trade

Barriers to Trade: Definition

Nowadays, only a few countries have closed economies with little to no international trade volume. Most of the countries in today’s world conduct trade with one another. This constant trade has significantly grown thanks to innovations that have brought down the cost of transporting goods worldwide, such as ships and airplanes.

Now you have goods coming from anywhere in the world into the US, and vice-versa. Although countries benefit from trade and may want to increase their international trade volumes with other countries, there are some limitations to the volume they can trade.

There are many reasons why two countries could face trade barriers. For instance, something simple like the distance between these countries could make it significantly costly for them to trade with one another.

Trade barriers could also result from government policies that aim to reduce the number of imported goods into the country. The practice of protecting domestic industries from imports is known as protectionism. The two main tools used by protectionism include tariffs and import quotas. The bottom line is that anything that impedes international trade is known as a trade barrier.

Types of Barriers to International Trade

There are three main types of barriers to international trade that you should know: tariffs, quotas, and other non-tariff barriers.

Barriers to Trade: Tariffs

Tariffs are taxes imposed on imported goods. These are a common tool governments use to protect their local suppliers from foreign competition. Tariffs work by increasing the price of other countries' goods making the imported goods less competitive. In other words, local goods become more attractive to domestic consumers. Tariffs impact the exporting country by cutting down the demand for their products.

Tariffs also provide a source of revenue for the government. The governments in some countries implement tariffs to increase their revenues because it may be difficult for them to collect taxes otherwise.

Tariffs could also be used for strictly political purposes. As tariffs cut down the demand for the exporting countries, governments can use them to negotiate certain political aspects of their respective bilateral relations.

Figure 1. Import tariff graph- StudySmarter Originals

Figure 1 shows the impact of tariffs on a country that chooses to implement them. Let's assume that it's a country that is importing computers. The autarky equilibrium with no international trade is at price P* and quantity Q*.

Initially, before the tariffs, there was a trade equilibrium at price P1, where the number of computers sold in Q1. Notice that most of the computers are coming from outside as at P1. At price P1, the domestic producers only supply up to quantity Q3, but the domestic consumers demand a quantity of Q1. The quantity gap of Q1-Q3 is filled by imports.

After implementing the tariff, the price jumps up as international suppliers have to raise the price to cover the tariff they have to pay the government. This then takes the price to P2. At P2 the number of computers supplied locally increases to Q4, whereas the quantity of the imported computers drops to Q2-Q4. There is also less quantity demanded in total. The equilibrium with tariff occurs at price P2, where there are Q2 computers sold.

Barriers to Trade: Quotas

Import quotas are a tool the government uses to target the quantity imported of a particular good. In other words, when import quotas are applied, there is only a certain amount of quantity of a good allowed to enter the domestic market.

Figure 2. Import quota graph - StudySmarter Originals

Figure 2 illustrates what happens when the US government decides to impose a quota of 2 million apples.

The price of apples on the international market is $9 and there is a perfectly elastic supply of apples. This means that there are infinitely many apples supplied at $9.

The domestic equilibrium price would occur at $15 if there was no international trade. And if there was free trade, the price would drop to $9. This would cost domestic apple producers $6 per unit of apples sold for the producers that can still supply at this price. Domestic producers would supply only 3 million apples. Other producers would drop out of the market because their production costs would make them lose money if they supply apples at the price of $9.

Let's say that the US government limits the number of imported apples to 2 million. The supply curve will shift out by the quota amount, which is 2 million. The new equilibrium with the quota only brings the price down to $12 instead of $9 in the case of free trade. At $12, domestic consumers demand 6 million apples. The domestic suppliers supply 4 million apples and the remaining 2 million are covered by international suppliers.

The aim of the quota here was to protect the domestic price from falling to $9 and to protect some of the market shares of the domestic apple producers. If the government chose to keep the price at $15, it would have to ban imports of apples into the country entirely.

Other Non-Tariff Barriers to Trade

Other than import tariffs and quotas, governments also use other trade barriers to limit trade between countries. Non-tariff obstacles include regulations, licenses, and sanctions.

Certain governments regularly use non-tariff trade barriers to limit the amount of commerce they undertake with other countries as part of their political or economic strategy. Every obstacle to international trade –including tariffs and non-tariff barriers– impacts the global economy because it restricts or eliminates the functioning of the free market.

The main difference between tariffs and other barriers to trade is that tariffs generate revenues for the government while other trade barriers don't. Alternatives to standard tariffs can significantly influence the amount of international commerce while creating a different monetary impact than standard tariffs.

Barriers to Trade: Licenses

Granting licenses to specific individuals and/or businesses is one non-tariff barrier to trade. This allows only certain people or companies to import goods from other countries. It contributes to significantly reducing the number of goods coming from other countries.

Barriers to Trade: Sanctions

Sanctions are government acts that ban individuals and companies from doing business with a country or certain entities in a country. Sanctions can make it hard for individuals or countries to conduct trade. They are politically motivated, and the most recent examples include the sanctioning of Russian banks by the US government in response to the Ukrainian crisis.

Embargoes are one form of sanctions. These are severe sanctions that completely ban the trade in certain goods or all goods from another country.

Effects of Trade Barriers

Tariffs, quotas, and other trade barriers are great at protecting the local producers of the protected goods. These domestic producers can supply a higher quantity of goods at a higher price. But there are negative effects associated with trade barriers:

• Reduced competition. Barriers to trade aim to protect local producers from international suppliers. This, in turn, reduces the competition in the market, which may cause local producers to be less efficient and less innovative.

• Harm to consumers. Consumers may be harmed as the price of goods that tariffs are applied on increases. This will cause a decrease in consumers’ purchasing power.

• Harm to other domestic producers. Barriers to trade can hurt domestic producers who rely on imported inputs for their productions.

• Potential trade wars. The country to which tariffs are imposed may respond by doing the same thing. This is known as trade wars and harms consumers and producers in both countries as there is less competition and prices of goods increase.

Barriers to Trade: Examples

There are many examples of barriers to trade.

Tariffs, for instance, were quite common during the Trump Administration as he decided to pursue his “America First” agenda, which revolved around ideas of protectionism. Trump signed an act that imposed tariffs on solar panels and washing machines. He applied a 20% tariff on the first 1.2 million washing machines imported and 50% for the subsequent ones in the following year.¹

An example of non-tariff trade barriers includes the UN sanctions on North Korea in 2017.² These sanctions prevented the importing of certain North Korean goods, including diesel, gasoline, and oil. They were intended to keep North Korea from using and developing nuclear weapons.