Tariffs, Quotas, Free Trade and Trade Barriers Explained

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What are Tariffs, Quotas and Trade Barriers? How Do they Work? And What is Free-Trade and why is it a good thing?

This video answers all those questions – which are fundamental to understanding some key elements of economics.

Video Transcript:

So what exactly is a tariff?

A tariff is a tax that is paid on imported goods. So let’s say that a supermarket chain buys a particular product from another country to sell in it’s supermarkets. And let’s say that these products cost the supermarket £1 each and have a 10% tariff charged on them.

This means that the supermarket chain would pay the supplier, in another country, £1 for each of these products, and then when the goods arrive, they will pay another 10 pence, for each product, in tax to the Government – that’s the tariff.

Tariffs make imported goods more expensive for consumers to buy. 

Why Impose Tariffs on Imports?

There are a number of reasons why a Government would impose tariffs.

  1. Protect Domestic Producers (Only show this one).
  2. Assist Developing Industries – E.G. if UK decided to create it’s own car industry again.
  3. National Security
  4. Retaliation

If the price of an imported product is increased, due to a tariff, then the price of the same, or a similar product, produced domestically will be relatively cheaper. Therefore people will most likely choose to buy the domestically produced products. So essentially, in this instance, the tariff protects domestic employment and domestic businesses against competition from other countries.

Let’s say that in the future, an independent United Kingdom wanted to again create it’s own large scale car industry, rather than building cars domestically for foreign manufacturers. The UK Government might impose tariffs on imported cars, for a period, to help the domestic car industry build a volume of domestic sales and in so doing, establish a new, sustainable and profitable industry. This new industry could potentially provide livelihoods for many thousands of people employed directly or who worked within the industry’s supply chain.

Tariffs, used in this way, provide a way for nations to develop competitive industries domestically before they are exposed to the full impact of international competition.

There are certain industries such as steel, energy and defence related industries which are often seen as being vital to the state’s interests. If a nation is forced to go to war, then the ability to defend itself will be critical and access to key resources such as energy and steel will be needed to build defensive weapons. In this instance, tariffs are used to prevent cheaper imports flooding domestic markets and wiping out key industries that may have taken generations to build up.

If a nation suddenly introduces high tariffs on a particular product, another nation who relies on exports of the product might retaliate by increasing tariffs on another product that they import from the country in question. Trade wars can escalate when this happens.

Quotas

The use of quotas are another way in which domestic industries may be protected from markets being flooded with cheap imports which might damage or destroy domestic industries. 

Quotas are limits on the quantities of imports of certain goods. A particular product might have a zero or a low tariff imposed on a certain quantity of imports and a higher tariff on imports above the set quota.

Free-Trade

The alternative to tariffs and quotas is free-trade. 

Free trade is generally thought to be a good thing. Free Trade essentially means trade between countries without tariffs, quotas or other restrictions. Consumers get to buy at the lowest prices and producers can sell their products beyond their domestic markets without restriction.

It has long been established that it makes sense for individuals, organisations and nations to concentrate on producing goods and services where they can do so efficiently or, to use the economist’s term, where they have what’s known as, a ‘comparative advantage’, and trade these things with others for the things they need.

Comparative Advantage

Put simply, a person has a comparative advantage at producing something if they can produce it at a lower cost than anyone else. Someone else might have a comparative advantage in the production of some other product or service. So it makes sense that each trade the things that they can produce most cheaply rather than producing them more expensively themselves.

Adam Smith, a scotsman who has been called ‘The father of Economics’ wrote a book in the 1700s known as ‘The Wealth of Nations’ which explained these ideas. 

Adam Smith explained that it would be perfectly possible for Scotland to create it’s own wine industry:

“By means of glasses, hotbeds, and hot walls, very good grapes can be raised in Scotland, and very good wine too can be made of them,” he said.

However, as he went on to point out, the cost of producing this Scottish wine in Scotland’s cold and rainy climate, compared for example, to France’s warm and dry climate would, he calculated, make the wine cost around thirty times the price that it could be bought for from other countries.

Instead of employing a large amount of Scottish labour and capital to produce wine, they should concentrate instead on producing something that they could produce efficiently and trade that across the world.

Like Scotch Whisky for example.

Tariffs and Quotas = Trade Barriers

Tariffs and quotas are very powerful tools that governments use to manage their economies. However, if they and other trade barriers, are used in the long term to protect domestic industries from foreign competition they will often simply maintain inefficient, outdated industries that employ labour and capital, or money, which could be more effectively employed elsewhere.

Rather than those industries being constantly driven to innovate and improve efficiency, by competition from elsewhere, the effect of trade barriers can be to reduce the incentive for those industries to use the best practices, or ways of operating, to be most efficient.

But Tariffs and Quotas are not the only Trade Barriers.

Subsidies

Subsidies are payments made by a Government to help an industry or business keep the price of a product or service low. 

For example, the agricultural industry in France in particular, and across Europe, is heavily subsidised by the European Union. EU Producers are not simply protected from much lower world food prices by tariffs and quotas, they are also receiving tax payer’s money in the form of subsidies.

Essentially consumers in the EU pay higher prices for food and also pay taxes to fund the system of subsidies.

Regulatory Barriers

These are legal barriers such as safety, pollution or product standards or specifications. These often exist to protect consumers from unhealthy or dangerous products but there are also many instances in which regulations are designed to favour particular producers and therefore make it harder for other suppliers to compete.

The European Union

It’s worth mentioning, before we finish, that the European Union Customs Union means that EU member states lose their individual ability to set quotas and tariffs and create regulations or standards when they join the EU. 

As we have seen, these are very important levers of Government used by states to manage their economies. In a future video we will look at Customs Unions, the EU Single Market and economic integration in more detail.

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