3 Types of Trade Barriers and their effects

“Complete Free Trade is not feasible. Why? Because it ensures everybody’s general interest and not someone’s special Interest”

- Milton Friendman

 

A hot topic among economic circles is the concept of free trade and the role of Barriers to Trade. Should countries protect their own producers at the cost of another? This article aims to enable answering of that question by bringing the appropriate facts to light.

 

First and foremost, it is important to understand what Barriers to Trade are. A Barrier to Trade can be thought of as a wall between traders of two nations in simplistic terms. In fact, one of the Barriers to Trade is geographical barriers. 

 

Despite all the modern world’s innovations in transportation and interconnection, we are still bound by the forces of nature. Ironic isn't it?

 

Trade Barriers can also be naturally prevalent or induced by businesses. When nations are too far apart to trade or even natural phenomena such as rough seas or weather problems. The term itself simply denotes any obstacle to Trade. They are both facilitators and inhibitors of growth.

 

(Suggested Read - What is Recession?)

 

In the modern world, Trade Barriers are government imposed restrictions on trade between countries or a particular country. Trade Barriers are primarily used to protect domestic producers from foreign competition or to cause economic harm to an enemy nation. 

 

Trade Barriers are most commonly employed by third world or developing nations. Many post colonial nations have poorly developed economies and backward production techniques that cannot compete with international competition. The best example of this practice is India prior to Economic Liberalisation in 1991. 

 

The Licence Raj, as it began to be known as, had extremely high tariffs on foreign goods entering India with huge restrictions on the import of commodities. Indian producers were still not ready to begin competing with foreign enterprises. 

 

Nearly 50 years post independence and an economic crisis that nearly put India in the red got rid of the prevalent system and replaced it with the modern Indian economy.

 

Trade Barriers are also used during Trade Wars, which are the retaliatory practices employed by nations when import tariffs are raised against them by a particular nation. The most notable case of a Trade Barrier would be the China - US Trade war under the Trump Administration.

 

(Speaking of Trade, check out our blog on Principles of Trading)

 

 

Types of Trade barriers

 

1. Natural Barriers

 

Natural Barriers to Trade are those Barriers imposed by Nature or are due to cultural clashes between countries. The most common example of a Natural Trade Barrier would be mountains. Take the case of Afghanistan. 

 

The country is surrounded by mountains to its eastern side. Considering the high cost of aerial shipment of cargo and no natural harbours in the country, the only way to enter is by road. 

 

For nations such as India or China to the east of Afghanistan, crossing the mountains and entering the country is an arduous task. Despite infrastructure projects, it is still difficult to transport goods into the country.

Even if transport is made easy, the problem of distance still exists. For trade to be profitable, a company must be able to produce a good and transport it at a cost lower than any domestic producer. 

 

This makes trade of agricultural goods particularly difficult. For example, cattle reared in Argentina cannot be sold to eastern European countries simply because of the high cost of transport and the geographical distance covered.

 

Another natural barrier would be the cultural barrier. When countries with different languages and cultures interact, there is bound to be either confusion or misinterpretation. Case in point the United Kingdom, who have commissioned studies to show the cost of a language deficiency to exports. 

 

The report revealed that nations sharing an official language have nearly 2 times more trade compared to those who do not. This is an active indication of the importance of linguistics in trade economics.

 

2. Tariff restrictions

 

A tariff is defined as a tax imposed on goods imported. A tariff can either be on a particular country or on a commodity. Tariffs are the most common way of imposing a Trade Barrier to another country. Tariffs are part of a government policy known as Protectionism. 

 

(Related blog - Commodity Trading)

 

Protectionism refers to the government policy of imposing economic safeguards against foreign competition such that domestic producers are not forced to compete with higher technologies and employment not taking a hit due to foreign competition.

Tariffs were the hallmark of Pre Liberalisation India with nearly a 100% tax on almost all foreign goods. Agricultural goods were the most taxed as India began a policy of import substitution. 

 

In this situation, Tariffs proved to be a boon as a growth in Indian productivity with the Green Revolution acting as a catalyst helped make India completely self reliant in terms of food production.

 

However, the same restriction on Capital goods proved to inhibit industrial development.

 

3. Non tariff restrictions

 

These restrictions are any restrictions to trade that are not tariffs. They can include Import Licences, Export Control, Import Quotas, Subsidies, Voluntary export restraints, Embargoes and Currency Devaluation. 

 

• Export Control refers to the governmental restriction of exports of certain commodities during times of stress. The best example of export control would be onions. The onion is famous for threatening the careers of many government officials with its characteristic rise in prices every now and then. 

 

In 2013, the Indian government imposed a total ban on the export of onions to ensure stability in the domestic market.

 

• Import Quotas refers to the policy of only allowing a certain amount of a particular commodity to be imported. For example, if a country only allows 1,000 metric tons of wheat to be imported, it is an import quota. 

 

Import quotas restrict the amount of foreign commodities that can be brought into a country.

 

• Subsidies refer to the practice of partial payment of raw materials by the government. In a subsidy, the government pays a part of the price of the commodity making it easier for producers to make profits as their input costs have decreased.

 

(Related blog - Types of Trading)

 

• Embargoes are comprehensive government bans on trade activity with another country. They are only used in cases of a trade war or poor relations between nations. An Embargo can effectively cripple nations that are dependent on other nations for particular commodities.

 

• Currency devaluation has more to do with foreign exchange rates rather than trade barriers directly. If a currency is devalued, it gives lesser returns on the same value in a foreign currency making imports less profitable and exports more economically viable. 

 

Devaluation, however, is also used to control inflation as well as prevent problems regarding a country’s balance of payments.

 

 

Effects of Trade Barriers

 

Using the above methods, countries may impose trade barriers with wide ranging effects. Economists across the world agree that trade barriers decrease the overall economic stability of the world economy. Trade barriers affect consumers and producers differently. 

 

A trade barrier is never a good thing for a consumer. The law of demand states that as price decreases, demand increases. When trade barriers are imposed, competition is reduced. One of the foremost features of competition is that it helps make prices competitive. 

 

Competitive prices are usually lower. When foreign firms enter the market, they bring with them better resources and more advanced technologies which allows them to undercut prices of domestic producers thus lowering the market rate. Thus, trade barriers increase prices.

 

(Now that we mentioned prices, check out - Pricing Strategies)

 

A trade barrier for a producer can mean different things based on where the producer is located. A producer located in a country imposing a trade barrier will celebrate his heart out at the removal of competition while a producer in a foreign country will be at the receiving end of a rather turbulent board meeting. 

 

Trade Barriers help domestic producers maintain their market share and encourage local firms to expand and take a bigger role without fear of being engulfed by another organisation. Thus, trade barriers can generate economic output and employment within a country and help the people attain self sufficiency. 

 

In conclusion, trade barriers present a hurdle against the policies of globalization and liberalisation. The World Trade Organisation as one of its fundamental objectives aims to remove international barriers to trade and facilitate the concept of a global economy. 

 

Whether or not this is economically viable for nations still rising from their colonial ashes or countries undergoing the socialist to capitalist switch is a concept that will only be seen in the future. 

 

With many countries starting to put their own interests ahead of the collective good, trade barriers seem to be the way ahead. Pushing the world to an isolationist economy can only deepen rifts between nations and must be viewed with a critical eye.