International Trade Controls

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International Trade Controls









V. STATE TRADINGJ. Carter Murphy



In international economic usage, protection usually refers to acts of government policy which protect an industry from foreign competition, thus enabling the industry to earn higher incomes than it otherwise would. It can also be interpreted more broadly to include all government policies which assist industries that are either competing with imports or are actual or potential exporters. The four main protective devices are subsidies to domestic producers, taxes on imports, quantitative restrictions on imports, and state trading. Taxes on imports are historically the principal device. These taxes are usually called tariffs or customs duties, though sometimes other terms, such as import surcharges or equalizing duties, are used. Tariffs may be classified by motive and by form. Since a tariff will normally produce customs revenue, protect domestic output, reduce consumption of the protected product, and reduce imports, in motive it may be a revenue tariff, a protective tariff, a tariff designed to reduce consumption of a product, or a tariff to improve the balance of payments. The principal distinction is between the first two motives—revenue and protection. In practice, motives and actual effects are usually mixed. Individual tariffs may be classified by form according to whether they are ad valorem (a percentage of the value of the unit), specific (a fixed sum for each unit), or a combination of the two, whether ad valorem percentages are fixed or variable with the price of the import, and whether the tariffs allow for exemptions—for example, of imports destined for re-export.

A tariff schedule is a complicated document consisting often of several thousand different items. Not only may there be a separate tariff rate for each item, but in addition a tariff schedule may have several columns, so that there is more than one duty for each item. Historically, most countries have had at least two columns in their tariff schedules, the distinction being usually between a conventional and a general column, the conventional tariff applying to some or all imports from countries with which a tariff agreement has been concluded and the general tariff to the remaining im-ports. Most trade agreements include the so-called most-favored-nation clause, which provides that (when countries A and B sign an agreement) country A will not discriminate in any tariff item against imports from country B. When countries are linked by a network of trade agreements, all containing such a clause of general application, a system of nondiscriminatory tariffs results. If a country is part of a preferential area a third column will state the preferential tariff applying to some or all of the imports from fellow members of the area, this tariff being normally less than the conventional tariff. If all trade between members of the preference area is free of duty, though each member still has its own tariff on imports from other sources, there is an extreme form of preference area, a free trade area. One step beyond the free trade area is the customs union. As in the free trade area, all trade between the members is free of duty and other trade restrictions, but in addition the members of a customs union have a common external tariff applying to all imports from outside the area. They are in fact a single unit for tariff purposes. [See International INTEGRATION, article On ECONOMIC UNIONS.]

History of protectionism

The history of commercial policies—that is, government policies affecting international trade—is difficult to sum up. Tariff schedules and other instruments of protectionism are complex, and there is no easy way of aggregating the individual elements. Moreover, movements- toward or away from protectionism in different parts of the world have not been synchronized and have had many different causes, some special to particular countries. From the tariff histories of the principal industrial countries there does not emerge a consistent causal relationship to explain why tariffs or quotas were imposed, raised, or reduced at certain times. Much prominence is usually given to the arguments of the advocates and the critics of protectionism, and to the interplay of tariff policy with class or regional divisions. It is not always clear to what extent the arguments provide actual explanations or mere rationalizations of the course of events.

One may also wonder how important specific books and economic theories have been in influencing the course of tariff history. Adam Smith’s Wealth of Nations (1776), Hamilton’s Report on the Subject of Manufactures (1791) and List’s National System of Political Economy (1841) were influential works, the first providing the intellectual support for the British and Continental free-trade movement, and the latter two for protection of infant manufacturing industry in the United States and Germany, respectively. But the British free-trade movement did not get under way until 50 years after the publication of Smith’s book, United States protectionism lagged 25 years behind Hamilton’s Report, while the Zollverein (the German customs union which preceded the establishment in 1871 of the German Empire) had a very moderate tariff, and when Germany did become protectionist after 1880 it was agriculture much more than manufacturing industry that was protected. The influence of “scribblers” was perhaps less than many tariff historians suggest. The legitimization by J. S. Mill in his Principles of Political Economy (1848) of the infant industry argument for protection, while convincing to most English economists, did not have any noticeable effect on tariff history. More recently, the terms of trade argument for protection, in the form in which theoretical economists have given it so much prominence, has made no apparent impact on actual commercial policies.

Some generalizations which may serve as guidefs lines through the tariff histories of the major Western industrial nations are, however, possible. The first is that war often leads to increases in protection. War usually gives rise to additional revenue needs. The revenue duties which are imposed have an incidental protective effect; after the war, when the extra revenue need disappears, the tariff is maintained so as to safeguard the infant industries established under the shelter of the tariff. War leads to a boom in demand for a wide range of industrial goods; after the war, tariffs may be im-posed to compensate for the fall in demand. War may cut a country off from imports and thus provide a form of natural infant protection; after the war, this protection is replaced by tariff protection to ensure survival of the infants. Finally, special measures may be taken in wartime to develop industries producing goods essential to the military effort or to the living standards of a nation cut off from outside supplies. After the war these industries are maintained, both to preserve employment and capital values and in awareness of the strategic argument for protection. The protectionist histories of Britain, France, the United States, and Australia all provide support for this generalization. The beginnings of American protectionism can be traced to the effects of the War of 1812 in protecting infant American industries from British competition. High protectionism in the United States originated in the Civil War. Industry in the North boomed in response to the war-generated demand and naturally created pressures for its survival after the war. More important, the federal government’s revenue needs soared during the war, and the customs were its principal source of revenue (Taussig 1888). Yet when the revenue needs fell after the war, the tariff was not reduced.

Another generalization which sheds some light on tariff history is that depressions, whether of the general cyclical type or long-term depressions in prices of particular products, generally lead to increases in protection. Falling prices automatically increase the protective incidence of specific duties. More important, the principal motive for protection is defensive—to protect sectional income levels from decline—and it is natural that when demand for the products of a country’s industries falls, commercial policy should try to reduce or exclude foreign competition. The revival of protectionism in France and Germany in the late nineteenth century can be explained principally by the depression of 1873-1879 and by the more prolonged fall in agricultural prices produced by the new supplies from Russia and the New World. A great increase in protection all over the world resulted from the depression of the early 1930s. In particular, Britain, which had been completely free trade from 1860 to World War I and remained predominantly free trade during the 1920s, finally became protectionist in 1931.

The converse of these two generalizations is that peace and prosperity usually encourage movements toward free trade. Prosperity and economic growth reduce protectionist pressure. In prolonged prosperity, industries become less dependent on protection and are less likely to insist that a trade barrier be maintained as an insurance against intensified foreign competition in the future. Moreover, prosperity is usually associated with rising prices and thus with automatic decline of the protective incidence of specific duties. Nevertheless, these generalizations do not, of course, explain all changes in tariff policy; for example, they do not explain the very high Hawley–Smoot tariff of the United States, which, though enacted in 1930, was conceived and lobbied for in the prosperous 1920s.

At the risk of some oversimplification, the state of world commercial policies in the 1960s may be summarized as follows. The nonindustrial countries use tariffs primarily for revenue, not protection, purposes. Taxes on trade, whether import taxes, export taxes, or the profits from a multiple exchange rate system, are usually the largest source of government revenue. In the semi-industrial or recently industrialized countries—notably, Canada, Australia, India, Brazil, and Argentina—tariffs or other restrictions on imports are primarily protective in intention and are essential to the preservation of substantial manufacturing industries. The protective tariff rates are usually high, and quantitative controls sometimes prohibitive; yet over-all tariff levels appear moderate because imports which are noncompetitive with domestic production, in particular raw material imports, are usually admitted free of duty. It is in these countries that industrial protection is a major element of economic policy and a topic of debate. In the advanced countries it is agricultural protection which is most important; the rates of protection are often high, varying between countries and products. Many European countries operate complex schemes, involving quantitative restrictions and variable import levies. Industrial protection in the advanced countries is much less significant, and recent years have seen important moves toward the freeing of world trade that affect mainly the trade in manufactured goods between the advanced countries. On the whole, the industrial protection of the advanced counties bears most heavily on “cheaplabor” products, such as textiles from Japan and Hong Kong, in which the advanced countries have lost their comparative advantage. The tariff structures of the advanced countries, as of the semi-industrialized ones, display in general the characteristic of “tariff escalation”: tariff rates rise with the degree of processing contained in a product, basic materials often paying no tariff at all. Finally, in the communist countries the concept of protection as generally understood cannot be said to have any real significance [see Communism, ECONOMIC


Theories of protection

An elaborate structure of economic theory concerned with the gains and losses from protection has grown up alongside the actual ebb and flow of world protectionism—sometimes influencing actual policies, as in the free trade movement of nineteenth-century Britain, and sometimes being influenced by them. The construction of a rigorous case for free trade was one of the earliest contributions of modern economic theory, and the free trade versus protection issue has preoccupied economists of most countries since Adam Smith. Much of this theory has developed out of attempts to refute crude protectionist beliefs or the advocacy of interest groups. To a lesser extent it has given precision and set boundaries to popular arguments. Sometimes it has even produced essentially new propositions.

The method of approach of most economic theorists to the problem is simple. The foundation is the classical case for free trade, first developed by Adam Smith and David Ricardo. The latter originated, in On the Principles of Political Economy and Taxation (1817), the formal law of comparative costs upon which the free trade case is now based. This classical case has been modified by a whole series of “arguments for protection.” While the extent of the modification must depend on the circumstances of each situation, so that, strictly, nothing can be said without specifying situations and relevant magnitudes, it is probably a fair summary to say that most economists regard the free trade case as only modified and not refuted by the various protectionist arguments.

Employment. A perennially popular argument is that protection preserves or increases employment in the protected industries. The free trader’s usual answer is that while employment will certainly be diverted into the protected industries, employment will be less elsewhere; the effect is thus a reshuffling rather than an increase in aggregate employment, a reshuffling into less productive activities which causes a real income loss. Full employment can always be maintained by fiscal and monetary policy along Keynesian lines, together with exchange rate adjustment to maintain external balance. The modern amendment to this free trade logic is that exchange rate adjustment may not be possible for one reason or another, and the internal cost level may be inflexible downward. One can imagine a situation of unemployment and external deficit which ideally calls for exchange devaluation to divert expenditure from foreign to domestic goods. In the absence of exchange rate adjustment, or of substitute protectionist devices, fiscal and monetary policy would have to be used to reduce expenditure so as to restore external balance, thus increasing unemployment instead of reducing it. This result can be avoided by tariffs, which would take the place of devaluation as a device to shift spending from foreign to domestic goods. In this sense tariffs can maintain full employment. But the issue of an optimum pattern of tariffs remains; while various sets of tariffs will raise employment, some will achieve a given employment increase at less cost or a greater welfare gain than others.

A slight variant of the basic employment argument is the “population-sustaining” argument popular in countries such as Canada and Australia, where population growth by immigration is an object of policy and where the inflow of migrants is responsive to employment opportunities. The assumption is made that export demand is expanding only very slowly. To maintain growing employment and external equilibrium it may then be necessary, if free trade is to be maintained, to associate the requisite monetary expansion with frequent exchange devaluations—the latter to prevent the growth of imports exceeding the slow growth of exports. But frequent devaluations may not be possible. One way out is to sacrifice the monetary expansion for the sake of external balance; but this would discourage immigration. The other way out is to sacrifice free trade—to steadily widen the scope of tariffs, or to raise tariffs, as a second-best alternative to frequent devaluation. An essentially similar argument applies in underdeveloped countries where the employment-seeking work force is growing rapidly through natural increase while export demand is growing more slowly.

Income redistribution. A second argument for protection is that it alters the distribution of internal real incomes in a desirable direction. Clearly protection will make the income earners in the protected industry better off, particularly if the service they supply or the capital equipment they own is quite specific to the industry. It is obvious that protection, while usually benefiting some, harms others, notably consumers of the protected products and competing users of labor and materials. These conflicts of interest are at the core of the political activities surrounding tariff making. Opposition to protection in Britain and the United States in the early nineteenth century was founded at least as much on the sectional interests of manufacturers (in Britain) and cotton growers (in the United States) as on any abstract case for free trade. But for a long time the common economic teaching was that while a small section could gain from protection, a large section—such as the aggregate of wage earners—could not, since its gains as protected producers would be more than offset by its losses as consumers. But an interesting theoretical development (Stolper & Samuelson 1941) has shown that, given certain assumptions, a gain to a large group can result. Whether such a redistribution of real income represents a gain or loss in national welfare is a question within the province of welfare economics [see WELFARE ECONOMICS].

The “pauper-labor” argument, which was the protectionist’s stand-by in the United States in the period of the high McKinley and Dingley tariffs of the 1890s and which crops up whenever protection for labor-intensive industries is sought, is a variant of the income distribution argument. Imports of labor-intensive goods do tend to reduce the demand for some types of labor and so lower the real wages of this labor. But it is also true that the gains to other sections of the community from free trade may be so great that the gainers could compensate the losers. Aggregate welfare would then perhaps be maximized by free trade combined with compensation. But if the institutions of the society do not in fact ensure that compensation takes place, who is to say whether there is a net social gain or loss from protection—whether one man’s gain is greater than another man’s loss? Popular statements of the “pauper-labor” argument, however, usually contain fallacious elements. Cheap labor does not necessarily mean low prices for given qualities of product, and low prices for some products do not mean low prices for all. If a country’s labor is really so cheap or efficient that it can sell everything cheaper, then clearly appreciation of its currency is required, though, indeed, tariffs imposed on its products by other countries may be a second-best alternative.

Infant industry. The infant industry argument for protection is the oldest and most respectable of the protection arguments. It has undergone considerable refinement. The main distinction is between the argument based on falling costs, which represent economies internal to firms and the benefits of which are reaped by firms themselves, and the so-called external economies. Support for protection on the grounds of internal economies—that a firm’s costs will fall with increased scale of output or over time—can only be given with reservations or for special cases. For, if a firm will eventually recover its initial losses, why should it require a subsidy, either direct or indirect? Can it not cover these losses from borrowed funds—to be repaid when costs later fall? One can readily think of situations where this is not possible or just would not happen; and in these situations the argument based on internal economies may be valid. Economists have given more attention to the case for protection based on external economies and have refined and classified the possible types of external economies. Most interesting are the external economies that are generated with the over-all growth of a manufacturing sector—economies external to the individual firms making up the sector, although internal to the sector as a whole. These economies provide the main justification for a general policy of industrial protection in countries which are semi-industrialized or show potentialities for industrialization. The discussion about the virtues, or otherwise, of a policy of balanced growth is closely related. This concept hinges on the interdependence of industries, especially of the different industries making up a manufacturing economy, an interdependence through both demand and supply. Any individual firm or industry may not find it profitable to expand, but if all expand together, maintaining some appropriate relation, they will all turn out to be socially and perhaps even privately profitable (Nurkse 1953). Against this must be set the advantages of unbalanced growth, among them the economies of specialization and the benefits to be derived from trade. A lively controversy is here unresolved.

Terms of trade. A country which restricts its trade, either by import tariffs or by export taxes, is likely to improve its terms of trade as a result. Restriction of demand may lower the prices at which foreign suppliers provide imports, and restriction of supply may raise export prices. On balance the gains from the terms of trade improvement may outweigh the losses from the country’s reduced use of the international division of labor. A country, in fact, can act as a monopsonist or a monopolist. This is the terms of trade argument for protection. The element of gain which a country derives is at the expense of its trading partners, whose terms of trade will decline. Much elaborate theory has been spun around this general proposition, and it has yielded the concept of the “optimum tariff”—optimum to one country and not the world. Account has been taken of the possibility that other countries will retaliate against an “optimum tariff.” If so, the terms of trade improvement may disappear and all countries may finally be worse off; although it is at least possible that when both countries restrict trade optimally, each responding to the other’s restriction, on balance one of them may still finally be better off than before the whole exercise began. The terms of trade argument in the form in which it appears in the theoretical literature has not been of much practical significance. But in the process of growth countries have sometimes chosen to develop import-competing rather than export industries for fear that their terms of trade would otherwise deteriorate, and industrial protectionism in primary-product exporting countries is rooted to some extent in a belief in the price-inelasticity of demand for their exports.

Second-best policies. In underdeveloped countries the average income in the industrial or the “Westernized” sector of the economy is usually higher than that in the agricultural sector. There are various possible reasons for this; and to some extent the discrepancy may be only in money income and not real income. But it has been argued recently that insofar as there is a discrepancy not only in average real incomes but also in marginal returns—that is, insofar as a transfer of labor from the agricultural to the industrial sector would raise aggregate real income—protection of the advanced sector to encourage this labor transfer may be justified. This argument for protection needs to be carefully qualified and is not accepted without reservations. But it is interesting as an argument which is more or less special to under-developed countries. It is really a particular case of what has lately been recognized as a much larger category, the second-best argument for protection (Meade 1955). This argument applies whenever there is some distortion or disequilibrium in the internal economy, so that prices do not correctly reflect marginal costs. One remedy would be to eliminate the distortion directly; another would be to compensate with internal subsidies and taxes. But the politically and administratively most convenient remedy is often to compensate the distortion through carefully chosen commercial policies, such as tariffs. This is a second-best remedy because in compensating indirectly for internal distortions it creates new distortions—for example, in consumption patterns.

In a sense all the arguments for tariffs so far discussed are second-best arguments, justified by the impracticability of the “first-best” policies. It can be held that the best policy to maintain full employment is to combine fiscal and monetary adjustment with exchange rate variations. Internal incomes are best redistributed by nontrade taxes (such as income taxes), which finance direct subsidies. Infant industry protection is best provided by direct subsidies which benefit infants irrespective of whether they are import-competing or potential exporters. And the income of one country can be raised at the expense of another by direct international aid, so avoiding the trade-restricting effect of the optimum tariff. Yet to subsume all these arguments into a single second-best argument is to ignore the distorting by-products and administrative costs of what appear on the surface to be first-best policies.

Economic growth. Is there a special argument for protection on the grounds that it facilitates or stimulates economic growth? While the growth of the protected industries will no doubt be stimulated, the question is whether the over-all growth of the economy would have been less under free trade. Part of the answer is in the infant industry argument for protection: infant protection can be summed up as the incurring of a current loss for the sake of a future gain; if the expected future gain is indeed realized, then growth will have been fostered, although the issue still remains whether the current costs of this growth justify the future benefits. Another part of the answer is in the employment, or demand-generating, argument for protection; the incentive to invest will be lower in an underemployed than a fully employed economy. If protection is really needed to maintain full employment it also stimulates growth. There remain two ways in which protection can raise or lower growth rates. First, it may redistribute internal incomes toward or away from sections with a relatively high propensity to save; for example, savings out of industrial profits are generally higher than out of peasant incomes or out of rents, so that industrial protection tends to foster savings. Second, protection may raise the inducement to invest by increasing some or all profits or by reducing the risk element in investment. Thus investment is usually more responsive to profit increases in some than in other industries, so that protection of particular industries at the expense of other industries may affect the over-all growth rate. Furthermore, protection may bring about an over-all redistribution of real income away from wages or rents and toward profits, and so stimulate investment. A particular case of these relationships is the role of high and secure profits in protected industries in attracting foreign capital inflow. In all these cases the returns from growth may or may not outweigh the costs of protection.

Methods of protection. All these arguments for protection do not distinguish between the methods of protection. There exists a fairly simple body of subsidiary analysis to assist the choice between the main methods—subsidies, tariffs, and quantitative import restrictions. Economists have tended to prefer the methods in that order—to prefer subsidies to tariffs because they distort only the production pattern and not the consumption pattern, and because their “cost” is more clearly apparent; and to prefer both subsidies and tariffs to quantitative import restrictions because of a predisposition in favor of the price mechanism and because of the monopoly profits that may be reaped under a scheme of quantitative restriction by holders of licenses to import. But beyond general arguments for protection and the broad choice of method, economic theory has provided little help in the construction of protective systems. We have seen that tariff schedules are usually complicated documents and that tariffs may assume many forms. The complexities in the tariff systems of most countries result from the piecemeal way, usually in response to numerous sectional pressures, in which tariff systems are constructed and amended and from the mixture of motives at work. One aim is often to tailor a tariff precisely to the object in view— for example, to achieve the desired protective effect with the minimum rise in prices to consumers and thus with the minimum incidental revenue effect. It is the pursuit of this aim which leads tariff makers in some countries (for example, Australia) to make detailed comparisons of production costs between countries and to construct complex tariffs which are finely adjusted to the estimated cost differences for those products which they have resolved to protect. But economists have not subjected the details of tariff making and the logic behind tariff structures to the same thorough analysis as they have the welfare effects of protection as a whole.

Measurement of protection

Increasing attention is being paid to the need to measure the magnitudes and effects about which economists generalize. The various exercises in measurement connected with tariffs may be classified as follows.

First of all, specific tariff rates and nontariff protection must be converted into ad valorem equivalents if one tariff or protective device is to be comparable with another. A problem is to discover the typical or “average” price to which each specific tariff rate applies. In the case of nontariff devices, the object is to discover the net result—the excess of the price received by the producer over the price of potential imports, expressed as a percentage of the latter. The main difficulty here is similar—to establish the prices of potential imports in those cases where actual imports have either been completely excluded or are unrepresentative of free-trade imports. A second step is to relate tariff rates to value added domestically rather than to the gross value of domestic output (which includes imported materials) and to allow for tariffs on imported materials. Such calculations yield effective protective rates (Barber 1955). For example, an apparent tariff rate of 10 per cent on cotton yarn will represent effective protection of 20 per cent when half of the yarn value (before duty) is raw cotton content, which would pay no duty if imported in that state. If the tariff on raw cotton were also 10 per cent, then the apparent and effective protection for yarn would both be 10 per cent. Calculations of effective protective rates are needed to determine the true impact of a protective system on an economy but have only recently been made systematically. They require detailed knowledge of the materials content in protected industries.

A further step is to calculate averages of tariff levels. Since one must sometimes sum up complex tariff schedules if one is to generalize at all, averages of tariff levels have frequently been calculated, though not always with awareness of the methodological traps. These averages usually refer to apparent, not effective, rates. The simplest and commonest method is to relate customs revenue to the value of total imports. The result is an average weighted by the value of imports after tariffs have been imposed. The higher a tariff, the more imports will be excluded, so that this method underweights the high tariff items. Indeed, a particular tariff which is so high as to be prohibitive will not enter the index at all. To avoid this bias, “unweighted” averages—that is, arithmetic averages of tariff rates—are sometimes calculated. The result then depends on the method of tariff classification and really has no coherent meaning. Yet another method is to weight by the value of the domestic production of items to which tariff rates apply. A practical difficulty here is that tariff classifications usually do not coincide with classifications of production statistics. This method in a sense yields the average, not of all tariffs, but only of the protective tariffs. It might be regarded as yielding an overstatement since it does not allow for items where there is no tariff but where a protective tariff could have been imposed. Other methods are to weight by consumption (imports plus domestic production) after tariffs have been imposed, to weight by the value of world trade, or to weight by the value of exports from some leading supplying countries. These latter methods are all approximations to what is often regarded as the preferable weighting system, namely, weighting by what imports would have been in the absence of tariffs. In fact, no method is ideal, since an average tariff, however calculated, cannot be a measure of the welfare or other effects of the tariff structure. Indeed, since the dispersion of tariffs has welfare implications, the use of a single figure to represent a complex tariff system may tend to obscure important implications.

Yet a further step is to estimate the effects of tariffs on output and employment (Salant & Vaocara 1961). The primary and the secondary effects of tariff imposition must here be distinguished. The primary effect consists of the direct rise in output or employment, when cost and exchange rate levels are given and when possible multiplier repercussions of the rise in incomes due to the initial rise in output are disregarded. It includes not only the effect on output and employment in the protected industry itself but also in industries which supply materials and components to it. The secondary effect allows for further repercussions. One possibility is that over-all employment and external equilibrium are maintained by exchange appreciation or by a rise in internal cost levels associated with the tariff increase. These adjustments would somewhat reduce employment in the newly protected industries. The other possibility is that the primary employment effect is not offset by deliberate policies—whether of exchange adjustment, cost adjustment, or demand reduction by fiscal or monetary policies—and is instead allowed to set off a multiplier process. A secondary rise in employment or in prices must then be added to the primary increase in employment.

Recently economists have become interested in the measurement of the welfare effects of protection (Corden 1957). The methodological problems involved are considerable. What is welfare? What is the precise configuration of the alternative situation with which the protection situation is being compared? The “cost” of protection, presumably, is the excess of free-trade welfare over protection welfare. How are changes in the distribution of income due to protection to be incorporated in the welfare measure? The simplest approach is to assume full employment in both situations, hold the terms of trade constant, ignore income distribution effects, and assume that free trade represents an optimum in the neoclassical sense. The cost of protection then results from a distortion of production and a distortion of consumption, both of which can be approximately measured, provided the effects of protection on the quantities produced and consumed are known or can be estimated.

An interesting approach is to measure what has been called the cash cost of protection, namely, the value of the production subsidy which would be needed to achieve a protective result equivalent to that of tariffs or other trade restrictions (Young 1957). This cash cost is the excess of the value of protected output over the value of duty-free equivalent imports (at the current exchange rate). It has been estimated for Canada and Australia. It states the cost of protection in the same form as the costs of other subsidizing activities of the government are stated. It is thus not a net social cost; rather it is a gross cost against which the various benefits of protection must be offset.


[See alsoInternational Trade.]



Hamilton, Alexander (1791) 1893 Report on the Subject of Manufactures. Pages 1-107 in Frank W. Taussig (editor), State Papers and Speeches on the Tariff. Cambridge, Mass.: Harvard Univ. Press.

List, Friedrich (1841) 1928 The National System of Political Economy. London: Longmans. → First published in German.

Mill, John Stuart (1848) 1961 Principles of Political Economy, With Some of Their Applications to Social Philosophy. 7th ed. Edited by W. J. Ashley. New York: Kelley.

Ricardo, DAVID (1817) 1951 Works and Corresponddence. Volume 1: On the Principles of Political Economy and Taxation. Cambridge Univ. Press.

Smith, Adam (1776) 1950 An Inquiry Into the Nature and Causes of the Wealth of Nations. 6th ed. 2 vols. Edited, with introduction, notes, marginal summary, and enlarged index, by Edwin Cannan. London: Methuen.


Barber, Clarence L. 1955 The Canadian Tariff Policy.Canadian Journal of Economics and Political Science 21:513–530.

Bhagwati, Jagdish 1964 The Pure Theory of International Trade. Economic Journal 74:1–84.

Corden, W. M. 1957 The Calculation of the Cost of Protection. Economic Record 33:29–51.

Haberler, Gottfried (1933) 1936 The Theory of International Trade, With Its Applications to Commercial Policy. London: Hodge. → First published as Der Internationale Handel

Meade, James E. 1955 The Theory of International Economic Policy. Volume 2: Trade and Welfare. Oxford Univ. Press. → See also the Mathematical Supplement.

Myint, Hla 1963 Infant Industry Arguments for Assistance to Industries in the Setting of Dynamic Trade Theory. Pages 173–193 in Roy F. Harrod and Douglas C. Hague (editors), International Trade Theory in a Developing World: Proceedings of a Conference Held by the International Economic Association. London: Macmillan; New York: St. Martins. → A discussion of Myint’s paper appears on pages 462–471.

Nurkse, Ragnar (1953) 1962 Problems of Capital Formation in Underdeveloped Countries. New York: Oxford Univ. Press.

Stolper, Wolfgang F.; and Samuelson, Paul A. (1941) 1949 Protection and Real Wages. Pages 333–357 in American Economic Association, Readings in the Theory of International Trade. Philadelphia: Blakiston.


Benham, Frederic C. 1941 Great Britain Under Protection. New York: Macmillan.

Haight, Frank A. 1941 A History of French Commercial Policies. New York: Macmillan.

National Institute Of Economic And Social Research 1943 Trade Regulations & Commercial Policy of the United Kingdom. Cambridge Univ. Press.

Salant, Walter S.; and Vaccara, Beatrice 1961 Import Liberalization and Employment: The Effects of Unilateral Reductions in United States Import Barriers. Washington: Brookings Institution.

Taussig, Frank W. (1888) 1931 The Tariff History of the United States. 8th ed. New York: Putnam.

Woytinsky, Wladimir S.; and Woytinsky, Emma S. 1955 World Commerce and Governments: Trends and Outlook. New York: Twentieth Century Fund. → See especially Chapter 6 on “Tariffs, Trade Agreements and Trade Restrictions.”

Young, John H. 1957 Canadian Commercial Policy. Ottawa: Royal Commission on Canada’s Economic Prospects.


Subsidies on exports are any payments, direct or indirect, to producers resulting in export prices that are below domestic prices. Used in this sense we can say that exports of a number of American farm commodities are subsidized. The same is true whenever an exported good is freed from domestic indirect taxes.

An export subsidy has much in common with an ordinary subsidy placed on the production of an exportable good. Both tend to increase the production of the good in question and to raise its volume of export, but the former generally reduces domestic consumption (unless there are important economies of scale), while the latter increases both exports and home consumption. [SeeSubsidies.]

The related but more emotive and less precise term “dumping” gained currency some time before World War I. As defined by Viner (1923), dumping refers to any reduction of foreign price below domestic price where such difference is not due to actual differences in cost of selling, production, or transportation. A firm may sell the same good abroad at a lower price than at home because foreign competition is more intense or its market position is less well established. Such price behavior has been explained in terms of the discriminating monopolist, who maximizes profit by adjusting markup in each market to the elasticity of demand. But there is no precise theory to describe the behavior of firms attempting to break into new markets, or to defend existing markets against aggressive newcomers. These price reductions may be hidden in quality differentials, spurious quantity discounts, or favorable credit terms. Governments may support lower prices for exports by means of special freight rates, tax rebates, direct subsidies, or even special treatment of business combinations entered into for foreign trade purposes.

Official policies and business practices

International agreements

Governmental views on direct or indirect subsidies for exports are ambiguous. International economic agreements of the post-World War II period and the organizations based on them have taken positions against discriminatory business practices in international trade. The abortive Havana Charter for an international trade organization contained an explicit condemnation of such practices. Its successor, the General Agreement on Tariffs and Trade (GATT), took over many parts of the Havana Charter but omitted the section dealing with discriminatory business practices. However, a GATT committee of experts has condemned dumping practices and approved antidumping duties. Curiously, they did not regard tax exemptions for exports to be a dumping device. The treaties establishing the European Coal and Steel Community (ECSC) and the European Common Market also deal with discriminatory business practices, including dumping. The ECSC especially has made important progress in eliminating the discrimination in pricing and freight charges formerly so common in both coal and steel.

On the other hand many countries, including the United States in the Webb–Pomerene Act of 1918, have legislation exempting business from prosecution for concerted actions in foreign trade, which would otherwise fall under antitrust laws.

Cartel practices

The interwar period saw an increase of business agreements to divide markets, exchange patents, and regulate prices. Overcapacity in numerous industries, changed political boundaries, and confiscation all created a climate conducive to protective arrangements among business firms. Mason (1946) reported the existence of private cartel agreements in such technical products as chemicals, electrical products, pharmaceuticals, and optical glass. A second group of agreements, mainly private but with government participation and support, included cement, steel products, tin plate, cables, dyes, paper, linoleum, plate glass, and numerous other products. A third group, usually with government participation and sometimes exclusively governmentally regulated, included rubber, tin, oil, kapok, sulfur, asbestos, tea, cocoa, coffee, quebracho, quinine, nitrates, aluminum, copper, sugar, lumber, phosphates, potash, and wheat.

The effect of any such agreement on price stability and price uniformity depends, of course, on the nature of the agreement. In the case of the first two groups, cartel arrangements often divided markets and tampered with prices. Home market prices were sometimes higher and sometimes lower than export prices; internal prices in producing countries differed considerably from one another. Stocking and Watkins (1946) give the dramatic examples of aluminum, electric light bulbs, magnesium, and steel, where clear evidence of discriminatory pricing existed. On the other hand, agreements on primary commodities probably had beneficial effects in maintaining orderly markets. Without them, individual governments might well have had stronger reason to interfere with free markets than they already had [seeCartelsAndTradeAssociations; CommodityAgreements, International].

U.S. antidumping laws

U.S. legislation against dumping began with the tariff act of 1890, which provided a countervailing duty against export bounties by other countries on sugar. There followed the antidumping acts of 1916 and 1921. The latter is still in effect and gives the secretary of the treasury administrative responsibility for determining cases of dumping and imposing countervailing duties. Both excise tax refunds and exchange controls have been taken as justification for countervailing duties. However, at present only some dozen commodities are in fact subjected to countervailing duties. The determination of injury to domestic producers (one prerequisite for a remedial duty) has since 1954 been delegated to the U.S. Tariff Commission. A difficult point in applying the law is determination of the “fair value” of a good suspected of being imported and sold below such price. For this purpose either foreign market price or estimated cost of production is used. The determination procedure at present requires an average of eight to nine months, during which time all goods of the category in question are prevented from entering the United States.

U.S. agricultural policy and dumping

The export-dumping aspect of U.S. agricultural policy merits special attention. Under the Agricultural Adjustment Act of 1935 a part of customs revenues was earmarked for agricultural programs, including subsidies for the export of cotton and wheat. Since 1949 these subsidies have been used mainly for fruit. The subsidy is paid directly to the commercial exporters and covers the difference between domestic and export price. More important by far are the Commodity Credit Corporation (CCC) sales under the Agricultural Act of 1949 (section 407) and later acts. Export sales by the CCC, usually at less than “support” prices, have included cotton, wheat, corn, peanuts, butter, cheese, dried milk, grass and cover-crop seeds, and a number of oils. The CCC’s price-support losses to the end of 1961 totaled $2,200 million (not including the dairy program). A large part of this loss has been suffered through its export program, since domestic sales are at support price plus 5 per cent. [SeeAgriculture, article onPriceAndIncomePolicies.]

Economic evaluation

Import and export subsidies

Only in recent decades have economists appreciated that the longrun effects of export and import subsidies are substantially the same. If a payment is made to encourage imports, resources are ultimately shifted out of import-competing home industries and into either the domestic or the exporting sectors. It is, however, necessary to depreciate the currency-exchange rate or lower domestic prices relative to foreign prices, in order to bring this shift about while maintaining external balance. Ultimately the value of both exports and imports are then increased in the same proportion, and the terms of trade altered in the same degree against the subsidizing country.

The foregoing stands in sharp contrast to most official views on the subject. Generally, export subsidies have acquired a bad name and are considered a legitimate cause for retaliation against the offending country. On the other hand, most countries would welcome enthusiastically any subsidy on imports put on by one of its trading partners.

Effects on world efficiency

The economist generally advocates measures which increase world trade because these improve the division of labor between countries. Such a view, however, needs a good deal of qualification. Reducing tariffs in an across-the-board, nondiscriminatory fashion tends to shift production to places of lower cost and thus increases world output. Such shifts are worthwhile so long as any differences in cost exist (making the appropriate adjustment for cost of transportation). Subsidies are more difficult to evaluate because they exist side by side with tariffs and other restrictions on trade. If there were no other distortions of the market we would conclude that subsidies worsen the allocation of resources because they encourage production in higher-cost places. Pushing trade beyond the level reached by a free market actually reduces world output, but where restrictions on the international flow of the same goods exist, subsidizing their movement by the exporting country tends to cancel the effect of the restriction. On the other hand, if the restrictions were mainly on trade in manufactures and the subsidies were mainly on farm commodities, the latter would tend to worsen the misallocation of resources already present [seeInternationalTradeControls, article OnTariffsAndProtectionism].

An additional complication is introduced by the fact that manufacturers often sell at a monopolistic price on protected domestic markets and at a lower one on foreign markets. If the degree of monopoly is higher in the domestic sector in question than in the rest of the domestic economy, the effect is for home consumption to be less than it would be under competitive pricing. On the other hand, the low export price tends to bring total output of the industry back toward where it should be, i.e., nearer where it would be under competitive conditions. The misallocation then may be mainly on the consumption side: consumers are paying different prices and could all be made better off if exchange among them were allowed to the point where all face the same set of relative prices. The point of this example is that to eliminate export dumping without lowering the domestic price of the dumped good may not bring any improvement of resource allocation. It may well bring about a less efficient allocation of production and put the world on a lower production-possibility curve.

We should consider also the question whether exemption of exports from sales and excise taxes amounts to a subsidy. The U.S. Treasury believes that it does, while GATT has stated that it does not. If domestic indirect taxes were the same proportion of price for all goods sold at home (and we neglect the abstruse problem of different substitutabilities between goods and leisure), then clearly an exemption from tax destroys the proportionality between prices and marginal costs. But the complexity of tax systems, not to mention imperfections of the market, makes the assumption of proportionality between prices and marginal costs highly questionable. One can therefore sympathize with the view of the GATT experts because exemption for exports may in some cases improve allocation.

We should emphasize that the foregoing arguments are made from the point of view of world efficiency and not from the national welfare point of view. Less interference with trade generally means that the world gets onto a higher production-possibility curve, i.e., it can, for the same combination of goods demanded, produce more of everything with the same productive effort. Removing all tariffs and subsidies, even if gradually, means the possible elimination of some national industries, reduced incomes for some groups in a nation, and perhaps worsened terms of trade for certain nations. Others must, however, become better off, and subject to some qualifications, those who gain could, if required, compensate those who lose. But compensation is seldom carried out in practice, so that who are the beneficiaries and who are the losers from an improvement of trade becomes an important question. [SeeInternationalTrade, article onTheory.]

Development argument

An interesting economic argument for subsidies on exports is based on the infant-industry idea. One can protect a budding but not yet competitive industry that has export potential either by artificially raising the prices of competing imports or by lowering, via subsidies, the prices of the potential export goods. If the domestic market is large, tariffs may have the advantage of providing revenues—and this is an important consideration for undeveloped countries—and they may, in addition, favorably affect the terms of trade. If the domestic market is small a subsidy on exports, financed perhaps by means of a duty on the import of the same goods, has the advantage of opening a wider market for the industry. This permits a scale of production great enough for any potential economies of scale to be realized. The subsidy may have the additional political advantage of being both visible and inconvenient to the finance ministry; it may thus be a degree easier to remove when it is no longer necessary to an industry’s survival.

In the case of many undeveloped countries this argument is strengthened by the presence of unemployed reserves of labor. The limited supply of agricultural land makes their effective employment in farming impossible. The social opportunity-cost of employing such labor in a newly established industry, even when counting capital costs and all costs of transferring labor, is less than private cost, if not by the whole amount of direct labor cost. Thus, even if no economies of scale were expected, there is justification for artificially lowering private money costs of production to something approaching estimated social cost.

The development of particular industries generally leads to (and indeed requires) a good deal of social infrastructure—housing, streets, schools, railroads, port facilities, electric power, communications, water, waste disposal, and so forth. This same social capital, which is an initial barrier to industrial development, provides the base for broad advance on many industrial fronts. Once this stage is reached costs may well become competitive in a number of activities at once, and the gradual removal of subsidies would lead not to a return of labor to agriculture or to inactivity but to a shifting of resources among a number of alternative industrial and service activities [seeCapital, SocialOverhead].

Need for foreign exchange

An immediate reason for subsidies on exports may be a shortage of foreign exchange due to domestic inflation combined with a fixed exchange rate. The subsidy may take the form of permitting exporters to surrender their foreign-exchange earnings at a premium rate. The existence of such a premium over the official parity is not, however, sufficient evidence for the existence of a subsidy. For example, Indonesia has for several years allowed exporters to sell foreign-exchange proceeds at higher than the official rate but has levied at the same time a tax on the exporters’ “profits” from the transaction. In effect, importers were paying a higher price in local currency for foreign exchange than exporters received. This transaction amounted not to a subsidy but to a tax on trade—it is immaterial whether it be regarded as a tax on exports or on imports, since the ultimate effect of either is to reduce foreign trade. If there had been a subsidy on trade, this fact would have been evidenced by exporters receiving a higher price for their foreign exchange than importers paid—with the treasury paying out the difference. In general, a good rule of thumb for determining whether a country is on balance taxing or subsidizing trade is to see whether its treasury is receiving in duties more than it pays in subsidies or the reverse. Complications are added, however, under exchange rationing with more-or-less pegged rates. In that case, trade restriction is reflected partly in importers’ profits rather than in tariff receipts.

Employment effects

In the 1930s export dumping gained disrepute for a reason which has since receded into the background. Foreign-exchange difficulties and severe unemployment both increased the temptation for governments to increase exports by artificial means and heightened the damage to other countries in similar difficulties. What were called “beggar-my-neighbor” remedies included such devices as export subsidies, import restrictions, and currency devaluation. At a time when policies to cope with unemployment were not mastered by most governments, the response to exchange difficulties was often to depress domestic activity further through tightening of credit and budgetary stringency. Countervailing restrictions on imports as a remedy for the external imbalance were common; in consequence the world found itself both with depressed employment and severely restricted trade.

The precise employment effects of export subsidies are difficult to trace in all detail. For the subsidizing country there is an initial expansion of activity in the exporting industries, with multiplier ramifications in the rest of the economy. In the importing countries there is a downward multiplier process to the extent that the additional imports displace home production, while in competing exporter countries there is a downward multiplier process through the displacement of exports. The impact on employment in the importing country may be small if the substitutability of imports for home-produced goods is slight and could even be favorable through the positive effect of improved terms of trade and real income.

In the postwar era, when unemployment has only occasionally been a problem, and then a manageable one, it has been balance-of-payments considerations and special domestic interests which have dominated government attitudes toward export dumping. There has, however, been one case, that of West Germany in the 1960s, where hyper-full employment and a rising price level have been used as arguments for measures to increase imports and discourage exports.

Despite the many domestic and international market imperfections that make prescription on a single issue so difficult, a few general things can perhaps be said. In conjunction with more vigorous antitrust policy in the United States, an entirely new antitrust climate in Europe, and a general tendency toward less restriction on trade, the elimination of dumping will generally improve the allocation of resources. But given the particular interests involved, especially in agriculture, and the difficulties of uncovering discrimination when it exists, progress will be slow. Finally, export subsidies may have a definite place in furthering the development of industry in underdeveloped countries and therefore are a valid exception to the policy of removing interferences with trade.

Franz Gehrels


[Burenstam] Linder, Staffan 1961 An Essay on Trade and Transformation. New York: Wiley.

contracting Parties To The General Agreement ON Tariffs AND Trade 1958 Anti-dumping and Countervailing Duties. Geneva: The Contracting Parties.

Ehrenhaft, Peter D. 1958 Protection Against International Price Discrimination: United States Counter-vailing and Antidumping Duties. Columbia Law Review 58:44–76.

Lerner, Abba P. (1936) 1953 The Symmetry Between Import and Export Taxes. Pages 123–133 in Abba P. Lerner, Essays in Economic Analysis. London: Macmillan.

Mason, Edward S. 1946 Controlling World Trade: Cartels and Commodity Agreements. New York and London: McGraw-Hill.

Meade, James E. 1951-1955 The Theory of International Economic Policy. 2 vols. Oxford Univ. Press. → Volume 1: Balance of Payments. Volume 2: Trade and Welfare.

Robinson, Joan 1949 Beggar-My-Neighbor Remedies for Unemployment. Pages 393–407 in American Economic Association, Readings in the Theory of International Trade. Philadelphia: Blakiston.

Samuelson, P. A. 1962 The Gains From International Trade Once Again. Economic Journal 72:820–829.

Stocking, George W.; and Watkins, Myron W. 1946 Cartels in Action: Case Studies in International Business Diplomacy. New York: Twentieth Century Fund.

U.S. Commission On Foreign Economic Policy 1954 Report to the President and the Congress. Washington: Government Printing Office. → Commonly known as the Randall Commission Report.

Viner, Jacob 1923 Dumping: A Problem in International Trade. Univ. of Chicago Press.


Quantitative restrictions represent one of several policy instruments for dealing with problems of international trade and payments. Other instruments include tariffs on exports and imports, variations in the exchange rate, and monetary and fiscal policies.

In principle, restrictions can be placed on both current and capital transactions between countries. The transfer of capital, for example, can be controlled; this is a typical example of restrictions on capital account. This article will, however, focus on quantitative restrictions on commodity trade entering a country’s current international accounts.

Construed in this way, quantitative restrictions represent the method of controlling foreign trade through quantitative specification of permissible imports (or exports). Hence these restrictions differ from tariff duties, which aim to control imports (or exports) by operating directly on the price at which commodities are imported (or exported).

Quantitative trade restrictions are imposed, in practice, on both exports and imports. However, those on exports are relatively rare. Recent examples are the quotas on exports (e.g., of cotton textiles) that Japan has applied to avoid the opprobrium of dumping and the quotas on certain agricultural exports (e.g., of oilseeds) that India has used to preserve internal supplies.

Import restrictions are imposed in a large number of ways. Where government purchases are involved, imports may be restricted without the need for any explicit licensing procedure. With private-sector imports, however, an import licensing system becomes inevitable.

Import licenses can take several forms. They may be stated in terms of value or in terms of physical quantity. There may, in addition, be an explicit over-all quota defining the maximum amount of the commodity permitted to enter the country during a specified period. Alternatively, licenses may be issued that specify particular quantities to be imported, without any over-all quota for the commodity. Frequently, all commodities are nominally put under import control, but some are permitted in automatically and without limit under a so-called open general license—as in the United Kingdom and India recently. In such cases licensing is not at all restrictive.

Import restrictions can be uniformly levied on all imports, or they can be discriminatory. The discrimination can be between different supplying countries. Alternatively, it may be between different commodities. These distinctions sometimes overlap, as when the discrimination is between two commodities each of which is exported by a different country. Indeed the practice of assigning quotas (as also tariffs) by detailed commodity categories has been criticized as an underhand method of evading most-favored-nation and nondiscrimination obligations. Import restrictions also discriminate frequently by currency areas, rather than by individual countries per se.

Import licenses are allocated to domestic importers in various ways, depending on convenience of administration and the economic objectives sought. Two steps are involved in the allocative process. The first is the classification of imports into different categories. Second, procedures have to be devised for allocating the permissible imports within each category to the various claimants.

The classifications vary from country to country. Thus one typical classification, used in India, divides import licenses into “established importers” (El), “actual users” (AU), and “capital goods” (CG). Imports of consumer goods and spare parts require El licenses, allocated to traders. Raw materials are imported through AU licenses, allocated to producers using them in their factories. Capital goods are imported through CG licenses, allocated to investors with approved projects.

The procedures for the actual allocation to the claimants within each category vary widely again. El licenses may be allotted on the basis of previous shares of the traders; AU licenses, on the basis of respective production capacities. Allocations on the basis of “first come, first served” have been practiced, as in the United Kingdom (Hemming et al. 1959). Import licenses for raw materials and other goods are sometimes linked to resulting exports, as in India and Pakistan recently. Allocation by auction has been suggested—on the grounds of economic efficiency and revenue collection (Bhagwati 1962).

History and present use

The use of quantitative trade restrictions in international trade dates back to early times. However, since the original motivation in regulating trade appears to have been the collection of revenue, tariff levies on imports and exports preceded the rise of quantitative restrictions. Tariffs came to be supplemented significantly by quantitative trade restrictions when the objective of regulating trade became that of protecting domestic industries and improving the balance of payments.

While the use of restrictions diminished between 1750 and 1850, it was revived after World War I and intensified thereafter. Since World War II, however, the General Agreement on Tariffs and Trade (GATT) has attempted to turn the tide. In this, GATT has benefited from the similar objectives of the International Monetary Fund (IMF) with respect to exchange restrictions. (See Tew 1960 for contrasts and parallels between IMF and GATT rules concerning restrictions.) However, GATT’s progress toward reduced restrictions has been halting thus far.

There are several reasons for this, most of them recognized by the GATT regulations themselves. Thus, while GATT forbids the use of quantitative restrictions—in article XI—it also explicitly makes provisions, in articles XII and XVIII:B, for their use under certain circumstances. Balance-of-payments difficulties must be cited to invoke either article, and article XVIII:B is applicable only to very low income countries. In addition, under article XVIII:C, the underdeveloped countries have the possibility of using quantitative restrictions to assist developing industries. (Also important in the early postwar years was article XIV, which permitted the use of restrictions against “scarce-currency” countries and by members going through a “transitional period.” Today its importance is negligible.)

Needless to say, these articles, especially XII and XVII:B, have been used continually. Besides, advanced countries have continued to use restrictions to protect domestic agriculture, contrary to GATT obligations. Moreover, nonmember countries frequently resort to restrictions.

As of the early 1960s, then, the use of restrictions is still considerable. On the one hand, the advanced countries have agreed to renounce use of restrictions as a regular practice, resorting to them only occasionally to ease severe balance-of-payments strains and more frequently (but with increasing difficulty) to protect domestic agricultural production. On the other hand, the majority of underdeveloped countries, with tight external accounts accompanying their planned developments, have maintained comprehensive import-control regimes, and there seems to be no sign of a change in this situation in the foreseeable future.

Economic effects

The economic effects of quantitative restrictions have been analyzed in two distinct ways. One approach works out the effects of restrictions assuming that the balance of payments is always somehow kept balanced. This is the so-called real analysis. It deals with the question of the equivalence of, and differences between, tariffs and quotas and is basically an extension of tariff analysis, in the “pure” theory of international trade, to quota restrictions.

The other approach is more important from the practical point of view: it attempts to analyze quantitative restrictions as a policy instrument for handling balance-of-payments difficulties. The typical questions here concern the effectiveness of restrictions in correcting external deficits, both absolutely and in relation to devaluation and deflation. The desirability of discriminatory restrictions, which are frowned upon by IMF and GATT, has also been debated.

Real analysis

The real analysis is nearly always presented for import tariffs and quotas but applies equally, mutatis mutandis, to export tariffs and quotas. The analysis demonstrates that ad valorem tariffs and quotas have important similarities and differences.

Traditionally, the question is investigated in the framework of a partial-equilibrium model of a perfectly competitive industry. An ad valorem tariff will, generally speaking, restrict imports and raise revenue. If the tariff is prohibitively high, it will raise no revenue; if it does not restrict imports at all, it will merely raise revenue. Moreover, it is easily shown that, corresponding to every tariff rate, there is a quota that will produce equivalent results for the following variables: (1) domestic production of the imported commodity; (2) domestic price; (3) foreign price; (4) domestic consumption; and (5) the quantity of imports. Consistent with this basic equivalence, in the sense defined, there is a well-known difference: a tariff raises revenue, whereas an equivalent quota does not. The revenue accrues as “monopoly” profit to the quota holders. This difference is clearly of importance.

But the foregoing proposition of equivalence holds only under perfectly competitive conditions in the import industry and breaks down if monopoly elemerts are introduced. For example, with a monopoly in domestic production, an import quota could well lead to a continuation of the internal monopoly. On the other hand, a tariff would permit imports freely at the tariff-inclusive price and, if the foreign supply is perfectly elastic, the domestic monopolist would eventually find himself in a perfectly competitive situation. Tariffs and quotas could thus lead to radically different market structures, and therefore equivalence, of the type obtaining under perfectly competitive assumptions, would not necessarily hold.

These propositions can be inferred from the current literature (e.g., Kindleberger 1953). A more systematic analysis of the equivalence proposition has recently been made, under alternative assumptions with respect to the market structure and allowing monopoly elements to obtain both in domestic production and in quota-holding, which underlines the crucial dependence of the equivalence proposition on the assumption of universally perfect competition (Bhagwati 1965).

Balance-of-payments analysis

The efficacy of quantitative import restrictions in reducing international deficits can be considered either in itself or in contrast to the effectiveness of other instruments of policy.

Quantitative restrictions per se. The primary effect of restrictions on imports is to cut imports. But there are secondary effects. The domestic expenditure, diverted from imports, will flow elsewhere. All of it may then cut into exports, leaving the original payments deficit unchanged. Secondary effects must therefore be carefully investigated.

Whether the net outcome of the primary and secondary effects can be expected to be favorable, in a specific case, is determined with reference to a proposition that forms the core of the newly developed absorption theory (Alexander 1952; Meade 1951). The proposition asserts that a balance-of-payments deficit reflects an excess of domestic investment over savings and hence any reduction in this deficit requires a reduction in domestic investment and/or an increase in domestic savings.

Thus, unless import restrictions lead to reduced investment or increased domestic savings, they cannot improve the balance of payments, and the secondary effect must necessarily offset the primary improvement. There are various ways in which import quotas may affect domestic savings and investment.

Savings can be affected, for example, in the following ways. (1) The restricted import of a commodity may result in “forced saving”: expenditure may be held off in the expectation of reduction in restrictions in the near future; or there may be no adequate immediate substitute in consumption; or there may be a temporary time lag in shifting to alternative consumption. These arguments are plausible for “temporary” increases in saving; in the long run, consumption may be expected to readjust itself to the preceding level. (2) Alternatively, import restrictions may cause a shift of income toward profits (accruing to quota-holders). If there is a higher propensity to save by profit-earners than by others, there will be a rise in savings. (3) Counter to this runs the argument that the “distortion” caused by interference with the pattern of consumption can bring about a fall in real savings (via the fall in real income). (4) Even if none of the preceding possibilities holds and there is diversion of the entire expenditure from (prevented) imports to exportables and nontraded goods, additional savings can nonetheless be generated. This may happen, for example, if the indirect tax rates on the exportables, etc., are higher on the average than on the imports, thereby generating higher tax revenue than previously. (5) Alternatively, if the expenditure is shifted to non-traded goods, raising their prices under full employment, but the mobility of factors between exportable and nontraded goods is low, the (secondary) restrictive effect on the supply of exports would be less than the (primary) restrictive effect on imports. The reduced deficit would be attributable then to the “forced savings” in the nontraded goods sector. (6) Assume, however, that there is Keynesian underemployment. In this case, a shift in expenditure toward exportables and nontraded goods will have a multiplier effect on incomes, and if the marginal propensity to save is positive, domestic savings will increase, improving the balance of payments by the same amount (ruling out further repercussions through multiplier effects abroad).

Similarly, import restrictions could affect investment. (1) If the deficit is caused by inventory accumulation, quotas on raw material imports can well lead to inventory decline, that is, to reduced investment. (2) Similarly, if capital-goods imports are necessary to domestic investment, restrictions on them could affect domestic fixed investment.

Where, however, no such increase in domestic savings and/or reduction in domestic investment is possible, import restrictions will have to be accompanied by deflation in order to engineer an improvement in the balance of payments under conditions of full employment. Deflation alone will cause unemployment while correcting a deficit. A combination of import restrictions and deflation, on the other hand, will generally bring about both internal and external equilibrium—both full employment and balance in the international accounts. This is only a special case of Tinbergen’s principle that n instruments are, in general, necessary to achieve n targets.

Restrictions have been analyzed, however, not merely from the viewpoint of their efficacy in reducing external deficits. Two interesting welfare questions have also been posed.

One relates to the optimum combination of deflation and import restrictions when the objectives are to achieve an assigned improvement in the balance of payments and to maximize the real income of the country, subject to the preceding constraint (Hemming & Corden 1958). Note that here maximization of real income replaces the achievement of full employment as an objective. Since deflation can produce less income (through reduced employment) and restrictions (through “distortions” in allocation of expenditure among commodities) can offset the income gain from improved terms of trade where relevant, the equilibrium condition naturally involves the equation of these two losses at the margin.

The other welfare question has been posed with respect to the use of discriminatory restrictions and relates not to national welfare but to world welfare. Although both IMF (by discouraging exchange restrictions in current accounts) and GATT (through article XIV) have set themselves against the use of discriminatory restrictions, theoretical opinion has continued to question this attitude from the view-point of world welfare. The classic articles of Frisch (1947; 1948) and Fleming (1951) have argued for discrimination and other writers (e.g., Tew 1960) have supported this case. Fleming’s is the most persuasive argument, although based on assumptions of cardinal utility and interpersonal comparisons of welfare, since he formulates his analysis so as to maximize world real income, whereas Frisch rests his analysis largely on the debatable objective of maximizing world trade.

Restrictions versus devaluation. Although restrictions can be contrasted, in principle, with numerous alternative policy instruments, customarily the contrast is made between them and devaluation as methods of improving the balance of payments (Alexander 1951; Hemming & Corden 1958; Johnson 1958, chapter 6).

When the deficit is generated by “temporary” factors—such as a decision to shift from cash to inventory accumulation, an essentially “stock” decision (Johnson 1958)—restrictions and similar measures are naturally preferable to devaluation. Thus, in the example of inventory accumulation, restrictions can be chosen in such a way as to act directly on inventories, whereas a devaluation would start reorienting the economy’s production and consumption decisions toward an external surplus. This orientation would then have to be reversed when the temporary change was itself reversed. Restrictions thus can avoid the costs of the far-ranging changes that devaluation implies.

On the other hand, when the deficit is of a “fundamental” nature—arising from a decision to consume more out of given income, an essentially “flow” decision (Johnson 1958)—the relative desirability of import restrictions or devaluation is more controversial. Most analysts resolve the issue by resorting to the equivalence of restrictions and ad valorem tariffs. They cite the optimum tariff argument, which admits tariffs under national monopoly power in trade, and then conclude that devaluation is a superior method of reducing deficits if the country has already placed optimum restrictions on trade (Johnson 1958). This view, however, rests on restrictive assumptions—for example, that the equivalence of tariffs and restrictions is universally valid.

Yet other arguments may favor restrictions. Destabilizing speculation, for example, is cited as a reason why devaluation is inferior (Tew 1960): a devaluation may destroy confidence in the currency’s stability. On the other hand, the imposition of restrictions also may make speculators expect that a devaluation is on its way, so that devaluation is not necessarily inferior on such grounds. A more persuasive argument is that when a country’s currency is being used as an international currency—as are the dollar and the pound sterling—devaluation could imperil the continuation of the system.

Perhaps the chief advantage of restrictions in correcting “flow” deficits consists in the speed with which they can work vis-à-vis devaluation, a difference of great importance to a country with hard-pressed reserves. The difference is easily explained. Restrictions immediately curtail imports, while the substitution (and/or multiplier) effects inevitably involve time lags and thus cut into this favorable effect only later. On the other hand, devaluation depends on substitution effects for its effectiveness and hence takes time to improve the balance of payments. No formal models have yet been developed to examine this difference (and this is a serious lacuna in the analytical literature), but it can hardly be doubted that, in practice, governments are keenly conscious of it in their occasional resort to restrictions.

Jagdish Bhagwati


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Corden, W. M. 1958 The Control of Imports: A Case Study; the United Kingdom Import Restrictions of 1951–1952. Manchester School of Economic and Social Studies 26:181–221.

Corden, W. M. 1960 The Geometric Representation of Policies to Attain Internal and External Balance. Review of Economic Studies 28:1–22.

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Trade agreements broadly refer to commercial treaties and agreements between countries that deal mainly with customs duties and other treatment accorded by each party to goods originating in the other. They may be distinguished from treaties of friendship, commerce, and navigation, which deal more generally with economic relations among nations—such as the treatment of foreign investments, the rights of foreign nationals, and foreign shipping. In recent years, the term “trade agreement” has been applied more specifically to accords between two or more governments that provide for reciprocal reductions in specific customs duties, along with an agreement on other measures and policies affecting imports. Trade agreements may be bilateral or multilateral. However, the reader should be cautioned that the term “bilateral trade agreement” is frequently used to denote import quota agreements, which usually provide for a bilateral balancing of trade by means of import and export quotas and which have to be renegotiated after a short interval.

While certain elements of the modern reciprocal trade or tariff agreements are to be found in commercial treaties negotiated during the eighteenth and nineteenth centuries, probably the most important counterpart to the modern trade agreements is the Cobden–Chevalier Treaty of 1860 between Britain and France. Under this treaty, which was in effect until 1880, France reduced all prohibitions against English goods and lowered tariffs to a 30 per cent level until 1864 and thereafter to 24 per cent. Britain, in turn, admitted all French goods duty-free, except for wines and spirits. This treaty, which contained a most-favored-nation clause, served as a basis for similar treaties negotiated by France with several other European countries.

The United States had a limited experience with reciprocal tariff agreements from 1890 to 1909 under the authority provided by the McKinley Tariff Act of 1890 and the Dingley Tariff Act of 1897. Under the 1890 act, the president was authorized to negotiate concessions from other countries in return for continued duty-free treatment of certain of their products and was given the right to impose duties on these products as a bargaining weapon. Under the act of 1897, the president was authorized to negotiate, without congressional approval, concessions in return for the application of specified minimum rates on a few products; in addition, the president was empowered for the first time to negotiate agreements for general reciprocal tariff reductions on a limited scale and subject to congressional approval. While a few executive agreements were negotiated under both the 1890 and the 1897 tariff acts, no agreements requiring the consent of Congress received the approval of the Senate. The Tariff Act of 1909 repealed all of the reciprocity provisions of the previous legislation, and from that time until the passage of the reciprocal trade agreements amendment (to the Hawley–Smoot Tariff Act of 1930) which became law in June 1934, U.S. tariffs were not negotiable.

The bilateral approach

The 1934 reciprocal trade agreements amendment deserves special consideration not only because it embodied principles and procedures which had been developed in agreements among countries over a span of a hundred years or more, but also because many of its provisions and principles were reflected in the General Agreement on Tariffs and Trade (GATT) negotiated in 1947, which has become the instrument for multilateral tariff negotiations among the major countries of the world outside the Sino–Soviet bloc.

The 1934 reciprocal trade agreements amendment granted authority to the president to enter into foreign trade agreements with foreign governments “whenever he finds as a fact that any existing duties or other import restrictions of the United States or any foreign country are unduly burdening and restricting the foreign trade of the United States. . . .” In doing so he is permitted to “proclaim such modifications of existing duties and other import restrictions, such additional import restrictions, or such continuance, and for such minimum periods, of existing customs or excise treatment of any article covered by foreign trade agreements.” This authority was limited in that “no proclamation shall be made increasing or decreasing by more than 50 per centum any existing rate of duty or transferring any article between the dutiable and the free lists.” Thus, the president had the power to change tariffs, within limits, by executive agreement with other countries, based on the principle of reciprocity in tariff relations. These procedures and principles were well grounded in the history of commercial agreements among countries, including the United States.

The 1934 amendment also explicitly provides for unconditional most-favored-nation treatment, since it states that when duties or other restrictions are once proclaimed they “shall apply to articles of growth, produce or manufacture of all foreign countries.” While the conditional form and interpretation of most-favored-nation treatment was employed by the United States during the nineteenth century and in the early twentieth century, the Tariff Act of 1922 adopted the principle of equal commercial treatment, and from that time U.S. commercial treaties employed the unconditional form. In fact, by 1933, of the 625 most-favored-nation clauses in treaties and agreements the world over, only 8 per cent were phrased in the conditional form. Nevertheless, the 1934 law did provide certain flexibility in the application of the most-favored-nation clause. For example, the president was empowered to suspend the application of tariff concessions to countries discriminating against American commerce. Moreover, the provisions of the Anti-Dumping Act of 1921, as well as the provision for levying countervailing duties offsetting subsidies to exports granted by other countries, were continued under the 1934 law.

The use of the unconditional most-favored-nation form, together with the principle of more or less equal reciprocal advantage which the United States and other nations sought to achieve through bilateral negotiations, had a serious shortcoming. Each country tended to offer its initial and largest possible concession with respect to any particular commodity to the “principal foreign supplier” of that commodity, since to offer a concession to a minor supplier would be “giving away” an incommensurately reciprocated concession to the more important suppliers. This practice constituted a major limitation on bilateral negotiations which was partially remedied by the multilateral negotiations under the General Agreement on Tariffs and Trade adopted in 1947.

Following the passage of the 1934 reciprocal trade agreements amendment, the United States had concluded agreements with 21 countries by January 1, 1940. These provided for reductions or binding of tariffs accounting for 60 per cent of U.S. trade, with concessions being granted on more than a thousand rates and being received on some sixteen hundred rates. In addition, there were some reciprocal tariff agreements among other countries to which the United States was not a party but from which the United States gained certain uncompensated benefits as a consequence of the almost universal application of the unconditional most-favored-nation principle. However, after 1934, commercial agreements among other countries increasingly took the form of trade quota and payments agreements, as the practice of controlling trade by means of import quotas and exchange controls became more common.

The typical bilateral tariff agreement entered into by the United States contained a number of provisions in addition to those pertaining to the schedules of tariffs on which concessions were made. These provisions dealt with customs formalities, discriminatory treatment of foreign products and business enterprises within me negotiating countries, the use of import quotas, exchange controls, and other commercial policy matters. Most of these provisions had been included in commercial treaties among nations for many years. Moreover, these nontariff provisions affecting trade in commodities were, with certain modifications, embodied in the General Agreement on Tariffs and Trade of 1947.

The multilateral approach

Only a handful of bilateral tariff agreements were negotiated during World War II and the early postwar period, but the creation of permanent machinery for multilateral tariff negotiations and of an international agreement embodying commercial policy commitments constituted an important part of the postwar planning by the United States and its allies. The groundwork for the establishment of such institutional arrangements was laid in the course of the Anglo–American financial and trade discussions held in the fall of 1945, in the course of which the U.S. government published a document entitled Proposals for Expansion of World Trade and Employment (U.S. Department of State 1945) and the U.S. Secretary of State recommended the calling of an international conference on trade and employment by the UN in 1946. The U.S. proposals were discussed with the British representatives prior to their publication and were agreed to in principle by the British as a part of the Anglo–American Financial and Commercial Agreement of December 1945 (for text, see “Anglo–American Trade . . .” 1946).

Early in 1946 a resolution was adopted by the Economic and Social Council of the United Nations that established a preparatory committee to draft an agenda for an international conference on trade and employment. Sessions of the preparatory committee were held in London, New York, and Geneva during 1946 and 1947, and a draft charter for an international trade organization was drawn up in Geneva in August 1947.

Simultaneously with the work of the preparatory committee in Geneva during the spring and summer of 1947, 23 countries participated in tariff negotiations. The bargaining was conducted on a product-by-product basis between pairs of countries, the products being confined to those for which one of the parties was the other’s chief supplier. However, the simultaneous staging of the bilateral negotiations made it possible to broaden the bargaining on particular product duties to include concessions to countries other than the chief supplier. Thus, for example, country A would make a larger cut in its tariff which affected the exports of B, C, and D, provided the latter three countries each made various concessions on products of interest to A. This, indeed, is the advantage of simultaneous bargaining, which, although initially taking place on a bilateral basis under the chief supplier principle, at a later stage involves compensatory concessions by other suppliers of a particular product. The tariff reductions and bindings of existing rates, achieved as a consequence of these negotiations, were incorporated by the 23 contracting parties into a single document, the General Agreement on Tariffs and Trade, completed on October 30, 1947.

In addition to the lists of tariff concessions negotiated, the GATT included a number of general provisions with respect to the treatment of trade. By and large these provisions paralleled the rules adopted by the preparatory committee in the draft charter for an international trade organization. In addition to the principle of unconditional most-favored-nation treatment to be accorded to all contracting parties (which accounted for three-quarters of the world’s trade before World War II), the provisions covered methods of customs administration, internal taxes and regulations, quotas and exchange controls, and the operation of state trading enterprises.

Part ii of the General Agreement on Tariffs and Trade, which contained general provisions relating to trade practices, was expected to be superseded by the charter of the International Trade Organization (ITO), which was negotiated in its final form at the UN Conference on Trade and Employment held in Havana from November 1947 to March 1948. On the other hand, GATT was a distinct instrument, recognized and referred to in the ITO charter, since it contained the schedule of tariff concessions which were negotiated at Geneva and which were to be expanded and altered from time to time in the course of subsequent negotiating meetings of the contracting parties. Also, it was expected that additional countries would become contracting parties to the GATT, but the advantages of membership, which included a guarantee of most-favored-nation treatment by other contracting parties, would be accorded only if the prospective members made tariff concessions to an extent regarded as satisfactory by the original 23 countries. It was expected that the general provisions of the GATT and the ITO charter would be parallel insofar as they dealt with matters concerned with the treatment of trade, and, in fact, certain changes were made in the Geneva protocol of the GATT at the Havana conference to conform with the ITO charter. However, the ITO charter was broader than the GATT since it established a trade organization and a secretariat with a special relationship to the UN and also provided for activities in the field of intergovernmental commodity agreements, restrictive business practices, and other matters not dealt with in the GATT.

The ITO never came into being, largely as a consequence of the failure of the U.S. Congress to approve the bill authorizing the president to accept membership on the part of the United States. However, the United States is a contracting party to the GATT by virtue of the authority of the president to negotiate agreements under the reciprocal trade agreements amendment. Nevertheless, the U.S. Congress has never specifically authorized or officially recognized U.S. membership in the contracting parties to the GATT. The contracting parties to the GATT continued to hold both tariff negotiating sessions and sessions dealing with problems arising out of operation of the agreement and proposals for amendments to the agreement. While the GATT has had a small secretariat with headquarters in Geneva, it has been hampered by the lack of a formal organizational structure and permanent legal status as an international organization. An attempt to remedy this shortcoming was made in 1955 by an agreement among the contracting parties on the establishment of an Organization for Trade Cooperation (OTC). However, the OTC never came into being; an administration bill authorizing U.S. membership was not submitted to the U.S. Congress.

Constraints and escape provisions. During the postwar period the president’s authority to negotiate trade agreements has been extended and amended a number of times—beginning with the Trade Agreements Extension Act of 1945, which authorized decreases in rates of duties applicable to particular classifications of U.S. imports by not more than 50 per cent of the rates in effect on January 1, 1945. The Trade Agreements Extension Acts of 1955 and 1958 provided for additional rate reductions, while the Trade Expansion Act of 1962 (which was a new act and not simply an amendment to the Tariff Act of 1930) not only gave the president substantially increased rate-reducing authority but also established new principles for tariff bargaining which were especially suited for multilateral negotiations within the framework of the GATT.

While the president’s rate-reducing authority was being expanded during the period prior to the 1962 act, the various amendments introduced several constraints on the application of tariff reductions to particular commodities. One of these checks on the president’s power, which first appeared in the 1948 amendment, was the “peril point” provision. This required that the Tariff Commission survey all commodities on which the president proposed to negotiate agreements and that it specify rates of duty below which a threat of serious injury to U.S. industry would exist. In the event that the president reduced a rate below the peril point, he was required to communicate to the Congress his reasons for doing so.

A further check on the president’s power was the “escape clause” requirement under which tariff concessions already granted could be withdrawn if they led to an increase in the quantity of imports (either in absolute amount or relative to the domestic market) such as to cause or threaten serious injury to U.S. industry. Procedures for escape clause action have been changed from time to time by congressional acts, but the 1958 act directed the Tariff Commission to make escape clause investigations “upon the request of the President, upon resolution of either House of Congress, upon resolution of either the Committee on Finance of the Senate or the Committee on Ways and Means of the House of Representatives, upon its own motion, or upon application of any interested party. . . .” If the Tariff Commission made a positive finding of injury and recommended an adjustment of rates of duty or the imposition of quotas, the president could accept or disapprove the recommendation, but, in the latter event, it still became effective when adopted by a two-thirds vote in each house of Congress.

Article XIX of the GATT provides for the withdrawal of a tariff concession if, as a result of unforeseen developments, there is such an increase in imports as to cause or threaten serious injury to domestic producers. The countries whose exports are affected by the withdrawal have the right to counterwithdrawals of concessions which have been granted in favor of imports from the country invoking article XIX. Hence, a large number of escape clause actions under article XIX could destroy the whole framework of concessions negotiated by the contracting parties in the course of the bargaining sessions because of the interdependent nature of the negotiating procedures and concessions. Fortunately, only a small number of concessions have actually been withdrawn by the contracting parties under the escape clause procedure. On the other hand, the continual threat of withdrawal of tariff concessions granted by the United States has constituted a barrier to the development of markets by foreigners in the United States.

Nontariff provisions. If trade agreements dealt only with tariff concessions they would leave the way open for the parties to the agreement to nullify or impair the effects of the concessions by such actions as the imposition of import quotas and internal excise taxes, use of exchange controls or multiple exchange rates, a change in the procedures for valuation of the imported commodity for customs purposes, or other types of restrictive action. More importantly, the purpose of trade agreements, whether they be bilateral, or multilateral as in the case of the GATT, is to establish certain rules of fair trading practice which go beyond a concern for trade in the commodities on which tariff negotiations have been conducted.

Thus the GATT, which embodies many of the provisions typically found in bilateral trade agreements negotiated by the United States and other countries before 1947, contains, among others, provisions with respect to: (1) the avoidance of the use of internal taxes and other regulations applied to imported products so as to afford protection to domestic production; (2) freedom of transit of goods destined for another country across the territory of a contracting party; (3) standard rules regulating the conditions for the use of antidumping and countervailing duties; (4) regulations regarding the valuation of goods for customs purposes; (5) regulations with respect to the use of marks of origin to avoid their use as a means of unduly restricting imports; (6) the conditions under which import restrictions may be instituted to safeguard the balance of payments; (7) regulations for applying the rule of nondiscrimination in the use of import quotas, including exceptions to the rule; (8) regulations with respect to the use of export subsidies; (9) regulations governing state trading enterprises; (10) more lenient rules governing the use of protective devices employed by less developed countries; (11) special exceptions permitting the withdrawal of concessions or other actions arising from serious injury or the necessity of action for protecting national security interests; and (12) the conditions under which exceptions to the rules on nondiscrimination are permitted for countries forming customs unions or free trade areas.

This list is by no means exhaustive and some of the provisions of GATT are quite complex, such as the balance of payments exceptions to the rules on the use of import quotas, which were designed to parallel the relevant provisions found in the articles of agreement of the International Monetary Fund. The provisions regarding the use of quotas and other nontariff restrictions on trade in agricultural commodities constitute a broad exception designed to permit restrictions on imports of commodities under domestic price support programs (see amended text of the GATT in Contracting Parties to the General Agreement on Tariffs and Trade 1961).

Limitations of product-by-product approach. The series of GATT tariff negotiations succeeded in reducing tariff rates on thousands of items and undoubtedly made a significant contribution to the expansion of international trade. However, by the late 1950s it had become clear to nearly all students of tariff bargaining that the principle of tariff negotiations on the basis of reciprocal gains to be achieved in bargaining on a product-by-product basis placed severe limitations on the potential liberalization of trade.

In part, the reason lay in the fact that negotiations with respect to individual products, which in the case of the United States were subject to the restrictions of both the peril point and the escape clause provisions of the Trade Agreements Acts, focused attention on injury to the domestic producers of these products and therefore left little room for further bargaining on a no-serious-injury basis. Actually the determination of the restrictive impact of tariffs on particular items and the quantitative effect of given tariff reductions on imports is extremely difficult. It is impossible to devise means of predicting the effects of a tariff reduction over a period of, say, five to ten years because of long-run shifts in demand and supply conditions. For example, the impact of the U.S. tariff reductions on certain manufactures in the early postwar period was deemed to be small at the time but may have been significant in 1963 after a substantial growth in U.S. imports of most categories of manufactures. Likewise, the value of concessions received in terms of the impact on exports cannot be projected with any degree of accuracy, at least beyond the first couple of years. Trade patterns are in the main determined by forces far more powerful than those exerted by a few percentage point changes in tariff rates.

In addition, the creation of the European Economic Community (EEC) in 1959 and the expectation that the six original members would be expanded to include all or most of the countries of western Europe, along with the possibility of other such regional trading groups, presented the prospect of very large free trading areas which discriminated in most products against the rest of the world. The only way to modify or eliminate such discrimination would be through extensive, across-the-board tariff reductions toward zero.

The product-by-product approach to reciprocity in tariff bargaining may also be criticized on theoretical grounds since the ultimate gains for a country arise from a general lowering of world trade barriers and not from an attempt to match import concessions on specific products against equivalent concessions by other countries. Consumers in all countries gain from a lowering of tariffs while, given flexibility of resources, all producers should gain directly or indirectly from a broadening of international markets.

Linear reductions

In recognition of both the practical and theoretical limitations of product-by-product bargaining, even within the framework of multilateral negotiations, the Kennedy administration proposed new legislative authority which was embodied in the U.S. Trade Expansion Act of 1962. This act broadened the power of the president, not only to negotiate additional percentage cuts in existing rates but also to reduce rates on categories of commodities without regard to bilateral reciprocity. The act also gave authority to reduce to zero the duties on tropical agricultural or forestry products not produced in significant quantities in the United States and on which the EEC had made significant import concessions. This broader authority, together with a new approach to the problem of injury, set the stage for tariff bargaining on a basis of “linear,” or across-the-board, percentage cuts on broad categories of commodities, of up to 50 per cent on nearly all commodities and even larger cuts for certain commodities. According to the 1962 act, a finding of injury on the part of the Tariff Commission may, if accepted by the president, result in a decision by the president to impose an import restriction or to invoke the adjustment assistance provisions of the act. Such adjustment assistance may take the form, in the case of firms, of technical, financial, or tax assistance, and in the case of workers, of supplementary unemployment compensation, retraining assistance, or relocation allowances. In addition, the 1962 act greatly modified the restrictions placed on the president arising from the peril point provisions of the 1958 and earlier acts. The president is still required to submit a proposed negotiating list to the Tariff Commission, but instead of the commission’s being required to set specific tariff points below which injury is likely to result, the 1962 act provides that the commission may present an analysis of the strengths and weaknesses of the industries that might be affected by tariff action. There are only a few commodities that are exempt from negotiation by statute under the 1962 act, principally the handful of commodities which previously had been subject to escape clause action.

The movement toward negotiations for linear tariff reduction, a practice widely employed by countries in the process of forming customs unions or free trade areas, met with considerable difficulty in the course of the GATT preparatory discussions for the tariff negotiations beginning in May 1964. The U.S. proposed a common percentage cut (as much as 50 per cent in most cases) in the U.S. tariff schedules covering most commodities, in the EEC common tariffs, and in the tariff schedules of most other industrialized countries. The EEC members took the position that allowance should be made for disparities in tariff rates—that a 50 per cent cut in an ad valorem tariff rate of 30 per cent should not be regarded as equivalent to a 50 per cent cut in an ad valorem rate of 10 per cent. At the time of writing, an acceptable compromise formula, which would take into account substantial disparities in rates, has not been reached among the contracting parties to the GATT.

Further problems

There were other issues facing the contracting parties prior to the 1964 tariff negotiations in Geneva which may require a change in the previous principles and procedures in bargaining on tariffs and other trade restrictions. There was, first of all, the existence of the EEC itself, which was moving rapidly toward a complete customs union with a common external tariff wall and a common policy for many agricultural products. The maintenance of agricultural prices within the EEC by means of variable levies on imports has greatly complicated the problem of tariff negotiations on such products with countries outside the EEC. It seems likely that international commodity agreements involving import quotas will be necessary to guarantee a share in the common market to traditional exporters of grains and certain other temperate zone products. Also, the negotiation by the EEC of preferential agreements with former African territories of the EEC members has resulted in serious discrimination against the products of Latin American and Asiatic countries and of African countries which were former British territories. In addition, nearly all less developed countries have requested preferential treatment for their exports to the industrialized countries as a means of promoting their exports (see United Nations Conference on Trade and Development 1964). These developments have weakened the application of the traditional most-favored-nation principle.

Economists have traditionally argued in favor of the most-favored-nation principle as a means of maximizing the gains from trade and of achieving an optimum allocation of world resources. On the other hand, some economists have challenged the traditional argument against preferential tariff treatment on the grounds that preferential treatment may simply serve to correct other disparities in the market or enable less developed countries to achieve economies of scale by expanding output [see International TRADE CONTROLS, article on TARIFFS AND PROTECTIONISM]. James E. Meade (1955, pp. 110–111) has argued that, contrary to the traditional approach to customs unions and that which is embodied in the GATT, a partial reduction of duties on imports from regional trading partners is more likely to increase welfare than is a complete removal of restrictions on trade within the preference area.

Unilateral reduction. It has been suggested that tariff reducing negotiations might be eliminated entirely in favor of unilateral reductions by individual countries, since countries will gain from a reduction of import barriers whether or not there is a reciprocal reduction of barriers to their exports. There are several answers to this argument. Perhaps the most significant one is that a country with a very large trade should use its bargaining power as a means of getting other countries to reduce their trade barriers. There is also the political argument that, because of sectoral losses, a government cannot easily reduce its tariffs unilaterally without obtaining an offsetting concession from other countries—even though such a unilateral tariff reduction might increase a country’s total welfare. Finally, the welfare gains from unilateral tariff reductions are not always easy to prove. If imports increase without an expansion of exports, some shift in resources must take place if balance of payments equilibrium is to be maintained. Currency devaluation may thus be necessary to maintain equilibrium. But devaluation may have an adverse impact on the country’s terms of trade, whereas if equilibrium is maintained by a reduction in import barriers abroad, an adverse reaction on terms of trade need not occur. Also, the effects of devaluation on the volume and pattern of a country’s trade—that is, whether the major impact is on increasing exports or reducing imports—cannot be accurately predicted, but presumably both imports and exports will be affected. Thus, when countries engage in unilateral tariff reductions the prospective increase in trade, after taking into account the effects of actions for maintaining the trade balance, must be measured against any possible adverse welfare effects resulting from changes in the terms of trade.

If all countries were convinced that a general liberalization of trade would redound to their benefit, directly or indirectly, then a gradual, multilateral reduction of barriers in accordance with some universal formula would clearly be the best approach. Unfortunately, such a mutually acceptable formula for effective trade liberalization has not, as yet, been developed.

Raymond F. Mikesell


Anglo–American Trade and Financial Negotiations. 1946 [U.S.] Board of Governors of the Federal Reserve System, Federal Reserve Bulletin 32:14–19.

Billings, Elden E. 1963a The European Common Market: A Basic List of Recent References. Washington: Library of Congress, Legislative Reference Service.

Billings, Elden E. 1963b The General Agreement on Tariffs and Trade (GATT): Selected References, 1952–1963. Washington: Library of Congress, Legislative Reference Service.

Brown, William A. 1950 The United States and the Restoration of World Trade: An Analysis and Appraisal of the ITO Charter and the General Agreement on Tariffs and Trade. Washington: Brookings Institution.

Catudal, HonorÉ M. 1961 The General Agreement on Tariffs and Trade: An Article-by-article Analysis in Layman’s Language. U.S. Department of State, Bulletin 44:1010–1020; 45:35–42.

Contracting Parties TO THE General Agreement ON Tariffs AND Trade 1961 The General Agreement on Tariffs and Trade (Text as Amended). U.S. Department of State, Publication No. 7182. Washington: Government Printing Office. → Originally signed in 1947.

Culbertson, W. S. 1931 Commercial Treaties. Volume 4, pages 24–31 in Encyclopaedia of the Social Sciences. New York: Macmillan.

Curzon, Gerard (1965) 1966 Multilateral Commercial Diplomacy: The General Agreement on Tariffs and Trade and Its Impact on National Commercial Policies and Techniques. New York: Praeger.

Ficker, Hermann 1962 Reciprocal Trade Agreements Act and Tariffs: A Bibliography. Washington: Library of Congress, Legislative Reference Service.

Hawkins, Harry C. 1951 Commercial Treaties and Agreements: Principles and Practice. New York: Rinehart.

Isaacs, Asher 1948 International Trade Tariff and Commercial Policies. Chicago: Irwin. → See especially pages 243–281, “The Present Tariff of the United States.”

Johnson, H. G. 1967 Economic Policies Toward Less Developed Countries. Washington: Brookings Institution.

Kelly, William B. (editor) 1963 Studies in United States Commercial Policy. Chapel Hill: Univ. of North Carolina Press.

Meade, James E. 1955 The Theory of Customs Unions. Amsterdam: North-Holland Publishing.

Mikesell, Raymond F. 1952 United States Economic Policy and International Relations. New York: McGraw-Hill. → See especially Chapter 6, “United States Commercial Policy” and Chapter 7, “Postwar Developments in United States Commercial Policy.”

National Planning Association, International Committee 1962 Foreign Trade and Foreign Policy: A Statement by the NPA International Committee and a Report by Howard S. Piquet. Washington: The Association.

Patterson, Gardner 1966 Discrimination in International Trade; the Policy Issues: 1945–1965. Princeton Univ. Press.

United Nations Conference ON Trade AND Employment, Geneva,1964 1964 Proceedings. Volume 1: Final Act and Report. New York: United Nations.

United Nations Conference ON Trade AND Employment, Havana,1947–1948 1948 Havana Charter for an International Trade Organization and Final Act and Related Documents. U.S. Dept. of State, Publication No. 3117. Washington: Government Printing Office.

U.S. Congress, Senate, Committee ON Commerce 1961 The United States and World Trade; Challenges and Opportunities: Final Report of the Committee on Commerce. 87th Congress, 1st Session, Senate Report No. 446. Washington: Government Printing Office.

U.S. Department OF State 1945 Proposals for Expansion of World Trade and Employment. U.S. Dept. of State, Publication No. 2411. Washington: Government Printing Office.

Wilcox, Clair 1949 A Charter for World Trade. New York: Macmillan.


There is difficulty in defining state trading precisely. At one extreme are corporations wholly owned by the state, with import or export monopoly privileges for certain commodities, such as India’s State Trading Corporation; at the other are licensing, tax, and subsidy arrangements, often exercised in connection with an official monopoly of foreign exchange, which, while leaving individual transactions completely to the initiative of private parties, nevertheless sensitively impose the objectives of the state on each foreign trade transaction. Somewhere between these extremes are trading corporations only partially owned by governmental bodies, marketing boards in which government and private representatives join in controlling the trade, and government bodies which, while effecting no foreign transactions themselves, constitute such important sources of supply or demand for their national markets that they in fact control foreign trade. Examples of the last type of arrangement are the marketing organizations in the Federal Republic of Germany which have been in recent times the sole legal domestic purchasers of privately imported foodstuffs. The Grain Equalization Board of Austria is in a similar position. And only one step removed from these agencies, in form of operation, is the Commodity Credit Corporation in the United States.

The line between official and private cartels is often an arbitrary one except, perhaps, for the potentialities for public control. Official export boards for Danish butter and bacon, for example, upon shedding their official status in 1950, promptly reorganized as private monopolies.

On the basis that usage distinguishes state trading from other forms of government commercial regulation, it is reasonable to say that an agency engaged in state trading (1) must be actually executing individual trade transactions with foreigners (including taking title to the goods at some point), or have decisive influence on individual transactions executed by others, and (2) must be governed by decisions actually or potentially dominated by government officials.

The definition includes purchases by the state for the execution of such traditional functions as the establishment of diplomatic representation and military forces. It may also encompass official transactions in gold and foreign currencies. [For discussion of state trading among countries within the communist bloc, seeCommunism, ECONOMIC ORGANIZATION OF, article on INTERNATIONAL

Extensive state trading in peacetime has developed only since 1930. It is partly a legacy of the depression of the 1930s and of World War n. It has since spread under the stimulus of trade offers by communist countries and as a result of planning for economic growth in less developed regions.

Quantitative significance

Assessment of the quantitative significance of state trading is hampered by the imprecision of the term and by data inadequacies. It is probable, however, that if the activities of the Commodity Credit Corporation of the United States, those of national marketing boards everywhere, and trade between the communist bloc and the rest of the world are included, the proportion of world trade in which buyer or seller was an agent of the state was as much as 15–20 per cent in 1964. For some countries, of course, the proportion is much higher. The United Nations Economic Commission for Asia and the Far East (1964, p. 2) estimated that 70–80 per cent of Burmese exports and 30–50 per cent of imports were handled by state agencies in the early 1960s. The percentage of state-traded imports in Ceylon was put at 25–30, in India 40–50, and in Pakistan 30–50. China (Taiwan) was said to state-trade 60–70 per cent of its exports and Indonesia 45 per cent. Most European countries engage in state trading to some degree, and in France the list of state-imported commodities in 1962 included grains and flour, alcohol, tobacco and tobacco manufactures, sugar, oil seeds, fruit, vegetable oil, certain dairy products, solid mineral fuels, petroleum and petroleum products, electric power, gas, newsprint, and matches.

Agricultural commodities bulk largest among state-traded commodities. Rice trade, for example, was conducted by the government in 8 of 16 exporting countries and 8 of 15 importing countries in 1962. At the same time wheat was sold through national marketing boards in two of the four largest exporting countries (Canada and Australia) and exported from the United States with the aid of the Commodity Credit Corporation. In Europe, bread grains or grains in general have been purchased for a number of years through state agencies in France, the Federal Republic of Germany, Italy, Norway, Finland, and Turkey.

Manufactured and semiprocessed goods also appear in state trading. A number of less developed countries import capital equipment through state-controlled organizations (e.g., India and the United Arab Republic). Government participation in production as well as international trade is common in petroleum and petroleum products. Drugs and Pharmaceuticals are imported by state agencies in a number of countries, and in Norway fishing equipment is state-imported. Coal and solid fuels are government-controlled in France and the United Kingdom. Alcohol is frequently a government monopoly, as are tobacco and tobacco products.

Even some services are subject to state trading. Many governments offer export loans, or export credit guarantees, or other financial services; and international transportation services—rail, ship, and air—together with radio and wire communications, are frequently furnished by government corporations.


State trading in a narrow sense is a modern phenomenon in the West. Although in ancient times trade in the Mediterranean region usually was strictly regulated and in some cases officially suppressed, it seems to have been conducted by private merchants for their own account. While trade and politics were tightly knit in the Italian city-states at their zenith, as they were in the north European commercial leagues of cities of the Renaissance, the actual timing and terms of individual foreign transactions in both these circumstances were still the prerogative of the private trader. The overseas joint stock companies of seventeenth-century Europe, although not agencies of the state, held state-granted monopolies in the trade with specific regions and are perhaps the most direct antecedents of modern state trading institutions. In the Orient, state trading existed in the seventeenth century and is probably much older than that.

World War I introduced extensive twentieth-century state trading. In the United States, shipping and the railways were requisitioned. Allied governments organized official purchasing missions, and there was some official preclusive buying. In the decade following the war this “interventionism’ was’ reduced, but the depression of the 1930s brought pressures to find outlets for exports and to minimize the foreign exchange cost of imports. A number of the present commodity marketing boards and importing authorities have their roots in this period. World War n brought a re-establishment of purchasing missions and corporations for preclusive buying. The United Kingdom’s Ministry of Food favored bulk-purchase transactions and spawned a number of national marketing boards, such as those still functioning in Australia and New Zealand.


The purposes which motivate the creation or maintenance of state trading agencies in the present are varied. The chief aim of some agencies is to effect trade with communist bloc countries. State trading by the governments of Cambodia, Vietnam, and China (Taiwan) has been at one time or another an arrangement for receiving and accounting for United States aid. In the Philippines and Indonesia, state importing of consumer goods is aimed partly at favoring nationals over foreigners in retail and wholesale trade. The United Arab Republic imports through public enterprises to ensure conformity of foreign trade with the national development plan and to protect against illicit capital exports in the form of commodities. Food products are widely imported through government monopolies to ensure “reasonable” supplies and prices. And state monopolies for alcohol and drugs aim in part at the protection of public health. The most common motivation for state trading, however, is the desire to improve the national terms of trade through the elimination of private competition for foreign supplies or markets. Marketing boards may have as further purposes the standardization of quality and the fostering of production. The objectives of state trading organizations are usually multiple and shift from time to time as government policies are reformulated.


The marketing board, directed by producer representatives but subject to ministerial authority, is the common form of export monopoly in the British Commonwealth. Elsewhere, the semi-autonomous, limited liability, public corporation, which may or may not have the same legal status as private corporations, predominates. In countries with extensive state trading, a mixture of forms is likely to be found, including purchasing missions, marketing boards, wholly and partially owned government corporations, government departments, and committees. A given agency may receive regular financing through ministerial budgets, be privileged to borrow from the national treasury or on the open market with government guarantee, or be dependent upon its own resources. Typically the origin of an agency is ad hoc and is a construction from pre-existing organizational facilities. The legal immunities of state trading entities from taxes and from suit in the courts vary from country to country and are not well established in international law.

Economic effects

A not uncommon pairing of state objectives is to improve the country’s international terms of trade and to raise public revenue by taxing exports. Consider the effects of a monopoly exporter seeking to obtain the greatest difference between export receipts and domestic cost. Such a monopoly maximizes profit by limiting exports until the marginal cost of its domestic purchases equals the marginal revenue of its export sales. In such a case, foreign production tends to be stimulated and foreign consumption retarded, while in the home market production tends to be retarded and consumption stimulated. An import monopoly’s effects are similar but opposite in direction in the foreign and domestic markets when it acts to maximize profits. Where an import monopoly fails to charge the maximum price obtainable for supplies made available to the domestic market, “shortages” will appear which may necessitate rationing. Similarly, when an export monopoly restricts its sales without depressing domestic prices, production or marketing controls may be necessary.

Monopolies may pay a premium for imports or subsidize exports as a form of foreign aid, as a device to sustain production and employment, or as a device of economic warfare. The form in which the national cost of these acts is distributed depends upon the agency’s domestic pricing policies and sources of financing.

An agency may hold inventories and use them to buffer disparities of demand and supply within a given price range. Or it may act as a stabilizing financial fund, minimizing domestic price movements. The latter policy, however, carried out without limitations on domestic production or consumption and without buffering inventory adjustments, retards purchases or sales abroad when these transactions are most advantageous and stimulates them when prices are disadvantageous. Monopolistic traders may discriminate in the terms offered in each transaction and may discriminate continuously between markets that cannot be joined.

When state monopolies as sellers deal with monopolistic buyers, or several state monopolies constitute a market, the probable terms of the resulting transactions cannot be specified on the basis of economic theory [seeMonopoly]. Such powers as a selling monopoly has depend upon the extent to which local production, or the resources employed in production, can be otherwise utilized in case foreign sales are restricted; the extent to which the foreign buyer has capabilities for duplicating the product or dispensing with it in consumption; and the expansibility of production and contractability of consumption in third countries. A country in a strong bargaining position may exact concessions from other parties by cessation or threat of cessation of trade. Monopoly powers tend to weaken with exercise, however, as a result of substitutions.

The theoretical case against monopoly in economic analysis has been diluted since the 1950s by a sharper understanding of forms of imperfect competition, by criticism of the nature of the welfare optimum obtainable in competitive static equilibrium, and by interest in the process of economic growth. In particular, the “theory of the second best,” according to which, when one of the conditions for an optimum is denied, the remaining conditions for that optimum are no longer necessarily desirable even when obtainable, undermines the attack on countervailing monopoly. State trading organizations, in some circumstances, may accelerate progress in less developed countries, although their contribution to this end is by no means axiomatic.

International control

International agreements calling for the reduction of tariffs, the elimination of quantitative trade restrictions, and application of the most-favored-nation principle have considerably less significance when applied to countries with national trade monopolies than when enforced as rules of behavior for governments where markets are competitive. Private enterprise countries have therefore sought, without great success, a formula which would exact from countries with state trading enterprises commitments equivalent in effect to pledges of nondiscriminatory import liberalization.

In bilateral treaties of the 1930s, two approaches predominated. One required the state-trading country to purchase specified values of goods per annum in the agreement-partner country in return for most-favored-nation tariff treatment. The other, sometimes used as a supplement to the first, bound the state-trading nation to follow “commercial and financial considerations.”

The loose commitment to follow “commercial considerations” has been repeated in the General Agreement on Tariffs and Trade (GATT). The GATT agreement, furthermore, notes that it is “of importance” for member countries to negotiate reductions of trade obstacles and requires that import monopolies report their price markups (art. XVII). Article II.4 strictly forbids an import monopoly to apply such markups “so as to afford protection on the average” in excess of that negotiated in the tariff schedules.

The pledges contained in the GATT to conduct state trading without discrimination or domestic market protection are not entirely satisfactory. Similarly, suitable treatment of the possibility of dumping by state agencies has not been found. Discrimination, or lack of it, in purchasing and selling policies is extremely difficult to prove. Furthermore, a state entity is following “commercial principles” when it purchases and sells where and when its bargaining power is greatest. And in wholly planned economies, domestic prices and exchange rates have uncertain meaning.


State trading currently waxes in less developed countries while waning in the more developed ones. Although support for agriculture in the industrialized countries shows little sign of abatement, the organizational forms are in transition. The liquidation of the United Kingdom Ministry of Food eliminated the largest state trading organ in western Europe, and the Common Agricultural Policy of the European Economic Community intends to substitute a system of import levies for national trading organizations. The end of the Argentine Trade Promotion Institute took from Latin America its largest state trader, but in Africa and Asia state trading is increasing. Unfortunately, state trading is infectious, each monopoly appearing to justify a countervailing one.

J. Carter Murphy


Contracting Parties TO THE General Agreement ON Tariffs AND Trade 1964 The Role of GATT in Relation to Trade and Development. Geneva: The Contracting Parties.

General Agreement ON Tariffs AND Trade 1963 United Nations, United Nations, Economic ading Enterprises: Notifications Pursuant to Article XVII 4(a). L/1949/Add. 1–26. Unpublished documents. → The most adequate single source of current data, these are unpublished documents representing government responses to a GATT questionnaire. Resolutions of the Contracting Parties call upon governments to respond fully to the questionnaire every third year after 1963 and General Agreement to give annual notification of state trading measures.

Hawkins, harry C. 1951 Commercial Treaties and Agreements: Principles and Practice. New York: Rinehart.

State Trading. 1959Law and Contemporary Problems 24:241–528.→ The entire issue is devoted to state trading.

United Nations, Economic Commission FOR Asia AND THE Far East 1964State Trading in Countries of Asia and the Far East Region. New York: United Nations. → General analysis and country studies. Viner, Jacob 1943 Trade Relations Between Free-market and Controlled Economies. Geneva: League of Nations.

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International Trade Controls

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International Trade Controls