Trade Barriers

Refer to all regulatory mechanisms enforced by the government on the conduct of international trade

Author: Andy Yan
Andy Yan
Andy Yan
Investment Banking | Corporate Development

Before deciding to pursue his MBA, Andy previously spent two years at Credit Suisse in Investment Banking, primarily working on M&A and IPO transactions. Prior to joining Credit Suisse, Andy was a Business Analyst Intern for Capital One and worked as an associate for Cambridge Realty Capital Companies.

Andy graduated from University of Chicago with a Bachelor of Arts in Economics and Statistics and is currently an MBA candidate at The University of Chicago Booth School of Business with a concentration in Analytical Finance.

Reviewed By: Christopher Haynes
Christopher Haynes
Christopher Haynes
Asset Management | Investment Banking

Chris currently works as an investment associate with Ascension Ventures, a strategic healthcare venture fund that invests on behalf of thirteen of the nation's leading health systems with $88 billion in combined operating revenue. Previously, Chris served as an investment analyst with New Holland Capital, a hedge fund-of-funds asset management firm with $20 billion under management, and as an investment banking analyst in SunTrust Robinson Humphrey's Financial Sponsor Group.

Chris graduated Magna Cum Laude from the University of Florida with a Bachelor of Arts in Economics and earned a Master of Finance (MSF) from the Olin School of Business at Washington University in St. Louis.

Last Updated:October 25, 2023

What are Trade Barriers?

Trade Barriers refer to all regulatory mechanisms enforced by the government on the conduct of international trade. This is done primarily to protect the domestic economy and its producers.

They are considered a restriction on international free trade among sellers and buyers in the global economy. 

Trade barriers are typically seen in closed market systems or protectionist markets where the government regulates the flow of goods among economies. In such cases, the government tends to opt for measures such as taxes, quotas, etc., that discourage imports.

Discouraging imports reduces the supply of goods in the home economy and prevents the price from falling. It also prevents foreign market players from competing with local producers.

This protects producers of certain industries in the home country from unfair competition by multinational companies. Hence, these barriers are also called "protection."

The cost of enforcing these trade barriers exceeds the benefits enjoyed by the producers in the economy. This is because the restriction on imports limits the choice of goods for consumers, who now face a higher price than the market value.

With very little competition from multinational firms, domestic producers have no incentive to increase the standard of services or quality of goods they provide. Consumers, on the other hand, are forced to accept these goods of inferior quality due to limited choices. 

Why Do Trade Barriers Exist?

There are three main reasons why a government may resort to enforcing barriers-

1. Anti-dumping provision

The term 'dumping' refers to the sale of goods in the domestic market by foreign producers at a price much lower than the foreign market. 

The foreign producers who can produce goods at a lower cost than the domestic producers use this comparative advantage to sell their goods at a lower price in the domestic market. Thus, they can earn a profit despite their low prices.

In some instances, foreign producers with more significant cash reserves and liquidity may also sell their products at a low price in another country to gain market share. This affects domestic producers adversely as the demand for higher-priced domestic goods reduces.

Governments may impose barriers to trade as an anti-dumping mechanism to protect domestic producers from dumping by foreign producers. 

These barriers may be in the form of taxes and additional costs on the import of dumped goods to increase their prices and keep them close to domestic prices. They could also be in the form of a complete ban on dumping by certain industries. 

2. National Defense

Like most industries, the national defense industry relies on a global network of suppliers to build and maintain national defense equipment. For example, nations import ammunition, planes, boats, jets, etc., from other countries.

In times of war or conflict, this becomes a sensitive issue. A country reliant on another for defense equipment may face an unfair advantage as the exporting country may refuse to supply equipment in a bid to win the war or gain negotiating advantage. 

Thus, a country needs to have a self-reliant national defense industry. To make foreign defense imports less attractive, governments impose trade tariffs.

3. Infant industries

Infant industries are industries still in their early stages of development. 

While some industries are developed in some economies, they may just be starting in other countries. This makes them vulnerable to dumping and unfair competition from foreign players.

When infant industries cannot compete with developed multinational companies, they may be forced to shut down. This adversely affects the development of the domestic economy.

A common example is the Import Substitution Industrialization (ISI) concept, wherein governments impose import duties on the industry in which it wants to foster growth in the domestic economy. 

Alternatively, governments may provide subsidies to these industries. This helps them compete with foreign industries in terms of price. In addition, fostering infant industries increases employment and helps countries shift from agrarian to good-finished economies. 

There are many criticisms of the infant industry argument. Economists believe that by reducing competition, infant industries could end up producing inferior quality goods that may not be able to compete with foreign goods in the future.

Political reasons

Governments may also impose barriers for political reasons. Some instances are as follows-

1. Domestic Employment

When faced with foreign competition, domestic producers tend to reduce costs by laying off excessive workers, lowering wages, or shifting production abroad. This creates unemployment in the domestic economy. 

To reduce the instances of unemployment, governments impose barriers to the entry of foreign firms into the domestic economy.

2. Protecting consumers

In case the government feels the import of a good may be detrimental to the consumers, they may impose a ban or a tax on its import.

For instance, a government may enforce a ban on the import of beef if they think it's laced with disease and may harm consumers. 

3. Retaliation

Governments may impose bans on imports from specific countries if they feel a country is not following the provisions of the foreign trade policy. 

For instance, trade restrictions imposed on North Korea by several countries, including China, Japan, the USA, and South Korea, follow ethical trade policies. 

These sanctions banned the trade of military equipment following North Korea's development of nuclear weapons and the first atomic test in 2006. These acts led to international condemnation and a ban on trade agreements with the country.   

Another instance would be when the United States government imposed several import duties on imports from China to retaliate against the low-priced Chinese goods dumped in foreign markets. 

It started with a tariff imposed on Chinese imports to the US by then-President Donald Trump in 2018, who accused China of unfair trade practices and intellectual property theft. In retaliation, China too imposed tariffs on US imports.

When two governments retaliate against each other through the imposition of trade barriers, it leads to a trade war.

There are typically three types of trade barriers: 

  • natural barriers, 
  • tariff barriers, and 
  • non-tariff barriers.

Natural barriers are barriers that exist without government intervention and restrict trading activities. Common natural barriers are distance and language.

Among countries with no common language, the lack of communication often acts as a barrier to trade, restricting the activities of producers and sellers. 

The government imposes tariff barriers to affect the price of imports, whereas non-tariff barriers affect the volume of imports through measures other than tariffs.

What are Tariffs

It is a tax the government imposes on imported goods to increase their price for domestic consumers. This increases the relative price of imported goods for consumers.

The consumers pay these taxes in the home country and not by the exporting country. The aim of imposing tariffs is to make imported goods less attractive to consumers in terms of price. They are also known as 'protectionist barriers. 

They can be imposed in the form of customs duties. However, each country has a list of goods free from tariffs and usually includes necessities like grains and certain medicines or vaccines for large-scale emergencies.

In instances of unfair competition by cheaper foreign goods, the imposition of tax also decreases the price difference to ensure the price of the foreign good is near its domestic value. 

This prevents dumping in the market and gives domestic producers fair price competition. In addition, tariffs are collected by the customs authority of a country and help raise government revenue.

It can be charged as a per-unit tax, as a percentage of the value of goods, or as a combination of both as specified by the government.

There are commonly four types of tariffs-

  • Specific tariff- When a per unit tax is imposed on goods, it is known as a specific tariff. For example, the tax imposed per unit barrel of oil imported.
  • Ad Valorem tariff- When the tax imposed is a fixed percentage of the value of goods imported, it is known as an ad valorem tariff.
  • Compound tariff- When a specific tax is charged on each unit of the good in addition to an ad valorem tariff on the total value, it is known as a compound tariff.
  • Sliding scale tariff- When the tax charged varies according to the price of the good, it is known as a sliding scale tariff. As a common practice, imports with higher prices are taxed more.

The main argument against the imposition of tariffs is that it restricts free trade among economies. Free trade provides benefits to both producers and consumers of a good. 

By increasing the prices of goods, tariffs also reduce the purchasing power of people as some necessary imports like steel and oil have now become expensive.

Tariffs on intermediate goods affect consumers in the domestic country even when they are not directly indulged in international trade.

For example, the tariffs imposed on computer software and parts imported by domestic producers from foreign countries drive up their cost of inputs. The producers then raise their prices to offset this increase and directly affect domestic consumers.

Non-tariff barriers

They refer to restrictions on trade by affecting the volume of imports and exports by measures other than tax imposition.

It includes regulations on how a foreign good can be manufactured, distributed, or advertised in a domestic country.

These barriers may take three forms-

  • Protectionist Barriers- They are designed to protect certain industries at the expense of foreign producers. Examples include import quotas, licensing agreements, anti-dumping duties, etc.
  • Assistive Policies- These policies do not directly restrict trade with other countries. These barriers are enforced to ensure the quality of goods imported. They include customs procedures, technical standards and norms, packaging and labeling procedures, and other requirements.
  • Non-protectionist Policies- They are designed to ensure the health and safety of consumers and animals and do not directly impede trade among countries. This includes licensing requirements, sanitary rules, plant and animal inspection, etc.

Types of non-tariff barriers

The most common non-tariff barriers to trade are as follows-

1. Licenses

It refers to the imposition of administrative procedures that require documentation on the part of the consumer before importing a good. An import license is issued by the national government, allowing the applicant to import certain goods.

Using an import license allows a business to import goods that are otherwise restricted in the country. 

The license also states the volume of goods that the holder can import. These licenses are given in consideration of a fee or a charge. 

A common argument against the imposition of import licenses is that it increases instances of lobbying and bribery in government procedures. It is a form of participation barrier.

2. Quotas

It is a form of quantitative restriction as it limits the number of exports and imports in a country. Usually, a government does not restrict imports until a certain quota has been reached. They are often used in international trade licensing agreements.

Quotas can be set for specific goods for a specific period. This limits the number of countries involved in trade and also caps the number of exports and imports.

They manage competition in the domestic country if the government does not want to eliminate foreign competition fully.

3. Embargoes

It is an extreme measure involving a complete ban on the trade of specific commodities from specific countries or both. They are included as legal barriers as they involve formal legislation.

They can be enforced due to several political and economic reasons. 

4. Import deposits  

An import deposit is a specified sum the importer must pay to a country's central bank for a definite period. This sum is set equal to the cost of producing the imported goods. 

5. Sanctions

Administrative barriers are enforced to slow or limit trade volume through the imposition of additional procedures or customs requirements. This includes assistive policy barriers like packaging and labeling procedures, technical standards, and norms.

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Researched and authored by Manya Bhardwaj  | LinkedIn 

Reviewed & Edited by Ankit Sinha | LinkedIn

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