Protectionism and Profits | AQA Q23, Paper 1 2018

Here is a suggested response to the 25-mark question on protectionism and profits in the AQA A-Level Business Paper 1 in 2018.

Protectionism, which aims to reduce the effects of free or open trade, is designed to “protect” some businesses against others. An increase in protectionism will, therefore, create winners and losers in terms of the impact on business profits and much depends on the situations that different UK businesses face based on the importance of international trade to them and the extent of competition faced from businesses that are “protected”.

In what situations might UK businesses experience a fall in profits from greater protectionism? An obvious example would be a UK business exporting into a country that then introduces or raises tariffs on the products exported. A tariff will increase the selling price of the UK product relative to domestic alternatives, making it less price competitive. If demand in that country is price-sensitive, then the tariff will result in lower overall sales and a reduction in contribution, thereby reducing profits if fixed costs are not lowered in response. A similar effect on profits might arise from the introduction of import quotas, although in this case it is not the UK businesses’ selling price that is changed, but the quantity that they are able to import into the export market. If the import quota is higher than the current sales volume exported, sales and profits will suffer directly, although the business might be able to respond by redirecting these products into an alternative market with lower or no quotas. The overall effect on the profits of UK businesses who are exporting will, of course, be largely determined by how much profits are dependent on exports (e.g. a business with 5% of sales from exports is much less exposed to increased protectionism than one, like JCB, which exports 75% of its output). Another factor to consider is how long the increased protectionism might last for, with a shorter period likely to have a lower impact on profits than where tariffs and quotas are implemented for the long-term.

Whilst increased protectionism is likely to damage the profits of UK businesses that trade internationally, it is not inevitable that it will do so. For example, there are some strategies available that might enable those businesses to “avoid” protectionism. In the case of tariffs and quotas, these tend to be applied to products that are imported. So, a response might be to set up an operation in the country concerned, producing locally and thereby avoiding the tariffs or quotas. An alternative might be to partner (e.g. through a joint venture) licensing them to produce locally. Of course, these strategies are likely to involve much higher risk than simple exporting, requiring more investment and management time. A business would have to judge whether the negative effect of protectionism on profits is worth avoiding compared with the risks and rewards of operating directly in the target market. Protectionism is also designed to support and encourage new domestic businesses to grow, so a UK business might find that operating locally means it is facing a different and tougher competitive environment there. Another reason why profits of UK businesses might not fall is if the UK government (or EU whilst the UK is still a member) retaliates with its own protectionist measures. For example, if the UK/EU imposed policies that made it harder for competitors from emerging economies like China to import into the UK, then UK businesses might enjoy the benefits of protectionism with fewer imported product competing for their share of UK demand.

So, with protectionism, the position is usually complex and the effects on business profits uncertain. On balance, it is reasonable to expect that, to a large extent, UK businesses that trade internationally will suffer from greater protectionism in their overseas markets, since that is what protectionism is designed to do. If sales to those countries fall, it is hard to imagine profits not falling too, assuming that international sales actually make a contribution. As argued above, there are steps that UK businesses could take to reduce and possibly eliminate the effect on profits, though there are few easy solutions. The overall effect on profits, and how long it lasts, will depend to a large extent on the importance of international trade to different UK businesses and industries.