July 23, 2024 

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IMPORT SUBSTITUTION: A strategy for economic development for a country based on replacing imported goods with domestic production. This is often directed toward imported inputs used for domestic production. The goal of this policy is to encourage domestic production, which subsequently increases domestic income and consumption. A contrasting economic development is export promotion.

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Policies enacted by the government sector of a domestic economy to discourage imports from, and encourage exports to, the foreign sector. The three most common foreign trade policies are tariffs, import quotas, and export subsidies. Tariffs and import quotas are designed to discourage imports and export subsidies are designed to encourage exports. The general goal of these foreign trade policies is to create or increase a country's balance of trade surplus, that is, to increase net exports.
Foreign trade policies are government actions, especially tariffs, import quotas, and export subsidies, designed to increase net exports by promoting exports or restricting imports. By increasing net exports (and creating a more "favorable" balance of trade), the domestic production of a nation increases, which then increases domestic income and employment.

While foreign trade policies can be beneficial to the aggregate domestic economy they tend to be most beneficial, and thus most commonly promoted by, domestic firms facing competition from foreign imports. Domestic firms benefit with higher sales, greater profits, and more income to resource owners. However, by increasing domestic prices and restricting accessing to imports, foreign trade policies also tend to be harmful to domestic consumers.

Consider if you will, one hypothetical country, the United Provinces of Csonda. Csonda, like any real world sovereign nation, is inclined to implement tariffs, import quotas, and export subsidies to increase net exports (and protect domestic firms such as those that produce sundials). The principal target of Csonda trade policies is the Republic of Northwest Queoldiola, which coincidentally has a comparative advantage in sundial production.


The first of three foreign trade policies designed to restrict imports and promote exports is tariffs on imports. The United Provinces of Csonda, perhaps with a little encouragement from the domestic sundial industry (represented by the Csondan Sundial Manufacturers Association -- CSMA), is bound to consider the imposition of import tariffs.

Tariffs are simply taxes placed on imports. They work like any other taxes. A tariff is added to the price of the imported good. The resulting price of the import is thus higher, which tends to decrease the quantity purchased. And if fewer imports are purchased, then more domestic production is sold.

Suppose, for example, that the price of imported Queoldiolan sundials in Csonda is 10 csonds (the Csondan currency) each. A tariff of 1 csond per sundial would then force importers to sell each sundial for 11 csonds.

The CSMA would be thrilled with a tariff like this because the higher price of Queoldiolan imports is bound to reduce the quantity sold in Csonda. This means more Csonda sundials are likely to be purchased. Moreover, Csonda sundial producers can also raise the price they charge for their sundials.

Of course, while domestic producers benefit from tariffs, domestic consumers tend to suffer. They pay higher prices for both imports and domestic production.

Import Quotas

The second of three foreign trade policies designed to restrict imports and promote exports is quotas on imports. In general, a quota is simply a quantity restriction placed on a good, service, or activity. For example, employers often face hiring quotas for different demographic groups and sales representatives often have quotas for sales activities.

Import quotas are then merely legal restrictions on the quantities of imports that are imposed by the domestic government. In this case, the Csondan government might stipulate that Queoldiolan sundial producers are legally allowed to sell a specified quantity of sundials in Csonda.

Import quotas can be established as a simple aggregate, presumably satisfied on a first-come-first-serve basis. Once the total is reached, then no more imports of the particular good are allowed. Alternatively, the total quota can be divided among foreign producers, perhaps pro-rated based on past imports.

While the Csondan Sundial Manufacturers Association undoubtedly would prefer setting the import quota at zero, preventing all foreign imports of sundials, any restriction is beneficial to the industry. With fewer imports entering the Csonda economy, more domestically produced imports are sold, and in all likelihood, at a higher price.

However, once again, import quotas are harmful to domestic consumers. With fewer imports available in the domestic economy, consumers have fewer choices and those choices more often than not come at higher prices.

Export Subsidies

The third of three common foreign trade policies is export subsidies. In general, a subsidy is a payment made by the government sector, either to a business or consumer, with no expectations of receiving any production in exchange. That is, subsidies are merely gifts. They are also commonly thought of as negative taxes. Whereas taxes a payments flowing from businesses and consumers to government, subsidies are payments flowing from government to businesses and consumers.

Subsidies are usually paid to encourage or promote specific activity. For example, government might subsidize job training or school lunch programs to encourage these activities.

An export subsidy is then a subsidy paid to domestic producers to encourage exports of production to the foreign sector. This export subsidization effectively increases the overall revenue received by the domestic firms when exporting production, which is bound to encourage exports.

Export subsidies are usually justified as a means of helping domestic producers compete with lower cost imports. While imports might have lower costs due to comparative advantage, they also might be subsidized by foreign governments.

The Csondan Sundial Manufacturers Association might be able to convince the Csondan government to subsidize their domestic industry. That is, the government would pay Csondan sundial manufacturers a few csonds for each sundial exported. The CMSA might is likely to promote the use of government subsidies so that Csondan sundial manufacturers can be "competitive" with "lower cost" Queoldiolan imports.

If, for example, the price of sundials in Csonda before the arrival of imports is 12 csonds each and then the price falls to 10 csonds once the Queoldiolan sundials hit the Csondan market, the CMSA is bound to argue for a 2 csond subsidy on each sundial produced.

A subsidy such as this allows the Csondan sundial manufacturers to produce more sundials at a lower price and presumably reduce the number of Queoldiolan sundials imported into the country.

Unlike tariffs and import quotas, domestic consumers, like domestic producers, tend to benefit from lower prices of both imports and domestic production. However, domestic taxpayers end up paying for this subsidization.


Recommended Citation:

FOREIGN TRADE POLICIES, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2024. [Accessed: July 23, 2024].

Check Out These Related Terms...

     | tariffs | import quotas | export subsidies | terms of trade | gains from trade |

Or For A Little Background...

     | international trade | comparative advantage | law of comparative advantage | exports | imports | net exports | foreign trade |

And For Further Study...

     | balance of trade | balance of trade surplus | balance of trade deficit | balance of payments | foreign exchange market | international market |

Related Websites (Will Open in New Window)...

     | World Trade Organization | North American Free Trade Agreement | General Agreement on Tariffs and Trade | European Union | International Monetary Fund |

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