Protected Markets Research Paper

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A protected market is defined as one shielded from competition.  The analytical concept dates back at  least to Adam Smith, David Ricardo, Alfred Marshall, and other economists who analyzed the implications of imperfect competition, trade restrictions, and market power. Market protections may be natural or man-made, private or public, and welfare enhancing or depleting.

Some markets are naturally protected from competition by high costs of transportation because of distance, bulk, or terrain. A market isolated by high transport costs and characterized by economies of size so that only one firm  can  operate at  low unit  cost is called a  natural monopoly. A cooperative form of business organization owned by patrons or government regulation of pricing has been used to avoid exploitation of producers and consumers in such naturally protected markets.

Naturally protected markets are the exception; protected markets more frequently emerge from deliberate action by firms, organizations, and  government. Firms engage in exclusionary, predatory, and price-fixing behavior to create or exploit protected markets (Black 2002). Most nations have antitrust laws to avoid or countervail such exercise of market power. In  the  modern  age of sophisticated science, technology, and  information  systems, firms turn to other strategies to protect markets. For example, a firm may protect its market by encouraging excessive standards (suited to the firm in question but not to other firms), by aggressive advertising, by exploitation of public ignorance (e.g., fear of chemicals or pathogens in tap water or in conventionally produced food), and by market power to expand shelf space in supermarkets.

In the case of organizations, workers form unions to protect their labor market from competition and so enable collective bargaining to raise wages and improve working conditions. Workers in some countries have lobbied successfully for laws requiring large severance payments, high minimum wages and unemployment compensation, long vacations, short workweeks, and strict work rules. A consequence, illustrated by France, is high overall labor costs that discourage employment, especially of young, inexperienced workers. These factors coupled with racism and discrimination in  French  labor markets brought  longterm unemployment rates of 20 percent or more among Muslim  youth  in  the  banlieue neighborhoods  across France, sparking massive social unrest in 2005.

Turning to markets protected by government, border controls attempt to protect domestic workers from immigrant laborers willing to work for low wages and benefits. The  result is salutary for domestic workers but  hurts would-be migrant workers. Thus, policies to protect labor and industry can be divisive, creating a dual labor market of  cosseted job-secure workers with  generous benefit packages on one hand and poor unemployed and underemployed workers with limited future prospects on the other.

Governments  of some countries pursue  an  infant industry policy or industrial policy by protecting selected domestic firms through tariffs, quotas, and regulation of competing imports while also promoting the firms with subsidies in the form of cheap credit, low taxes, and concessional access to public research and educational benefits. Such market protection is intended to help new firms until they attain the critical mass necessary to compete in international markets without  assistance. A problem is that governments are not very adept at picking industrial winners. Target  industries  and  firms are  likely to  be favored for political rather than sound economic reasons. Partly because market protection invites complacency in industry, favored treatment tends to be institutionalized and continued even after the favored industry was expected to mature.

Instruments such as tariffs, licenses, and regulations used to protect markets create economic rents—the stream of  income  generated over  time  by  such  instruments. Individuals, firms, and organizations have reason to engage in unethical practices, lobbying and bribing politicians and bureaucrats to  create or remove such instruments. The consequence is corruption in government.

However, some market protections are justified and raise real national income. Firms that protect their market by being a first mover or by innovating faster than competitors  serve consumers  and  raise  national  income. Market protection is useful in supplying public goods. In a laissez-faire competitive market, firms can recover only the marginal cost of their products. Hence, a firm is dissuaded from developing a new soybean variety, for example, because it cannot recover the millions of dollars spent to develop the seed. Governments award patents, copyrights, and  trademarks so that  firms can protect  their intellectual property.  Thus,  firms can  exercise market power to charge prices above marginal costs and pay for research and development.

Charging above marginal cost is a second-best policy. The first-best “textbook” policy in such cases is to rely on the public rather than the private sector to develop and pay for such technology. But governments do not have a favorable record, suffering from a dearth of funding and a surfeit of political misdirection in providing such public goods.

Society benefits from grades, standards, and sanitary and phytosanitary regulations that improve private market performance. Unfortunately, these and other market protections sometimes are employed to the detriment of society. The World Bank (Anderson et al., pp. 346, 351, 352) estimates that  elimination  of 2006  barriers (tariff and nontariff impediments not justified by sound science) to international trade in goods would add $278 billion to world income each year by 2015 and beyond—nearly half of that accruing to developing countries.

Public protection  of markets often  is justified to serve the environment (Southgate et al. 2007, pp. 103–123). Natural resources such as oceans, the atmosphere, and  land  are frequently open-access property  inviting overuse. The consequent overexploitation of open-access property is called the tragedy of the commons. Uncontrolled  access leads  users  to  exploit  resources “before the hoarders get them.” In 1960 Nobel laureate Ronald  Coase pointed  out  that  creation  of  property rights to  such resources can  align private with  social incentives to achieve efficient resource use.

An example is the “cap and trade” market employed successfully to reduce sulfur dioxide emissions at low economic cost in the United States. The system begins with emission permits issued to each firm. The permits, which can be sold to firms or given to firms (reduced appropriately from historic emission levels), are negotiable. Firms that can reduce emissions at low cost sell their permits to firms expanding emissions to produce highly valued products.

In  conclusion, prudent  public  policy to  privatize, deregulate, and open markets at home and abroad has the potential to improve the quality of life around the world. In some cases that means opening markets, as in international trade. In other cases that means protecting markets, as in cap and trade systems for effluents or in patents for intellectual property.

Bibliograhy:

  1. Anderson, Kym, Will Martin, and Dominique van der Mensbrugghe. 2006. Market and Welfare Implications of Doha Reform Scenarios. In Agricultural Trade Reform and the Doha Development Agenda. Eds. Kym Anderson and Will Martin, Report No. 34206. New York: Palgrave Macmillan, and Washington, DC: World Bank. Chapter 12.
  2. Black, John. 2002. Barriers to Entry. A Dictionary of Economics. Oxford University Press. Oxford Reference Online. http://www.oxfordreference.com/views/ENTRY.html.
  3. Coase, Ronald. 1960. “The Problem of Social Cost.” Journal of Law and Economics 3 (1): 1–44. Reprinted in Economics of the Environment:  Selected Readings. 4th ed. Ed. Robert Stavins. New York: Norton, 2000.
  4. Southgate, Douglas, Douglas Graham, and Luther Tweeten. 2007. The World Food Economy. Malden, MA: Blackwell.

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