Question

Suppose Canada imposes high tariffs on Japanese automobiles. The intention is to make autos produced in Japan so expensive for Canadians to buy that they choose instead to purchase autos constructed in Canada. Advocates of the policy contend this will create new employment in Canada. Assuming the Bank of Canada maintains a flexible exchange rate, will this trade policy prove effective? Explain thoroughly. What if the Bank of Canada maintains a fixed exchange rate, how would be your answer? Explain thoroughly.

Answer 1

Canada imposes high tariff on Japanese automobiles. So if the Canadians want to import machinery from Japan they will have to shell out more money, and they will opt for cheaper local brands instead of spending more on imported one's. So suppose Canadian automobile now costs $100, whereas Japanese costs $150. This will increase demand for local cars and increase employment as new industries will be set up to meet the demand.

So if there is a flexible exchange rate, the imports reduce, which will favor the local currency, the currency will appreciate. In the same way because of this appreciation in the currency, exports money earned by trading, will decline, because of which exports will be non-competitive, this will reduce existing employment and not help in creating new employment opportunities. Thus even if the country is saving on imports, exports suffer because of increase in the value of the currency. Also high tariffs lead to more expenditure by the locals on Japanese cars, which will increase inflation and cost of living. Thus this trade policy won't prove effective as there is a net effect (imports decline and so do exports) in the economy.

Under a fixed exchange rate the imports would reduce and exports will stay the same as the producers are getting same amount for the goods produced. Thus this might reduce the import bill and prove somewhat beneficial for Canada in generating new employment opportunities by creating local industries.