What are the effects of trade diversion?

The effects of trade diversion refer to the economic consequences that occur when a country shifts its imports from a more efficient and lower-cost producer to a less efficient and higher-cost producer due to the implementation of trade barriers, such as tariffs or quotas.

The main effects of trade diversion include:

1. Inefficiency: Trade diversion leads to a less efficient allocation of resources as countries are forced to import goods from higher-cost producers within a preferential trading bloc, rather than from more efficient producers outside the bloc. This results in higher production costs and reduced economic welfare.

2. Higher prices: Trade diversion can lead to higher prices for consumers as they are forced to purchase goods from higher-cost producers within the bloc. This reduces consumer purchasing power and can lead to a decrease in overall living standards.

3. Reduced competition: Trade diversion can reduce competition within the domestic market as imports from more efficient producers outside the bloc are replaced by imports from less efficient producers within the bloc. This can result in reduced product quality, limited product variety, and decreased innovation.

4. Trade imbalances: Trade diversion can also lead to trade imbalances between countries within the trading bloc. If one country within the bloc becomes the dominant producer of a particular good due to trade diversion, it may lead to an over-reliance on that country for the supply of that good, potentially creating trade deficits for other countries within the bloc.

Overall, trade diversion has negative effects on economic efficiency, consumer welfare, competition, and trade balances, making it an undesirable outcome of trade barriers.