Lecture 5 International trade policy

ECON 335 International Economy Lectures 5: International trade policy GENERAL PLAN 1 2 3 Free Trade Versus Protectionism Trade Barriers: Tariffs, Subsidies and Quotas Other trade policies The Case for Free Trade  We have demonstrated how free trade benefits all trading countries1  The theory of comparative advantage is the case for free trade  A good/service is not imported unless its net price to the buyer is below that of the domestically produced alternative An exception: Large countries possess monopoly power in international trade For them free trade is not Pareto optimal (Brazil in coffee, Japan in automobiles, Thailand and Vietnam maybe for rice, for instance) The Case for Protection  Arguments can also be made in favor of tariffs and quotas Common Arguments Against Free Trade: Protection saves jobs Free trade would change income distribution (social gap) Some countries engage in unfair trade practices 4 Cheap foreign labor makes competition unfair Protection safeguards national security Protection discourages dependency Protection safeguards infant industries Protection provides protection during temporary currency overvaluation Suppressing luxuries 10 Simple way to collect money for government GENERAL PLAN Free Trade Versus Protectionism Trade Barriers: Tariffs, Subsidies and Quotas Other Trade Policies Economics of Tariffs  Tariffs are the most common type of trade restriction  A tariff requires the importer of a good to pay a specified fraction of the price to the government  By raising the domestic price of imports, a tariff helps domestic producers but hurts domestic consumers The Effect of a Tariff Sdom Ddom & Sdom show the domestic demand and supply for a good If the world price is Pw, and there is free trade, domestic firms supply Qs, domestic demand is Qd Pw + T Pw and the difference is imported Ddom A tariff can stimulate domestic Qs Qs' Qd' Qd Quantity supply and restrict imports At a domestic price Pw + T , where T is the size of the tariff, quantity of domestic demand falls to Qd', quantity of domestic supply rises to Qs' and imports fall The Welfare Costs of a Tariff The tariff leads both to transfers and net social losses Consumer surplus is decreased by the area between Pw+T, Pw and D S The government raises revenue – i.e there is a transfer to the government, and there is a transfer in the form of extra profits to producers Pw + T Pw D Qs Qs' Qd' Qd Quantity There is also dead-weight loss from consumption inefficiency There is a social deadweight cost from production inefficiency, given that the good could be imported at Pw 10 The contracting spiral of world trade, January 1929 to March 1933 (total imports of 75 countries in millions of U.S dollars) Husted/Melvi n, © 20 01, Addi son Wesley Long man , Inc All rights reserve d 11 Tariffs of countries in GATT/WTO  1947: 37%  1950-1970: 20 - 25%  1970- 1990: 10 - 15%  1990- 1995: -10%  After 1995: - 5% 12 The case for tariffs – good arguments  When a country's imports form a significant share of the world market for a commodity, a higher level of imports is likely to bid up the world price  Then an imposition of an import tariff could lead to a welfare improvement for the country, relative to free trade 13 An Example of Optimal Tariff  Let’s assume that country A is an economically large country (a large world importer of a product L)  Country B exports product L  Let’s consider the situation under free trade and after an import tariff is imposed by country A 14 International Free-trade Equilibrium Husted/Melvin, © 2001, Addison Wesley Longman, Inc All rights reserved 15 Illustration of a Tariff for a Large Country Husted/Melvin, © 2001, Addison Wesley Longman, Inc All rights reserved 16  Welfare Cost of a tariff Imposed by a large Country  in CS -$a -$b  in PS $a  in G revenue Net welfare change -$c -$d $c -$b +$e -$d +$e Optimal tariff would max $e - $(b + d) 17 Rate of Protection  Example of a measure of openness: the Rate of Protection (low or high?)  The Nominal Rate of Protection is the percent tariffs paid by consumers on its output 18 Effective Rate of Protection  The ERP of an individual industry is defined as the percentage by which the entire set of a nation’s trade barriers raises the industry’s value added per unit of output   Value added is the amount that is available to make payments to the primary production factors in the industry Value added is the sum of wages paid to the labor, the rent paid to landowners, and the profits and other returns to the owners and providers of capital 19 Illustrative of calculation of an ERP Unit value With Free (Price) of Trade output Pj = 200 With 10% tariff on output, 5% tariff on inputs Unit Price added V = 60 Unit Price 220 added 200 V’ = 73 10% tariff on output Unit cost of inputs Pi = 140 Unit cost of inputs Pi = 147 5% tariff on inputs 147 140 20 NRP vs ERP  The NRP is 10%  The ERP is  21 GENERAL PLAN  4.1 Free Trade Versus Protectionism  4.2 Trade Barriers: Tariffs, Subsidies and Quotas  4.3 Other Commercial Policies 22 Other commercial policies  Although tariff rates have fallen under GATT and WTO, there has been a proliferation of other trade restrictions   quotas non-tariff barriers • administrative regulations that discriminate against foreign goods  export subsidies 23 Quotas  Even though quotas restrict the quantity of imports, this does not mean they have no effect on domestic prices of the restricted goods  With lower supply the equilibrium price will be higher than under free trade So quotas affect in a same way as tariffs! 24 Welfare effects of a quota Husted/Melvin, © 2001, Add ison Wesley Longman, Inc All rights rese rved 25 Export subsidies  "commercial policy to boost exports" Price Exports P’ P Sdom B A G Sw+ s E Sw F C Ddom Qd’ Qd Qs Qs’ Quantity 26 More of Non-Tariff Barriers  delays at border  quality control measures  even standards some times…  VERs  VIEs 27 Voluntary Export Restraints  Arrangements by which government of an exporting country F agrees to the importing country H to “voluntarily” restrict their exports to that country  So, gives market power to foreign exporters, forces them to take it, hence, shifts rent to F (why?), and calls it “voluntary”  VERs have similar effects as of quotas  Negotiate for a specified period of time 28 VERs  Measures for specific countries Trade detour to third countries  Using by powerful countries to protect their industries having trouble competing against rising tide of imports  The US has forced VERs on Asian and other suppliers since early 1960s  First in clothing and textiles, later in in steel, automobiles  To avoid the embarrassment of imposing quotas 29 (violate GATT) VERs  Famous VERs on cars towards Japan started in 1981 by R Reagan  Other countries using VERs: EU, Canada (towards Japan, Korea, Central and Eastern Europe on textiles and clothing, ag products, steel, footwear, automobiles, machine tools 30 10 Voluntary Import Expansions  Import side of a VER  A VIE is an agreement to increase the quantity of imports of a product over a specified period of time  Popular in trade relation between US and Japan  Semi-conductor agreement in 1986  There are also such agreements on automobile parts and automobiles between the two countries 31 11 ... reserve d 11 Tariffs of countries in GATT/WTO  1947: 37%  1 950 -1970: 20 - 25%  1970- 1990: 10 - 15%  1990- 19 95: -10%  After 19 95: - 5% 12 The case for tariffs – good arguments  When a country's... government GENERAL PLAN Free Trade Versus Protectionism Trade Barriers: Tariffs, Subsidies and Quotas Other Trade Policies Economics of Tariffs  Tariffs are the most common type of trade restriction ... under free trade and after an import tariff is imposed by country A 14 International Free -trade Equilibrium Husted/Melvin, © 2001, Addison Wesley Longman, Inc All rights reserved 15 Illustration