International economics chapter 6 trade policy

Kinh tế quốc tế 21-Mar-21 Chapter INTERNATIONAL ECONOMICS Lecturer: PhD Tran Nguyen Chat Division: International Trade Instruments of Trade Policy Email: trannguyenchat.cs2@ftu.edu.vn FOREIGN TRADE UNIVERSITY HOCHIMINH CITY CAMPUS 1 2 How Do Governments Intervene In Markets? How Do Governments Intervene In Markets? Governments use various methods to intervene in markets including tariff and nontariff measures Tariffs ➢ increase government revenues ➢ force consumers to pay more for certain imports ➢ are pro-producer and anti-consumer ➢ reduce the overall efficiency of the world economy Tariffs - taxes levied on imports that effectively raise the cost of imported products relative to domestic products 3 Dr Tran Nguyen Chat Kinh tế quốc tế 21-Mar-21 Costs and Benefits of Tariffs Defining tariffs • A tariff raises the price of a good in the importing country, so we expect it to hurt consumers and benefit producers there A tariff is a tax (duty) levied on products as they move between nations Transaction/ movement of goods – Import tariff - levied on imports – Export tariff - levied on exported goods as they leave the country Main Purpose – Protective tariff - designed to insulate domestic producers from competition – Revenue tariff - intended to raise funds for the government budget (no longer important in industrial countries) • In addition, the government gains tariff revenue from a tariff • How to measure these costs and benefits? • We use the concepts of consumer surplus and producer surplus 5 6 Tariff welfare effects Tariff welfare effects • Consumer surplus measures the amount that a consumer gains from a purchase by the difference in the price he pays from the price he would have been willing to pay – The price he is determined buy) curve • Producer surplus measures the amount that a producer gains from a sale by the difference in the price he receives from the price he would have been willing to sell at – The price he would have been willing to sell at is determined by a supply (willingness to sell) curve would have been willing to pay by a demand (willingness to – When price increases, the quantity supplied increases as well as the producer surplus – When the price increases, the quantity demanded decreases as well as the consumer surplus 7 Dr Tran Nguyen Chat 8 Kinh tế quốc tế 21-Mar-21 Costs and Benefits of Tariffs Consumer and producer surplus • A tariff raises the price of a good in the importing country, making its consumer surplus decrease (making its consumers worse off) and making its producer surplus increase (making its producers better off) • Also, government revenue will increase 9 10 10 10 Who pays for import restrictions? Tariff trade and welfare effects • Domestic consumers face increased costs – Low income consumers are especially hurt by tariffs on low-cost imports • Overall net loss for the economy (deadweight loss) • Export industries face higher costs for inputs • Cost of living increases • Other nations may retaliate, further restricting trade 11 11 Dr Tran Nguyen Chat 11 12 12 Kinh tế quốc tế 21-Mar-21 Why Do Governments Intervene In Markets? Arguments for trade restrictions • • • • • • • Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons There are two main arguments for government intervention in the market Political arguments - concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) Economic arguments - concerned with boosting the overall wealth of a nation – benefits both producers and consumers 13 13 14 14 What Are The Political Arguments For Government Intervention? What Are The Political Arguments For Government Intervention? Protecting jobs - the most common political reason for trade restrictions Protecting industries deemed important for national security - industries are often protected because they are deemed important for national security results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than consumers 15 15 Dr Tran Nguyen Chat 16 16 Kinh tế quốc tế 21-Mar-21 What Are The Political Arguments For Government Intervention? What Are The Political Arguments For Government Intervention? Retaliation for unfair foreign competition - when governments take, or threaten to take, specific actions, other countries may remove trade barriers Furthering the goals of foreign policy preferential trade terms can be granted to countries that a government wants to build strong relations with ➢ if threatened governments not back down, tensions can escalate and new trade barriers may be enacted ➢ risky strategy Protecting consumers from “dangerous” products – limit “unsafe” products trade policy can also be used to punish rogue states 17 17 18 18 What Are The Political Arguments For Government Intervention? What Are The Economic Arguments For Government Intervention? The infant industry argument - an industry should be protected until it can develop and be viable and competitive internationally Protecting the human rights of individuals in exporting countries – through trade policy actions Protecting the environment – international trade is associated with a decline in environmental quality ➢ accepted as a justification for temporary trade restrictions under the WTO ➢ concern over global warming ➢ enforcement of environmental regulations 19 19 Dr Tran Nguyen Chat 20 20 Kinh tế quốc tế 21-Mar-21 What Are The Economic Arguments For Government Intervention? Strategic trade policy – first-mover advantages can be important to success Politics of protectionism • “Supply” of protectionism (trade policy) depends on: – the cost to society of restricting trade – the political importance of the import-competing industries – Magnitude of the adjustment costs from free trade – Public sympathy for those sectors hurt by free trade ➢ governments can help firms from their countries attain these advantages ➢ governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage 21 21 22 22 When Should Governments Avoid Using Trade Barriers? Politics of protectionism • “Demand” for protectionism depends on: Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are: – The amount of the import-competing industry’s comparative disadvantage – The level of import penetration – The level of concentration in the affected sector – The degree of export dependence in the sector beggar-thy-neighbor policies that boost national income at the expense of other countries countries that attempt to use such policies will probably provoke retaliation 24 23 23 Dr Tran Nguyen Chat 24 Kinh tế quốc tế 21-Mar-21 When Should Governments Avoid Using Trade Barriers? Tariffs Export-import goods tariff nomenclature (schedule): o Each country has an export-import goods tariff nomenclature/Schedule o VN tariff is based on HS o There are export tax rate & import tax rate Krugman argues that since special interest groups can influence governments, strategic trade policy is almost certain to be captured by such groups who will distort it to their own ends 25 25 26 26 Types of tariff Effective rate of protection • Specific tariff – Fixed monetary fee per unit of the product • Ad valorem tariff – Levied as a percentage of the value of the product • Compound tariff • The impact of a tariff is often different from its stated amount • The effective tariff rate measures the total increase in domestic production that the tariff makes possible, compared to free trade – Domestic producers may use imported inputs or intermediate goods subject to various tariffs, which affects the calculation – A combination of the above, often levied on finished goods whose components are also subject to tariff if imported separately 27 27 Dr Tran Nguyen Chat 28 28 Kinh tế quốc tế 21-Mar-21 Tariffs Effective rate of protection • When tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate • This is referred to as tariff escalation Tax calculation for exported goods AMOUNT OF TAX = VALUE OF GOODS RATE (%) X TAX 29 29 30 30 Tariffs Tariffs Tax rates for imported goods: Tax calculation for imported goods Percentage tax rate: Amount of tax = Value of goods X tax rate (%) Value of goods → transaction value → methods Specific tax rate: Amount of tax = Quantity of goods X tax rate Compound tax rate a) Preferential tax rates (MFN tax rate): Preferential tax rates are the rates applicable to imported goods originated from countries or groups of countries which have reached agreements on most-favored-nation (MFN) treatment in trade relations with Vietnam Preferential tax rates are specified for every goods item in the Preferential Import Tariffs 31 31 Dr Tran Nguyen Chat 32 32 Kinh tế quốc tế 21-Mar-21 Tariffs Tariffs Tax rates for imported goods : Tax rates for imported goods : b) Specially preferential tax rates (FTA tax rate): Specially preferential tax rates are the rates applicable to imported goods originated from the countries or groups of countries those have reached agreements with Vietnam on specially preferential import tax rates under the institution of free trade areas, tariffs alliance, or aiming to facilitate border trade exchanges and other cases of specially preferential treatment Specially preferential tax rates shall be applicable specifically to every goods item according to the provisions of the agreements c) Ordinary tax rates: • Ordinary tax rates are the rates applicable to imported goods originated from countries or groups of countries with which Vietnam has not reached any agreement on MFN or on specially preferential import tax rates • Ordinary tax rate is 50% (fifty percent) higher than the preferential tax rate of each goods item specified in the Preferential Import Tariffs Nomenclature (or equal to 150% MFN rate) 33 33 34 34 Customs Valuation Customs Valuation The WTO Valuation Agreement: • The Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994 (GATT 1994) • Establishes a Customs valuation system that primarily bases the Customs value on the transaction value of the imported goods • The price actually paid or payable for the goods when sold for export to the country of importation, plus certain adjustments Concept: • The Customs value on imported goods is determined mainly for the purpose of applying ad valorem duties • Constitutes the taxable basis for Customs duties • An essential element for trade statistics, for monitoring quantitative restrictions, tariff preferences and for collecting internal national taxes, etc 35 35 Dr Tran Nguyen Chat 36 36 Kinh tế quốc tế 21-Mar-21 How Do Governments Intervene In Markets? Customs Valuation Governments use various methods to intervene in markets including tariff and non-tariff measures Valuation methods: The transaction value of the imported goods The transaction value of identical goods; The transaction value of similar goods; The deductive value method; The computed value method; The fall-back method Non-Tariffs measures (NTMs) are policy measures — other than ordinary customs tariffs — that can potentially have an economic effect on international trade in goods, changing quantities traded, or prices or both →Trends of tariffication 37 37 38 38 WTO AGREEMENTS: GATT 1994 Non-tariff measures Agriculture (AoA) Sanitary and Phytosanitary Measures (SPS) Textiles and Clothing Note (terminated on Jan 2005) Technical Barriers to Trade (TBT) Trade-Related Investment Measures (TRIMs) Anti-dumping (Article VI of GATT 1994) (ADA) Customs valuation (Article VII of GATT 1994) (ACV) Preshipment Inspection Rules of Origin (ROO) 10 Import Licensing (ILP) 11 Subsidies and Countervailing Measures (SCM) 12 Safeguards 13 Trade facilitation (TFA) 40 Government procurement: a plural agreement Some popular NTMs: • Quantitative restrictions: prohibition, quota, import licensing (non-automatic license) • Trading rights • Para-tariff measures: surcharge, customs valuation • Price control • Technical measures (Technical Barriers to Trade – TBT) • Distribution restrictions • Trade-related investment measures • Administrative procedures • Trade remedies (anti-dumping, countervailing, safeguard measures) 39 39 Dr Tran Nguyen Chat 40 10 Kinh tế quốc tế 21-Mar-21 Non-tariff measures Non-tariff measures Sanitary and Phytosanitary Measures: • Measures that are applied to protect human or animal life from risks arising from: additives, contaminants, toxins or diseasecausing organisms in food • Geographical restrictions on eligibility: Imports of dairy products from countries Technical Barriers to Trade: • Measures referring to technical regulations, and procedures for assessment of conformity with technical regulations and standards • Labelling requirements Eg: Refrigerators need to carry a label indicating their size, weight and electricity consumption level 41 42 41 42 Import Quota Import quotas • Quotas are a restriction on the quantity of a good that may be imported in any one period (usually below free-trade levels) • Global quotas restrict the total quantity of an import, regardless of origin • Selective quotas restrict the quantity of a good coming from a particular country • An import quota is a restriction on the quantity of a good that may be imported • This restriction is usually enforced by issuing licenses to domestic firms that import, or in some cases to foreign governments of exporting countries • A binding import quota will push up the price of the import because the quantity demanded will exceed the quantity supplied by domestic producers and from imports 43 43 Dr Tran Nguyen Chat 44 44 11 Kinh tế quốc tế 21-Mar-21 Import Quota Tariff-rate quota • When a quota instead of a tariff is used to restrict imports, the government receives no revenue • The tariff-rate quota is a two-tiered tariff – A specified number of goods (up to the quota limit) may be imported at one (lower) tariff rate, while imports in excess of the quota face a higher tariff rate – Instead, the revenue from selling imports at high prices goes to quota license holders: either domestic firms or foreign governments – These extra revenues are called quota rents 45 45 46 46 46 Voluntary Export Restraint Tariff-rate quota: trade & welfare effects • A voluntary export restraint works like an import quota, except that the quota is imposed by the exporting country rather than the importing country • However, these restraints are requested by the importing country usually • The profits or rents from this policy are earned by foreign governments or foreign producers – Foreigners sell a restricted quantity at an increased price 47 47 Dr Tran Nguyen Chat 47 48 48 12 Kinh tế quốc tế 21-Mar-21 Local Content Requirement Local Content Requirement • A local content requirement is a regulation that requires a specified fraction of a final good to be produced domestically • It may be specified in value terms, by requiring that some minimum share of the value of a good represent domestic valued added, or in physical units • Often has the effect of forcing lower-priced imports to include higher-cost domestic components or be assembled in a higher-cost domestic market • From the viewpoint of domestic producers of inputs, a local content requirement provides protection in the same way that an import quota would • From the viewpoint of firms that must buy domestic inputs, however, the requirement does not place a strict limit on imports, but allows firms to import more if they also use more domestic parts 49 49 50 50 Subsidies Local Content Requirement • Local content requirement provides neither government revenue (as a tariff would) nor quota rents • Instead the difference between the prices of domestic goods and imports is averaged into the price of the final good and is passed on to consumers • Domestic subsidy – Payments made to import-competing producers to raise the price they receive above the market price • Export subsidy – Payments and incentives offered to export producers intended to raise the volume of exports 51 51 Dr Tran Nguyen Chat 52 52 52 13 Kinh tế quốc tế 21-Mar-21 Export Subsidy (WTO) Export Subsidy • An export subsidy can also be specific or ad valorem Subsidies: A form of financial aid or support extended to an economic sector There are two general types of subsidies: export and domestic An export subsidy is a subsidy conferred on a firm by the government that is contingent on exports A domestic subsidy is a subsidy not directly linked to exports – A specific subsidy is a payment per unit exported – An ad valorem subsidy is a payment as a proportion of the value exported • An export subsidy raises the price of a good in the exporting country, making its consumer surplus decrease (making its consumers worse off) and making its producer surplus increase (making its producers better off) • Also, government revenue will decrease 53 53 54 54 BCA on Export Subsidy Export Subsidy • An export subsidy raises the price of a good in the exporting country, while lowering it in foreign countries • In contrast to a tariff, an export subsidy worsens the terms of trade by lowering the price of domestic products in world markets 55 55 Dr Tran Nguyen Chat 56 56 14 Kinh tế quốc tế 21-Mar-21 Export Subsidy Main instruments of trade restrictions • An export subsidy unambiguously produces a negative effect on national welfare All four trade policies benefit producers and hurt consumers Subsidy and VER definitely hurt the nation as a whole, while tariffs and import quotas are potentially beneficial only for large countries that can drive down world prices Why, then, governments so often act to limit imports or promote exports? • The triangles b and d represent the efficiency loss – The tariff distorts production and consumption decisions: producers produce too much and consumers consume too little compared to the market outcome • The area b + c + d + f + g represents the cost of government subsidy – In addition, the terms of trade decreases, because the price of exports falls in foreign markets to P*s 58 57 57 58 Dumping Dumping Dumping is a situation of international price discrimination, where the price of a product when sold in the importing country is less than the price of that product in the market of the exporting country Thus, in the simplest of cases, one identifies dumping simply by comparing prices in two markets However, the situation is rarely, if ever, that simple, and in most cases it is necessary to undertake a series of complex analytical steps in order to determine the appropriate price in the market of the exporting country (known as the “normal value”) and the appropriate price in the market of the importing country (known as the “export price”) so as to be able to undertake an 60 appropriate comparison • The practice of selling a product at a lower price in export markets than at home (or exporting at prices below production cost) – Sporadic dumping - to clear unwanted inventories or cope with excess capacity – Predatory dumping - to undermine foreign competitors – Persistent dumping - reaping greater profits by engaging in price discrimination 59 59 Dr Tran Nguyen Chat 60 15 Kinh tế quốc tế 21-Mar-21 Other Trade Policies Strategic trade policy • Export credit subsidies – A subsidized loan to exporters – US Export-Import Bank subsidizes loans to US exporters • Government procurement – Government agencies are obligated to purchase from domestic suppliers, even when they charge higher prices (or have inferior quality) compared to foreign suppliers • Bureaucratic regulations – Safety, health, quality or customs regulations can act as a form of protection and trade restriction • Response to competition in sectors with imperfect competition - small number of producers, each large enough to affect market price • Subsidies can give the advantage to domestic manufacturers over foreign ones • Critics argue that it is too difficult to determine where assistance makes economic sense 61 61 62 62 Import-Export strategies Import substitution: pros • Import substitution • Risk of establishing home import-replacing industry is low because home market already exists • Easier for developing nations to protect their own markets than to force industrial nations to open theirs • Gives foreign firms an incentive to locate production in developing country, providing jobs – Trade barriers protect emerging domestic industries – Popular in 1950s and 1960s • Export-led growth (export-oriented strategy) – Focus on export of manufactures as engine of growth – Became more common starting in 1970s 63 63 Dr Tran Nguyen Chat 64 64 16 Kinh tế quốc tế 21-Mar-21 Import substitution: cons Export-led growth: pros • Trade restrictions shelter home industry from competition, giving no incentive for efficiency • Small size of most developing country markets makes it difficult to benefit from economies of scale • Protection of import-competing industries draws resources away from all other sectors, including potential exporters • Encourages industries in which developing countries are likely to have a comparative advantage - such as labor-intensive manufactures • Export markets allow domestic producers to utilize economies of scale • Low level of trade restrictions forces domestic firms to remain competitive 65 65 66 66 The effects of Trade Policy: Summary Export-led growth: cons • Main disadvantage to export-led growth is that it depends on the ability and willingness of industrial nations to absorb large quantities of manufactures from developing countries • In other words, it is sensitive to economic cycles and protectionist pressures in the export markets A tariff drives a wedge between foreign and domestic prices, raising the domestic price but by less than the tariff rate An important and relevant special case, however, is that of a “small” country that cannot have any substantial influence on foreign prices In the small country case, a tariff is fully reflected in domestic prices 68 67 67 Dr Tran Nguyen Chat 68 17 Kinh tế quốc tế 21-Mar-21 The effects of Trade Policy: Summary The effects of Trade Policy: Summary The costs and benefits of a tariff or other trade policy may be measured using the concepts of consumer surplus and producer surplus If we add together the gains and losses from a tariff, we find that the net effect on national welfare can be separated into two parts: On one hand is an efficiency loss, which results from the distortion in the incentives facing domestic producers and consumers On the other hand is a terms of trade gain, reflecting the tendency of a tariff to drive down foreign export prices Using these concepts, we can show that the domestic producers of a good gain because a tariff raises the price they receive; the domestic consumers lose, for the same reason There is also a gain in government revenue 69 69 In the case of a small country that cannot affect foreign prices, the second effect is zero, so that 70 there is an unambiguous loss 70 The effects of Trade Policy: Summary The analysis of a tariff can be readily adapted to analyze other trade policy measures, such as export subsidies, import quotas, and voluntary export restraints An export subsidy causes efficiency losses similar to those of a tariff but compounds these losses by causing a deterioration of the terms of trade Import quotas and voluntary export restraints differ from tariffs in that the government gets no revenue Instead, what would have been government revenue accrues as rents to the recipients of 71 import quota and to foreigners (VER) 71 Dr Tran Nguyen Chat 72 18 ... prices 68 67 67 Dr Tran Nguyen Chat 68 17 Kinh tế quốc tế 21-Mar-21 The effects of Trade Policy: Summary The effects of Trade Policy: Summary The costs and benefits of a tariff or other trade policy. .. producers to utilize economies of scale • Low level of trade restrictions forces domestic firms to remain competitive 65 65 66 66 The effects of Trade Policy: Summary Export-led growth: cons • Main disadvantage... – Became more common starting in 1970s 63 63 Dr Tran Nguyen Chat 64 64 16 Kinh tế quốc tế 21-Mar-21 Import substitution: cons Export-led growth: pros • Trade restrictions shelter home industry