5 Non-discriminatory (MFN) Tariff Consider tariff of T euros per unitMFN non-discriminatory tariffsWTO rules: lowest tariff (most-favored nation) must apply equally to all trading partnersException: FTAsTariff shifts MS curve up by T.Exporters earn domestic price minus TThey would need domestic price of P+T to continue to offer the same exports.
6 MFN Tariff Analysis MS with T MS XS=MS P’ PFT PFT P’-T MD New equilibrium in Home (MD=MS) is at P’ and M’.Domestic price P’ now differs from border price (price exporters receive) P’-T.Domestic price rises.Border price falls.Imports fall.Border priceDomestic priceMS with TMSXS=MSP’PFTPFTTP’-TMDForeignexportsHomeimportsM’MFTX’=M’XFT= MFT
7 Welfare effectsForeign loss due to drop in exports equal to area D (trade volume effect).Foreign loss due to drop in border price equal to area B (border price effect, a.k.a., ToT effect).Net effect on Foreign = -D-B.Home loss equal to area -A-C (trade volume drops and price rises).Home gain due to drop in border price and tariff revenue equal to area A+B.Net effect on Home = -C+B.World welfare change is -D-C.If Home gains (-C+B>0) it is because it exploits foreigners by ‘making’ them pay part of the tariff (i.e. area B).
8 Distributional consequences Home consumers lose area E+C2+A+C1Home producers gain EHome tariff revenue: A+B.Net change = B-C2-C1 (this equals B-C in left panel).Net effect can be positive or negative.Tariffs imposed because they benefit domestic producers who are often organized and politically influentialThis comes at a cost to domestic consumers and to foreignersIf Foreign retaliates and also imposes a tariff, everyone losesWith reciprocity, protectionism is not a zero-sum game
10 Preferential Trade Liberalization Previous analysis used 2 countries only: Home and ForeignEuropean integration is discriminatory (or preferential) and its analysis requires at least three countries:At least two integrating nations.At least one excluded nation.MD-MS diagram must to allow for two sources of imports.
11 The PTA Diagram: Free trade RoWPartnerHomeBorder priceBorder priceDomestic priceXSPMSXSR12PFTMDXRRoWExportsXPPartnerExportsHomeimportsM=XP+XR
12 The PTA Diagram: MFN tariff Domestic priceHomeimportsMDPFTRoWExportsPartnerXSPXSRMSMSMFNP’M’M=XP+XRBorder priceTP’-T21X’RX’PXPXR
13 Discriminatory unilateral liberalization Assume Home removes T on imports only from Partner.This liberalization shifts up MS (as with MFN tariff) but not as far since it applies only to one half of imports.Shifts up MS to half way between MS (free trade) and MS (MFN tariff)More complex, kinked MS curve with PTA.If price falls below Pa, RoW will export zero.
15 Domestic price & border price changes Domestic price falls to P’ from P”.Partner-based firms see border price rise, P’-T to P”.RoW firms see border price fall from P’-T to P”-T.Border priceBorder priceDomestic priceMSMFNXSRXSPMSPTAMSP’P”P”TP’-TP’-TP”-TMDXR”XR’RoWExportsXP’XP”PartnerExportsM’M”Homeimports
16 Quantity changes: supply switching RoW exports fall and Partner exports rise: supply switching: trade diversionDomestic imports rise: trade creation.Partner exports rise more than RoW exports fall.Domestic priceHomeimportsMDRoWExportsPartnerXSPXSRMSMSMFNM’Border priceMSPTAP’TP”P’-TP”-TXR”XR’XP’XP”M”
18 Welfare effects XSR A XSP D C B MD Home’s net change = A+B-C ambiguousPartner’s net change = +D.RoW’s net change = -E.Domestic priceHomeimportsMDRoWExportsPartnerXSPXSRM’Border priceP’P”XR’XP’XP”M”CBAXR”P’-TP”-TED
19 Analysis of a Customs Union European integration involved a sequence of preferential liberalisations, all of them reciprocal:Both Home & Partner drop T on each other’s exports.Need to address the 3-nation trade pattern.Example: each country produces 3 goods, exports 2 and imports 1
20 Analysis of a Customs Union Home and Partner eliminate T on their mutual tradeBoth impose T on trade with RoWHome-Partner CU has Common External Tariff (CET) equal to TAnalysis is simply a matter of recombining results from the unilateral preferential case.In market for good 1, analysis is identical.In market for good 2, Home plays the role of Partner and Partner plays role of Home.
21 Welfare effects of a customs union In market for good 1:Home change = A+B-C1-C2.In market for good 2:Home change = +D1+D2.NB: D1=C1.Net Home impact =A+B-C2+D2 .Partner impact identical.RoW loses in both markets.RoW exports fall but imports stay the same: trade deficiteurosimportsMDExportsXSM’AD21CBC2XP”XP’XR”XR’P’-TP”P’P”-T
28 Institutions Trade policy is an exclusive prerogative of the EU. Customs Union requires agreement.Commission has responsibility for negotiatingTrade Commissioner.Council of Ministers sets “Directives for Negotiation,” accepts/rejects final deal.Commission in charge of surveillance and enforcement of 3rd nation commitments.Trade disputes with US, China, etc.
29 EU External Trade Policy EU has special arrangements with 139 nations; often more than one per partner. Each can be very complex.
30 Non-preferential trade Only about 1/3 EU imports are not granted some sort of preferential treatmentOnly 9 nations (US, Japan, etc.).