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Economics of Trade Liberalization and Integration Jan Fidrmuc Brunel University.

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Presentation on theme: "Economics of Trade Liberalization and Integration Jan Fidrmuc Brunel University."— Presentation transcript:

1 Economics of Trade Liberalization and Integration Jan Fidrmuc Brunel University

2 Import demand curve (MD) price Home Supply P* P P ZC quantityimports ZC Home Demand Home import demand curve, MD H P P MM 1 2 3

3 Import supply curve (MS) P* P P C quantity exports C XX price Foreign export supply curve, XS F, or MS H. Foreign Supply Foreign Demand 1 3 ZZ 2

4 MD-MS Diagram MD-MS diagram permits tracking domestic & international consequences of trade policy changes.` euros importsquantity MS MD Z C Domestic price, euros Import (foreign export) supply curve Domestic demand curve Domestic supply curve Imports Import demand curve Imports S dom D dom P FT

5 Non-discriminatory (MFN) Tariff Consider tariff of T euros per unit MFN non-discriminatory tariffs WTO rules: lowest tariff (most-favored nation) must apply equally to all trading partners Exception: FTAs Tariff shifts MS curve up by T. Exporters earn domestic price minus T They would need domestic price of P+T to continue to offer the same exports.

6 MFN Tariff Analysis 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. Home imports MD Border price Foreign exports XS=MS MS MS with T Domestic price T P-T X=M M FT X FT = M FT P FT M P

7 Welfare effects Foreign 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+C 2 +A+C 1 Home producers gain E Home tariff revenue: A+B. Net change = B-C 2 -C 1 (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 influential This comes at a cost to domestic consumers and to foreigners If Foreign retaliates and also imposes a tariff, everyone loses With reciprocity, protectionism is not a zero-sum game

9 Distributional consequences euros importsquantity MS MD C Domestic price, euros S dom D dom P FT Z P P-T P CZ A C BDB E C2C2 A C1C1

10 Preferential Trade Liberalization Previous analysis used 2 countries only: Home and Foreign European 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 Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS M=X P +X R PartnerHomeRoW Border price 2 1 XPXP XRXR

12 The PTA Diagram: MFN tariff Domestic price Home imports MD P FT RoW Exports Partner Exports XS P XS R MS MS MFN P MM=X P +X R PartnerHomeRoW Border price T P -T 2 1 XRXR X P XPXP XRXR

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 P a, RoW will export zero.

14 Discriminatory, unilateral liberalization Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Partner Home RoW Border price MS PTA 1 PaPa P T T P P P -T XRXR XRXR XPXP XPXP M p*

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. Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

16 Quantity changes: supply switching RoW exports fall and Partner exports rise: supply switching: trade diversion Domestic imports rise: trade creation. Partner exports rise more than RoW exports fall. Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

17 Impact of customs union formation

18 Welfare effects Homes net change = A+B-C ambiguous Partners net change = +D. RoWs net change = -E. Domestic price Home imports MD RoW Exports Partner Exports XS P XS R M Partner Home RoW Border price P P XRXR XPXP XPXP M C B A X R XRXR P -T P E D

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 others 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 trade Both impose T on trade with RoW Home-Partner CU has Common External Tariff (CET) equal to T Analysis 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- C 1 -C 2. In market for good 2: Home change = +D 1 +D 2. NB: D 1 =C 1. Net Home impact =A+B-C 2 +D 2. Partner impact identical. RoW loses in both markets. RoW exports fall but imports stay the same: trade deficit euros imports MD euros Exports XS M A D 2 D 1 C 1 B C2C2 X P X R P-T P P

22 EU Trade Policy

23 Geographical Structure of Trade

24 Differences among Member States

25 Composition of trade

26 What with whom?

27 EUs MFN tariff structure (the CET)

28 Institutions Trade policy is an exclusive prerogative of the EU. Customs Union requires agreement. Commission has responsibility for negotiating Trade Commissioner. Council of Ministers sets Directives for Negotiation, accepts/rejects final deal. Commission in charge of surveillance and enforcement of 3 rd 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 treatment Only 9 nations (US, Japan, etc.).


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