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Trade Bargaining & Enforcement International Political Economy Prof. Tyson Roberts 1.

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Presentation on theme: "Trade Bargaining & Enforcement International Political Economy Prof. Tyson Roberts 1."— Presentation transcript:

1 Trade Bargaining & Enforcement International Political Economy Prof. Tyson Roberts 1

2 Puzzle Comparative advantage: free trade good for all nations, in aggregate Then why do governments pursue protectionist policies? 2

3 Some possible answers Government leaders have “Wrong ideas” and believe protectionism helps – Mercantilism, etc. Protectionism may hurt in short-run but help in long-run (Lecture 8) Government leaders concerned more about losers from trade than winners from trade (Today and Lectures 6-7) 3

4 Review of Comparative Advantage 4

5 The basic Ricardo model Two countries Two products One factor of production (e.g., labor) 5

6 Home 1200 labor units 30 labor units to make iPods – Can produce up to 40 iPods 5 labor units to make pair of running shoes – Can produce up to 240 pairs of shoes Opportunity cost ≈ Price – “Price” of 1 iPod is 6 pairs of shoes – “Price” of 1 pair shoes is 1/6 iPod 6

7 Production possibility frontier Home Shoes iPods 7 Slope = -1/6

8 Foreign 720 labor units 12 labor units to make iPods – Can produce up to 60 iPods 4 labor units to make pair of running shoes – Can produce up to 180 pairs of shoes Opportunity cost ≈ Price – “Price” of 1 iPod is 3 pairs of shoes (12 hours/4 hours) – “Price” of 1 pair of shoes is 1/3 iPod (4 hours/12 hours) 8

9 Production possibility frontier Frontier Shoes 180 iPods 60 9 Slope = -1/3

10 Another example Now assume that demand curves in Home & Foreign are such that the international price of shoes per iPod is 5 (and price of iPods per shoes is 1/5) What is the new PPF for Home and Frontier after trade? 10

11 Production possibility frontier: Home with trade Home can make 240 shoes and buy 240/5 = 48 iPods Shoes iPods 48 11

12 Production possibility frontier: Foreign with trade Foreign can make 60 iPods and buy 60 x 5 = 300 pairs shoes Shoes 180 iPods BUT Home cannot make 300 shoes!

13 Home can only make 240 pairs shoes Shoes iPods 48 13

14 Production possibility frontier: Foreign with trade So Foreign can make 48 iPods and trade for 48 x 5 = 240 Shoes Then Foreign can take the remaining 720 – (48 x 12) = 144 hours and make 144/4 = 36 Shoes Shoes 180 iPods Foreign can buy 240 Shoes and make 36 Shoes Total possible shoes =

15 Return to the Price = iPod for 4 shoes scenario Home can trade 240 shoes for 60 iPods Shoes iPods 60 15

16 Foreign can trade 60 iPods for 240 shoes Shoes 180 iPods

17 If International Price = 4 shoes/iPod 17 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal?

18 If International Price = 4 shoes/iPod 18 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? Offer, Offer

19 Some Game Theory Terminology Pareto Improvement: At least one player is better off and no players are worse off Pareto Efficient/Optimal: No Pareto Improvements available Pareto Inefficient/Sub-Optimal: Pareto Improvements are available Trade enables Pareto Improvements for Pareto Sub- Optimal Situations 19 Vilfredo Pareto

20 If International Price = 4 shoes/iPod 20 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? Offer, Offer Is this a Nash Equilibrium?

21 Solving simultaneous games in game theory Left actor chooses row, top actor chooses column Payoff for left actor is on left, payoff for top actor is on right of each cell Actors get payoff from cell determined by joint choices Simultaneous: Each actor does not know what other actor will choose 21

22 Nash Equilibrium No player has anything to gain by changing his own strategy unilaterally 22

23 Best Home strategy if Foreign offers? 23 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

24 Best Home strategy if Foreign offers? Offer 24 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

25 Best Home strategy if doesn’t offer? 25 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

26 Best Home strategy if doesn’t offer? Offer or Consume 26 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

27 Best Foreign strategy if Home offers? 27 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

28 Best Foreign strategy if Home offers? Offer 28 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

29 Best Foreign strategy if Home offers? 29 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

30 Best Foreign strategy if Home offers? Offer or consume 30 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 70 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes Which outcomes are Pareto optimal? What are the equilbria?

31 Nash Equilibrium: No player has anything to gain by changing his own strategy unilaterally 31 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 60 iPods Foreign: 240 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes What are the equilbria if international price = 4 shoes/iPod? ANSWER: (1)Offer, Offer (2)Consume, Consume

32 If Price is outside the range of 3 and 6 shoes per iPod (e.g., 8 shoes per iPod), no trade will occur 32 Foreign Offer iPods for shoesConsume own shoes HomeOffer shoes for iPods Home: 30 iPods Foreign: 480 shoes Home: 40 iPods Foreign: 180 shoes Consume own iPods Home: 40 iPods Foreign: 180 shoes Home: 40 iPods Foreign: 180 shoes What are the equilbria if international price = 8 shoes/iPod? ANSWER: (1)Consume, Consume

33 But there is an opportunity for Pareto improvements Foreign can offer a lower price for iPods than 6 shoes Starting endowment

34 Summary Comparative advantage enables mutual gains from trade If no mutual gains are available, countries will not trade Therefore, trade is always Pareto efficient – Assumes voluntary, fully informed decisions – Ignores long-term effects, externalities, etc. Prices will adjust until no Pareto improvements are available (invisible hand) 34

35 If R obinson lives alone, he does everything himself 35

36 If a second person arrives, one can specialize in coconuts and the other can specialize in fish, and they can benefit from trade 36

37 If each actor is “fully informed,” trade results in a Pareto Improvement 37 Friday Don’t tradeTrade Robinson Don’t trade0, 0 Trade0, 01, 1

38 However, each actor may have an incentive to cheat 38 Friday CheatStay true Robinson Cheat0, 02, -2 Stay true-2, 21, 1

39 Cheat, Cheat is the Nash Equilibrium Stay true, Stay true would be Pareto Improvement 39 Friday CheatStay true Robinson Cheat0, 02, -2 Stay true-2, 21, 1

40 Institutions to prevent cheating 1.Long-term relationships based on reciprocity and trust 40

41 What is/are the Nash Equilibrium/a? 41 Friday Cheat Stay true first trade; Cease trading if cheated Robinson Cheat0, 02, -2 Stay true first trade; Cease trading if cheated -2, …, …

42 The prospect of repeated interactions converts cooperation into a Nash Equilibrium (But Cheat, Cheat also remains a Nash Equilibrium!) 42 Friday Cheat Stay true first trade; Cease trading if cheated Robinson Cheat0, 02, -2 Stay true first trade; Cease trading if cheated -2, …, … Which Nash Equilibrium is Pareto Efficient?

43 The prospect of repeated interactions converts cooperation into a Nash Equilibrium (But Cheat, Cheat also remains a Nash Equilibrium!) 43 Friday Cheat Stay true first trade; Cease trading if cheated Robinson Cheat0, 02, -2 Stay true first trade; Cease trading if cheated -2, …, … Which Nash Equilibrium is Pareto Efficient? Stay true, Stay true

44 If the coconut seller gets a bad fish, he knows who sold it to him. He can refuse to trade again until he is compensated 44

45 As the distance and complexity of trade increases, potential for trade benefits increase, but cheating is more difficult to monitor 45

46 Necessary conditions for cooperation Repeated interaction Reciprocity strategy (e.g., tit-for-tat) – If you cheat me today, I will cheat you tomorrow – You might get 2 today, but you’ll get 0 every day after that 46

47 Necessary conditions for cooperation Repeated interaction Reciprocity strategy (e.g., tit-for-tat) Sufficient value of future payoffs – If value of future payoffs is too low, then cheat will remain the dominant strategy 47

48 What is/are the Nash Equilibrium/a? 48 Friday Cheat Stay true first trade; Cease trading if cheated Robinson Cheat0, 02, -2 Stay true first trade; Cease trading if cheated -2, 21+1/10 + 1/100…, 1+1/10 + 1/100…

49 What is/are the Nash Equilibrium/a? Cheat, Cheat 49 Friday Cheat Stay true first trade; Cease trading if cheated Robinson Cheat0, 02, -2 Stay true first trade; Cease trading if cheated -2, 21+1/10 + 1/100…, 1+1/10 + 1/100…

50 Necessary conditions for cooperation Repeated interaction Reciprocity strategy (e.g., tit-for-tat) Sufficient value of future payoffs These conditions can but do not necessarily lead to cooperation – Cheat, cheat is still a Nash Equilibrium 50

51 Doha Example 51

52 Factor Endowments & Comparative Advantage Europe: High endowments of capital vs. land G20: High endowments of land vs. capital Food is land intensive Manufactured goods are capital intensive Europe: comparative advantage in manufactures G20: comparative advantage in agriculture 52

53 Comparative advantage and policy preferences Each country prefers to – Protect products with comparative disadvantage (high tariff), and – Liberalize products with comparative advantage (low tariff) 53

54 Starting point (Status Quo policy) for Doha Round High tariffs on agricultural goods in developed countries – Rice in Japan, sugar in US, wheat in Europe, etc. Relatively high tariffs on manufactured goods in developing countries Non-tariff barriers – Subsidies, barriers to investment, etc. 54

55 The EU ideal point is high tariffs in their market for agriculture 55

56 The EU ideal point is High tariffs in their market for agriculture And Low tariffs for the G-20 Goods Market 56

57 The G-20 ideal point is Low tariffs in the EU market for agriculture 57

58 The G-20 ideal point is Low tariffs in the EU market for agriculture And High tariffs for their own Goods Market 58

59 Each country would have a higher utility if they could negotiate a policy that is closer to their ideal point than the existing Status Quo policy 59

60 Lower US/EU tariffs on Ag benefits G-20 (but harms US/EU interests) Lower G-20 tariffs on Manu benefits US/EU (but harms G-20 interests) Each resists unilateral liberalization, but can benefit from joint liberalization 60

61 61 G20 Liberalize (manu)Protect (manu) EU Liberalize (agr)5, 5-10, 10 Protect (agr)10, -10-5, -5 What is the Nash Equilibrium? Is it Pareto Efficient?

62 62 G20 Liberalize (manu)Protect (manu) EU Liberalize (agr)5, 5-10, 10 Protect (agr)10, -10-5, -5 What is the Nash Equilibrium? Protect, Protect Is it Pareto Efficient? No

63 Institutions to prevent cheating 1.Long-term relationships based on reciprocity and trust – Works best in smaller groups because of repeated interactions 63

64 Methods to achieve cooperation in Prisoners’ Dilemma Cooperation – Repeated interaction – Reciprocity strategy (e.g., tit-for-tat) – Sufficient value of future payoffs Belief system/ideology Third-party enforcer – Imperial powers can play this role, but nation-states are (officially) sovereign Treaties such as GATT/WTO help with first 2 criteria of cooperation. 64

65 International Decision-Making Rules Anarchic – Unilateral or negotiated decisions based on self interest and power. – Lack of cooperation => War Hegemonic Institution(s) – Hegemon’s law backed by power (empire, gunboats) Multilateral Institution (official) – Majoritarian – Weighted voting – Consensus Multilateral institution (unofficial) – Invisible weighting/ informal agenda setting

66 Scope of GATT Trade in most manufactured goods liberalized quickly – Exceptions: Clothes, textiles, some cars, etc. Services & agriculture initially left alone Focus on tariffs and trade quota Developing countries given waivers or extra time to comply GATT had weak enforcement teeth

67 GATT decision making rules Officially: majoritarian Unofficially: Informal consensus – Launching rounds: law-based bargaining – Closing rounds: increased power-based bargaining

68 Sources of bargaining power Patience – Willingness to live with status quo Outside option – Related to market size (US can produce for self) & international relations Agenda setting – Access to “Green Room” Ability to act collectively – OECD, G-20

69 Organized Hypocrisy Consensus in the GATT/WTO Naked power available as alternative Consensus rules provide legitimacy and information gathering to powerful nations – stable, low cost method to achieve goals Some votes bought with pay-offs Weaker nations unlikely to protest openly if hypocrisy not too blatant Multiparty elections in authoritarian regimes Naked power available as alternative Multiparty elections provide legitimacy & information gathering to ruling elites – stable, low cost method to achieve goals Some votes bought with pay-offs Opposition unlikely to protest openly if hypocrisy not too blatant

70 Bargaining in the Shadow of Law or Power (Steinberg 2002) The Tokyo Round ( ) closed with law- based bargaining LDC’s outside option: Trade with Soviet Bloc Result: Exceptions for LDCs Uruguay Round ( ) closed with power- based bargaining No outside option for LDCs Result – uniform rules in WTO

71 Scope of WTO Liberalization of all goods (including textiles & agriculture) and services Rules extended to subsidies, intellectual property, investment, regulations & standards All members (including developing countries) bound to comply Enforcement teeth: appellate court to decide disputes – authorizes dispute winner to retaliate

72 Cotton Wars Does the cotton dispute indicate law-based or power-based decision making? Does the cotton dispute indicate that international regimes change outcomes? How do sub-national interest group politics play a role in determining the outcome?

73 GATT/WTO Benefits – Worldwide Trade & GDP per capita growth 73 Source: PWT for countries w/1950 data only; not sure about Maddison BW Post-BW

74 GATT/WTO Benefits - Distribution International: – According to some studies, developed countries benefited more from WTO (Uruguay Round) than developing countries – According to some studies, some developing countries are net losers from WTO (diminished development policy space) – Other developing countries are winners, e.g. China and India

75 GATT/WTO Benefits - Distribution Intranational: – Trade integration has contributed to income inequality in the US (but technological change likely played a larger role) – Inequality has also increased in China and India – Low-skilled workers in labor-intensive manufacturing sectors were first losers in US; higher skilled workers in services may follow

76 Takeaways All countries can benefit from free trade Within countries, there are winners and losers Domestically, potential losers from free trade (e.g., producers) can solve collective action problem, which enables successful lobbying Institutions such as WTO facilitate cooperation for mutual benefit (at the country level) WTO increases role of law, but power still plays a role (e.g., availability of outside options) – Some countries may be net losers from WTO


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