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Slides prepared by Thomas Bishop Lecture 7 International Factor Movements The Instruments of Trade Policy Chiquita Case.

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1 Slides prepared by Thomas Bishop Lecture 7 International Factor Movements The Instruments of Trade Policy Chiquita Case

2 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-2 Organizational Stuff Paper Draft due Tuesday ( it) Problem Set 3 due Thursday, 6pm Midterm should be graded by Wed

3 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-3 Road Ahead Finish Part I: International Trade Theory  Ch. 7: International Factor Mobility (Today: Labor) Part II: International Trade Policy  Ch. 8: Instruments of Trade Policy  Ch. 9: Political Economy of Trade Policy  Ch. 10: Trade and Development  Ch. 11: Controversies in Trade Policy Part III: Globalization

4 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-4 Preview International labor mobility Instruments of Trade Policy Tariffs and quotas Chiquita Brands Case Other trade policy instruments:  Subsidies  Voluntary export restraints  Safety standards

5 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-5 US Immigration Policies The collapse of attempts for US immigration reform in June Key Area of dispute:  Illegal Immigrants (path to citizenship to the estimated 12 millions of them) Other aspects of the bill:  Guest Worker Program  Tougher Border Security  Skilled Migrants

6 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-6 Movements in Factors of Production Movements in factors of production include  labor migration,  the transfer of financial capital through international borrowing and lending,  transactions of multinational corporations involving direct ownership of foreign firms

7 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-7 Government Restrictions on Movements in Factors of Production Like movements of goods and services (trade), movements of factors of production are politically sensitive and are often restricted.  Restrictions on immigration  Restrictions on financial capital flows (less common today in Europe and US)  Restrictions on the activities of multinational corporations

8 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-8 Decreasing Marginal Product of Labor To show the effects of labor migration (mobility), let’s build a simple model with only one good (output). Suppose that there are only two important factors of production: land and labor. On a fixed parcel of land, each worker often becomes less productive or efficient as more workers are added to that fixed parcel of land.  The marginal product of labor often decreases.

9 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-9 Marginal Product of Labor falls as more workers are employed (Holding the amount of Land fixed)

10 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Shares of Output: Wages and Rents

11 Copyright © 2006 Pearson Addison-Wesley. All rights reserved The area under marginal product of labor curve=value of output produced Because of diminishing marginal product, productivity of labor depends on the quantity of labor employed.  The marginal product decreases as more workers are employed. Because of competition, the real wage paid to workers equals their marginal product. The area under the marginal product of labor curve equals the value of output produced, which equals the value of wages and rental income paid to factors of production due to competition.

12 Copyright © 2006 Pearson Addison-Wesley. All rights reserved If Home is Labor Abundant, Home Workers will move to Foreign If the domestic country is the labor abundant country and the foreign country is the land abundant country,  the marginal product of domestic workers is less and therefore they earn less than those in the foreign country, if technology is the same across countries. There is an incentive for domestic workers to move to the foreign country.

13 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Wages: Key trigger for labor movement Workers in the domestic country have an incentive to move to the foreign country until the real wages between the countries are equal.  Emigration from the domestic country raises the real wage of the remaining workers there.  It increases the quantity of labor and decreases the real wage in the foreign country.

14 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Wage Convergence in the First Wave of Globalization

15 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigration to US and Canada:

16 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Some assumptions of the migration model 1.The model assumes that trading countries produce the same goods, but countries may produce different goods so that marginal product of labor in producing a given good are not comparable. 2.The model assumes that trading countries have the same technology, but different technologies could affect the productivities of factors and therefore the wages/rates paid to these factors.

17 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Assumptions of the migration model 3.Barriers to immigration and emigration and transportation costs may prevent factor prices from equalizing.  Barriers to movements for other factors of production are also important in the real world (e.g., for land and capital).

18 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Complete wage equalization not present Despite real wage differences across countries, complete factor price equalization with labor mobility does not really occur for reasons that are similar to the reasons given in the Heckscher- Ohlin model.

19 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigration and the US Economy: Lowest Skilled and Highest Skilled In the past generation, immigration in the US has increased substantially, especially among workers with the lowest education levels and the highest education levels.  The largest increase in immigration occurred among workers with the lowest education levels, making less educated worker more abundant,  possibly causing a widening wage gap between low educated workers and high educated workers.

20 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Initially OL 1 Workers at Home, L 1 O* in Foreign: Migration until wages equal

21 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Migration increases world output Labor migration between the domestic country and the foreign country will also increase world output.  Foreign output rises by the area under its MPL * curve from OL 1 to OL 2  Domestic output falls by the area under its MPL curve from OL 2 to OL 1  The value of world output is maximized when the marginal product of labor is the same across countries.

22 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Winners receiving country migrants their new employers workers who stay in the sending country world as a whole

23 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Losers Employers in the sending country The sending country Competing workers in the new country Note: Some other studies dispute that the sending country loses as we need to take into account remittances from workers abroad to their home countries

24 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Gains to receiving country Employers and consumers of products produced by these firms gain more than the native workers lose We also need to consider other costs/benefits: Impact on government budget Externalities

25 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Fiscal effects of migration: mostly positive Immigrants usually overall pay more in taxes than they receive in public services But declining relative quality of immigrants to the US suggests the fiscal benefits to the US are falling, and may be even negative

26 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Unskilled migrants are costly, skilled bring net fiscal benefits Smith & Edmonston found that: College educated immigrants (at least 1 year of college) bring net fiscal benefits of $105,000 during their lifetime Less educated bring net fiscal costs (up to $90K) Descendants of migrants (including uneducated) bring fiscal benefits though

27 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Externalities Positive: new knowledge Negative: congestion, social friction

28 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Policies Should be based on skills: select young, educated, skilled In reality mostly based on family links and refugee status (90% in the US, 75% in Canada)

29 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigrant share rising in high school dropout and college degree category

30 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigration and US Income Inequality: College Educated More Abundant But Still Benefiting From Rising Wages But immigration can not wholly explain the widening income distribution in the US. The fraction of US workers without a high school diploma fell, while that with a college education rose, during 1980–1990.  More highly educated workers became more abundant. So why did the wage of highly educated workers rise relative to that of low educated workers?  Possibly due to technological changes that made education more valuable to employers.

31 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigration to EU: From Outside

32 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Immigration in EU: From Inside

33 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Young Poles coming to UK factories 427,000 workers from eight EU accession states successfully applied for work in UK Over half (62%) are Polish 82% are aged % work in factories

34 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Road Ahead Part II: International Trade Policy  Ch. 8: Instruments of Trade Policy  Ch. 9: Political Economy of Trade Policy  Ch. 10: Trade and Development  Ch. 11: Controversies in Trade Policy Part III: Globalization

35 Copyright © 2006 Pearson Addison-Wesley. All rights reserved In the news: Subsidies and Tariffs in Doha Round of WTO Talks Stalled WTO Doha Round of Trade Talks: Suggestions to cut US Agricultural Subsidies from $22bn to $13bn (US wants $17bn) Developing countries should limit their tariffs in the disputed categories to %, India and Brazil demand 30%

36 Copyright © 2006 Pearson Addison-Wesley. All rights reserved From Free Trade to Safe Trade? Food Safety Hot Trade Issue: China vs US China’s recent ban on imports of chicken and pork from US firms (Tyson) Came as a reaction to US ban on on imports of some Chinese seafood last month Beijing executed the former head of its own food and drug regulator after he was convicted of corruption this month.

37 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Do you think globalization is having a positive or negative effect in your country?

38 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-38

39 Slides prepared by Thomas Bishop Chapter 8 The Instruments of Trade Policy

40 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Preview Partial equilibrium analysis of tariffs: supply, demand and trade in a single industry Costs and benefits of tariffs Import quotas Chiquita Case Export subsidies Voluntary export restraints Local content requirements

41 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Types of Tariffs A specific tariff is levied as a fixed charge for each unit of imported goods.  For example, $1 per kg of cheese An ad valorem tariff is levied as a fraction of the value of imported goods.  For example, 25% tariff on the value of imported cars.

42 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Tariff rates Average of 2.5-4% in 2004 (nonagricultural imports to the US, Canada, EU, Japan) Average of 10% for imports to China, 17% for Mexico For some items tariffs up to 48% in the US (99% in 2000) In Mexico up to 50% in 2004 (254% in 2000)

43 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-43

44 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Supply, Demand and Trade in a Single Industry: Effects of a Tariff Let’s construct a model measuring how a tariff affects a single market, say that of wheat. Suppose that in the absence of trade the price of wheat in Foreign country is lower than that in the domestic country.  With trade the foreign country will export: construct an export supply curve  With trade the domestic country will import: construct an import demand curve

45 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Export supply and import demand curve An export supply curve is the difference between the quantity that foreign producers supply minus the quantity that foreign consumers demand, at each price. An import demand curve is the difference between the quantity that domestic consumers demand minus the quantity that domestic producers supply, at each price.

46 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Deriving Home’s Import Demand Curve: Difference btw Home’s Demand, Supply

47 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Deriving Foreign’s Export Supply Curve: Difference btw supply and demand

48 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Equilibrium: world demand=world supply In equilibrium, import demand = export supply domestic demand – domestic supply = foreign supply – foreign demand In equilibrium, world demand = world supply

49 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Home import demand (MD)= =Foreign export supply (XS)

50 Copyright © 2006 Pearson Addison-Wesley. All rights reserved The Effects of a Tariff: Price of Wheat Will Rise in Home and Fall in Foreign A tariff by Home acts as an added cost of transportation, making shippers unwilling to ship goods unless the price difference between the domestic and foreign markets exceeds the tariff. Price of wheat initially lower in Foreign, the exporter If Foreign shippers are unwilling to ship wheat, there is excess demand for wheat in the domestic market and excess supply in the foreign market.  The price of wheat will tend to rise in the domestic market.  The price of wheat will tend to fall in the foreign market.

51 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Price change should eventually equal the tariff rate Thus, a tariff will make the price of a good rise in the domestic market and will make the price of a good fall in the foreign market, until the price difference equals the tariff.  P T – P * T = t  P T = P * T + t  The price of the good in foreign (world) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic tariff.

52 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Tariff by Home raises price in Home, lowers price in Foreign

53 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Quantity of imports, exports falls from Q W to Q T Because the price in domestic markets rises (to P T ), domestic producers should supply more and domestic consumers should demand less.  The quantity of imports falls from Q W to Q T Because the price in foreign markets falls (to P * T ), foreign producers should supply less and foreign consumers should demand more.  The quantity of exports falls from Q W to Q T

54 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Domestic import demand= Foreign export supply when P T – P * T = t The quantity of domestic import demand equals the quantity of foreign export supply when P T – P * T = t In this case, the increase in the price of the good in the domestic country is less than the amount of the tariff.  Part of the tariff is reflected in a decline of the foreign country’s export price, and thus is not passed on to domestic consumers.  But this effect is often not very significant.

55 Copyright © 2006 Pearson Addison-Wesley. All rights reserved The Effects of a Tariff in a Small Country When a country is “small”, it has no effect on the foreign (world) price of a good, because its demand for the good is an insignificant part of world demand.  Therefore, the foreign price will not fall, but will remain at P w  The price in the domestic market, however, will rise to P T = P w + t

56 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Small “Home” Country’s Tariff Can’t Lower Foreign’s Price of Good that Home Imports

57 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Costs and Benefits of Tariffs: Introducing Consumer and Producer Surplus A tariff raises the price of a good in the importing country, so we expect it to hurt consumers and benefit producers there. 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.

58 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Consumer Surplus 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 would have been willing to pay is determined by a demand (willingness to buy) curve.  When the price increases, the quantity demanded decreases as well as the consumer surplus.

59 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Consumer Surplus: Under demand curve and above price line

60 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Producer Surplus 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.  When price increases, the quantity supplied increases as well as the producer surplus.

61 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Producer Surplus: Above supply curve and below price line

62 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Costs and Benefits of Tariffs 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.

63 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Intro to graphical analysis The tariff raises domestic price from P W to P T It also lowers the foreign export price from P W to P* T Remember that tariff t= P T - P* T

64 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Costs and Benefits of Tariffs: Consumers, Producers, Government

65 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Costs and Benefits of Tariffs: Efficiency Loss to Consumers, Terms of Trade Gain For a “large” country that can affect foreign (world) prices, the welfare effect of a tariff is ambiguous. 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 rectangle e represents the terms of trade gain.  The terms of trade increases because the tariff lowers foreign export (domestic import) prices.

66 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Government revenue: c + e Government revenue from the tariff equals the tariff rate times the quantity of imports.  t = P T – P * T  Q T = D 2 – S 2  Government revenue = t x Q T = c + e Part of government revenue (rectangle e) represents the terms of trade gain, and part (rectangle c) represents part of the value of lost consumer surplus.  The government gains at the expense of consumers and foreigners.

67 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Is terms of trade gain > efficiency loss? If the terms of trade gain exceeds the efficiency loss, then national welfare will increase under a tariff, at the expense of foreign countries.  However, this analysis assumes that the terms of trade does not change due to tariff changes by foreign countries (i.e., due to retaliation).

68 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Comparing e and b+d

69 Copyright © 2006 Pearson Addison-Wesley. All rights reserved But are losses as valuable as gains? We used a subjective one-dollar one-vote metric

70 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Experiment I offer you a gamble 50% chance that you will get extra 10 points on the midterm 50% chance that you will get 10 less points on the midterm Would you accept this gamble?

71 Copyright © 2006 Pearson Addison-Wesley. All rights reserved A new experiment A new gamble 60% chance that you will get extra 10 pts 40% chance that you will get 10 pts less 70-30% chance?

72 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Daniel Kahneman: we are loss averse 2002 Nobel Prize in economics Princeton psychologist We experience more (about twice as much) pain from losing $10 than pleasure from gaining $10

73 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Most people are risk averse but some are risk loving Most people refuse a gamble that offers you a 50% chance of winning $1000 and the same chance of losing $1000 These people are loss (risk) averse, however, we have a number of risk loving people (say those who play the lotteries where odds are against them…)

74 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Example of loss aversion We hang on to losing stocks (because we are twice as much averse to facing up to that loss as we are tempted by the potential gain of moving the money elsewhere)

75 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Import Quota 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.

76 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Import Quota (cont.) When a quota instead of a tariff is used to restrict imports, the government receives no revenue.  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.

77 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 7-77

78 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Chiquita Brands Case Study 1.What were the key causes of Chiquita’s losses? 2.Were EU quotas the main cause of the losses? 3.How did Chiquita respond to the EU quotas? Was Chiquita’s response effective? 4.What else can Chiquita do to make the firm profitable again?

79 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Chiquita Brands Case The problem: Chiquita, a leading global banana wholesaler and distributor, has significant losses in , after years of profitability The CEO says that the EU quotas on banana imports from Latin America have been the primary cause of this You should recommend him how to respond to EU policies and to the losses in general

80 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Establish understanding of case Company ; Strategy, Financials - Diversification, Market shares Industry - Competitors, Market trends Environment - EU Policy (Quota, Framework Agreement) - Falling banana prices

81 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Create an analytical framework Question: What should Chiquita do to respond to losses and EU’s policies? Demand (how important is EU) Supply (how important is Lat. Am.) Policy (change it or work with it?)

82 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Analyze the case Demand (EU, banana’s share on sales) (EU 45% of Chiquita’s ’93 sales, bananas 60%) Supply (where is production, global mkt share) (significant banana operations in non-framework Latin countries, 46.6% market share worldwide) Policy (policy/losses-what was first, EU share loss) (In effect since Jul ’93, big loss posted already in ’92; by Sep ’94 Chiquita lost 20-50% of EU market share)


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