Presentation on theme: "International trade and trade policies in the world economy"— Presentation transcript:
1 International trade and trade policies in the world economy
2 Traditional trade theory Traditional trade theory (Ricardo, H-O):adopts countries as its basic unit for analysisfirms do not exist at allemphasizes comparative advantage - that is variation in opportunity costs of production across countries and industries - as the basis for international tradeCountries trade because they are different in terms of technology and/or their relative supplies of the factors of production (labour, capital, land, etc.)
3 Traditional trade theory: predictions “Different” countries should trade morethe greater the differences in factor supplies and/or technological development, the greater the volume of trade among countries.“Different” countries should specialize in “different” goodstrade will be inter-industry: Portugese wine for English wool in Ricardo's famous exampleThe increased trade will result in both increased specialization and a tendency to equalize factor incomesEconomic welfare for all countries could increase through the mutual specialization induced by dismantling of trade barriers.
4 Limitations of the traditional trade theory Comparative advantage has had limited success in explaining trade patternsactual trade mostly intra-industry andEuropeans buying Boeing jets while Americans buy Airbusmostly between countries that are similar in their factor supplies and technological levelLiberalizing countries were observed to diversify their production and trade rather than to specializeThe gains from trade liberalization based on comparative advantage were estimated to be surprisingly small compared to the apparently powerful role that trade expansion played in the growth of the global economy in the post-World War II period.
5 The New Trade TheoryThe New Theory of international trade (Krugman,1980; Helpman, 1981; Ethier, 1982):considers the industry as its basic unit for analysis.Firms exist but are homogeneous – assumption of a representative firm within each industryIntra-industry trade is explained on the basis of love of variety by consumers and product differentiation by firms operating under conditions of monopolistic competition and facing increasing returns to scale
6 The New Trade Theory (ct’d) The presence of increasing returns to scale allows that:similar countries will specialize in different goods to take advantage of large-scale production, thereby leading to tradecountries may exchange goods with similar factor contentThe new trade theory provides new sources of gains from trade:reduction of monopoly profits – new firms enter the marketrise in efficiency resulting from increased scale of production (firms move down their average cost curves)gains for consumers from access to increased variety and from lower costs of imports
7 The New Trade Theory (ct’d) The new trade theory opened the door to “strategic trade policy“ (Brander and Spencer, 1985)protection could promote exports and shift rents to the protectionist countryin this case, free trade was not necessarily the optimal policy for an individual countryBut the gains from deviating from free trade were smallpossibility of Prisoner’s Dilemma “lose-lose" outcomes if rival governments subsidized the same industry to gain global market share in strategic industries (as in the case of commercial aircraft).
8 Arguments for protectionism Trade PolicyArguments for protectionism
9 Key questions addressed What do countries gain by trading with each other instead of opting for self-sufficiency?What are the main instruments of trade policy?What are the effects of trade policy on consumers, producers, the government and total welfare?
10 Gains from trade Autarchy Free trade Consumers can only buy domestic productsProducers can only sell to domestic consumersDomestic and international prices differFree tradeIn any product countries can be:Net importersinternational price lower than autarky price (pA>pf)Net exportersinternational price higher than autarky price (pA<pf)
11 Gains from trade In general: Net importers gain because: consumers can buy more and cheaper products and resources like labour and capital are transferred from inefficient to efficient producersNet importers gain because:Domestic consumers can buy cheaper products and new varietiesInefficient domestic producers loose market sharesNet exporters gain because:Efficient domestic producers sell larger quantities of their products at a higher priceDomestic consumers reduce consumption of expensive products
12 Welfare effects Consumer surplus Producer surplus The difference between the price buyers would be willing to pay and what they actually payProducer surplusThe revenue producers receive above the minimum amount required to induce them to produce a good
14 Instruments of Trade Policy Price based measures:TariffsSpecific: p=pf + tAd valorem: p=(1+t)pfExport subsidies: px= pf + sExport taxes: px= pf - TQuantitative restrictions:QuotasVoluntary Export Restraints
15 Defining tariffsA tariff is a tax (duty) levied on products as they move between nationsImport tariff - levied on importsExport tariff - levied on exported goods as they leave the countrySpecific tariffa monetary sum that must be paid to import 1 physical unit of a productAdvantage: easy to collectDisadvantage: doesn’t take price changes into accountAd valorem tariffa percentage of the monetary value of 1 unit of importAdvantage: takes price changes into accountDisadvantage: Need to know the monetary value of the good and seller is tempted to undervalue the price
16 Other Features of Tariff Schedules Preferential Duties:tariffs applied to imports from particular group of countriescountries are charged a lower tariff than countries outside the groupGeneralized System of Preferences:developed countries charge lower tariffs for specific imports from developing countrieslist of goods chosen by developed countries (textiles and clothing not included)
17 Basic Tariff Analysis Useful definitions: The terms of trade is the relative price of the exportable good expressed in units of the importable good.A small country is a country that cannot affect its terms of trade no matter how much it trades with the rest of the world.Consumer SurplusProducer Surplus
18 Welfare effects Consumer surplus Producer surplus The difference between the price buyers would be willing to pay and what they actually payProducer surplusThe revenue producers receive above the minimum amount required to induce them to produce a good
19 Consumer and producer surplus TariffsConsumer and producer surplus
20 Consumer and Producer Surplus Price (P)In a partial equilibrium approach we can use the concepts of consumer and producer surplusBoth reflect the fact that there is only one market priceHence, there are consumers who would have been willing to pay more for the productSimilarly, all but the “last” unit is produced with lesser marginal cost than the market price receivedS =marginal costof productionconsumersurplusPproducersurplusDQuantity (Q)
21 How to evaluate trade and trade policy Individual actors in the country introducing the policy measure:Consumers:Changes in prices and varieties of goods consumed ( changes in consumers’ surplus)Producers:Changes in prices of goods produced and inputs purchased (changes in producers’ surplus)Government:Effects on net revenuesNet effect:Sum of changes in consumers and producers surplus and in government’s net revenues
22 Effects of trade policy in general Import protection as well as export promotion distort production and consumption decisions; therefore, they are generally welfare reducing.They also have effects on the distribution of income. Even when trade policy reduces national income and causes serious inefficiency in the economic system, it always benefits some firms or individuals at the expense of the rest of society.
23 Effects of a tariff Distributional effect p=pf + t or p=(1+t)pf→ Domestic price increases→ Domestic quantity supplied increases→ Domestic quantity demanded falls→ Increase of government revenuesDistributional effectsurplus is transferred from the consumers to the producers and the governmentConsumers lose more than producers and government win: deadweight loss
24 The Impact of Import Tariff: The Small-Country* Case * Small country = cannot affect world pricesIncrease of producer surplus andgovernment incomeLoss of consumer surplusSDSDPP(1+τ)Pint(1+τ)Pintincrease ofproducersurplustariff to thegovernmentLoss of consumer surplusdeadweightlossdeadweightlossPintPintDDDDQimports after tariffQimports after tariffimports in free tradeimports in free trade
25 The impact of import tariff: the large-country case In the absence of tariff, the world price of wheat (Pw) would be equalized in both countries.With the tariff in place, the price of wheat rises to PT at Home and falls to P*T (= PT – t) at Foreign until the price difference is $t.In Home: producers supply more and consumers demand less due to the higher price, so that fewer imports are demanded.In Foreign: producers supply less and consumers demand more due to the lower price, so that fewer exports are supplied.Thus, the volume of wheat traded declines due to the imposition of the tariff.
26 The impact of import tariff: the large-country case The areas of the two triangles b and d measure the loss to the nation as a whole (efficiency loss) and the area of the rectangle e measures an offsetting gain (terms of trade gain).The efficiency loss arises because a tariff distorts incentives to consume and produce.Producers and consumers act as if imports were more expensive than they actually are.Triangle b is the production distortion loss and triangle d is the consumption distortion loss.The terms of trade gain arises because a tariff lowers foreign export prices (or Home import prices).If the terms of trade gain is greater than the efficiency loss, the tariff increases welfare for the importing country.
27 Export Subsidies Export subsidy A payment by the government to a firm or individual that ships a good abroadWhen the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy.It can be either specific or ad valorem.
28 Effects of a subsidy - small country px= pf + sSmall countryRaises the domestic price of the exported goods:Consumers loose (less and more expensive products)Producers gain (get a transfer from the government on their exported products and sell their products in the domestic market at a higher price)Government looses (transfer to producers)Net welfare effect NEGATIVE becauseGovernment subsidises inefficient producers (dead weight loss in government’s revenues)Loss of opportunities for beneficial consumption
29 Export Subsidies: Europe’s Common Agricultural Program Price, PQuantity, QSDSupport priceEU price without imports= cost of governmentsubsidyWorld priceExports
30 Import QuotasAn import quota is a direct restriction on the quantity of a good that is imported.Example: The United States has a quota on imports of foreign cheese.The restriction is usually enforced by issuing licenses to some group of individuals or firms.Example: The only firms allowed to import cheese are certain trading companies.In some cases (e.g. sugar and apparel), the right to sell in the United States is given directly to the governments of exporting countries.
31 Import QuotasAn import quota always raises the domestic price of the imported good.License holders are able to buy imports and resell them at a higher price in the domestic market.The profits received by the holders of import licenses are known as quota rents.They accrue to licenses holdersWelfare analysis of import quotas versus that of tariffsThe difference between a quota and a tariff is that with a quota the government receives no revenue.In assessing the costs and benefits of an import quota, it is crucial to determine who gets the rents.
32 Voluntary Export Restraints Voluntary Export Restraints (VERS)A restriction on a country's imports that is achieved by negotiating with the foreign exporting country for it to restrict its exports (foreign suppliers agree to “voluntary” refrain from sending some exports)alternative to import quotaimporting home country pressures exporting country to restrain its exports to the home marketusually such agreements are made with the threat of quotas being imposed if exports are not limitedH. Breinlich, U. of Essex, EC246: Free Trade vs. Protectionism
33 Voluntary Export Restraints A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country.A VER is always more costly to the importing country than a tariff that limits imports by the same amount.The tariff equivalent revenue becomes rents earned by foreigners under the VER.Example: About 2/3 of the cost to consumers of the three major U.S. voluntary restraints in textiles and apparel, steel, and automobiles is accounted for by the rents earned by foreigners.A VER produces a loss for the importing country.
35 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.
36 Local Content Requirement (cont.) 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.
37 Local Content Requirement (cont.) 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.very restrictive policyusually seen in developing countries trying to grow through import substitution
38 Government Procurement Provisions Government agencies are obligated to purchase from domestic suppliers, even when they charge higher prices (or have inferior quality) compared to foreign suppliers.If quantity of government procurement is less than the quantities produced by domestic firms in free trade, then there is no distortion on production and importHowever, when it is higher than domestic original production, this will raise domestic price.As a result, producer surplus increasesBut Government has to pay more. It has deadweight lossImport also decreases.
39 Government procurement In the absence of government procurement requirement, government buys S1, and import G-S1.In the presence of government procurement requirement, government buy G but pays Pd. Total cost=a+b.Producers gain=aDeadweight loss=b.Import decreases from M1 to M2 accordingly.
40 Nontariff Barriers (NTBs) Technical barriers to trade - A technical regulation (health, environment and safety standards) or other requirement (for testing, labelling, packaging, marketing, certification, etc.) applied to imports in a way that restricts tradeTrade-Related Investment Measuresperformance requirements: forcing a foreign investor to use domestic inputs, or export final productAdditional Restrictionsforeign exchange controls, import licencesadvance deposit requirements - firm has to deposit funds with government equal to a percent of future import (to be refunded when import purchased)
41 Administered protection allowed by WTO rules Antidumping duties - Tariff levied on dumped imports, i.e. imports provided at a price that is ‘unfairly low’, defined as either below the home market price or below costCountervailing duties - A tariff levied against imports that are subsidized by the exporting country's government, designed to offset (countervail) the effect of the subsidySafeguard measures: when imports cause “injury” to domestic industriesH. Breinlich, U. of Essex, EC246: Free Trade vs. Protectionism
42 Arguments for protectionism The Infant Industry ArgumentThe Terms-of-Trade ArgumentThe Antidumping ArgumentArgument for a Tariff to Offset Foreign SubsidyArgument for a Tariff to Reduce Aggregate UnemploymentTariff to Increase Employment in a Particular IndustryThe National Defence Argument for a Tariff
43 The Infant Industry Argument There is a potential comparative advantage that cannot be realized in the short run due to foreign competition. However, given a temporary tariff, domestic industry is able to mature, that is, it will achieve a reduction in unit cost by realizing the economies of scale OR through learning-by-doingObjectiveto realize a potential comparative advantageConsistencyKey assumption: There is a market failure (external economies of scale, imperfect capital markets…).If this does not hold, you should ask why doesn’t the industry proceed on its own?ImplementationProblem with identifying the right industriesTime consistency: will the protection eventually become permanent?
44 The Terms-of-Trade Argument Restrictive trade policy can improve country’s terms-of-trade and thus increase its welfareObjectivesincrease the ratio PX/PM ( = to make imports cheaper)increase country’s aggregate welfareConsistency & ImplementationIF the country is large enough, imposing a tariff may result enough decrease in world price and thus improvement in country’s terms of tradeo IF the benefits from improved terms of trade are larger than the costs (deadweight loss and reduction of exports due to tariff), country’s welfare increasesoptimum tariff = a tariff structure that maximizes country’s welfare
45 The Antidumping Argument Foreign firms’ dumping into the home country constitutes a threat to domestic producers. Thus we need to impose an antidumping duty to prevent this unfair practice.Objectiveto stop an unfair trading practice (dumping)Consistency: Depends on the type of dumpingDefinitions of dumpingEconomics: 3rd degree price discrimination (different price in separate markets when there is no difference in the production cost)Trade laws: selling below the cost or “fair value”
46 Argument for a Tariff to Offset Foreign Subsidy The foreign government subsidizes the foreign firm. This unfair subsidy should be matched with a tariff to restore equal footing to the home and foreign industry.Objectiveto offset a distortion due to a foreign subsidyConsistencyThe subsidy moves foreign supply curve downwards, a tariff moves it upwards → a tariff can be used to offset the impact of a subsidy
47 Argument for a Tariff to Reduce Aggregate Unemployment Imposition of a tariff results a shift of demand from imports to domestic goods, which increases the output of import-competing firms. Further, the new workers hired will use their salaries, setting off a Keynesian multiplier process. Hence also other industries will expand and create new jobs.Objectiveto decrease aggregate unemployment• ConsistencyTraditional models assume full employmenta tariff/quota will increase the domestic production of the protected good (and hence demand for labour in this sector)however, it will decrease exports due to decrease of the foreign country’s purchasing power, retaliation and appreciation of the home currencythe net impact on unemployment is ambiguous, i.e. the policy may not accomplish the objective
48 Tariff to Increase Employment in a Particular Industry Tariff on imports will increase the domestic production of the import competing goods and hence labour will move to this sector. We do not care that this may occur as an expense of the other sectors.Objectiveto increase the production of and reallocate labour to the import competing industryConsistencysetting a tariff will lead to the objectiveNegative net impact due to efficiency lossAlternative policyagain, subsidising the import-competing industry would result the same outcome with less cost
49 The National Defence Argument for a Tariff Some industries are vital during a time of war or national emergency. Thus these industries must be protected by imposing a sufficient tariff to ensure self-sufficiency.Problem: Identifying the vital industriesMore efficient policies: creating joint business- government R&D companies, subsidizing the domestic production