1. Chapter 10 The Political Economy of Trade Policy
Prepared by Iordanis Petsas
To Accompany
International Economics: Theory and Policy, Sixth Edition
by Paul R. Krugman and Maurice Obstfeld

2. Chapter Organization Introduction The Case for Free Trade
Income Distribution and Trade Policy
International Negotiations and Trade Policy
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3. Introduction
What reasons are there for governments not to interfere with trade?
There are three arguments in favor of free trade:
Free trade and efficiency
Economies of scale in production
Political argument
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4. The Case for Free Trade Free Trade and Efficiency
The efficiency argument for free trade is based on the result that in the case of a small country, free trade is the best policy.
A tariff causes a net loss to the economy (i.e. deadweight loss).
A move from a tariff equilibrium to free trade eliminates the efficiency loss and increases national welfare.
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5. Figure 9-1: The Efficiency Case for Free Trade
The Case for Free Trade
Figure 9-1: The Efficiency Case for Free Trade
Price, P
Quantity, Q S D
Production
distortion
Consumption
distortion
World price
plus tariff
World price
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6. The Case for Free Trade Economies of scale in production
Protected markets in small countries do not allow firms to exploit economies of scale.
Example: In the auto industry, an efficient scale assembly should make a minimum of 80,000 cars per year.
In Argentina, 13 firms produce a total of 166,000 cars per year.
The presence of scale economies favors free trade that generates more varieties and results in lower prices.
Free trade, as opposed to “managed” trade, provides a wider range of opportunities and thus a wider scope for innovation.
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7. The Case for Free Trade Political Argument for Free Trade
A political commitment to free trade may be a good idea in practice.
Trade policies in practice are dominated by special-interest politics rather than consideration of national costs and benefits.
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8. Income Distribution and Trade Policy
Who Gets Protected?
Two sectors get protected in advanced countries:
Agriculture
Farmers are well organized and the structure of the U.S.
government enhances their political power.
Clothing
Both textiles and apparel have enjoyed substantial
protection. This sector employs less skilled workers and
it is unionized as well.
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9. International Negotiations and Trade Policy
How was the removal of tariffs politically possible?
The postwar liberalization of trade was achieved through international negotiation.
Governments agreed to engage in mutual tariff reduction.
The Advantages of Negotiation
It is easier to lower tariffs as part of a mutual agreement than to do so as a unilateral policy because:
It helps mobilize exporters to support freer trade.
It can help governments avoid getting caught in destructive trade wars.
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10. International Negotiations and Trade Policy
Table 9-3: The Problem of Trade Warfare
Japan
U.S.
Free trade
Protection 10 20
-10 20
-10 -5
Protection
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11. International Negotiations and Trade Policy
In Table 9-3, each country has a dominant strategy: Protection.
Even though each country acting individually would be better off with protection, they would both be better off if both chose free trade.
Japan and the U.S. can establish a binding agreement to maintain free trade.
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12. International Negotiations and Trade Policy
International Trade Agreements: A Brief History
The multilateral tariff reductions since World War II have taken place under the General Agreement on Tariffs and Trade (GATT), established in 1947 and located in Geneva.
It is now called the World Trade Organization (WTO).
The WTO system is a legal organization that embodies a set of rules of conduct for international trade policy.
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13. GATT Eight Rounds of Trade Negotiations
Year
Place/name
Subjects covered
Countries
1947
Geneva
Tariffs 23
1949
Annecy 13
1951
Torquay 38
1956 26
Dillon
Round
Kennedy Round
Tariffs and anti-dumping measures 62
Tokyo
Tariffs, non-tariff measures, “framework” agreements
102
Uruguay Round
Tariffs, non-tariff measures, rules, services, intellectual property, dispute settlement, textiles, agriculture, creation of WTO, etc
103
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14. International Negotiations and Trade Policy
How different is the WTO from the GATT?
The GATT was a provisional agreement, while the WTO is a full-fledged international organization.
The GATT applied only to trade in goods, while the WTO included rules on trade in services (the General Agreement on Trade in Services (GATS)) and Trade Related Aspect of Intellectual Property Rights (TRIPs).
The WTO has a new “dispute settlement” procedure which is designed to reach judgments in a much shorter time.
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15. Principles of the WTO Trading System
Trade without discrimination
A. Most-favored-nation:
    Under the WTO agreements, countries cannot normally discriminate between their trading partners. Cannot grant someone a special favor.
B. National treatment:
    Imported and locally-produced goods should be treated equally at domestic market. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents.
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16. Freer trade: gradually, through negotiation
Lowering trade barriers is one of the most obvious means of encouraging trade. The barriers concerned include tariffs and measures such as import quotas.
Predictability: through binding and transparency
Sometimes, promising not to raise a trade barrier can be as important as lowering one, because the promise gives businesses a clearer view of their future opportunities. With stability and predictability, investment is encouraged, jobs are created and consumers can fully enjoy the benefits of competition choice and lower prices.
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17. Economic Integration
A free trade area allows free-trade among members (no tariffs), but each member can have its own trade policy towards non-member countries.
A customs union allows free-trade among members and requires a common external trade policy (common tariff) towards non-member countries.
A common market is a customs union with free mobility of factors of production (capital and labor) among members.
A monetary union is a common market with common currency and common monetary policy.
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18. Stages of Economic Integration
Elimination of Tariffs
Unified External Tariff
Free Movement of Factors
Common Currency and Monetary Policy
Preferential Agreement
Free Trade Area √
Customs Union
Common Market
Monetary Union

19. Main Regional AgreementsEU
NAFTA
EFTA
GAFTA
APEC
GCC
CAFTA
SAFTA
WAEMU
ASEAN
COMESA
Mercosur