1. Chapter 7 Commercial Policy

2. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-2 Learning Objectives Give at least three reasons why economists favor further trade opening even as the estimated gains are relatively small in terms of world GDP. List the sectors where tariffs tend to be higher. Draw a supply and demand diagram and use it to show the costs to consumers and the net welfare costs of tariffs and quotas.

3. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-3 Learning Objectives (cont.) Explain why countries resort to protectionism and analyze each reason. Discuss the paths to protection in the United States. Define each form of legal protection granted by the U.S. government.

4. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-4 Introduction: Commercial Policy, Tariffs, and Arguments for Protection In this chapter, we look at the data on tariff levels and consider the most frequently given arguments for protection This chapter offers a deeper look into the reasons given for protection and sets forth criteria showing that trade barriers are not usually an optimal policy tool for achieving those goals.

5. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-5 TABLE 7.1 Applied Tariffs for Major World Traders

6. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-6 Tariff Rates in the World’s Major Traders Table 7.1 shows several patterns. First, several reasons why further trade is beneficial even if the dollar values of the gains are not that high. Second, overlap between countries in the sectors they protect most rigorously Third, overall levels of tariff rates (top part of the table) are relatively low, particularly for non- agricultural goods and especially in high-income countries

7. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-7 The Costs of Protectionism There are several reasons why further trade opening is beneficial even if the dollar values of the gains are not that high. 1.keep their markets open when there is a severe downturn avoids protectionist and retaliation behavior and no one gained an advantage. 2.trade increases exposure of countries to each other, and in the process, it leads to new knowledge. 3.trade protection is grossly inefficient in achieving the goals it seeks

8. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-8 TABLE 7.2 Costs of Tariffs and Quotas in High-Income Countries (Current US Dollars)

9. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-9 The Logic of Collective Action Given that the costs of tariffs and quotas are high to consumers, why do consumers tolerate them? Economist Mancur Olson’s studies make two points: –The costs of tariffs and quotas are borne by a great many people: everyone pays a little for protection –The benefits of protection is concentrated in a few industries: few benefit a lot from protection –Thus, there is an asymmetry in the incentives to oppose the policy: those benefiting from protection have much greater incentives than those hurt by it to lobby for it

10. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-10 Table 7.3 Agricultural Subsidies, 2009

11. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-11 Why Nations Protect Their Industries: Revenue In a developing country’s economy, a large percentage of economic activity is unrecorded making income taxes and sales taxes are difficult if not impossible to impose. Tariffs, can be relatively easily collected at the ports and border crossings.

12. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-12 Why Nations Protect Their Industries: Revenue (cont.) Poorer regions (Africa, South Asia, parts of the Middle East) rely more on tariffs as a source of government revenue. Tariffs may still be used for other purposes, but for some countries, the primary goal is to generate income for the operation of government services.

13. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-13 TABLE 7.4 Tariffs as a Share of Government Revenue, By Region

14. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-14 Why Nations Protect Their Industries: The Labor Argument The Labor Argument: Protection must be used against imports from countries where wages are much lower – Problem: Does not consider differences in productivity between different workforces: As productivity rises, so will wages

15. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-15 Why Nations Protect Their Industries: The Infant Industry Argument Infant Industry Argument: mainly associated with the tariff policies of developing nations to protect their “infant” industries against the competition of more mature firms in industrial countries. - Assumes: (1) market forces do not allow for the development of a certain industry and (2) the industry has positive externalities—spillover benefits (valuable linkages to other industries or technologies) - Problems: does not demonstrate that there is some inherent advantage in making something as opposed to buying it

16. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-16 Why Nations Protect Their Industries: The National Security Argument National Security Argument: Certain industries must be protected in order to guard national security (military security, cultural values) - Prohibitions imposed on exports or tariffs on imports to develop domestic mineral or other resources are often not an optimal policy. - Usually more efficient to build stockpiles of minerals and other materials by buying large quantities in peacetime when less expensive.

17. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-17 Why Nations Protect Their Industries: The Cultural Protection Argument The cultural industries include movies, television programming, music, print media, theater, and art. Goal of protecting national cultural values is usually an argument in favor of protecting a nation’s filmmaking, television programming, and music production against complete domination by its U.S. counterparts

18. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-18 Why Nations Protect Their Industries: The Retaliation Argument Retaliation Argument: Another country's trade barriers must be countered with trade barriers - Problems: Although retaliation can provide an incentive for trade negotiations, it can also lead to escalating trade wars

19. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-19 The Politics of Protection in the United States Protectionist pressures have increased in the U.S. –Political reforms reduced Congress’s past insulation from industry lobbyists –The end of the Cold War reduced U.S. willingness to sacrifice domestic political considerations for geopolitical alliances

20. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-20 The rise of the newly industrialized countries (NICs) increased competitive pressures on U.S. industries The growth of the U.S. trade deficit in the 1980s spurred fears of the loss of competitiveness The Politics of Protection in the United States (cont.)

21. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-21 Protection is obtained through (1) direct action by the president (e.g., VERs) or (2) four types of legal procedures –Countervailing duties –Antidumping duties –Escape clause relief –Section 301 retaliation The Politics of Protection in the United States (cont.)

22. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-22 The Politics of Protection in the United States (cont.) In the case of these four legal procedures, a firm or industry petitions the federal government to initiate an investigation into foreign country or foreign firm practices Let's analyze each of the four procedures in greater detail…

23. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-23 Countervailing Duties Countervailing duty (CVD): A tariff that is granted to a U.S. industry that has been hurt by a foreign country’s subsidizing its firms –Subsidies allow foreign firms to sell their products at lower prices; countervailing duty seeks to counter the effect of the subsidy –Problem: defining subsidy is subjective –Uruguay Round defined subsidies as (1) a direct loan or transfer, (2) preferential tax treatment, (3) the supply of goods or services other than general infrastructure, or (4) income and price supports

24. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-24 Antidumping Duties Antidumping duty: a tariff levied on an import that is selling at a price below the product’s fair value – Problem: Defining fair value is subjective; antidumping duties are thus a source of tension between countries

25. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-25 Antidumping Duties (cont.) According to the WTO dumping occurs when an exporter sells a product at a price below the one it charges in its home market – Problem: Comparing domestic and foreign market prices is difficult due to differences in the price of transportation, wholesale, and other add-ons

26. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-26 Antidumping Duties (cont.) There are three methods to determine whether a good is being dumped: 1.Comparing the price in third-country markets 2.Estimating the cost of production 3.Estimating the foreign firm’s production costs (dumping occurs if the foreign firm is not selling at a price that provides a normal rate of return on invested capital)

27. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-27 Antidumping Duties (cont.) In order for antidumping duties to be allowed, the country claiming dumping must show that the dumping has caused material injury to its firms - If dumping occurs without material injury, antidumping duty is not allowed

28. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-28 Antidumping Duties (cont.) Problems: Economic theory and legal definitions are not in agreement –If a firm is not earning above average profits somewhere, it cannot maintain a price somewhere else that is below the cost –Firms often sell below costs May sell at below costs in order to penetrate a market May go for extended periods selling at prices that do not cover fixed costs as long as the costs of variable inputs (labor and materials) are covered

29. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-29 Antidumping Investigation U.S. firms can initiate antidumping actions by filing a petition with the International Trade Administration (ITA) in the Department of Commerce If ITA finds dumping (or subsidization in the case of countervailing duty) - the U.S. International Trade Commission (USITC) conducts additional investigation to determine whether the dumping has posed substantial harm to the domestic industry The relative success of U.S. firms in proving foreign dumping has induced a growing number of firms to file petitions with ITA

30. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-30 Escape Clause Relief Escape clause relief: Temporary tariff on imports to allow a domestic industry to escape the pressure of imports and thus obtain a period of adjustment –Refers to a clause in the U.S. and GATT trade rules –Initiated when a firm or industry petitions the USTIC directly for relief from a surge of imports –The petitioning firm or industry must show that it has been harmed by imports and not some other factor (e.g., poor management)

31. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-31 Section 301 and Special 301 Section 301: A section of the U.S. 1974 Trade Act that requires the U.S. Trade Representative (USTR) to take action against any nation that persistently engages in unfair trade practices –U.S. defines the meaning of unreasonable and unfair trade practices –Action is launched by a request for negotiations with the country in question

32. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-32 Section 301 and Special 301 (con’t.) Special 301: Requires the USTR to monitor property rights enforcement around the world - In 2005, the USTR surveyed 90 countries and identified 52 as lacking adequate enforce or denying market access

33. Copyright ©2014 Pearson Education, Inc. All rights reserved.7-33 TABLE 7.5 Economic Sanctions since World War I