Trade Policies Free trade vs protectionism 1

 This part is simple:  Free trade makes the country as a whole better off, even though it may not make every individual in the country better off  Winners gain more than the losers lose  The tale of a great inventor  Trade allows us to obtain the goods at lower cost just as superior technology would allow us to obtain the goods at lower cost 2

 “Valid” arguments for protection  Advantages of diversification  What if we have a war?  What if our staple industry becomes obsolete?  May be valid for small countries  Protection for specific groups  Skilled workers vs unskilled workers (with factor endowment induced comparative advantage)  Increase incomes of a group at expense of lower average income  Could be done by other means, better?  These arguments take sides in income vs other objectives tradeoff 3

 “Valid” arguments for protection  Improving terms of trade  Recall, terms of trade = 100 (index of export prices) / (index of import prices)  If a tariff increases export prices more than import prices, terms of trade may improve  May be valid only for large countries  Protection of infant industries  Large economies of scale  Significant learning by doing  Seems to have worked historically  Or did it?  Strategic trade policies  Hoping to “break in” very profitable industries worldwide  These arguments suggest economic gains to a country as whole 4

 Erroneous arguments for protection  Keeping money at home  But you don’t need to, the money always return anyway  Protection against low-wage foreign labour  But this is refusing to obtain goods at low cost  Exports are “better” than imports  Exports EX increase GDP, imports IM decrease GDP  NX = (EX – IM)  But this says income is more important than consumption  Protection creates domestic jobs  It may create jobs for some  But it destroys jobs for others 5

 How does protectionism work?  Tariff (import duty)  The price increases above the world price  Domestic quantity supplied increases  Domestic quantity demanded (consumed) decreases  Total surplus decreases => net effect is negative  Producers gain less than consumers gain  Quota  Can import no more than set amount  Quota reduces our surplus more than “equivalent” tariff does  The difference is:  With tariff, government receives revenue  With quota, foreign producers receive that revenue  Voluntary export restriction VER  A country who sells may prefer self-imposed quota because  With tariff, foreign government receives revenue  With quota, Canadian producers receive that revenue 6

 How does protectionism work?  Tariff (import duty)  The price increases above the world price  Domestic quantity supplied increases  Domestic quantity demanded (consumed) decreases  Total surplus decreases => net effect is negative  Producers gain less than consumers gain  Quota  Can import no more than set amount  Quota reduces our surplus more than “equivalent” tariff does  The difference is:  With tariff, government receives revenue  With quota, foreign producers receive that revenue  Voluntary export restriction VER  A country who sells may prefer self-imposed quota because  With tariff, foreign government receives revenue  With quota, Canadian producers receive that revenue 7

 Current Trade Policies  Read. NOT tested. 8