Globalization and International Trade Lecture 8 – academic year 2014/15 Introduction to Economics Fabio Landini

2 What do we do today? Lect. 8: the welfare effects of globalization Lect. 8: is it convenient to impose a tax on Chinese shoes imported in Europe? If so, convenient for whom?

3 Question of the day Who made our shoes?

4 Globalization What’s “globalization”? Process of growing economic and financial, e.g. exchange of goods and financial activities (assets). We ask: Which are the effects of globalization on welfare? Who gain and who looses from the free trade among nations?

5 World exports of goods (Billions US $ x 1000)

Updating… the crisis

7 Equilibrium in the absence of international exchanges Economy without international exchanges (“closed”): the price adjusts so as to equalize internal demand and supply.

8 Equilibrium in the absence of exchanges Price of steel Equilibrium price 0Quantity of steelEquilibrium quantity Internal supply Internal demand Consumer surplus Producer surplus

9 EXAMPLE – Market for steel Hypotheses: A country that is not in contact with the rest of the world and produces steel. The market for steel consists of producers and consumers of that country. Equilibrium in the absence of exchanges

10 Opening to international trade: questions If a country opens to international trade, what happens to exporters and importers of steel? Who gains and who looses from the opening of the market (= globalization)? Are the gains of some compensated by the losses of the others?

11 Baseline hypothesis: the country is SMALL in the world market. Hence: it behaves like consumers and producers under perfect competition. Take the world price as a given. The country decides whether to sell or buy steel to/from the world market. Opening to international trade

12 World price and comparative advantage If a country has a “comparative advantage” in the production of a good, then: internal price < global price –why? Price= opportunity cost In this case: the country becomes an exporter of that good

13 If a country does not have a “comparative advantage”, then internal price > global price. In this case: the country becomes exporter of that good World price and comparative advantage

14 International trade in an importing country If global p < internal p, “once the borders are opened”, the country becomes an importer of steel. Key question: who do the consumers want to buy from (given that they are free to choose) ?

15 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand World price International trade in an importing country

16 Internal consumers want to buy steel at a lower price. –For small quantities, the most efficient among the internal producers can satisfy demand –For larger quantities, the internal producers are too inefficient compared to foreign competitors and imports International trade in an importing country

17 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand World price Internal quantity supplied Internal quantity demanded Import International trade in an importing country

18 Import= Internal quantity demanded – internal quantity supplied, at the world price. Internal price until internal p = global p Internal consumption and internal production i.e., the country becomes an importer of steel. International trade in an importing country

19 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand World price International trade in an importing country Consumer surplus in a closed economy A Import

20 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand International trade in an importing country Consumer surplus in a closed economy A C B World price Import Produce surplus in a closed economy

21 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand International trade in an importing country Consumer surplus in a open economy A World price Import B D

22 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand International trade in an importing country Consumer surplus in a open economy A World price Import B D Produce surplus in a open economy C

23 Price of steel Price in a closed economy 0 Quantity of steel Internal supply Internal demand International trade in an importing country Consumer surplus in a open economy A World price Import B Produce surplus in a open economy C Additional surplus in an open economy D

24 Gains and losses from free trade When a country opens its frontiers to free trade becoming an importer, its consumers gain. They pay a lower price and can buy more. The national producers, instead, are damaged. They receive a lower price and sell less units.

25 Overall, international trade increases the total welfare of the country. The net variation of total welfare (surplus) is positive The gains of consumers are greater than the losses of producers. Gains and losses from free trade

26 The effects of a custom duty A custom duty is a tax on a good produced abroad and imported. A custom duty increases the global price proportionally.

27 National producers take advantage of the duty, while consumers experience a loss. The effects of a custom duty

28 Price of steel 0 Quantity of steel Internal supply Internal demand Import without duty World price QS1QS1QS1QS1QQ QD1QD1QD1QD1 The effects of a custom duty Price without duty

29 Price of steel 0 Quantity of steel Internal supply Internal demand Import without duty World price QS1QS1QS1QS1QQ QD1QD1QD1QD1 The effects of a custom duty Consumer surplus without duty Producer surplus Without duty Price without duty

30 Price of steel 0 Quantity of steel Internal supply Internal demand Import without duty World price QS1QS1QS1QS1QQ QD1QD1QD1QD1 Price without duty The effects of a custom duty

31 Price of steel 0 Quantity of steel Internal supply Internal demand Import without duty World price QS1QS1QS1QS1QQ QD1QD1QD1QD1 The effects of a custom duty Price with duty Duty QS2QS2 QD2QD2 Price without duty

32 Price of steel 0 Quantity of steel Internal supply Internal demand World price The effects of a custom duty Price with duty Duty QS2QS2 QD2QD2 Price without duty Import with dutyQ QD1QD1QD1QD1

33 Price of steel 0 Quantity of steel Internal supply Internal demand World price The effects of a custom duty Price with duty Duty QS2QS2 QD2QD2 Price without duty Q QD1QD1QD1QD1 Consumer surplus without duty Producer surplus with duty

34 Price of steel 0 Quantity of steel Internal supply Internal demand World price The effects of a custom duty Price with duty Duty QS2QS2 QD2QD2 Price without duty Q QD1QD1QD1QD1 Consumer surplus without duty Producer surplus with duty Public revenue

35 Price of steel 0 Quantity of steel Internal supply Internal demand World price The effects of a custom duty Price with duty Duty QS2QS2 QD2QD2 Price without duty Q QD1QD1QD1QD1 Consumer surplus without duty Producer surplus with duty Net loss due to the duty Public revenue

36 As any other tax, a duty creates a distortion in incentives and affects the optimal allocation of resources The effects of a custom duty

37 The argument in favour of restrictions to free trade Employment National security Infant industry protection Dumping Protectionism as bargaining tool

38 Hence Through the comparison between internal price and world price one can identify which countries are exporters and which are importers of a particular good.

39 Globalization means: In exporting countries, producers gains, while consumers loose. In importing countries, consumers gain, while producers loose. In both cases gains are greater than losses.

40 Conclusion The custom duty... Increases the national price of a good. Reduces the welfare of internal consumers Increases the welfare of internal producers Creates a net loss in terms of welfare