Chapter 5 - Trade & Macro 5.1 Macroeconomic Factors – exchange rates – interest rates – government fiscal balance 5.2 International Agricultural Trade –Trade agreements 5.3 Trade Theory –Gains from trade –Distortions (tariffs & subsidies) –Farm programs

1) Exchange Rates Affects the competitiveness of agr. Products Early 1970’s – floating exchange rates Policy – over or under value exchange rate What is the impact of a ER distortion? Example 1: Argentina: Overvalued Exchange Rate (exporter) Shift of excess demand function Lower producer price Lower quantity exported Loss of producer surplus

Source: International Monetary Fund -IFS

P Q S ED Increase in Exchange Rate

Interest Rates: Why interest rates are important: 1) Value of currency – prices received and paid Most commodities are US$ denominated 2) Cost of borrowing: Agriculture is capital intensive (borrowing) Inputs: seed, fertilizer, machinery 1980’s- high interest rates – low grain prices - debt crisis Cost of borrowing: How is it determined ? Role of central bank (Bank of Canada) Role of the market Government intervention (interest subsidies)

100 Basis points = 1% Src. Globe & Mail - March 8, 2008

Government Fiscal Balance Consequences for Agricultural Policy 1 – interest rate - more borrowing = higher rates "crowding out effect" - higher cost for farm borrowing 2001 Average capital/farm = $800,000 Total farm capital= $ 200 Billion 1% change in interest rates => $ 2 Billion ( ) - Net market income $B (2002) 3.3 $B (1975) 2 – capacity to fund interventions - deficits = limited marge de manouvre - reduced scope for intervention

5.2 International TRADE Gains from trade: > increase in output due to specialization  based on comparative advantage each country –concentrates on producing goods and that it produces relatively efficiently – trading to obtain goods that it does not Trade Distortions many forms of distortion (welfare reducing) tariffs, taxes, subsidies, quantitative measures non-tariff barriers (health, safety reg’s) Trade Agreements institutional arrangement – restraint on behaviour multi-lateral (regional), bilateral Levels of cooperation –Range of goods (agr vs industrial) –Scope of instruments included –Customs union – full economic integration (EU)

Reasons for Protection new industry (infant industry argument) national health + phyto-sanitary unfair foreign trade policy Defend domestic programs improve balance of payments improve “Terms of Trade” generate revenue slow down painful economic adjustment Political economy benefits of additional trade are spread thinly among many individuals but the cost is high for only a few firms or groups

Trade Theory Why do nations trade? What are the benefits? Implications of trade distortions Theory comparative advantage (Ricardo) absolute advantage Ohlin (1933) comparative advantage –due to resource endowments –Canada land rich, capital poor –=> export agr & import manufactures Gains from trade Trade allows for specialization – increased welfare

Gains from Trade. Agr. Manufactures P1P1 P2P2 W1W1 W2W2

ES/ED Framework Excess Demand (ED) Excess Supply (ES) Gains from trade (versus no trade) depend on the impact of a country on world prices Small country – no price impact Large country – prices adjust, impacts smaller 2 Country Model – 1 good e.g. US/Canada cattle market Assume: Canada - low cost producer How are consumers and farmers affected by trade between the two countries? Winners and losers – distribution effects –US – consumers gains, farmers lose –CA – consumers lose, farmers gain

Gains from Trade. Canada US Trade Sector ED ES PWPW P US P CA Trade W US W CA

Analysis: Trade Distortions 1 ) Import Tariff Fixed-tariff rate vs ad valorem Small country (fixed tariff) –domestic price increases –Supply increases, demand decreases –imports reduced –Net dead weight loss Large country –domestic price increases –world price decreases –Imports decrease; domestic output increases –Consumers lose; producers gain –Government gains tariff revenue –Net welfare gain –Potential to compensate consumers

Import Quota Binding quota –if it restricts imports below free trade imports Similar price effects to a tariff –Imports lower –Domestic price higher –World price lower –Rents to importers Quota value: right to import –Based on difference between new world price and domestic price

Large Country – Import Quota World Market Domestic Market ED 0 ES S D PwPw. Q PQPQ IQIQ P WQ

Large Country - Tariff. World Market Domestic Market ED 0 ED 1 ES S D PwPw TR

Import tariff – Small Country PwPw PTPT S D ab G income Government income – few transactions

Export Subsidy Used extensively –Purpose: support domestic income (price) support –Subsidy to export the excess supply –US (EEP) starting in 1985 –EU (ERP) – export restitutions – 1970’s –not unique to agriculture – e.g. Bombardier price support program – increases ES Subsidy Impacts –world price falls (large country) –Domestic price falls –Exports expand –Government payments = (P s -P Ws )*exports value of exports increase relative to free trade Deadweight loss –Consumers gain –Producers gain –Foreign importers gain –Taxpayer loses

Export Subsidy – Large Country Dd – domestic demand D T – total demand – including world demand PwPw P ws S DTDT DdDd PsPs Exports Before Exports After DWL

Export Tax Tax exporters Exporting government gain revenue from export taxes Producers in exporting country lose

Export Cartel Assumptions: 2 countries Cartel: importer + domestic supplier Suppliers maximize joint profits Price according to joint supply function MR = MC (joint MC) Results: Domestic price increases Imports and domestic production decrease Foreign surplus increases Deadweight loss

Export Cartel. Importer Exporter S PwPw MR D SdSd STST S d – domestic supply S T – domestic + foreign supply Exporter gain = (a-b) Deadweight loss = c PCPC QEQE QdQd a b c Q

Decoupled Subsidies Programs that do not distort trade –within the green box category under GATT policies that lead to a per-unit payment to producers are not decoupled trade distorting => affects trade and prices Is any farm program completely decoupled ?