1. 1 International Trade and Development Raul Caruso Università Cattolica del Sacro Cuore di Milano raul.caruso@unicatt.it

2. 2 In the previous classes, we considered only competitive scenarios. Ricardian and HO worlds were purely competitive. In reality, there is no free trade. Different trade policies affect patterns and evolution of trade. In particular, protectionism seems to be the rule.

3. 3 Integration,Exchange Threat, Power Trade Protection clealry is closer to the Power apex. Protection and the Triangle

4. 4 Measuring Protection The effective rate of protection can be computed through: Where V is the value added in a sector. The subscripts denote the value added in the presence of trade policies and the value added evaluated at world prices respectively

5. 5 Effect of a Tariff on Prices If the Home country imposes a tariff the price home at home goes up. Because of the existence of a tariff there will be an excess demand which leads to a higher world market price On the foreign market if the country is relatively large there will an excess of supply which should lead to a lower price. The latter statement canno t hold when the country is small and cannot affect world prices.

6. 6 Who gains from a tariff? 1. Domestic Producers obviously gain from the imposition of a tariff. 2. The government also gains from a tariff since it has higher revenues.

7. 7 Who loses from a tariff? 1.consumers lose because they face higher prices. 2.Terms of trade of Small countries worsen. When a country is price-taker it cannot influence the world price, then the negative impact of foreign price does not occur.

8. 8 Net gain or loss? The net cost of a tariff is: Consumer loss - producer gain – government revenue = net cost of a tariff

9. 9 Quantitative Non-Tariff Barriers Quotas, VERs and other quantitative restrictions have the same effect of a tariff but they add also the emergence of rents through system of licenses and administrative tasks to manage them.

10. 10 Export Subsidies An export subsidy is payment to an exporting firm. It can be either specific (a fixed sum per unit) or ad valorem ( a proportionof the value exported) In general, once subsidy is applied the price in the exporting country rises and the price in the importing country falls.

11. 11 Export Subsidies What happens to terms of trade? Terms of trade of exporting country worsen. If the exporting country is relatively large (can set prices) the world prices decrease. Terms of trade of other exporting countries decrease as well. This is the case of competition over a third market. However, terms of trade of importing country would improve.

12. 12 Export Subsidies The paradox of subsidies is that only producers of the exporting country gain. Consumer surplus falls Government revenue falls, (government spending rises) Overall National Welfare Falls

13. 13 European CAP policy It was implemented in order to guarantee high prices for agricultural sector by having the European Union buy agricultural products whenever the prices fell below specific levels. Since the 70s the level of protection turned to be so high that EU would have been an importer of agricultural products in the presence of free trade.

14. 14 US Policy, (Farm Bill) In USA there is a very similar institutional architecture to protect farmers in USA.

15. 15 IL MERCATO AGRICOLO UE USA

16. 16 Commodities and LDCs

17. 17 Prices of Commodities and LDCS Many LDCs are dependent upon the exports of a small number of commodities According to FAO(2003), as many as 43 LDCs depend upon only one commodity More than 50 LDCs depend on exports of three or fewer agricultural commodities

18. 18 Price of Commodities and LDCs

19. 19 Price of Commodities and LDCs Over the last twenty years commodity prices declined continously Cotton (-47%), Coffee (-64%), Cocoa (- 71%), sugar (-77%)

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21. 21 Price of Commodities and LDCs Why? Oversupply of commodities which drives the prices down. Oversupply is based upon enhancements of productivity and emergence of new producers (ex. Coffee in Vietnam) Shocks in supply determine volatility of prices

22. 22 Price of Commodities and LDCs The Argument of ‘IMMISERIZING GROWTH’ is based upon the evidence of declining terms of trade for developing countries turned largely on differences in the degree of competition between industries in developed countries, or core, and those found on the periphery. Competition among producers of raw materials and foodstuffs drive prices down to marginal costs in the developing economies. The result was that the prices of primary goods produced on the periphery declined relative to those of manufactures produced in the core. For developing countries, free trade supposedly resulted in “immiserization” (or “immiserizing growth”) rather than in increasing wealth. Hence, according to the terms-of-trade argument, developing economies should not favor free trade but advocate the protection of domestic industrialization instead.

23. 23 Price of Commodities and LDCs Increased Export volumes until now do not appear to compensate the losses in the value of exports. The decline of prices for some selected commodities has been so significant that the increase in volume could not compensate for the decline of prices.

24. 24 Price of Commodities and LDCs

25. 25 Price of Commodities and LDCs Possible Solutions 1.Diversification of Production (long-term strategy).However, in the presence of western subisidies diversification strategy could fail also in the long run 2.Cartel of Producers to ensure high prices (the demand could decrease dramatically) 3.Stabilization Mechanism through international agreements on commodities.

26. 26 Price of Commodities and LDCs Natural evolution? An increased demand from newly industrialized countries (ex. China, India) and other growing economies could stop (or move against) a continous decline in commodity prices.

27. 27 Future markets However, in the latest years (before the subprime crises) prices of commodities have been subject to high pressure. Such a pressure emerged in the presence of a high liquidity in the financial markets. This increased dramatically the volatility of prices.

28. 28 Prices of selected commodities (Oil, Wheat, Rice, Corn) ( 2003=100) Volatility and pressure on financial markets for some commodities

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30. 30 Trade Integration However countries also integrate by means of: (1)Preferential Trade Agreement (PTA) (2)Free Trade Areas (3)Customs Unions

31. 31 Trade Integration 1.A PTA occurs when a country (or a group of countries) establishes a more favorable duty system for goods coming from some selected countries. (ex. Tariff are lower) Example: EEC/Lomè convention

32. 32 Trade Integration 2. A Free Trade Area (FTA) is an agreement between countries allowing for free movement of goods. No restriction is allowed. (no tariffs, no quotas) Example. USA has a FTA with Israel. NAFTA is also a FTA. There is FTA between EU and non-member countries in europe.

33. 33 Trade Integration 3. A costums union (CU) is an agreement between countries establishing a common duty against the rest of the world. Tariffs and quotas are chosen and implemented collectively. Example: EU is a customs union.

34. 34 Trade Integration What happens? Economists usually distinguish between: (1)Trade creation; (2) Trade diversion. The ideas of Trade Creation and Trade Diversion date back to Viner (1950).

35. 35 Trade Integration Trade creation is supposed to be beneficial for member countries. a. Volume of trade increases. b. Prices decrease.

36. 36 Trade Integration By contrast Trade diversion is supposed to have a negative impact on trade with third countries. a.Volume of trade with third countries decrease b.The impact on world prices is not precisely predictable.

37. 37 Trade Integration In a FTA the individual member countries agree to free trade between themselves but retain their individual regime of tariffs and other restrictions on imports from third countries. In the absence of intra-trade restrictions goods exported by third countries cound eneter the market of both countries by entering the member country with the lowes level of pretection. This is called Trade deflection.

38. 38 Trade Integration Finally: Trade integration is beneficial for member countries and have a negative impact on third countries. However, third countries can deflect trade. An effective system of rules of origin must be implemented.

39. 39 Trade Integration Hint: Trade integration is beneficial for member countries if and only if there is a body committed to dispute resolution. [UE has been also built on this].

40. 40 The WTO Dispute Resolution System A dispute arises when a member government believes another member government is violating an agreement or a commitment that it has made in the WTO. The authors of these agreements are the member governments themselves — the agreements are the outcome of negotiations among members. Ultimate responsibility for settling disputes also lies with member governments, through the Dispute Settlement Body.

41. 41 Main Point The main point we have to remember is that the WTO lacks the direct enforcement capacity. Countries must cooperate. Why? 1)Information mechanism leading to a reputation building; 2)Higher payoffs which emerge in the long run.

42. 42 Number of disputes since 1995

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45. 45 When countries invoke the dispute resolution system? Which countries rely on DSS? Which variables can be considered to interpret the ‘success’ of DSS?

46. 46 VariableExpected Correlation Complainant’s GDP+ Defendant’s GDP+ Relative military power of complainant + Threat of retaliation? Trade competitiveness+ Degree of Openness? Trade dependence between countries involved ? Share of contested sector in total export of complainant + Share of contested sector in total export of respondant ?

47. 47 Few reasonable Facts The countries that trade more with one another tend to have more trade disputes Larger economies seem to be more likely to take on a trade dispute due to greater ability to withstand the effects of (retaliatory) trade restrictions Differences in ‘power’ matter

48. 48 LDCs do not invoke the Dispute Settlement Body very often. Why? (1)Simply, the process is costly; (2)Reputation (inverse signalling) (3)Insurance effect for its exports (threat of retaliatory measures adopted by respondant)

49. 49 Consider also…. Consider also that actors ealuate differently the stake of a contest. A contest which is vital for one country can be negligible for the other country. In such a case: (1) the higher-evaluation actor is willing to concede more than the opponent. (2) When the evalutions converge both actors have to concede.

50. 50 An asymmetry in the evaluation of the stake can depend upon: (1)Asymmetric Information; (2)Different productive systems; (3)Internal competition between groups

51. 51 Summary of the course Summary of the whole story about trade and development: (1)Trade can foster growth (we have empirical evidence about this); (2)Some economic policies are desirable for growth and then for trade (resolution of conflicts through redistribution of rents, investment in education to enhance productivity) (3)Joining international trade negotiations is also a desirable policy. In particular, cooperation among LDCs should be enhanced.