1. L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1 L3 Free Trade & The Real World Sloman Chapter 23, p664- 668 Swann Chapter 1

2. Free Trade & the Real World There are a number of key influences affecting world trade today 1. 1.Historical Protectionism, exacerbated by the great recession between the world wars, led to very low levels of international trade. 2. 2.Post WWII, 23 nations formed the GATT with the object of reducing tariffs and, more recently, other trade barriers. - Slow progress, and some continuing, and highly contentious, stumbling bocks, e.g. Agriculture and Textiles 3. 3.These problems have led some regions (most notably the EU) to go down the path of Preferential Trading Arrangement as a sort-of Free Trade half-way house

3. Preferential Trading Arrangement as a form of Free Trade: –free trade areas –customs unions –common markets PREFERENTIAL TRADING

4. Preferential Trading Arrangement as a form of Free Trade: Free Trade Areas – –Each country maintains its pre-existing tariffs against third countries (NAFTA, ASEAN). – –Need to prevent back-door trades. Customs Union – –Adopt a common EXTERNAL tariff. PREFERENTIAL TRADING

5. – –A common system of regulations governing production, employment and trade – –Free movement of labour & capital markets and a common market for services and government procurement – –Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate. – –A common system of regulations governing production, employment and trade – –Free movement of labour & capital markets and a common market for services and government procurement – –Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate. Common Market

6. Reminder - Why we trade 1. Different tastes1. Different tastes –(same Technology & Factors) 2. Different technology or physical capabilities2. Different technology or physical capabilities –(Patented R&D, Land/Minerals) 3. Differences in Factor Endowments3. Differences in Factor Endowments –Labour/Capital 4. Differences in Taxes - e.g. Corporation tax, alcohol,4. Differences in Taxes - e.g. Corporation tax, alcohol, 5. (Differences in, or restrictions on) Competition5. (Differences in, or restrictions on) Competition –(Monopoly pushes prices up) 6. One Special case: Can trade even if we are identical6. One Special case: Can trade even if we are identical –Increasing Returns to Scale

7. Applying Free Trade Analysis to the EU Trade due to differences in tastesTrade due to differences in tastes –clearly an element but hard to measure. But when combined with other factors clearly welfare enhancing Trade due to differences in technologyTrade due to differences in technology –Would clearly have been an issues in the early stages of EU (1960s & 70s). Liberalisation of capital flows, the ability of firms to locate and reverse engineer traded goods has reduced this issue. Patents and IP still an issue. Clearly still an issue for emerging economies.

8. Trade due to differences in endowments –Originally regarded as the key motive for trade, and even with original 6 : Germany, France, Italy, Belgium, Luxembourg & Netherlands seen as a factor. When UK, Ireland & Denmark join, followed by Spain Portugal & Greece trade still seen as shake out of comparative advantage due to vague factor endowment reasons But factor endowments are also endogenous and improved financial capital flows makes endowment of physical capital less crucial.But factor endowments are also endogenous and improved financial capital flows makes endowment of physical capital less crucial. –Now endowment of skilled capital versus unskilled capital seen to be more crucial. Hence Lisbon AgendaHence Lisbon Agenda –But no longer sure how important differences are Estimated to be about 2% of GNP in 1992 exercise.

9. Trade due differences in taxes – this is a mildly important issue in the EU.– this is a mildly important issue in the EU. –Technically this sort of trade is a distortion. –In a true single market the cheapest, most efficient producer should win out but if exercise taxes, local rates, or low corporate tax rates or financial taxes and/or regulatory regimes affects production (firm location) and consumption patterns (alcohol, cigs & petrol) then this might be a problem. But US, Canada, Australia or even UK & German regions no different.But US, Canada, Australia or even UK & German regions no different.

10. Appling Free Trade Analysis to the EU Trade due to increasing returns to scaleTrade due to increasing returns to scale This was seen as the major advantage of the 1992 single market exercise.This was seen as the major advantage of the 1992 single market exercise. –Abolitions of non-tariff barriers to trade crucial. Common technical specifications and requirements –Estimates 6-12% of GNP. Big bang!! –Larger Market allows greater specialisation AND improves our competitive position v.v. the rest of the world. But again skills, patents & IP crucial for Increasing Returns to scale– Lisbon AgendaBut again skills, patents & IP crucial for Increasing Returns to scale– Lisbon Agenda

11. Single market versus Fortress Europe But our arguments above were for freer trade.But our arguments above were for freer trade. PTA is not free trade, just a sub-set of countries with free trade towards themselves and trade restrictions on everyone elsePTA is not free trade, just a sub-set of countries with free trade towards themselves and trade restrictions on everyone else In addition, in the case of the EU some very special types of distortions/restrictions e.g. Agriculture (CAP) and Textiles (Multi-Fibre Agreement).In addition, in the case of the EU some very special types of distortions/restrictions e.g. Agriculture (CAP) and Textiles (Multi-Fibre Agreement). So is a PTA a move towards Free Trade?So is a PTA a move towards Free Trade? Or have we created Fortress Europe?Or have we created Fortress Europe? And does that matter?And does that matter?

12. Consumer and Producer Surplus Chapter 4 Sloman p94 &95 Chapter 11 p292 & 299 Consumer and Producer Surplus Chapter 4 Sloman p94 &95 Chapter 11 p292 & 299

13. Quantity (tonnes: 000s) Demand A B C D E Demand Curve with market Price of £8 Price (£ per kg)

14. Quantity (tonnes: 000s) Demand A B C D E However, some consumers were prepared to pay £20 for the good Price (£ per kg)

15. Quantity (tonnes: 000s) Demand A B C D E However, some consumers were prepared to pay £20 for the good Price (£ per kg)

16. Quantity (tonnes: 000s) Price (£ per kg) Demand A B C D E So all these people have essentially saved £12

17. Quantity (tonnes: 000s) Demand A B C D E Similarly, some people were prepared to pay £16 Price (£ per kg)

18. Quantity (tonnes: 000s) Demand A B C D E Similarly, some people were prepared to pay £16 Price (£ per kg)

19. Quantity (tonnes: 000s) Demand A B C D E Similarly, some people were prepared to pay £16 So they have all saved £8 Price (£ per kg)

20. Quantity (tonnes: 000s) Demand A B C D E Similarly, some people were prepared to pay £12 Price (£ per kg)

21. Quantity (tonnes: 000s) Demand A B C D E Similarly, some people were prepared to pay £12 Price (£ per kg)

22. Quantity (tonnes: 000s) Demand A B C D E In general, everyone along the demand curve who was willing to pay more than £8 is gaining Price (£ per kg)

23. Quantity (tonnes: 000s) Demand B In general, everyone along the demand curve who was willing to pay more than £8 is gaining Price (£ per kg)

24. X* Demand B This area represents the gain of the Consumer OR Consumer Surplus P max Px*Px*

25. X* Demand B This area represents the gain of the Consumer OR Consumer Surplus CS = ½ X(P max -P x *) P max Px*Px* X*

26. The cost of protection O P Q S dom (=MC) D dom PwPw Similarly, firms also gain from selling at market price compared with the price they were prepared to supply at

27. The cost of protection O P Q S dom (=MC) D dom PwPw Similarly, firms also gain from selling at market price compared with the price they were prepared to supply at

28. Market Consumer Surplus Market Consumer Surplus Market Consumer Surplus Market Consumer Surplus

29. The cost of protection O P Q S dom (=MC) D dom

30. O P Q S dom (=MC) S world PWPW D dom The cost of protection

31. O P Q S dom (=MC) S world Q1Q1 Q2Q2 PWPW D dom The cost of protection

32. O P Q S dom (=MC) S world a cb Q1Q1 Q2Q2 PWPW D dom The cost of protection

33. O P Q S dom (=MC) S world a cb Q1Q1 Q2Q2 PWPW D dom The cost of protection Consumer Surplus Producer Surplus

34. O P Q S dom (=MC) S world + tariff S world a cb Q1Q1 Q2Q2 Tariff P W + t PWPW D dom The cost of protection New Diagram

35. O P Q S dom (=MC) S world + tariff S world a cb Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection

36. O P Q S dom (=MC) S world + tariff S world a d e cb Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection Consumer Surplus

37. O P Q S dom (=MC) S world + tariff S world a d e cb f 1 2 3 4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection Loss of CS=1+2+3+4 Gain of PS =1

38. O P Q S dom (=MC) S world + tariff S world a d e cb f 1 2 4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection Tariff Revenue =3 3

39. O P Q S dom (=MC) S world + tariff S world a d e cb f 1 2 4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection Welfare Loss = 2+ 4 3

40. O P Q S world + tariff S world a d e cb f 1 2 4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection Overall Loss of CS=1+2+3+4 Gain in PS=1 Tariff Revenue=3 Welfare Loss = 2+ 4 3

41. O P Q S world + tariff S world a d e cb f 2 4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Tariff P W + t PWPW D dom The cost of protection 3 Overall Loss of CS=1+2+3+4 Gain in PS=1 Tariff Revenue=3 Welfare Loss = 2+ 4

42. Preferential Trading: Trade creation O P Q S UK D UK P EU + tariff P1P1

43. O P Q S UK Q2Q2 Q1Q1 D UK P1P1 P EU + tariff Trade creation

44. O P Q S UK Q2Q2 Q1Q1 D UK P EU P1P1 P2P2 P EU + tariff Trade creation

45. O P Q S UK Q4Q4 Q3Q3 Q2Q2 Q1Q1 D UK P EU P1P1 P2P2 P EU + tariff Trade creation

46. O P Q S UK 1 2 3 4 Q4Q4 Q3Q3 Q2Q2 Q1Q1 D UK P EU P1P1 P2P2 P EU + tariff Trade creation

47. O P Q S UK 1 2 3 4 Q4Q4 Q3Q3 Q2Q2 Q1Q1 D UK P EU P1P1 P2P2 Gains P EU + tariff Trade creation

48. Trade diversion O P Q S UK Q SUK Q DUK D UK P NZ + tariff P1P1 P3P3 P NZ P EC + tariff P EC

49. O P Q S UK Q* DUK D UK P EC P1P1 P2P2 P3P3 P NZ P NZ + tariff Trade diversion P EC + tariff Q SUK Q DUK Q* SUK

50. O P Q S UK 1 2 3 4 Q* SUK D UK P EC P1P1 P2P2 P3P3 P NZ P NZ + tariff Trade diversion Q SUK Q DUK Q* DUK

51. O P Q S UK 1 2 3 4 D UK P EC P1P1 P2P2 P3P3 P NZ 5 Gains Losses P NZ + tariff Trade diversion Q SUK Q DUK Q* SUK Q* DUK

52. O P Q S UK 1 23 4 Q4Q4 Q3Q3 Q2Q2 Q1Q1 D UK P EC P1P1 P2P2 P3P3 P NZ 5 Gains Losses P NZ + tariff Trade diversion

53. THE EUROPEAN UNION Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions Airline restrictions Government procurement – –cost-increasing barriers Taxing foreign products more Subsidies to domestic firms – –barriers to entry Technical regulations Non-recognition of qualifications Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions Airline restrictions Government procurement – –cost-increasing barriers Taxing foreign products more Subsidies to domestic firms – –barriers to entry Technical regulations Non-recognition of qualifications

54. THE EUROPEAN UNION Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions – –cost-increasing barriers – –barriers to entry Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions – –cost-increasing barriers – –barriers to entry The single market the Single European Act (1987) 300 measures - implementation in 1992 The single market the Single European Act (1987) 300 measures - implementation in 1992

55. PREFERENTIAL TRADING – –A common system of regulations governing production, employment and trade – –Free movement of labour & capital markets and a common market for services and government procurement – –Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate. – –A common system of regulations governing production, employment and trade – –Free movement of labour & capital markets and a common market for services and government procurement – –Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate. free trade areas customs unions common markets free trade areas customs unions common markets

56. THE EUROPEAN UNION Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions – –cost-increasing barriers – –barriers to entry The single market – –the Single European Act – –(1987) 300 measures - implementation in 1992 Non-tariff barriers pre 1993 – –quotas and other quantitative restrictions – –cost-increasing barriers – –barriers to entry The single market – –the Single European Act – –(1987) 300 measures - implementation in 1992 Mutual recognition, race to the bottom & Majority Voting (but not taxes) Mutual recognition, race to the bottom & Majority Voting (but not taxes)

57. THE EUROPEAN UNION The benefits of the single market – –trade creation – –reduction in the direct costs of barriers – –economies of scale – –greater competition: short run – –greater competition: long run Criticisms of the single market – –radical economic change is costly – –adverse regional multiplier effects – –development of monopoly / oligopoly power – –trade diversion The future of the EU? The benefits of the single market – –trade creation – –reduction in the direct costs of barriers – –economies of scale – –greater competition: short run – –greater competition: long run Criticisms of the single market – –radical economic change is costly – –adverse regional multiplier effects – –development of monopoly / oligopoly power – –trade diversion The future of the EU?

58. WinEcon Links WinEcon does not have many links relevant to the material in these lectures but there are a few that may be beneficial. A good link is Understanding Consumer Surplus Understanding Consumer Surplus 5.4.5 Looks at The Effect of a Tariff on Imports But this largely repeats what is covered in the lecture The Effect of a Tariff on Imports The Direction of International Trade17.5 17.5. The Direction of International TradeThe Direction of International TradeThe Direction of International Trade gives a good background on World Trade patterns. Remember for these links to work you must have WinEcon on your machine or be in the Strathcona Labs or insert your WinEcon CD from the Sloman textbook. WinEcon does not have many links relevant to the material in these lectures but there are a few that may be beneficial. A good link is Understanding Consumer Surplus Understanding Consumer Surplus 5.4.5 Looks at The Effect of a Tariff on Imports But this largely repeats what is covered in the lecture The Effect of a Tariff on Imports The Direction of International Trade17.5 17.5. The Direction of International TradeThe Direction of International TradeThe Direction of International Trade gives a good background on World Trade patterns. Remember for these links to work you must have WinEcon on your machine or be in the Strathcona Labs or insert your WinEcon CD from the Sloman textbook.