International Trade 2

International Trade 2

1. Instruments of trade policy

   • Tariff: raises the cost of trading
     • Specific tariff: fixed charge for each unit
     • Ad valorem: fraction of the value
     • Provides gov revenue
     • Protect domestic industry: Corn laws
     • • Prices rises in Importing country relative to the world equilibrium price, falls in Exporting country until the price difference equals the tariff
         • • Pt-Pw<t: Part of the tariff reflected in a decline of Pt*, not to the home consumers
           • Small Country: foreign price does not change; Pt = Pw+t
             • Only a cost of b+d
       • • b,d = efficiency loss, (distortions) e = terms of trade gain
         • Gov gains at the expense of domestic consumers
         • Social welfare effect: depends on how gov uses the revenue
         • Global welfare effect: always negative, trade and efficiency loss due to low price
     • Dd + Df = Qd + Qf assuming no transportation cost and currency exchange
     • Effective rate of protection
       • (Vt-Vw)/Vw
   • Nontariff barriers
     • Import quota
       • Restriction on the quantity of imports by issuing licences to domestic firms
         • Push up the price of the import because D>S
           • No gov revenue, but quota rents to licence holders i.e. sugar in the US
     • Voluntary export restraint
       • Quota imposed by exporting country, requested by importing country
         • Profits or rents earned by foreigners
           • Foreigners sell limited quantity at an increased price, i.e. car exports to US enforced by Japan
     • Local Content Requirement
       • No gov revenue nor quota rents, but diff between prices of domestic goods and imports averaged into the final good, passed onto consumers
         • Regulation that requires a specific fraction of a final good to be produced domestically
           • i.e. American buses made in Hungary
             • From domestic producers, provides protection like import quota. From firms that buy inputs, no limit on imports
   • Export subsidy
     • Prices rises in Exporting country, falls in Importing country
       • Cost exceed benefit: terms of trade worsens because price of exports falls to Ps* in world market
         • EUCAP: high prices for agricultural products and subsidises exports to dispose excess, reducing world price

2. Controversies in trade policy

   • Arguments FOR Activist trade policies
     • Support export industries through subsidies
       • Externalities and the appropriability
         • New knowledge that other firms can use without paying, hard to capture the benefits of knowledge creation
           • Benefits or costs accrue to parties other than the one generates it
             • Marginal social benefit of investment not represented by producer surplus
         • The ability of gov to subside RIGHT activity
           • subsidising equips or workers doesn't generate new tech
           • instead can subsidise R&D through the tax code
             • How to define R&D, paper clips? legal loopholes
         • Economic importance of externalities
           • quantitative difficulty, so how much to subsidise?
         • Externalities across countries
           • No incentive if taken advantage of
       • Strategic trade policy with imperfect competition
         • Dominated by few firms that generate monopoly profits
           • i.e. Brander-Spencer analysis for Boeing vs Airbus (SE)
             • First-mover advantage
               • But a subsidy can make one more profitable: strategic trade policy (SW)
                 • Requires more information i.e. Boeing may have special technology (NE before subsidy)
                   • After subsidy (NW)
                     • After subsidy (NW)
                 • Foreign retaliation
                   • Trade policy is a dynamic game, increase its welfare at the expense of others (beggar-thy-neighbour)
                   • Trade war + waste tax
                 • Manipulated by politically powerful groups
               • Raises profits more than subsidy because of deterrent effect on foreign competition
   • Arguments concerning trade and people
     • Trade and Labour
       • Workers in developing countries are poorly paid, long hours, poor environment
         • i.e. Maquiladora: low wages + conditions; NAFTA replace US workers with Mexican workers
           • But, Ricardian model: Mexican wages will rise relative to pre-trade level
             • Strong evidence, hence the true problem is not trade, but lack of other opportunities in Mexico
               • Labour standards: too expensive; International standards: protectionist policy or a basis for lawsuits
               • A system monitor wages and conditions
           • HO model: unskilled US workers loss, unskilled Mexican workers gain
     • Trade and environment
       • i.e. heavy logging in SE Asian forests
         • But, without trade, gov policy degrade environment: i.e. Brazil subsidising destroying rainforests
           • Environmental standards: too expensive International standards: protectionist policy or a basis for lawsuits
     • Trade and culture
       • Homogenisation of cultures
         • But, free societies define their culture through the choices they make, not through standards set by others

3. Political economy of trade policy

   • If trade policies hurt more than benefit, why pursue?
     • Argument FOR free trade
       • Efficiency case for free trade
         • Producers and consumers allocate resources most efficiently when no gov intervention (distortion of market price)
           • National welfare of a small country is highest
             • With restricted trade, distorted prices cause overproduction (quantity or # of firms)
         • Counter Argument: Tariff rates low, import quota rare
           • Estimated gains from moving to free trade is only a small fraction of GDP
             • Protection costs <1% of GDP
               • Gains higher in developing countries i.e. Brazil (9.5% in 1960s)
       • Dynamic benefits not reflected in static estimates of the elimination of efficiency loss
         • Economies of scale
           • Protected markets fragment production and encourage too many firms to enter this industry
             • i.e. Argentine car industry, 13 firms producing 166,000 cars in TOTAL
         • Competition and innovation
           • Gives incentive to differentiate products
             • i.e. EU, removing borders to encourage consolidation and productivity gains
       • Political argument
         • Free trade is the best feasible political policy
           • Any policy deviates from free trade will be manipulated by special interest, decreasing national welfare
     • Argument AGAINST free trade
       • Under some circumstances, free trade might not be optimal
         • Terms of trade gain
           • Tariff or quota lowers the price of imports, generating gains which may exceed efficiency loss
           • Instead of subsidy (ultimate loss), tax on exports
             • Optimum export tax raises price of exports in the world market, gain
               • i.e. Saudi Arabia oil exporters levy tax on oil exports, pushing oil price in the world market
           • Counter argument: other countries may retaliate against large countries by enacting their own trade restrictions
         • Theory of the second best
           • Domestic market failures
             • i.e. Failure in the labour market might justify overproduction in the coal mining industry
               • If markets are inefficient, consumer & producer surplus do not properly measure welfare benefits, misleading efficiency loss calculations
                 • Particularly applies to developing countries
             • Type of market failures which not accurately measured by marginal social benefit
               • Persistently high unemployment
                 • Desirable to impose a tariff on labour intensive imports
               • Persistently high under-utilisation of capital
               • Uncaptured technological benefits for society (i.e. spillover effects)
               • Environmental costs for society
             • Counter argument: Internal malfunctioning of an economy
               • domestic market failures should be corrected by a first-best policy directly aimed at the source
                 • Gov can subsidise cost of labour or the production to keep employment
                 • i.e. US import quota on cars, subsidising not feasible politically due to budget deficit, but quota even more expensive because higher price for consumers, but the cost spread across ppl
               • Uncertainty about market failures
                 • When and to what degree gov intervene
                 • Gov policies manipulated by politically powerful groups
           • gov intervention may increase national welfare by offsetting the consequences of market failures elsewhere
     • Political models of trade economy
       • Median voter theorem
         • Democratic political parties change their policies to court the voter in the middle of the ideological spectrum
           • Assumption: 2 political parties, election from majority vote
             • Both parties offer the same tariff policy
               • • loss on few ppl, gains on large ppl
                   • Except, sugar import was not abolished
       • Collective action
         • Group has the incentive, individual has no incentive because benefit is not large compared to the cost and time required to advocate free trade
           • Policy that impose large losses for society but small losses on individual may face no strong opposition
             • Overcome by keeping the group small
       • A model of trade policy
         • Politicians win because:
           • advocate popular policies
           • fund from groups who overcome collective action problem
           • Measures the trade-off between the reduction of constituents' overall welfare in return for additional campaign contributions
             • Politicians are for sale, special interests buy large # of votes
               • i.e. Agriculture (farmers) Clothing (textiles and apparel)
     • International negotiations of trade policy
       • GATT (1947)
         • WTO (1995)
           • Reduction of tariff rates
           • Binding (upper limit)
           • Prevention of nontariff barriers
             • costs of tariff protection are more apparent
               • Exception: export subsidies in agriculture; market disruption
       • Multilateral negotiation mobilises exporters to support freer trade if export markets will expand
         • Counter argument: Restricted trade by import-competing groups
       • Multilateral negotiations help avoid destructive trade war
         • If each country protect domestic producers regardless of what other countries do, then all countries could enact trade restrictions
           • Coordination device (Prisoner's dilemma)
             • The need for international coordination of trade policies through international agreements
       • Preferential trading agreements
         • lower tariff for each other, but not ROW
           • Free trade area i.e. NAFTA (different trade policy to ROW)
             • Administrative nightmare: arbitrage import tariff differences across members
           • Custom union: EU (common external trade policy)
             • Political nightmare: time and effort to streamline the external trade policies
         • Not necessarily good for NW, might end up importing expensive products from member countries than gaining tariff revenue
         • NW increase when new trade is created i.e. high-cost domestic production to low-cost imports

4. Trade policy in developing countries

   • 1970, economic development heavily dependent on manufacturing
   • Import-substituting industrialisation
     • Infant industry argument
       • Potential CA cannot initially compete with well-established foreign industries
         • i.e. US, Japan & Germany
       • Timing
       • spoilt due to lack of incentive to improve
       • if the industry was promising, why private investors did not move in? (no justification for gov intervention unless market failure)
         • Imperfect capital markets: can't borrow, so high tariffs second best policy
         • Appropriability: benefits are public goods, lack of property rights, high tariffs second best policy
     • to encourage domestic industries (i.e. manufacturing) by limiting competing imports
       • Draw resources away from potential export sectors, discouraging exports
     • Economic development? No
       • Difficult to establish causality: could be reverse causality
         • Similar problem: Development aid
         • 60-70s, infant industry argument invalid
           • firms did not become competitive because of trade restrictions
             • lack of skilled labour, managerial competence etc
             • costs and wasteful use of resources for a small domestic market
   • Trade liberalisation 1985
     • Evidence in freer trade with higher economic growth
       • But difficult to establish causality
         • Brazil had slower growth than ISI, but could be due to unstable macroeconomic policies and financial crisis in 1980s
         • Income inequality, declining and increasing real wages between sectors
   • Export-oriented industrialisation
     • East Asian "miracle"
       • Japan after 1945; Asian tigers 1960s, SE Asia & China late 1970s
         • Still had some restrictions i.e. 24%
           • Causality vs Correlation i.e. Saving + investment, education
           • Industrial policies: to promote certain industries i.e. subsidised loans for industries and R&D

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