The Political Economy of Trade Policy

The Political Economy of Trade Policy

1. The cases of free trade

   • Free trades allows firms or industry to take advantage of economies of scale.
     • Protected markets limit gains from external economies of scale by inhibiting the concentration of industries:
       • Too many firms to enter the protected industry. The scale of production of each firm becomes inefficient.
   • Free trades avoids the loss of resources trough rent seeking
     • Spend time and other resources seeking quota rights and the profit that they will earn.
     • The political argument for free trade says that free trade is the best feasible political policy, even though there may be better policies in principle.

2. The cases against free trade

   • An export tax that completely prohibits exports leaves a country worse off, but an export tax rate may exist that maximizes national welfare trough the terms of trade.
     • Ignores the likelihood that other countries may retaliate against large countries by enacting their own trade restrictions
       • A tariff rate that completely prohibits imports leaves a country worse off, but tariff rate tO may exist that maximizes national welfare: an optimum tariff.
         • A second argument against free trade is that domestic market failures may exist that cause free trade to be a suboptimal policy.
           • The domestic market failure argument against free trade is an example of a more general argument called the theory of the second best.
             • Government intervention that distorts market incentives in one market may increase national welfare by offsetting the consequences of market failures elsewhere.

3. Types of market failures

   • 1. Persistently high underemployment of workers 2. Persistently high underutilization of structures, equipment and other forms of capital. 3. Property rights not well defined or well enforced 4. Economists calculate the marginal social benefit to represent the additional benefit to society from private reduction. 5. When tariff increases domestic production, the benefit to domestic society will increase due
     • Economists calculate the marginal social benefit to represent the additional benefit to society from private production.
       • It’s possible that when a tariff increases domestic production, the benefit to domestic society will increase due to a market failure.

4. International negotiations of trade policy

   • After rising sharply at the beginning of the 30s, the average of the US tariff rate has decreased substantially from the mid-30s to 1998
     • Multilateral negotiations mobilize exporters to support free trade if they believe export markets will expand.
       • Also help avoid trade war between countries. Result if each country has an initiative to adopt protection, regardless of what other countries do.

5. Preferential trading agreements

   • Are trades agreements between countries in which they lowest tariffs for each other but not for the rest of the world.
     • Free trade area
     • Customs union
   • Preferential trading agreements increase national welfare when new trade is created, but not when existing trade from the outside world is diverted to trade with member countries.
     • Trade creation
       • Occurs when high cost domestic production is replaced by low cost imports from other countries.
     • Trade diversion
       • Occurs when low cost imports from nonmembers are diverted to high cost imports from member nations.

6. World trade organization negotiation address trade restrictions in at least 3 ways

   • 1. Reducing tariff rates through multilateral negotiations 2. Binding tariffs rates 3. Eliminating non tariff barriers
     • WTD is based in a number of agreements: • General Agreement on Tariffs and Trade • General Agreement on Tariffs and Services • Agreement on Trade-Related Aspects • The dispute settlement procedure • The GATT multilateral organization in the Uruguay Round