Lecture 5 International trade policy

1 ECON 335 International Economy Lectures 5: International trade policy 2 GENERAL PLAN Protectionism  2 Trade Barriers: Tariffs, Subsidies and Quotas  3 Other trade policies 3

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ECON 335

International Economy

Lectures 5:

International trade policy

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GENERAL PLAN

Protectionism

 2 Trade Barriers: Tariffs,

Subsidies and Quotas

 3 Other trade policies

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The Case for Free Trade

We have demonstrated how free trade

benefits all trading countries1

case for free trade

price to the buyer is below that of the

domestically produced alternative

1 An exception : Large countries possess monopoly power

in international trade For them free trade is not Pareto

optimal (Brazil in coffee, Japan in automobiles,

Thailand and Vietnam maybe for rice, for instance)

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The Case for Protection

 Argumentscan also be madein favorof

tariffs and quotas

Common Arguments Against Free Trade:

1 Protection saves jobs

distribution (social gap)

practices

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4 Cheap foreign labor makes

competition unfair

security

industries

8 Protection provides protection during

government

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GENERAL PLAN

1 Free Trade Versus

Protectionism

Subsidies and Quotas

3 Other Trade Policies

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Economics of Tariffs

trade restriction

to pay a specified fraction of the price to

the government

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The Effect of a Tariff

D dom

S dom

Quantity

D dom & S dom show the domestic demand and supply for a good

P w

If the world price is P w , and there is free trade,

Q s

domestic firms supply Q s,

Q d

domestic demand is Q d

A tariff can stimulate domestic supply and restrict imports

P w + T

At a domestic price P w + T ,

where T is the size of the tariff,

Q s ' Q d '

quantity of domestic demand falls to Q d ', quantity of domestic supply rises to Q s '

and the difference is imported

and imports fall

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The government raises revenue – i.e there is a transfer to the government,

There is a social dead-weight cost from production inefficiency, given that the good could

be imported at P w

There is also dead-weight loss

from consumption inefficiency

and there is a transfer in the form of extra profits to producers

The Welfare Costs of a Tariff

D

S

Quantity

P w

P w + T

Q s ' Q d '

The tariff leads both to transfers and net social losses

Consumer surplus is decreased by the area between

P w +T, P w and D.

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The contracting spiral of world trade, January 1929 to

March 1933 (total imports of 75 countries in millions of U.S dollars)

Tariffs of countries in GATT/WTO

 1947: 37%

 1950-1970: 20 - 25%

 1970- 1990: 10 - 15%

 1990- 1995: 5 -10%

 After 1995: 0 - 5%

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The case for tariffs – good

arguments

significant share of the world market for

a commodity, a higher level of imports is

 Then an imposition of an import tariff could

lead to a welfare improvement for the

country, relative to free trade

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An Example of Optimal Tariff

economically large country (a large world

importer of a product L)

and after an import tariff is imposed by

country A

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International Free-trade Equilibrium

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Husted/Melvin, © 2001, Addison Wesley Longman, Inc All rights reserved.

Illustration of a Tariff for a Large Country

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Country

-$a -$b -$c -$d $a

$c +$e -$b -$d +$e

Net welfare change

Optimal tariff would max $e - $(b + d)

Rate of Protection

of Protection (low or high?)

percent tariffs paid by consumers on its

output

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Effective Rate of Protection

the percentage by which the entire set of a

nation’s trade barriers raises the industry’s value

added per unit of output

payments to the primary production factors in the

industry

the rent paid to landowners, and the profits and

other returns to the owners and providers of capital

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Illustrative of calculation of an ERP

Unit value

(Price) of

output

Pj = 200

With Free

Trade

With 10%

tariff on output, 5% tariff

on inputs

Unit Price

added

V = 60

Unit Price added V’ = 73

on output

Unit cost

of inputs

Pi = 140

Unit cost

of inputs

Pi = 147

147 140 5% tariff on inputs

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NRP vs ERP



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GENERAL PLAN

 4.1 Free Trade Versus

Protectionism

 4.2 Trade Barriers: Tariffs,

Subsidies and Quotas

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Other commercial policies

GATT and WTO, there has been a

proliferation of other trade restrictions

quotas

non-tariff barriers

• administrative regulations that discriminate

against foreign goods

export subsidies

Quotas

of imports, this does not mean they have

no effect on domestic prices of the

restricted goods

will be higher than under free trade So

quotas affect in a same way as tariffs!

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Welfare effects of a quota

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Export subsidies

 "commercial policy to boost exports"

Quantity

D dom

S dom

S w

S w + s P’

P

Q d ’ Q d Q s Q s ’

C

F Exports

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More of Non-Tariff Barriers

 delays at border

 quality control measures

 VIEs

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Voluntary Export Restraints

exporting country F agrees to the importing

to that country

forces them to take it, hence, shifts rent to F

(why?), and calls it “voluntary”

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VERs

third countries

industries having trouble competing against rising

tide of imports

suppliers since early 1960s

automobiles

(violate GATT)

VERs

started in 1981 by R Reagan

Canada (towards Japan, Korea, Central

and Eastern Europe on textiles and

clothing, ag products, steel, footwear,

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Voluntary Import Expansions

imports of a product over a specified period of

time

parts and automobiles between the two countries