Trade Policy & Intervention: Trade Policy & Intervention ECON 758 Advanced International Economics Dr. Jeffery Heinrich


Module 5B: Agenda: Module 5B: Agenda Revisit the wins and losses from trade – consider the ideas of consumer and producer surplus. Describe the various tools of trade protection and promotion. Analyze the economic and welfare impact of trade policies. Contrast the impacts of different tools of trade protection.


Mercantilism, Revisited: Mercantilism, Revisited Mercantilism Past (Pre-19th C.) National welfare thought to depend on gold holdings. Imports bad (gold out); Exports good (gold in) Mercantilism Present: contemporary “gold” = jobs! Trade viewed as zero-sum game  exporter’s gain is importer’s loss. Adam Smith & Wealth of Nations (1776) Imports cheaper than domestic substitutes  imports increase consumption Exports generate income to pay for imports Trade is win-win situation! Hume: More gold = higher prices, not more wealth.


Gains from Trade, Revisited: Consumer and Producer Surplus: Gains from Trade, Revisited: Consumer and Producer Surplus Consumer Surplus (CS) “Demand” = Marginal Benefit (MB) MB – price = net benefit  CS! Total CS = area between Demand and Price (area a) Price Changes let price fall p1 to p2 CS : consume more units (Q2 > Q1) at a lower price. Total CS  = area b Price changes and CS? Imports  effect on CS? Exports  effect on CS?


Producer Surplus: Producer Surplus Selling Price = gross benefit Supply = marginal cost unit Producer Surplus (PS) = price less cost Total PS = area below price & above supply (at p1, PS = area c) Price Changes price falls  sell less at a lower price  total PS falls! price rises ~ PS? Imports, Exports and PS? (Opposite of CS!)


Winners and Losers from Trade: Winners and Losers from Trade PA = autarky (pre-trade) price Imports: PM = import price Quantity of imports = Q2 – Q1 PS  by area c; CS  by areas c + d Net national gain area d, but losses to producers! Exports: PX = export price Quantity of exports = Q2 – Q1 Changes in PS, CS? Net gains? Who loses? Winners favor free trade; Losers favor trade protection.


Trade Equilibrium: Trade Equilibrium Domestic Qty Demanded > Domestic Qty Supplied; difference = Import Demand (MD) Domestic Qty Supplied > Domestic Qty Demanded; difference = Export Supply (XS) Trade Equilibrium: Country 1 MD = Country 2 XS Country 2 Country 1


Tariffs: Tariffs Tariff = tax on imports ad valorem: percent of value (e.g., 4% tariff) specific: fixed tariff (e.g., 40¢ per unit) Economic Impact: Tariff-inclusive domestic price   Domestic qty supplied  & Domestic qty demanded   Quantity imports falls to QT Exporter exports fewer units  export price falls from PW to PT*. Distributional/Welfare Impact: PS  by a; government gains revenue c+e; CS  by a+b+c+d welfare transfer from consumers to producers and government Net Welfare change + e – b – d e is terms of trade gain for importer; b & d are dead-weight loss


Effective Rate of Protection (ERP): Effective Rate of Protection (ERP) Multiple stages of production, only some done domestically  tariff on imported inputs can hurt domestic producers! ERP = % change in domestic value added from a given tariff structure, compared to free-trade prices. Example: 1 output using 1 imported input, facing world prices for both PWout = $10, PWin = $5. Under free trade, dom. value added = $5 20% tariff on output: Pout* = $12  dom. value added = $7  ERP? 20% tariff on input: Pin* = $6  dom. value added = $4  ERP? Gives rise to cascading tariff structures  tariffs are higher on later stages of production. ERPs often higher than nominal tariffs!


Tariffs, concl.: Tariffs, concl. Tariffs increase domestic price of both foreign and domestic goods! Terms-of-trade gain: force exporter to lower tariff-exclusive price of import. Small country faces perfectly elastic export supply curve  no ability to influence terms of trade. Foreign retaliation: force you to lower your export price, remove terms of trade gain, even lower volume of trade. Deadweight Loss: inefficiently high domestic production, inefficiently small consumption. Overall loss to country imposing tariff likely (b+d > e) Nominal tariff rates may misstate effective rate of protection.


Quotas: Quotas Quota is a set maximum on imports in volume or value terms. Similarities to tariff that results in same level of imports: increase domestic sale price and production; reduce consumption. transfer from consumer to producer. Quotas do not generate any tariff revenue! Instead, areas c + e are quota rent  domestic sale price in excess of cost of imports. Quota rent is pure profit. Quotas likely welfare inferior to tariff due to lost quota rent. wasted in costly lobbying for quota licenses. given to foreign governments.


Quotas – additional considerations: Quotas – additional considerations Suppose domestic demand increases: tariff: imports increase, no change in price. quota: domestic price increases, no change in imports Quotas reduce price competition. foreign firms cannot increase sales by lowering price, so don’t compete on basis of price  domestic firms end up with more market power. reduced economies of scale Voluntary Export Restraints (VERs) often at request of importing country rents definitely go to foreigners more politically expedient than formal barriers to trade Quotas and/or VERs common in textiles, iron/steel, autos, agriculture


Export Subsidies: Export Subsidies per-unit payment to exporter Economic impact increase exports increase domestic price (PW to PS); lower foreign sale price (PW to PS*) Distributional Impact PS ; CS ; government expenditure! gain to producer > loss to consumer, but by less than cost of subsidy! Overall Impact deadweight loss = b + d terms of trade deterioration/loss = e + f + g EU CAP – price supports and subsidized exports lower world prices, increase European prices


Other Barriers to Trade: Other Barriers to Trade Anti-Dumping and Countervailing Duties in response to foreign firms “unfairly” selling goods in the U.S. at “less than fair value.” Countervailing duty meant to offset foreign subsidies. Dumping: 1) selling in U.S. at price lower than in home market, or 2) at price below cost. system biased in favor of finding of unfair pricing Restrictions on Services aircraft landing rights; sea transport restrictions; insurance Domestic Content Provisions particularly important in Preferential Trade Areas, e.g., NAFTA


Other Barriers to Trade, cont.: Other Barriers to Trade, cont. Government Procurement Policies Administrative Classification Health and Safety Standards European Border Taxes and U.S. Offshore Sales Corporations Social Policies Performance Requirements (typically applying to foreign direct investment)