Economia Internazionale

Trade Policy

Luca De BenedictsUniversità di Macerata

debene@unimc.it

The effects of barriers to international trade

(partial equilibrium)

Which barriers?

• tariffs

• non-tariff barriers

• new instruments for protection

Quantity, Q

Price, PPrice, P

Quantity, Q

MDD

S

APA

P2

P1

S2 D2 D2 – S2

2

S1 D1 D1 – S1

1

Derivation of the import demand curve in A

P2

P*A

D*

S*

P1

XSPrice, P Price, P

Quantity, Q Quantity, QS*2 – D*2S*2D*2 D*1 S*1 S*1 – D*1

Derivation of the export supply curve in B

XS

Price, P

Quantity, Q

MD

PW

QW

1

World Equilibrium

Useful definitions:

• The terms of trade is the relative price of the export good expressed in terms of the price of the import good

• A small country is a country which is not able to modify its terms of trade, independently from how much it trades with the rest of the world

• The effect of a tariff is different depending on the case we are considering: – a small country trading with the rest of the world– two large countries

Consumer’s surplus

• It measures the benefit for the consumer from buying a good. It is the measure of the difference between the price that it is actually paid and the price she would accpt to pay for it.

• Graphically, it is given by the area under the demand curve above the price

• Example: assume that an individual is willing to pay 20€ for each unit of a given good, but that the good’s price is only 5€. The consumer’s surplus (that derives from buiyng the good) is given by 15€.

Geometry of consumer’s surplus

a

bP1

P2

D

Price, P

Quantity Q

Q2Q1

Producer’s surplus

• It measures the benefit for the producers. It is given by the difference between the actual selling price and the price the producer would accept to sell her product.

• Graphically, it is equal to the area above the supply curve and below the selling price.

• Example: assume that the produce is willing to sell her good at the price of 2€. If she receives 5€, the producer’s surplus is equal to 3€.

d

c

P2

P1

S

Price, P

Quantity, QQ2Q1

Geometry of producer’s surplus

– Assume that the country is large

– Assume that A imposes a tariff of 2€/Kg on imported wheat

– For exporters in B it will be not convenient to export in A unless the difference between the price in the two markets is not larger than 2$.

Effects of a tariff: large country

XS

PT

MDD*

S*

D

S

PW

2

QT

1

QW

Effects of a tariff: large country

P*T

3t

Quantity, Q

Price, P

Market in A World market Market in B

Price, PPrice, P

Quantity, Q Quantity, Q

– Without tariffs, the world price of wheat (Pw) is equalized across countries.

– With the tariff, the price of wheat increase to PT in A and decreases to P*T (PT – t ) in B, i.e. until the difference is equal to t.

• In A: as a consequence of the change in the price, producers offer more and the consumers demand less. Thus, import demand decreases

• In B: as a consequence of reduction in the price , producers offer less and consumers demand more. Thus, the export supply decreases.

– After the introduction of a tariff, the volume of international trade in wheat decreases.

– The increase in the domestic price in A is smaller than the tariff because the tariff also implies a reduction in the export price from B

Effects of a tariff: large country

• A tariff increases the price of a good in the importing country and decreases it in the exporting country.

• Following these changes in the prices:– Consumers’ welfare decreases in the importing country and

increases in the exporting country– Producers’ welfare increases in the importing country and

decreases in the exporting country– The government of the importing country receives the tariff

revenues

• We now measure this costs and benefits

Effects of a tariff: large country

Costs and benefits for the importer country

PT

PW

P*T

b c d

e

D

a

= consumer loss (a + b + c + d)

= producer benefit (a)

= government revenues (c + e)

QT

D2S2

S

S1 D1

Price, P

Quantity, Q

•The areas of triangulars b and d mesuare the aggregate country loss (efficiency loss) while the rectangular measure benefits due to the change in the terms of trade

•The efficiency loss emerges because the tariff affect both consumption and production incentives.- Producers and consumers behave as if imports were more

expensive than they actually are- The triangular b represents the distortion in production and triangular d represents distortion in consumption

•The benefit due to change in the terms of trade is due to the fact that the tariff reduces the price of (foreign) export.

Cost and benefits of a tariff

Net effect of a tariff

PT

PW

P*T

b d

e

D

Import

SPrice, P

Quantity, Q

= efficiency loss (b + d)

= terms of trade benefit (e)

If the benefit due to the change in the terms of trade is larger than the efficiency loss, the tariff increases the welfare in the import country.

– Assume that the country is small

– Assume that A imposes a tariff of 2€/Kg on imported wheat

– For exporters in B it will be not convenient to export in A unless the difference between the price in the two markets is not larger than 2$.

Effects of a tariff: small country

Quantity, Q

Price, PPrice, P

Quantity, Q

MDD

S

P2

P1

S2 D2 D2 – S2

2

S1 D1 D1 – S1

1

Tariff: small country

xs

Net welfare effect of a tariff

PT

PWb d

D

= efficiency loss (b + d)

= terms of trade benefit (e)

Import

SPrice, P

Quantity, Q

The tariff necessarily reduces welfare in the importer country

Average tariff level on manufacturing (1995)(percentage)

Exporter regionImporter region

Industrialized countries LDCs countries

Industrialized countries 0.8 10.9

LDCs countries 3.4 12.8

World 1.5 11.5

1. LDCs are on average more protectionist than industrialized countries

2. Industrialized countries are highly protectionist in the textile and agricultural sectors (in which LDCs have comparative advantage)

3. Increase in the use and importance of non-tariff barriers

• Resume of previous lessons• International trade as production• Efficiency• Effects of tariff protection

• Free trade and protectionsm • Terms of trade, otpimal tariff and political

economy • Who wins and who loose

• Why do we need international institutions?• Games theory

Arguments in favor of free trade

• Efficiency/Consumption• Economies of scale• Competition• Political consideration

D

S

P w

P t

Inefficiency: consumption

Inefficiency: production

Price

Quantity

Efficiency of free international exchange

S f D fS t D t

1 - Why do countries protect themselves?

- terms of trade- optimal tariff- political economy

2 - Who wins and who looses

1

Aggregate welfare

TariffOptimal tariff, to

Prohibitive tariff, tp

Terms of trade and optimal tariff

Optimal tariff

– The tariff that maximizes aggregate welfare

– It is always positive, but it is smaller than the prohibitive tariff, i.e. the tariff level for which there is no import

– It is zero in the case of a small country, i.e. a country that cannot modify the terms of trade

Terms of trade and export

– Which policy implication for the exporting sectors derives from arguments based on the terms of trade?

– An export subsidy implies a deterioration of the terms of trade Thus, it surely decreases aggregate welfare.

– The optimal policy for the exporting sectors is a negative subsidy, i.e. an export tax

– As for the optimal tariff, also the export tax it is always positive but smaller than the prohibitive tax, i.e. the level of the tax that would eliminate any export.

Political economy and aggregate welfare

• Do policy makers maximize aggregate welfare?

• Very often, trade policies are dictated by distributions concerns: Stolper-Samuelson theorem

• Government decision may capture individual preferences to a very different extend depending on the issues

• It would be useful to consider models in which governments maximize their own political success:– median voter – collective action– lobby activity

• Electoral competition: political scientists say that policies are the result of competition between parties that try to capture the majority of votes

– Assumptions of the model:• there are two political parties that compete • the objective of each is to elect its own representative• each party has to decide the level of the tariff to impose

(this is assumed to be the only policy that it is possible to implement)

• voters do have preferences concerning trade policies and these preferences are differentiated across individuals

– Which policies will the two parties promise to implement?

• the two parties will promise the same policy. This is the one that impose the tariff level that it is preferred by the median voter, i.e. the voter that lies at the median of a distribution of individual voter preferences

Political economy and income distribution

Median voter

Voters

Preferred tariff

Median voter

tM

tB

tA

Political support

Political economy and income distribution

Median voter

– Political activity is a public good (i.e. non-excludable,

– For instance, consider a tariff that protects all firms belonging to a specific sector from foreign competition. The cost of the lobby activity has been paid by a sub-group of firms but the benefit goes to all of them.

Predictions– Trade policies causing large losses that are

distributed between a large number of consumers or firms are nonetheless implemented

– Well organized sectors (or sectors characterized by a small number of firms) obtain protection.

Political economy and income distribution

Collective action

• Interest group and lobbies• Who is protected in OECD countries?

Two sectors are mostly protected in US and EU• Agriculture

– Farmers are few and very well organized. In US, the structure of the government strengthen their political influence

• Textile and apparel– Both sectors are highly protected. These

sectors are characterized by low skilled workers and a large presence of labor unions

Political economy and income distribution

Lobbying

Protectionism may end up in a commercial war

Loosers• consumers• not well-organized lobby groups• small countries• mono-specialized producers

How to manage the ‘latent’ conflict? - Insights from Game Theory

Game TheoryGame theory is the mathematical apparatus used to study conflict and cooperative situations with rational and strategic agents.

•Rational: each agent maximizes her expected utility•Strategic: each agents knows that she has to interact with other rational and strategic agents

Characteristic feature of game theory is strategic interaction

Non-cooperative gameIt is not possible to make an ex-ante agreement because it does not exist a mechanism that can enforce that contract.

11 , 7

10 , 12

8 , 10

6 , 12

b1 b2

a1

a2

Player BPla

yer

A

Game in strategic form

Game in strategic form

11 , 7

10 , 12

8 , 10

6 , 13

b1 b2

a1

a2

a1 is dominant

b2 is dominant

Player BPla

yer

A

The dilemma

The Prisoner’s dilemma is the most famous non-cooperative non-zero sum game

It represent the opposite of the Walrasian scheme

The game is characterized by:– a Nash-equilibrium which is Pareto sub-optimal– the realization of the lowest possible

aggregate collective benefit

-1, -1

0, -6

-6, 0

-5, -5

b1 b2

a1

a2

Dominant strategy

The prisoner’s dilemma

(a1; b1) = Free trade (a2; b2) = protectionism

Pla

yer

APlayer B

How is the Prisoner’s dilemma solved?1. Tit for tat

2. Time

3. A third actor: it becomes a cooperative game

Tariffs in U.S.

The large trade liberalization after WWII has been obtained trough international negotiationsGovernments reciprocally agreed on reducing tariffs

Advantages of negotiations

Copaire libro E ’ più facile ridurre i dazi nell’ambito di un accordo reciproco piuttosto che su iniziativa unilaterale perchè:

– ciò consente di mobilitare gli esportatori come sostenitori del libero scambio– ciò vincola i governi nelle scelte di politica commerciale e riduce la probabilità di guerre commerciali

Why did tariffs decline?

Trade, distribution and growth

Distribution

Growth

• efficiency = equality ?

• sectors and factors which loose

• redistribution, welfare and short run

• weak empirical evidence

• the role of institutions

The governance of world trade: the WTO

- The coordinated reduction in tariffs dates back to the second half pf the 30s’ (after the Smoot-Hawley Act ).

- The multilateral reduction in tariffs after WWII has taken

places under the General Agreement on Trade and Tariffs (GATT) signed in 1947 in Ginevra.

- The GATT has evolved into the World Trade Organization (WTO)

- The WTO is a formal institution which includes a set of rules of behavior concerning trade policies

International trade agreements: historical notes

Since GATT’s creation in 1947–48 there have been eight rounds of trade negotiations. The Doha round is the ninth.

At first these focused on lowering tariffs on imported goods.

But by the 1980s, the negotiations had expanded to cover non-tariff barriers on goods, and to the new areas such as services and intellectual property.

GATT

– Dal 1947 ad oggi, hanno avuto luogo otto round negoziali

– i primi cinque hanno assunto la forma di negoziati bilaterali “paralleli” (per esempio, Germania con Francia e Italia).

– il sesto accordo commerciale multilaterale, noto come Kennedy Round, venne completato nel 1967:

• comportava una riduzione generalizzata del 50% di tutti i dazi vigenti da parte dei paesi industrializzati, eccezion fatta per alcuni specifici settori industriali in cui i dazi rimasero immutati

• complessivamente, il Kennedy Round comportò una riduzione media dei dazi del 35% circa.

GATT: trade rounds

– IlTokyo round (conclusosi nel 1979) comportò:

• la riduzione ulteriore dei dazi• nuovi codici per controllare la proliferazione di barriere non

tariffarie, quali ad esempio le VER.

– L’ ottavo round di negoziati, l’ Uruguay Round, si è concluso nel 1994.

– L’impatto economico dell’Uruguay Round è difficile da stimare (CGE).

• Le stime del GATT e dell’OCSE indicano un beneficio per l’economia mondiale quantificato in 200 miliardi di dollari all’anno, una volta che l’accordo sarà pienamente in vigore.

• Gli economisti tendono a ritenere troppo basse queste stime.

• I PVS sostengono di non aver tratto nessun beneficio.

– Con l’Uruguay round nasce il WTO

GATT: trade rounds

WTO: what is it?

The WTO describes itself as• an organization for liberalizing trade. • a forum for governments to negotiate trade agreements• a place for them to settle trade disputes

Location: Geneva, SwitzerlandEstablished: 1 January 1995Created by: Uruguay Round negotiations (1986-94)   Membership: 149 countries (on 11 December 2005)Budget: 175 million Swiss francs for 2006Secretariat staff: 635Head: Pascal Lamy (Director-General) Functions:• Administering WTO trade agreements• Forum for trade negotiations• Handling trade disputes• Monitoring national trade policies• Technical assistance and training for developing countries• Cooperation with other international organizations 

• Ministerial conferences

• General Council • Dispute Settlement Body • Trade Policy Review Body

• Councils – Council for Trade in Goods – Council for Trade in Services – Council for TRIPs

WTO: structure

WTO: structure

– The last and largest GATT round, was the Uruguay Round which lasted from 1986 to 1994 and led to the WTO’s creation.

– GATT was an agreement (and an un-official de facto organization), while WTO is an international organization

– Whereas GATT had mainly dealt with trade in goods, the WTO and its agreements now cover trade in services, and in traded inventions, creations and designs (intellectual property).

– Being a member of the WTO implies a set of “Rights and obligations” and it provides a place to settle disputes.

From GATT to WTO

Most-favoured-nation (MFN): treating other people equallyUnder the WTO agreements, countries cannot normally discriminate between their trading partners. Grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members.

Some exceptions are allowed. • Countries can set up a free trade agreement that applies only to goods traded within the group• Countries can give developing countries special access to their markets• A country can raise barriers against products that are considered to be traded unfairly from specific countries.

But the agreements only permit these exceptions under strict conditions.

WTO’s basic principles (1)Non-discrimination (sectoral and geographic)

National treatment: Treating foreigners and locals equally Imported and locally produced goods should be treated equally — at least after the foreign goods have entered the market. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents.

WTO’s basic principles (2)Non-discrimination (sectoral and geographic)

• Countries sign preferential trade agreements in which they negotiate the reciprocal reduction of tariffs , but not with respect to the rest of the world (ROW)

• The GATT-WTO “most favorite nation” (MFN) principle prohibits this type of agreements

• Preferential trade agreements are allowed only if it creates a free trade situation between member countries (art. XXIV, GATT).

WTO and RegionalismPreferential trade agreements

Two or more WTO member countries may negotiate different forms of free trade:

– Free trade area: it allows the free trade between member countries, but each member can have its own trade policy with respect to the ROW

• Example: il North American Free Trade Agreement (NAFTA)

– Custom union: it allows free trade between member countries and requires the adoption of a common trade policy with respect to the ROW

• Example: the European Union (EU)

– Common market : it is a custom union in which there is free movement of factors of production between the member countries.

Preferential trade agreements

Are preferential trade agreement beneficial?

It depends on which of the following two effect prevails:

Creation of trade flows

– It takes place when the creation of a trade agreement induce the substitution of high cost domestic production with low cost import from other member countries

Diversion of trade flows

– It takes place when the creation of a trade agreement produce the substitution of import from low cost third countries with higher cost member countries

Preferential trade agreements

Trattamento speciale e differenziato

Enabling Clause

E’ prevista maggiore flessibilità per i paesi a reddito più basso nell’uso di stumenti di protezione della produzione nazionale

Sono previste fasi di transizione più lunghe

WTO and LDCs

• The benefits from large scale negotiations may be reduced by the costs associated with the increasingly complicated decisional process

• If it is true that the steps forward have been slow, the negotial rounds have nonetheless avoided steps back

• L’accordo dell’Uruguay Round sull’agricoltura ha obbligato gli USA a posiz ag. trade reforms from the ‘86 and ‘90 farm bills,

and the EU 1992 CAP reforms.

WTO come vincolo

Problems and perspectives

• The “bigness” of the WTO

• Promises and results of the WTO: commitment

• Unilateral trade policies

• Capacità decisionale e consensus