Global Trade:6

Global Trade: LessonsLessons Topics

Lesson 1The World Economy and Global Trade: An Overview and Stylized Facts on Global Trade

Lesson 2Theories of International Trade-I: The Ricardian Model: Labor Productivity and Comparative Advantage:

Lesson 3Theories of International Trade-II:The Heckscher-Ohlin Model: Factor Endowments and Comparative Advantage

Lesson 4Theories of International Trade-III:The Standard Trade Model and Gains from TradeCombination of Labor Productivity and Factor Endowments

Lesson 5Policy Instruments of International Trade: Tariffs, Export Subsidies, Import Quotas, Export Restraints

Lesson 6Policy Issues of International Trade: 1) Free Trade vs. Protectionism2) Liberalization in Developing Countries3) The Role of the World Trade Organization

TextsMain Text: Required:

1. International Economics: Theory & Policy, Krugman, P.R., and Obstfeld, M., 8th Edition, Pearson-Addison-Wesley.

Recommended:2. International Economics, Husted, S., and Melvin, M., 8th Edition, Addison-

Wesley.

3. International Economics, Gerber, J., 5th Edition, Addison-Wesley.

4. World Trade and Payments: An Introduction, Caves, R.E., Frankel, J.A., and Jones, R.W., 10th Edition, Pearson-Addison-Wesley.

5. The World Economy: International Trade, Yarbrough, B.V., and Yarbrough, R.M., 7th Edition, Thomson-South-Western.

6. Principles of Microeconomics, Only Chapter 3: Interdependence and the Gains from Trade, Mankiw, N.G., 5th Ed., South-Western Cengage Learning.

Lesson 6 Lesson 6: Trade Policy IssuesProcedure: The PowerPoint PresentationDuration: 60 minutes

OverviewThis lesson discusses different policy issues of

international trade: free trade vs. protectionism, trade liberalization in the developing world, the effects of international negations, and the role of the World Trade Organization in globalization.

Lesson 6 (cont.)Outline List of Class needs: the text, a computer, and a

notebook. Pre-class reading and preparation: Chapter 9 and 10 of

the text.Activities and timing: Go over the entire presentation

in 60 minutes and think about the main findings of the lesson. Read any latest online discussion on global trade. See the links as mentioned above for the latest data and discussion.

Identification of Learning Objectives: Objective #6 from Section I

Lesson 6 (cont.)Identification of the Global Workforce Skills for the

lesson: Skill points 1, 2, and 4 in Section II

Lesson notes and suggestions for Instructors: Read the relevant chapters in the recommended texts and look for online data for the latest figures of global trade.

Acknowledgment: The Course Developer took help of different sources as referred while preparing the study materials. When a considerable number of diagrams have been developed to enhance interest in the subject, many diagrams come from the required text for the convenience of the students.

Policy Issues of global tradeGlobal trade cannot be judged only on the basis of

theories and analyses. Government policies reflect objectives that go beyond simple measures of cost and benefit. Hence, we observe a number of debates on the policies of global trade. The following are the main topics:

Free trade vs. protectionismLiberalization in the developing worldThe role of the World Trade Organization (WTO)

Free tradeFree trade means there will be no

restrictions on either exports or imports in the form of

Tariffs SubsidiesQuotasRestrictions

Cases for free tradeThe first case for free trade is the argument that

producers and consumers allocate resources most efficiently when governments do not distort market prices through trade policy.

National welfare of a small country is highest with free trade. With restricted trade, consumers pay higher prices.

With restricted trade, distorted prices cause overproduction either by existing firms producing more or by more firms entering the industry.

Cases for free trade (cont.)The efficiency argument for free trade suggests that a trade restriction, such as a tariff, leads to production and consumption distortions.

Cases for free trade (cont.)When quotas are used instead of tariffs, costs

can be magnified through rent seeking.

To seek quota licenses or the rights to sell a restricted number of imports and the profit that they will earn, individuals or institutions need to spend time and other resources.

Thus, another reason why trade allocates resources efficiently is that it avoids the loss of resources through rent seeking.

Cases for free trade (cont.)A second argument for free trade is that it

allows firms or industry to take advantage of economies of scale.

A third argument for free trade is that it provides competition and opportunities for innovation.

These are dynamic benefits, unlike the static benefits of eliminating the efficiency losses caused by distorted prices and overproduction.

Cases for free trade (cont.)A fourth argument, called 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.

Any policy that deviates from free trade would be quickly manipulated by political groups, leading to decreased national welfare.

Cases against free trade For a “large” country, a tariff or quota lowers

the price of imports in world markets and generates a terms of trade gain.

This benefit may exceed the losses caused by distortions in production and consumption.

In fact, a small tariff will lead to an increase in national welfare for a large country.

But at some tariff rate, the national welfare will begin to decrease as the economic efficiency loss exceeds the terms of trade gain.

Cases against free trade (cont.) The Optimum Tariff

For a large country, there is an optimum tariff to at which the marginal gain from improved terms of trade just equals the marginal efficiency loss form production and consumption distortions.

Cases against free trade (cont.)A tariff rate that completely prohibits imports

leaves a country worse off, but tariff rate t0 may exist that maximizes national welfare: an optimum tariff.

An export tax (a negative export subsidy) that completely prohibits exports leaves a country worse off, but an export tax rate may exist that maximizes national welfare through the terms of trade.

Cases against free trade (cont.)An export subsidy lowers the terms of trade for

a large country; an export tax raises the terms of trade for a large country.

An export tax may raise the price of exports in the world market, increasing the terms of trade.

A second argument against free trade is that domestic market failures may exist that cause free trade to be a suboptimal policy.

Cases against free trade (cont.)Types of market failures include:Persistently high under-employment of workers◦ surpluses that are not eliminated in the market for

labor because wages do not adjust

Persistently high under-utilization of structures, equipment and other forms of capital ◦ surpluses that are not eliminated in the market for

capital because prices do not adjust

Cases against free trade (cont.)Types of market failures include (cont.):Technological benefits for society discovered

through private production, but from which private firms can not fully profit

Environmental costs for society caused by private production, but for which private firms do not fully pay. Property rights that are not well defined or well enforced

Sellers that are not well informed about the (opportunity) cost of production or buyers that are not well informed about value from consumption

Cases against free trade (cont.)Economists calculate the marginal social

benefit to represent the additional benefit to society from private production.

With a market failure, marginal social benefit is not accurately measured by the producer surplus of private firms, so that economic efficiency loss calculations are misleading.

It is possible that when a tariff increases domestic production, the benefit to domestic society will increase due to a market failure.

Cases against free trade (cont.)

The Domestic Market Failure Argument for a Tariff suggests that if production of a good yields extra social benefits (measured in panel (b) by area (c) not captured as producer surplus), a tariff can increase welfare.

Cases against free trade (cont.)The domestic market failure argument against

free trade is an example of a more general argument called the theory of the second best.

This theory states that government intervention which distorts market incentives in one market may increase national welfare by offsetting the consequences of market failures elsewhere.

DecisionNow it’s your turn to decide between free

trade and protectionism

Trade liberalization in developing economiesThere is some evidence that low and middle

income countries which had relatively free trade had higher average economic growth than those that followed import substituting industrialization.

But this claim is a matter of debate.Regardless, by the mid-1980s many governments

had lost faith in import substituting industrialization and began to liberalize trade.

Trade liberalization (cont.)Effective Rates of Protection for Manufacturing in

India and Brazil

Effective rates of protection for manufacturing in India have decreased by 68 percent between the late 1980s and 1990s. They dropped by 75 percent in Brazil over the same period of time.

Trade liberalization (cont.) The Growth of Developing-Country Trade

Trade liberalization after 1985 led to a surge in both imports and exports as a percentage of GDP in the developing world.

Trade liberalization (cont.)As with import substituting industrialization,

economic development was the ultimate goal of trade liberalization.

Has trade liberalization promoted development?The evidence is mixed.Growth rates in Brazil and other Latin American

countries have been slower since trade liberalization than they were during import substituting industrialization,

Trade liberalization (cont.)But unstable macroeconomic policies and financial

crises contributed to slower growth since the 1980s.

Other countries like India have grown rapidly since liberalizing trade in the 1980s, but it is unclear to what degree liberalized trade contributed to growth.

Some economists also argue that trade liberalization has contributed to income inequality, as the Hechscher-Ohlin model predicts.

Trade liberalization (cont.)Instead of import substituting industrialization,

several countries in East Asia adopted trade policies that promoted exports in targeted industries.

Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia, and China are countries that have experienced rapid growth in various export sectors and rapid economic growth in general.

These economies or a subset of them are sometimes called “high performance Asian economies.”

International negotiations of trade policyThe average U.S. tariff rate on dutiable imports

has decreased substantially from 1920–1993.Since 1944, much of the reduction in tariffs and

other trade restrictions came about through international negotiations.

The General Agreement of Tariffs and Trade (GATT) was begun in 1947 as a provisional international agreement and was replaced by a more formal international institution called the World Trade Organization (WTO) in 1995.

http://www.wto.org/ Further discussion on the WTO follows

International negotiations of trade policy (cont.) The U.S. Tariff Rate: An Example

After rising sharply at the beginning of the 1930s, the average tariff rate of the U.S. has steadily declined.

International negotiations of trade policy (cont.)Multilateral negotiations mobilize exporters to

support free trade if they believe export markets will expand.

This support would be lacking in a unilateral push for free trade.

This support counteracts the support for restricted trade by import-competing groups.

Multilateral negotiations also help avoid a trade war between countries.

World Trade Organization The WTO negotiations addresses trade

restrictions in at least 3 ways:

1. Reduction of tariff rates through multilateral negotiations.

2. Binding: a tariff is “bound” by having the imposing country agree not to raise it in the future.

3. Prevention of non-tariff barriers: quotas and export subsidies are changed to tariffs because the costs of tariff protection are more apparent.

World Trade Organization (cont.)The World Trade Organization was founded in

1995 on a number of agreements:

◦General Agreement on Tariffs and Trade: covers trade in goods

◦General Agreement on Tariffs and Services: covers trade in services (ex., insurance, consulting, legal services, banking).

◦Agreement on Trade-Related Aspects of Intellectual Property: covers international property rights (ex., patents and copyrights).

World Trade Organization (cont.)The World Trade Organization was founded in

1995 on a number of agreements (cont.):

◦The dispute settlement procedure: a formal procedure where countries in a trade dispute can bring their case to a panel of WTO experts to rule upon.

◦The cases are settled fairly quickly: even with appeals the procedure is not supposed to last more than 15 months.

World Trade Organization (cont.)The World Trade Organization was founded in

1995 on a number of agreements (cont.):

◦The panel uses previous agreements by member countries to decide which ones are breaking their agreements.

◦A country that refuses to adhere to the panel’s decision may be punished by allowing other countries to impose trade restrictions on its exports.

World Trade Organization (cont.)The GATT/WTO multilateral negotiations,

ratified in 1994 (called the Uruguay Round),

◦agreed that all quantitative restrictions (ex., quotas) on trade in textiles and clothing as previously specified in the Multi-Fiber Agreement were to be eliminated by 2005.

But as the restrictions were eliminated, China had to re-impose quotas until 2011 due to political pressure.

World Trade Organization (cont.)In 2001, a new round of negotiations was

started in Doha, Qatar, but these negotiations have failed to produce an agreement.

Most of the remaining forms of protection are in agriculture, textiles and clothing—industries that are politically active.

Summary pointsTrade policy issuesArguments favoring and opposing free

tradeTrade liberalization in the developing

worldEffects of international trade negotiationsWorld Trade Organization

Activity/Essay

1. After examining the arguments for and against free trade, it’s your turn to decide. Write an essay on free trade justifying your opinion.

Activity/Essay

Do you think whether developing countries should liberalize. Explain your opinion.

Comment critically on the role of the World Trade Organization (WTO).

Suggest what should the WTO do to improve the trade balance of developing/developed countries?