Economia Internazionale
Trade Policy
Luca De Benedicts
Università 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, P
Price, P
Quantity, Q D MD
S
PA A
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
Price, P Price, P XS
Quantity, Q S*2 – D*2 Quantity, Q S*2
D*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
b P1
P2
D Price, P
Quantity Q Q2
Q1
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, Q Q2
Q1
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
MD
D* S*
D S
PW
2
QT 1
QW
Effects of a tariff: large country
P*T
3 t
Quantity, Q
Price, P
Market in A World market Market in B
Price, P Price, 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 D2 S2
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
Price, P S
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, P
Price, P
Quantity, Q D MD
S
P2
P1
S2 D2 D2 – S2
2
S1 D1 D1 – S1
1
Tariff: small country
x
s
Net welfare effect of a tariff
PT
PW b d
D
= efficiency loss (b + d)
= terms of trade benefit (e)
Import Price, P S
Quantity, Q The tariff necessarily reduces welfare in the importer
country
Average tariff level on manufacturing (1995)
(percentage)
Exporter region
Importer 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 S t D t D f
1 - Why do countries protect themselves?
- terms of trade - optimal tariff
- political economy
2 - Who wins and who looses
1
Aggregate welfare
Tariff Optimal
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 Theory
Game 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 game
It 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
a 1
a2
Player B
P la y e r A
Game in strategic form
Game in strategic form
11 , 7
10 , 12
8 , 10
6 , 13
b1 b2
a 1
a2
a1 is dominant b2 is dominant
Player B
P la y e r 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
a 1
a2
Dominant strategy
The prisoner’s dilemma
(a1; b1) = Free trade (a2; b2) = protectionism
P la y e r A
Player 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 negotiations
Governments 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, Switzerland Established: 1 January 1995
Created by: Uruguay Round negotiations (1986-94) Membership: 149 countries (on 11 December 2005) Budget: 175 million Swiss francs for 2006
Secretariat staff: 635
Head: 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 equally
Under 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 Regionalism
Preferential 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.
