Chapter 3

International Trade
Policies

1
 International Trade Policies

Outline…………
3.1 The Concept Of Free Trade
3.2 Trade Protection
3.2.1 Concept Of Meaning Of Protection
3.2.2 Method Of Protection
3.2.2.1 Import Tariff
3.2.2.2 Export Subsidy and Import Quota

2
 Introduction

 We have seen that free trade maximizes world output and

benefits all nations.

 However, practically all nations impose some restrictions on the

free flow of international trade.

 Since these restrictions and regulations deal with the nation’s trade
or commerce, they are generally known as trade or commercial
policies.

3
 Introduction
 Policy analysis in international trade theory generally emphasizes
the analysis of trade policies specifically.

 Trade policy includes any policy that directly affects the flow of
goods and services between countries, including import tariffs,
import quotas, voluntary export restraints, export taxes, export
subsidies, and so on.

 During the 1980s and 1990s, as trade barriers came down,

especially between developed countries, more and more attention
was brought to the effects of certain domestic policy types, including
their international effects.
 3.1 The Concept Of Free Trade
Free trade, also called laissez-faire, a
policy by which a government does not
discriminate against imports or interfere
with exports by applying tariffs (to
imports) or subsidies (to exports).
A free-trade policy does not
necessarily imply, however, that a
country abandons all control and
taxation of imports and exports.

5
 Free trade…....
 Free trade is the unrestricted importing and exporting of goods
and services between countries.

 The opposite of free trade is protectionism—a highly-restrictive

trade policy intended to eliminate competition from other
countries.

 Today, most industrialized nations take part in hybrid free trade

agreements (FTAs), negotiated multinational pacts which allow
for, but regulate tariffs, quotas, and other trade restrictions.
6
 Advantages of Free Trade
 It stimulates economic growth

 t helps consumers

 It increases foreign investment

 It reduces government spending

 It encourages technology transfer

7
 Disadvantages of Free Trade
 It causes job loss through outsourcing

 It encourages theft of intellectual property

 It allows for poor working conditions

 It can harm the environment

 It reduces revenues

8
3.2 Trade Protection

Have you ever heard of free trade and protection?

What do you understand about it?

 3.2.1 Concept Of Meaning Of Protection

Protection implies granting a protective cover to the home industries

against foreign competition either by imposing duties on the foreign
goods or by helping the domestic industries by giving subsidies and
making raw materials available at subsidized prices.

10
 Generally, protection of industries may involve:

i. Levying of import duties which may raise price of foreign goods

relative to domestic goods; or

ii. Fixing of quotas or posing of non-tariff restrictions, which make

the entry of cheap foreign goods difficult or impossible; or

iii. Granting of subsidies or reward to the domestic industries to

enable them to compete with cheap foreign goods.

11
 3.2.2 Method Of Protection

 Tariff refers to a tax or duty levied by the government of a

country on goods and services entering foreign trade.

 When a duty is imposed on a commodity at the time of its leaving

the national border, it is called 'export duty' and when it is levied
on the goods entering the national border, it is called 'import
duty'.

12
 There are four types of tariffs.

1. Specific Duty. It is a fixed sum of money imposed as a duty on a

commodity according to its weight or measurement (physical
dimensions) as Birr. X per unit or per meter or per liter, etc.

2. Ad valorem Duty. It is imposed as a percentage of the value of the

imported commodity.

 The value is inclusive of insurance plus freight charges, that is,

cost of the commodity plus insurance and freight charges,
represent the total value of a commodity on which, the duty is
charged. 13
 There are four types of tariffs.

3. Compound Duty. A combination of both specific and ad valorem

duties is a compound duty levied on a commodity.

4. Sliding Scale Duty. It is levied on the basis of the price of the

imported commodity rising and falling with an increase or
decrease in the price. It can be specific or ad valorem but mostly it
is specific.

14
 Meaning and Types of Quotas
 Quotas are a device under which limit is fixed in respect
of either the value or the quantity of a commodity that
may be imported or exported by a country during a
specified period of time, usually one year.
 The prime objective is the quick and effective regulation
of imports and exports.
 Export quotas may be used for
 Equitable distribution of scarce export,
 Regulation of exports of essential raw materials; or
 To execute international export agreements. 15
 Cont.………..
 Import quotas are often used to protect:
 Domestic industries from foreign competition;
 To correct a disequilibrium in the balance of
payments
 For commercial bargaining;
 To execute barter deals with different countries.

16
A country may use different types of quotas, which includes:

 Tariff Quotas: Under this system a country may allow the imports of
a specified quantity of a commodity either duty free or at a very
low duty.

 Beyond this limit a high rate of duty is charged.

 Unilateral Quotas: Under this a country may unilaterally fix a

quantity or value of a commodity either through legislation or by
decree that can be imported.

 It is global if a specific commodity can be imported from any

part of the world.
A country may use different types of quotas, which includes:

 Bilateral Quotas: When the quotas are fixed by mutual agreement

between the countries, it is known as bilateral quota system.

 Such a system works more smoothly than the unilateral

quota system.

 Mixing Quotas: When the domestic producers are made to use the
imported raw material in a fixed proportion with domestic raw
material in the production of a commodity and quotas for the
import of specified raw material are fixed on this basis the quotas
are called 'mixing quotas'.
 Meaning and types of Subsidies
 National governments sometimes grant subsidies to their producers
to help improve their trade position.
 By providing domestic firms a cost advantage, a subsidy allows
them to market their products at prices lower than warranted by
their actual cost or profit considerations.
 There two types of subsidies:
i. A domestic subsidy, which is sometimes granted to producers of
import-competing industries and
ii. An export subsidy, which goes to producers of goods that are to
be sold overseas.

19
Summary
In this chapter you learnt that:

 Protection implies granting a protective cover to the home industries

against foreign competition either by imposing duties on the foreign
goods or by helping the domestic industries by giving them subsidies
and making available raw materials subsidized prices.

 The policy of protection may comprise of a number of

measures like tariffs, import quotas, import restrictions,
expenditure control, subsidies, devaluation, etc.
 Which of these methods of protection would be in the interest
of a country and which one should be adopted will largely
depend upon the objectives in view.

20
Summary
In this chapter you learnt that:

 Tariffs and quotas are the two most import methods of

protection.
 They are the most widely used devices all over the world for
restricting foreign trade with the objective of protecting home
industries from foreign competition.
 The use of tariffs restricts trade in an indirect manner while the
use of quotas restricts trade directly.

21
 Chapter Four
Economic Integration and
Regional Trade
Organizations

22
 Economic Integration and Regional Trade
Organizations
Outline……….

4.1 Types of economic integration

4.2 Effects of regional trade arrangements
4.3 The Major Trade Agreements
4.4 Regional Trade Organizations (GATT, WTO…)

23
 Introduction

 Ethiopia as of today, is not a member of Regional Trading

Arrangement Free Trade Area Africa has done only a 10 percent
reduction of tariff for the goods coming from COMESA member
states to beware of fear of loss of public revenue as tariff
revenue is the most significant source of government revenue and
the potential damage to its weak infant industries and low degree
of domestic firms’ competitiveness. What Regional Trading
Arrangement mean?

 COMESA=Common Market for Eastern and Southern Africa 24

 The Common Market for Eastern
and Southern Africa (COMESA) is a
free trade area with twenty-one
member states stretching from
Tunisia to Eswatini.
 COMESA was formed in December
1994, replacing a Preferential
Trade Area which had existed
since 1981.

25
 4.1 Types of economic integration

 Economic integration is a process of eliminating restrictions on

international trade, payments and factor mobility.

 Economic integration thus results in the uniting of two or more

national economies in a regional trading arrangement.

 There are different degrees of economic integration (regional

trading arrangements).

 Below are the different types of economic integration.

26
 Types of economic integration.

1. Free- trade area. This is an association of trading nations whose

members agree to remove all tariff and non- tariff barriers among
themselves.

 Each member, however, maintains its own set of trade

restrictions against outsiders.

 An example of this stage of integration is the North American

Free Trade Agreement (NAFTA), consisting of Canada, Mexico
and the US.
27
2. Customs Union. A second stage in the process of economic
integration is the formation of customs union.
 Like a free trade association, a custom union is an agreement
among two or more trading partners to remove all tariff and
non- tariff trade barriers among themselves.
 In addition, however, each member nation imposes identical
trade restrictions against non participants.
 That is, each nation follows a common external trade policy.
 The effect of the common external trade policy is to permit
free trade within the customs union, while all trade restrictions
imposed against outsiders ( non- members) are equalized.
28
3. Common Market. A further stage in the process of economic
integration is a common market. A common market is a group of
trading nations that permits;

a. The free movements of goods and services among member nations

b. The initiation of common external trade restrictions against non

members and

c. The free movement of factors of production across national

borders within the economic bloc (group).
29
 The common market thus represents a more complete stage of
integration than a free-trade area or customs union. The European
Union (EU) achieved the status of a common market in 1992.

4. Economic Union: This represents an even further step in economic

integration than a common market.
 In addition to permitting free movement of goods, services and
factors of production, and following a common external trade
policy against non members, national, social, taxation and fiscal
policies are harmonized and administered by a supranational
institution in economic union. In other words, in addition to abolition
of existing trade barriers, economic union requires an agreement
to transfer economic sovereignty to a super natal authority. 30
5. Monetary Union: This represents the ultimate degree of economic
union and it requires the unification of national monetary policies
and the acceptance of a common currency administered by a
supranational monetary authority.

 The U.S. serves as an example of a monetary union.

 Fifty states are linked together in a complete monetary union with

a common currency, implying completely fixed exchange rates
among 50 states
31
 4.2 Effects of regional trade arrangements

 In this section, we will see the theoretical benefits and costs of

customs union from two perspectives: static and dynamic. First, let’s
see the static effects of economic integration (customs union) on
productive efficiency and consumer welfare.
 Customs Union is the major method to achieve a regional
economic integration.
 The most important characteristic of a customs union is the
complete elimination of tariffs between member countries.
 In the customs union, there is the implementation of a common
external tariff and common trade policies against the third
countries
32
Static effects of customs union
 There are two kinds of effects of customs unions, static and
dynamic.
 The static effects relate to the impact of the establishment of
the customs union on welfare.
 The formation of customs union leads to a welfare-
increasing trade- creation effect and a welfare-decreasing
trade-diversion effect.
 The overall effect of the customs union on the welfare of its
members, as well as on the world as a whole, depends on
the relative strength of these two opposing forces.

33
 Trade creation occurs when some domestic production of one
customs – union member is replaced by another member’s
lower- cost imports.
 The trade creation effect consists of a consumption effect
and a production effect.
 Trade diversion occurs when imports from a low cost supplier
outside the union are replaced by purchases from a higher
cost supplier within the union.
 Generally speaking, our static analysis concludes that the
formation of a customs union will increase the welfare of its
members, as well as the rest of the world, if the positive
trade- creation effect more than offsets the negative trade-
diversion effect.
 Dynamic effects of customs union
 However, not all welfare consequences of regional trading
arrangements are static in nature.
 There may also be dynamic gains that influence member-
nation growth rates over the long-run.
 These dynamic gains stem from the creation of larger
markets by the movement to freer trade under customs
unions.
 The benefits associated with a customs union’s dynamic gains
may more than offset any unfavorable static effects.
 The dynamic gains include economies of scale, greater
competition and a stimulus of investment.
35
35
 Summary………..

 Static effects
 Trade-creation effect
 Welfare gain
 Some domestic production of one customs-union member
 Replaced by another member’s lower-cost imports

 Consumption effect
 Production effect

36
36
Summary………..
 Static effects
 Trade-diversion effect
 Welfare loss
 Imports from a low-cost supplier outside the union
 Are replaced by purchases from a higher-cost supplier within the union

37
37
Summary………..
 Trade creation
 Occurs when the formation of a FTA or CU leads to a switching of
imports from a high-cost
 source to a low-cost source
 • Tends to improve welfare
 Trade diversion
 Occurs when imports switch from a low-cost source to a high-cost
source
 Tends to worsen welfare

38
Summary………..
 Dynamic effects
 Creation of larger markets
 By the move
 Dynamic gains
 Economies of scale
 Greater competition
 Stimulus of investment

39
39
 4.3 The Major Trade Agreements
Trade agreement

 An enforceable treaty between two or more

countries that involves the movement of goods and
services, elimination of trade barriers, establishment
of terms of trade, and encouragement of foreign
investment.

 Agreements may be multilateral (involving three or

more parties) or bilateral (involving two countries). 40
 Trade Agreements
Advantages of NAFTA Disadvantages of NAFTA
 Has helped create higher  Manufacturing jobs have
paying jobs in education, been lost to Mexico, where
engineering, and banking labour costs are lower
sectors in Canada
 Without tariffs, many
 Allows freer flow of goods
and services across North Mexican farmers could not
America, providing better compete and lost their
access to raw materials, livelihoods
talent, capital, and  Canadian companies sold to
technology
foreign investors
 Trade has tripled between
the three members since
NAFTA’s inception 41
Trade Agreements
The European Union (EU)
 A trade agreement signed in 1993 that now encompasses
twenty-seven countries in Europe and a population of
almost half a billion people. It has its own flag, anthem,
and currency, and common financial, security, and foreign
policies.

42
Trade Agreements

43
Trade Agreements

The euro
 The European currency unit adopted by the
European Union and used in most EU
countries.

44
Trade Agreements

Advantages of a
common currency
Decreased risk of exchange-
rate fluctuations
Price transparency
Disadvantages of a
common currency
Initial costs of implementation
Lack of national control

Elimination of transaction costs Loss of tradition

Increased markets

45
Trade Organizations

Trade organizations

 Groups established to help with the free flow of

goods and services.

 They may be global in scope or national

organizations created by individual governments to
help domestic companies expand into international
markets.
46
 4.4 Regional Trade Organizations
World Trade Organization (WTO)
 An international organization established in 1995
(which now has over 150 member countries) that
promotes trade liberalization throughout the world.

The main purposes of the WTO are:

 To act as a forum for negotiations

 To provide a set of rules that have been negotiated and
signed by the governments of member countries
 To offer a forum for dispute settlement
47
Trade Organizations

Asia-Pacific Economic Co-operation (APEC)

 A trade organization, created in 1989, that unites twenty-one

of the countries surrounding the Pacific Ocean to co-operate
on regional trade.

 Its goals are to foster open and free trade among its
members, increase prosperity and economic growth, and
develop the Asia-Pacific community.

48
Trade Organizations
The Group of Eight (G8)
 A trade organization encompassing the major economies of
the world, which meet to discuss macroeconomic issues such as
economic growth, trade liberalization, and helping
developing countries.

Member Countries:
 France  Italy
 United States  Germany
 Canada  Japan
 Great Britain  Russia

49
 Trade Organizations
The Group of Twenty (G20)
 A trade organization established during the economic crisis of
the 1990s to provide a discussion forum for the major
economies of the world beyond the G8.

The G20 focuses on:

 Economic and employment growth
 Elimination of trade barriers
 Reforming financial institutions and regulations
 Restructuring global financial organizations

50
 Trade Organizations

Organization for Economic Co-operation and

Development (OECD)
 A trade organization with thirty member countries, established in
1961 to promote the advancement of democracy and market
economies.

 OECD members have worked together to eliminate bribery,

money laundering, and fraud, and to create a code of conduct for
multinational companies.

51
 Trade Organizations
 General Agreement on Tariffs and Trade (GATT) was made in
the year 1947, that aimed at initiating an international trade, by
liberalizing policies and removing tariffs.
 It was succeeded by World Trade Organization (WTO), which is
a global organization, that encourages and facilitates inter-
country trade and also helps in resolving trade disputes.
The World Bank
 An organization with 186 member countries that provides
monetary and technical support for developing countries.

 Provides loans and grants to assist with education, health,

infrastructure, farming, environmental issues, resource
management, and other economic concerns. 52
Summary
In this chapter you learnt that:

 Economic integration, the process of eliminating restrictions on

international trade, payments, and factor input mobility, has several
stages including free-trade area, customs union, common market,
economic union, and monetary union.

 The static welfare effect of regional integration depends on the

magnitudes of the welfare increasing trade creation and the
welfare reducing trade diversion effects.

 The dynamic welfare effect of regional integration

is favorable, and it stems from greater competition,
economies of scale, and stimulus to investment
spending.. 53
 Chapter 5

Trade And Economic Growth And

Development

54
 Trade And Economic Growth And Development

OUTLINE…………..

5.1 International trade and economic growth

5.2 International trade and economic development

5.3 Trade Development Strategies

5.3.1 Import Substitution

5.3.2 Export Promotion

55
 Pre-test

 What kind of relationship do you think between international

trade and economic growth and development?

 Does international trade facilitate and foster economic growth and

development for nations particularly for developing countries?

56
Economic Growth Vs Economic Development
 Economic growth means an increase in real national income
/ national output.
 Economic development means an improvement in the quality
of life and living standards, e.g. measures of literacy, life-
expectancy and health care.

57
 5.1 International trade and economic growth

 Aside from trade based on technological gaps and product cycles

which is dynamic in nature, the trade theory discussed thus far is
completely static in nature.

 Given the nation’s factor endowments, technology, and tastes, we

proceeded to determine the nation’s comparative advantage and
the gain from trade.

 However, factor endowments change over time; technology usually

improves; and tastes may also change.

58
 As a result the nation’s comparative advantage also changes
over time.

 Therefore this section extends the trade model to incorporate

these changes.

59
 Growth of factors of production
 Through time, a nation’s population usually grows and with it the
size of its labor force.
 Similarly, by utilizing part of its resources to produce capital
equipment, the nation increases its stock of capital.
 Although there are many different types of labor and capital,
for simplicity we assume that all units of labor and capital are
homogenous and also assume that labor and capital are the only
factor of production.
 The assumption of constant returns to scale and the nation
produces only two commodities (commodity X which is labor
intensive and commodity Y, which is capital intensive) continue to
be considered.
60
 Labor growth and capital accumulation over time

 An increase in endowment of labor and capital over time causes

the nation’s production frontier to shift outward.
 The type and degree of the shift depends on the rate at which L
and k grow.
 If L and K grow at same rate, the nation’s production frontier will
shift out evenly in all directions at the rate of factor growth.
 As a result the slope of the old and new production frontiers will
be the same at any point where they are cut by the ray from the
origin. This is the case of balanced growth.

61
 Technical progress and the nation’s production
possibility curve

 Several empirical studies show that most of the increase in real

per capital income in industrial nations is due to technical
progress and much less to capital accumulation.
 However, the analysis of technical progress is much more
complex than the analysis of factor growth because there are
several definitions and types of technical progress, and they can
take place at different rates in the production of either or both
commodities.
 As in the case of factor growth, all types of technical progress
cause the nation’s production possibility curve to shift outward.
 The type and the degree of the shift depends on the type and
rate of technical progress in either or both commodities
62
 Technical progress and the nation’s production
possibility curve

 With the same rate of neutral technical progress in the production of

both commodities, the nation’s production possibility curve will shift out
evenly in all directions at the same rate at which technical progress
takes place.
 This has the same effect on the nation’s production possibility curve as
balanced factor growth.
 Thus, the slope of the nation’s new and old production possibility curve
will be the same at any point where they are cut by the ray from the
origin.
 finally it must be pointed out that, in the absence of trade, all types
of technical progress tends to increase the nation’s welfare.
63
 5.2 International trade and economic development
 In fact international trade may maximize welfare of developing
nations in the short term.
 However, these nations believe that this pattern of specialization and
trade leads them to a subordinate position with developed nations
and keeps them from reaping the dynamic benefits of industries and
from maximizing their welfare in the long-run.
 The dynamic benefits resulting from industrial production includes a
more trained labor force, more innovations, higher and more stable
prices for the nation’s exports, and higher income for citizens.
 Therefore all or most of these dynamic benefits accrue to developed
nations, leaving developed nations poor, undeveloped and
dependent.
64
 5.2 International trade and economic development
 This belief is reinforced by the observation that all developed nations
are primarily industrial while all developing nations are primarily
agricultural.
 Thus developing nations attack traditional trade theory as completely
static and irrelevant to the development process.
 As a result developing nations demand changes in the pattern of
trade and reform of the present international economic system to take
in to consideration their special development needs.
 Traditional trade theory can readily be extended to incorporate
changes in factor supplies, technology and tastes by the technique of
comparative statics.
65
 This may indicate that a nation’s pattern of development is not
determined once and for all, but must be recomputed as
underlying conditions change or is expected to change over time.
 Therefore developing nations are not necessarily or always
relegated by traditional trade theory to export mostly primary
commodities and import mostly manufactured products

66
 The contribution of trade to development
 Beside the static gain from comparative advantage, by which it
can contribute to the economic development developing nations,
there are important beneficial effects that international trade
can have on economic development.
 Trade can lead to full utilization of underemployed domestic
resources.
 By expanding the size of the market, trade makes possible
division of labor and economies of scale.
 This is specially important and has actually taken place in
the production of light manufactures in such small economic
units as Taiwan, Hong Kong, and Singapore.
67
 The contribution of trade to development
 International trade is a vehicle for the transmission of new ideas,
new technologies and new managerial and other skills.
 Trade also stimulates and facilitates the international flow of
capital from developed to developing nations.
 In several large developing nations, the importation of new
manufactured products has stimulated domestic demand until
efficient domestic production of these goods become possible.

68
 5.3 Trade Development Strategies
 During the past decades, most developing nations made a
deliberate attempt to industrialize rather than continuing in
specializing in the production of primary commodities for export,
as prescribed by traditional trade theory.
 The desire of developing nations to industrialize is natural in view
of the fact that all developed nations are industrial while all
developing nations primarily agrarian.
 Having decided to industrialize, developing nations had to
choose between import substitution and export- oriented
industrialization.
 Both policies have advantages and disadvantages.
69
 Industrialization through import substitution:
 Industrialization through import substitution: is a way of
promoting domestic industrialization, particularly in consumer
goods through import restriction, so that domestic market is
preserved for domestic products, which can thus takeover
markets already established in the country.
 The main advantages of this policy are the following:
 The market for industrial products already exists, as evidenced by imports
of the commodity, so that risks are reduced in setting up an industry to
replace imports.
 It is easier for developing nations to protect their domestic market against
foreign competition than to force developed nations to lower trade
barriers against their manufactured exports.
 Foreign firms are induced to establish tariff factories to overcome the
tariff wall of developing nations 70
 Against those advantages, there are the following
disadvantages.

 Domestic industries grow accustomed to protection from foreign

completion and have no incentive to become more efficient
 Import substitution leads to inefficient industries because the
smallness of the domestic market, which does not allow to take
advantage of economies of scale.
 After the simpler manufactured imports are replaced by domestic
production, import substitution becomes more difficult and costly as
more capital incentive and technologically advanced imports have to
be replaced by domestic production.

71
 The main advantages of export promotion are the following:
 It overcomes the smallness of domestic market and allows a
developing nation to take advantage of economies of scale.
 This is particularly important for many developing nations that are
very poor and small.
 Production of manufactured goods for export requires and
stimulates efficiency throughout the economy.
 This is specially important when the output of an industry is used
as an input by another industry in the economy.
 The expansion of manufactured exports is not limited ( as in
the case of import substitution) by the growth of the domestic
market. 72
 The two serious disadvantages of export promotion as a policy
are:
 It may be very difficult for developing nation to set up exporting
industries because of the competition from the more established and
efficient industries in developed nations.
 Developed nations often provide a high level of protection for their
simple labor-intensive commodities in which developing nations already
have or can soon acquire a comparative advantage.

73
Summary
In this chapter you learnt that:
 The theory of comparative advantage maintains that all nations can
enjoy the benefits of free trade if they specialize in production of those
goods in which they have a comparative advantage and exchange some
of these goods for goods produced by other nations.

 Policy makers in many advanced nations maintain that the

market-oriented structure of the international trading system
furnishes a setting in which the benefits of comparative
advantage can be realized.

74
Summary
In this chapter you learnt that:

Advanced nations also maintain that to achieve trading

success, they must administer their own domestic and
international economic policies.

 International trade can contribute significantly to the

development process, though the level and the rate of
economic development depends on internal conditions in
developing countries.
 They claim that the existing international trading system has
provided widespread benefits and that the trading interests
of all nations are best served by pragmatic, incremental
changes in the existing system.
75
 Counted…….
In this chapter you learnt that:

 However there are some economists contend that

standard international trade theory based on
comparative advantage is completely irrelevant for
developing nations and the development process.
 Therefore they advocate industrialization through
import substitution and generally less reliance on
international trade by developing nations.

76
77