Trade policy

What are the costs and bene ts of trade protection?

- terms of trade gains

- distortionary losses

- general equilibrium analysis using \o er curves" | see Krugman pp.107-109, 199-202

- the equivalence of import quota and tari under perfect competition: a quota that limits
imports to the same extent as a tari would give rise to the same domestic price and same welfare
as long as the quota rents are given to domestic citizens (c.f. voluntary export restraints or VER)

-the non-equivalence of import quota and tari under domestic monopoly: a quota that limits
imports to the same extent as a tari gives rise to higher domestic price and lower welfare | see
Krugman pp.203-206

Why do countries engage in trade protection?

- terms of trade argument: optimum tari | see Krugman pp.213-214, 240-242 (handout to be
given) and Feenstra pp.218-220. Note that the gains all come from tari revenue

- domestic market failure | e.g. technological spillovers of certain \key industries". See Krug-
man pp.214-217

- infant industry argument | govt. should provide temporary protection to certain sectors
in a developing economy so that they can learn, or their pro ts are raised so that they can grow
to some critical viable size of operation. Two main arguments are: imperfect capital market
argument (private entrepreneurs cannot borrow enough money from the capital market even though
the businesses are highly pro table in the long term) and appropriatability argument ( xed cost of
being the pioneer, but the property rights of accumulating such knowledge cannot be appropriated
by the pioneer). Both are based on market failure argument. See Krugman pp.244-246

- external economies (dynamic increasing returns) | a country that specializes in the non-
increasing returns industry can lose from trade. See Krugman pp.139-143 (including Figures 6-9,
6-10 and 6-11), and my notes on external economies

- imperfect competition: Brander and Spencer (1985), Feenstra pp.286-288 | under quantity-
setting (Cournot) duopoly (one rm from each country, selling to a third country), if one govt. can
\strategically" commit to subsidizing its domestic rm's export, it is possible to \shift rents" to
the doemstic rm su ciently that domestic welfare is improved (i.e. the improvement in pro t of
the domestic rm is higher than the value of the subsidy).

- political economy: e.g. Grossman and Helpman (1994, 2001), see Feenstra pp.305-311;
Branstetter and Feenstra (2002), who analyze policies towards multinationals in China, see Feenstra
pp.327-334.

What are the problems of some of the arguments for adopting activist trade policies?

- optimum tari argument | retaliation by trade partners leading to trade wars

- infant industry argument | 1. di cult to evaluate which industries really need special treat-
ment; 2. there are risks that a policy intended to promote development will end up being captured
by special interests.

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 - \rent shifting" argument of Brander and Spencer (1985) | if rms engage in price competition
instead, then the optimal policy is export tax. (If export tax is the optimal policy, it would be
hard to carry out since home rm will oppose it vigorously.) Therefore, optimal policy is sensitive
to the mode of competition between the rms. It is doubtful that the govt. can understand the
market that well. Finally, when both countries adopt strategic export subsidy policy, there will be
a trade war | both countries will be worse o . The opportunities for using this type of policy are
very limited.