Course Title:

International Economics

Instructor: Jia Huey (Jessica) Hsu

124116@mail.tku.edu.tw
Research Room: B1123

TLFBB4A
DIVISION OF GLOBAL COMMERCE,
DEPARTMENT OF INTERNATIONAL
BUSINESS
2022
Please off to
bed earlier.
Don't stay
up at will
just because
you think
you're ugly.

1
The Political Economy of Trade Policy

➢ The cases for free trade

➢ The cases against free trade
➢ Political Models of Trade Policy
➢ International negotiations of trade policy
(World Trade Organization)

2
The Cases for Free Trade

➢Efficiency argument
➢Additional gains from free trade
➢Political argument for free trade

3
 Efficiency argument
4

The 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 and consume too little while firms produce
too much.
 Figure 1 The Efficiency Case for Free Trade
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition,
Global Edition. Pearson, p.269. 5
 Exercise
The efficiency case made for free trade is that as trade distortions
such as tariffs are removed
(A) government tariff revenue will decrease, and therefore national
economic welfare will decrease.
(B) government tariff revenue will increase, hence increasing
national economic welfare.
(C) efficiency losses for producers and consumers will decrease,
hence increasing national economic welfare.
(D) efficiency losses for producers and consumers will decrease,
hence decreasing national economic welfare.
Answer: 6
 Exercise
The efficiency case made for free trade is that as trade distortions
such as tariffs are removed
(A) government tariff revenue will decrease, and therefore national
economic welfare will decrease.
(B) government tariff revenue will increase, hence increasing
national economic welfare.
(C) efficiency losses for producers and consumers will decrease,
hence increasing national economic welfare.
(D) efficiency losses for producers and consumers will decrease,
hence decreasing national economic welfare.
Answer: C 7
 Efficiency argument
8

➢ Because tariff rates are already low for most

countries, the estimated benefits of moving to free
trade are only a small fraction of national income
for most countries.
➢ For the world as a whole, protection costs less than
1 percent of GDP.
➢ The gains from free trade are somewhat smaller
for advanced economies such as the United States
and Europe and somewhat larger for poorer
developing countries.
Table 2 Benefits of a Move to Worldwide Free Trade (% of GDP)

United States 0.57

European Union 0.61
Japan 0.85
Developing countries 1.40

World 0.93
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition,
Global Edition. Pearson, p.270.
9
 Additional gains from free trade

➢ Free trade provides competition and

opportunities for innovation (dynamic benefits).

➢ Free trade allows firms or industry to take

advantage of economies of scale.

10
 Economies and Diseconomies of Scale

Economies of scale Situation in which output can be doubled for less

than a doubling of cost.

Diseconomies of scale Situation in which a doubling of output

requires more than a doubling of cost.

Increasing Returns to Scale: Output more than doubles when the quantities of all
input are doubled.
Economies of Scale: A doubling of output requires less than a doubling of cost.
11
 The Relationship between Short-Run and
Long-Run Cost

• Economies of scale: ATC

falls as Q increases.
• Constant returns to scale:
ATC stays the same as Q
increases.
• Diseconomies of scale: ATC
rises as Q increases.

12
 Additional gains from free trade

➢ Protected markets limit gains from external

economies of scale by inhibiting the
concentration of industries:
• Too many firms to enter the protected
industry.
• The scale of production of each firm
becomes inefficient.
13
 Political argument for free trade

➢ 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.
14
 The terms of trade
argument for a tariff
The Cases
against
Free Trade
The domestic market
failure argument

15
 The terms of trade argument for a tariff
For a large country, a tariff 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.

A small tariff will lead to an increase in national

welfare for a large country.
16
Free Trade

17
19
 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
from production and
consumption distortion.

P*+t = equilibrium price, no

more international trade
happens
Figure 2 The Optimum Tariff
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition,
Global Edition. Pearson, p.273. 20
 Exercise

The optimum tariff is most likely to apply to

A) a small tariff imposed by a small country.
B) a small tariff imposed by a large country.
C) a large tariff imposed by a small country.
D) a large tariff imposed by a large country.

21
 Exercise

The optimum tariff is most likely to apply to

A) a small tariff imposed by a small country.
B) a small tariff imposed by a large country.
C) a large tariff imposed by a small country.
D) a large tariff imposed by a large country.
Ans: B
22
 23

➢ A tariff rate that completely prohibits imports

leaves a country worse off.
➢ Tariff rate tO may exist that maximizes national
welfare: an optimum tariff.
➢ For some large countries like the U.S., an import
tariff could improve national welfare at the
expense of other countries.
➢ But this argument ignores the likelihood that other
countries may retaliate against large
countries.
 The domestic market
failure argument
Domestic market failures may exist that
cause free trade to be a suboptimal policy.
The economic efficiency loss calculations using
consumer and producer surplus assume that
markets function well.

24
 Types of market failures
➢ Persistently high underemployment of workers
➢ Persistently high underutilization of structures,
equipment, and other forms of capital
➢ Property rights not well defined or well enforced
➢ Technological benefits for society discovered through
private production, but from which private firms cannot
fully profit
 Types of market failures
➢ Environmental costs for society caused by private
production, but for which private firms do not fully
pay
➢ Sellers that are not well informed about the
(opportunity) cost of production or buyers that are
not well informed about value from consumption
The Domestic Market Failure
Argument for a Tariff

➢ Economists calculate the marginal social benefit to

represent the additional benefit to society from private
production.
➢ It’s possible that when a tariff increases domestic
production, the benefit to domestic society will
increase due to a market failure.
 If production of a good
yields extra social benefits
not captured as producer
surplus, a tariff can increase
welfare.

If the tariff is small enough,

the area c must always
exceed the area a + b and
that there is some welfare-
maximizing tariff that yields a
level of social welfare higher
than that of free trade.

Figure 3 The Domestic Market Failure Argument for a Tariff

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global
Edition. Pearson, p.274.
28
 The Cases against Free Trade

➢ The domestic market failure argument against free

trade is an example of a more general argument
called the theory of the second best.
➢ The theory of the second best states that a hands-
off policy is desirable in any one market only if all
other markets are working properly.

29
 The Cases against Free Trade

➢ Government intervention that distorts market

incentives in one market may increase national
welfare by offsetting the consequences of market
failures elsewhere.
Example: if the labor market is malfunctioning and fails to
deliver full employment, a policy of subsidizing labor-intensive
industries, which would be undesirable in a full-employment
economy, might turn out to be a good idea.
30
 Exercise

The domestic market failure argument is a particular

case of the theory of
(A) the optimum, or first-best.
(B) the efficiency case for free trade.
(C) the second best.
(D) the sufficing principle.
Ans:
31
 Exercise

The domestic market failure argument is a particular

case of the theory of
(A) the optimum, or first-best.
(B) the efficiency case for free trade.
(C) the second best.
(D) the sufficing principle.
Ans: C
32
How is trade
policy
determined?

33
 Models of governments
maximizing political success
rather than national welfare:
Political ➢ Median voter theorem
Models of ➢ Collective action
Trade Policy ➢ A model that combines
aspects of collective
action and the median
voter theorem

34
Suppose the level of a tariff rate is
the policy issue.
Assumptions of the model:
✓There are two competing political
parties. Median Voter
✓The objective of each party is to
get elected by majority vote.

What policies will the

parties promise to follow?
35
 This Political
Competition drives
both parties to propose
tariffs close to tM, the
tariff preferred by the
median voter.

Figure 4 Political Competition

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition,
Global Edition. Pearson, p.277. 36
 Collective Action

Political activity is often described as a collective action

problem.
➢ While consumers as a group have an incentive to advocate
free trade, each individual consumer has no incentive
because his benefit is not large compared to the cost and
time required to advocate free trade.
➢ For groups who suffer large losses from free trade (for
example, unemployment), each individual in that group has a
strong incentive to advocate the policy he desires.
37
 38

The welfare of voters

VS
A Model of A larger campaign fund
Models of trade restrictions try to
Trade Policy measure the trade-off between the
reduction in welfare of constituents as
a whole and the increase in campaign
contributions from special interests.
 Exercise

3. The reason protectionism remains strong in the United States is that

A) economists can produce any result they are hired to produce.
B) economists cannot persuade the general public that free trade is
beneficial.
C) economists do not really understand how the real world works.
D) the losses associated with protectionism are diffuse, making
lobbying by the public impractical.
39
 Exercise

3. The reason protectionism remains strong in the United States is that

A) economists can produce any result they are hired to produce.
B) economists cannot persuade the general public that free trade is
beneficial.
C) economists do not really understand how the real world works.
D) the losses associated with protectionism are diffuse, making
lobbying by the public impractical. Ans:D
40
 Exercise

4. The fact that trade policy often imposes harm on large

numbers of people, and benefits only a few may be
explained by
A) the lack of political involvement of the public.
B) the power of advertisement.
C) the problem of collective action.
D) the basic impossibility of the democratic system to reach a
fair solution.
41
 Exercise

4. The fact that trade policy often imposes harm on large

numbers of people, and benefits only a few may be
explained by
A) the lack of political involvement of the public.
B) the power of advertisement.
C) the problem of collective action.
D) the basic impossibility of the democratic system to reach a
fair solution.
Ans: C 42
 Exercise

The strongest political pressure for a trade policy that

results in higher protectionism comes from
A) domestic workers lobbying for import restrictions.
B) domestic workers lobbying for export restrictions.
C) domestic workers lobbying for free trade.
D) domestic consumers lobbying for export restrictions.
43
 Exercise

The strongest political pressure for a trade policy that

results in higher protectionism comes from
A) domestic workers lobbying for import restrictions.
B) domestic workers lobbying for export restrictions.
C) domestic workers lobbying for free trade.
D) domestic consumers lobbying for export restrictions.
Ans: A 44
 Who Gets Protected?
Agricultural and clothing industries are
the most protected industries in many countries

45
 Agriculture: In the U.S., Europe, and
Japan, farmers make up a small fraction
of the electorate but receive generous
Which subsidies and trade protection.
Industries • European Union’s Common
Are Agricultural Policy
Protected? • Japan’s 1000% tariff on imported
rice(in 1998)
• America’s sugar quota.

46
International negotiations of
trade policy
(World Trade Organization)

47
The Multilateral Trading System
The Bretton Woods conference in 1944

➢ The International Monetary Fund

(IMF) (Successful)
➢ The World Bank (Successful)
➢ The International Trade
Organization (ITO) (Failed)
 1948

The General
Agreement on
Tariffs and Trade
The Multilateral (GATT)

Trading System World Trade

– From GATT to
Organization
(WTO)
WTO 1995

✓To negotiate global trade agreements

✓To settle members’ trade disputes
✓To promote members’ economic growth and development
 GATT rounds of trade negotiations

Year Name Subjects covered Countries

1947 Geneva Tariffs 23
The General 1949 Annecy Tariffs 13

Agreement 1951
1956
Torquay
Geneva
Tariffs
Tariffs
38
26

on Tariffs and 1960-

1961
Dillon
Round
Tariffs 26

1964- Kennedy Tariffs and anti-dumping measures 62

Trade (GATT) 1967
1973-
Round
Tokyo Tariffs, non-tariff measures, 102

Trade Rounds 1979 Round “framework”

agreements
1986- Uruguay Tariffs, non-tariff measures, rules,
1994 Round services, intellectual property, dispute
123
settlement, textiles, agriculture,
creation of WTO
Source: https://www.wto.org/english/thewto_e/whatis_e/tif_e/fact4_e.htm#rounds (Accessed 15 February 2019).
What is the World Trade Organization (WTO)?

An intergovernmental Addressing the rules

organization of trade between
nations
 Let’s Talk WTO

The creation of the WTO

How does the WTO work?

Source: https://www.wto.org/english/res_e/webcas_e/ltt_e/ltt3_e.htm
 The
WTO’s
members

Source: https://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr_e.htm
 The vast majority of WTO
member are states.

Who can A separate customs

apply for territory which possesses full
WTO autonomy in the conduct of its
Membership? external commercial relations can
become member of the WTO.
Taiwan, Macao and Hong Kong.
Non-discrimination

More open and predictable trade

Transparency

Special treatment for less-developed members

The basic principles of the WTO

Non-discrimination

The most-favored nation

(MFN) principle: treating
other WTO members equally

The National treatment

principle: treating foreigners
and locals equally
 Technical Assistance for
acceding governments
Acceding governments benefit from
WTO technical Assistance

The special position of LDCs is

acknowledged

WTO website - includes basic

information, news, list of members in
process of accession
 The institutional structure of the WTO

How does
the WTO
work?
 WTO
organization
chart

Source: https://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr_e.htm
 Developing countries comprise a majority
of the WTO membership.
Definition of a “developing country”
Who are the
developing ➢ There are no WTO definitions of
“developed” and “developing” countries.
countries in
➢Members announce for themselves
the WTO? whether they are “developed” or
“developing” countries.
➢Other members can challenge the
decision of a member to make use of
provisions available to developing
countries.
 The exceptions provide flexibility for the members
to meet their policy objectives.

Main
exceptions to
the Basic
Principles
 WTO Members have the right to grant
preferential treatment to their
Regional Trade trading partners within a customs
Agreements
(RTAs): Customs unions or a free trade area, without
Unions and Free having to extend such better
Trade Areas
treatment to all WTO members,
subject to certain conditions.
 The EU is a
group of 27
countries in
Europe.
The European Union
These countries
came together
to make things
better, easier
and safer for
people.

A future EU-UK
partnership
North American Free
Trade Agreement
(NAFTA)

The United States commenced bilateral trade negotiations with Canada more than 30
years ago, resulting in the U.S.-Canada Free Trade Agreement, which entered into force
on January 1, 1989. In 1991, bilateral talks began with Mexico, which Canada joined. The
NAFTA followed, entering into force on January 1, 1994.
The Comprehensive and Progressive Agreement for
Trans-Pacific Partnership (CPTPP) is a free trade
agreement (FTA) between Australia, Brunei Darussalam,
Canada, Chile, Japan, Malaysia, Mexico, Peru, New Zealand,
Singapore, and Vietnam.
The Association of Southeast
Asian Nations (ASEAN) was
established on 8 August 1967 in Bangkok,
Thailand by Indonesia, Malaysia, Philippines,
Singapore, and Thailand.
Brunei Darussalam then joined on 7 January
1984, Viet Nam on 28 July 1995, Lao and
Myanmar on 23 July 1997, and Cambodia on
30 April 1999, making up what is today the
ten members of ASEAN.
The Southern Common Market (MERCOSUR for
its Spanish initials) is a regional integration process.
SADC-EAC-COMESA Tripartite Free Trade
The Heads of State and Government of the
Common Market for Eastern and Southern Africa
(COMESA), East African Community (EAC) and
Southern African Development Community
(SADC) met on 10 June, 2015 in Sharm El Sheikh,
Egypt at the Third Tripartite Summit to officially
launch the COMESA-EAC-SADC Tripartite Free
Trade Area (TFTA). The Agreement initially
covered 26 member states across the three RECs,
but with the expansion of the EAC to include
South Sudan in April 2016, the total number of
participating member states has risen to 27.
 Case Study

Agreement between New Zealand and the Separate Customs Territory

of Taiwan, Penghu, Kinmen, and Matsu on Economic
Cooperation(ANZTEC), 10 July 2013
70
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