International trade policy

Trade Restrictions:
Tariffs

Chapter 8
LECTURE OVERVIEW

•Trade policy
•Tariff as a trade policy instrument
•Partial equilibrium analysis of a tariff
•The theory of tariff structure
•TRADE POLICY
FREE TRADE

Free trade or trade protectionism ?!

Free trade
• A government does not attempt to restrict imports and exports.
• Does not necessarily imply that a country abandons all control and taxation of
imports and exports
• Laissez-faire: government intervention as little as possible.
• Adam Smith, David Ricardo…
 TRADE
• Trade PROTECTIONISM
protectionism/Government intervention
• Policy of protecting domestic industries against foreign competition by trade policy
instruments
• Protectionist policies were common in Europe in the 17th–18th centuries under
mercantilism.
• How to protect trade/ intervene in trade?
• Tariffs
• Export subsidies
• Import quotas
• Voluntary export restraints (VERs)
• Antidumping policies
• Other non-tariff barriers (e.g Administrative policies)
• => Trade policy instruments
TARIFF
PARTIAL EQUILIBRIUM OF TARIFF

•How does a tariff affect production,

consumption, trade and price in a nation?
•Who are winners and losers of a tariff?
ASSUMPTIONS

•Nation in the analysis: a small nation

–Tariff will not affect the world price
–Price taker => must accept the world price
–E.g: Vietnam – small rice importer

•Industry in analysis is small

–Tariff will not affect the rest of the economy
 Provide Supply and Demand function, Graph Demand
5 line, Supply line?
Supply
4

1 Demand
0
0 10 20 30 40 50 60 70 80 90

demand supply Linear (demand) Linear (supply)

 State I: Autarky Px=3, Qx=?
5
Supply
4

1 Demand
0
0 10 20 30 40 50 60 70 80 90
demand supply Linear (demand) Linear (supply)
 State 2: Free trade Px=1, QD=?,QS=?, QI=?
5
Supply
4

1 Demand
0
0 10 20 30 40 50 60 70 80 90
demand supply Linear (demand) Linear (supply)
 State 3: 100%tariff Px=2, QD=?,QS=?, QI=?
5
Supply
4

1 Demand
0
0 10 20 30 40 50 60 70 80 90
demand supply Linear (demand) Linear (supply)
 Aurtarky Free Trade100%tariff
5
Supply
4
E
P 3
G J H
P w+t 2

Pw 1
A C M N B Demand
0
0 10 20 30 40 50 60 70 80 90
demand supply Linear (demand) Linear (supply)
SUMMARY OF PRODUCTION, CONSUMPTION, TRADE
AND PRICE EFFECTS OF A TARIFF
SOCIAL WELFARE EFFECTS OF A TARIFF

•Who are winners and losers of a tariff?

•Consumers’ welfare:
–consumer surplus (CS)
•Producers’ welfare:
–Producer surplus (PS)
•Government:
–revenue from tariff.
PRODUCER SURPLUS
 SUMMARY OF WELFARE EFFECTS

Who will be losers and winner of a tariff?

Winners:
• Government (+c), producers (+a)
Losers: Consumer –(a+b+c+d)
• So tariffs are unambiguously pro-producer and anti-consumer
National welfare effects?
• Small country case: -(b+d) is called deadweight loss
• b: welfare loss due to production distortion
• d: welfare loss due to consumption distortion
 CHAPTER 9

Nontariff Trade Barriers and

the New Protectionism
LECTURE OVERVIEW

Import quotas
Voluntary Export Restraints
Administrative regulations
International Cartel
Dumping
Export Subsidies
NON-TARIFF BARRIERS (NTB)

After the WW2

a lot of negotiations have been conducted
•  the reduction in tariff
•  increase in non-tariff trade barriers.
NTBs:
any trade barrier other than tariffs
such as quotas, voluntary export restraints (VERs), government
regulations, international cartels, dumping, and export subsidies.
The effects of NTBs are similar
either restrict imports or stimulate exports
cause a misallocation of resources in the world.
IMPORT QUOTA

• Concept of Import Quota

A import (export) quota: a direct quantitative restriction
on the amount of a commodity allowed to be imported
(exported).
Why use import quota?
Protect domestic industry
Protect domestic agriculture
Balance-of-payment reasons
SUMMARY OF WELFARE EFFECTS OF A QUOTA

• Question: Who will be losers and winner of a tariff?

Winners:
Government/Firms + c
Producers + a
Losers:
Consumers - (a+b+c+d)
•  So, quota are unambiguously pro-producer and anti-consumer.
National welfare effects?
If domestic firms receive import license free of charge or government
auction off the import licencse:
National welfare effect = - (b+d)
If foreign firms receive import license free of charge:
National welfare effect = - (b+d+c) => loss more
COMPARISON OF AN IMPORT QUOTA TO AN
IMPORT TARIFF

Similarities:
Barrierto trade
Import quota and an equivalent import tariff has similar effects
on
Quantity imported
Domestic price
CS
PS
Government revenue
COMPARISON OF AN IMPORT QUOTA TO AN
IMPORT TARIFF (CONT.)

1st Difference:
Quota: increase in demand
• => higher domestic price
• => higher domestic production
Import tariff: an increase in demand
• leave the domestic price and domestic production
unchanged
•  higher consumption and imports
COMPARISON OF AN IMPORT QUOTA TO AN
IMPORT TARIFF (CONT.)
COMPARISON OF AN IMPORT QUOTA TO AN
IMPORT TARIFF (CONT.)
COMPARISON OF AN IMPORT QUOTA TO AN
IMPORT TARIFF (CONT.)

Fairness in trade
Quota:

Depending on the distribution of import licenses

Firms receive import licenses will get monopoly profit.
• => rent seeking activities
Tariff:

As for import tariff, the government collects it for all the imports.
Certainty of import limits
Import quota limits import to the specified level with certainty
while the trade effect of an import tariff may not be uncertain.
•=> What does a domestic producer likes: import tariff or import quota? Why?
•Voluntary export restraints
VOLUNTARY EXPORT RESTRAINS

a nontariff barrier
importing country induces another nation to reduce its export of a commodity
“voluntarily”, under the threat of higher all around trade restrictions
EFFECT OF VERS

• they have all the economic effects of equivalent import quotas

TECHNICAL, ADMINISTRATIVE, AND OTHER
REGULATIONS
Administrative

Customs

Buy domestic products

Technical

Other Regulations
Safety regulations
Health regulations
Labeling requirements
Packing of imported products
Environmental regulations
•=> A lot of technical regulations are disguised tools to limit the imports
INTERNATIONAL CARTEL

An organization of suppliers of a commodity located in different

nations (or a group of governments) that agrees to restrict output
and export of the commodity with the aim of maximizing or
increasing the total profits of the organization.
E.g: OPEC
Conditions for success:
 Few international suppliers
 Essential commodity for which there are no close
substitutes
DUMPING

Definition:
the export of a commodity at below cost
or at least the sale of a commodity at a lower price abroad
than domestically
•EXPORT SUBSIDIES
WHAT IS AN EXPORT SUBSIDY?

Export subsidies:
Payments/Assistance given by the government

to producers of exported goods or exporters.

to encourage export

What are goods often subsidized?

The United States:
Export Enhancement Program (EEP)

Vietnam
THE EFFECTS OF EXPORT SUBSIDIES IN A SMALL
COUNTRY
THE EFFECTS OF EXPORT SUBSIDIES IN SMALL
COUNTRY
RESULTS FOR DISCUSSION
THE EFFECTS OF EXPORT SUBSIDY IN SMALL
COUNTRY

• An export subsidy results in an unambiguous net loss in

national welfare consisting of efficiency loss due to
production and consumption distortions ( b+d)
KEY WORDS

Non-tariff trade barriers

Quota
Welfare effects of quota
International cartel
Technical, administrative and other regulations
Dumping
Voluntary Export Restraint
Export subsidies
Welfare effects of export subsidies
Non-tariff Trade Barriers and
the New Protectionism

Session 2
LECTURE OVERVIEW

 Fallacious and Questionable Arguments for Protection

 The infant – industry and other qualified arguments for
protection
 Strategic Trade and Industrial policies
 The World Trade Organization
INTRODUCTION
• The case for free trade:
• “If a country can supply us with a commodity cheaper than we ourselves can make
it, better buy it of them with some part of the produce of our own industry, employed
in a way in which we have some advantage” (Adam Smith)
INTRODUCTION (CONT.)

• - Many people are unconvinced about the benefits of trade.

• - They say it is unfair and therefore the government should introduce regulations to
correct the unfairness
• => Protectionism
• FALLACIOUS AND QUESTIONABLE
ARGUMENTS FOR PROTECTION
FALLACIOUS ARGUMENTS FOR PROTECTION

Protect domestic labor against cheap foreign labor

E.g: China exports garments to the US
Reasons for fallaciousness
Productivity: Higher domestic wages does not mean
higher cost, but higher productivity.
Comparative advantage: Mutual beneficial trade could
still be based on comparative advantage
FALLACIOUS ARGUMENTS FOR PROTECTION
(CONT.)

 Scientific tariff
 This is the tariff rate that would make the price of imports equal
to domestic prices.
 However, this would
eliminate international price differences
Eliminate competition
Do not promote the domestic efficient producers
QUESTIONABLE ARGUMENTS FOR PROTECTION

 Reduce domestic unemployment

 Cure a deficit in a nation’s BOP
 Reasons

 Protection is a beggar-thy-neighbor policy.

 As a result, other nations are likely to retaliate => trade war => political tension => all
nations lose in the end.
 Domestic unemployment and BOP deficit must be corrected/solved with appropriate
monetary, fiscal and trade policies rather with trade restriction which causes loss to
others.
•The infant – industry and other qualified
arguments for protection
THE INFANT-INDUSTRY ARGUMENTS

 The Infant-Industry Arguments:

 Nation may have a potential comparative advantage in a
commodity but may lack of know-how and initial small level of
output
 That industry should be protected during infancy until it can develop,
can meet foreign competition, and be viable and competitive
internationally
 The permanent gains to the industry will pay for the temporary
losses caused by the protection.
OTHER QUALIFIED ARGUMENTS

 Qualifications for Infant-Industry Arguments:

 More justified for developing nations
 Difficult to identify the infant industry
 Production subsidy can do better
 It is useless unless it makes the industry more efficient
WHO GETS PROTECTED?

 Government often act for special interest groups.

 E.g: Impose a tariff (Who will benefit? Loss?) or Lower a
tariff (Who will benefit? Loss?)
 Often act for interests of producers. WHY?

 Producers:
 Few => gain a great deal from protection
• => Strong incentive to lobby the government to protect
 Consumers:
 Many => loses diffused among many
•=> Little motivation to lobby government to remove trade
barriers
• The Strategic Policy and Industrial
Policies
 CONCEPT
 Recent developments in trade theory that establish possible gains from protectionism of
significant external economies
A nation can create a comparative advantage in such fields by protecting temporarily.
 crucial to future growth in the nations.
 subjects to high risks
 require large-scale production to achieve economics of scales
 give rise to extensive external economics when successful.
 E.g: the steel industry in the 1950s, the semiconductors in the 1970s and 1980s in Japan;
Airbus from the 1970s in Europe and semiconductors in the US in 1970s
 To some extent similar to infant industry arguments
 Difference?

 This is advanced for industrial nations to acquire a comparative advantage in crucial

high technology industries.
 DIFFICULTIES IN CARRYING OUT THE STRATEGIC
AND INDUSTRIAL POLICIES
 Firstly, extremely difficult to choose/identify the appropriate industries to protect and
nurture.
 Secondly, since most leading nations undertake strategic trade policy at the same
time => potential benefits to each may be small.
 Thirdly, this comes at the expense of other countries

• => retaliate and trade war

•=> Special interest groups can milk strategic trade policies for their benefit at the
expense of national welfare.
• Free trade is still the best policy, after all. That is, free trade may be suboptimal in
theory, but it is optimal in practice.
STRATEGIC TRADE POLICY AND GAME
THEORY
STRATEGIC TRADE POLICY AND GAME THEORY

 Two firms (Boeing and Airbus) compete in the international

market but are located in two different countries (United States
and Europe).
 Both firms are interested in manufacturing airplanes, but each
firm’s profits depends on the actions of the other.
 Each firm decides to produce or not depending on profit levels
STRATEGIC TRADE POLICY AND GAME THEORY

- Cells indicate the payoffs to Boeing and Airbus, respectively.

-Cell I : losses if both firms decide to produce.
- Cell II: Boeing enters the market first, gaining a strategic advantage and
enabling it to deter entry for the rival Airbus, and make monopoly profits.
• -Cell III: Airbus enters the market first, and deters the entry of Boeing, and
makes monopoly profits.
• => the firm that enters the market first could be reversed by activist policy e.g. a
subsidy.
STRATEGIC TRADE POLICY AND GAME THEORY

 The predicted outcome depends on which firms invests/produces first.

 If Boeing produces first, then Airbus will not find it profitable to
produce.
 If Airbus produces first, then Boeing will not find it profitable to
produce.
 But a subsidy of 25 by the European Union can alter the outcome by
making it profitable for Airbus to produce regardless of Boeing’s action.
STRATEGIC TRADE POLICY AND GAME THEORY
(CONT.)
STRATEGIC TRADE POLICY AND GAME THEORY
(CONT.)

 If Boeing expects that the European Union will subsidize Airbus,

Boeing will be deterred from entering the industry.
 Thus, the subsidy of 25 will generate profits of 125 for Airbus.
 The subsidy raises profits more than the amount of the subsidy
itself because of its deterrent effect on foreign competition.
• A government policy to give a domestic firm a strategic advantage in
production is called a strategic trade policy.
•THE WTO
GATT

 GATT was established in 1947

 GATT’s membership: over 120 nations
 GATT objectives: eliminate barriers to trade
 8 rounds of negotiations
GATT (CONT.)
Round Dates Tariff-cut %
1. Geneva 1947 21
2. Annecy 1949 2
3. Torquay 1951 3
4. Geneva 1956 4
5. Dillon 1960-61 2
6. Kennedy 1964-67 35
7. Tokyo 1973-79 33
8. Uruguay 1986-1993 34
MTN Rounds 1 to 6 addressed mainly tariff issues.
MTN Rounds 7 to 8 addressed reduction of both tariff & NTBS
• The WTO: 1 January 1995
 Members?
 164 countries
 Budget: 188 million Swiss Franc
• http://www.wto.org/english/thewto_e/secre_e/contrib09_e.htm
 Director - General?
WTO (CONT.)

 What is the WTO

 Not superman
 It is an organization for liberalizing trade
 It is a negotiation forum
 It is a set of rules
 It helps to settle disputes
 Born in 1995, but not so young
WORLD TRADE ORGANIZATION (CONT.)
DOHA ROUND - DEADLOCKED

Trade issues Winners Losers

Health Aids patiens in Africa US drug companies

Agricultural subsides Australia French farmers

US refuses to import US textile companies Textile producers in

more textiles (VERs) China & S. Asia.
Anti- dumping laws Foreign steelmakers US steelmakers

Labor and The world Polluters(ACs& DCs)

Environmental
standards
Trading blocs
KEY WORDS

 Fallacious arguments for protection

 Scientific tariff
 Infant-industry
 Infant – industry arguments
 Strategic trade policy
 Industrial policy
 Game theory
 GATT’s negotiation Round
 Doha Round’s deadlock
 TRADE CREATION & TRADE DIVERSION
• When customs unions are established the flow of trade between countries involved in the new
union and those outside will be affected. Customs unions eliminate barriers to trade between
members, which is assumed to provide a considerable incentive to increase trade between
members and to reduce trade between members and non-members.
• It is often easiest to appreciate the effect of a customs union by considering what happens
when one country joins an existing union.
• Once a union is created, members agree to eliminate tariffs between themselves. The effect of
this is that, facing lower priced, zero-tariff, imports from members, consumers increase their
demand for these goods, and new trade will be created – a process called trade creation.
• The process of efficient producers losing out to inefficient ones is generally referred to as
trade diversion.