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Trade Policy Analysis (Competitiveness Analysis) Dr. Naved Ahmad IBA, Karachi Topics • • • • • • • Theory of Absolute Advantage Theory of Comparative Advantage Revealed Comparative Advantage Trade Policy Analysis: Tariffs, NTMs Trade Creation and Trade Diversion (FTA) Viner’s Model Case Study (Pakistan and India) 2 Text books • An Introduction to International Economics: Kenneth A. Reinert New Perspectives on the World Economy Cambridge University Press Revised: June 23, 2011 © 2012 (Chapters # 1, 2, 3, 4, 5, and 6) • Methodology for impact assessment of Free Trade Agreements, Michael G. Plummer, David Cheong, and Shintaro Hamanaka, © 2010 Asian Development Bank 3 Theory of Absolute Advantage • Why does a country export or import a particular good? • Answer this fundamental question by utilizing demand-supply framework. • Absolute advantage refers to the possibility that, due to differences in supply conditions, one country can produce a product at a lower price than another country 4 5 Consumer surplus and producer surplus • Consumer Surplus • Producer Surplus 6 7 Theory of Absolute Advantage There are a number of properties of the supply and demand curves in Figure 2.1 that are important to understand. Supply side factors:  Input or factor prices  Technology. Demand side factors:      Incomes Preferences. Prices of related products, Wealth Expectations 8 Theory of Absolute Advantage • Rice is produced in many countries, but to simplify, suppose we consider just Vietnam and Japan. • Assumption: Same demand conditions in both countries. • Allow supply conditions for rice to differ between Vietnam and Japan. • Assume that the supply curve for Vietnam is farther to the right than the supply curve for Japan. 9 Autarky Price • This situation is depicted in Figure 2.3. • The intersections of the supply and demand curves determine the equilibrium prices of rice in the two markets. • Since no trade is involved, these two prices are known in international economics as autarky prices. 10 11 Theory of Absolute Advantage • In international trade theory, this situation is interpreted as Vietnam having an absolute advantage in the production of rice vis-à-vis Japan. • This absolute advantage reflects the differences in supply conditions in the two countries. The presence of absolute advantage makes international trade a possibility. • The world price of rice will be somewhere between the two autarky prices. 12 13 Theory of Absolute Advantage • It is important to stress here that Figure 2.5 is only a preliminary look at international trade. • In the real world, international trade is actually determined by comparative advantage rather than absolute advantage. 14 15 Gains from Trade • Up to this point, we have seen that, given a pattern of absolute advantage, it is possible for a country to give up autarky in favor of importing or exporting. 16 17 Limitations • It suggests the possibility that a country could not have an absolute advantage in anything, and therefore would have nothing to export at all. This, it turns out, is unlikely. • The notion of the gains from trade also has its limits. It suggests that countries as a whole mutually gain from trade. It does not suggest, however, that everyone within a country will gain from trade. 18 Theory of Comparative Advantage • Assume that the two goods are consumed in the same fixed proportion as shown in the next diagram • Allow supply conditions to differ Vietnam and Japan • Let me draw two Production Possibility Frontiers (Figure 3.3) 19 20 21 22 23 COMPARATIVE ADVANTAGE • Under perfect competition, opportunity costs are fully reflected in relative prices. • The slope of a PPFs where the demand diagonal crosses it is the relative price of rice, • Tangency line giving relative prices is flatter in Vietnam than in Japan. That is, the opportunity cost of rice is lower in Vietnam than in Japan. 24 COMPARATIVE ADVANTAGE • This situation is depicted in Figure 3.4. The world price ratio here is depicted with dashed lines . • The tangencies of these world price lines with the PPFs determine the new production points in Vietnam and Japan. • In Vietnam, the movement involves an increase in the production of rice, while in Japan, this movement involves an increase in the production of motorcycles. • This is known as specialization in production. 25 26 COMPARATIVE ADVANTAGE • Look at Figure 3.5 (next slide), which removes the autarky points and autarky price lines. • In Vietnam, production of rice exceeds consumption of rice, and the difference is exported • Production of motorcycles, however, falls short of consumption of motorcycles, and this shortfall is imported 27 28 Revealed Comparative Advantage • Beginning with Belassa (1965), the standard practice is to examine actual trade flows of a country to understand what is known as revealed comparative advantage. 29 • The standard calculation of revealed comparative advantage measures how much a country is exporting a given good relative to its total trade, in comparison to the share of that good in world trade. Country i is said to have a "revealed comparative advantage" in a good when the share of that good in its exports is bigger than the share of that good in world exports Tools: Revealed Comparative Advantage (RCAs) 30 Trade Policy Analysis • Ikuo Kanno, a fourth-generation Japanese rice farmer stated: “I believe that the value of agriculture can’t be measured just by an economic yardstick. Japan has been a farming country for centuries, and rice farming is embedded in the culture. It should be preserved” 31 DEMAND FOR PROTECTION • Trade Policy Analyst should be able to assess, both qualitatively and quantitatively, the numerous impacts of government interventions in international trade. • it is important for you to understand how these assessments are made 32 TARIFFS AND NONTARIFFS MEASURES • Trade protection can be broadly classified as either tariffs or nontariff measures. • A tariff is a tax on imports. • It is a very common trade policy used by almost all countries. 33 TARIFFS AND NONTARIFFS MEASURES • From the point of view of many trade policy analysts and the World Trade Organization (WTO), the ideal trading system would consist of only tariffs. • Tariffs are seen as the most transparent kind of trade policy • Least susceptible to political manipulation and corruption. • The range of NTMs is limited only by the imaginations of policy makers 34 PAKISTAN custom tariff • http://www.tdap.gov.pk/HS_codes_11th_nov. pdf 35 Non Tariff Measures Tax-like measure: Anti-dumping duties (AD) Tariff-like charges imposed on imports that are deemed by the imposing government to have been “dumped” or sold at “less than fair value” by the exporter. Countervailing duties (CVDs) Tariff-like charges imposed on imports that are deemed by the imposing government to have been “unfairly” subsidized by the exporting country government 36 NTM • Tax-like measure Temporary import surcharges Extra import tariffs imposed in “emergency” circumstances of various kinds.  Variable levies Import tariffs whose size depends on the price of the imported good. This is usually to help maintain a certain level of domestic price, particularly in agricultural sectors. 37 NTM • Cost-increasing measures Standards and technical regulations (STRs) or technical barriers to trade (TBTs) A large set of measures including certification guidelines, performance mandates, testing procedures and labeling requirements designed to contribute to consumer safety, environmental protection, national security, product interoperability and other goals. 38 NTM • Cost-increasing measures Sanitary and Pphytosanitary (SPS) requirement Technical barriers to trade in the agricultural arena designed to protect plant, animal and human health Prior import deposits Non-interest bearing deposits equal to a percentage of the value of an imported good that must be deposited into a central bank for a specified amount of time 39 NTM • Cost-increasing measures Customs procedures Inspection and customs clearance procedures that can increase costs of imports and impose delays Reference or minimum import prices Official prices used to calculate import tariffs 40 NTM • Quantitative trade restrictions – Import quota • A maximum import quantity set for a particular good. – Tariff rate quota • Involves two tariff levels: a lower tariff for levels of imports within the quota and a higher tariff for levels of imports above the quota – Voluntary export restraint • An export quota that is “voluntarily” applied by the exporting country 41 NTM • Quantitative trade restrictions – Import licensing • The requirement that a license be obtained from the importing country government before a product can be imported Foreign exchange controls The allocation of foreign exchange by the importing country government among potential importers as a way to limit imports Sanctions and embargoes , Local or domestic content requirements , Import or export balancing requirements 42 NTM • Quantitative trade restrictions – Sanctions and embargoes • Export bans and trade embargoes imposed on countries for political reasons – Local and domestic content requirements • A requirement that imported goods must contain a minimum amount of intermediate products from the importing country – Import or export balancing requirements • A requirement that a firm importing intermediate products must export a certain amount 43 NTM • Government procurement policies: – The myriad processes that governments employ in determining their contract procurements and the posture of these contracts toward imported goods. 44 EXAMPLE OF SPS • • • • • • • Requiring specific product or process criteria Requiring product to come from disease-free area Quarantine regulations Certification or inspection procedures Sampling and testing requirements Food safety packaging and labelling requirements Limitation on food additives, pesticide residue 45 Fundamental Concepts of Trade Creation and Trade Diversion. • Trade creation is the displacement of less efficient national production in favor of more efficient partner-country production • While trade diversion is the displacement of more efficient non-partner imports in favor of less efficient partner-country sourced imports. 46 Viner’s Model Viner’s model shows that the net welfare effect of an FTA on an importing country is ambiguous. If the partner country is the cheapest import source, then it would be easy to show that the FTA would only have a trade creation effect FTA would be unambiguously beneficial to the home country. Multiple sources of imports and changes in terms of trade are possible if the importing country’s demand is large enough to influence the prices at which foreign exporters supply their goods 47 TRADE INDICATORS • • • • • • • Intraregional trade ratio Intraregional Trade Intensity Regional Trade Introversion Index Revealed Comparative Advantage Regional Orientation Complementarity Export Similarity 48 RCA For Pakistan and India • RCA PAKISTAN • • • • • Pharmaceutical = 2.4 Textile & Clothing = 9.3 Electronics = .038 Leather = 6.14 Automobile = 0.04 • RCA IND • • • • • Pharmaceutical = 14.9 Textile & Clothing = 15.1 Electronics = 4.8 Leather = 1.7 Automobile = 0.5 49 Switching of Trade Arrangements for India from existing positive list to negative list (Case Study) Dr. Naved Ahmad Dr. Ather Elahi Existing Trade Regime Pakistan and India Trade is based on a POSITIVE LIST of 1917 items (Annexure G, Import Policy Order 2009) ◦ Agriculture (HS 1- 24) = 222 Products ◦ Minerals & Ores (HS 25-27) = 65 products ◦ Chemicals (HS 28-29) = 369 ◦ Pharmaceutical (HS 30) =14 ◦ Leather (HS 41) = 33 ◦ Textile (HS 50-59) = 103 ◦ Iron & Steel (HS 72) = 71 ◦ Electronics (HS 85) = 40 Problems with Existing Positive List Arrangement: ◦ Restricted Trade limits the potential of economic growth ◦ Adhoc arrangement --- Various lobbies played a role ◦ Inter-Industry Economic Frictions ◦ Contrary to International Commitments 51 Data Source • UN Comtrade 6-Digit HS Code data. • 8 Digit HS Code data was provided by TDAP. • Software used for Calculating RCA’s & BRCAs is Trade Sift 52 Step-wise Procedure 1. 2. All products which India has not exported in year 2010 are deleted from the negative list.(No threat from India) We have then calculated Normalized RCA’s and excluded those from negative list which are having negative NRCA’s for Indian products. Products in which both countries are competitive and having a positive NRCA are further analyzed by BRCA and those products are excluded which have a BRCA of greater than 1. Pakistani Products having a negative NRCA or BRCA less than 1 are included in the negative list. Finally, We have used BRCA arrive at the 8 – Digit HS code negative list. 3. 4. 5. 53 Product Universe (5677) India Exporting ? No (476) Safe List (3528) Yes (2136) Only those sector are analyzed that face potential threat. (2612) India Exports India Competitive? (NRCA>1) No (1442) Safe List Yes (694) Pak Competitive? (NRCA>1) No (397) Negative List Yes (297) Yes (217) 477 TOTAL No (80) Safe List Bilateral Comparison? (PKBRCA>1) Negative List 54