1 ch. 9: the political economy of trade policy 2 preview the cases for free trade the cases for free...

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Ch. 9: The Political Economy of Trade Policy

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PreviewPreview

The cases for free tradeThe cases for free trade

The cases against free tradeThe cases against free trade

Political models of trade policyPolitical models of trade policy

International negotiations of trade policy and the International negotiations of trade policy and the World Trade OrganizationWorld Trade Organization

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The Case For Free TradeThe Case For Free TradeEfficiency:Efficiency: tariffs distort the producer and tariffs distort the producer and

consumer efficiencies leading to consumer efficiencies leading to deadweight losses.deadweight losses.

High cost firms:High cost firms: protected industries attract protected industries attract more firms and reduce the benefits of more firms and reduce the benefits of economies of scale.economies of scale.

Political argument:Political argument: any government any government intervention will be contaminated by special intervention will be contaminated by special interests. It is better to have a general free interests. It is better to have a general free trade rule.trade rule.

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The Cases for Free TradeThe Cases for Free Trade

The first case for free trade is the argument The first case for free trade is the argument that producers and consumers that producers and consumers allocate allocate resources most efficientlyresources most efficiently when when governments do not distort market prices governments do not distort market prices through trade policy.through trade policy. National welfare of a small country is highest with National welfare of a small country is highest with

free trade.free trade.

With restricted trade, consumers pay higher prices.With restricted trade, consumers pay higher prices.

With restricted trade, distorted prices cause With restricted trade, distorted prices cause overproduction either by existing firms producing overproduction either by existing firms producing more or by more firms entering the industry.more or by more firms entering the industry.

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The Cases for Free TradeThe Cases for Free Trade A second argument for free trade is that allows firms or A second argument for free trade is that allows firms or

industry to take advantage of industry to take advantage of economies of scaleeconomies of scale.. Including the economies of scale calculations, gave an estimate Including the economies of scale calculations, gave an estimate

for Canada at 8.6% in 1984, though Canada was more open at for Canada at 8.6% in 1984, though Canada was more open at the time than either Turkey or the Philippines.the time than either Turkey or the Philippines.

A third argument for free trade is that it provides A third argument for free trade is that it provides competition and opportunities competition and opportunities for innovationfor innovation..

These dynamic benefits would not be reflected in static These dynamic benefits would not be reflected in static estimates of the elimination of efficiency losses of estimates of the elimination of efficiency losses of producers, caused by distorted prices and producers, caused by distorted prices and overproduction.overproduction.

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A fourth argument, called the A fourth argument, called the political political argument for free tradeargument for free trade, says that free trade is , says that free trade is the best the best feasiblefeasible political policy, even though political policy, even though there may be better policies in principle.there may be better policies in principle.

Any policy that deviates from free trade would be Any policy that deviates from free trade would be quickly manipulated by special interests, leading to quickly manipulated by special interests, leading to decreased national welfare.decreased national welfare.

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Political Argument for Free Political Argument for Free TradeTrade

Even if there may be an increase in Even if there may be an increase in national welfare through a regime of national welfare through a regime of tariffs and subsidies, any political tariffs and subsidies, any political decision making process will be decision making process will be captured by interest groups and the captured by interest groups and the outcome will be a redistribution of outcome will be a redistribution of income to the politically influential.income to the politically influential.

It is therefore, better not to provide It is therefore, better not to provide favoritism to anyone.favoritism to anyone.

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The Cases Against Free Trade The Cases Against Free Trade

For a “large” country, a tariff or quota lowers the For a “large” country, a tariff or quota lowers the price of imports in world markets and generates price of imports in world markets and generates a a terms of trade gainterms of trade gain.. This benefit may exceed production and consumption This benefit may exceed production and consumption

distortions.distortions.

In fact, a small tariff will lead to an increase in In fact, a small tariff will lead to an increase in national welfare for a large country.national welfare for a large country. But at some tariff rate, the national welfare will begin But at some tariff rate, the national welfare will begin

to decrease as the economic efficiency loss exceeds to decrease as the economic efficiency loss exceeds the terms of trade gain.the terms of trade gain.

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The Cases Against Free TradeThe Cases Against Free Trade

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An export An export taxtax (a negative export subsidy) that (a negative export subsidy) that completely prohibits exports leaves a country completely prohibits exports leaves a country worse off, but an export tax rate may exist that worse off, but an export tax rate may exist that maximizes national welfare through the terms of maximizes national welfare through the terms of trade.trade.

An export subsidy lowers the terms of trade for a An export subsidy lowers the terms of trade for a large country; an export tax raises the terms of trade large country; an export tax raises the terms of trade for a large country.for a large country.

An export tax may raise the price of exports in the An export tax may raise the price of exports in the world market, increasing the terms of trade.world market, increasing the terms of trade.

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Counter-ArgumentCounter-Argument

For some countries like the US an import tariff or For some countries like the US an import tariff or and export tax could improve national welfare at and export tax could improve national welfare at the expense of other countries.the expense of other countries.

But this argument ignores the likelihood that But this argument ignores the likelihood that other countries may retaliate against large other countries may retaliate against large countries by enacting their own trade countries by enacting their own trade restrictions.restrictions.

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A second argument against free trade is that A second argument against free trade is that domestic market failuresdomestic market failures may exist that cause may exist that cause free trade to be a suboptimal policy.free trade to be a suboptimal policy.

The economic efficiency loss calculations using The economic efficiency loss calculations using consumer and producer surplus assume that markets consumer and producer surplus assume that markets are functioning efficiently.are functioning efficiently.

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Spiral of World Trade: Jan. Spiral of World Trade: Jan. 1929 to Mar. 19331929 to Mar. 1933

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Domestic Market Failure ArgumentDomestic Market Failure ArgumentWhat if protection provides jobs to What if protection provides jobs to

otherwise unemployed?otherwise unemployed?What if free trade would shrink the What if free trade would shrink the

import competing industries but not import competing industries but not increase the size of the exporting increase the size of the exporting industries because the structural shift industries because the structural shift didn’t work?didn’t work?

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What if the technological benefits of an industry What if the technological benefits of an industry were public, spilling over to the society?were public, spilling over to the society?

What if capital was under-utilized?What if capital was under-utilized?

What if free trade increased the environmental What if free trade increased the environmental burden to the society?burden to the society?

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Economists calculate the Economists calculate the marginal social marginal social benefitbenefit to represent the additional benefit to to represent the additional benefit to society from additional production. society from additional production. In each of the market failure cases, marginal social In each of the market failure cases, marginal social

benefit is not accurately measured by the producer benefit is not accurately measured by the producer surplus of private firms, so that economic efficiency surplus of private firms, so that economic efficiency loss calculations are misleading.loss calculations are misleading.

It is possible that a tariff raises domestic It is possible that a tariff raises domestic production, thereby increasing the benefit to production, thereby increasing the benefit to domestic society because a market failure.domestic society because a market failure.

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The Cases Against Free TradeThe Cases Against Free Trade The domestic market failure argument against free trade The domestic market failure argument against free trade

is an example of a more general argument called the is an example of a more general argument called the theory of the second besttheory of the second best..

This theory states that government intervention which This theory states that government intervention which distorts market incentives in one market may increase distorts market incentives in one market may increase national welfare by offsetting the consequences of national welfare by offsetting the consequences of market failures elsewhere.market failures elsewhere. The best policy would be to fix the market failures themselves, The best policy would be to fix the market failures themselves,

but if this is not feasible, then government intervention in another but if this is not feasible, then government intervention in another market may the “second-best” way of fixing the problem.market may the “second-best” way of fixing the problem.

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How Prevalent is Market Failure?How Prevalent is Market Failure?

Market failures are difficult to ascertain.Market failures are difficult to ascertain.Policies to correct market failures are Policies to correct market failures are

even more uncertain.even more uncertain.Should jobs be provided in urban areas to Should jobs be provided in urban areas to

alleviate unemployment?alleviate unemployment?What if this spurs higher immigration rates What if this spurs higher immigration rates

and unemployment actually increases?and unemployment actually increases?

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Can We Get the Same Effect Can We Get the Same Effect Cheaper?Cheaper?

Pw

Instead of trying to solve the market failure through trade, to approach the problem directly is more beneficial. In this case, a production subsidy would only impose the one triangle as cost instead of the two triangles.Which is better: import quotas or production subsidies for steel?

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Counter-ArgumentsCounter-Arguments

Because it is unclear when and to what degree a Because it is unclear when and to what degree a market failure exists in the real world, it is unclear market failure exists in the real world, it is unclear when and to what degree government policies when and to what degree government policies should respond.should respond.

Government policies to address market failures are Government policies to address market failures are likely to be manipulated by politically powerful groups.likely to be manipulated by politically powerful groups.

Because it distorts the incentives of producers and Because it distorts the incentives of producers and consumers, a trade policy may have consumers, a trade policy may have unintended unintended consequencesconsequences that make a situation worse, not better. that make a situation worse, not better.

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Counter-ArgumentsCounter-Arguments

Economist supporting free trade counter- argue Economist supporting free trade counter- argue that domestic market failures should be that domestic market failures should be corrected by a corrected by a ““first-bestfirst-best”” policy: a domestic policy: a domestic policy aimed directly at the source of the policy aimed directly at the source of the problem.problem. If persistently high under-employment of labor is a If persistently high under-employment of labor is a

problem, then the cost of labor or production of labor-problem, then the cost of labor or production of labor-intensive products could be subsidized by the intensive products could be subsidized by the government.government.

These subsidies could avoid the economic efficiency These subsidies could avoid the economic efficiency loss for consumers due to a tariff.loss for consumers due to a tariff.

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http://www.economist.com/finance/displaystory.cfm?story_id=E1_RVQRGGT

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Political Models of Trade PolicyPolitical Models of Trade Policy

How is trade policy determined?How is trade policy determined?

Models that address this question:Models that address this question:

1.1. Median voter theoremMedian voter theorem

2.2. Collective actionCollective action

3.3. A model of trade policy that combines aspects of A model of trade policy that combines aspects of collective action and the median voter theoremcollective action and the median voter theorem

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Median Voter TheoremMedian Voter Theorem

The median voter theorem predicts that The median voter theorem predicts that democratic political parties may change their democratic political parties may change their policies to court the voter in the middle of the policies to court the voter in the middle of the ideological spectrum (i.e., the median voter).ideological spectrum (i.e., the median voter).

Suppose that this ideological spectrum is Suppose that this ideological spectrum is defined only by a tariff rate policy.defined only by a tariff rate policy.

And suppose that voters can be ranked according to And suppose that voters can be ranked according to whether they desire high or low tariff rates.whether they desire high or low tariff rates.

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Thus, the median voter theorem implies that a Thus, the median voter theorem implies that a two-party democracy should enact trade policy two-party democracy should enact trade policy based on how many voters it pleases. based on how many voters it pleases.

A policy that inflicts large losses on a few people A policy that inflicts large losses on a few people (import-competing producers) but benefits a large (import-competing producers) but benefits a large number of people (consumers) should be enacted into number of people (consumers) should be enacted into law. law.

But trade policy doesn’t seem to follow this But trade policy doesn’t seem to follow this prediction. prediction.

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Assumptions of the model:Assumptions of the model:1.1. There are two competing political parties.There are two competing political parties.2.2. The objective of each party is to get elected by The objective of each party is to get elected by

majority vote (not to maintain ideological purity).majority vote (not to maintain ideological purity).

What policies will the parties promise What policies will the parties promise to follow?to follow?

Both parties will offer the same tariff policy to court Both parties will offer the same tariff policy to court the median voter (the voter in the middle of the the median voter (the voter in the middle of the spectrum) in order to capture the most votes on spectrum) in order to capture the most votes on either side of the median voter.either side of the median voter.

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Collective ActionCollective Action

Political activity is often described as a Political activity is often described as a collective action problemcollective action problem: :

While consumers While consumers as a groupas a group have an incentive to have an incentive to advocate free trade, each advocate free trade, each individualindividual consumer has no consumer has no incentive because his benefit is not large compared to incentive because his benefit is not large compared to the cost and time required to advocate free trade.the cost and time required to advocate free trade.

Policies that impose large losses in for society as a Policies that impose large losses in for society as a whole but small losses on each individual may whole but small losses on each individual may therefore not face strong opposition.therefore not face strong opposition.

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Collective ActionCollective Action

However, for those groups who may suffer large However, for those groups who may suffer large losses from free trade (for example, losses from free trade (for example, unemployment), each individual in that group unemployment), each individual in that group has a strong incentive to advocate the policy he has a strong incentive to advocate the policy he desires.desires. In this case, the cost and time required to advocate In this case, the cost and time required to advocate

restricted trade is small compared to the cost of restricted trade is small compared to the cost of unemployment.unemployment.

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A Model of Trade PolicyA Model of Trade Policy

While politicians may win elections partly because they While politicians may win elections partly because they advocate popular policies as implied by the median voter advocate popular policies as implied by the median voter theorem, they also require funds to theorem, they also require funds to run campaigns.run campaigns.

These funds may especially come from groups who do These funds may especially come from groups who do not have a collective action problem and are willing to not have a collective action problem and are willing to advocate a special interest policy.advocate a special interest policy.

Models of policy making try to measure the trade off Models of policy making try to measure the trade off between reduction of overall welfare of constituents in between reduction of overall welfare of constituents in return for additional campaign contributions.return for additional campaign contributions.

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Which Industries Are Protected?Which Industries Are Protected?

AgricultureAgriculture: in the US, Europe and Japan : in the US, Europe and Japan farmers make up a small fraction of the farmers make up a small fraction of the electorate but receive generous subsidies and electorate but receive generous subsidies and trade protection.trade protection.

Examples: European Union’s Common Agricultural Examples: European Union’s Common Agricultural Policy, Japan’s 1000% tariff on imported rice, Policy, Japan’s 1000% tariff on imported rice, America’s sugar quota.America’s sugar quota.

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Which Industries Are Protected? Which Industries Are Protected?

ClothingClothing: textiles (fabrication of cloth) and : textiles (fabrication of cloth) and apparel (assembly of cloth into clothing).apparel (assembly of cloth into clothing).

Import licenses for textile and apparel exporters are Import licenses for textile and apparel exporters are specified in the Multi-Fiber Agreement between the specified in the Multi-Fiber Agreement between the US and many other nations.US and many other nations.

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Which Industries Are Protected? Which Industries Are Protected?

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International Negotiations of Trade International Negotiations of Trade PolicyPolicy

The average US tariff rate on dutiable imports The average US tariff rate on dutiable imports has decreased substantially from 1920–1993.has decreased substantially from 1920–1993.

Since 1944, much of the reduction in tariffs and Since 1944, much of the reduction in tariffs and other trade restrictions came about through other trade restrictions came about through international negotiations.international negotiations. The The General Agreement of Tariffs and TradeGeneral Agreement of Tariffs and Trade was was

begun in 1947 as a provisional international begun in 1947 as a provisional international agreement and was replaced by a more formal agreement and was replaced by a more formal international institution called the international institution called the World Trade World Trade OrganizationOrganization in 1995. in 1995.

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International Negotiations International Negotiations of Trade Policyof Trade Policy

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Spiral of World Trade: Jan. Spiral of World Trade: Jan. 1929 to Mar. 19331929 to Mar. 1933

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Multilateral negotiation mobilize exporters to Multilateral negotiation mobilize exporters to support free trade if they believe export markets support free trade if they believe export markets will expand.will expand.

This support would be lacking in a unilateral push for This support would be lacking in a unilateral push for free trade.free trade.

This support counteracts the support for restricted This support counteracts the support for restricted trade by import-competing groups.trade by import-competing groups.

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NegotiationNegotiation

It is best for a country to eliminate tariffs It is best for a country to eliminate tariffs regardless of what other countries do.regardless of what other countries do.

The political economy of trade doesn’t The political economy of trade doesn’t allow countries to follow this policy.allow countries to follow this policy.

International negotiation allows each International negotiation allows each country to “sell” her citizens the idea country to “sell” her citizens the idea that they won for their export industries that they won for their export industries even though they lowered tariffs.even though they lowered tariffs.

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Multilateral negotiations also help avoid a trade Multilateral negotiations also help avoid a trade war between countries, where each country enacts trade war between countries, where each country enacts trade restrictions.restrictions.

If each country has a political interest (due to political If each country has a political interest (due to political pressure) to protect domestic producers, pressure) to protect domestic producers, regardless of regardless of what other countries do,what other countries do, then all countries could enact trade restrictions, then all countries could enact trade restrictions, even if it is in the even if it is in the

interest of all countries to have free tradeinterest of all countries to have free trade..

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In this simple example, each country acting In this simple example, each country acting individually would be better off with protection, individually would be better off with protection, but both would be better off if both chose free but both would be better off if both chose free trade.trade.

If Japan and the US can establish a binding If Japan and the US can establish a binding agreement to maintain free trade, both can avoid agreement to maintain free trade, both can avoid the temptation of protection and both can be the temptation of protection and both can be made better off.made better off.

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World Trade OrganizationWorld Trade Organization

The WTO negotiations addresses trade The WTO negotiations addresses trade restrictions in at least 3 ways:restrictions in at least 3 ways:

1.1. Reduction of tariff ratesReduction of tariff rates through multilateral through multilateral negotiations.negotiations.

2.2. BindingBinding: a tariff is “bound” by having the : a tariff is “bound” by having the imposing country agree not to raise it in the imposing country agree not to raise it in the future.future.

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3.3. Prevention of non-tariff barriersPrevention of non-tariff barriers: quotas and : quotas and export subsidies are changed to tariffs because export subsidies are changed to tariffs because the costs of tariff protection are more apparent.the costs of tariff protection are more apparent.

Subsidies for agricultural exports are an exception.Subsidies for agricultural exports are an exception.

Exceptions are also allowed for “market disruptions” Exceptions are also allowed for “market disruptions” caused by a surge in imports.caused by a surge in imports.

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The World Trade Organization was founded in The World Trade Organization was founded in 1995 on a number of agreements 1995 on a number of agreements

General Agreement on Tariffs and Trade: General Agreement on Tariffs and Trade: covers trade in goodscovers trade in goods

General Agreement on Tariffs and Services: covers General Agreement on Tariffs and Services: covers trade in services (e.g., insurance, consulting, legal trade in services (e.g., insurance, consulting, legal services, banking).services, banking).

Agreement on Trade-Related Aspects of Intellectual Agreement on Trade-Related Aspects of Intellectual Property: covers international property rights (e.g., Property: covers international property rights (e.g., patents and copyrights).patents and copyrights).

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The dispute settlement procedure: a formal procedure The dispute settlement procedure: a formal procedure where countries in a trade dispute can bring their where countries in a trade dispute can bring their case to a panel of WTO experts to rule upon.case to a panel of WTO experts to rule upon.

The cases are settled fairly quickly: even with appeals The cases are settled fairly quickly: even with appeals the procedure is not supposed to last more than 15 the procedure is not supposed to last more than 15 months.months.

The panel uses previous agreements by member The panel uses previous agreements by member countries to decide which ones are breaking their countries to decide which ones are breaking their agreements.agreements.

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A country that refuses to adhere to the panel’s A country that refuses to adhere to the panel’s decision may be punished by allowing other countries decision may be punished by allowing other countries to impose trade restrictions on its exports. to impose trade restrictions on its exports.

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The GATT/WTO multilateral negotiations ratified The GATT/WTO multilateral negotiations ratified in 1994 (called the Uruguay Round),in 1994 (called the Uruguay Round), agreed that all quantitative restrictions (e.g., quotas) agreed that all quantitative restrictions (e.g., quotas)

on trade in textiles and clothing as previously on trade in textiles and clothing as previously specified in the Multi-Fiber Agreement were to be specified in the Multi-Fiber Agreement were to be eliminated by 2005.eliminated by 2005.

But as the restrictions were eliminated (mostly in But as the restrictions were eliminated (mostly in 2005), political pressure to again restrict trade in 2005), political pressure to again restrict trade in textiles and clothing has grown. textiles and clothing has grown.

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Preferential Trading Preferential Trading AgreementsAgreements

Preferential trading agreements are trade agreements Preferential trading agreements are trade agreements between countries in which they lower tariffs for each between countries in which they lower tariffs for each other but not for the rest of the world.other but not for the rest of the world.

Under the WTO, such discriminatory trade policies are Under the WTO, such discriminatory trade policies are generally not allowed:generally not allowed: Each country in the WTO promises that all countries will pay Each country in the WTO promises that all countries will pay

tariffs no higher than the nation that pays the lowest: called the tariffs no higher than the nation that pays the lowest: called the “most favored nation” (MFN) principle.“most favored nation” (MFN) principle.

An exception to this principle is allowed only if the lowest tariff An exception to this principle is allowed only if the lowest tariff rate is set at zero. rate is set at zero.

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Preferential Trading AgreementsPreferential Trading Agreements

There are two types of preferential trading There are two types of preferential trading agreements in which tariff rates are set at or agreements in which tariff rates are set at or near zero:near zero:

1.1. A A free trade areafree trade area: an agreement that allows : an agreement that allows free trade among members, but each member free trade among members, but each member can have its own trade policy towards non-can have its own trade policy towards non-member countriesmember countries

An example is the North America Free Trade An example is the North America Free Trade Agreement (NAFTA).Agreement (NAFTA).

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2.2. A A customs unioncustoms union: an agreement that allows : an agreement that allows free trade among members and requires a free trade among members and requires a common external trade policy towards non-common external trade policy towards non-member countries.member countries.

An example is the European Union.An example is the European Union.

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Are preferential trading agreements necessarily Are preferential trading agreements necessarily good for national welfare?good for national welfare?

No, it is possible that national welfare decreases No, it is possible that national welfare decreases under a preferential trading agreement.under a preferential trading agreement.

How? Rather than gaining tariff revenue from How? Rather than gaining tariff revenue from inexpensive imports from world markets, a inexpensive imports from world markets, a country may import expensive products from country may import expensive products from member countries but not gain any tariff member countries but not gain any tariff revenue.revenue.

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Preferential trading agreements increase national Preferential trading agreements increase national welfare when new trade is created, but not when existing welfare when new trade is created, but not when existing trade from the outside world is diverted to trade with trade from the outside world is diverted to trade with member countries.member countries.

Trade creation Trade creation occurs when high cost domestic production is replaced by occurs when high cost domestic production is replaced by low low

cost imports from other memberscost imports from other members..

Trade diversion Trade diversion occurs when low cost imports from non-members are diverted to occurs when low cost imports from non-members are diverted to

high cost imports from member nations.high cost imports from member nations.

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US Tariff History in 20US Tariff History in 20thth CenturyCentury

At the beginning of the century average At the beginning of the century average tariffs were under 20%.tariffs were under 20%.

In the 1920s the tariff rates rose to 40%.In the 1920s the tariff rates rose to 40%. In the 1930s it rose to 60%.In the 1930s it rose to 60%. In the 1940s it fell to 40%.In the 1940s it fell to 40%.From 1950 on the rate has been below From 1950 on the rate has been below

10% and steadily falling to 5%.10% and steadily falling to 5%.

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Smoot-Hawley ActSmoot-Hawley ActCongress started to discuss in 1929.Congress started to discuss in 1929.Tariff rates were raised steeply in the Tariff rates were raised steeply in the

1930s.1930s.US trade fell sharply; other countries US trade fell sharply; other countries

retaliated.retaliated.US GDP fell with a prolonged US GDP fell with a prolonged

depression.depression.

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Rescinding Smoot-HawleyRescinding Smoot-Hawley

Tariff reductions were considered Tariff reductions were considered necessary.necessary.

Import competing areas would not vote for Import competing areas would not vote for reductions.reductions.

Exporter support was needed.Exporter support was needed. Bilateral negotiations provided the political Bilateral negotiations provided the political

background.background. Average tariff rate was reduced from 59% in Average tariff rate was reduced from 59% in

1930s to 25% after WWII.1930s to 25% after WWII.

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Bilateral NegotiationsBilateral NegotiationsSpillover effects make it necessary to Spillover effects make it necessary to

include others in the negotiations: include others in the negotiations: multilateral negotiations.multilateral negotiations.

US reduced tariffs for Brazilian coffee.US reduced tariffs for Brazilian coffee.US is major consumer; it imports more US is major consumer; it imports more

and world price of coffee rises.and world price of coffee rises.Columbia benefits from the agreement Columbia benefits from the agreement

between US and Brazil.between US and Brazil.

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Agricultural LiberalizationAgricultural LiberalizationAgricultural export subsidies to be Agricultural export subsidies to be

reduced by 36%.reduced by 36%.The volume of subsidized exports to be The volume of subsidized exports to be

reduced by 21%.reduced by 21%. Import quotas on agriculture to be Import quotas on agriculture to be

replaced by tariffs.replaced by tariffs.

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Clothing LiberalizationClothing LiberalizationMulti-Fiber Agreement (MFA) to be Multi-Fiber Agreement (MFA) to be

phased out by 2005.phased out by 2005.All import quotas on textiles and apparel All import quotas on textiles and apparel

to be eliminated but tariffs may remain.to be eliminated but tariffs may remain.The measures do not have to be acted The measures do not have to be acted

on until 2003.on until 2003.

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Procurement LiberalizationProcurement LiberalizationTypically, government procurement has Typically, government procurement has

been limited to domestic firms.been limited to domestic firms.Uruguay Round opened up government Uruguay Round opened up government

contracts to foreign companies.contracts to foreign companies.

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Administrative ReformsAdministrative ReformsGATT is replaced by WTO.GATT is replaced by WTO.WTO has rules for speedy resolution of WTO has rules for speedy resolution of

disputes among members.disputes among members.GATT took decades to resolve disputes.GATT took decades to resolve disputes.GATT did not have enforcement power.GATT did not have enforcement power.WTO allows affected countries to WTO allows affected countries to

retaliate.retaliate.An example: An example: banana wars.

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GATSGATS Another agreement signed by Uruguay Round was Another agreement signed by Uruguay Round was

General Agreement on Trade in Services.General Agreement on Trade in Services. Services comprise almost 2/3 of the GDP of Services comprise almost 2/3 of the GDP of

advanced nations and more than 1/5 of total trade.advanced nations and more than 1/5 of total trade. Trade in banking, insurance, accounting have been Trade in banking, insurance, accounting have been

subject to regulation that kept foreign suppliers out subject to regulation that kept foreign suppliers out of a nation’s market.of a nation’s market.

GATS established the rules upon which future GATS established the rules upon which future negotiations on removing trade barriers in services negotiations on removing trade barriers in services will take place.will take place.

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The Impact of Uruguay RoundThe Impact of Uruguay Round

It is expected that once the provisions are It is expected that once the provisions are in force (2005), world income will in force (2005), world income will increase by a full percentage point, increase by a full percentage point, although there is no consensus on this.although there is no consensus on this.

What is sure to happen is protected What is sure to happen is protected industries like agriculture and clothing will industries like agriculture and clothing will be adversely affected: costs will be felt by be adversely affected: costs will be felt by concentrated, well-organized groups.concentrated, well-organized groups.

Benefits will be diffuse and unnoticed.Benefits will be diffuse and unnoticed.

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MFN: Most Favored NationMFN: Most Favored Nation GATT (and WTO) rules require that if GATT (and WTO) rules require that if

tariffs are reduced for one country, they tariffs are reduced for one country, they should apply to all countries.should apply to all countries.

The US reduces tariffs on t-shirts from The US reduces tariffs on t-shirts from India; it should apply the same low tariff India; it should apply the same low tariff to Pakistan and China and Turkey.to Pakistan and China and Turkey.

There is an exception to this rule: Free There is an exception to this rule: Free Trade Areas or Customs Unions do not Trade Areas or Customs Unions do not have to abide by this rule. They can have to abide by this rule. They can charge a higher rate outside the charge a higher rate outside the membership.membership.

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FTA and CUFTA and CU

Free Trade Area is a collection of Free Trade Area is a collection of countries that eliminated tariffs among countries that eliminated tariffs among themselves but are free to impose any themselves but are free to impose any tariff they want to outsiders.tariff they want to outsiders.

Customs Union is a collection of Customs Union is a collection of countries that eliminated tariffs among countries that eliminated tariffs among themselves and have the same tariff themselves and have the same tariff against outsiders.against outsiders.

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Problem with FTAProblem with FTA In order to restrict re-exporting, there In order to restrict re-exporting, there

needs to be extensive checks at the needs to be extensive checks at the border.border.

If US has high tariffs against sugar but If US has high tariffs against sugar but Canada doesn’t, Canadians could Canada doesn’t, Canadians could import sugar and then re-export them to import sugar and then re-export them to the US as if they were Canadian sugar.the US as if they were Canadian sugar.

Documentation becomes important.Documentation becomes important.

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Efficiency Problem with FTA and CUEfficiency Problem with FTA and CUUS has tariffs on textiles. Even with US has tariffs on textiles. Even with

tariff, US imports from low cost tariff, US imports from low cost producer, Pakistan.producer, Pakistan.

US is part of NAFTA and tariffs between US is part of NAFTA and tariffs between US and Mexico are eliminated. Mexico US and Mexico are eliminated. Mexico becomes the cheaper textile producer.becomes the cheaper textile producer.

Trade is diverted from the low cost Trade is diverted from the low cost producer.producer.

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Efficiency Problem with FTA and CUEfficiency Problem with FTA and CU

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Pmexico

Pp+t

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Efficiency Problem with FTA and CUEfficiency Problem with FTA and CU

Ppakistan

Pmexico

Pp+t

1 ch. 9: the political economy of trade policy 2 preview the cases for free trade the cases for free...

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