INTERNATIONAL ECONOMIC POLICY AND

DEVELOPMENTAA 2018-2019

PROF. PIERLUIGI MONTALBANOpierluigi.montalbano@uniroma1.it

Trade Policy

Trade policy The government of a country can use laws and regulations, called

“trade policies,” to affect international trade flows

The most commonly used trade policies are:

• Import Tariffs: A tax on a good coming into a country

• Import Quotas: Physical restriction on the number of goods coming into a country

• Non-Tariff Barriers: Any methods not covered by a tariff (ex: standards on fuel emissions from cars; documentation required to sell drugs in different countries; ingredients in products ; etc), most usually:

– Rules

– Regulations

– Voluntary Export Restraints (VERs)

– Legislation

– Exacting Standards or Specifications

Arguments pro-protectionismCommon reasons in favour of protectionism:

• Protect domestic industries

• Protect domestic employment

• Strategic reasons

• Political pressures (lobbies)

From a theoretical standpoint, the traditional and modern approaches to the trade theory substantially agreed on the fact that protection produces distortive effects on the economy that introduces it.

But there are cases of protectionism contemplated by theory:• Optimal tariff: for a “large” country, a small tariff or quota lowers the price of

imports in world markets leading to an increase in national welfare that may exceed the losses caused by distortions (but risk of retaliation!).

• Theory of the second best: if domestic market failures exist (persistently high under-employment of workers, under-utilization of capital, environmental costs for society , property rights not well defined ), free trade can be a suboptimal policy (government intervention may increase national welfare by offsetting the consequences of market failures)

Costs and Benefits of Import tariffs: the small country’s case

We examine the effect of an import tariff on Home’s welfare by assuming that Home is a small country taking the world price as fixed (the world price is unchanged by the tariff applied by the importing country).

• Applying a tariff of t dollars will increase the import price from PW to PW + t.

• The domestic price of that good also will rise to PW + t. This price rise leads to an increase in Home supply from S1 to S2, and a decrease in Home demand from D1 to D2.

• Imports fall due to the tariff from S1D1 to S2D2.

0

Import tariff: the small country’s case -2

Effects of Tariff :

Consumer Surplus (difference between what the consumers are willing to pay, represented by the demand curve, minus what they actually pay): it falls by (a + b + c + d).

Producer Surplus (area between the price received and the marginal cost of production, given by the supply curve): it rises by area a

Government Revenue: it increases by the area c

Overall Effect: the net loss in welfare is (b + d)

• The area of triangle b can be interpreted as the production loss (or the efficiency loss).

• The area of the triangle d can be interpreted as the consumption loss due to the higher price.

FIGURE 8-5 (2 of 2)

Effect of Tariff on

Welfare (continued)

Therefore, the net loss

in welfare, the

deadweight loss to

Home, is (b + d),

which is measured by

the two triangles b and

d in panel (a) or the

single (combined)

triangle b + d in panel

(b).

Effect of Tariff on Consumer Surplus, Producer Surplus, Government

Revenue, Overall Effect of the Tariff on Welfare, Production Loss and

Consumption Loss

The triangle (b + d) is a deadweight loss, or

a loss that is not offset by a gain elsewhere in

the economy

Fall in consumer surplus: − (a + b + c + d)

Rise in producer surplus: + a

Rise in government revenue: + c

Net effect on Home welfare: − (b + d)

3 Import Tariffs for a Small Country

MtWL

2

1

Effect of Tariff on Consumer Surplus, Producer Surplus, Government

Revenue, Overall Effect of the Tariff on Welfare, Production Loss and

Consumption Loss

Summing up, in addition to deadweight loss (triangle (b +

d)), there are other losses:

• The area of triangle b equals the increase in marginal costs for

the extra units produced and can be interpreted as the

production loss (or the efficiency loss) for the economy due to

producing at marginal cost above the world price.

• The area of the triangle d can be interpreted as the drop in

consumer surplus for those individuals who are no longer able

to consume the units between D1 and D2 because of the higher

price. We refer to this drop in consumer surplus as the

consumption loss for the economy.

3 Import Tariffs for a Small Country

Import tariff: the small country’s case -3

The use of a tariff by a small importing country always leads to a net loss in welfare. We call that loss the “deadweight loss.”

• If a small country suffers a loss when it imposes a tariff, why do so many have tariffs as part of their trade policies?

• One answer is that a developing country does not have any other source of government revenue. Import tariffs are “easy to collect.”

• A second reason is politics. The benefits to producers (and their workers) are typically more concentrated on specific firms and states than the costs to consumers, which are spread nationwide.

TABLE 8-1

APPLICATIONU.S. Tariffs on Steel and Tires

U.S. ITC Recommended and Actual Tariffs for Steel Shown here are the tariffs recommended by

the U.S. International Trade Commission for steel imports, and the actual tariffs that were

applied in the first year.

Response of the European Countries

• The WTO has a formal dispute settlement procedure

under which countries that believe that the WTO rules

have not been followed can bring their complaint and

have it evaluated.

• The countries in the European Union (EU) took action by

bringing the case to the WTO. The WTO ruling entitled

the European Union and other countries to retaliate

against the United States by imposing tariffs of their own

against U.S. exports.

• The use of tariffs by an importer can easily lead to a

response by exporters and a tariff war.

APPLICATIONU.S. Tariffs on Steel and Tires

Copyright 2008 Worth Publishers ▪

International Trade ▪ Feenstra/Taylor

Is there a link btw steel and Orange Juice?

Actually yes! Tariffs on steel applied by G.W.Bush in March 2000 were removed in 2 years;

Why? Because in 2002, the DSB allowed EU 2,2 billion dollars of retaliatory tariffs to US exports;

In the EU list of retaliatory tariffs there were oranges/orange juice coming from Jeb Bush’s FloridaL) as well as toilet paper (key product of US paper industry)

Is Trump right?

US steel producers are about 1,500 (almost 30,000 US firms use steel and alominum for their own production)

Estimates show that about +33,500 new jobs will be created in the steel industry (-179,300 will be destroied in the rest of the economy);

All this exluding the cost of retaliation;

Figure 1.4 Average Worldwide Tariffs, 1860–2000

Feenstra and Taylor: International Economics, Second EditionCopyright © 2011 by Worth Publishers

Tariffs 1860–2000

Trade wars2 Examples:

Banana Wars: The banana wars started in 1993 when the European Union set a rigid tariff quota for banana imports from America and quotas favoring banana imports from former colonies. The preferential policies—whose aims were to assist the development of former colonies—were challenged by American banana companies and the Latin American countries where bananas were grown. The suit finally ended in late 2009.

American sugar: In an effort to protect American farmers from import competition, the United States imposes import quotas on foreign sugar. As a result of the restriction, the domestic sugar price has been two to three times higher than the world price for the past 25 years. However, the sugar program may need to change given that the world price of sugar has now risen to the U.S. level and a shortage exists. Under the current condition, the U.S. government could potentially remove the import quota, which would improve domestic welfare. Not surprisingly, the U.S. sugar producers have a strong incentive to maintain the status quo by lobbying for limits on trade expansion.

Other trade policy measures:Export Subsidy

An export subsidy is payment to firms for every unit .

Governments give subsidies to encourage domestic firms to produce more in particular industries.

Examples:

• Europe maintains a system of agricultural subsidies known as the Common Agricultural Policy (CAP).

• Other countries maintain similarly generous subsidies. For example, the U.S. pays cotton farmers to grow more cotton and subsidizes agribusiness and manufacturers to buy the American cotton.

Other Trade Policy measures :Voluntary Export Restraint

A voluntary export restraint (VER) is a trade restriction on the quantity of a good that an exporting country is allowed to export to another country.

This limit is self-imposed by the exporting country but usually requested by the importing country to provide a measure of protection for its domestic businesses that produce substitute goods.

VERs are often created because the exporting country would prefer to impose its own restrictions than risk sustaining worse terms from tariffs and/or quotas

Examples: The most notable example of VERs is when Japan imposed a VER on its auto exports into the U.S. as a result of American pressure in the 1980s

Other Trade Policy measures:Anti-dumping

Dumping is the practice of a Foreign firm exporting goods at a price that is below its own domestic price or below its average cost of production (example of price discrimination and unfair competition).

Countries respond to dumping by imposing antidumping duties on imports.

Under the rules of the WTO, an importing country is entitled to apply an antidumping tariff any time that a foreign firm is dumping its product.

Examples of antidumping duty :

• the tariff that the European Union applies to imports of shoes from China and Vietnam or imports of steel bars from China.

• the tariff applied by the US to the imports of solar panels from China

Trade Agreements(multilateral & regional)

International Trade Agreements• When countries seek to reduce trade barriers (trade

liberalization) between themselves, they enter into a trade agreement—a pact to reduce or eliminate trade restrictions.

• There are two primary types of free-trade agreements: multilateral and regional/bilateral agreements.

• Multilateral agreements are negotiated among large groups of countries to reduce trade barriers among them

• The WTO is an example of a multilateral trade agreement

Integration & interaction link

• There has been lively debate among economists, on the effectiveness of trade

liberalisation, for centuries.

• Dissemination of the free trade doctrine occurred in Europe in the nineteenth

century (i.e. A. Smith, 1776; D. Ricardo 1815)

• The 1860 Cobden-Chevalier Treaty, and introduction of the ‘most favoured

nation’ (MFN) clause, played a key role in trade history in the second half of

the nineteenth century (Bairoch, 1976, 1989)

• Most favoured nation (MFN) is a status or level treatment awarded by one

nation to another in international trade. Each member treats all the other

members equally as “most-favoured” trading partners. If a country improves

the benefits that it gives to one trading partner (i.e. a lower customs duty rate

for one of their products), it has to give the same “best” treatment to all the

other partners of the agreement

process of trade liberalisation

phenomenon of increased world trade linkages

• Following this treaty, between 1863 and the 1866, most European countries, through treaties signed with France or the UK, became part of a dense network of spontaneous and informal free trade agreements, which became known as ‘the network of Cobden-Chevalier Treaties’.

• In a period of 15 years, this led to the conclusion of 56 similar PTAs in Europe, liberalising trade (mostly on manufactured goods) to a large extent.

• This guaranteed the development of free trade among the main trading powers for around 20 years.

• Economic depression and the economic and social consequences of World War I opened the way to a return of protectionism.

The Cobden-Chevalier Treaty

The ‘Mother of all Spaghetti Bowls’: The Cobden-Chevalier Network in 1875

Source: Lampe (2011)Note: Lines represent unconditional MFN-PTAs signed between 1857 and 1875

A Brief History of the MultilateralTrade Negotiations

• After World War II, the Allied countries met to discuss issues such as high trade barriers and unstable exchange rates.

• In 1947 the General Agreement on Tariffs and Trade (GATT) was established to reduce barriers to trade between nations.

• Under the most favored nation principle of the GATT/WTO, the

lower tariffs agreed to in multilateral negotiations must be

extended equally to all GATT/WTO members.

• A central exception to the MFN is for customs unions and free trade areas.

Two reasons:

• 1. such agreements can contribute to the growth of world trade.

• 2. regional trade liberalization can serve as a building block to further

liberalization at the multilateral level

International ConferencesSingapore (1996); Geneva (1998); Seattle (1999); Doha (2001); Cancùn (2003), Hong Kong (2005), Geneva (2009 and 2011), Bali (2013), Nairobi (2015), Buenos Aires (2017)

Critical Issues: About 80% of members countries are DCs Regionalism NTBFailure of DDA state of deadlock

Scheme

Location: Geneva,

Switzerland

Born: 1 January 1995

Agreement: Uruguay

Round (1986-1994)

Members: 164 countries

since 29 July 2016

Staff: 640

Head: Roberto Azevêdo

(Director-General)

Functions: • Administering WTO trade agreements• Forum for trade negotiations• Handling trade disputes• Monitoring national trade policies• Technical assistance and training for developing countries• Cooperation with other international organizations Switzerland

Its main function is to ensure that trade flows as smoothly, predictably and freely as possible

AlgeriaAndorraAzerbaijanBahamasBelarusBhutanBosnia and HerzegovinaComorosEquatorial GuineaEthiopiaHoly See (Vatican)IranIraqLebanese RepublicLibyaSao Tomé and PrincipeSerbiaSomaliaSudanSyrian Arab RepublicTimor-LesteUzbekistan

Observer governments

Andrew K. Rose’s critique

Professor of Economic Analysis and Policy

University of California at Berkeley

http://faculty.haas.berkeley.edu/arose/

3 key papers:

1. Rose, Andrew K. (2004a) “Do We Really Know that the

WTO Increases Trade?” American Economic Review.

2. Rose, Andrew K. (2004b) “Do WTO Members have

More Liberal Trade Policy?” Journal of International

Economics.

3. Rose, Andrew K. (2005c) “Which International

Institutions Promote International Trade?” Review of

International Economics.

David Hume’s Price Specie-Flow Mechanism

But if England has a more productive economy (Industrial Revolution), its demand for money will be higher, in proportion to its higher GDP.

If the economies are closed off, the disproportionatelyhigh money supply in Spain will drive up its price level.

Initially, Spain piles up gold, from the New World (mercantilism).

model developed by Scottish economist David Hume (1711–1776) to illustrate how trade imbalances can be self-correct

and adjust under the gold standard.

ITF-220 - Prof.J.Frankel

Hume’s Price Specie-Flow Mechanism

If trade is open, then money flows to England (Spain runs a balance of payments deficit), until prices are equalized internationally.

continued

Multilateralism vs Regionalism Under the WTO, such discriminatory trade policies are generally

not allowed:

• the “most favored nation” (MFN) principle states: ”Grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members”

BUT:

Article XXIV: allows members to form an RTA provided they:

1. eliminate within-union trade barriers on “substantially” all trade

2. do not raise trade barriers on goods produced outside the union

Article XXIV recognizes:

- free-trade areas, in which a group of countries voluntarily agree to

remove trade barriers between themselves, and

- customs unions, which are free-trade areas in which the countries also

adopt identical tariffs between themselves and the rest of the world.

Multilateralism vs Regionalism

Contrasting stances among economists:

1. Regionalism is an alternative to multilateralism (a stumbling bloc) Bhagwati (1998)

2. Regionalism is a useful supplements to multilateralism (a building bloc) Ethier (1998) e Baldwin (1999).

Are RTAs desirable?

“Classical” answer:• “It all depends”. Different degrees of preferences, depth of

integration, country coverage , country size etc.

Regional Agreements

• Regional agreements operate among a smaller group of countries, often in the same region

• Regional trade agreements are also known as “preferential trade agreements,” because they give preferential treatment (i.e., free trade) to the countries included within the agreement, but maintain tariffs against outside countries.

Regional integration:RTAs classification

3. COMMON MARKET (CM): CU + free movement of factors of production among member-countries

2. CUSTOMS UNION (CU): FTA + common external tariff (CET)

1. FREE TRADE AREA (FTA): eliminates protection among members but each member keeps its own tariff structure

Regional economic integration can be classified into 4 stages (Machlup, 1977)By increasing order of integration:

4. ECONOMIC UNION: CM + single currency and common economic policiesEx. Economic and Monetary Union of the EU

34

Levels of Integration

E

M

U

Effects of trade agreements

The welfare gains and losses that arise from regional trade agreements are more complex than those that arise from multilateral trade agreements

2 main effects:

• Trade creation: occurs when high-cost domestic production is replaced by low-cost imports from other members.

• Trade diversion: occurs when low-cost imports from nonmembers are diverted to high-cost imports from member nations.

Trade Diversion in a Graph

1 International Trade Agreements

FIGURE 11-3 (1 of 2)

Trade Diversion

With Mexico and Asia

facing the same tariff of t

for sales into the United

States, the equilibrium is at

A

with the quantity Q2

exported by Mexico and the

remainder exported by Asia

at a price of Pasia + t.

Trade Diversion in a Graph

1 International Trade Agreements

FIGURE 11-3 (1 of 2)

Trade Diversion

(continued)

U.S. tariff revenue is the

area (a + b + c + d).

Eliminating the tariff with

Mexico under NAFTA leads

to an expansion of Mexican

exports to Q3.

The United States loses the

tariff revenue (a + b + c),

which is the U.S. loss as a

result of trade diversion

from Asia to Mexico.

Loss in U.S. tariff revenue: − (a + b + c )

Gain in Mexico’s producer surplus: + (a + b)

Combined effect due to NAFTA: − c

During the last decades there has been a rapid growth in the number of regionaltrade agreements.

Regional economic integration

Source: WTO 2016

‘Spaghetti bowl’ RTAs in the Western Hemisphere

Source: Baldwin, 2009

Source: WTO Secretariat

Participation in RTAs by country

EGR

IR

L

FIN

IS

EFTA-7

EEC-6

West European Trade Arrangements in 1960s:The EFTA-7 and the EEC-6 form two non-overlapping circles.

N

S

PCH

A

UKI

D

F

BL

NL

DK

EGR

IR

L

FIN

IS

EFTA-7

EEC-6

West European Trade Arrangements in 1960s:The EFTA-7 and the EEC-6 form two non-overlapping circles.

N

S

PCH

A

UKI

D

F

BL

NL

DK

Fonte: Baldwin, Wyplosz (2003)

Mega-regionals The Transatlantic Trade and Investment Partnership

TTIP(EU+US), the Trans-Pacific Partnership TPP (Trans-Pacificamong Australia, Brunei Darussalam, Canada, Chile, Japan,Malaysia, Mexico, New Zealand, Peru, Singapore, US, Vietnam)now Comprehensive and Progressive Trans-Pacific Partnership(CPTPP) and the Regional Comprehensive Economic PartnershipRCEP (ASEAN+ Australia, China, India, japan, South Korea, NewZealand) represent over three quarters of global GDP and twothirds of world trade (Ash & Lejarraga, 2014)

The sheer size of the mega-regions means that there would beeffects on third parties

The outcomes of the mega-regionals for rules on trade andinvestment, trade-related standards and regulation would likelydrive the international rules and standards

Nenci, S.

• The Transatlantic Trade and Investment Partnership (TTIP) is a trade agreement being negotiated between the European Union and the United States (talks started in July 2013)

• It aims at removing trade barriers in a wide range of economic sectors

• On top of cutting tariffs across all sectors, the EU and the US want to tackle non tariff barriers such as differences in technical regulations, standards and approval procedures

• The TTIP negotiations will also look at opening both markets for services, investment, and public procurement. They could also shape global rules on trade.

The Trans-Atlantic Trade and Investment Partnership (TTIP)

Effects of TTIP

TTIP is designed to drive growth and create jobs.

Independent research shows that TTIP could boost:

• the EU's economy by €120 billion;

• the US economy by €90 billion;

• the rest of the world by €100 billion

Trade diverting effects are mainly observed for Brazil and China and negative welfare effects for LDCs (Brockmeier & al, 2014)

The Trans Pacific Partnership (TPP)

• The Trans-Pacific Partnership (TPP) is a regional trade agreement of broad scope and comprehensive coverage.

• The TPP partners included 12 countries on both sides of the Pacific that participate in negotiations: Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States, and Vietnam.

• The TPP Agreement included 30 chapters covering trade and trade-related issues (trade in goods; customs and trade facilitation; sanitary and phytosanitary measures; technical barriers to trade; trade remedies; investment; services; electronic commerce; government procurement; intellectual property; labour; environment).

• The Trans-Pacific Partnership (TPP) was the centerpiece of President Barack

Obama’s strategic pivot to Asia. It was set to become the world’s largest free

trade deal, covering 40 percent of the global economy.

• Formal negotiations began in March 2010 and concluded in October 2015. Finalagreement signed by trade minister on February 4, 2016. President Trump

withdrew the United States in 2017.

TPP members were already part of existing Asia-Pacific FTAs

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