international economics

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

The World of International Economics

Chapter 1 Taught by CHAN BONNIVOIT

1-2

Introduction

International trade and finance have never been more important.

Signs of globalization are everywhere.

1-3

International Trade: Questions

Well explore these questions: What are the effects of trade? What determines the basis of trade? What determines the value and volume

of trade? What factors impede the flow of trade? What happens when policies impede

the flow of trade?

1-4

International Monetary Economics: Questions

Well explore these questions: What is a countrys balance of

payments? How are exchange rates determined? What makes capital flow between

countries? What policies should countries pursue?

1-5

The Nature of Merchandise Trade

The volume and value of world exports have grown tremendously.

The value of global exports was $15.8 trillion in 2008; it was $2 trillion in 1985.

Over the past 40 years, global trade has grown faster than global production.

1-6

Growth in World Production and Trade, 1963-2007 (average annual percentage change in volume)

1963-73 1970-79 1980-85 2000-07 Production All commodities 6.0% 4.0% 1.7% 3.0% Agriculture 2.5 2.0 2.9 2.5 Mining 5.5 2.5 -2.7 1.5 Manufacturing 7.5 4.5 2.3 3.0 Exports All commodities 9.0% 5.0% 2.1% 5.5% Agriculture 14.0 4.5 1.0 4.0 Mining 7.5 1.5 -2.7 3.5 Manufacturing 11.5 7.0 4.5 6.5

1-7

Geographical Composition of Trade

North America, Europe, and Asia dominate global exporting and importing.

These regions tend to trade with other countries in the same region.

1-8

Merchandise Exports and Imports by Region, 2007 (billions of dollars) Value of Exports Share Value of Imports Share North America $1,853.5 13.3% 2,707.5 19.0% South and Central America 499.2 3.6 456.0 3.2 Europe 5,772.2 41.4 6,060.8 42.5 Commonwealth of Indep. States 510.3 3.7 377.6 2.7 Africa 424.1 3.0 358.9 2.5 Middle East 759.9 5.4 479.3 3.4 Asia 4,131.0 29.6 3,804.3 26.7 World $13,950.0 100.0% $14,244.0 100.0%

1-9

Top 10 Merchandise Exporters, 2007 Value $, billions, Percentage Country Share Germany $1,326.4 9.5% China 1,217.8 8.7 United States 1,162.5 8.3 Japan 712.8 5.1 France 553.4 4.0 Netherlands 551.3 4.0 Italy 491.5 3.5 United Kingdom 437.8 3.1 Belgium 430.8 3.1 Canada 419.0 3.0

1-10

Top 10 Merchandise Importers, 2007 Value $, billions, Percentage Country Share United States $2,020.4 14.2% Germany 1,058.6 7.4 China 956.0 6.7 Japan 621.1 4.4 United Kingdom 619.6 4.4 France 615.2 4.3 Italy 504.5 3.5 Netherlands 491.6 3.5 Belgium 413.2 2.9 Canada 389.6 2.7

1-11

Regional Structure of Exports, 2007

N. America

South and

Central America

Europe CIS

Africa Middle East

Asia Total

N. America 51.3% 7.0% 17.7% 0.7% 1.5% 2.7% 19.0% 100% So. And C. America

30.3% 24.4% 21.2% 1.3% 2.7% 1.8% 16.1% 100%

Europe 7.9% 1.4% 73.5% 3.3% 2.6% 2.6% 7.5% 100% CIS 4.6% 1.3% 56.3% 20.2% 1.3% 3.2% 11.7% 100% Africa 21.7% 3.4% 39.5% 0.2% 9.5% 2.5% 19.1% 100% Middle East 11.0% 0.6% 14.3% 0.6% 3.6% 12.3% 52.3% 100% Asia 19.9% 2.4% 18.8% 2.1% 2.4% 4.0% 49.7% 100%

1-12

Commodity Composition of Trade

Manufactures comprise 69.8% of trade, with agricultural and mining-related products making up the balance.

1-13

Composition of World Merchandise Exports (billions of U.S. $)

Product Category Value in

2007 Share in

2007 Share in

1980 Agricultural Products $1,128 8.3% 14.7% Mining Products $2,659 19.5% 27.7% Manufactures $9,500 69.8% 53.9%

1-14

Trade and the U.S.

The U.S. trades the most with our NAFTA partners (Canada and Mexico), followed by the European Union.

Trade with Asia is also very important. China is the second largest trading partner of the United States.

1-15

U.S. Merchandise Trade by Area and Country, 2007 (millions of dollars and %)

Exports to Imports From value share value share Region or Country European Union $242,244 24.5% $356,180 20.9% Europe, non-EU 38,601 3.4% 54,999 2.8% Canada 249,712 21.7% 320,323 16.3% Mexico 135,962 11.8% 213,552 10.9% Latin America (not Mexico)

107,101 9.3% 134,826 6.9%

China 65,073 5.7% 321,685 16.3% Japan 60,898 5.3% 146,037 7.4% Other Asia 182,277 15.9% 250,840 12.7% Middle East 43,646 3.8% 77,405 3.9% Africa 22,966 2.0% 92,055 4.7% Total 1,148,481 100.0% 1,967,853 100.0%

1-16

Commodity Composition of U.S. Trade

The U.S. tends to export capital goods and industrial supplies.

The U.S. tends to import consumer goods and industrial supplies.

1-17

Commodity Composition of U.S. Trade, 2007 (billions of dollars and %)

Exports to Imports From value share value share Foods, feeds, beverages $84.3 7.3% $81.7 4.2% Industrial supplies/materials 316.4 27.5% 639.4 32.5% Capital goods (non-auto) 447.4 39.0% 444.5 22.6% Automotive 121.0 10.5% 258.9 13.2% Consumer goods 146.1 12.7% 478.5 24.3% Other goods 33.3 2.9% 64.9 3.3% Total 1,148.5 100.0% 1,967.9 100.0%

1-18

Trade in Services

Over $3 trillion annually (2007). About 20% of total trade (closer to

30% for U.S.).

1-19

Leading Exporters of Commercial Services, 2007

Country Value (billions of $)

Share

U.S. $456.4 13.9% United Kingdom 273.0 8.3% Germany 205.8 6.3% France 136.7 4.2% Spain 128.3 3.9% Japan 127.1 3.9% China 121.7 3.7% Italy 110.5 3.4% India 89.7 2.7% Ireland 89.0 2.7%

1-20

Leading Importers of Commercial Services, 2007

Country Value (billions of $)

Share

U.S. $335.9 10.9% Germany 250.5 8.1% United Kingdom 194.1 6.3% Japan 148.7 4.8% China 129.3 4.2% France 124.1 4.0% Italy 118.3 3.8% Spain 98.4 3.2% Ireland 94.5 3.1% Netherlands 86.8 2.8%

1-21

The Changing Degree on Economic

Interdependence The relative importance of trade

has grown for most countries. The relative importance of trade for

all countries together has also grown.

1-22

International Interdependence for Selected Countries and Groups of Countries, 1970 2007 (exports as a % of GDP)

1970 2007 Industrialized Countries: Australia 14% 21% Belgium 52% 89% Canada 23% 36% France 16% 27% Germany NA 47% Italy 16% 29% Japan 11% 16% Netherlands 42% 75% United Kingdom 23% 26% United States 6% 11% Developing Countries: Argentina 9% 25% Chile 15% 47% China 3% 42% Czech Republic NA 80% India 4% 21% Kenya 30% 26% Mexico 6% 28% Nigeria 8% 40%

Early Trade Theories:

Mercantilism and the Transition to the

Classical World of David Ricardo



2-2

Learning Objectives

Describe Mercantilist concepts and policies.

Examine Humes price-specie flow mechanism and its challenge to Mercantilist thought.

Discuss Smiths ideas of wealth and absolute advantage as foundations of international trade.

2-3

Mercantilism

A collection of economic thought in Europe during the period between 1500 and 1750.

Mercantilism is often called the political economy of state building.

2-4

The Mercantilist Economic System

A countrys wealth is measured by its holdings of precious metals (specie).

International trade is a zero sum game.

A country should maintain a positive trade balance (that is, export more than it imports).

Mercantilism employed the labor theory of value.

2-5

The Role of Government Bullionism Substantial regulation of the

domestic economy, including governmental granting of monopolies,

and controls of labor through craft guilds.

2-6

The Role of Government

Policies to ensure low wages, including policies to discourage importation and

encourage exportation, and policies to discourage exportation of

specie.

2-7

The Paradox of Mercantilism

To be rich, a country needed to have a lot of poor people!

2-8

The Challenge to Mercantilism by Early

Classical Writers In the early 1700s, questions began

to emerge regarding the logic of mercantilism.

2-9

Humes Challenge: the Price-Specie Flow

Mechanism Hume (mid-18th century): maintaining

a trade surplus forever is impossible. Trade surplus inflow of specie inflow of specie increased Ms increased Ms higher prices (and

wages) higher prices lower exports and

higher imports

2-10

Smiths Challenge: Absolute Advantage

Smith believed trade to be a positive-sum game.

Countries should export those goods which they can produce efficiently, and import those which they cannot.

If countries trade according to this principle, all will gain from trade (trade will be mutually beneficial).

2-11

Absolute Advantage: An Example

Corn Blankets

U.S. 1 hour/bu 6 hrs/bl

Mexico 3 hrs/bu 5 hrs/bl

Autarky PriceRatios (APRs)

1B = 6C,1C = 1/6B

1B = 5/3C,1C = 3/5B

2-12


Suppose the U.S. and Mexico agree to trade at a ratio of 1B = 4C (or 1C = B).

Suppose further that Mexico will specialize in blankets and the U.S. in corn.

From the U.S.s perspective: Can now buy blankets at a lower price

(1B = 6C in autarky, but 1B = 4C in trade). Can sell corn at a higher price (1C = 1/6 B

in autarky, but 1C = B in trade).

2-13


From Mexicos perspective: Can now sell blankets at a higher price

(1B = 5/3C in autarky, but 1B = 4C in trade).

Can buy corn at a lower price (1C = 3/5 B in autarky, but 1C = B in trade).

2-14


Bottom line: both countries gain from trade, even if certain industries (blanket industry in U.S., corn industry in Mexico) stand to lose.

2-15

Limits to Smiths Thinking

If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.

2-16

Absolute Advantage: The Limits to Smiths Thinking

Corn Blankets

U.S. 1 hour/bu 5 hrs/bl

Mexico 3 hrs/bu 6 hrs/bl

Autarky PriceRatios (APRs)

1B = 5C,1C = 1/5B

1B = 2C,1C = 1/2B

2-17

Limits to Smiths Thinking

If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.

But David Ricardos Principle of Comparative Advantage (1817) took Smiths work farther: even in the above example, trade can be mutually beneficial!

The Classical World of David

Ricardo and Comparative Advantage



3-2

Learning Objectives

Explain comparative advantage as the basis of trade.

Identify the difference between absolute and comparative advantage.

Calculate gains from trade in a 2x2 model.

Illustrate comparative advantage using production possibility frontiers.

3-3

Assumptions of the Ricardian Model

A 2-country, 2-commodity world Perfect competition No transportation costs Factors mobile internally, immobile

internationally Constant costs of production Fixed technology for each country All resources are fully employed The labor theory of value holds

3-4

Notation

Let: ax = labor time to produce 1 X in

country A ay = labor time to produce 1 Y in

country A bx = labor time to produce 1 X in

country B by = labor time to produce 1 Y in

country B

3-5

Comparative Advantage Defined

Country A has a comparative advantage in good X if:

(Px/Py)A < (Px/Py)B OR if

ax/ay < bx/by OR if ax/bx < ay/by If country A has a comparative

advantage in good X, country B must have a comparative advantage in good Y.

Comparative Advantage: An Example

Corn (X) Blankets (Y)

U.S. (A) 1 hour/bu 5 hrs/bl

Mexico (B) 3 hrs/bu 6 hrs/bl

Autarky Price Ratios (APRs)

1B = 5C, 1C = 1/5B

1B = 2C, 1C = 1/2B

3-6

3-7

Comparative Advantage

Since the U.S.s APR for corn is lower than Mexicos (1/5 < 1/2), the U.S. must have a comparative advantage in corn.

Since Mexicos APR for blankets is lower than the U.S.s (2 < 5), Mexico must have a comparative advantage in blankets.

3-8

Comparative Advantage and the Total Gains from

Trade Ricardos argument is that trade

will be mutually advantageous as long as the two countries autarky price ratios are different.

How do we know that this is true?

3-9

Comparative Advantage and the Total Gains from

Trade The Production Possibilities

Frontier (PPF) is the set of all combinations of goods that a country is capable of producing, given available technology and resources.

Suppose in our example the U.S. has 1000 hours of labor available and Mexico has 1800.

3-10

U.S. Production Possibilities

1000

Corn

Blankets 200

500

100

A

Slope: rise/run = -1000/200 = -5

3-11

Slope of the PPF

for this example, -5 Notice: the slope (in absolute

value) is the APR of the good on the horizontal axis.

Therefore, the slope is the opportunity cost of the good on the horizontal axis.

The slope is also the marginal rate of transformation.

3-12

Mexicos Production Possibilities

600

Corn

Blankets 300

Slope = -2, or the opportunity cost of blankets

3-13

Classical Model: The Gains from Trade

Suppose that in autarky, the U.S. is at point A, producing and consuming 500 corn and 100 blankets.

Suppose that in autarky, Mexico is at point B, producing and consuming 300 corn and 150 blankets.

3-14


1000

Corn

Blankets 200

500

100

A

3-15


600

Corn

Blankets 300

300

150

B

3-16

Classical Model: The Gains from Trade

Suppose now that the U.S. and Mexico agree to trade at an exchange rate of 1B = 3.33C (or, 1C = .3B).

If the U.S. specializes in corn, how many units of corn could it produce? 1000.

If Mexico specializes in blanket manufacture, how many blankets could be made? 300.

3-17

The Gains from Trade: U.S.

If the U.S. wants to continue to consume 500C, they will now have 500C to trade for blankets.

If the exchange rate is 1B = 3.33C (or, 1C = .3B), how many blankets can the U.S. get in exchange for 500C?

150 Therefore, the U.S. can consume

outside its PPF (to point C) by trading!

3-18


1000

Corn

Blankets 200

500

100

C A

150

3-19

The Gains from Trade: Mexico

If Mexico wants to continue to consume 150B, they will now have 150B to trade for corn.

If the exchange rate is 1B = 3.33C (or, 1C = .3B), how much corn can Mexico get in exchange for 150B?

500 Therefore, Mexico can also move

outside its PPF (to point D) by trading!

3-20


600

Corn

Blankets 300 150

B 300

500 D

3-21

The Gains from Trade Note: In general, the Ricardian

model results in complete specialization.

However, in trade between a small and a large country the small country may not be able to produce enough to satisfy the large country; the large country might then partially specialize.

3-22

The Consumption Possibilities Frontier

(CPF) The CPF is a collection of points that

represent combinations of corn and blankets that a country can consume if it trades.

3-23

U.S. Consumption Possibilities

1000

Corn

Blankets 200

500

100

C A

150 300

CPF

3-24

The Consumption Possibilities Frontier

(CPF) The CPFs slope is the same as the

terms of trade. The CPF pivots around the

production point. If trade is to the benefit of a country,

the CPF lies outside the PPF.

3-25

Mexicos Consumption Possibilities

600

Corn

Blankets 300 150

B 300

500 D

1000

CPF

3-26

The Limits to Mutually Advantageous Trade

Exchange rate must be at least as great as Mexicos APR.

Exchange rate must be no greater than the U.S.s APR.

Bottom line: we still dont know how the terms of trade will be determined, but they must be between the countries APRs if trade is to be mutually beneficial.

3-27

The CPF and Small Countries

The nearer are the terms of trade to a countrys APR, the less that country will gain from trade.

The farther away the terms of trade are from a countrys APR, the more that country will gain from trade.

Moral: to Ricardo, small countries stand to gain a lot from trade, large countries gain less.

The Basis for Trade: Factor Endowments

and the Heckscher-Ohlin Model



8-2

Learning Objectives

Examine how relative factor endowments affect relative factor prices.

Demonstrate how different relative factor prices generate a basis for trade.

Describe how trade affects relative factor prices and income distribution.

Analyze how real-world phenomena can modify Heckscher-Ohlin conclusions.

8-3

Heckscher-Ohlin In General

Heckscher, and his student Ohlin, worked in the early part of the 20th century.

Paul Samuelson refined their work after WWII.

Closer attention is paid in this model to each countrys resource endowment.

8-4

The Hecksher-Ohline Theory

Eli Hecksher laid out the basic fundamentals of the model of the patterns and determinants of international trade in a paper first published in 1919.

This paper was written in Swedish and was not translated into English for almost 30 years.

An English translation of this paper entitled the Effect of Foreign Trade on the Distribution of Income appears in Howard S. Ellies and Lloyd A. Metzler, Reading in International Trade, Philadelphia: The Blakiston Co., 1949.

8-5

The Hecksher-Ohlin (HO) Theory

Heckshers pupil, Ohlin, elaborated on the ideas of Hecksher in his 1924 doctoral dissertation (also in Swedish) and later in a book published in English by Harward University in 1933.

Ohlins book is titled Interregional und international trade, in Boston: Harward University Press, 1933.

Ohlin has got the Nobel Price of Economic in 1977.

8-6

H-O-S Assumptions

2 countries 2 commodities 2 factors (labor and capital) Perfect competition exists in all

markets. Each countrys endowment of

factors is fixed. Factors are mobile internally, but

immobile internationally.

8-7

H-O-S Assumptions (contd)

Each producer has a wide range of options as to how to produce X or Y if K is cheap relative to labor, a

relatively capital-intensive method will be adopted.

if K is expensive relative to labor, a relatively labor-intensive method will be adopted.

Each country has the same CRTS technology.

Tastes and preferences are the same for both countries.

8-8

Concepts and Terminology

The capital-labor ratio for good X is simply KX/LX, and for Y is KY/LY. If KX/LX > KY/LY, production of good X is

capital intensive relative to production of good Y.

For example, the amount of capital per worker in the U.S. petroleum and coal industry is $468,000.

The similar figure for apparel products is $8,274.

Therefore, petroleum and coal is produced in a relatively capital-intensive manner.

8-9


Also, production of Y must be relatively labor intensive (If KX/LX > KY/LY, then LY/KY > LX/KX). That is, clothing is produced in a

labor-intensive manner (as compared to petroleum and coal).

8-10


Factor intensity, and factor endowments

K

L

Country A (Mexico or China)

2

2

3 4 6

4

L/K in Y = 2 or K/L in Y = 1/2

8

L/K in X = 4 or K/L in X = 1/4

L 2

2

3 4 6

4

L/K in Y = 1/4 or K/L in Y = 4

8

Country B (US)

8

1

L/K in X = 2 or K/L in X = 1/2

K

e.g. Y = Cars and X = Textiles

8-11


PPF of both Countries base on assumption

Y = Cars

X = Tex X = Tex Country A (Mexico or China) Country B (US)

Y = Cars

8-12


Taking PPF of both Countries into one panel

Car

Tex US Tex Mexico Tex

PPF of Country Mexico

PPF of US

I

J CIC0

(c)

(PC/PT) of US

(PC/PT) of Mexico Cars Mexico

Cars US

Relative Factor Intensities, Selected Canadian Industries

(2006), in C$ Commodity Capital per employee Petroleum and coal $617,066 Chemicals $144,029 Paper $118,777 Transportation equipment $92,315 Truck Transportation $30,180 Leather and products $12,573 Clothing $8,954

8-13

8-14


Country A is said to be capital abundant relative to Country B if (K/L)A > (K/L)B. For example, if the U.S. has a

capital stock of $4.8 trillion and a labor force of 153 million, then K/L is about $32,000.

K/L for Mexico works out to $328 billion/45 million = $7,282.

Therefore, the U.S. is K- abundant relative to Mexico; Mexico is relatively L-abundant.

Relative Factor Endowments, Selected

Countries (2007), in U.S. $

Country Capital per worker Japan $49,081 France $31,810 U.S. $31,657 Australia $30,792 Canada $24,700 Mexico $7,282

8-15

8-16


To summarize: goods are produced relatively K

or L intensively. countries are relatively K or L

abundant.

8-17


The factor price of labor (the wage) is denoted w.

The factor price of capital is denoted r.

If labor is relatively expensive, w/r will be a relatively big number.

If labor is relatively cheap, w/r will be a relatively small number.

8-18

More on Factor Prices

What makes labor relatively expensive? If it is relatively scarce.

What makes labor relatively cheap? If it is relatively abundant.

So: If (K/L)A is a relatively big number (that is, capital is relatively abundant), w/r will be a relatively big number, reflecting the relative scarcity of L and abundance of K.

8-19

A Review of Trade in the Neoclassical Model

Suppose the U.S. is capital abundant relative to Mexico.

This, of course, means that Mexico is relatively labor abundant.

These differences affect the shape of each countrys PPF.

Suppose that cars are produced rel. K-intensively, and textiles labor intensively.

8-20

Autarky in Mexico and the U.S.

The relative price of textiles in autarky is greater in the U.S. than in Mexico.

That is, the U.S.s autarky price line is steeper than Mexicos.

In symbols, (PT/PC)U.S. > (PT/PC)Mex.

This means that Mexico has the comparative advantage in textiles.

8-21

Autarky in Mexico and the U.S.

This also means that the relative price of cars in autarky is lower in the U.S. than in Mexico.

That is, (PC/PT)U.S. < (PC/PT)Mex.

This means that the U.S. has the comparative advantage in cars.

8-22


PPF of both Countries base on assumption

Y = Car

X = Tex X = Tex Country Mexico (X) Country US (Y)

Y =Car

8-23


Taking PPF of both Countries into one panel

Car

Tex US Tex Mexico Tex

PPF of Country Mexico

PPF of US

I

J CIC0

(c)

(PC/PT) of US

(PC/PT) of Mexico Cars Mexico

Cars US

Trade in the H-O Model

Mexico U.S. Cars Cars

Textiles Textiles X1

Y1

X6

Y4 E e

X2

Y2

X5

Y5 e'

E'

C'

c'

X3

Y3

X4

Y6

8-24

8-25

The Result

The relatively capital abundant country (U.S.) exports the relatively capital intensive good (cars).

The relatively labor abundant country (Mexico) exports the relatively labor intensive good (textiles).

8-26

The Heckscher-Ohlin Theorem

A country will export the commodity that uses relatively intensively the factor that country has in relative abundance.

A country will import the commodity that uses relatively intensively the factor that is relatively scarce in that country.

8-27

The Source of Comparative Advantage

So it is a countrys relative factor endowment that determines its comparative advantage.

This is why the H-O-S model is also called the factor proportions theory.

8-28

Changes in Relative Commodity Prices : Review As we learned before,

(PT/PC)US falls as the U.S. moves to trade. That is, the international relative textile price is lower than the U.S.s autarky price.

(PT/PC)Mex rises as Mexico moves to trade. That is, the international relative textile price is higher than Mexicos autarky price.

8-29

Changes in Factor Prices

In autarky, the K-intensive product (cars) is less expensive to produce in the U.S. as compared to Mexico. This is because K is relatively

abundant in the U.S., which makes the price of capital relatively low.

As trade commences, r will rise since demand for capital will rise.

8-30

Changes in Factor Prices

In autarky, the L-intensive product (textiles) is more expensive to produce in the U.S. as compared to Mexico. This is because L is relatively

scarce in the U.S., which makes the price of labor relatively high.

As trade commences, w will fall since demand for labor will fall.

8-31

Commodity and Factor Prices In Trade: A Summary In our example, (PT/PC)US falls as

trade commences. (w/r)US also falls. In Mexico, the opposite is

happening: (PT/PC)Mex rises. (w/r)Mex also rises.

Therefore relative commodity and factor prices move together as trade commences.

The Relative Cost Curve

PT/PC

w/r (w/r)Mex

(PT/PC)Mex

(w/r)US

(PT/PC)US

Both relative commodity and factor prices equalize in trade.

(PT/PC)Int

(w/r)Int 8-32

8-33

The Factor Price Equalization Theorem

In equilibrium, with both countries facing the same relative product prices, relative costs will be equalized. This can only happen if relative factor prices are equalized between countries.

8-34

H-O and the Distribution of Income

The H-O theorem, together with the FPE theorem, also tell us about how the incomes of different groups within a country change as trade starts.

This provides insight into the politics of free trade.

8-35

The Stolper-Samuelson Theorem

As trade commences, the owners of the relatively abundant factor will find their real incomes rising; the owners of the relatively scarce factor will find their real incomes falling.

8-36

H-O and the Distribution of Income

According to the S-S theorem, if the U.S. is a relatively K-abundant country, who in America should favor free trade?

Who in America should favor protectionism?

8-37

Theoretical Qualifications to H-O

Suppose we relax some of the many assumptions. Will the implications of the H-O-S model still be the same?

8-38

Qualification #1: Demand Reversal

Suppose we let demand conditions differ.

Suppose domestic demand for the good that uses relatively intensively the relatively abundant factor is very strong in each country.

That is, suppose demand for cars is very strong in the U.S., and that demand for textiles is very strong in Mexico.

8-39

Qualification #1: Demand Reversal

Such strong demand makes the autarky car price in the U.S. higher, and the textile price in Mexico higher.

In the extreme, demand reversal could occur: (PC/PT)US > (PC/PT)Mex, and

(PT/PC)US < (PT/PC)Mex

8-40

Bottom Line on Demand Reversals

If demand reversals occur, the H-O theorem no longer holds: the K-abundant country is exporting the L-intensive good, and the L-abundant country is exporting the K-intensive good.

8-41

Qualification #2: Factor Intensity Reversal

Implicitly, weve assumed that if good X is K-intensive relative to good Y at one factor price ratio, it will be K-intensive at all factor prices.

A FIR is when a good is relatively K-intensive at one set of factor prices, but relatively labor intensive at another.

8-42

Qualification #2: Factor Intensity Reversal

FIRs occur when capital and labor can be substituted more easily in the production of one good than another.

8-43

Factor Intensity Reversal: Implications for Trade

Suppose France is K-abundant relative to Germany (that is (K/L)F > (K/L)G).

This means that (w/r)F > (w/r)G. Suppose further that there is a FIR:

in France, at (w/r)F apples are produced relatively K-intensively but in Germany at (w/r)G apples are produced in a relatively L-intensive way.

8-44

Factor Intensity Reversal: Implications for Trade

If trade begins, according to the H-O theorem the relatively K-abundant country (France) will export the rel. K-intensive good (apples) and the rel. L-abundant country will export the rel. L-intensive good (also apples).

H-O theorem breaks down.

8-45

Qualification #3: Transportation Costs

In the real world, it is costly to transport goods internationally.

How do the implications of our model change if we allow for transportation costs?

Consider the supply and demand curves for textiles in Mexico and the U.S.

8-46

Adding Transportation Costs

Unless Mexico is the only seller in the world, transportation costs will be borne by both the consumer (the U.S.) and the seller (Mexico).

How does this look on the graph?

Adding Transportation Costs

U.S. Mexico

SText

DText

PT

QT

SText

DText

PT

QT

PIntl PIntl

q1 q2 q1 q2

Imp.

Exp. t-costs

8-47

8-48

Adding Transportation Costs: the Bottom Line

In general, the H-O theorem will still hold.

The FPE theorem breaks down, since factor prices only equalize if the commodity prices do.

Therefore, in the presence of transportation costs, factor prices have a tendency to move towards each other, but we should not expect equalization.

8-49

Relaxing Other Assumptions

One can relax many other assumptions and examine how the implications of the model change: perfect competition CRTS identical production technologies lack of policy obstacles factors being perfectly

transferable

PostHeckscher-Ohlin Theories of Trade and Intra-Industry Trade



10-2

Learning Objectives Explain the basis of trade in

manufactures beyond Heckscher-Ohlin.

Discuss the roles of technology dissemination, demand patterns, and time in affecting trade.

Demonstrate how the presence of imperfect competition can affect trade.

Describe the phenomenon known as intra-industry trade.

10-3

Vertical Specialization

Different stages of production process may occur in different countries.

If different parts of the production process vary in terms of capital or labor intensity, the production process may be spread over multiple countries.

10-4

Firm-Focused Theories Stage theory: owners and managers

learn over time; this implies exporting firms tend to be larger and run by more experienced managers.

Resource-exchange theory: firms internationalize because they cannot generate all resources domestically.

Network theory: networking can compensate for any lack of experience or expertise.

10-5

The Linder Theory

In the H-O model, the pattern of trade is determined by relative resource endowments.

A model by Linder (1961) focuses mainly on the demand side.

Basic idea is that a country produces stuff to satisfy domestic demand; these goods will be likely exports (and imports, too).

10-6

The Linder Theory: An Example

Suppose Country Is income pattern is such that it produces goods A, B, C, D and E.

Let Country I have a relatively low per capita income level.

Suppose these goods are in ascending order of sophistication: A and B are fairly simple. C, D, and E are slightly more

sophisticated.

10-7


Suppose Country II has a higher level of per capita income.

It therefore produces goods C, D, and E (just like Country I), but also F and G.

F and G are even more sophisticated.

10-8


Suppose Country III has an even higher level of per capita income.

It therefore produces good E (just like Country I), F and G (just like country II), but also H and J.

H and J are even more sophisticated.

Lets look at a diagram of these countries:


A B C D E

C D E F G

E F G H J

I

II

III

What products will I and II trade?

C, D, and E.

10-9


A B C D E

C D E F G

E F G H J

I

II

III

What products will II and III trade?

E, F, and G.

10-10


A B C D E

C D E F G

E F G H J

I

II

III

What products will I and III trade?

E only.

10-11

10-12

The Linder Theory

So trade will involve goods for which there is overlapping demand.

Implication: trade should be most intense between countries with similar levels of per capita income.

10-13

The Linder Theory

This theory would explain two things that H-O cannot: why most trade is between the

industrialized countries, which all have (presumably) very similar resource endowments.

why a country might import and export the same product (intra-industry trade).

10-14

The Linder Theory

The theory has been subjected to a barrage of tests. Sailors, et al. (1973), Thursby and

Thursby (1987), and McPherson, Redfearn and Tieslau (2000) and others found evidence to support the Linder theory.

Hoftyzer (1984), Kennedy and McHugh (1983) and others found evidence against the theory.

10-15

The Krugman Model

Incorporates economies of scale and monopolistic competition.

Consider a graph: The price of the good relative to the

wage (P/W) is on the vertical axis. Per capita consumption (c) is on the

horizontal axis.

10-16

The Krugman Model

Two functions are on the graph: The PP curve slopes upward, since P/W

increases as c increases. The ZZ curve has a negative slope: as c

increases, average cost decreases (due to economies of scale). To maintain the zero-profit condition in monopolistically competitive firms, price must be reduced.

10-17

The Krugman Model

P/W

c

P

P

Z

Z

c1

(P/W)1

Point E is the initial equilibrium, with the firm maximizing its profit, and earning zero economic profit.

E

10-18

The Krugman Model Suppose this firm exists in country 1. Let country 2 be identical to country 1 on

both the demand and the supply sides of the economy.

Traditional trade theory posits that these countries would not trade.

However, because trade effectively increases the market size in each country, economies of scale are realized in the Krugman model.

Trade effectively shifts the ZZ curve to the left.

10-19

The Krugman Model

P/W

c

P

P

Z

Z

c1

(P/W)1

Point E is the new equilibrium; per capita consumption and P/W have both decreased as a result of trade.

E

Z

Z

E

c2

(P/W)2

10-20

The Krugman Model: The Bottom Line

Although trade causes per capita consumption (c) to fall, total consumption of the firms output has risen.

P/W has decreased because of trade; this also means that its reciprocal (W/P) rises.

This suggests that trade causes the real wage of workers to rise.

Even owners of the relatively scarce factor see a rise in real wages, suggesting that the negative income distribution effects of trade may not occur.

10-21

Other Trade Models Reciprocal dumping model (Brander and

Krugman, 1983) Because of imperfect competition, intra-industry

trade occurs in this model. Welfare may increase due to increased

competition, but may decrease due to waste involved with transporting identical products internationally; the overall welfare effect is unclear.

The gravity model The focus is on explaining trade volume. These models illuminate the underlying causes

of trade.

10-22

Intra-Industry Trade

Examples: Japan imports and exports

computers. The Netherlands imports and

exports beer. The U.S. imports and exports

broccoli. H-O-S is useless in explaining this -

theres no way a country could export and import the same good.

10-23

Intra-Industry Trade: Possible Explanations

Product differentiation Transportation costs Dynamic economies of scale Degree of product aggegation Differing national income

distributions Differing factor endowments and

product variety

10-24

How Common is Intra-Industry Trade?

A recent study by Brlhart attempts to measure IIT in several countries, using an index: an index value of 0 implies no IIT is

taking place. an index value of 1 implies that a

countrys exports in one product category exactly equal its imports.

10-25

Intra-Industry Trade: Evidence from Brlhart

(2009) Country SITC 3-digit

Germany 0.570

U.S. 0.503

Japan 0.398

Brazil 0.373

China 0.305

Indonesia 0.291

Bulgaria 0.287

Morocco 0.150

Russian Fed. 0.146

Saudi Arabia 0.070

The Instruments of Trade Policy



13-2

Learning Objectives

Describe the different tax instruments employed to influence imports.

Discuss policies used to affect exports.

Explain the problems encountered in measuring the presence of protection.

Summarize the different nontariff policies used to restrict trade.

13-3

Tariffs in General

Tariffs are simply taxes a country places on its imports.

Purpose of tariffs: to protect domestic (import-competing)

industries to raise revenue for the government

There are two sorts of tariffs: specific and ad valorem.

13-4

Specific Tariffs Specific tariffs involve charging a tax

per physical unit imported. For example, the tariff on frozen

orange juice is 7.85 per liter. Specific tariffs may be easier to

administer. Specific tariffs are less likely to

maintain the same degree of protection in times of high inflation.

13-5

Ad Valorem Tariffs

Ad valorem tariffs involve charging a tax as a percentage of the value of the good.

For example, the tariff on golf clubs is 4.4%.

Ad valorem tariffs may be more complicated to administer than specific tariffs, but do hold their protective value in the face of inflation.

13-6

Preferential Duties and the Generalized System of

Preferences (GSP) Preferential duties: tariff rates vary

according to products geographic source.

The GSP involves developing countries paying lower (or zero) tariffs when exporting to the developed world.

13-7

Permanent Normal Trade Relations Status

PNTR status is a way to achieve non-discrimination in trade.

If the U.S. negotiates a lower tariff with a PNTR country, U.S. tariffs fall for all countries with which the U.S. has a PNTR treaty.

This is also called multilateralism (and once was called most favored nation status).

13-8

Offshore Assembly Provisions

With OAPs, the tariff applies only to the foreign value added.

For example, if there is a tariff on computers, the tariff is not applied to the value of domestic-made components.

13-9

Measuring Tariffs

How can we tell how much tariff protection a country has on average?

This is sometimes referred to as the height of tariffs.

There are two ways to measure this height: Unweighted average Weighted average

13-10

Unweighted Tariffs

Suppose there are 3 imported goods. Good A has a 30% tariff Good B has a 40% tariff Good C has a 10% tariff

The unweighted average is the simple average of the three:

(30%+40%+10%)/3 = 26.7% Unfortunately, this doesnt account

for the fact that the quantities of each good that are imported may differ.

13-11

Weighted Tariffs

Suppose there are 3 imported goods. Good A has a 30% tariff and 200 units

are imported Good B has a 40% tariff tariff and 100

units are imported Good C has a 10% tariff tariff and 400

units are imported The weighted average is the simple

average of the three: [(30%)(200)+(40%)(100)+(10%)(400)]/ (200+100+400) = 20%

13-12

Nominal and Effective Rates of Protection

Nominal tariff rates apply only to final products.

Effective tariff rates take into account not only tariffs on final products, but also those on inputs into the final product.

Basic idea: a tariff on an intermediate good (e.g., steel) raises the cost of many final goods (cars); this reduces the protection afforded to auto makers.

13-13

Nominal Rate of Protection (NRP)

First consider the nominal rate of protection (NRP).

NRP = (PDt - PDFT)/ PDFT

NRP is always equal to the tariff on the final product.

13-14

Effective Rate of Protection (ERP)

First, lets define value added VA = price of good - price of

inputs. Now we can define effective rate of

protection ERP = (VADt - VADFT)/VADFT.

13-15

Effective Rate of Protection

The effective rate of protection measures how much protection a tariff or other trade policy provides domestic producers. It represents the change in value that an industry adds to

the production process when trade policy changes.

The change in value that an industry provides depends on the change in prices when trade policies change.

Effective rates of protection often differ from tariff rates because tariffs affect sectors other than the protected sector, a fact which affects the prices and value added for the protected sector.

13-16

Effective Rate of Protection (cont.)

For example, suppose that an automobile sells on the world market for $8000, and the parts that made it are worth $6000. The value added of the auto production is

$8000-$6000 Suppose that a country puts a 25% tariff on imported

autos so that domestic auto assembly firms can now charge up to $10000 instead of $8000.

Now auto assembly will occur if the value added is up to $10000-$6000.

13-17

Effective Rate of Protection (cont.)

The effective rate of protection for domestic auto assembly firms is the change in value added:

($4000 - $2000)/$2000 = 100%

In this case, the effective rate of protection is greater than the tariff rate.

13-18

Table 11.1 Characteristics of Industries in Relation to Levels of Protection Given by U.S.

Tariffs

13-19

Does the tariff protect labor-intensive industries?

The least-protected industries are indeed the least labor intensive.

However, the most heavily protected industries are not very labor intensive.

It does not confirm the prediction of the majority of voters that tariffs favor labor-intensive industries.

13-20

Does the tariff protect low-skilled ?

If the politicians aim in part to redistribute income to those poor, high tariffs should protect industries that employ low-skill and low-wage labor.

Evidence: Low-wage industries do get the highest protection.

However, their real income as consumers suffer seriously.

13-21

ERP

When tariffs on inputs > tariffs on final products, ERP < NRP.

When tariffs on inputs < tariffs on final products, ERP > NRP.

When tariffs on inputs = tariffs on final products, ERP = NRP.

13-22

Case of nominal rate and effective rate of protection

The nominal rate of protection is the percentage tariff imposed on a product as it enters the country. For example, if a tariff of 20 percent of value is collected on clothing as it enters the country, then the nominal rate of protection is that same 20 percent.

13-23


The effective rate of protection is a more complex concept: consider that the same productclothingcosts $100 on international markets. The material that is imported to make the clothing (material inputs) sells for $60. In a free-trade situation, a firm can charge no more than $100 for a similar piece of clothing (ignoring transportation costs). Importing the fabric for $60, the clothing manufacturer can add a maximum of $40 for labour, profit markup, rents, and the like. This $40 difference between the $60 cost of material inputs and the price of the product is called the value added.

13-24


The same situation may be considered with tariffssay, 20 percent on clothing and 10 percent on fabric. The 20 percent tariff on clothing would raise the domestic price by $20 to $120, while a 10 percent tariff on fabrics would increase material costs to the domestic producer by $6 to $66. Protection would thus enable the firm to operate with a value-added margin of $54the difference between the domestic price of $120 and the material cost of $66. The difference between the value added of $40 without tariff protection and that of $54 with it provides a margin of $14. This means that the effective rate of protection of the domestic processing activitythe ratio of $14 to $40would be 35 percent.

13-25


The effective rate of protection derived35 percentis greater than the nominal rate of only 20 percent. This will be the case whenever the tariff rate on the final product is greater than the tariff on inputs. Because countries generally do levy higher tariffs on final products than on inputs, effective rates of protection are usually higher than nominal ratesoften much higher.

13-26


The effective rate of protection also depends on the share of value added in the product price. Effective rates can be very high if value added to the imported commodity is a small percentage or very low if value added is a large percentage of the total price. Thus, effective protection in one country may be much higher than that in another even though its nominal tariffs are lower, if it tends to import commodities of a high level of fabrication with correspondingly low ratios of value added to product price.

13-27

ERP: The Bottom Line

ERP gives an indication of the effects of the whole tariff structure on industries; NRP only looks at particular goods.

ERPs have an impact on resource allocation: resources flow out of industries with low ERPs, and into industries with high ERPs.

13-28

Export Taxes

An export tax is a tax a government places on its own exporters.

Are applied for several reasons to raise government revenue. to encourage domestic

processing of raw materials.

13-29

Export Subsidies

Governments can encourage exports by paying exporters a certain premium per unit exported.

Export subsidies work like export taxes in reverse.

13-30

Non-Tariff Barriers

Trade gets restricted in ways not involving taxes: import quotas, voluntary export restraints

(VERs), and other provisions.

13-31

Import Quotas

Many countries restrict the quantity of certain imports allowed entry in a given time period (usually a year).

Quotas affect the quantity directly and the price indirectly; tariffs do the opposite.

However, in most respects quotas and tariffs have the same effects.

13-32

Voluntary Export Restraints

Importing countries persuade exporting countries to voluntarily limit their exports. Example: 1.68 million Japanese

cars permitted annually beginning in 1981.

There is an implied threat of tariffs or quotas if exporting country doesnt comply.

VERs exist for political reasons, not economically valid ones.

13-33

Government Procurement Provisions

Some countries require their government to purchase from domestic suppliers unless the imported version is substantially cheaper.

Example: Buy American Act requires many U.S. government purchases to be from domestic firms unless domestic bid is more than 6% higher.

13-34

Domestic Content Provisions

Some countries require that a certain percentage of the value of a good sold domestically must consist of domestic components or labor.

Example: NAFTA members do not allow duty-free access to goods unless at least 62.5% of the goods value originates in NAFTA countries.

13-35

European Border Taxes

European (and some other) countries have value added taxes that increase the prices of domestically produced goods.

To compensate, European countries impose tariffs on imported products.

13-36

Other Non-Tariff Barriers

Administrative classification Restrictions on trade in services Trade-related investment measures Exchange rate controls Quality provisions Packaging and labeling

requirements

The Impact of Trade Policies



14-2

Learning Objectives Illustrate how tariffs, quotas, and

subsidies affect domestic markets. Identify the winners, losers, and net

country welfare effects of protection.

Explain how the effects of protection differ between large and small countries.

Demonstrate how protection in one market can affect other markets in the economy.

14-3

Consumer Surplus

Consumer surplus (CS) is a measure of the overall well-being of consumers.

CS is the area between the demand curve and the price.

CS varies inversely with the price.

14-4

Consumer Surplus

D

Q

P

P*

14-5

Producer Surplus

Producer surplus (PS) is a measure of the well-being of producers.

PS is the area between the supply curve and the price.

PS varies directly with price.

14-6

Producer Surplus

S

Q

P

P*

14-7

Trade Restrictions in Partial Equilibrium: The

Small Country Case What happens when a country

imposes a tariff? Its domestic price rises.

Therefore, tariffs: benefit domestic producers harm domestic consumers generate tariff revenue for the

government

Tariffs: Small Country Case

D

Q

P S

$1

$1.35

1000 2000 1250 1750

c d b a

CS falls by area a+b+c+d, or $656.25. PS rises by area a, or $393.75. Revenue rises by area c, or $175. Deadweight loss is areas b+d, or $87.50.

14-8

14-9

Tariffs: Small Country Case

A tariff makes producers better off, but overall, the small countrys welfare falls.

14-10

Import Quotas: Small Country Case

Recall that quotas and tariffs can be designed to be equivalent.

The difference is that with quotas there is no revenue collected.

Instead rent will be captured by holders of import licenses or the government if it auctions the

licenses, or foreign suppliers, if they organize.

The welfare implications of the quota are otherwise the same as for tariffs.

Production Subsidies: Small Country Case

D

Q

P S

$5

$6

100 190 120 160

c b

a

A $1 subsidy has the effect of shifting the supply curve to the right. CS doesnt change, because consumers still pay $5. PS rises by areas a+b The cost of the subsidy is a+b+c Deadweight loss is areas c.

S'

14-11

14-12

Production Subsidies: Small Country Case

Production subsidies lead to deadweight loss because of the expansion of relatively inefficient production.

However, the DWL is less than would have occurred if an equivalent tariff or quota were used.

14-13

Export Taxes: Small Country Case

Export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore.

Wed predict an increase in CS, a decrease in PS, and a gain in revenue.

14-14


P

Q

S

D

PFT

PET

CS rises by area a. PS falls by areas a+b+c+d. Revenue rises by area c. DWL is b+d.

a d

c b

14-15


An export tax tariff makes consumers better off, but overall, the small countrys welfare falls.

14-16

Export Subsidies: Small Country Case

Export subsidies cause the price in the imposing (i.e., exporting) country to rise, since more of what is produced is now exported.

Wed predict an decrease in CS, an increase in PS.

The subsidy will generate cost, not revenue.

14-17


P

Q

S

D

PES

PFT

CS falls by area a+b PS rises by areas a+b+c+d+e Subsidy cost is b+c+d+e+f Overall effect is a loss: b+f

a d c

b e

f

14-18


An export subsidy tariff makes producers better off, but overall, the small countrys welfare falls.

14-19

Voluntary Export Restraints: Small Country Case

Similar to tariffs or quotas, VERs raise the domestic price which lowers CS raises PS

Rent, however, is captured by the exporting country.

The imposing country will lose not only the DWL triangles, but also the rent rectangle; welfare falls.

14-20

Tariffs: Large Country Case

In the previous analysis, the tariff caused the imposing countrys price to rise by the full amount of the tariff.

This would mean that the imposing country is small; if it imposes a tariff, it is unable to affect the world price.

What if a country is not small?


P

Q

P

Q

S

D

S

D

Importing Country Exporting Country

PFT a b d c e

The tariff causes price to rise in the importing country; P falls in the exporting country.

14-21


P

Q

P

Q

S

D

S

D


PFT a b d c e

Importing country CS falls by a+b+c+d PS rises by area a. Revenue increases by areas c+e Overall effect: e(b+d)

14-22

14-23


A large country could increase its welfare by imposing a tariff if the revenue extracted from the exporting country (area e) is bigger than the deadweight loss (areas b+d).

This assumes that the exporting country does not retaliate.

14-24

Import Quotas: Large Country Case

As with the tariff, IQs cause prices in the importing country to rise, and prices in the exporting country to fall.

As with the tariff, if enough of the quota rent is transferred from the exporting country to offset the deadweight loss, a quota can increase a countrys overall welfare.

This also assumes no retaliation.

14-25

VERs: Large Country Case

As with the tariff and the quota, VERs cause prices in the importing country to rise, and prices in the exporting country to fall.

However, unlike quotas rent generated is captured by the exporting country.

VERs are welfare-diminishing even in the large country case.

14-26

Export Taxes: Large Country Case

In the previous analysis, the export tax caused the imposing countrys price to fall by the full amount of the tax.

If the exporting country is large, its price will fall somewhat but the price in the importing country will also rise.


P

Q

P

Q

S

D

S

D


PFT

The export tax causes the price to fall in the exporting country and rise in the importing country.

a b d c

e

14-27


P

Q

P

Q

S

D

S

D


PFT

CS rises by area a. PS falls by areas a+b+c+d Revenue rises by areas c+e

a b d c

e

14-28

14-29


A large country could increase its welfare by imposing an export tax if the revenue extracted from the importing country (area e) is bigger than the deadweight loss (areas b+d).

This assumes that the importing country does not retaliate.

14-30

Export Subsidies: Large Country Case

CS falls. PS rises. But there is no revenue; instead

cost. Overall, export subsidies are

welfare-diminishing for small countries and for large countries.

14-31

Trade Restrictions in General Equilibrium: The Small

Country Case We can use general equilibrium

analysis to better understand the economy-wide effects of protection.

A tariff on imports of good Y will stimulate domestic production.

The economy winds up on a lower indifference curve.

Tariffs in General Equilibrium: Small Country Case

Y

X

B0

C0

B1

(Px/Py)0

C1

Px/Py(1+t)

In free trade, producer equilibrium is at B0, and consumer equilibrium is at C0. The tariff changes production to point B1;consumption moves to C1 (on a lower indifference curve).

14-32

14-33

Trade Restrictions in General Equilibrium: The

Large Country Case To understand the effects of

protectionism in the large country case we can use offer curve analysis.

14-34

Tariffs or Export Taxes

Y

X

(PX/PY)FT

X2

Y2

OCA

OCB

OCA' (PX/PY)t

By imposing a tariff or an export tax, Country A decreases trade volume, but improves its terms of trade (note: Bs terms of trade deteriorate).

Y1

X1

14-35

Export Subsidies

Y

X

(PX/PY)FT

X1

Y1

OCA

OCB

(PX/PY)ES

X2

Y2

Country As terms of trade deteriorate; volume rises.

14-36

Import Quotas

Y

X

(PX/PY)FT

X1

Y1

OCFTA

OCFTB

OCIQA

Y2

The quota causes the imposing countrys terms of trade to improve, and trade volume to fall.

(PX/PY)IQ

X2

14-37

VERs

Y

X

(PX/PY)E

X1

Y1

OCFTA

OCFTB

OCVERB

Y2

The quota decreases trade volume, and causes As terms of trade to deteriorate.

Political

Economy and Cambodia

Trade Policy



16-2

The Political Economy of Trade Policy

Q: If free trade has so many economic benefits, why is there so much protectionism?

A: The political economy of trade policy must be considered.

Two main areas examine these political factors: the self-interest approach, and the social objectives approach.

16-3

The Self-Interest Approach to Trade Policy The median-voter model: public

decision-makers can increase their re-election chances by voting to satisfy the median voter.

This should mean that the will of the majority is followed.

However, if some parties do not have full information, some policies that benefit only a few may be enacted.

16-4

The Self-Interest Approach to Trade Policy Interest groups can have great

influence. The benefits of protectionist

policies to interest group members may be great; the costs to the many other individuals may be so diffuse that no one individual has incentive to acquire information or participate.

16-5

The Social Objectives Approach to Trade Policy Some economists argue instead that

a government may conduct trade policy in order to meet certain social objectives, such as avoiding loss of real incomes of certain

groups, minimizing consumer loss, or improving real incomes of disadvantaged

groups. Govt must stick to its guns;

otherwise credibility suffers.

16-6

The rectangular Strategy of RGC The core of the rectangular strategy is

good governance focused at four reform areas: Anti-Corruption Legal and judicial reform, Public administration reform, including

decentralization and de-concentration, and

Reform of the armed forces, especially demobilization

The integration of Cambodia into the region and the world is a significant part of the rectangular strategy of RGC.

16-7

The Integrate Framework of RGC

The Integrated Framework (IF) is the outcome of a commitment made by six multilateral Agencies (IMF, ITC, UNCTAD, UNDP, World Bank, and WTO) to coordinate their assistance in the area of trade and investment integration into the global economy among themselves and with other multilateral and bilateral donors.

IF came about as a result of the High Level Meeting (HLM) for LDCs organized by the WTO in October 1997 in Geneva.

The IFs strategy must be fully mainstreamed in the countrys national strategy for poverty reduction. In other words, the countrys trade sector strategy must be fully support and coherent with national objectives of poverty reduction.

In the donor community based in Cambodia, UNDP has taken the lead to ensure effective implementation of IF and coordination among local donors. UNDP-Phnom Penh and the International Trade Center (Geneva) are cooperating and working directly with RGC and others to backstop work in this area.

16-8

The Integrate Framework of RGC (cont)

The IF was undergoing some restructuring that include the creation of an Integrated Framework Trust Fund (IFTF) and the adoption of a Pilot Phase Work Program during the Second IFTF Steering Committee Meeting held in New York in late March 2001

The Pilot Phase Work Program is to be implemented by the IF Agencies under the leadership of the World Bank in a small number of Pilot Countries using IFTF and other resources.

Cambodia has been designated as one of the Pilot Countries.

The IF Pilot Phase Work Program seeks to provide financial and technical support to the selected pilot countries for the formulation of a full-fledged pro-poor trade sector strategy that is fully mainstreamed into the PRSP

16-9

The Pro-Poor Trade Strategy of RGC

Preliminary evidence examined suggests that trade is making a significant positive contribution to economic growth and poverty reduction and that such contribution can be further enhanced and provided Cambodia to become proactive in promoting trade for poverty reduction.

Regarding this issue RGC established a Pro-Poor Trade Strategy organized around tree basic concepts:

Shifting the balance of policy emphasis from issues of market access and macro-reforms for trade to micro and meso-level issues of supply capacity

Focusing strongly on the delivery of capacity-building support at the export enterprise and export sector level; and

Stressing the regionalization and geographical decentralization of export business within Cambodia

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The Pro-Poor Trade Strategy of RGC (cont)

The early efforts of the RGC to formulate a pro-poor trade sector strategy initially under the umbrella and with the support of the Integrated Framework (IF) for Trade coincides closely with the PRSP effort.

The pro-poor trade integration strategy will include: (1) policy and institutional reforms to target key

bottlenecks and constraints that emerge from the analysis;

(2) several action plans at the product-sector level including project proposals to capitalize on major opportunities identified in the strategy;

(3) assessment of technical assistance and capacity-building priorities to support implementation of the trade strategy as well as recommended actions that might be taken by high-income and regional partner countries to improve access to their markets.

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The Pro-Poor Trade Strategy of RGC (cont)

The RGC has identified eight sectors with current or potential opportunities for expanding, diversifying, and developing exports under the Pro-Poor Trade Strategy. These are: Specialty crops and agro-processing Rice Fresh water fish and seafood Handicraft (including furniture making) Tourism Labor services Garment and shoe manufacturing Rubber, sawn timber and processed wood

16-12

Trade Sector wide Approach (SWAp) SWAp is an instrument for better management,

coordination and effectiveness of resources. Now RGC is willing to utilize SWAp in the Trade Sector.

The Ministry of Commerce stands ready to develop SWAp in order :

To include all initiatives, strategies, measures and actions,

To strengthen partnerships for consensus building and coordination with the private sector, civil society and donors, and

To improve implementation and delivery.

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Trade Sector wide Approach (SWAp) (cont)

The Trade SWAp is lead by the Ministry of Commerce in close cooperation with other line Ministries, Cambodian Trade Stakeholders and Development Partners.

The Trade SWAp is to be guided and monitored by the Sub-Steering Committee on Trade Development and Trade-Related Investment chaired by the Ministry of Commerce.

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Trade Sector wide Approach (SWAp) (cont)

The Sub-Steering Committee on Trade Development and Trade-Related Investment has endorsed the creation of three teams responsible for formulating the three pillars of the program aimed at implementing the broad objectives of the Cambodias 2007 Trade Integration Strategy.

The three pillars are: Legal Reform and Cross-Cutting Issues Product and Service Export Sectors

Development Capacity Development for Trade

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Integrating Cambodia into the international Community

Cambodias membership in ASEAN (30-04-1999) and WTO (13-10-2004), as well as cooperation within the framework of the ASEM.

Cambodias membership in Great Mekong Sub-Region, the Ayeyawadee-Chao Phraya-Mekong Economic Cooperation Strategy (ACMECS) and other Triangular Developments at sub-regional level.

Integrating Cambodia into the international Community will provide great opportunities to reform the investment and foreign trade regime.

16-16

Country Industrial and Agro-Industrial Products

Agricultural Products

IL TEL IL TEL SL

ASEAN-6 1993-2003 1996-2003 1996-2003 1997-2003 2001-2010

Vietnam 1996-2006 1999-2006 1999-2006 2000-2006 2004-2013

Laos & Myanmar 1998-2008 2001-2008 2001-2008 2002-2008 2008-2015

Cambodia 2000-2010 2003-2010 2003-2010 2004-2010 2008-2017

Schedules of Tariff Rate of Cambodia in ASEAN

16-17

Cambodias Tariffs by Product Groups for Accession into WTO

16-18

Cambodias Service Commitments for Accession into WTO

Undertaken market access and national treatment commitments in at least one sub-sector under each of 11 different service which are communications services, construction and related engineering services, distribution services, education services, environmental services, financial services, health-related services, tourism and travel services, recreational services and transport services.

Allowing foreign firm to operate in the areas of legal services (with some exceptions), accounting, auditing, bookkeeping, banking, management consulting, telecommunication and transport, but some conditions were attached to market access in areas of financial services (banking and insurance) and telecommunication services.

Allowing foreign firms to provide higher education and adult education services.

Reserving part of a market for Cambodian small and medium sized enterprise in areas such as banking, tourism and courier service (tourist guides services; opening hotel market only for hotels of three stars or higher; and allowing foreign supply of retailing services only a small number of specific items or for very large supermarkets or department stores.

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Modes of supply: 1) Cross-Border supply 2) Consumption abroad 3) Commercial presence 4) Presence of natural persons

Sector or sub-sector Limitations on market access Limitations on national treatment Additional commitments

B. SECTOR-SPECIFIC COMMITMENTS

I. BUSINESS SERVICES

1. Professional Services

(a) Legal services (CPC 861):

(1) None (2) None (3) In commercial association with Cambodian law firms[1], and may not directly represent clients in courts. (4) Unbound, except as indicated in the horizontal section.

(1) None (2) None (3) None (4) Unbound, except as indicated in the horizontal section.

Foreign legal consultancy on law of jurisdiction where service supplier is qualified as a lawyer (including home country law, third country law, and international law)



(b) Accounting, auditing, bookkeeping (CPC 86211, 86212, 86220)

(1) None, except must have commercial presence in Cambodia for auditing services. (2) None (3) None (4) Unbound, except as indicated in the horizontal section


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Trade related to Investment: Investment Protection

Equal treatment of all investors No nationalization adversely affecting

the property of investors No price controls on products or

service No restriction on foreign equity

participation No restriction on foreign convertibility Remittance of foreign currencies

abroad

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GATT and Multilateralism

General Agreement on Tariffs and Trade (GATT) was born in 1947.

GATT involved multilateral negotiations to lower trade barriers.

In general GATT espoused non-discrimination in trade.

GATT established of the Most-Favored Nation principle (now called Normal Trade Relations).

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GATT: Early Rounds

Negotiations (called rounds) occurred every few years.

The first two rounds were: Geneva (1947), and France (1949).

These first rounds were very successful, mainly because protectionist groups within each country hadnt gotten organized.

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GATT: Early Rounds

Other early rounds: England (1951) Geneva (1956) Dillon Round (Geneva, 1962)

These rounds were less successful than the first two, but progress was made.

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GATT: The Kennedy Round

In 1962, Congress passed the Trade Expansion Act (TEA). President was authorized to make tariff

cuts across the board, not just item-by-item.

Trade Adjustment Assistance: industries damaged by imports could receive unemployment compensation and retraining for workers.

16-25

GATT: The Kennedy Round

70 countries participated in the Kennedy round.

Negotiations went from 1964-1967, and were named in memory of President Kennedy.

Tariffs on manufactured goods were reduced by one-third.

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GATT: The Tokyo Round

The Trade Reform Act (TRA): 1974 President authorized to complete further tariff reductions of 60%. get rid of any tariff under 5% (nuisance tariffs).

The Tokyo round ended in 1979, with average tariff reductions of 30%.

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GATT: The Uruguay Round

Tariff levels were by this time quite low.

Negotiations began in earnest in 1986.

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The Uruguay Round: Agenda

Further tariff reductions Reductions in non-tariff barriers Negotiations regarding the Multi-

Fiber Agreement (MFA) Trade in services Anti-dumping duties Agricultural protection Intellectual property rights

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Uruguay Round: Actions Most tariffs to be cut another 34%; others

eliminated. MFA to be phased out over 10 year period. Many remaining quota to be converted to

tariffs. Patent protection to be tightened

somewhat. Very little progress was made with services. Agricultural subsidies to be cut over a 6 - 10

year period.

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The World Trade Organization (WTO)

The Uruguay round was the end of GATT.

GATTs successor, the WTO, was approved during the Uruguay round.

WTO was established January 1, 1995.

WTO has 148 member countries (Cambodia most recently).

In theory, WTO has a stronger dispute-settling mechanism.

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Trade Policy Issues After the Uruguay Round

Many countries wanted further relaxation of protectionism in agriculture.

Developed countries wanted to discuss labor and environmental standards.

Other issues being discussed included trade in services, anti-trust policy, the Multi-Fiber Agreement phase-out, and others.

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WTO and the Doha Round WTO trade ministers met in Seattle in

1999 to set an agenda; no agreement was reached due in part to anti-trade demonstrations.

WTO members met in Doha, Qatar in November of 2001 to set an agenda for the round.

An attempt at meeting in Mexico City ended bitterly in 2003.

Negotiations still havent started.

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WTO and the Doha Round

The agenda will include continued reductions in trade barriers, cutting farm subsidies, patent laws, and other issues.

Doha is supposed to be the round that addresses developing countries concerns.

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The Conduct of Trade Policy

Should trade policy be rules-based or results-based?

Rules-based policies follow rules embodied by the WTO and similar organizations. These embrace the normal trade

relations concept. These follow WTO standards on anti-

dumping duties, countervailing duties, etc.

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The Conduct of Trade Policy

Results-based policies suggest aggressive unilateral action to ensure that certain results are achieved. For example, the U.S. may demand

penetration of a particular foreign market of a certain percentage.

Failure by the trading partner to comply would result in trade sanctions.

This notion is also referred to as industrial policy or managed trade.

Economic Integration



17-2

Learning Objectives

Differentiate among the four basic levels of economic integration.

Identify the static and dynamic effects of economic integration.

Analyze the real-world impact of economic integration on countries in the EU and NAFTA.

Summarize current economic integration efforts in the world.

17-3

Economic Integration

Economic integration occurs when two or more countries come together for purposes of trade and/or economic coordination.

Greater integration may yield additional benefits, but it may also involve giving up increasing sovereignty.

17-4

4 Types of Integration

Free Trade Areas (FTAs) Customs Unions (CUs) Common Markets Economic and/or Monetary Union

17-5

Free Trade Areas

Members remove tariffs and other trade barriers on each other.

Each member maintains its own tariff structure for non-members.

Possible problem: transshipment Example: NAFTA

17-6

Customs Unions

Tariffs between members are eliminated (just like a FTA), but also: members agree to a common set

of external tariffs and other trade barriers, and

members speak with one voice in external trade negotiations.

Example: Southern African Customs Union (SACU)

17-7

Common Markets Tariffs between members are

eliminated, a common external tariff is established (all of the features of CUs) plus free movement of labor and capital.

Example: European Community (1957 1993)

17-8

Economic and/or Monetary Union

Similar to a common market: Tariffs between members are

eliminated. A common external tariff is

established. Factors can move freely between

member countries. But economic policy is coordinated

by a supranational institution in the economic and/or monetary union.

17-9

Welfare Effects of Integration: Static Issues Jacob Viner argued that integration

leads to two welfare effects: trade creation: increases a

countrys welfare trade diversion: decreases a

countrys welfare Whether economic integration is

welfare-enhancing depends on which effect is larger.

17-10

Trade Creation and Trade Diversion: An Example

Suppose we have three countries: Uganda, Sudan, and Kenya.

Initially, Uganda imports textiles and applies a 50% tariff to textiles from both Sudan and Kenya.

Suppose that Sudan is able to produce a unit of textiles for $1, whereas it costs Kenyan producers $1.20 per unit.


ProductionCosts

Price with50% Tariff

Sudan $1.00 $1.50

Kenya $1.20 $1.80

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17-12


Prior to integration, Uganda imports from the most efficient supplier, Sudan.

Suppose now that Uganda enters into a free trade agreement with Kenya, but not Sudan.

That is, Sudanese textile imports are dutiable, but Kenya textiles can enter duty-free.


ProductionCosts

Price with50% Tariff

Price withFTA

Sudan $1.00 $1.50 $1.50

Kenya $1.20 $1.80 $1.20

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17-14


Notice that Uganda will now import from Kenya, although Sudan is the more efficient producer.

Uganda loses tariff revenue, but reverses some of the deadweight loss caused by the protectionism.


D

P

Q

S

Tariff price $1.50

160 200

Free trade price $1.00

PS rises as a result of initial protection.

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D

P

Q

S

Tariff price $1.50

160 200


CS falls as a result of the initial protection.

17-16


D

P

Q

S

Tariff price $1.50

160 200


Revenue rises as a result of the initial protection.

17-17


D

P

Q

S

Tariff price $1.50

160 200


Welfare declines overall by the DWL triangles.

17-18


D

P

Q

S

Tariff price $1.50

160 200

Free trade price $1.00 FTA price $1.20

With FTA, CS rises.

17-19


D

P

Q

S

Tariff price $1.50

160 200


With FTA, PS falls.

17-20


D

P

Q

S

Tariff price $1.50

160 200


With FTA, revenue falls.

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D

P

Q

S

Tariff price $1.50

160 200


Lost revenue transferred back to domestic consumers

Lost revenue not transferred back to domestic consumers

17-22


D

P

Q

S

Tariff price $1.50

160 200


Overall, we must compare the gain in welfare (trade creation) with the lost revenue (trade diversion).

trade creation

trade diversion

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17-24

Trade Creation and Trade Diversion

When is it likely that trade diversion outweighs trade creation? When the excluded countries are

much more efficient than the included countries.

When there are only a few members of the FTA (consider a global FTA: there would be no trade diversion because no country would be excluded).

17-25

Dynamic Welfare Effects

In the long run, integration may increase a countrys welfare because: increased competition may occur,

leading to lower prices, larger markets may allow economies of

scale to be realized, more investment may be attracted, and increased factor mobility may lead to

greater efficiency.

17-26

The European Community: A Brief History

1951: France, Italy, West Germany, and Benelux countries form European Coal and Steel Community.

1958: ECSC expanded to all products; name changed to European Economic Community (EEC).

17-27

The European Community: A Brief History

Other countries joined over the years: 1973: Denmark, Ireland, U.K. 1981: Greece 1986: Portugal and Spain 1995: Austria, Finland, Sweden Recent additions: Bulgaria, Cyprus,

Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, Slovenia

17-28

EC 92

During the 1980s, there were still various and sundry barriers to trade between member countries.

1985: Single European Act (commonly called EC 92): elimination of all barriers to the flow of goods, services, people, and capital by 1992.

It wasnt 1992, but it eventually happened.

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Further Integration: Monetary Union

international economics

Documents

global trade

volume of trade

flow of trade

effects of trade

basis of trade

nature of merchandise

value of world exports

value of global exports