international trade policy
TRANSCRIPT
International
Trade Policy
T.J. Joseph
Introduction• Classical trade theories advocate the economic gains
from free trade
• They show that free trade supports a higher level of domestic consumption and more efficient utilization of resources
• Also explain how free trade stimulates economic growth and the creation of wealth
• But the political reality of international trade is different
• Nations/Govts. Intervene in international trade to protect the interests of politically important groups
Instruments of Trade PolicyWhat should a nation’s trade policy be?
Different trade policies include:-
Tariffs
Non-tariff barriers
• Subsidies
• Quotas
• Voluntary Export Restraints
• Local Content Requirements
• Others
Tariff
• Simplest and the oldest form of trade policy
• It is a tax levied when a good is imported
• Purposes – to provide revenue to the Govt. and also to protect particular domestic sector
• Specific Tariff – Fixed charge for each unit of good imported
• Ad Valorem Tariff – levied as a fraction of the value of the imported goods
Trade in a Single IndustryAssume:-
• Two countries – Home and Foreign
• A single product – Wheat
• Free trade (no transportation cost)
• In each country supply and demand are functions of market prices
• Exchange rate remains same
Trade:
• Wheat will be exported from countries with low price to countries with high price, until the price differences get eliminated
• Suppose Home pricewheat > Foreign pricewheat
• Home imports and Foreign exports Wheat
• World Equilibrium reaches when Home import demand equals Foreign export supply, i.e.,
Home DD – Home SS = Foreign SS – Foreign DD
Home DD + Foreign DD = Home SS + Foreign SS
World DD = World SS
Costs and Benefit of a TariffEffect of a Tariff:
• Prices – rise in the importing country and falls in the exporting country
• Consumers – loss in the importing country and gain in the exporting country
Ex: tariffs on foodstuffs, cosmetics and chemicals cost the average Japanese consumer about $890 per year in 1989
• Producers – gain in the importing country and loss in the exporting country
• Government – gains revenue through tariff
Effect of a Tariff• Assume a import tariff of $t per unit of Wheat at Home
• For trade to take place, Home price should exceed at least by $t from that of Foreign price
Result – price in Home will rise and that in Foreign will fall
In Home;
• Consumers demand less, so fewer import demand
In Foreign;
• Producers get lower prices, so smaller export supply
Effects of Tariffs
• It reduce the overall efficiency of the world economy
– By encouraging domestic firms to produce productsat home which could have produced more efficientlyabroad
– Result in inefficient utilization of resources
Ex: car production in India before 1991
Measuring the Amount of Protection
• The principle objective of tariff is to protect domestic producers from the low prices due to import competition
• How much protection a tariff actually provides?
– Usually expressed as a percentage of free trade prices
– If tariff is an ad valorem, tariff rate itself should measure the amount of protection
The Effective Rate of ProtectionThe Effective Rate of Protection measures the percentage effect of the entire tariff structure on the value added per unit of output in each industry
• Tariff Structure
Tariff structure refers to the relationship among tariffs in related industries
• Value Added
Value added is the difference between the selling price and the cost of intermediate goods.
V = PA – Psa
The Effective Rate of Protection
ERP = (VT – VW ) / VW
ERP = Effective Rate of Protection
VT = Value Added with tariff
VW = Value added with free trade
Where,
VW – Value added in the sector at world prices
VT – Value added in the presence of trade policies
PA – World price of finished good
PC – World price of input component
tA – tariff rate on imported finished good
tC – tariff rate on input component
Provided tariffs does not affect world prices
The Effective Rate of Protection
The Effective Rate of Protection
The ERP can also be calculated using the following formula
ERP = (tA – atC ) / (1 – a)
Where,
tA - the nominal tariff on the imported finished good
a - the value of imported inputs as a share of the value of the final good under free trade
tC - the tariff on imported inputs used by the domestic producers.
Important!: Please refer the article by Frank Flatters for illustrative examples explaining the Effective Rates of Protection
Export Tariffs
• Levied on exports of a product from a country
• Less common than import tariffs
• Objectives:
1. To raise revenue for the government
2. To reduce exports from a sector, usually due to somepolitical reasons
Ex: China’s tariff on textile exports
Other Instruments of Trade Policy
Subsidies
• Subsidy is a payment to a domestic producer
• It can be in the form of cash grants, low-interest loans, tax breaks, and govt. equity
• Helps domestic producers compete against foreign imports and gaining export markets
Ex: Agricultural subsidies in U.S., Europe (43% of gross farm receipts. Almost $43 bn), Japan (62% of GFR), etc.
Effects of a Subsidy
• Domestic producers gain: increase in their international competitiveness
• The home country government loss
• Consumers loss: Govts. typically pay for subsidies by taxing individuals
• Advocates of Strategic Trade Policy (a section of New Trade Theory) favour subsidies to help domestic firms to achieve economies of scale
• Ex: Boeing got substantial U.S. govt. subsidies in the form of R&D grant
Effects of a Subsidy
• Mostly subsidies protect the inefficient and promote excess production
• Ex: Agriculture subsidies:
a. Allow inefficient farmers to stay in business
b. Encourage countries to overproduce
c. Encourage countries to produce products that can be produced more cheaply elsewhere and imported
d. Reduce international trade in agricultural products
Research shows that if advanced countries abandoned subsidies to farmers,
global trade in agricultural products would be 50% higher and the world as a
whole would be better off to the tune of $160 bn.
• A direct restriction on the quantity of some good that may be imported
• Restrictions are enforced through import licenses
• Import quotas are issued either to an individual or firm in the importing country or given directly to the government of exporting countries
Ex: (1) U.S. has quota on Cheese imports licensed to certain U.S. trading companies
(2) Sugar & textile imports in U.S. is given directly to the governments of exporting countries
Import Quotas
Effects of an Import Quota
• Raises the domestic price of the imported good
• Have the same effects of a tariff
• Revenue for government under quota system is the import license fee collected
• Quota Rents: The profits received by the holder of import license
• The recipient of Quota rents depend on who gets the rights to sell in the domestic market – whether domestic firm or government of exporting countries.
• A variant of import quota
• A VER is a quota on trade imposed from the exporting country’s side
• Generally imposed at the request of the importer
• It is like an import quota assigned to foreign govts.
Ex: limitation on auto exports to US enforced by Japanese automakers in 1981 (Max. 1.68 mn. vehicles per year)
Ex: the Multi-Fiber Agreement (MFA) that limits textile exports from 22 countries
Voluntary Export Restraints (VER)
Effects of a VER
• Foreign producers agree to VERs because they fear far more damaging punitive tariffs or import quotas
• VER – a way of making the best of a bad situation
• Benefits domestic producers by limiting import competition
• Domestic consumers are affected due to higher domestic price for the imported good (foreign supply is limited)
Ex: Study shows that due to import quotas, the price of sugar in US has been almost 40% greater than world price
• Very costly to an importing country than a tariff –revenue under a tariff becomes rent earned by foreigners
• A regulation that requires some specified fraction of a final good be produced domestically
• Widely used by the developing countries
• For the domestic producers of parts, this provides protection in the same way an import quota does
Ex: the Buy American Act specifies US govt agencies must give preferences to American products that uses at least 51% of the materials by value produced domestically
• Does not produce either government revenue or quota rent
Local Content Requirement
• Bureaucratic rules that are designed to make it difficult for imports to enter a country
Ex: Japan’s customs inspection on tulip bulbs from Netherland and courier packages of FedEx
France required that all imported videotape recorders arrive should go through a small customs entry point that was poorly staffed. The delays kept Japanese VCRs out of French market
Informal or Administrative Policies
• Dumping is variously defined as selling goods in a foreign market at below their cost of production or below their domestic market price
• Viewed as a method by which firms unload excess production in foreign markets
• Using substantial profits from their home markets to subsidize prices in a foreign market to drive indigenous competition out of that market
• Antidumping policies are designed to punish foreign firms that engage in dumping
• Antidumping duties are often called countervailing duties
Antidumping Policies
Summary
Tariff SubsidyImport Quota
VER
Producer surplus
rise rise rise rise
Consumer surplus
falls falls falls falls
Govt. Revenue
rise
Falls (Govt.
spending rises)
No change (Rent to license
holders)
No change (Rents to
foreigners)
Overall welfare
Ambiguous falls Ambiguous falls
THE POLITICAL ECONOMY OF TRADE POLICY
The Case for Government Intervention
Free Trade and Efficiency
The efficiency case of free trade
• Free trade eliminates distortions due to tariff and increase national welfare
• Protected markets fragment production internationally and reduce competition
• Too many firms in a narrow domestic market leads to inefficient scale of production
Political Arguments for Intervention• Protecting jobs and industries
• Protecting industries deemed important for national security
• Retaliation - use trade policy as a threat while bargaining for foreign market access or implement patent laws, etc.
• Protecting human rights of individuals in exporting countries
• Protecting consumers from “unsafe” products
Ex: European Union ban on the import of hormone-treated beef
Economic Arguments for Intervention• The infant industry argument
New manufacturing industries of developing countries cannot initially compete with well-developed industries in developed countries
• The New Trade Theory and Strategic Trade Policy
New Trade Theory argues that firms engage in international trade because they enjoy economies of scale mostly achieved through first-mover advantage
Some New Trade Theorists argue for strategic trade policy
• Their arguments have two components:
I. Govt. should provide subsidies to firms in newly emerging industries to help them achieve first-mover advantage (Ex: Boeing, LCDs by Japanese companies)
II. Govt. should intervene in industries to help domestic companies to overcome the barriers already created by the foreign firms enjoying first-mover advantage (Ex: Airbus)
“Trade policies in practice are dominated by special-interest politics rather than consideration of national costs and benefits”
National Welfare Argument against Free Trade
– Most trade policy measures are primarily to protect the income of particular interest groups
– “It is in the interest of the nation as a whole” - Politicians
– “Deviation from free trade reduces national welfare” - Economists
Discussion Questions
1. Do you think governments should consider human rights when granting preferential trading rights to countries?
2. Whose interests should be the paramount concern of government trade policy - the interests of producers or those of consumers?
References
1. Chapters 6, ‘International Business’ by
Charles W. Hill and Arun K. Jain, Tata McGraw
Hill publication.
2. Chapter 2, ‘International Business’ by Oded
Shenkar and Yadong Luo, Wiley publication.