1 Ch. 8: The Instruments of Trade Policy 2 What Should A Nation’s Trade Policy Be? Should a nation protect a vital industry? Should a nation protect

11

Ch. 8: The Instruments of Trade Policy

22

What Should A Nation’s Trade What Should A Nation’s Trade Policy Be?Policy Be?

Should a nation protect a vital industry?Should a nation protect a vital industry?Who would benefit and who would lose?Who would benefit and who would lose?Would the benefits exceed the losses?Would the benefits exceed the losses?What kind of protection yields what kind of What kind of protection yields what kind of

benefits and losses?benefits and losses? Import tariffImport tariff Import quotaImport quotaExport subsidyExport subsidyVoluntary export restraintsVoluntary export restraints

33

TariffsTariffs Specific tariffs are $ amounts per unit, e.g. Specific tariffs are $ amounts per unit, e.g.

$15 per case of imported wine.$15 per case of imported wine. Ad valorem tariff is percent of the value of Ad valorem tariff is percent of the value of

the product imposed as tariff, e.g. 50% the product imposed as tariff, e.g. 50% tariff on imported wine.tariff on imported wine.

Tariffs that were traditionally the main Tariffs that were traditionally the main revenue of governments have declined in revenue of governments have declined in importance.importance.

Protection nowadays is through quotas, Protection nowadays is through quotas, standards and export restraints.standards and export restraints.

44

Which Country Will Export Beef Which Country Will Export Beef and Which Will Import?and Which Will Import?

D

S

D

S

Pbeef Pbeef

Q QCountry A Country B

55

Country A’s Import Demand Country A’s Import Demand (High Cost Country)(High Cost Country)

D

S

MD

Pbeef Pbeef

Q QCountry A Country A

66

Country B’s Beef Export Country B’s Beef Export Supply (Low Cost Country)Supply (Low Cost Country)

D

S

Pbeef Pbeef

Q QCountry B Country B

XS

77

Equilibrium Price and Quantity Equilibrium Price and Quantity in the World Marketin the World Market

MD

Pbeef

Q Q

Pbeef

Country B

XS XS

88

Imposing a TariffImposing a Tariff

D D

S

S

PwPw

Pt

Pt*

In a two-country world, imposing a tariff affects both parties. In this case, both countries are large countries: their behavior affects price. As a result, the tariff is shared by both: T=(Pt-Pw)+(Pw-Pt*) or T=Pt-Pt*.

99

Tariff in a Small CountryTariff in a Small Country

Pw

S

D

QdQs

Pt

The definition of a small country is a country that cannot affect prices outside. In this case, the price effect of the tariff is solely on the small country.

1010

Effective Rate of ProtectionEffective Rate of Protection Suppose automobile companies use $3,000 Suppose automobile companies use $3,000

worth of steel to produce a $10,000 worth of worth of steel to produce a $10,000 worth of car.car.

If US were to impose an import tariff on cars If US were to impose an import tariff on cars that raised the price to $12,500, can we say that raised the price to $12,500, can we say the protection was 25%?the protection was 25%?

If US were to impose an import tariff on steel If US were to impose an import tariff on steel that raised the cost to car companies to that raised the cost to car companies to $4,500, can we say the protection to steel $4,500, can we say the protection to steel was 50%?was 50%?

1111

Effective Rate of ProtectionEffective Rate of Protection

Before the tariff on cars, price was Before the tariff on cars, price was $10,000; afterwards, $12,500.$10,000; afterwards, $12,500.

Before tariff, value added was $7,000; Before tariff, value added was $7,000; afterwards, $9,500.afterwards, $9,500.

The effective rate of protection is (9500-The effective rate of protection is (9500-7000)/7000 or 2500/7000, which is 7000)/7000 or 2500/7000, which is 35.7%.35.7%.

1212

Effective Rate of ProtectionEffective Rate of Protection

If steel had $3000 value added before If steel had $3000 value added before and $4500 after the tariff, the effective and $4500 after the tariff, the effective rate of protection will be %50.rate of protection will be %50.

The impact on autos will be to reduce The impact on autos will be to reduce their value added from $7000 to $5500.their value added from $7000 to $5500.

The effective rate of protection for the The effective rate of protection for the auto industry will be (5500-7000)/7000 auto industry will be (5500-7000)/7000 or 1500/7000 or -21.4%.or 1500/7000 or -21.4%.

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Costs and Benefits of a TariffCosts and Benefits of a TariffTariff raises the price in the importing Tariff raises the price in the importing

country.country.Producers gain.Producers gain.Consumers lose.Consumers lose.Government gains revenue.Government gains revenue.

Tariff lowers the price in the exporting Tariff lowers the price in the exporting country.country.Producers lose.Producers lose.Consumers gain.Consumers gain.

1414

Consumer SurplusConsumer Surplus The market demand curve shows at each and The market demand curve shows at each and

every price how many units will be bought in the every price how many units will be bought in the market.market.

It also shows to sell a specific amount in the It also shows to sell a specific amount in the market, what the highest price should be.market, what the highest price should be.

If a number of people are willing to pay that price If a number of people are willing to pay that price and more, the product must have been worth to and more, the product must have been worth to them that much.them that much.

Some people were willing to pay more than the Some people were willing to pay more than the ongoing price. They have a windfall: consumer ongoing price. They have a windfall: consumer surplus.surplus.

1515

Consumer SurplusConsumer Surplus

D

Q

P

127

$5.81

439

$3.54

The 127th unit can only be sold if the price were $5.81. All the previous units could be sold at higher prices. The people who paid $5.81 for those got a bargain.

The windfall they got is equal to the triangle above the price.

1616

Consumer SurplusConsumer Surplus

D

Q500

$3.54

$6.54Calculate the consumer surplus.

$2.54

667

Calculate the additionalconsumer surplus.

$584

$750

1717

Producer SurplusProducer Surplus Supply curve shows the amount brought to the Supply curve shows the amount brought to the

market at each and every price.market at each and every price. In order to have more units brought to the market, In order to have more units brought to the market,

the price has to rise to cover the increased cost of the price has to rise to cover the increased cost of producing one more unit; i.e., MC is upward producing one more unit; i.e., MC is upward sloping.sloping.

If the cost of last unit sold just matches the price If the cost of last unit sold just matches the price earned, the cost of previous units will be lower earned, the cost of previous units will be lower than the price.than the price.

The producers will earn profits on each previous The producers will earn profits on each previous unit.unit.

1818

Producer SurplusProducer Surplus

S

396

$4.07

In order to produce the 396th unit the price has to be at least $4.07. To produce more requires a higher price.All the units before 396 cost less than $4.07 toproduce yet they are sold at $4.07. Theproducer surplus is the trianglebetween the price and the supply curve.

1919

Producer SurplusProducer Surplus

$1.50

$4.50

100

$7.50

200

Calculate the producer surplus at $4.50 and at $7.50.

$450

$150

2020

Import Tariff in a Small CountryImport Tariff in a Small Country

Pw

Q1 Q2

D

S

Pt

Q3 Q4

Identify producergain, governmentgain, and consumerloss.

2121

Import Tariff in a Small CountryImport Tariff in a Small Country Consumer loss is greater than the gains of Consumer loss is greater than the gains of

the producer and the government.the producer and the government. The efficiency (deadweight) loss is The efficiency (deadweight) loss is

composed of production distortion and composed of production distortion and consumption distortion.consumption distortion.

Production is distorted because high cost Production is distorted because high cost producers are allowed to produce instead of producers are allowed to produce instead of low cost producers.low cost producers.

Consumption is distorted because Consumption is distorted because consumers are forced to consume less at consumers are forced to consume less at higher price.higher price.

2222

Import Tariff in a Large CountryImport Tariff in a Large Country

Pw

Pt

Pt*

Q1 Q2 Q3 Q4

D

STerms of trade effect maycompensate for the deadweight loss.

2323

Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999 as quoted in The Economist, May 24, 1999, p. 84.

Average EU tariff on selected Average EU tariff on selected products, 1997products, 1997

Beef and lamb 87.7%Beverages 22.2Cereals 67.8Clothing 12.0Dairy products 57.7Food products 26.9Sugar 61.8Tobacco 58.8

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European anti-dumping duties on European anti-dumping duties on selected products, 1997selected products, 1997

Footwear 29.1%Industrial chemicals 28.3Iron and steel 29.3Leather products 22.9Metal products 44.4Motorcycles and bicycles 28.4Office and computing equipment 19.5Printing and publishing 18.6Radio, TV and communication 23.2


2525

Export Subsidy in a Small CountryExport Subsidy in a Small Country

Pw

Ps

Q1 Q2 Q3 Q4

S

D

When there is no terms of trade effect, identify the welfare gains and losses.

a b cd

2626

Export Subsidy in a Small CountryExport Subsidy in a Small Country

There is no terms of trade effect.There is no terms of trade effect.Consumers lose a+b.Consumers lose a+b.Producers gain a+b+c.Producers gain a+b+c.Government “loses” b+c+d.Government “loses” b+c+d.Net loss b+d.Net loss b+d.Consumption distortion is b.Consumption distortion is b.Production distortion is d.Production distortion is d.

2727

Export Subsidy in a Large CountryExport Subsidy in a Large Country

Ps

PwPs*

Negative terms of trade effect. Show welfare results.

2828

Export Subsidy in a Large CountryExport Subsidy in a Large Country

Export price falls; negative terms of Export price falls; negative terms of trade effect.trade effect.

Government subsidy is larger than in a Government subsidy is larger than in a small country case.small country case.

Net loss is greater than the small Net loss is greater than the small country case.country case.

2929

EU’s Common Agricultural PolicyEU’s Common Agricultural PolicyEU countries are a net importer of EU countries are a net importer of

agricultural products.agricultural products.To protect the incomes of the farmers To protect the incomes of the farmers

initially support prices were established initially support prices were established and import tariffs imposed to keep prices and import tariffs imposed to keep prices high.high.

The support prices are so high that it The support prices are so high that it works as an export subsidy.works as an export subsidy.

3030

EU’s Common Agricultural PolicyEU’s Common Agricultural Policy

Ps

Pw

Show benefit to farmers, cost to consumers and export subsidy.

3131

Common Agricultural PolicyCommon Agricultural PolicyOver half of EU's budget goes to CAP. Over half of EU's budget goes to CAP. ((The The

Economist, Economist, May 8, 1999, p. 18May 8, 1999, p. 18.).)

European beef farmers benefit from tariffs European beef farmers benefit from tariffs up to 125% on beef imports and from the up to 125% on beef imports and from the ban on hormone-treated beef, which ban on hormone-treated beef, which keeps out most American and Canadian keeps out most American and Canadian produce. The cost is $14.6 billion a year produce. The cost is $14.6 billion a year in higher prices and taxes, or around in higher prices and taxes, or around $1.60 per kilo of beef.$1.60 per kilo of beef.


3232

Common Agricultural PolicyCommon Agricultural Policy

European import restrictions more European import restrictions more than double the price of many foods, than double the price of many foods, such as milk, cheese and wheat. The such as milk, cheese and wheat. The duty on offal imports peaks at 826%. duty on offal imports peaks at 826%. The cost of protecting European The cost of protecting European farming could be as much as 10-15% farming could be as much as 10-15% of value added in agriculture.of value added in agriculture.


3333


Saving Jobs in EUSaving Jobs in EUEurope's costs of protection in 1999 Europe's costs of protection in 1999

was about 7% of EU's GDP - some was about 7% of EU's GDP - some $600 billion. $600 billion.

With nearly 17 million Europeans out With nearly 17 million Europeans out of work in 1999, politicians were of work in 1999, politicians were susceptible to claims that competition susceptible to claims that competition from imports is costing jobs.from imports is costing jobs.

3434


Saving Jobs in EUSaving Jobs in EUProtection in 22 heavily protected sectors Protection in 22 heavily protected sectors

safeguards only 200,000 jobs at a cost of safeguards only 200,000 jobs at a cost of $43 billion a year - or some $215,000 per $43 billion a year - or some $215,000 per job, enough to buy each lucky worker a job, enough to buy each lucky worker a new Rolls-Royce every year. new Rolls-Royce every year.

Since most workers in import-competing Since most workers in import-competing industries eventually find jobs elsewhere, industries eventually find jobs elsewhere, the true number of jobs "saved" is tiny - the true number of jobs "saved" is tiny - and the annual cost of preserving them and the annual cost of preserving them astronomical.astronomical.

3535

Protection in Industry in EUProtection in Industry in EU The average tariff (not effective tariff) on non-The average tariff (not effective tariff) on non-

agricultural goods imported in 1997 was 5.1%. agricultural goods imported in 1997 was 5.1%. It excludes the impact of other import It excludes the impact of other import

restrictions. For example, anti-dumping duties restrictions. For example, anti-dumping duties on "unfairly" cheap imports of products like on "unfairly" cheap imports of products like steel, textiles and video recorders; quotas on steel, textiles and video recorders; quotas on imports from China and Russia; Japan's imports from China and Russia; Japan's "voluntary" agreement to restrict its car exports "voluntary" agreement to restrict its car exports all add to protection costs. all add to protection costs.


3636

Protection in Industry in EUProtection in Industry in EU

Taking these into account, the true overall Taking these into account, the true overall rate of industrial protection is at around 9% rate of industrial protection is at around 9% in 1997. The cost of that protection comes in 1997. The cost of that protection comes to as much as 8-12% of the value added in to as much as 8-12% of the value added in industry.industry.


3737

Protection in Services in EUProtection in Services in EU

A thicket of regulations whose costs A thicket of regulations whose costs cannot easily be estimated protects cannot easily be estimated protects service sectors such as health care, service sectors such as health care, telecommunications, financial services telecommunications, financial services and airlines. But Mr. Messerlin estimates and airlines. But Mr. Messerlin estimates cost of protection could amount to 10-cost of protection could amount to 10-15% of value added in services.15% of value added in services.

Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999 as quoted in The Economist, May 24, 1999, p. 84

3838

Import Quota on Sugar in USAImport Quota on Sugar in USA In 1990, US had import quota of 2.13 million In 1990, US had import quota of 2.13 million

tons on sugar; in 2002, it was 1.4 million tons.tons on sugar; in 2002, it was 1.4 million tons. The world price of sugar was $280 per ton in The world price of sugar was $280 per ton in

1990; it was $157.60 in 2002.1990; it was $157.60 in 2002. The quota raised the US price to $466/ton in The quota raised the US price to $466/ton in

1990; in 2002, it was $417.40.1990; in 2002, it was $417.40. Given the demand curve and the local production of Given the demand curve and the local production of

5.14m tons at $280/ton, the quota created a shortage 5.14m tons at $280/ton, the quota created a shortage of 1.99m tons in 1990.of 1.99m tons in 1990.

Price increase to $466 eliminated the shortage by Price increase to $466 eliminated the shortage by providing domestic incentives to increase production providing domestic incentives to increase production to 6.32m tons in 1990.to 6.32m tons in 1990.

For 2002 results, see Figure 8-13 in the text.For 2002 results, see Figure 8-13 in the text.

3939

Import Quota on Sugar in USA, 1990Import Quota on Sugar in USA, 1990

$466

$280

5.14 6.32 8.45 9.26

a = 186*5.14 +(186*1.18)/2=$1066m

b

c=186*2.13=$396 d

b=.5*186*1.18=$110md=.5*186*0.81=$75m

4040

Import Quota on Sugar in USA, 1990Import Quota on Sugar in USA, 1990Producer gains of $1066 million for 12,000 Producer gains of $1066 million for 12,000

workers means a subsidy of $89,000 per workers means a subsidy of $89,000 per worker.worker.

Consumer loss is 1066+110+396+75 = Consumer loss is 1066+110+396+75 = $1647 million or $6 per capita.$1647 million or $6 per capita.

If because of the quota 2500 extra people If because of the quota 2500 extra people are employed in the industry, the cost of are employed in the industry, the cost of per job “saved” is $1,647,000,000/2,500 or per job “saved” is $1,647,000,000/2,500 or $658,800.$658,800.

4141

Update on Sugar QuotasUpdate on Sugar Quotas According to GAO, the cost to consumers in According to GAO, the cost to consumers in

1998 was $1.9 billion in higher prices.1998 was $1.9 billion in higher prices. Artificially high prices led to overproduction Artificially high prices led to overproduction

where $1.4 million a month is paid by taxpayers where $1.4 million a month is paid by taxpayers to store one million pounds of sugar.to store one million pounds of sugar. That is enough sugar to sweeten 180 billion donuts.That is enough sugar to sweeten 180 billion donuts.

The chief beneficiaries are beet and cane The chief beneficiaries are beet and cane growers.growers.

http://www.nytimes.com/2001/05/06/business/06SUGA.html?ex=990249498&ei=1&en=70dd040d727a9c94Source:

4242

Update on Sugar QuotasUpdate on Sugar Quotas The present program was put in place in The present program was put in place in

1981, during Reagan presidency.1981, during Reagan presidency. In recent years, helped by technology and In recent years, helped by technology and

weather, production has exploded.weather, production has exploded. A record 8.5 million tons of sugar was A record 8.5 million tons of sugar was

produced in the US in 1999.produced in the US in 1999. Excess supply forced raw sugar price down to Excess supply forced raw sugar price down to

18 cents/lb, lowest level in 20 years.18 cents/lb, lowest level in 20 years. The Agriculture Dept bought 132,000 tons in The Agriculture Dept bought 132,000 tons in

July 2000 at a cost of $54 million, 20 cents/lb.July 2000 at a cost of $54 million, 20 cents/lb.

4343

Update on Sugar QuotasUpdate on Sugar QuotasThe largest producer of raw sugar, Flo-Sun The largest producer of raw sugar, Flo-Sun

of Palm Beach, FL, is owned by two Cuban of Palm Beach, FL, is owned by two Cuban exiles and are big donors to both exiles and are big donors to both Republican and Democratic parties.Republican and Democratic parties.

They want to restrict beet and cane They want to restrict beet and cane production to control supply and limit production to control supply and limit imports of sugar.imports of sugar.

The US sugar supports provide direct The US sugar supports provide direct payments by taxpayers to sugar growers.payments by taxpayers to sugar growers.

4444

Update on Sugar QuotasUpdate on Sugar Quotas

Under 1994 Uruguay Round agreement, Under 1994 Uruguay Round agreement, US is required to import about 1.1 million US is required to import about 1.1 million tons.tons.

NAFTA requires unlimited access to NAFTA requires unlimited access to American market in 2008.American market in 2008. In 2001, American officials claim 100,000 tons In 2001, American officials claim 100,000 tons

will be allowed in from Mexico. Mexicans will be allowed in from Mexico. Mexicans claim the amount should be 500,000 tons.claim the amount should be 500,000 tons.

4545

4646

Voluntary Export Restraints (VER)Voluntary Export Restraints (VER)Quotas imposed by the exporting country.Quotas imposed by the exporting country. It is similar the import quota where quota It is similar the import quota where quota

rents are reaped by the exporting country.rents are reaped by the exporting country.Multi-Fiber Agreement on textiles and the Multi-Fiber Agreement on textiles and the

Japanese auto VERs in early 1980s are Japanese auto VERs in early 1980s are examples.examples.

According to the US government estimates According to the US government estimates Japanese VERs cost the US $3.2 billion in Japanese VERs cost the US $3.2 billion in 1984.1984.

4747

Local Content RequirementsLocal Content Requirements Laws that require a fraction of the final good to be Laws that require a fraction of the final good to be

locally produced.locally produced. It protects the local producers similar to an import It protects the local producers similar to an import

quota.quota. The firms that are required to buy locally will have The firms that are required to buy locally will have

an increase in cost of production.an increase in cost of production. Unlike an import quota, it does not restrict Unlike an import quota, it does not restrict

imports; the increased cost is passed to the imports; the increased cost is passed to the consumers.consumers.

Sometimes, local content laws accept exports by Sometimes, local content laws accept exports by the firms to replace local content.the firms to replace local content.

4848

Other Trade Policy InstrumentsOther Trade Policy InstrumentsExport credit subsidies:Export credit subsidies: low interest low interest

loan given by the exporter to the loan given by the exporter to the importer.importer.

National procurement:National procurement: requirements requirements that governments have to buy that governments have to buy domestically produced goods.domestically produced goods.

Red-tape barriers:Red-tape barriers: increasing health, increasing health, safety or customs regulations to safety or customs regulations to discourage imports.discourage imports.

4949

Summary of Trade PoliciesSummary of Trade Policies

Tariff Export Subsidy Import Quota VERProducer Surplus + + + +Consumer Surplus - - - -Government revenue + - 0 0Rents 0 0 Licenses ForeignersOverall welfare ?; - small - ?; - small -

Documents

1 Ch. 8: The Instruments of Trade Policy 2 What Should A Nation’s Trade Policy Be? Should a nation protect a vital industry? Should a nation protect