Commercial PolicySanna-Randaccio Lecture 36-37

A general equilibrium approach

Tariffs and the offer curves

The large country case: ambiguous effects

With no retaliations: the optimum tariff

The other country retaliates (Trade Wars)

Any historical example?

General Equilibrium: the Offer Curves (reciprocal demand curve)

It is the locus of all points indicating the maximum quantity of theexported good which a country is willing to exchange for a given quantityof imported good.

Desired level of import and export for different relative prices of the twogoods in the international market (i.e. for various terms of trade)

See Appendix 2 in MMKM

Offer curves: I

Source: MMKM Appendix 2 p. 437

Offer curves: II

Source: MMKM Appendix 2 p.438

H

Offer curves: III

Source: MMKM Appendix 2 p.

Tariffs and Offer Curves

We can analyze the repercussions on the other country

How the Offer Curve shifts when a tariff is introduced

The terms of trade for the country imposing the tariff improve

The relative internal price of the protected good increases but less than the full tariff (less than applying the tariff to the pre-tariff international price ratio)

Tariffs and the terms of trade

Source: Gandolfo (2014), p.

Optimum Tariff

For the individual country (in the absence of retaliation) there isalways an optimum tariff leading to a higher welfare than in free trade.

Considering country H

The optimum tariff is the one shifting downwards the Offer Curve ofcountry H, in such a way of intersecting the point in which the OfferCurve of country F is tangent to the social indifference curve forcountry H. This indifference curve represents for country H the highestlevel of welfare which is compatible with the constraint represented byGF .

But…......the other country will retaliate. Retaliations and counter-retaliations leading to a trade war.

See Gandolfo (2014 : 10.5.2 and 11.1)

Optimum tariff and tariff wars

Source: Gandolfo (2014), p.

TRADE WARS

When both countries implement protectionist measures, the outcome is a prisoner dilemma situation.

Thus multilateral rules are necessary to avoid such a painful outcome.

COUNTRY II

TARIFF

COUNTRY I

TARIFF

A historical example: the inter-war years

1) Reintroduction of the gold-standard•Exchange rates rigidly fixed•Deflationary policies

2) Lack of sufficient international cooperation; several centres of economic power not sufficiently coordinated had emerged internationallyMany countries reacted to the problems associated with the economic crises with:

•Competitive devaluations•Introducing restrictions to international payments and trade

This is the case of the so-called “Beggar-thy-neighbor” policies. These policies however may generate retaliations enacted by the countries harmed by the protectionist measures, leading to a fall in welfare for all the countries involved (for instance the case of trade wars).

INTERWAR YEARS

In the late 1920’s, as the Great Depression set in, many domestic economies collapsed.

Many countries adopted extreme forms of trade protectionism to preserve domestic production and employment:

1930 the US introduced the Smoot-Hawley Tariff which raised duties on imports at an average of 60%. Quickly US major trade partners retaliated.

The WWI carnage (1914- 18)

Morti militari Totale mortiMil & civili

% della popolazione

Militari feriti

Francia 1.397.800 1.697.800 4,29% 4.266.000

Italia 651.000 1.240.000 3,48% 1,663,435

Impero Britannico

1.115.597 1.226.000 2,19% (solo UK) 953.000

Russia 1,8 ‐ 2,3 milioni 500.000 1,9‐2,1% 3,8 – 5,0 mil

Austria 1.100.000 1.567.000 3,1% 3.620.000

Germania 2.050.897 2.476‐897 3,8% 4.247.143

TOTALEMONDO

9.800.000 16.600.000 1,8% 21.300.00

CARNAGE IN WORLD WAR II REACHED A MUCH LARGER SCALE

• Human losses of World War II (a truly global war) reached a level unprecedented even in WWI (mainly European).

• The power of destruction of the new technologies (up to the atomic bomb) increased exponentially

• The tragedy of the war was compounded by the horrifying mass murder of the Holocaust.

Human losses of WWII

• Military deaths are estimated between 22 and 30 million (of which 9-14 million in Soviet Union alone)

• Considering also civilian deaths, human losses of WWII reach the colossal number of 60-85 million (3,2-4% of world population).

• In the six years of the war, in many countries income fall back to the level of the previous generation