Principles of International Principles of International and Interregional Tradeand Interregional TradePart IIPart II

Econ Dept, UMR

Presents

The Forces of Protectionism

StarringStarring

FeaturingFeaturing

Answers to: If free trade is so good, Answers to: If free trade is so good, why are so many concerned?why are so many concerned?

Tariffs/Quotas and Other Tariffs/Quotas and Other RestrictionsRestrictions

As we saw earlier, by trade, countries are able to consume more than they can produce. Graphically we showed this for two countries by locating consumption point to the right of their production possibilities curve. This can only be done because they are specializing and trading for the other goods they consume.

So, if Free Trade is so Good, So, if Free Trade is so Good, Why So Many Restrictions?Why So Many Restrictions?

To Protect IndustryTo Protect IndustryTo Protect WorkersTo Protect WorkersTo Protect the Good Old USATo Protect the Good Old USATo Protect Free Trade To Protect Free Trade

To Protect IndustryTo Protect Industry

The Infant Industry ArgumentThe Infant Industry Argument----”Protect ”Protect us until we get our act together”us until we get our act together”The Cushion ArgumentThe Cushion Argument----”Give use time ”Give use time to upgrade and we’ll kick butt”to upgrade and we’ll kick butt”

Protect IndustryProtect Industry--RejoinderRejoinderFirst, industry doesn’t have standing, First, industry doesn’t have standing, only people doonly people doSecond, these infants don’t seen to Second, these infants don’t seen to grow upgrow upThird, which industries deserve the Third, which industries deserve the protection?protection?

In sum: Save your sympathy for people who need it

Protect WorkersProtect WorkersWhich workers? A reduction of Which workers? A reduction of imports will be followed by a reduction imports will be followed by a reduction in exports. Jobs saved vs. jobs lostin exports. Jobs saved vs. jobs lostJobs saved are likely to be costlyJobs saved are likely to be costly**

In textiles and apparel, 56,000 jobs saved at In textiles and apparel, 56,000 jobs saved at an annual cost of $10b, or $178,000/joban annual cost of $10b, or $178,000/jobIn motor vehicles, 3,400 jobs saved at a In motor vehicles, 3,400 jobs saved at a yearly cost of $925m, or $270,000/jobyearly cost of $925m, or $270,000/job

**An update of An update of The Economic Effects of Significant U.S. Import The Economic Effects of Significant U.S. Import Restraints, Restraints, 19961996

Protect WorkersProtect Workers--RejoinderRejoinderAgain, the problem of deciding which Again, the problem of deciding which workers to protectworkers to protectTrade restrictions are too costlyTrade restrictions are too costlyRetraining, relocation, through Trade Retraining, relocation, through Trade Adjustment funds are warrantedAdjustment funds are warranted----a a redistribution from those that gain from redistribution from those that gain from free trade to those that losefree trade to those that lose

Protect the Good Old USAProtect the Good Old USA

If we import all our guns, we will be up If we import all our guns, we will be up a creek if we need more gunsa creek if we need more gunsProduction abroad will hurt the Production abroad will hurt the environmentenvironmentProduction abroad will subject our Production abroad will subject our consumer to dangerous productsconsumer to dangerous products

Protect the USAProtect the USA--RejoinderRejoinder

Who decides what industry is strategic?Who decides what industry is strategic?There are cheaper ways to stockpile There are cheaper ways to stockpile materials than trade restrictionsmaterials than trade restrictionsEvidence is clear: Environmental Evidence is clear: Environmental quality is a normal good. Countries quality is a normal good. Countries with less income are apt to make the with less income are apt to make the tradetrade--off of more pollution for a higher off of more pollution for a higher standard of living standard of living

Protect Free TradeProtect Free Trade

We need to have a credible threat of We need to have a credible threat of restricting imports in order for other restricting imports in order for other countries to take the necessary steps to countries to take the necessary steps to overcome their special interests and overcome their special interests and promote free tradepromote free trade

Protect Free TradeProtect Free Trade--RejoinderRejoinder

As with many of the other arguments: As with many of the other arguments: Yes, but . . .Yes, but . . .When should the threat be carried out?When should the threat be carried out?Is this argument just another veiled Is this argument just another veiled reason for special interest protection?reason for special interest protection?

A Look at Trade Restriction A Look at Trade Restriction PolicyPolicy

TariffsTariffsQuotas or VERs Quotas or VERs (voluntary export (voluntary export restrictions)restrictions)

Other RestrictionsOther RestrictionsWe use comparative We use comparative analysisanalysis

The situation with trade restrictionsThe situation with trade restrictionsAnd, the situation without restrictionsAnd, the situation without restrictions

Market Restricted to Market Restricted to Domestic SuppliersDomestic Suppliers

SSUSUS

Q2

P0

P3

P

Q/t

D

Q2 Quantity bought and sold P3 Price

Market UnrestrictedMarket Unrestricted

SSUSUSSSrowrow

SSTotalTotal

Q0 Q4

P0

P1

P

Q/t

D

Q4 Quantity bought and sold

Q0 Domestic Supply Q4 - Q0 Imports

SStotal total = S= Susus + S+ SrowrowP1 Price

P3

Q2

row: rest of world

Gains and Losses from Gains and Losses from Unrestricted TradeUnrestricted Trade

Consumers gain from lower price and Consumers gain from lower price and greater quantity to consumegreater quantity to consumeU.S. producers lose from lower price U.S. producers lose from lower price and less salesand less salesConsumer gain exceeds U.S. producer Consumer gain exceeds U.S. producer loss therefore removing trade loss therefore removing trade restrictions is efficient, restrictions is efficient, c.p.c.p.

Gain from Unrestricted TradeGain from Unrestricted TradeSSUSUSSSrowrowSSTotalTotal

Q0 Q4

P0

P1

P

Q/t

D

P3

Q2

Consumers gain due to lower price, (P3 -P1)Q2, and greater quantity, (P3 - P1)(Q4 -Q2)/2. US producers loss due t o fewer sales (P3 - P1)Q0 + (P3 -P1)(Q2 - Q0)/2

Society’s gain = consumers gain minus US suppliers loss =

a b

c

c

a b - a

b c=

Restricting Trade by a TariffRestricting Trade by a Tariff

A tariff is a tax on importsA tariff is a tax on importsA tariff is also called a custom dutyA tariff is also called a custom dutyThe U.S. imposes tariffs on about 70% The U.S. imposes tariffs on about 70% of our importsof our importsAverage tariff ratesAverage tariff rates

Currently averages about 3.7%Currently averages about 3.7%Peaked in 1930 with passage of the SmootPeaked in 1930 with passage of the Smoot--Hawley Act that imposed an average tariff Hawley Act that imposed an average tariff of 59%of 59%

Market With TariffMarket With Tariff

SSUSUSSSrowrowSSTotalTotal

With Tariff

Without Tariff

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

Q3 Quantity bought and sold

Q1 Domestic Supply Q3 - Q1 Imports

P2 Price

Tariff and Consumer LossTariff and Consumer Loss

SSUSUSSSrowrowSSTotalTotal

With Tariff

Without Tariff

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

Consumer loss due to higher price and reduced quantity

(See Ch. 5)

a

a

b

b

Tariff and Domestic Supplier Tariff and Domestic Supplier GainGain

SSUSUSSSrowrowSSTotalTotal

With Tariff

Without Tariff

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

US Producer gain due to higher price and increased quantity

(See Ch. 6)

Tariff and Treasury Revenue Tariff and Treasury Revenue GainGain

SSUSUSSSrowrowSSTotalTotal

With Tariff

Without Tariff

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

Tax revenue brought in due to the tariff = tariff * Imports

Tariff and Society’s LossTariff and Society’s Loss

Society’s Loss equals:Society’s Loss equals:Consumer’s LossConsumer’s Loss

minusminusUS Producer’s GainUS Producer’s Gain

minusminusTaxpayer’s GainTaxpayer’s Gain

Society’s Loss is due toSociety’s Loss is due toLost benefits from what we want: Area ALost benefits from what we want: Area AHigher cost of increased domestic Higher cost of increased domestic production: Area Bproduction: Area BFor Areas A and B, see next slideFor Areas A and B, see next slide

Tariff and Society’s LossTariff and Society’s Loss

SSUSUSSSrowrowSSTotalTotal

With Tariff

Without Tariff

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

Society’s Loss is the sum of the loss to consumers minus the gains to domestic producers and to the treasury. The loss is due to the higher cost of Q1 - Q0 and to the lost surplus on foregone trade.

AB

BA

Restricting Trade by a Quota Restricting Trade by a Quota or VERor VER

A quota is a limit of the amount of a A quota is a limit of the amount of a good that can be importedgood that can be importedA VER is a “voluntary” export restraint A VER is a “voluntary” export restraint agreed to by an exporting countryagreed to by an exporting countryIn 1984, VERs on autos by Japan In 1984, VERs on autos by Japan increased the price of Japanese cars by increased the price of Japanese cars by about $1,300 and the price of domestic about $1,300 and the price of domestic cars by about $660cars by about $660About 12% of U.S. imports are subject About 12% of U.S. imports are subject to Quotas or VERsto Quotas or VERs

Market With Quota or VERMarket With Quota or VER

SSUSUSSSrowrowSSTotalTotal

With Quota

Without Quota

Q0 Q1 Q3 Q4

P0

P1

P2

P

Q/t

D

Q3 Quantity bought and soldQ1 Domestic Supply (Q3 - Q1) = Q0 = imports

P2 Price w quotaQ0 Imposed Quota

SSrow row w quotaw quota

Quota (VER) and Consumer LossQuota (VER) and Consumer Loss

SSUSUSSSrowrowSSTotalTotal

With Quota

Without Quota

Q0 Q1 Q3 Q4

P0

P1

P2

P

Q/t

DSSrow row w quotaw quota

Consumer loss

due to higher price

Consumer loss

due to lower quantity

Quota (VER) and US producer Quota (VER) and US producer gaingain

SSUSUSSSrowrowSSTotalTotal

With Quota

Without Quota

Q0 Q1 Q3 Q4

P0

P1

P2

P

Q/t

DSSrow row w quotaw quota

US Producer gain

due to higher price

US Producer gain

due to greater sales

Quota (VER) and Society’s LossQuota (VER) and Society’s LossSociety’s Loss equals:Society’s Loss equals:

Consumer’s LossConsumer’s Lossminusminus

US Producer’s GainUS Producer’s GainNotice with a quota there is no Notice with a quota there is no Taxpayer’s GainTaxpayer’s GainSociety’s Loss is due toSociety’s Loss is due to

Lost benefits from what we want: Area ALost benefits from what we want: Area AHigher cost of increased domestic Higher cost of increased domestic production: Area Bproduction: Area BHigher Import Prices: Area CHigher Import Prices: Area CFor Areas A, B, and C, see next slideFor Areas A, B, and C, see next slide

Quota (VER) and Society’s LossQuota (VER) and Society’s Loss

SSUSUSSSrowrowSSTotalTotal

With Quota

Without Quota

Q0 Q1 Q3 Q4

P0

P1

P2

P

Q/t

DSSrow row w quotaw quota

Society’s Loss is the sum of the loss to consumers minus the gains to domestic producers. The loss is due to the higher cost of Q3 - Q2 and to the lost surplus on foregone trade Q4 - Q3

Q2

A

AB

B

C

C

Other RestrictionsOther RestrictionsTrade embargoes, e.g., Cuba, Iraq for Trade embargoes, e.g., Cuba, Iraq for political reasonspolitical reasonsTo prevent “dumping,” selling abroad at To prevent “dumping,” selling abroad at lower price than domestically lower price than domestically To protect the environment, e.g., the tuna To protect the environment, e.g., the tuna ban.ban.

In 1972 the US banned use of tuna nets by US ships In 1972 the US banned use of tuna nets by US ships to protect dolphins and boycotted tuna caught by to protect dolphins and boycotted tuna caught by Mexican ships using netsMexican ships using netsThe World Trade Organization ruled the ban was an The World Trade Organization ruled the ban was an illegal restriction on tradeillegal restriction on trade

To protect consumers, e.g., US restrictions To protect consumers, e.g., US restrictions pre NAFTA of “small” tomatoes from pre NAFTA of “small” tomatoes from MexicoMexico

The Cost of Protectionism to The Cost of Protectionism to ConsumersConsumers

In 1990, U.S. consumers incurred a cost In 1990, U.S. consumers incurred a cost of about $70 billion. That’s about $270 of about $70 billion. That’s about $270 per person per year.per person per year.The largest costs are in the apparel The largest costs are in the apparel industry (about $84 per person) and in industry (about $84 per person) and in the textile industry (about $13 per the textile industry (about $13 per person)person)

Source: G. Hufbauer, et al., Source: G. Hufbauer, et al., Measuring the Cost of Measuring the Cost of Protectionism in the U.S.Protectionism in the U.S., 1994, 1994

The Cost of Protectionism to The Cost of Protectionism to SocietySociety

Most, but not all, consumer cost is a Most, but not all, consumer cost is a transfer to US producerstransfer to US producersSociety’s (US) loss is due to Society’s (US) loss is due to

the loss of benefits of foregone trade (A) the loss of benefits of foregone trade (A) the higher cost of increased US production the higher cost of increased US production (B)(B)and the higher price of imports due to and the higher price of imports due to quota (C)quota (C)

Society’s Loss from ProtectionismSociety’s Loss from Protectionism

SSUSUSSSrowrowSSTotalTotal

With Protection

Without Protection

Q0 Q1 Q2 Q3 Q4

P0

P1

P2

P

Q/t

D

AB C

A: Loss of benefits of foregone trade

B: Higher cost of US production

C: Higher cost of imports due to quota (with a tariff this is a transfer from consumers to government revenues, not a cost)

Estimates of Society’s Loss from Estimates of Society’s Loss from ProtectionismProtectionism

Midpoint annual estimates for different Midpoint annual estimates for different industries, in billions of 1985 $sindustries, in billions of 1985 $s**

IndustryAutoDairy

Textiles & Apparel

SteelSugar

Aver. Tariff

Total

Loss A&B Loss C Total Loss0.71.40.20.1

5.4

2.3

10.1

5.050.251.350.85

5.05

0

12.5

5.751.651.550.95

10.45

2.3

22.6

*Source: Feenstra, R., “How Costly is Protectionism?”, JEP, 6:3, 1992

Society’s Loss in PerspectiveSociety’s Loss in Perspective$22.6 billion was about 0.75% of 1985 $22.6 billion was about 0.75% of 1985 Gross National ProductGross National ProductLess than the loss to consumers since Less than the loss to consumers since US producers gain is netted outUS producers gain is netted outBut this estimate is clearly a lower But this estimate is clearly a lower boundboundOther costs not counted include (see Other costs not counted include (see chs. 9 & 10)chs. 9 & 10)

those stemming from increased market those stemming from increased market power by domestic producers power by domestic producers those stemming from rent seeking activitiesthose stemming from rent seeking activities

The End