6,0006,5007,0007,5008,0008,5009,0009,500

10,00010,50011,00011,50012,000

0 10 20 30 40 50 60 70 80 90 100 110Quantity of autos

Free Trade – Good Restriction – BadPr

ice

($) Sd

F Sd+w

Ef G Sd+w+t

a b c d

e

g

Dd

h

Free Trade: Price = World Price = $8,000Domestic Production=20; Domestic Consumption=80; Imports=60 Consumer Surplus: a+b+c+d+e+f+g; Producer Surplus = h

6,0006,5007,0007,5008,0008,5009,0009,500

10,00010,50011,00011,50012,000

0 10 20 30 40 50 60 70 80 90 100 110Quantity of autos

Free Trade – Good Restriction – BadPr

ice

($) Sd

F Sd+w

Ef G Sd+w+t

a b c d

e

g

Dd

h

Tariff: Price = World Price + Tariff = $8,000 + $1,000 = $9,000Domestic Production=40; Domestic Consumption=60; Imports=20 Reduced Consumer Surplus: a+b+c+d

Increased Producer Surplus = a (Redistributive Effect)

Increased Tax Revenue = cDeadweight Loss: Inefficient Production = b

Deadweight Loss:Reduced Consumption = d

Costs of import restrictionsDomestic consumers face increased costs

Low income consumers are especially hurt by tariffs on low-cost imports

Overall net loss for the economy (deadweight loss) Production effect: output that cost more than it has to (b) Consumption effect: surplus lost from reduced

consumption (d) Export industries face higher costs for inputs Cost of living increases Other nations may retaliate

So why restrict trade? Benefits of free trade in final goods are spread

widely Tariffs on intermediate inputs tend to be low

Costs of free trade are felt rapidly by domestic producers Lobbying by business and labor“… those persons who demand cheaper coats would be ashamed of

themselves if they could realize that their demands cut the wages of the women who made those coats.”

Benjamin Harrison, Election Campaign of 1888 Strategic trade policy

Reduce demand for foreign stuff lower its price a lot Big gain on what you still buy

Ways to restrict trade Tariffs Non-Tariff Barriers

5

Flavors of tariffsTariff: a tax (duty) on internationally traded products Import tariffs Export tariffs … unconstitutional in US

Raise revenue Favor domestic users of exported commodities

Protective tariff … insulate domestic producers Revenue tariff - raise funds for government Specific tariff - Fixed $/Unit Ad valorem tariff - % of product’s value

“Free-on-board” (FOB) as it leaves port Levied “cost-insurance-freight” (CIF) as it arrives in port

Compound tariff - Combination of fixed and ad valorem tariffs Levied on finished goods whose imported inputs are subject to tariff

Fixed portion offsets tariffs on imports paid by domestic producers % portion protects domestic producers against finished good imports

Effective rate of protection For a finished good,

Effective tariff rate = {Nominal tariff – (% value Imports)x(Tariff on Imports)} (% Domestic Value Added)

The impact of a tariff is often different from its stated amount Tariff Escalation: If domestic value added (domestic

content) is low and tariffs on imports are also low

Effective tariff >> Nominal tariff.

Nominal and Effective Tariff Rates(US and Japan, early 1980s)

US JapanNominal Effective Nominal Effective

Agriculture, fish, forest. 1.8% 1.9% 18.4% 21.4%Food, beverages,tobacco 4.7 10.6 25.4 50.3Footwear 8.8 15.4 15.7 50.0Furniture 4.1 5.5 5.1 10.3Leather products 4.2 5.0 3.0 -14.8Paper and paper products 0.2 -0.9 2.1 1.8Textiles 9.2 18.0 3.3 2.4Wearing apparel 22.7 43.3 13.4 42.2Wood products 1.6 1.7 0.3 -30.6

Avoiding and postponing tariffs Production sharing special treatment for

foreign assembly using domestic inputs OAP: Offshore Assembly Provision

Maquiladoras

Bonded warehouses Assemble imported components and reexport duty free If sell domestically, tariff is levied only on imported value

Foreign trade zones (FTZ)

Arguments for trade restrictions Job protection

… but losses elsewhere Protect against “cheap” foreign labor

… but is foreign labor “cheap”? Worker productivity Fairness in trade - level playing field

Principles of Fair Trade

Democratic organization Producer cooperatives

Recognize unions No child labor Decent working conditions Environmental sustainability Prices that cover production costs

Price guarantees irrespective of world prices Social premiums

Pay premiums to organizations public goods Long-term relationships

Reduce uncertainties

Arguments for trade restrictions Job protection

… but losses elsewhere Protect against “cheap” foreign labor

… but is foreign labor “cheap”? Worker productivity Fairness in trade - level playing field

… but sacrifice gains from trade Equalization of production costs

… but whose costs? [Their low cost producer = Our high cost?] Infant-industry protection Achieve efficient scale

… but protect senile industries too? Political and social reasons

Protect against cultural imperialism National defense/Self–sufficiency…reduce interdependence... but could build strategic reserves instead

Import quotas Quota: how much can be imported in a year

Global quotas Selective quotas

Government loses tariff revenue Quota is insensitive to demand shifts

Tariff-rate quota: a two-tiered tariff More can be imported if demand increases … but

only at a higher tariff rate

Non – Tariff Barriers (NTBs)

Voluntary export restraints (VERs) export quota by foreign country … or else Japanese auto exports unintended

consequences Domestic content requirements Subsidies

Domestic subsidy … e.g. R & D Export subsidy

Government procurement policies Social regulations (health, environmental and

safety rules … MGOs) Sea transport and freight restrictions

Other NTBs

Costs of import restrictions redux

Domestic consumers face increased costsOverall net loss for the economy (deadweight loss)

Production effect: output that cost more than it has to (b) Consumption effect: surplus lost from reduced

consumption (d) Export industries face higher costs for inputs Cost of living increases Retaliation