Geoffrey HalePolitical Science 3170University of LethbridgeSeptember 14, 2010

OutlineThe Trade Policy ContinuumTypes of Trade PolicyThe Theory of Comparative AdvantageComparative Advantage in the Real WorldFactors Shaping the Emergence of the Modern Canadian Trade Policy (Macdonald Commission)

The Trade Policy ContinuumUnrestricted Free Trade(unilateral) Negotiated free trade ---------------------------- Greater Restrictions Fewer (Tariffs, Quotas, non-tariff barriers)Mercantilism / Protectionism (Managed Trade)------------------------------------UnilateralNegotiated Autarky

The Trade Policy Continuum IIProtectionism, not free trade, has been the norm through modern economic history (18th 20st centuries)AutarkyMinimal trade or economic relations with other countriesEmphasis on national self-sufficiency (pre-1840 China, modern N. Korea)Mercantilism / ProtectionismMercantilism: unilateral effort by national governments to maximize trade surplus, usually to finance growth of national stateNeo-mercantilism: use of protectionist policies to foster economic development through policies favouring domestic firms / industries, encouraging import substitution, other trade restrictions.

Types of Trade Policy IImport Restricting PoliciesTariffs tax levied on imported goodsExport taxes tax levied on certain kinds of exports [e.g. US-Canada Softwood Lumber Agreement (2006)]Quotas quantitative restrictions on imports, either by volume, or as share of domestic market. e.g. Cdn. supply managed agriculture]Voluntary export restraints (VERs) = negotiated quota. e.g. Textiles (MFA): 1970s-90s; Autos (early 1980s)Government Procurement restrictions (access, price preferences) Administrative Barriers to Trade (non-transparent or unpredictable administrative processes)

Types of Trade Policy IIPreferential Export Promoting PoliciesDirect export subsidies (usually subject to Countervailing Duties under WTO, NAFTA, domestic laws)Export cartels / monopolies * e.g. Canpotex; Canadian Wheat Board.Production controlsOther regulations / government policies providing preferential access to key inputs (capital / skilled labour / resources / infrastructure subsidies / technology / intellectual property rules)Restrictions, Conditions on Foreign OwnershipOwnership limits, requirements for domestic partner.e.g. Big banks, airlines / railways, cultural industriesState-ownership or dominance of specific industry sectorse.g. Electric utilities (8 provinces), auto insurance (3 provinces)

The Trade Policy Continuum IIINegotiated free tradeApplied through bilateral, plurilateral (several partners), or multilateral agreements.Key principles:Reciprocity: mutuality or agreed equivalence of rules applying to economic citizens of each country (usually accompanied by national treatment)most favoured nation principle: best provisions applying to one contracting partner available to all.Often have detailed technical rules determining application of general principles Colgins managed free trade (e.g. NAFTAs rules of origin) . . . may be more or less restrictive of trade. Often have sectoral exceptions restricting general application of rules, retaining elements of managed trade

Reciprocity vs. Free Trade??Prevalence of restrictive trade policies creates expectations of government protection among major domestic interest groups.Negotiating trade liberalization (fewer barriers to trade) creates overall economic benefits, but also potential losses, adjustment costs for many sectors.Principle of reciprocity or mutuality in trade policy concessions allows governments to point to similar trade-offs by treaty partners, thus providing political cover in selling these trade-offs to domestic interests.

The Trade Policy Continuum IVNegotiated Free Trade (continued)Problem of compliance / enforcementPotential for negotiated dispute settlement provisions (e.g. NAFTA, WTO)Most countries retain right to use retaliatory trade policies in absence of formal dispute resolution processes.Unrestricted Free Trade (unilateral)Idealized objective of many market-oriented economists.No / minimal restrictions on trade.Unusual (e.g. UK free trade regime: 1840s 1920s)Usually requires substantial economic strength or adaptability of comparative advantage.

Economic Foundations of Trade Policy Comparative Advantage IUnder normal circumstances, countries will be economically better off from engaging in tradeTrade allows for:More efficient use of resources by allocating more resources (capital, labour, other resources) to areas in which countries have relative or comparative advantage to one another in order to exchange them for goods, services which can be produced relatively more efficiently by other countries.Allows for greater specialization within, between industries, resulting efficiency gains from economies of scale.Allows for greater value, range of choices for consumers.Comparative advantage applies even when one country has absolute advantage across wide range of goods, because of differences in relative advantages in producing one set of goods, services over another.

Economic Foundations of Trade Policy Comparative Advantage IITable 1 Comparative advantage (before trade)Cost / UnitInputCarsWheatTotal UnitsCarsWheatUSA20,00010 ($ 10k)50 ($10k)60$ 1,000$ 200Thailand20,000 2 ($ 10k)25 ($10k)27$ 5,000$ 400Total40,000127587

Table 2 Comparative advantage (production specialization)Cost / UnitInputCarsWheatTotal UnitsCarsWheatUSA20,00015 ($15k)25 ($5k)40$ 1,000$ 200Thailand20,000 050 ($20k)50n.a.$ 400Total40,000157590

Table 2C Comparative Advantage (after trade)Net Cost / Unit*InputCarsWheatTotal UnitsCarsWheatUSA20,00012 (15-10k)50 (5k+10k) 62$ 417$ 300Thailand20,000 3 (10k)25 k (10k) 28$ 3,300$ 400Total40,0001575 90* all things equal

Adapted from Colgin (2005), The Promise and Peril of International Trade, 27-33.

Comparative Advantage in the Real WorldUsually multi-dimensional, not uni-dimensionalMany products, multiple potential markets / sources of supply in modern economy.Frequently dynamicSubject to shifts inIndustrial organization and management (at home / abroad)Relative factor costs (capital, labour, input costs, technologies)Introduction / diffusion of new technologiesPolicy shifts by domestic, foreign governmentsExchange rate volatility (e.g. compare Canada, China)

Comparative Advantage in the Real World IICanadas trade surplus with the United States is increasingly offset by its trade deficit with the rest of the worldReflects volatility of commodity prices, exchange rates, etc.

Comparative Advantage in the Real World IIIGoods Balances by Geographic Area Canada 2006-2010Statistics Canada 67-001, Sept. 2010

Factors Shaping Emergence of ModernCanadian Trade Policies (Macdonald Comm.)Canada traditionally relatively open, trade-dependent economy growing trade dependence : 1960-80Moving up value-added chain, but still commodity-driven.Growing dependence on U.S. export markets despite sporadic efforts to diversity 1954: 60%1984: 76%Growing international competitionJapan + Newly Industrialized countries (NICs) growing factor in international tradeGrowth of international investment changes in industrial organization . . . growth of related party tradeMajor adjustment challenges for Canadian industry

Factors Shaping Emergence of Modern Canadian Trade Policies IIGrowth of RegionalismTrend towards emergence of regional trading blocs characterized by discrimination against non-members European Community, Japan + ASEAN, smaller groupsCanada one of few major industrial countries lacking free access to market of over 100 million people.Growing trend towards coordination of negotiating positions among members of trade blocs.