Trade Policy

Global Trade and Finance

Prof. Bryson, Marriott School

Part I. Tariffs

A tariff is a tax, usually ad valorem (on the value or some percentage of the estimated market value of a commodity).

It is imposed as a commodity crosses the frontier of the importing country.

First, they create revenues

Second, they hinder foreign competition.

The Two Functions of Tariffs

Trade Before Tariffs

Sd

Dd

World Price

Imports

Because the world price is below the domestic price, imports are equal to the shortage between Dd and Sd at the world price.

Tariffs

Now, this country imposes a tariff,

World Price

Pw plus tariff

and the price rises from Pw to Pw + Tariff.

Tariffs

We get the famous areas a,b,c, and d.

World Price

Wp plus tariff

Imports after tariff

a b c d

Imports before tariff

Consumers lose areas a+b+c+d in consumers surplus as the tariff raises the price.

World Price

Wp plus tariff

a b c d

Producers gain Area A

Smaller than what consumers lost

Net national loss from the quota: areas b and d. These are losses in consumer surplus not offset by gains made elsewhere.

World Price

Wp plus tariff

a b c d

Government collects area c as tariff revenues

World Price

Wp plus tariff

a b c d

b is the Production effect. This is a deadweight loss. Consumers

purchases are shifted to the more expensive, less-efficient

domestically produced product.

d is the consumption effect, also deadweight loss, resulting

from the reduction in consumption due to the higher price.

World Price

Wp plus tariff

a b c d

So the net national welfare loss is b + d.

More about b and d

The net losses, b and d, dont appear very large, but 1% of US GNP is still well over $100 billionNet national loss is substantially less than consumer loss.

More about b and d

There is also an administrative cost to a tariff (part of c must be added to b and d).Protection has dynamic (technological effects).Stagnation.

Part II. Quotas

Import Quotas

Historically, as tariffs decrease through the efforts of GATT/WTO, other barriers replace them. This has gone on since the early 1950s.

Import Quotas, a most popular substitute for tariffs, are limits on the total Q of imports permitted.

Import Quotas

With quotas, importing countries have absolute assurance about import quantities. With tariffs, countries have less control over import volumes, since foreign exporters can cut prices to increase sales when they face tariffs.

Quotas

Analytically speaking, quotas are not better and are usually worse than tariffs.Total market supply is the domestic supply curve plus the fixed quota at all prices above the world price.

Pw

Sd

Sd + Quota

Imports, limited to the Quota,

simply shift the S curve out.

Quantities are determined

by the Intersection of D

and Sd + Quota.

Dd

Imports before quota

Imports after

But stop!

Lets compare this to a tariff and we will notice they are almost identical analyses.

Tariffs and Quotas Compared

This country has imposed a tariff. How would a quota look?

World Price

Wp plus tariff

Just add the quota to the supply curve

Sd + Quota

Sd

Quotas

Once again, we have the same net economic welfare situation illustrated by the areas in the strip abcd diagram

Pw

Sd

Sd + Quota

Dd

a b c d

Consumers lose areas a+b+c+d in consumers surplus,

World Price

a b c d

Sd

Sd + quota

Equilibrium price with

quota where

Dd = Sd + quota

Producers gain area a.

a b c d

Sd

Sd + quota

Government could collect area c auctioning import licenses.

World Price

a b c d

Sd

Sd + quota

Equilibrium price with

quota where

Dd = Sd + quota

Net national loss from the quota:at least areas b and d.

World Price

a b c d

Sd

Sd + quota

Equilibrium price with

quota where

Dd = Sd + quota

a b c d

b is the Production effect. This is a deadweight loss. Consumers

purchases are shifted to the more expensive, less-efficient

domestically produced product.

d is the consumption effect, also deadweight loss, resulting from

the reduction in consumption due to the higher price.

Sd

Sd + quota

Additional Quota Problems

First, the quota can create domestic and foreign monopoly power.

The domestic firm may have very high prices, and limited competing imports dont force prices down.

Additional Quota Problems

The foreign producers can tacitly collude and charge the domestic monopoly price.

Additional Quota Problems

Second, efficiency depends on how the rights to import are distributed. Import licenses can be allocated as follows:

1. by competing auctions (generates same as tariff revenues.

2. by sales (or bribes) by corrupt customs officials

Additional Quota Problems

3. by fixed favoritism some arbitrary method, e.g., on the basis of pre-quota sales proportions

4. by resource-using application procedures. Use the bureaucratic method, viz., queues.

Part III. Voluntary Export Restraints

Voluntary Export Restraints

Here, a major exporting partner is warned to restrict its sales in your country voluntarily.

Voluntary Export Restraints

The importing country says:

As you invade our market, you had better restrain yourself voluntarily, or our parliament will cream you with tariffs or quotas.

Voluntary Export Restraints

President Reagan did this with Japanese auto exporters.

Unwittingly, this is like saying,

You had better behave like a monopolist in our market! (Restrict your output and do what you will with your price.)

VERs, Quotas, and Free Trade, See Figure 8.2 in the text

A VER is, in effect, like a quota.

Lets compare the VER, quota, and free trade.

VERs, Quotas, and Free Trade,

Free Trade

Dm = demand for imports

Dm

Fs= foreign supply of Ms

Fs

Small Country Large country (w/monopsony power)

With free trade, both countries enjoy same consumers surplus

With free trade, both cases enjoy the same producers surplus.

VERs, Quotas, and Free Trade

Using a Quota

Dm = demand for imports

Dm

Fs= foreign supply of Ms

Fs

Small Country Large country (with monopsony power)

With a quota, the small country loses consumer surplus, but can get

the yellow area by auctioning import licenses.

With a quota, the large country gains the larger yellow box.

VERs, Quotas, and Free Trade

Using a Quota

Dm = demand for imports

Dm

Fs= foreign supply of Ms

Fs

Small Country Large country (with monopsony power)

With a quota, the exporter loses the larger green area of

producer surplus.

VERs, Quotas, and Free Trade

A VER is, in effect, like a quota.

Lets compare the three types of protectionVER, quota, and free trade.

Using a VER

Dm = demand for imports

Dm

Fs= foreign supply of Ms

Fs

Small Country Large country (with monopsony power)

With a VER, the small country loses consumer surplus. It gives

the yellow box to the foreign monopolist.

With a VER, the large country is like the small one, except

it gives its larger yellow box to the foreign monopolist.

Trade and Historical Societies

Contrast the cases of the USSR and China

The case of the Lamanites and Nephites

THE BOOK OF HELAMAN, CHAPTER 6

The righteous Lamanites preach to the wicked NephitesBoth peoples prosper during an era of peace and plenty

7And behold, there was peace in all the land, insomuch that the Nephites did go into whatsoever part of the land they would, whether among the Nephites or the Lamanites. 8And it came to pass that the Lamanites did also go whithersoever they would, whether it were among the Lamanites or among the Nephites; and thus they did have free intercourse one with another, to buy and to sell, and to get gain, according to their desire. 9And it came to pass that they became exceedingly rich, both the Lamanites and the Nephites; and they did have an exceeding plenty of gold, and of silver, and of all manner of precious metals, both in the land south and in the land north.

10Now the land south was called Lehi and the land north was called Mulek, which was after the son of Zedekiah; for the Lord did bring Mulek into the land north, and Lehi into the land south.

11And behold, there was all manner of gold in both these lands, and of silver, and of precious ore of every kind; and there were also curious workmen, who did work all kinds of ore and did refine it; and thus they did become rich.

12They did raise grain in abundance, both in the north and in the south; and they did flourish exceedingly, both in the north and in the south. And they did multiply and wax exceedingly strong in the land. And they did raise many flocks and herds, yea, many fatlings.

13Behold their women did toil and spin, and did make all manner of cloth, of fine-twined linen and cloth of every kind, to clothe their nakedness. And thus the sixty and fourth year did pass away in peace. 14And in the *sixty and fifth year they did also have great joy and peace, yea, much preaching and many prophecies concerning that which was to come. And thus passed away the sixty and fifth year.

And what was the result?

How well did the Nephites handle their wealth?

17For behold, the Lord had blessed them so long with the riches of the world that they had not been stirred up to anger, to wars, nor to bloodshed; therefore they began to set their hearts upon their riches; yea, they began to seek to get gain that they might be lifted up one above another; therefore they began to commit secret murders, and to rob and to plunder, that they might get gain.

18And now behold, those murderers and plunderers were a band who had been formed by Kishkumen and Gadianton.