International TradePRINCIPLES OF ECONOMICS (ECON 210)

BEN VAN KAMMEN, PHD

Introduction•There is not much that can be said of international trade that is untrue of trade, generally.

• Refer to chapter 2 on trade and comparative advantage for the merits of trade.

•Here we limit attention to a single market at a time.• Not very much trade is barter.• We can look at buyers in one country and sellers in another who “trade” goods for money.• The recipient of the money uses it either to buy other goods in the foreign country or invests it in a

stock, bond, or account in the foreign country.• For more on this, check out the 36th chapter in the Cowen and Tabarrok textbook.

•Supply and demand analysis can be used to illustrate:• conditions for importing/exporting, and • the effects of policies that alter the incentives to import/export, e.g., tariffs.

Art VandelayELAINE: (incredulity) Art Vandelay? This is my boyfriend?

GEORGE: That's your boyfriend.

ELAINE: What does he do?

GEORGE: He's an importer.

ELAINE: Just imports? No exports?

GEORGE: (getting irritated) He's an importer-exporter. Okay?

ELAINE: Okay. So, I'm dating Art Vandelay. What is the problem we're discussing?

GEORGE: (thoughtful) Yes. Yes.

ELAINE: (sighs) Yi-yi-yi.

(Elaine and George go into another bout of deep thought.)

ELAINE: Ah! (explaining, with hand gestures) How 'bout this? How about, he's thinking of quitting the exporting, and just focusing in on the importing. And this is causing a problem, because, why not do both?

[from Seinfeld episode 125: “The Cadillac (part 2)”]

Autarchy and free trade•The possibility of imports (or exports) can be added to a diagram of the market quite easily.

•The usual equilibrium refers to domestic producers and consumers only.

•A horizontal line indicates the price at which the good could be imported from foreign countries, i.e., the world price.

•You can easily show the free trade equilibrium, quantity of imports and quantity of domestic production.

Effects on gains from trade in the market•The lower price of imports explains both the benefits of free trade and a source of opposition to it.

•It increases consumer surplus by enabling more people to buy the good—and at a lower price.

•But it decreases producer surplus by substituting imports for domestic production and reducing the price for which domestic producers sell output.• See graphs on the following slides.

Autarchy•The usual division of gains from trade between consumers and producers.

Free trade•Some gains get shifted from producers to consumers.• Observe the trapezoid that is

transferred from sellers to buyers.

•Overall gains from trade are larger.• The triangle (below autarchy

equilibrium) that is newly generated gains.

Protectionism•The reduction in producer surplus resulting from free trade is one motive for protectionist trade policy, e.g.,• tariffs (taxes on imports),• import quotas (limits on the quantity of imports),• regulations that burden foreign (but not domestic) producers.

•The effect of a tariff is easily shown on a supply and demand graph.• As with any tax, it represents an increase in the cost of imports.• Art Vandelay would have to sell his imports to American consumers for enough to cover the foreign

producer’s costs, as well as the tariff on importing.

Tariffs raise the price of imports•Among the many observations

to make from this graph, start with the height of the red line.

• It has increased by the amount of the tariff.

• The higher price means less imports and less consumption:

•𝑄𝑄𝑑𝑑𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡

• It also means more domestic production:

•𝑄𝑄𝑠𝑠𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡

• And tariff revenue is generated:•𝑅𝑅𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 = 𝑄𝑄𝑡𝑡𝑖𝑖𝑖𝑖𝑖𝑖𝑡𝑡𝑡𝑡𝑠𝑠 ∗ 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡

Tariffs create deadweight loss•What are the 2 little triangles that look like bookends around the tariff revenue?

• Not consumer surplus.• Not producer surplus.• Not tariff revenue.• They’re simply gains that are lost to the universe (DWL).

•The extreme version of this phenomenon is shown on the graph on the next slide (from the textbook).• In it the tariff is raised to the point it “chokes off” imports completely.

Tariffs create DWL (continued)•Raising the tariff enough to choke off imports means that tariff revenue is $0.• So the bookends close in on one another as shown

and the price rises to the autarchy level.

•This creates DWL in 2 ways:• It reduces consumption, so there are fewer trades

to contribute to the sum (the red shaded area).• The units consumed are produced much less

efficiently than possible. The domestic costs are considerably higher than the foreign producers’ costs (yellow shaded area).

• U.S. inputs could be utilized more effectively in some other production. They are wasted here by our refusal to import cheaper goods.

The lollipop war•The model on the previous slide mimics the U.S. market for sugar.

•The protectionist laws in the U.S. farm bill keep the price of sugar much higher here than in the rest of the world.

•This is bad news for producers that use sugar as an input, who oppose the sugar protectionism in the farm bill.• And it has prompted many of them to substitute a sweetener called high fructose corn syrup in place of

sugar.

Winners and losers from trade•I said earlier that voluntary trade makes both parties better off.

•That doesn’t mean it has to make all the competing traders better off as well!• In the case of import competing producers this is evident by the loss of producer surplus.

•But in quantitative terms it is more than offset by gains to consumers.

•So why do we still have so many protectionist laws that cost social welfare!?

Winners and losers from trade (continued)

•The answer has to do with the concentration of costs among a (relatively) small number of individuals that know explicitly that the imports compete with their goods.• They have a strong incentive to protect their profits by lobbying the government for tariff protection.

•The benefits, on the other hand, are dispersed among millions of consumers—none of which gets a large enough benefit to complain and lobby against tariffs.• Are you really going to take the time to write your congressman if you pay 75₵ per year for sugar

instead of 25₵?

Arguments against free trade (for protectionism)

•So a problem is that the losers are more organized and vocal about tariffs than the winners are.• Note also that an argument similar to the “rationing by waiting in lines” (applied to price controls)

applies to the lobbying.• The lobbying efforts waste productive resources, adding to the costs of protectionism and subtracting

producer surplus anyway.

•Nonetheless a lobbying effort based on the sales pitch “we need protection from imported goods; please help us,” is not a compelling one.

•The following arguments get more traction with legislators (and the public, too) as a pretext for enacting protectionist laws.

Arguments against free trade (for protectionism), continued

•“Free trade means ‘exporting American jobs’ to other countries.”

•“Imports are cheap because they are produced with child labor and lower standards for working conditions of workers, so we should not buy them.”

•“Certain industries are of strategic importance, and we cannot allow dependence on a foreign country for their production.”

•“Some ‘key’ industries have spillover benefits to other industries that justify keeping them at home.”

•“Protectionism can strategically increase our gains from trade at the expense of other nations.”

Trade and jobs•The problem of salience distorts one’s impression of how imports affect employment.

• It is salient (easy to see) that being outcompeted by imports reduces output and employment at competing domestic firms.

• It is less salient that the lower prices enjoyed by consumers translate into more demand, output and employment in other domestic industries. But it’s true; a lower price on imported goods means more of each household’s budget left over to buy more of other goods.

•Trade shifts employment from import-competing industries to other domestic industries, rather than reducing employment.• Especially export industries because that is one way of spending the $U.S. that American importers

exchange for foreign currency when they buy the imported goods.

Trade and jobs (continued)•The weight of these “macro” effects are enough to justify free trade to an academic audience or politician truly interested in growing the national economy.• But the losers of jobs are unlikely to be consoled by a “sacrifice for the greater good” argument.

•Being displaced from a job by import competition is still painful.

•But it is a fact of life in a dynamic economy, and the remedy is not to harm the whole economy to protect individual industries.

Trade and jobs (concluded)•The better strategy is treating the pain, i.e., by facilitating displaced workers as they move from shrinking sectors to expanding sectors.

•Government has a role here:• Unemployment insurance to keep consumption up during a jobless spell,• Subsidizing education and re-training to fit displaced workers for the requisites of a new job.

•Individuals also have a responsibility to self insure by saving when they are employed and to acquire skills that are general enough to transfer to a new job when they are required.

Child labor, also “pollution havens”•Most of the child labor in the world (see Edmonds & Pavcnik 2005 in the Journal of Economic Perspectives) is employed in agriculture.• The role of child labor in export production is not as large as some highly publicized cases suggest.

•The cause is poverty . . .

•Exports from poor countries raise incomes; free trade actually reduces child labor.• Rising income is associated with higher opportunity costs of child labor (think investments in human

capital “school”) and lower benefits (households don’t “need” kids to work if adults are able to provide).• Empirical evidence.

Child labor (continued)•The capacity for import restrictions to eradicate child labor, then, is modest: not much of the (farming) output is exported.

•Trade restrictions cannot improve the conditions of child poverty in developing countries, but they can make it worse.• Consider that, in those countries, the “sweatshops” may be (sadly) the best available alternative for

children.

•Poverty is the real problem, and we should strive to eliminate that foremost.

Trade and national security•In the event of a war or pandemic, it would be irresponsible to have outsourced the nation’s military intelligence or medicine production to a foreign producer who can withhold it.• One can surely imagine examples that fit this criterion.• But . . .

•Every industry in the economy will attempt the same argument!• At some point we should doubt whether avoiding the probabilistic removal of imports in an emergency

justifies the huge and certain inefficiency costs of working around restrictive laws in daily commerce.• This point may be closer than you think. The shipping industry, which has a relatively strong claim in

this regard, has protection that has ridiculously wasteful consequences on a daily basis.

•You can only imagine the inefficiency that results from some of the less plausible protections.

I never knew . . .

Key industries•This is the argument that has the most credence in the eyes of economists.

•It goes as follows: some goods create positive externalities (benefits that accrue to other firms) as part of their production, and this justifies encouraging domestic production instead of importing.

•Example: producing automobiles may involve the discovery of design principles that can be learned and applied by makers of other mechanical products, increasing their quality and/or lowering their costs.

Key industries (continued)•But it’s still not very compelling for 2 reasons.

•The goal is to get more output of a good with positive externalities, and protectionism cannot actually increase production beyond the competitive equilibrium level.• A subsidy can, though, and that is the better policy to encourage such industries.

•It’s difficult to know a priori which industries have significant spillovers.• The entrepreneurs and managers may have some idea how their firms depend on the spillovers from

other companies, • but it is much harder for a government observer to “pick winners” on the basis of spillovers.

Strategic trade protection•A nation could attempt to improve its terms of trade by taxing exports (to collect revenue on the higher price paid by foreign consumers).• This can work if the higher price can be “passed through” to the foreign buyers, i.e., demand is not

perfectly elastic and there are no close substitutes for the export.• The text uses OPEC oil as an illustration.

Strategic trade protection (concluded)•This strategy in isolation seems clever, but it does not occur in isolation. Other countries that discover this will retaliate by taxing the other exports of that country.• A “trade war” like this is like the prisoner’s dilemma game. It is individually rational to strategically

influence your terms of trade, but every “player” doing it impedes trade, as well as the benefits from it.

•A common lesson in economics: when agents focus on trying to increase their slice of the pie instead of on the size of the pie, the pie usually gets smaller.

Conclusion•Free trade raises social welfare by substituting lower cost imports for domestic production.

• “Reasonable estimates say that the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP) could boost the world’s annual output by $600 billion—equivalent to adding another Saudi Arabia. Some $200 billion of that would accrue to America.”*

• But it creates winners and losers.

•This is why the idea of free trade is under constant attack. And its attackers have the advantage of being more vocal and better organized than the defenders.• “There is nothing inevitable about globalisation. Governments have put up barriers before—with

disastrous consequences during the 1930s—and could do so again.”*

•If the economics-initiated don’t stand up for free trade, the forces conspiring against it will win.

* “How to make the world $600 billion poorer.” The Economist, 22 Feb. 2014.

Conclusion•Some arguments against free trade are more persuasive than others, but they recommend healing the losers rather than handicapping those that would benefit.

•Despite the reputation that economists never agree on things, free trade is the most conspicuous area (among many) where there is a consensus among economists: free trade is good.• There are prominent dissenters, when it comes to the designs of particular free trade agreements.• But economists are nearly unanimously in favor of freer international trade. Even most skeptics

concede that tariff barriers are harmful.• Maybe I am increasingly preaching to the choir?

Pollution havens•The same argument is made on the grounds of environmental standards.

• Developing countries become “havens” for polluting exports because of their weak laws.• We “shouldn’t buy their low-cost exports because not paying for pollution makes them artificially

cheap.”• Again, empirical evidence that U.S. imports are not as “dirty” as critics fear.

•Only a problem for the importing country if the pollution spills over to affect you.• Carbon emissions and climate change, e.g.• If the pollution is “merely” local, the export country has an incentive to fix it.

•Back.

ApplicationsECON 210: PRINCIPLES OF ECONOMICS

Cowen and Tabarrok Thinking and Problem Solving #7In March 2002, then President George W. Bush put a tariff on imported steel as a means of protecting the domestic steel industry. In February, before the tariff went into effect, the United States produced 7.4 million metric tons of crude steel and imported about 2.8 million metric tons of steel products at an average price of $363 per metric ton. Two months later, after the tariff was in effect, U.S. production increased to 7.9 million metric tons. The volume of imported steel fell to about 1.7 million metric tons, but the price of the imported steel rose to about $448 per metric ton.

The supply and demand diagram (on the next slide) shows this situation (along with an estimated no-trade domestic equilibrium at a price of $625 per metric ton and a quantity of 8.9 million metric tons).

Cowen and Tabarrok Thinking and Problem Solving #7

Determine which areas on the graph represent each of the following:

a. The increase in producer surplus gained by U.S. steel producers as a result of the tariff

ANS: Area C

b. The loss in consumer surplus suffered by U.S. steel consumers as a result of the tariff

ANS: Areas C+D+E+F+G

c. The revenue earned by the government because of the tariff

ANS: Areas E+F

d. The gains from trade lost (DWL) because of the tariff

ANS: Areas D+G

Cowen and Tabarrok Thinking and Problem Solving #8

For each of the four parts of Question 7 above, calculate the values of these areas in dollars. How much of the deadweight loss is due to the overproduction of steel by higher-cost U.S. steel producers, and how much is due to the under-consumption of steel by U.S. steel consumers?

a. Area C

ANS: $650,250,000

b. Areas C+D+E+F+G

ANS: $841,500,000

c. Areas E+F

ANS: $144,500,000

d. Areas D+G

ANS: $46,750,000: $21,250,000 from D and $25,500,000 from G