Trade Policy Global Trade and Finance Prof. Bryson, Marriott School

Trade PolicyTrade Policy

Global Trade and FinanceGlobal Trade and Finance

Prof. Bryson, Marriott SchoolProf. Bryson, Marriott School

Part I. TariffsPart 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

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.

Trade Before TariffsTrade Before Tariffs

TariffsTariffs

Now, this country imposes a tariff,

World Price

Pw plus tariff

and the price rises from Pw to Pw + Tariff.

TariffsTariffs

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

World Price

Wp plus tariffa b c d

Producers gain Area ASmaller than what consumers lost

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

World Price


Government collects area c as tariff revenuesGovernment collects area c as tariff revenues

World Price


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


So the net national welfare loss is b + d.

More about b and dMore about b and d

The net losses, b and d, don’t appear The net losses, b and d, don’t appear very large, but very large, but 1% of US GNP is still well over $100 1% of US GNP is still well over $100

billionbillion Net national loss is substantially less Net national loss is substantially less

than consumer loss.than consumer loss.

More about b and dMore about b and d

There is also an administrative cost to a There is also an administrative cost to a tariff (part of c must be added to b and tariff (part of c must be added to b and d).d).

Protection has dynamic (technological Protection has dynamic (technological effects).effects).

Stagnation.Stagnation.

Part II. QuotasPart II. Quotas

Import QuotasImport 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 QuotasImport 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.

QuotasQuotas 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! But stop!

Let’s compare this to a tariff and we Let’s compare this to a tariff and we will notice they are almost identical will notice they are almost identical analyses.analyses.

Tariffs and Quotas ComparedTariffs 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 + QuotaSd

QuotasQuotas 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 consumer’s Consumers lose areas a+b+c+d in consumer’s surplus,surplus,

World Pricea b c d

SdSd + quota

Equilibrium price with quota where Dd = Sd + quota

Producers gain area a.Producers gain area a.

a b c d

SdSd + quota

Government Government couldcould collect area c collect area c auctioning import licenses.auctioning import licenses.

World Pricea b c d

SdSd + quota


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

World Pricea b c d

SdSd + 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.

SdSd + quota

Additional Quota ProblemsAdditional Quota Problems

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

The domestic firm may have very The domestic firm may have very high prices, and limited high prices, and limited competing imports don’t force competing imports don’t force prices down. prices down.


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


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


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. Part III. Voluntary Export Voluntary Export

RestraintsRestraints

Voluntary Export RestraintsVoluntary Export Restraints

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


The importing country says: The importing country says:

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


President Reagan did this with President Reagan did this with Japanese auto exporters. Japanese auto exporters.

Unwittingly, this is like saying,Unwittingly, this is like saying,

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

VER’s, Quotas, and Free Trade, VER’s, Quotas, and Free Trade, See Figure 8.2 in the textSee Figure 8.2 in the text

A VER is, in effect, like a quota.A VER is, in effect, like a quota.

Let’s compare the VER, quota, and Let’s compare the VER, quota, and

free trade.free trade.

VER’s, Quotas, and Free Trade, VER’s, Quotas, and Free Trade,

Free TradeFree Trade

Dm = demand for importsDm

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.

VER’s, Quotas, and Free TradeVER’s, Quotas, and Free Trade

Using a Using a QuotaQuota



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.


Using a Using a QuotaQuota



Fs

Small Country Large country (with monopsony power)

With a quota, the exporter loses the larger green area of producer surplus.


A VER is, in effect, like a quota.

Let’s compare the three types of protection VER, quota, and free trade.

Using a Using a VERVER



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, exceptit gives its larger yellow box to the foreign monopolist.

Trade and Historical SocietiesTrade and Historical Societies

Contrast the cases of the USSR and ChinaContrast the cases of the USSR and China

The case of the Lamanites and NephitesThe case of the Lamanites and NephitesTHE BOOK OF HELAMAN, CHAPTER 6THE BOOK OF HELAMAN, CHAPTER 6

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

7 And 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. 8 And 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. 9 And 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.

1010 Now 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.

11 And 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.

12 They 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.

13 Behold 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. 14 And 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 How well did the Nephites handle their wealth?their wealth?

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

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

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Trade Policy Global Trade and Finance Prof. Bryson, Marriott School