The Political Economy of International Trade Chapter 7 The Political Economy of International Trade By: Ms. Adina Malik (ALK)

Learning Objectives The range of policy instruments that governments use to intervene in international trade The WTO & its objectives

Instruments Of Trade Policy The main instruments of trade policy are: Tariffs Subsides Import Quotas Voluntary Export Restraints Local Content Requirements Administrative Polices Antidumping Policies

Tariffs Tariffs are taxes levied on imports (or exports) Specific tariffs are levied as a fixed charge for each unit of a good imported (e.g. $3 per barrel of oil) Ad valorem tariffs are levied as a proportion of the value of the imported good (e.g. In March 2002, the U.S. government placed an ad valorem tariff of 8% to 30% on imports of foreign steel) Tariffs increase government revenues, provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods, and force consumers to pay more for certain imports So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy Whether the gains to the government and domestic producers exceed the losses to the domestic consumers depends on various factors: amount of tariff, the importance of the imported good, the number of jobs saved in the protected industry, etc. In the steel case of U.S., the consumers were the losers. WTO in November 2003 declared that tariffs represented a violation of the WTO Treaty and hence USA removed tariffs in that year in December. E.g. of reducing economic efficiency: South Korea and production of rice at home country than anywhere else (low-cost producers). This points to inefficient use of resources. The land could have been used for growing other foodstuff, or residential or industrial purposes, that cannot be produced more efficiently elsewhere.

Tariffs Export Tariffs These are far less common than import tariffs In general export tariffs have two objectives: to raise the revenue of the government and to reduce exports from a sector, often for political reasons Example: In 2004, China imposed a tariff on textile exports. The primary objective was to moderate the growth in exports of textiles from China, thereby alleviating tensions with other trading partners.

Subsidies Subsidies are government payments to domestic producers Consumers typically absorb the costs of subsidies Subsidies help domestic producers in two ways: they help them compete against low-cost foreign imports they help them gain export markets Example: Developed nations gave $45 billion subsidies to their automobile makers during the global financial crisis between mid 2008 and early 2009. Subsidies are government payments to domestic producers. They can be in the form of: Cash grants Low-interest loans Tax breaks Government equity participation in the company Subsidy revenues are generated from taxes. Subsidies encourage over-production, inefficiency and reduced trade.

Import Quota & Tariff Rate Quota Import quotas directly restrict the quantity of some good that may be imported into a country. The restriction is usually imposed by issuing import licenses to a group of individuals or firms. Example: USA on cheese import Tariff rate quotas are a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota. Example: Tariff rate quotas are common in agriculture.

Voluntary Export Restraints & Quota Rent Voluntary export restraints are quotas on trade imposed by the exporting country, typically at the request of the importing country’s government. Example: USA on Japanese govt. on the export of automobiles. A quota rent is the extra profit that producers make when supply is artificially limited by an import quota Import quotas and voluntary export restraints benefit domestic producers by limiting import competition, but they raise the prices of imported goods

Local Content Requirements A local content requirement demands that some specific fraction of a good be produced domestically The requirement can be expressed either in physical terms (e.g. 75% of component parts of the product must be produced locally) or in value terms (e.g. 75% of the value of the product must be produced locally) Local content requirements benefit domestic producers, but consumers face higher prices

Administrative Policies Administrative trade polices are bureaucratic rules that are designed to make it difficult for imports to enter a country These polices hurt consumers by denying access to possibly superior foreign products Examples: Japanese are the masters of this trade barrier. Tulip bulb exported from Netherlands to Japan is an example.

Antidumping Policies Dumping refers to selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value Dumping enables firms to unload excess production in foreign markets Some dumping may be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits Antidumping polices (or countervailing duties) are designed to punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition

Development Of The World Trading System WTO: Experience To Date Since its establishment, the WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services So far, the WTO’s policing and enforcement mechanisms are having a positive effect Most countries have adopted WTO recommendations for trade disputes The WTO: Had 145 members in 2003 Represents 90% of world trade Settles 9 of 10 disputes satisfactorily Reduced tariff from 40% to 5% Saw trade volume of manufactured goods has increased 20 times

Development Of The World Trading System WTO: Experience To Date The 1999 meeting of the WTO in Seattle was important not only for what happened between the member countries, but also for what occurred outside the building Inside, members failed to agree on how to work toward the reduction of barriers to cross-border trade in agricultural products and cross-border trade and investment in services Outside, the WTO became a magnet for various groups protesting free trade

The Future Of The WTO: Unresolved Issues And The Doha Round The current agenda of the WTO focuses on: the rise of anti-dumping policies the high level of protectionism in agriculture the lack of strong protection for intellectual property rights in many nations continued high tariffs on non-agricultural goods and services in many nations

The Future Of The WTO: Unresolved Issues And The Doha Round The WTO is encouraging members to strengthen the regulations governing the imposition of antidumping duties The WTO is concerned with the high level of tariffs and subsidies in the agricultural sector of many economies TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years The WTO would like to bring down tariff rates on nonagricultural goods and services, and reduce the scope for the selective use of high tariff rates Because members believe that the protection of intellectual property rights is an essential element of the international trading system, TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years, and copyrights lasting 50 years.

The Future Of The WTO: Unresolved Issues And The Doha Round The WTO launched a new round of talks at Doha, Qatar in 2001 The agenda includes: cutting tariffs on industrial goods and services phasing out subsidies to agricultural producers reducing barriers to cross-border investment limiting the use of anti-dumping laws This feature explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the American economy from free trade, found that America’s GDP was more than 7 percent higher as a result of reductions in trade barriers than it would have been if the barriers remained. The study also estimated that if tariffs were reduced to zero, significant gains would still result. Suggested Discussion Questions 1. What does the Institute for International Economics suggest about the benefits of free trade? Discussion Points: The Institute for International Economics found that thanks to reductions in trade restrictions, America’s GDP was up. The Institute also estimated that even greater gains in the country’s GDP would occur if protectionism was eliminated all together. Students should recognize that these findings follow the principles of Adam Smith and David Ricardo and suggest that free trade is beneficial. 2. According to the Institute for International Economics study, a move toward free trade would cause disruption in employment. Is it still worth pursuing free trade if it means that some people lose their jobs? Discussion Points: This question should prompt a strong debate among students. Some students will probably suggest that the costs in terms of lost wages and benefits associated with free trade outweigh the benefits that would be gained. Other students however, will probably argue that since protectionism typically benefits only a few at the expense of others, while free trade generates greater economic growth and higher wages, a free trade policy should be followed. Teaching Tip: The Web site for Institute for International Economics is available at {http://www.iie.com/}.