International Trade Politics and Policies © 2018 Melvin Jameson

Why trade increases welfare Local prices converge toward a world price Production is reallocated Each region specializes in its comparative advantage Permits an increase in production of all products © 2018 Melvin Jameson

Winners and Losers from Trade Producers in exporting country Consumers in importing country Losers Producers in importing country Consumers in exporting country Total gains exceed total losses © 2018 Melvin Jameson

Factor-Price Equalization: Consequences for trade policy “Stolper-Samuelson Theorem” extends theory of factor price equalization. A country has a comparative advantage in products that intensively utilize abundant factors. Trade increases the (domestic) price of these products and thus the wage of the abundant factor. Thus owners of the relatively abundant factor favor free trade and those of scarce factors oppose it. Particularly when the factors are specialized or immobile. Despite net benefit resulting from trade © 2018 Melvin Jameson

Political Economy of Trade Policy Typically dominated by producers: Well organized, well defined groups that are very aware of their economic interests. Consumers Economic losses, although large in total, are widely dispersed and individually small. Generally not organized or well-informed © 2018 Melvin Jameson

Trade History Interwar era/Great Depression Generally characterized by tariffs and protectionism © 2018 Melvin Jameson

A tariff reduces the effects of trade Volume of trade Degree of price convergence Gains of winners Losses of losers Net benefit of trade Partial transfer to government collecting tariff © 2018 Melvin Jameson

Effect of a Tariff P* = world price T = Tariff A = Gain to Suppliers C = Tariff Revenue A+B+C+D = Loss to Consumers price Domestic Supply P*+T A C D B Domestic Demand P* Quantity S S’ D’ D © 2018 Melvin Jameson

Dynamic effects of trade barriers Reduced competitiveness of domestic industry Foreign competitors adjust Direct foreign investment Change product types Substitute more expensive products Seek loopholes in tariff Trade retaliation © 2018 Melvin Jameson

The chicken tax and van stripping Responses to tariffs The chicken tax and van stripping WSJ 22 September 2009 © 2018 Melvin Jameson

Trade History Post-World War II era General Agreement on Tariffs and Trade (GATT) (1947 – 1994) Seeking benefits of trade primarily by reducing tariffs Agreed limits to tariffs Rules restricting trade retaliation Steadily growing membership © 2018 Melvin Jameson

Other direct trade restrictions Quotas Tariff-rate quota Export quotas (“voluntary” export restraint) Subsidies © 2018 Melvin Jameson

Other types of non-tariff Barriers Domestic content requirements Government procurement policies Social Regulations health, safety, environment Sea transport and freight regulations can be costly and restrictive © 2018 Melvin Jameson

Trade History World Trade Organization (WTO) 1995 – present Successor organization to GATT Aimed to expand focus beyond tariffs to non-tariff trade barriers. Some success in its initial years. Membership expanded to 159 countries. “Doha round” began 2001 issues included Protection of IP Agricultural subsidies © 2018 Melvin Jameson

Trade History With failure of the Doha round emphasis turned to Regional trade agreements Previously existing and new Bilateral trade agreements © 2018 Melvin Jameson

Regional Trade Agreements Types Preferential trade area – reduced tariffs for members Free trade area- zero tariff for members Customs union – common external tariff policy Common market – all factors mobile within Economic Union: Complete economic integration – common currency, regulation, tax policy etc. © 2018 Melvin Jameson

Do regional agreements improve resource allocation? Not necessarily Trade creation occurs when production shifts from high to low cost location as a result of a trade preference Trade diversion occurs production shifts from a low to a high cost source. © 2018 Melvin Jameson

Trade creation vs. diversion   Policy Home B C Result 0% tariff 35 26 20 Free Trade 100% tariff 52 40 prohibitive tariff 50% tariff 39 30 free trade w/ B trade diversion © 2018 Melvin Jameson