Understanding Global Trade Politics

Why Trade Increases Welfare Because of the differences between countries, reallocating production to increase specialization increases total output.

Why Trade Increases Welfare Theoretical Background Absolute Advantage (Adam Smith)

Why Trade Increases Welfare Theoretical Background 2. Comparative Advantage (David Ricardo) Trade between two countries is beneficial even if one of the countries is inferior in producing all products as long as the degree of inferiority is not exactly the same for all products.

Sources of Gains Local prices converge toward a world price Production is reallocated Each region specializes in its comparative advantage Permits an increase in production of both products

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

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

America’s economy has been benefitting from trade lower U.S. prices of clothes; home furnishings etc. “trade with China alone put $250/year into the pocket of every American” But its costs have been amplified by policy failures wages squeezed for those whose skills are abundant abroad (less-skilled workers) consistent with economic theory. “a sharp rise in the college premium … from around 30% in 1979 to almost 50% by 2000” Those who lost out from increased trade tended to be least prepared for major career change (retraining) or relocation “trade-induced job losses, while relatively small, are particularly painful.” Meanwhile government support for those impacted has been minimal and ineffective “Even for those workers who did qualify for TAA (trade-adjustment assistance), support was woefully inadequate.”

Effect of a Tariff A C D B 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

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

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

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