Comparative Advantage and Gains from Trade We all excel and some kinds of production and not others. Everyone gains when we specialize at what we do best and trade with others Even those whose skills are very limited have a comparative advantage at something and can benefit from specialization Gains from specialization and trade apply to trade between countries as well as trade between individuals.

Tariffs Tariff: a tax on imported goods/services As a % of monetary value As an amount per physical unit Purposes Raise revenue for govt Protect domestic industries from competition Preserve domestic jobs

Effects of tariffs Income Increase for domestic firms who are less efficient than foreign competitors Decrease for more efficient foreign firms Decrease income for domestic businesses who would benefit from free trade Prices Domestic consumers pay higher prices Net world production reduced because capital and labor are no longer used most productively. Likelihood of retaliatory tariffs Increased international tension

Quotas Quota is a limit on the amount of imports of some specified good voluntary Japanese car import quotas sugar quotas Purpose Protect domestic industries and jobs No revenue as with tariffs Side effects (unintended consequences) Domestic consumers pay higher prices Deadweight loss Some consumer surplus transferred to foreign producers.

Retaliation for dumping Foreign suppliers, usually with foreign government backing, sell low-priced goods into domestic markets Analogous to domestic corporations engaged in predatory pricing Supposedly justifies trade barriers Victims of dumping: domestic business owners and workers foreign consumers and taxpayers Beneficiaries: domestic consumers foreign producers (if subsidies > lost revenue)

U.S. Tariff history 1789: Hamiltons tariff for protection of infant industries 1826: Tariff of Abominations Tariff on manufactured goods (primarly British) for the benefit of northern U.S. manufacturers Hurt southern cotton growers Higher prices for manufactured goods Reduced British demand for their cotton S. Carolina legislature considered nullification, could have led to civil war 1930: Smoot-Hawley Tariff Decimated European exporters Helped Europes move to fascism and war

Public choice Public choice (C&G p. 190). Examines incentives that motivate various participants in the political process: Politicians and bureaucrats Income, prestige, power, etc. Rent-seekers Businesses and labor unions that try to get government to provide special favors such as suppressing their competition Voters Rational ignorance Voting as an emotive experience

Sugar quotas Limits on the amount of sugar that can be imported into the U.S. Costs U.S. consumers $1.6 billion per year The annual cost of each domestic job saved is about $500,000 Penalty for sneaking sugar into the U.S. up to 2 years jail up to $250,000 fine Devastating to poor countries who have a comparative advantage in sugar lower income incentive to grow marijuana instead

Sugar quotas Proponents (rent-seekers) Domestic sugar growers Domestic sugar employees They have successfully sought quotas to raise their income through Lobbying Campaign contributions Side effects Higher price for foods with sugar Switch to high-fructose corn syrup Poor sugar-growing countries turn to drugs

Concentrated benefits, dispersed costs The benefits of sugar quotas are concentrated among a small number of growers. They can afford to spend a lot of money on rent-seeking Costs are borne by 310 million consumers. Sugar is a very small amount of our budget. We have little incentive to resist quotas. Foreign countries may be devastated Poor countries with comparative advantage in agricultural products (sugar, cotton, etc.)

Globalization Trade barriers (tariffs and quotas) substantially reduced in recent years World Trade Organization Most major governments are members Rules intended to promote free trade Some governments flaunt the rules when convenient (e.g. U.S. sugar quotas) Multinational trade agreements NAFTA (U.S., Canada, Mexico) European Union US and South Korea

Why are tariffs and quotas remain popular Nearly all economists advocate free trade Globalization has vastly increased standards of living worldwide Yet free trade remains unpopular. Why? Some people do suffer when trade opens up – business owners and workers. Their losses are apparent. Consumer gains are not so evident because they are spread widely Losses to foreign suppliers from tariffs/quotas are not apparent Racism?