1 Lectures 23-25: Trade Policy What: instruments of trade policy How: effects of trade policy Why: arguments against free trade

2 Fall 2007 NU-FAST Zahid Siddique What and how of trade policy? Trade or commercial policy refers to restrictions and regulations against free trade Most important of these are –Tariff: a tax/duty levied on traded goods may be on export & import may be specific (a fixed sum per physical unit traded) & ad valorem (a fixed percentage of traded-value) –Subsidy: direct payment, tax-relief to exporters –Quantity restrictions: prohibition or limit on quantity- traded Quotas –Some others include Anti-dumping Buy local legislation, Standards & administrative delays

3 Fall 2007 NU-FAST Zahid Siddique Effect of tariff on imports Consider the following free-trade diagram again If govt. imposes a specific-tariff, P w would rise to P w + tariff –world supply curve shifts up by tax-amount Tariff reduces difference b/w world and domestic price levels Domestic production increases from S d to S 1 Domestic demand falls from D d to D 1 0 DdDd SdSd PSPS Sugar P d 1 e S wo PwPw Import falls from (D d - S d ) to (D 1 – S 1 ) Govt. revenue equals tariff rate times imports (T × M) Tariff helps –dampen import demand –improve balance of payment (BOP = Exports - Imports) SdSd DdDd M bt S w1 Pw+TPw+T S1S1 D1D1 M at

4 Fall 2007 NU-FAST Zahid Siddique Effect of import quota on imports Consider the following free-trade diagram again Govt. sets limits on output imported –distributes licenses to importers Domestic supply curve remains same below P w, shifts right by amount of quota above P w P d1 prevails domestically b/c people cant buy from int. mkt Domestic production increases from S d to S 2 0 DdDd SdSd PSPS Sugar P d 1 e S wo PwPw Domestic demand falls from D d to D 2 Import falls from (D d - S d ) to (D 2 – S 2 ) Revenue of (P d1 – P w ) × M flows to license-holders –max they would pay to buy this license Effect of quota on imports more certain SdSd DdDd M bq S w1 S1S1 D1D1 M at P d1 Import quota

5 Fall 2007 NU-FAST Zahid Siddique Effect of subsidy on exports Disagreement on what subsidy actually is Consider the following diagram with domestic D-S curves Let P w be above P d to analyze case of export With free-trade, domestic demand and supply are D d & S d –Surplus production is exported (= S d - D d ) If govt gives subsidy of Rs S, P d rises to P w +S for exporters 0 DdDd SdSd PSPS Sugar P d 1 e DwDw PwPw Demand falls to D 3 –and supply rises to S 3 Exports rise to (S 3 – D 3 ) Producers receive extra income of S × (D 3 + X) –Govt. pays S × X subsidy –Home consumers worse off as they pay more –Foreigners better off DdDd SdSd X bs D w1 Pw+SPw+S D3D3 S3S3 M aS

6 Fall 2007 NU-FAST Zahid Siddique Anti-Dumping Dumping is export of a good below cost or at lower price abroad than domestically Classified into three categories –Persistent dumping: continuous sale of a good at higher price domestically and at lower price abroad due to international competition a form of international-price discrimination –Predatory dumping: temporary sale of a good abroad at below cost to derive foreign producers out of business so as to acquire new monopoly –Sporadic dumping: occasional sale of a good abroad at below cost to unload unforeseen surplus Anti-dumping duties are levied to off-set price differentials –especially against predatory dumping Difficult to identify any particular form of dumping –Domestic producers will always demand protection

7 Fall 2007 NU-FAST Zahid Siddique Technical, administrative and other policies Trade is also hampered by a number of other barriers –Standards: e.g. safety regulations for automobile & electrical goods, health regulations for food items, labeling requirements showing origin and content –Buy local legislation: e.g. state purchases are restricted to domestic goods, certain percent of a good must be of local origin (local-content requirement) –Permission requirements: e.g. importers/exporters are supposed to obtain import/export licenses –Administrative delays: e.g. bureaucratic rules designed to make imports difficult

8 Fall 2007 NU-FAST Zahid Siddique Why trade barriers State intervention in trade is justified on both economic and non-economic grounds Economic Justifications 1)Job argument –Unemployment may result due to destruction of foreign take-over of domestic markets but it may lead to retaliation by other countries 2)Infant-industry argument –Becoming competitive internationally takes time as economies of scale and worker-efficiency increase –So protect infant-industries from foreign competition –Difficult to identify what infancy is, and who is infant 3)Unfair-competition argument –Combat the effects of differences in fiscal, monetary and tax policies across world

9 Fall 2007 NU-FAST Zahid Siddique Why trade barriers 4)Industrialization argument –Seek protection to promote industrialization b/c it brings faster growth and investment funds, diversifies economy, raises levels of income etc. 5)Government-revenue argument –Import tariffs and quotas are easy source of state- revenue 6)Income-redistribution argument –Taxes help mobilize income from income brackets to lowers ones

10 Fall 2007 NU-FAST Zahid Siddique Why trade barriers Non-Economic justifications 1)National sovereignty –Protect essential industries for political sovereignty 2)Dealing with unfriendly countries –Protection should be used as bargaining tool mainly exercised in defense-goods 3)Preserving culture –limit foreign products and services to maintain cultural heritage

11 Fall 2007 NU-FAST Zahid Siddique Assignment 4 Study Budget and Economic Survey of Pakistan and outline features of Pakistans trade policy Last date of submission –October 31, 2007