Free Trade – GoodRestriction – Bad Price ($) SdSd F S d+w E f G S d+w+t ab c d e g DdDd h Free Trade: Price = World Price = $8,000 Domestic Production=20; Domestic Consumption=80; Imports=60 Consumer Surplus: a+b+c+d+e+f+g; Producer Surplus = h

Free Trade – GoodRestriction – Bad Price ($) SdSd F S d+w E f G S d+w+t ab c d e g DdDd h Tariff: Price = World Price + Tariff = $8,000 + $1,000 = $9,000 Domestic Production=40; Domestic Consumption=60; Imports=20 Reduced Consumer Surplus: a+b+c+d Increased Producer Surplus = a (Redistributive Effect) Increased Tax Revenue = c Deadweight Loss: Inefficient Production = b Deadweight Loss: Reduced Consumption = d

Costs of import restrictions Domestic consumers face increased costs  Low income consumers are especially hurt by tariffs on low-cost imports Overall net loss for the economy (deadweight loss)  Production effect: output that costs more than it has to (b)  Consumption effect: surplus lost from reduced consumption (d)  Export industries face higher costs for inputs  Cost of living increases  Other nations may retaliate

So why restrict trade?  Benefits of free trade in final goods are spread widely  Tariffs on intermediate inputs tend to be low  Costs of free trade are felt rapidly by domestic producers  Lobbying by business and labor “… those persons who demand cheaper coats would be ashamed of themselves if they could realize that their demands cut the wages of the women who made those coats.” Benjamin Harrison, Election Campaign of 1888  Strategic trade policy  Reduce demand for foreign stuff  lower its price a lot  Big gain on what you still buy  Ways to restrict trade  Tariffs  Non-Tariff Barriers

5 Flavors of tariffs Tariff: a tax (duty) on internationally traded products  Import tariffs  Export tariffs … unconstitutional in US  Raise revenue  Favor domestic users of exported commodities  In primary goods exporting courntries, favor urban over rural areas  Protective tariff … insulate domestic producers  Revenue tariff - raise funds for government  Specific tariff - Fixed $/Unit  Ad valorem tariff - % of product’s value  “Free-on-board” (FOB) as it leaves port  Levied “cost-insurance-freight” (CIF) as it arrives in port  Compound tariff - Combination of fixed and ad valorem tariffs  Levied on finished goods whose imported inputs are subject to tariff  Fixed portion offsets tariffs on imports paid by domestic producers  % portion protects domestic producers against finished good imports

Effective rate of protection  For a finished good,  Effective tariff rate =  {Nominal tariff – (Value of Imports/Total Value)x(Tariff on Imports)}  (Domestic Value Added)/Total Value  The impact of a tariff is often different from its stated amount  Tariff Escalation: If domestic value added (domestic content) is low and tariffs on imports are also low Effective tariff >> Nominal tariff.

Nominal and Effective Tariff Rates (US and Japan, early 1980s) USJapan Nominal EffectiveNominal Effective Agriculture, fish, forest. 1.8% 1.9% 18.4% 21.4% Food, beverages,tobacco Footwear Furniture Leather products Paper and paper products Textiles Wearing apparel Wood products

Avoiding and postponing tariffs  Production sharing  special treatment for foreign assembly using domestic inputs  OAP: Offshore Assembly Provision  Maquiladoras  Bonded warehouses  Assemble imported components and reexport duty free  If sell domestically, tariff is levied only on imported value  Foreign trade zones (FTZ)

Arguments for trade restrictions  Job protection … but losses elsewhere  Protect against “cheap” foreign labor … but is foreign labor “cheap”?  Worker productivity  Fairness in trade – “level playing field”

Principles of Fair Trade  Democratic organization  Producer cooperatives  Recognize unions  No child labor  Decent working conditions  Environmental sustainability  Prices that cover production costs  Price guarantees irrespective of world prices  Social premiums  Pay premiums to organizations  public goods  Long-term relationships  Reduce uncertainties

Arguments for trade restrictions  Job protection … but losses elsewhere  Protect against “cheap” foreign labor … but is foreign labor “cheap”?  Worker productivity  Fairness in trade -- level playing field … but sacrifice gains from trade  Equalization of production costs … but whose costs? [Their low cost producer = Our high cost?]  Infant-industry protection  Achieve efficient scale … but protect senile industries too?  Political and social reasons  Protect against cultural imperialism  National defense/Self–sufficiency…reduce dependence... but could build strategic reserves instead

Import quotas  Quota: how much can be imported in a year  Global quotas  Selective quotas  Government loses tariff revenue  Quota is insensitive to demand shifts  Tariff-rate quota: a two-tiered tariff  More can be imported if demand increases … but only at a higher tariff rate Non – Tariff Barriers (NTBs)

 Voluntary export restraints (VERs)  Impose export quota … or else!  Japanese auto exports  unintended consequences  Domestic content requirements  Subsidies  Domestic subsidy … e.g. R & D  “Green jobs”  Export subsidy  Government procurement policies  Social regulations (health, environmental and safety rules)  Sea transport and freight restrictions Other NTBs

Costs of import restrictions redux Domestic consumers face increased costs Overall net loss for the economy (deadweight loss)  Production effect: output that cost more than it has to (b)  Consumption effect: surplus lost from reduced consumption (d)  Export industries face higher costs for inputs  Cost of living increases  Retaliation

Problem 4.15  “Australian market for TVs”  In autarky  Market clearing price  Quantity supplied and bought  Consumer surplus  Producer surplus Price Quantity Demanded Quantity Supplied Export (Import) $ (10) (30) (50)

 “Australian market for TVs”  World price = $100  Quantity bought  Quantity supplied by Australian producers  Consumer surplus  Producer surplus Problem 4.15 Price Quantity Demanded Quantity Supplied Export (Import) $ (10) (30) (50)

 “Australian market for TVs”  World price = $100 / Tariff = $100  Quantity bought  Quantity supplied by Australian producers  Consumer surplus  Producer surplus  Revenue  Redistributive effect  Protective effect / Consumption effect / Deadweight loss Problem 4.15 Price Quantity Demanded Quantity Supplied Export (Import) $ (10) (30) (50)

Problem 5.16  “Venezuelan market for TVs”  World price = $150 / Free trade  Quantity bought  Quantity supplied by Venezuelan producers  Consumer surplus  Producer surplus Price Quantity Demanded Quantity Supplied Export (Import) $ (900) (500) (100)

Problem 5.16  “Venezuelan market for TVs”  World price = $150 / Import quota = 300 TVs  Price in Venezuela … Quantity bought  Quantity supplied by Venezuelan producers  Reduced consumer surplus  Increased producer surplus  Earnings of Venezuelan importers who buy at world price  Net loss to Venezuelans Price Quantity Demanded Quantity Supplied Export (Import) $ (900) (500) (100)

Problem 5.16  “Venezuelan market for TVs”  World price = $150 / Import quota = 300 TVs  Price in Venezuela … Quantity bought  Quantity supplied by Venezuelan producers  Reduced consumer surplus  Increased producer surplus  Earnings of foreign monopolists who sell at Venez’n price  Net loss to Venezuelans Price Quantity Demanded Quantity Supplied Export (Import) $ (900) (500) (100)

Problem 5.16  “Venezuelan market for TVs”  World price = $150 / Subsidy to producers = $100/TV  Price in Venezuela … Quantity bought  Quantity supplied by Venezuelan producers  Increased producer surplus  Increased production cost  Cost of subsidy to Venezuelan taxpayers  Net loss to Venezuelans Price to Consumers Quantity Demanded Quantity Supplied Export (Import) $ (700) (300)