International Tradeand Public Policy F ERNANDO Q UIJANO, Y VONN Q UIJANO, K YLE T HIEL & A PARNA S UBRAMANIAN PREPARED BY: © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 2 of 24 1 Do tariffs (taxes) on imported goods hurt the poor disproportionately? The Impact of Tariffs on the Poor 2 How much does it really cost to “save” a job that might be lost under free trade? Measuring the Costs of Protecting Jobs 3Does the concept of “unfair” competition make sense? Protection for Candle Makers 4What are the most pressing current issues in today’s trade negotiations? Ongoing Trade Negotiations

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 3 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 4 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1 Production Possibilities Curve production possibilities curve A curve that shows the possible combinations of products that an economy can produce, given that its productive resources are fully employed and efficiently used.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 5 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1 Production Possibilities Curve ► FIGURE 18.1 Production Possibilities Curve 1 All shirts and no chips: point a. 2All chips and no shirts: point d. 3Equal division of resources: point b.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 6 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1 Comparative Advantage and the Terms of Trade comparative advantage The ability of one person or nation to produce a good at a lower opportunity cost than another person or nation. absolute advantage The ability of one person or nation to produce a product at a lower resource cost than another person or nation. terms of trade The rate at which units of one product can be exchanged for units of another product.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 7 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1 The Consumption Possibilities Curve consumption possibilities curve A curve showing the combinations of two goods that can be consumed when a nation specializes in a particular good and trades with another nation.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 8 of 24 BENEFITS FROM SPECIALIZATION AND TRADE 18.1 The Consumption Possibilities Curve Given the terms of trade, Chipland can exchange 40 of its120 chips for 80 shirts, leading to point h. At point h, Chipland can consume 80 chips and 80 shirts. Shirtland can exchange 80 of its 108 shirts for 40 chips, leading to point k on its consumption possibilities curve. Shirtland can consume 28 shirts and 40 ships. ► FIGURE 18.2 Consumption Possibilities Curve How Free Trade Affects Employment

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 9 of 24 PROTECTIONIST POLICIES 18.2 Import Bans  FIGURE 18.3 Effects of an Import Ban

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 10 of 24 PROTECTIONIST POLICIES 18.2 Quotas and Voluntary Export Restraints import quota A government-imposed limit on the quantity of a good that can be imported. voluntary export restraint (VER) A scheme under which an exporting country voluntarily decreases its exports.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 11 of 24 PROTECTIONIST POLICIES 18.2 Quotas and Voluntary Export Restraints  FIGURE 18.4 Market Effects of a Quota, a VER, or a Tariff

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 12 of 24 PROTECTIONIST POLICIES 18.2 Quotas and Voluntary Export Restraints import licenses Rights, issued by a government, to import goods. tariff A tax on imported goods. Responses to Protectionist Policies

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 13 of 24 THE IMPACT OF TARIFFS ON THE POOR APPLYING THE CONCEPTS #1: Do tariffs (taxes) on imported goods hurt the poor disproportionately? Economists have found that tariffs in the United States fall most heavily on lower- income consumers. Footwear accounts for: 1.3 percent of the expenditure of lower-income households. 0.5 percent of the expenditure of higher-income households. The highest tariffs fall on the cheapest products—precisely those that will be purchased by lower-income consumers. Low-price sneakers face a 32-percent tariff. Expensive track shoes face only a 20-percent tariff. To protect U.S. industries, tariffs are highest on labor-intensive goods; but these goods tend to be lower priced. That is why tariffs do fall disproportionately on the poor.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 14 of 24 U.S. URGED TO ACT ON FARM SUBSIDIES The current U.S. farm subsidy program transferred about $20 billion dollars last year to farmers. Reformers are calling for ending the subsidies and subsidizing crop insurance or creating tax efficient savings accounts for farmers. U.S. farm subsidies are gaining attention in the world of international trade. Many economists believe the practice must end in order to avoid sanctions from the World Trade Organization (WTO). The Doha round of trade talks appears stalled largely as a result of the impasse over agriculture subsidies. The current U.S. proposal calls for phasing out the subsidies over a 15 year period. Critics maintain that the U.S. could satisfy trade partners by reducing the phase-out period to five years. Farm subsidies are typically paid based on the number of acres of a particular crop in production. If you look at the corn market for example, you would see the subsidies generate an increase in supply. If you removed subsidies, the supply of corn would decrease and price per bushel would move higher as shown by P 2. Extra Application 5

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 15 of 24 CORPORATIONS GET BREAK ON TARIFFS One such proposal to suspend tariffs on dog collars was introduced by Senator Blanche Lincoln (D) from Arkansas at the request of Wal-Mart stores. Congressional sponsors maintain the bills will lower prices to consumers and create jobs. The Dungey family in New York has been manufacturing dog collars for three decades in a six-person shop. The bill sponsored by Lincoln would seriously impact their company’s financial health. Some analysts indicate that these tariff waivers cost the government hundreds of millions in lost tariff revenue. Each year Congress passes hundreds of pieces of legislation to suspend tariffs, most of which apply to relatively obscure products. The legislation is typically drafted to benefit a Congress person’s home state or constituency at the request of lobbyists. If the tariff is removed on dog collars, the price of dog collars will fall from P 0 to P 1. The fall in price may push some domestic producers out of the market since domestic quantity will also fall from Q t back to Q. However, lowering prices will benefit consumers. Extra Application 6

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 16 of 24 WHAT ARE THE RATIONALES FOR PROTECTIONIST POLICIES? 18.3 To Shield Workers from Foreign Competition To Nurture Infant Industries To Help Domestic Firms Establish Monopolies in World Markets learning by doing Knowledge and skills workers gain during production that increase productivity and lower cost. infant industries Industries that are at an early stage of development.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 17 of 24 MEASURING THE COSTS OF PROTECTING JOBS APPLYING THE CONCEPTS #2: How much does it really cost to “save” a job that might be lost under free trade? The Federal Reserve Bank of Dallas recently examined the cost to the United States to protect jobs in 20 different industries. Below are the top five industries in terms of costs per job saved: In other industries, the costs per job may be a bit lower, but the total cost to the economy is much higher because the number of jobs saved is much greater. In textiles and apparels, the annual cost per job is “only” $199,241, but the total cost of protecting this industry is $33.6 billion a year.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 18 of 24 PROTECTION FOR CANDLE MAKERS APPLYING THE CONCEPTS #3: Does the concept of “unfair” competition make sense? In response to the spread of protectionism, the French economist Frédéric Bastiat (1801–1851) wrote the following fictitious petition, in which French candle makers asked for protection from “unfair” competition: Does it not argue to the greatest inconsistency to check as you do the importation of coal, iron, cheese, and goods of foreign manufacture, merely because... their price approaches zero, while at the same time you freely admit, and without limitation, the light of the sun, whose price is during the whole day at zero?

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 19 of 24 A BRIEF HISTORY OF INTERNATIONAL TARIFF AND TRADE AGREEMENTS 18.4 General Agreement on Tariffs and Trade (GATT) An international agreement established in 1947 that has lowered trade barriers between the United States and other nations. World Trade Organization (WTO) An organization established in 1995 that oversees GATT and other international trade agreements, resolves trade disputes, and holds forums for further rounds of trade negotiations. In addition to the large group of nations involved in the WTO, other nations have formed trade associations to lower trade barriers and promote international trade: The North American Free Trade Agreement (NAFTA) The European Union (EU) Asian Pacific Economic Cooperation (APEC) U.S.-Central America Free Trade Agreement (CAFTA)* *must be approved by the U.S. Congress and by National Assemblies in the Central American countries before it becomes law.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 20 of 24 ONGOING TRADE NEGOTIATIONS APPLYING THE CONCEPTS #4: What are the most pressing current issues in today’s trade negotiations? The comparative advantage of many developing countries lies in agriculture, but the developed countries still provide subsidies and protection to their agriculture industries. Problem: Subsidies to exports lower world prices, and thereby make it more difficult for developing countries to compete in world markets. The Doha rounds: Negotiators agreed to eliminate all export subsidies for agriculture exports by the year Many more details and issues need to be negotiated before the Doha round can come to a fruitful conclusion.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 21 of 24 BUSH, PUTIN TO SIGN WTO DEAL IN HANOI Analysts viewed the meeting as an attempt by both countries to ease tensions that have built up since the U.S. invasion of Iraq, a move that was opposed by Russia. There is some expectation that the meeting was prompted by the recent U.S. elections since many Russians are wary of the new Democratic control coming in the U.S. and fear that it may mean new focus on Russia’s “democratic record.” Russian leader Vladimir Putin met with President Bush during a recent refueling stop in Moscow. The two leaders confirmed the anticipated signing of a bilateral agreement on Russia’s entry to the World Trade Organization (WTO). The meeting was unexpected and described as “extraordinarily positive and friendly.” Both leaders will continue the discussion at the upcoming Asia-Pacific Economic Co-operation summit in Hanoi. Note that with free trade the total supply of product J increases and the result is a drop in price and an increase in quantity of J. U.S. consumers are now better off with free trade. Extra Application 7

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 22 of 24 RECENT POLICY DEBATES AND TRADE AGREEMENTS 18.5 Are Foreign Producers Dumping Their Products? dumping A situation in which the price a firm charges in a foreign market is lower than either the price it charges in its home market or the production cost. price discrimination The process under which a firm divides consumers into two or more groups and charges a different price for each group buying the same product. predatory pricing A pricing scheme under which a firm decreases the price to drive rival firms out of business and increases the price when rival firms leave the market.

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 23 of 24 RECENT POLICY DEBATES AND TRADE AGREEMENTS 18.5 Do Trade Laws Inhibit Environmental Protection? outsourcing Firms producing components of their goods and services in other countries. Do Outsourcing and Trade Cause Inequality? Why Do People Protest Against Free Trade?

chapter © 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan Sheffrin Perez 24 of 24 absolute advantage comparative advantage consumption possibilities curve dumping General Agreement on Tariffs and Trade (GATT) import licenses import quota infant industries learning by doing outsourcing predatory pricing price discrimination production possibilities curve tariff terms of trade voluntary export restraint (VER) World Trade Organization (WTO)