International Economics Mordecai E. Kreinin Copyright ©2002 South-Western/Thomson Learning. All rights reserved. Copyright ©2002 South-Western/Thomson Learning. All rights reserved. Part I International Trade Relations Part I International Trade Relations

C5-2 CHAPTER 5 Nontariff Barriers (NTBs) to Trade

C5-3 Import Quotas to Protect Domestic Industries Common in Western Europe after WW II Not used for manufactured goods today by developed nations Prohibited by WTO Often used for agricultural products Tariff quotas Quotas used in all sectors in developing countries Common in Western Europe after WW II Not used for manufactured goods today by developed nations Prohibited by WTO Often used for agricultural products Tariff quotas Quotas used in all sectors in developing countries

C5-4 Economic Effects of Quotas Raises domestic price of imported commodity Percentage increase is implicit tariff equivalent Tariff equivalent calculated by subtracting foreign from domestic price, dividing result by foreign price Raises domestic price of imported commodity Percentage increase is implicit tariff equivalent Tariff equivalent calculated by subtracting foreign from domestic price, dividing result by foreign price

C5-5 Economic Effects of Quotas Import consumption declines Consumption and Production of domestic substitutes expands Resources drawn from other (presumably more efficient) industries No revenue to government Quota rents Auctioning import licenses Import consumption declines Consumption and Production of domestic substitutes expands Resources drawn from other (presumably more efficient) industries No revenue to government Quota rents Auctioning import licenses

C5-6 Economic Effects of Quotas Replaced market mechanism with government decisions No limit to differential between domestic and world prices Rise in domestic demand raises domestic price, leaves admissible imports unchanged Raises production and consumption costs of protection, forces further misallocation of resources and less desirable consumption patterns A quota and tariff are equivalent if demand and supply are stationary, perfect competition exists in all markets, and government auctions import licenses. Replaced market mechanism with government decisions No limit to differential between domestic and world prices Rise in domestic demand raises domestic price, leaves admissible imports unchanged Raises production and consumption costs of protection, forces further misallocation of resources and less desirable consumption patterns A quota and tariff are equivalent if demand and supply are stationary, perfect competition exists in all markets, and government auctions import licenses.

Domestic Market for Cars in a Small Importing Country FIGURE 5.1 C5-7

Tariff and Quota When Domestic Demand Rises FIGURE 5.2 C5-8

C5-9 Economic Effects of Quotas With a reduction in domestic supply, quotas are more harmful to welfare than tariffs. A reduction in domestic demand results in more harm from tariffs than from quotas. In case of tariff, price is constant, quantity adjusts. In case of quota, quantity is constant. price adjusts. With a reduction in domestic supply, quotas are more harmful to welfare than tariffs. A reduction in domestic demand results in more harm from tariffs than from quotas. In case of tariff, price is constant, quantity adjusts. In case of quota, quantity is constant. price adjusts.

C5-10 Economic Effects of Quotas Theory of effective protection Quotas on imported raw materials raise production costs of final output. Import duties on raw materials are sometimes rebated, no rebate occurs with quotas. Monopoly effect Cumbersome administrative apparatus Corruptibility of license prices Theory of effective protection Quotas on imported raw materials raise production costs of final output. Import duties on raw materials are sometimes rebated, no rebate occurs with quotas. Monopoly effect Cumbersome administrative apparatus Corruptibility of license prices

C5-11 Economic Effects of Quotas Licenses usually distributed among importers functioning at time control is imposed System freezes situation Incentive for efficiency diminishes LDCs can least afford inefficiency, but impose quotas anyway WTO imposed tariffication Licenses usually distributed among importers functioning at time control is imposed System freezes situation Incentive for efficiency diminishes LDCs can least afford inefficiency, but impose quotas anyway WTO imposed tariffication

C5-12 Voluntary Export Restraints VERs avoid violating WTO prohibition against import quotas and avoid retaliation VERs restrict supply and raise prices in importing country Importing countries threatened with more restrictive action if they fail to agree Administered by government or export industries VERs under WTO phase-out agreement VERs avoid violating WTO prohibition against import quotas and avoid retaliation VERs restrict supply and raise prices in importing country Importing countries threatened with more restrictive action if they fail to agree Administered by government or export industries VERs under WTO phase-out agreement

C5-13 Voluntary Export Restraints 10% of world trade covered by VERs Most affected products: steel, textiles, agriculture and food, electronics, footwear, machine tools Markets protected by VERs: U.S., EU, Canada Exporters limited by VERs: Japan, Korea Taiwan, LDCs 10% of world trade covered by VERs Most affected products: steel, textiles, agriculture and food, electronics, footwear, machine tools Markets protected by VERs: U.S., EU, Canada Exporters limited by VERs: Japan, Korea Taiwan, LDCs

C5-14 Voluntary Export Restraints Usually discriminate between supply sources. Violate WTO nondiscriminatory rule Have effects similar to quotas Tend to produce raised prices, provide rents to exporters (exceeding $25 billion annually) Usually discriminate between supply sources. Violate WTO nondiscriminatory rule Have effects similar to quotas Tend to produce raised prices, provide rents to exporters (exceeding $25 billion annually)

C5-15 Voluntary Export Restraints Trade barriers ranked in terms of damage to domestic welfare: Tariffs, least harmful Import quotas, more harmful VERs, most harmful Produce quality upgrading phenomenon Intended to save domestic jobs threatened by imports Inefficient—annual cost per job saved greatly exceeds average wage in industry Trade barriers ranked in terms of damage to domestic welfare: Tariffs, least harmful Import quotas, more harmful VERs, most harmful Produce quality upgrading phenomenon Intended to save domestic jobs threatened by imports Inefficient—annual cost per job saved greatly exceeds average wage in industry

C5-16 International Commodity Agreements ICAs designed to stabilize world price of certain commodities (raw materials, agricultural products) or dispose of surpluses Initiated by producing nations to compensate for low consumer and producer response to price changes, to avoid huge price fluctuations If a country’s economy is devoted to one or two exports, entire level of economic activity fluctuates with these prices ICAs designed to stabilize world price of certain commodities (raw materials, agricultural products) or dispose of surpluses Initiated by producing nations to compensate for low consumer and producer response to price changes, to avoid huge price fluctuations If a country’s economy is devoted to one or two exports, entire level of economic activity fluctuates with these prices

C5-17 International Commodity Agreements ICAs involve producing and consuming countries: export restriction schemes, buffer stocks, multilateral contracts Export restriction schemes: employ national quotas for production or export Buffer stocks: set minimum and maximum stock prices Multilateral contracts: specify maximum selling price, minimum purchase price for stipulated quantities ICAs involve producing and consuming countries: export restriction schemes, buffer stocks, multilateral contracts Export restriction schemes: employ national quotas for production or export Buffer stocks: set minimum and maximum stock prices Multilateral contracts: specify maximum selling price, minimum purchase price for stipulated quantities

Commodity Price Stabilization Under a Buffer Stock ICA FIGURE 5.3 C5-18

C5-19 International Commodity Agreements All ICAs suffer from attempts to fix and maintain price different from long-run equilibrium Producers continuously pressure for higher prices, leading to more production, surpluses ICAs become subsidies paid by consumers paying above-equilibrium prices, encouraging greater production All ICAs suffer from attempts to fix and maintain price different from long-run equilibrium Producers continuously pressure for higher prices, leading to more production, surpluses ICAs become subsidies paid by consumers paying above-equilibrium prices, encouraging greater production

C5-20 International Commodity Agreements Declining use in recent years Other ways must be found to combat effects of violent price fluctuations on developing countries IMF Compensatory financing Textile industry WTO administered Multifibre Arrangement (MFA) Losers—consumers in industrial countries, producers in LDCs 2005 phase-out Declining use in recent years Other ways must be found to combat effects of violent price fluctuations on developing countries IMF Compensatory financing Textile industry WTO administered Multifibre Arrangement (MFA) Losers—consumers in industrial countries, producers in LDCs 2005 phase-out

C5-21 International Cartels Group of corporations in different countries or group of supplying governments agree to restrict trade (OPEC) Cartel power may be restricted by supply increases from outside sources, development of substitutes, reduced consumption Cartels restrict output, misallocate resources, extract artificially high prices from consumers, can negate government policies EC rules of competition in industry Group of corporations in different countries or group of supplying governments agree to restrict trade (OPEC) Cartel power may be restricted by supply increases from outside sources, development of substitutes, reduced consumption Cartels restrict output, misallocate resources, extract artificially high prices from consumers, can negate government policies EC rules of competition in industry

C5-22 Local Content Requirements Specify minimum portion of value of product to be produced domestically Pervasive form of trade control Specify minimum portion of value of product to be produced domestically Pervasive form of trade control

C5-23 Border Tax Adjustments An import tax on commodity, rebate on its export, which equal or adjust for domestic indirect taxes (excise, value-added) Direct vs. indirect taxes U.S.-EU trans-Atlantic dispute An import tax on commodity, rebate on its export, which equal or adjust for domestic indirect taxes (excise, value-added) Direct vs. indirect taxes U.S.-EU trans-Atlantic dispute

C5-24 Dumping Selling identical product abroad cheaper than domestically Identical difficult to establish, due to differences in specifications, packaging, other features International standards for judging commodity dumping Selling identical product abroad cheaper than domestically Identical difficult to establish, due to differences in specifications, packaging, other features International standards for judging commodity dumping

C5-25 Dumping Sporadic dumping—disposal of occasional surplus, effects negligible Predatory dumping—large firm sells low abroad to drive out competition and exploit market, most harmful form of dumping Persistent dumping—domestic monopolistic supplier consistently sells lower abroad to attract sales from international competitors, harmful to producers in countries receiving dump, but consumers reap price benefit Sporadic dumping—disposal of occasional surplus, effects negligible Predatory dumping—large firm sells low abroad to drive out competition and exploit market, most harmful form of dumping Persistent dumping—domestic monopolistic supplier consistently sells lower abroad to attract sales from international competitors, harmful to producers in countries receiving dump, but consumers reap price benefit

A Monopolist Facing Separate Markets FIGURE 5.4 C5-26

C5-27 Dumping Dumping margin Anti-dumping import duty Equals dumping margin, offsets dumping Imposition elaborate, dumping must be proven and injury to competing domestic industry demonstrated Voluntary curtailment of exports to avoid duty Diversionary input dumping Dumping margin Anti-dumping import duty Equals dumping margin, offsets dumping Imposition elaborate, dumping must be proven and injury to competing domestic industry demonstrated Voluntary curtailment of exports to avoid duty Diversionary input dumping

C5-28 Export Subsidies Government payment to domestic firm for each unit exported Despite WTO prohibitions, export subsidies abound Deadweight welfare loss Large countries incur added cost of world price reduction, deteriorated terms of trade Intended to promote exports, protect employment Government payment to domestic firm for each unit exported Despite WTO prohibitions, export subsidies abound Deadweight welfare loss Large countries incur added cost of world price reduction, deteriorated terms of trade Intended to promote exports, protect employment

C5-29 Export Subsidies Importing country gains in terms of trade Other exporting countries lose in terms of trade Labor and capital harmed in importing country’s competing industries Countervailing duty to offset subsidy Disputes over forms of unreasonable trade restriction Importing country gains in terms of trade Other exporting countries lose in terms of trade Labor and capital harmed in importing country’s competing industries Countervailing duty to offset subsidy Disputes over forms of unreasonable trade restriction

C5-30 Export Subsidies Below-market interest rates Direct resources to favored export industries Transfer income from exporting to importing country Two-thirds of such loans are made by industrial countries to LDCs OECD minimum interest rate for export credit Below-market interest rates Direct resources to favored export industries Transfer income from exporting to importing country Two-thirds of such loans are made by industrial countries to LDCs OECD minimum interest rate for export credit

C5-31 Export Subsidies Mixed credit programs Research and development aid WTO subsidies code Mixed credit programs Research and development aid WTO subsidies code

C5-32 NTBs vs. Tariffs More harmful to national economy VERs more harmful than import quotas NTBs displace market mechanism Hidden devices Difficult to negotiate More harmful to national economy VERs more harmful than import quotas NTBs displace market mechanism Hidden devices Difficult to negotiate Less harmful to national economy Tariffs only distort market mechanism Transparent More easily negotiable

C5-33 Strategic Trade Policy? In perfectly competitive environment, government trade intervention justified by Imposition of optimum tariff to improve terms of Infant industry protection when direct subsidy infeasible Possible offset to domestic distortion when domestic measures unavailable In perfectly competitive environment, government trade intervention justified by Imposition of optimum tariff to improve terms of Infant industry protection when direct subsidy infeasible Possible offset to domestic distortion when domestic measures unavailable

C5-34 Strategic Trade Policy? Oligopolistic markets lead to arguments for strategic trade policy Government measures increasing global market share of country’s oligopolistic firms to increase profit at expense of foreign firms Boeing and Airbus subsidy case American and Japanese firms protection case Oligopolistic markets lead to arguments for strategic trade policy Government measures increasing global market share of country’s oligopolistic firms to increase profit at expense of foreign firms Boeing and Airbus subsidy case American and Japanese firms protection case

C5-35 Strategic Trade Policy? Problems Governments lack information Resource transfer and subsequent loss in other industry Competition eliminates rents; subsidy costs to government or protection costs to consumers may exceed rent gains Inducement to enter industry, lower efficiency, higher average cost Retaliation may nullify gain Problems Governments lack information Resource transfer and subsequent loss in other industry Competition eliminates rents; subsidy costs to government or protection costs to consumers may exceed rent gains Inducement to enter industry, lower efficiency, higher average cost Retaliation may nullify gain

C5-36 Summary Some NTBs, common in recent years, more harmful than tariffs Import quotas and VERs limit quantity, raise prices, produce quality upgrading Import licenses VERS discriminatory, scheduled for phase-out VERs intended to save jobs, but cost per job saved is usually multiple of average industry wage ICAs apply to primary commodities and textiles Buffer stock MFA Some NTBs, common in recent years, more harmful than tariffs Import quotas and VERs limit quantity, raise prices, produce quality upgrading Import licenses VERS discriminatory, scheduled for phase-out VERs intended to save jobs, but cost per job saved is usually multiple of average industry wage ICAs apply to primary commodities and textiles Buffer stock MFA

C5-37 Summary International Cartels OPEC Minimum Local Content Border Tax Adjustment Dumping Export subsidies More harmful than tariffs, NTBs widespread, effects difficult to measure Oligopolistic markets offer theoretical argument for government intervention in trade International Cartels OPEC Minimum Local Content Border Tax Adjustment Dumping Export subsidies More harmful than tariffs, NTBs widespread, effects difficult to measure Oligopolistic markets offer theoretical argument for government intervention in trade

C5-38 Important Concepts Nontariff barriers (NTBS) Import quotas Quota rents Auctioning import licenses Equivalence of a tariff and a quota Nontariff barriers (NTBS) Import quotas Quota rents Auctioning import licenses Equivalence of a tariff and a quota Local content requirement Indirect taxes Border tax adjustment Value-added tax (VAT) Dumping Sporadic dumping

C5-39 Important Concepts Primary and secondary boycotts (FN3) Voluntary export restraints (VERs) Quality upgrading Cost per job saved International Commodity Agreements (ICAs) Primary and secondary boycotts (FN3) Voluntary export restraints (VERs) Quality upgrading Cost per job saved International Commodity Agreements (ICAs) Predatory dumping Persistent (long-run) dumping Dumping margin Antidumping duty Export subsidy Countervailing duties Strategic trade policy

C5-40 Important Concepts Buffer stocks Compensatory financing Multifibre Agreement (MFA) International cartel Buffer stocks Compensatory financing Multifibre Agreement (MFA) International cartel Organization of Petroleum Exporting Countries (OPEC) Monopoly rents Tariff Equivalent of NTBs

A Monopolist Under A Tariff and a Quota FIGURE 5.5 C5-41