1. AAMP Training Materials
Module 4.4: Winners & Losers from Regional Trade
Nicholas Minot (IFPRI)
This is the fourth section of the Trade Module which is part of the AAMP Training Materials.
Exercises in this presentation are found in the excel spreadsheet entitled:
Module 4.4 – Winners and Losers from Regional Trade.xls

2. Objectives Understand welfare impact of trade
Identify types of gains from trade
Learn how to measure welfare impact of trade
Address myths about trade
Examine effects of trade restrictions
Who gains & who loses from trade restrictions
Highlight politics of trade restrictions
Explore policies to compensate for losses

3. Module Contents Objectives Types of gains from trade Myths about trade
Measuring welfare impact of trade
Exercises
Conclusions

4. What are gains from trade?
Gains from trade refer to the benefits gained by a group of people from exchanging goods and services with other groups of people
Usually we think of gains from trade from countries trading with each other, but there are also gains from districts, villages, or even households trading with each other
The term “gains from trade” does not mean that everyone in the group gains…
It means that benefits > losses

5. Why are there gains from trade?
Four types of gains from trade:
Comparative advantage
Competition
Economies of scale
Dynamic gains from trade

6. 1. Comparative Advantage
Definition: Each country can produce some goods at relatively lower cost than other goods
A country will export goods it can produce at relatively lower cost and import goods that cost relatively more to produce
Comparative advantage is not the same as “absolute advantage”. Absolute advantage compares the production of a good between two countries. A country is said to have absolute advantage if it can produce a good at lower cost than the other country.
Comparative advantage compares the production of two goods within the same country. A country has a “comparative advantage” in goods it produces at low cost relative to other goods it produces.

7. 1. Comparative advantage (cont.)
Example
Bolivia is a high-cost producer
Argentina has an absolute advantage in everything
What can Bolivia export?
Argentina
Bolivia
Cost in days of Labor
Potatoes 10
Beef 15 30
Soap 12 18
Beer 22 66
Shirts 45
Radios 25 75
This table gives the cost of producing different products in Argentina and Bolivia, expressed in days of labor. Note that there are no products that Bolivia produces more cheaply than Argentina.

8. 1. Comparative advantage (cont.)
Example (continued)
Argentina will export beer and radios (goods for which it has the largest cost advantage)
Bolivia will export potatoes and soap (goods which it produces least inefficiently)
Argentina
Bolivia
Ratio
Cost in days of Labor
Potatoes 10
1.0
Beef 15 30
2.0
Soap 12 18
1.5
Beer 22 66
3.0
Shirts 45
2.5
Radios 25 75
Because it can produce everything at lower cost than Bolivia, Argentina will export the products which have the biggest cost advantage over Bolivia, i.e. beer and radios.
Although Bolivia does not have an absolute advantage in any good, it can still gain through exports to Argentina. The two goods that Bolivia produces at the least cost (comparative advantage) are potatoes and soap.

9. 2. Increased competition
Without trade, some companies dominate their industry, so they can act as monopolists and charge higher prices
With trade, companies have to compete with imports and offer prices close to costs
Usually does not apply to crop production because many small farmers keep prices competitive
May apply to agricultural inputs (seeds, fertilizer, chemicals, etc) and agricultural machinery
Often applies to manufacturing, particularly in countries with a small market
Competition keeps prices down. In a competitive market, consumers choose between competing producers for the lowest-cost product, and reject producers who charge higher prices. In some markets, particularly in developing countries, there may be very few domestic producers. If the borders are closed to competition from producers in other countries (i.e. imports), then domestic producers can charge higher, monopolistic prices, which hurts consumers.

10. 3. Economies of scale
Many goods have “economies of scale” in production
Definition: Economies of scale : the per-unit cost declines as the volume of production increases
Common among manufactured goods (e.g. cars)
But less common among agricultural commodities
If the domestic market is small and there is no trade, the costs of production will be high
In this case, trade allows a larger market, higher production, and lower costs

11. 3. Economies of scale - example
Without trade, Paraguay produces P1 radios,
Bolivia produces B1 radios. Costs are high.
With trade, Paraguay produces P2 radios for both countries at lower cost. Bolivia stops producing radios, importing instead B2 P2 P1 B1
Cost per unit
Radios
Cost of producing radios declines (red arrow)

12. 3. Economies of scale - example
At the same time, Bolivia increases production of another good (say soap) while Paraguay stops producing soap and imports.
The cost of soap also goes down (red arrow). P2 B2 B1 P1
Cost per unit
Radios
Note that this is not the same as comparative advantage because both countries have the same cost of production.

13. 4. Dynamic gains from trade
Static gains mean that trade gives a one-time increase in income (GDP)
Dynamic gains means that trade increases the rate of growth in income (GDP)
Why does trade create dynamic gains?
Competition spurs innovation and investment
Trade introduces new technology and inputs
Open trade policy increases investment, particularly foreign investment
Open trade policy is a signal of a good investment climate
Allows foreign companies to invest while catering to home consumers

14. 4. Dynamic gains from trade - examples
North Korea vs South Korea
North Korea has followed extreme self-sufficiency policy but economic growth is stagnant
South Korea has followed more open trade policy and has been one of the Asian Tigers, with rapid growth
Studies of determinants of economic growth show:
Landlocked countries have less trade and slower growth than countries with coast
Countries with open trade policies have higher growth rates on average

15. Three common trade myths
“When two countries trade, one country wins and the other loses.”
“Some countries are so inefficient, they don’t have a comparative advantage in anything”
“The country should promote exports and reduce imports”

16. Myth #1: “When two countries trade, one country wins and the other loses”
Trade is not a zero-sum game
Both countries generally benefit from trade, though the benefits may not be equal, and there are winners and losers in each country
Example: If Uganda exports maize to Kenya, both countries gain overall, but:
Some Ugandan maize producers and Kenyan maize consumers gain
Some Ugandan maize consumers and some Kenyan maize producers lose
What do we mean by “winners” and “losers”? Winners are individuals or groups that benefit from trade, and losers are those who are negatively impacted.
In the example, some Ugandan maize producers are said to be “winners” because exports to Kenya raise the domestic price of maize, giving them more revenue for the sale of their surplus maize. Likewise, Ugandan consumers might be “losers” because, with maize exports, the Uganda price is higher than it would be without trade (see Module 4.2: Import and Export Parity Pricing for more).

17. Myth #2: “Some countries are so inefficient, they don’t have a comparative advantage in anything”
Some countries may not have an absolute advantage in anything
Like Bolivia the example earlier
Every country has a comparative advantage in something
Although it may be difficult to predict ahead of time

18. Myth #3: “The country should promote exports and reduce imports”
Mercantilist philosophy (1500s): Maximize exports and minimize imports
This is a flawed philosophy
The only reason to export is to be able to pay for imports, either now or later
Exports help the economy via job creation
Imports help the economy by lowering cost and increasing variety of inputs for producers and goods for consumers

19. Measuring the static gains from trade
Three scenarios
Exports vs. Autarky
Imports vs. Autarky
Removing import barriers
Autarky (definition): Self-sufficiency, or a situation in which there is not international trade

20. Gains from trade: Exports vs. Autarky
Trade vs. Autarky in Exports
Price
Demand
Supply
Quantity
World
Autarky
Export price is higher than autarky price
Producer benefit from the higher price = blue + green
Consumer loss from higher price = blue
Net gain = green

21. Gains from trade: Imports vs. Autarky
Trade vs. Autarky for Imports
Price
Demand
Supply
Quantity
Import
Autarky
Import price is lower than autarky price
Consumer benefit from lower price = blue + green
Producer loss from lower price = blue
Net gain = green

22. Gains from trade: Removing Import Barriers
Static gains from reducing import barriers
Domestic price with tariff is higher than price without tariff
Removing import barrier reduces price
Consumer benefit from lower price = blue + green
Producer loss from lower price = blue
Net gain = green
Price
Demand
Supply
Quantity
Price w/o
Tariff
Price w/
tariff

23. Measuring static gains from trade
Information needed to calculate static benefits of eliminating an import tariff (green area)
Current level of imports with tariff (Mt)
Current price with tariff (Pt)
What price would be with no tariff (Pn)
What imports would be with no tariff (Mn)
Net benefit = green area =
0.5 x (Mt + Mn) x (Pt – Pn) Pt Pn Mn
Price
Quantity Mt

24. Example: Measuring Static Gains from Trade
Wheat import tariffs in Kenya
Net benefit = Area = 0.5 x (Mt + Mn) x (Pt – Pn)
= 0.5 x ( ) x (430 – 270)
= 725 thousand tons x $160/ton = $116 Million
$430
$270
845 thousand tons
293
360
960
1138
Price
Quantity
In this example, the elimination of the import tariff reduces the price from $430 to $270 and the quantity imported increases from 600,000 Tons to 845,000 Tons.

25. How big are gains from trade?
Static gains from trade
Most studies of trade liberalization show gains of 1 – 6% of GDP, depending on how restrictive trade policy was before liberalization.
Dynamic gains from trade
Harder to measure, but generally much larger
Wacziarg and Welch (2008)
Econometric study of dozens of countries from 1950 – 1998
Trade liberalization increased trade/GDP ratio 5 – 10 pct points
Trade liberalization increases GDP growth rate 1.5 to 2 pct points
Over 10 years, this represents a GDP that is 22% higher

26. Why do governments impose trade restrictions?
Political influence of producers
Producers are usually larger, better informed and better organized than consumers
Infant industry argument
Problem of infants who never grow up
Concern about impact on poverty
If producers are poorer than consumers
Dependence on tariff revenue
Cost of transition
Organized producer groups lobby their governments to impose trade restrictions because producers gain from import restrictions. They want closed borders because imports create competition and drive prices down.
The infant industry argument says that a new industry should be protected from competition from foreign nations until they can attain economies of scale. The danger however, is that the industry will never become competitive relative to “mature” industries from other nations, and if the import restrictions remain in place indefinitely, the restrictions hurt consumers who can not benefit from lower priced imported goods.

27. Why do governments impose trade restrictions?
In most cases, political influence of producers:
Source: Reuters:

28. Ameliorating negative effects of trade
Who is hurt by removing trade barriers
Removing export restrictions raises domestic price, benefiting producers but hurting consumers
Removing import restrictions lowers domestic price, benefiting consumers but hurting producers
Compensation - Some governments try to compensate or assist those hurt by removing trade barriers
Tax relief
Retraining
Assistance to regions hard-hit by trade reform
Safety-net programs (for poor in general)

29. Exercises – How to use
Open Excel Workbook “Module 4.4 gains_from_trade”
Yellow areas can be changed by user
Green areas give results and should not be changed by user
Graph shows results
Solid lines are “before” change
Dashed lines are “after” change
Two worksheets
First represents an imported good
Second represents an exported good

30. Exercise 1 – Higher world prices & imports
Open worksheet “Ex1 – Import gains”
Simulate 10% increase in import price by inserting “10” in yellow cell next to “Pct increase in import price” (D16)
What happens to production? Consumption? Imports?
Why does the higher price cause these three effects?
What is the impact on consumer welfare?
What is the impact on producer welfare?
What is the net impact on producers and consumers?
Return import price to original value (10  0)
Production increases 5%
Consumption declines by 5%
Imports decline 31%
Impact on consumers is US$ 18 million loss
Impact on producers is US$ 14 million gain
Net impact is US$ 4 million loss

31. Exercise 2 – Import tariffs
Simulate a 10% import tariff by inserting “10” in yellow cell next to “New import tariff” (D19)
What happens to production? Consumption? Imports?
What is the net impact on producers and consumers?
What is the tariff revenue generated by the tariff?
How is this result different than a 10% increase in import price?
Return tariff to original value (10  0)
Production increases 5%
Consumption declines by 5%
Imports decline 31%
Net impact is US$ 4 million loss
Tariff revenue is US$ 3.46 million
Only difference is tariff revenue

32. Exercise 3 - Self-sufficiency via tariffs
Increase the tariff rate (D19) in intervals until you reach self-sufficiency (no imports)
How high does the tariff have to be in order to achieve self-sufficiency?
After reaching self-sufficiency, what is the net effect on producers and consumers?
After reaching self-sufficiency, what is the tariff revenue? Why?
Write down the tariff revenue for tariff rates of 10%, 15%, 20%, 30%, and 40%.
Why does the tariff revenue rise and then fall as tariff rate increases?
A 37% tariff will achieve self-sufficiency
A loss of US$ 63 million for consumers, gain of US$ 54 million for producers
Tariff revenue is zero because there are no imports to tax
Revenue rises as tariff rate increases, but eventually declining imports causes revenue to decline

33. Exercise 4 – Self-sufficiency via productivity
Increase productivity (D18) in intervals until you reach self-sufficiency (no imports)
How high much does productivity have to increase to achieve self-sufficiency?
What is the effect of productivity growth on prices?
Why is this?
[Note that in this spreadsheet, the welfare impact measures do not work for changes in productivity]
About 36% increase in productivity to reach self-sufficiency
No effect on price
Because it is a tradable good, so price determined by world markets & trade policy

34. Exercise 5 – Export taxes
Open worksheet “Ex2 – Export Gains”
Increase the new export tax (D19) at 5% intervals
What export tax yields the highest tax revenue?
What is the effect of that tax on producers, consumers and net effect?
What export tax would result in stopping exports completely?
Export tax of about 31% maximizes tax revenue
Consumers gain US$ 27 million from lower prices
Producers lose US$ 57 million from lower prices
Net effect on producers and consumers is a US$ 30 million loss

35. Exercise 6 – Productivity and exports
Increase productivity (D18) by 35%
What is the effect on domestic prices?
Why?
What is the effect on consumption?
What is the effect on exports?
Productivity increase has no effect on domestic price
Because it is a tradable good, so price set by international markets
Productivity increase has no effect on consumption
Because consumers face same prices as before
Exports increase 57%

36. Conclusions Every country can benefit from trade through
Comparative advantage
Increased competition
Economies of scale
Dynamic gains from trade
Trade creates a net benefit over autarky
Consumers win if imports reduce the price of goods
Producers win if exports increase the price of their produce

37. Conclusions However, not everyone gains from trade
Producers of import-competing goods lose from trade
Consumers of exportable goods lose from trade
Gains and losses can be estimated
Requires information on production, consumption, trade, prices, and price elasticities
Potential negative effects of trade can be moderated by
Training programs for displaced workers
Safety net programs that help poor households
Regional development programs that assist regions adversely affected.