1. 1 Global Economics Eco 6367 Dr. Vera Adamchik Nontariff Trade Barriers

2. 2 A nontariff barrier (NTB) to imports is any policy used by the government to reduce imports, other than a simple tariff on imports. Economists have noted that as tariffs have been reduced through multilateral tariff negotiations during the past 40 years, the impact of this reduction may have been importantly offset by the proliferation of NTBs.

3. 3 An NTB reduces imports by operating through one or more of the following channels: –limiting the quantity of imports; –increasing the costs of getting imports into the market; –creating uncertainty about the conditions under which imports will be permitted.

4. 4 NTB can take many forms (see the “Major Types of NTBs” slide). Although antidumping duties and countervailing duties are not listed in the table, they are also often considered NTBs. Governments claim that they impose these kinds of duties in response to unfair practices by foreign exporters.

5. 5 Major types of NTBs

6. 6 IMPORT QUOTA

7. 7 An import quota The best-known nontariff barrier is the import quota, a limit on the total quantity of imports of a product allowed into the country during a period of time (usually, a year). The government gives out a limited number of licenses to import the quota legally and prohibits importing without a license.

8. 8 Global quota – limit on the total number of units of a good from all other countries. Selective quota – limit on the number of units of a good from a specific country or countries.

9. 9 Welfare Effects of an Import Quota, Small Country. Illustration 1

10. 10 Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium without trade World price free trade Q S Q D Welfare under free trade

11. 11 Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium without trade World price free trade Q S Q D Producer surplus under free trade Welfare under free trade Consumer surplus under free trade

12. 12 Welfare effects of an import quota Price of Steel 0 Quantity of Steel Domestic supply Domestic supply + Import supply Domestic demand Price with quota Imports free trade Equilibrium with quota Equilibrium without trade Quota Imports with quota Q D World price free trade Q S Q D Q S

13. 13 c a b d Price of Steel 0 Quantity of Steel Domestic supply Domestic supply + Import supply Domestic demand Price with quota Imports free trade Equilibrium with quota Equilibrium without trade Quota Imports with quota Q D World price free trade Q S Q D Q S Consumer surplus with quota Producer surplus with quota Quota rent Welfare effects of an import quota

14. 14 Welfare Effects of an Import Quota, Small Country. Illustration 2 An example from the textbook

15. 15 With Free Trade: U.S. consumer surplus U.S. producer surplus Import quota welfare effects An example from the textbook

16. 16 Import quota welfare effects With Import Quota U.S. consumer surplus U.S. producer surplus An example from the textbook

17. 17 With Import Quota: a = redistributive effect b + d = deadweight loss b = protective effect d = consumption effect c = revenue effect “windfall profit” “quota rent” Import quota welfare effects An example from the textbook

18. 18 Welfare Effects of an Import Quota, Small Country. Illustration 3 (Handout)

19. 19 The U.S. market for bicycles with a quota

20. 20 Conclusions (compared to free trade) For a competitive market, the effects of a quota on price, quantities and well-being are the same as those of an equivalent tariff, with one possible exception. The “possible exception” is area c. With a tariff, area c is government tariff revenue. With a quota, what is it? Who gets it?

21. 21 Ways to allocate import licenses The quota license to import is a license to buy the product from foreign suppliers at the world price and resell these units at the domestic price. The quota results in a price markup (or economic rent). For all units imported with the quota, the markup totals to rectangular area c. Who gets this price markup? That depends on how the licenses to import the quota quantity are distributed.

22. 22 The main ways to allocate import licenses 1.The government allocates the licenses for free to importers using a rule or process that involves (almost) no resource costs. 2.The government auctions off the licenses to the highest bidders. 3.The government allocates the licenses to importers through application and selection procedures that require the use of substantial resources.

23. 23 Fixed favoritism Import licenses can be allocated for free on the basis of fixed favoritism, in which the government simply assigns the licenses to firms (and/or individuals) without competition, application, or negotiation. In this case the importers lucky enough to receive the import licenses will get area c.

24. 24 Auction The government can run an import license auction, selling import licenses on a competitive basis to the highest bidders. How much would some individuals be willing to pay in a competitive auction? – An amount very close to the price difference. If the winning bids are very close to the price difference, the government gets almost all of area c.

25. 25 Public auctions of import licenses are rare. They were used in Australia, New Zealand, and Colombia in the 1980s. There is informal variant of a quota auction, when corrupt government officials sell import licenses “under the table” to whoever pays them the highest bribes.

26. 26 Resource-using procedures The government can insist that firms (and/or individuals) that want to acquire licenses must compete for them in some way other than simple bidding or bribing. Resource-using application procedures include allocating quota on a first-come, first-served basis; on the basis of demonstrating need or worthiness; or on the basis of negotiations.

27. 27 First-come… -- Resource wastage because those seeking licenses use resources to try to get to and stay at the front of the line. Worthiness… -- awarding quota licenses for materials and components based on how much production capacity firms have for producing the products that use these inputs. Resource wastage because it causes firms to overinvesting in production capacity. Negotiations… -- Resource wastage is the time and money spent on lobbying with government officials to press each firm’s case.

28. 28 Resource-using procedures encourage rent- seeking activities, and some or all of area c is turned into a loss to society by wasting productive resources. Hence, compared to an equivalent tariff, the quota can potentially cause an even larger deadweight loss, if a political mechanism such as lobbying is employed to allocate the import licenses. In this case quota is worse than the equivalent tariff in its effects on net national well-being.

29. 29 There is a fourth way that the quota licenses might be distributed. The importing country government can allocate the licenses to the exporting firms (or to others in the exporting country). In this case, the exporters will be able to raise their export price and capture area c. Hence, this case is essentially identical to the VER.

30. 30 More on the distribution of the quota’s revenue (area c)… The distribution of the quota’s revenue may also be determined by the degree of market power that domestic importers and foreign exporters possess. Cases A and B below consider the two possible outcomes. For simplicity let’s assume that import licenses are allocated to the importing companies for free.

31. 31 Case A The exporting companies operate as competitive sellers and sell the product at the prevailing world price ($300 in our example). The importing companies organize and become a monopoly buyer. They buy the product at the prevailing world price ($300) and resell it to domestic consumers at the domestic market price ($330). The quota’s revenue effect accrues to the importing companies.

32. 32 Case B The exporting companies organize and become a monopoly seller. The importing companies operate as competitive buyers. They will bid against each other to buy the product and drive the world market price up (from $300 to $330). The quota’s revenue effect accrues to the exporting companies.

33. 33 Quota vs tariff There are several reasons why protectionists and government officials may favor using quota instead of a tariff: 1. A quota ensures that the quantity of imports is strictly limited; a tariff would allow import quantity to increase if foreign producers cut their prices or if our domestic demand increases.

34. 34 Quota vs tariff 2. A quota gives government officials greater power. As discussed above, these officials often have administrative authority over who gets the import licenses under a quota system, and they can use this power to their advantage (for instance, by taking bribes).

35. 35 Quota versus tariff initially similar - however if demand increases o tariff leads to more imports at the same price o quota leads to a higher price with the same level of imports Thus an import quota can be more restrictive. imports

36. 36 TARIFF-RATE QUOTA

37. 37 A tariff-rate quota allows imports to enter the country at a zero or low tariff (the within-quota rate) up to a specified quantity ( a quota), and imposes a higher tariff (the over-quota rate) on imports above this quantity. Hence, a tariff-rate quota is a two-tier tariff. Licenses are required to import at the within-quota tariff. Common techniques to allocate import licenses are: license on demand; first-come, first-served; historical market share; and auctions.

38. 38 EXPORT QUOTAS a.k.a. VOLUNTARY EXPORT RESTRAINTS (VERs) a.k.a. ORDERLY MARKETING AGREEMENTS

39. 39 An export quota is a restriction imposed on own exporters, either voluntarily or on the behest of other countries. This limit is self- imposed by the exporting country.

40. 40 Reasons for its imposition may include: 1.protection of local industry from shortages of raw materials, 2.protection of local population from shortages of foodstuffs or other essential goods, 3.maintenance of international commodity prices (an orderly marketing agreement), 4.export restraint agreement with the members of a producer’s cartel (such as OPEC), or 5.export restraint agreements with consumer countries (a voluntary export restraint).

41. 41 VERs A voluntary export restraint (VER) is an odd-looking trade barrier in which the importing country government coerces the foreign exporting country to agree “voluntarily” to restrict its exports to this country.

42. 42 The VER originates primarily from political considerations. An importing country that has been preaching the virtues of free trade may not want to impose an outright import quota because that implies a legislated move away from free trade. Instead, the country may choose to negotiate an administrative agreement with a foreign supplier whereby that supplier agrees “voluntarily” to refrain from sending some exports to the importing country.

43. 43 VERs were used by large countries as a rear-guard action to protect their industries that are having trouble competing against a rising tide of imports. This form of protection became important in the 1990s, especially in the U.S., EU, Canada where the VER was a major form of import restrictions for textiles, clothing, agricultural products, steel, footwear, electronics, and machine tools.

44. 44 An export quota vs an import quota The graphical analysis of an export quota is very similar to that of an import quota. The two key differences between an export quota and an import quota are the effect on the export price and who gets area c.

45. 45 Under a negotiated VER agreement, the exporting country government usually distributes licenses to export specified quantities to its producers. The main foreign exporters form a cartel among themselves, agreeing to cut export quantities and to divide up the market. In return, they are allowed to charge the full markup on their limited sales to the importing country, where the product has become more expensive.

46. 46 Who gets area c? The foreign exporters get area c as additional revenue on the quota-limited quantity of exports.

47. 47 Welfare Effects of an Export Quota, Small Country. Illustration 1

48. 48 Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium without trade World price free trade Q S Q D Welfare under free trade

49. 49 Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium without trade World price free trade Q S Q D Producer surplus under free trade Welfare under free trade Consumer surplus under free trade

50. 50 Welfare effects of an export quota Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium with quota Equilibrium without trade Quota Imports with quota World price free trade Q S Q D Q S Domestic supply + Import supply World price with quota Q D

51. 51 b c d Domestic supply + Import supply a Welfare effects of an export quota Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports free trade Equilibrium with quota Equilibrium without trade Quota Imports with quota World price free trade Q S Q D Q S World price with quota Q D Consumer surplus with quota Producer surplus with quota Quota rent

52. 52 Welfare Effects of an Export Quota, Small Country. Illustration 2

53. 53 With Free Trade: U.S. consumer surplus U.S. producer surplus Export quota welfare effects World price free trade

54. 54 Export quota welfare effects With Export Quota U.S. consumer surplus U.S. producer surplus World price with quota World price free trade

55. 55 With Export Quota: a = redistributive effect b + d = deadweight loss b = protective effect d = consumption effect c = revenue effect “mark-up” “quota rent” Export quota welfare effects World price with quota World price free trade

56. 56 Welfare Effects of an Export Quota, Small Country. Illustration 3 (Handout)

57. 57 The U.S. market for bicycles with an export quota World price with quota free trade

58. 58 Why do exporters agree to VER? The inducement for the exporter to “voluntarily agree” may be the threat of imposition of an import quota if the VER is not adopted by the exporter. If the VER is replaced with an import quota, foreign exporters will lose their markup revenue (area c).

59. 59 The VER may be a politically attractive way of offering protection to an import- competing industry, but it is also economically expensive for the importing country.

60. 60 DOMESTIC CONTENT REQUIREMENTS

61. 61 A domestic content requirement mandates that a product produced and sold in a country must have a specified minimum amount of domestic value, in the form of wages paid to local workers or materials and components produced within the country. For example, under the NAFTA, members do not permit duty-free entry of automobiles from other members unless 62.5% of the value of the automobile originates in the NAFTA countries.

62. 62 Domestic content requirements can create import protection at two levels: (1) They can be a barrier to imports of the products that do not meet the content rules; (2) They can limit the import of materials and components that otherwise would have been used in domestic production of the products.

63. 63 A closely related NTB, sometimes called a mixing requirement, stipulates that an importer or import distributor must buy a certain percentage of the product locally. For instance, the government may require that certain retail stores in the country must source at least a specified percentage of their inventory in the country.

64. 64 GOVERNMENT PROCUREMENT

65. 65 Governments are major purchasers of goods and services (about 1/10 of all product sales in the industrialized countries). Government procurement practices can be a nontariff barrier to imports if the purchasing processes are biased against foreign products, as they often are. In the U.S., the Buy American Act of 1933 is the basic law that mandates that government-funded purchases favor domestic products.

66. 66 For different types of purchases the bias takes different forms, including: –prohibitions on buying imports; –local content requirements; –mandating that domestic products be purchased unless imported products are priced much lower (6-12-up to 50% above the foreign supplier’s price). More than half of the states and many cities and towns also have “buy American” or “buy local” rules for purchases by their governments.

67. 67 A WTO-sponsored agreement on government procurement went into effect on January 1,1996, but not all purchases or all WTO members are included. In addition, government procurement provisions are increasingly being expanded to include nonprice considerations (for example, “eco-safe”, “eco-audit”, etc.).

68. 68 TECHNICAL AND PRODUCT STANDARDS

69. 69 Product standards – laws and regulations pertaining to protect quality, including those enforced in the names of health, sanitation, safety, and the environment. These standards need not discriminate against imports. But, if a government is determined to protect local producers, it can always write rules that can be met more easily by local products than by imported products.

70. 70 Product standards usually do not raise tariff or tax revenues for the importing country’s government. On the contrary, enforcing these rules uses up government resources (and businesses must use resources to meet the standards.) The standards can bring a net gain in overall well-being to the extent that they truly protect health, safety, and the environment. Yet it is easy for government to disguise costly protectionism in virtuous clothing.

71. 71 Product standards, domestic content and mixing requirements do not generate tariff or tax revenue for the government. The gains on the price markups are captured by the protected home-country sellers of the protected products.

72. 72 OTHER CUSTOMS PROCEDURES

73. 73 Arbitrary administrative classification decisions can influence the size of imports. Because tariffs on goods coming into a country differ by type of good, the actual tax charged can vary according to the category into which a good is classified There is some leeway for customs officials, as the following example makes clear:

74. 74 In-class exercise Read the handout on “Carrots Are Fruit, Snails Are Fish, and X-Men Are Not Humans.”

75. 75 ADVANCE DEPOSIT REQUIREMENTS

76. 76 Advance deposit requirements are sometimes used by developing countries. In this situation, a license to import is awarded only if the importing firm deposits funds with the government equal to a specified percentage of the value of the future import. The deposit is refunded when the imports are brought into the country, but in the meantime the firm has lost the opportunity cost of the funds.

77. 77 OTHER NTBs

78. 78 As mentioned above, countervailing duties and antidumping duties are not NTB per se, but they are often considered NTBs. A countervailing duty is a tariff to offset the price or cost advantage created by the subsidy to foreign exporters. An antidumping duty is a tariff equal to the discrepancy (the dumping margin) between the actual export price and the fair value.

79. 79 SUBSIDIES

80. 80 Government funding to domestic producers allows producers to sell goods for a lesser price. It includes tax concession, low interest loans, insurance arrangement and cash disbursements. Domestic production subsidy – granted to producers of import competing goods. Export subsidy – granted to producers of goods that are to be sold in other countries.

81. 81 DOMESTIC PRODUCTION SUBSIDY (a subsidy to an import-competing industry)

82. 82 A subsidy to an import-competing industry If the intent of a tariff, quota, or VER is to provide an incentive to increase domestic production and sales in the domestic market, then an equivalent domestic production result could be achieved by paying a sufficient per-unit subsidy to domestic producers, who are thereby induced to supply the same quantity at international prices that they were willing to provide at the higher tariff inclusive domestic price.

83. 83 Welfare Effects of the Domestic Production Subsidy, Small Country. Illustration 1 An example from the textbook

84. 84 Domestic Production-Welfare Effect An example from the textbook Free Trade - No Subsidy assuming the domestic market is relatively small in relation to the world free trade will lower price consumer surplus substantial because of the lower price caused by free trade producer surplus is a small area for the same reason

85. 85 Domestic Production Subsidy-Welfare An example from the textbook Domestic Production Subsidy increases domestic supply but price does not change producer surplus increases due to greater sales this increase was partially redistributed consumer surplus and partially protective effect/deadweight loss result: subsidies do not decrease welfare as much as tariffs or quotas

86. 86 Welfare Effects of the Domestic Production Subsidy, Small Country. Illustration 2 (Handout)

87. 87 Conclusions The domestic market price remains equal to the international price. Hence, consumers are not worse off. There is, however, a production-efficiency loss. The increased domestic production at a resource cost exceeds international price on the margin. It can be viewed as the cost of moving from a lower-cost foreign supply to a higher cost domestic supply on the margin.

88. 88 Conclusions Consumers surplus: No change. Producers gain surplus equal to area a. The cost to the government of paying the domestic production subsidy is area a+b. The net welfare effect in the country is the loss of area b.

89. 89 EXPORT SUBSIDY

90. 90 Rather than granting a production subsidy to import-competing producers, a government could pay a subsidy on exports only.

91. 91 Export Subsidy – Welfare Effects An example from the textbook Free Trade - No Subsidy assuming the domestic market is relatively small in relation to the world, free trade will raise the price in this case consumer surplus is relatively limited because of higher price associated with free trade producer surplus is a large area for the same reason

92. 92 Export Subsidy – Welfare Effects An example from the textbook With Export Subsidy export subsidy raised the price consumer surplus is decreased further because of higher price producer surplus increases for same reason cost to taxpayers

93. 93 Conclusions Producers gain surplus equal to area a+b+c. Consumers lose surplus equal to area a+b. The cost to the government of paying the export subsidy is area b+c+d. The net welfare effect in the exporting country is the loss of areas b and d.

94. 94 Conclusions An export subsidy expands exports and production of the subsidized product. In fact, the export subsidy can switch the product from being imported to being exported. An export subsidy lowers the price paid by foreign buyers, relative to the price that local consumers pay for the product.

95. Export subsidy, Small country vs Large country When the exporting country is a small country, the export subsidy does not affect the world price. When the exporting-country is a large country the export subsidy will lower the world price. When government offers the export subsidy, exporting firms want to export more to get more of the subsidy. To get foreign consumers to buy more of the exported product, the exporting firms must lower the export price. (Read the last paragraph on p. 162 in the textbook.) 95

96. 96 DUMPING

97. Dumping is selling exports at a price that is too low – less than normal value (or “fair market value,” as it is often called in the US). There are two legal definitions of normal value:

98. (1) the long-standing definition of normal value is the price charged to comparable domestic buyers in the home market (or to comparable buyers in other markets). Under this traditional definition, dumping is international price discrimination favoring buyers of exports;

99. (2) the second definition of normal value arose in the 1970s. It is cots-based – the average cost of producing the product, including overhead costs and profit. Under this second standard, dumping is selling exports at a price that is less than the full average cost of the product.

100. Please keep in mind that in trade disputes over dumping, the government compares the price that a foreign firm earns in the country’s market, NET OF TRANSPORTATION COSTS, to the price that the foreign firm earns in its domestic market.

101. 101 In-class exercise Exercise # 1 (handout).

102. 102 Forms of dumping Sporadic dumping (distress dumping) - firm disposes of excess inventory on foreign markets Predatory damping - temporary reduction in price designed to force foreign competitors out of business to gain monopoly power Persistent dumping - indefinite reduction in foreign price in order to maximize profits

103. 103 Maximizing Profits - One Price An example from the textbook the firm maximizes profits by producing at a quantity where MC = MR charging price of $500 in each market

104. 104 Price Discrimination to Maximize Profits An example from the textbook production where MC = MR in each market result is a higher price where demand is inelastic and a lower price where demand is elastic

105. 105 Fair value: Recent debates Many economists argue that Average Variable Cost (and not Average Total Cost) should be the yardstick for defining dumping.

106. 106 Governments often impose stiff penalties against foreign commodities that are believed to be subsidized or dumped in the home country [see pp. 200-205 in Chapter 6].