Trade Policy

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Chapter 18

• Trade Policy

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Trade Policy Tools

• Open economy macro
• Viewing macro analysis from a global rather than
  national perspective
• There are many governments, but they can not
  impose their rules beyond their borders
• However, other nations can respond to one
  nations policies

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Trade Policy Tools

• Nations have several tools they can use in order
  to influence their position in global trade
• We will examine them and also look at the
  problems with using these tools

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Trade Policy Tools

• A nation can out-compete its rivals by lowering
  its cost of production and offering a better
  price on goods
• This can be done by increasing efficiency and/or
  lowering factor costs
• Under the nice assumptions, this advantage would
  not be maintained, as others enter and profits
  get driven to zero

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Trade Policy Tools

• In the global economy, as in the domestic one,
  advantages can be sustained if competitors play
  by a different set of rules

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Trade Policy Tools

• Nations can create market power for themselves by
  shaping policies regarding production standards
• Ex. Have no child labor laws, no limits on work
  hours, no safety rules, and no environmental
  rules
• This gives a real advantage to those nations
  compared to nations which place those
  restrictions on themselves

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Competitive Edge on Consumer Satisfaction

• A nation could become more competitive in the
  global economy by
• Making products suitable with tastes of the time
• (ex. Volkswagen 1960s)
• Developing a reputation for quality and
  dependability
• (ex. Toyota, Honda - 1970s and 80s)

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Competitive Edge on Consumer Satisfaction

• An imbalance in trade can not be sustained
  without an offsetting capital flow
• Increased Japanese car imports were a result of
  the U.S. high budget deficits causing higher
  interest rates, and a stronger dollar
• Each Japanese car was on sale because of
  exchange rate changes

9
Red Tape and Regulations

• Nations can make it difficult to have others sell
  in their country through red tape
• Red tape is bureaucratic hassles for importers
• U.S. claimed Japan was a master at this
• Some see these same rules as a reasonable
  regulation
• Ex. Biologically engineered food

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Red Tape and Regulations

• Public respond to the impact of regulations
• People who lose jobs and market share to other
  nations often call for their politicians to have
  a response
• These responses can be subtle, or more in your
  face

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Exchange Rate Manipulation

• A nation can weaken its own currency. This
  encourages more exports and less imports and can
  be done in two ways.

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Exchange Rate Manipulation

• A nation can weaken its own currency. This
  encourages more exports and less imports and can
  be done in two ways.

• First,
• governments can buy and sell currencies on the
  open market
• Many governments not only have access to their
  own currencies, but also have stocks of other
  currencies as well
• To weaken our dollar, the U.S. could buy yen on
  the open market and supply more dollars, shifting
  supply of dollars out

• Second,
• Monetary policy choices can weaken a currency
• A lower domestic interest rate means capital
  flows out, weakening the dollar

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Exchange Rate Manipulation

• Manipulating exchange rates carries risk
• Weaker currencies and lower rates may provide
  stimulus
• As foreign competitors goods become more
  expensive, it might be easier for domestic
  producers to raise prices
• Stimulus plus protection may cause inflation

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Quotas

• Quotas
• More direct response to a trade problem
• Set limit on number of units to be imported
• Ex. Only so many cars allowed to be sold
• Can invite retaliation as other restrict their
  market to your goods

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Tariffs

• Tariffs
• Taxes on imports
• Most direct, in your face response
• Can stop all imports with high enough tariffs
• Almost invariably invites retaliation
• Tariff wars can result
• Some economists argue that the Great Depression
  was so severe because of high tariffs that
  nations imposed
• In the U.S., this was called the Smoot-Hawley
  tariff

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Trade policy Historical Background

• Global economy emerges in the 1400s and 1500s
  with the rise of nation states
• Dutch do extremely well with little homeland to
  develop
• Their wealth was based on success at trade
• Many thinkers thought success at trade would
  determine a nations wealth

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Trade policy Historical Background

• The dominant view
• at this time was trade was a zero sum game-more
  for me means less of the pie for you
• With winners and losers, nations tried to figure
  out how to be the winner
• Mercantilism 1700s and 1800s
• Restrict imports, have strong navies to control
  trade, get colonies for raw materials
• Nations tried to sustain these advantages

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Trade policy Historical Background

• 1776 Adam Smith writes Wealth of Nations
• Smith imagines a liberal society where
  opportunities are not skewed by power,
• competition exists and justice prevails
• He sees a positive sum game where constructive
  competition is good for individuals and nations
• Debunks mercantilism

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Promise of a Liberal System

• Promise of free and open global economy Pareto
  optimality
• Problems justice of the distribution of initial
  endowments and distortions of market power and
  market failure
• Instead of one government, there are many
• Interventionist hope for good government
  intervention and
• Non-interventionist hope for no intrusion
• Seem more remote

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Power and Response

• Mercantilist thinking still abounds
• Protectionism is very popular politically because
  job losses to imports do hurt people
• Trade wars have no winners, however
• Keynes wrote prior to to WWII that if nations
  could just provide full employment through their
  domestic policies, there was no need to interfere
  with free international markets

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Powerlessness and Response

• Developing nations face challenges in a global
  economy
• Little financial capital
• Some compete with cheap labor costs, but with
  what many consider to be violations of human
  rights

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Powerlessness and Response

• Financial capital is really important to compete
• With so little capital at home, these countries
  must attract capital from the outside
• Capital is mobile and fickle
• The International Monetary Fund (IMF) is the
  lender of last resort to make sure panics dont
  occursee http//www.imf.org/

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Conclusion on International Economic Policy

• Some institutions have been established to set
  global rules for international trade
• Early effort Global Agreement on Tariffs and
  Trade (GATT)
• Tried to encourage free and open global markets
• Replaced by the WTO World Trade
  Organizationsee http//www.wto.org/

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Conclusion on International Economic Policy

• Some regional agreements have been made
• NAFTA North American Free Trade Agreement
• U.S., Canada, Mexico functioning as a free trade
  zone
• Europes use of the common currency of the Euro
  makes it a United States of Europe from a trade
  perspective
• Monetary policy is now in the hands of the
  European Central Bank

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Conclusion on International Economic Policy

• Both NAFTA and the WTO
• Suffer from the fact that the participants are
  sovereign nations which
• Can interpret differently and even ignore certain
  provisions with regard to
• Workers right and environmental protections

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Conclusion on International Economic Policy

• Anyone who says its simple is either simple
  minded, or thinks you are