International Trade and Public Policy

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International Tradeand Public Policy
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Benefits from Specialization and Trade

• If a nation produced everything it consumed, it
  would not depend on any other nation for its
  livelihood.
• Although self-sufficiency sounds appealing,
  countries are better off if they specialize in
  the production of some products and trade some of
  them to other countries.
• Specialization and trade are concepts based on
  the principle of opportunity cost.

PRINCIPLE of Opportunity CostThe opportunity
cost of something is what you sacrifice to get it.
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Benefits from Specialization and Trade

• The production possibilities frontier (PPF or
  PPC) shows the possible combinations of two goods
  that can be produced by an economy, assuming that
  all resources are fully employed.

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Production Possibilities Curve (PPC)
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Production Possibilities Curve (PPC)

• Each nation could decide to be self-sufficient,
  picking a point on the production possibilities
  curve and producing everything it wants to
  consume. This is the case of autarky, or
  self-sufficiency
• Chipland picks point c (60 chips and 60 shirts).
• Shirtland picks point s (28 chips and 24 shirts).

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Comparative Advantageand the Terms of Trade

• The nation with the lower opportunity cost has a
  comparative advantage in producing that good.
• Chipland has a comparative advantage in the
  production of chips because it sacrifices fewer
  shirts to produce one chip. Chipland should
  therefore produce chips.
• Shirtland has a comparative advantage in the
  production of shirts because it sacrifices fewer
  chips to produce one shirt. Shirtland should
  therefore produce shirts.

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Comparative Advantageand the Terms of Trade

• The terms of trade are the rate at which two
  goods will be exchanged.
• The consumption possibilities curve shows the
  combinations of two goods that a nation can
  consume when it specializes in producing one good
  and trades with another nation.

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The Consumption Possibilities Curve

• Each consumption possibilities curve lies above
  the nations production possibilities curves,
  meaning that each nation has more options about
  how much to consume under specialization and
  trade.

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The Employment Effects of Free Trade

• In our example, some people in both nations will
  be harmed by free trade.
• In Chipland, for example, people in the shirt
  industry will lose their jobs when the shirt
  industry disappears. Some workers can easily
  move into the expanding computer-chip industry,
  but others will be unable to make the move and
  will be forced to accept lower-paying jobs or
  face unemployment.

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Protectionist Policies

• Four common import-restriction policies are
• An outright ban on imports.
• A voluntary export restraint (VER), where a
  nation voluntarily decreases its exports in an
  attempt to avoid more restrictive policies.
• An import quota, or a limit on the amount of a
  good that can be imported.
• A tariff, or a tax on imported goods.

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Import Ban

• The decrease in supply resulting from the import
  ban increases the price consumers have to pay for
  shirts and decreases the quantity available for
  them to buy.

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Quotas and VoluntaryExport Restraints

• An import quota is a restrictive policy that
  falls between free trade and an outright ban
  Imports are cut but not eliminated. Import
  quotas are illegal under international trading
  rules.
• To get around these rules, an exporting country
  will sometimes agree to a voluntary export
  restraint (VER). A VER is similar to an import
  ban. Like a quota, a VER increases the price of
  the restricted good, making it more feasible for
  domestic firms to participate in the market.

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Quotas and VoluntaryExport Restraints

• An import quota shifts the supply curve to the
  left. The market moves upward along the demand
  curve to point q, which is between point x (free
  trade) and c (an import ban).
• We can reach the same point with a tariff that
  shifts the total supply curve to the same
  position.

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Tariffs

• A tariff is a tax on an imported good. Tariffs
  have the same effect as quotas and VERs. A
  tariff shifts the total supply curve with free
  trade so that equilibrium occurs at point q.
• Consumers pay the same 20 per shirt, and
  domestic firms produce the same quantity 22
  shirts.

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Responses to Protectionist Policies

• A restriction on imports is likely to lead to
  further restrictions on trade. Countries may
  retaliate, and a trade war could escalate to the
  point where the two nations return to
  self-sufficiency. This would force countries to
  scale back their consumption.
• The most famous of import restrictions that
  sparked retaliatory policy was the Smoot-Hawley
  tariff of 1930 when the United States increased
  its average tariff on imports to 59 and its
  trading partners retaliated with higher tariffs
  on U.S. products.

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Rationales for Protectionist Policies

• Three possible motivations to restrict trade are
• 1- To shield workers from foreign competition.
• 2- To nurture infant industries until they
  mature.
• Learning by doing is the knowledge gained during
  production, resulting in increases in
  productivity.
• An infant industry is a new industry that is
  protected from foreign competitors.
• 3- To help domestic firms establish monopolies in
  world markets.

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A Brief History of International Tariff and Trade
Agreements

• The first major trade agreement following World
  War II was the General Agreement on Tariffs and
  Trade (GATT).
• There have been nine rounds of negotiations,
  resulting in progressively lower tariffs for the
  member nations.
• In 1995, the World Trade Organization (WTO) was
  formed to enforce GATT and other international
  trade agreements.

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A Brief History of International Tariff and Trade
Agreements

• Other nations have formed trade associations to
  lower trade barriers and promote international
  trade
• The North American Free Trade Agreement (NAFTA)
  between Canada, Mexico, and the United States.
• The European Union (EU), which today includes
  close to 20 countries.
• The leaders of 18 Asian nations have formed the
  Asian Pacific Economic Cooperation (APEC).

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Recent Policy Debatesand Trade Agreements

• We will discuss three recent policy debates in
  international trade
• Are foreign producers dumping their products?
• Do trade laws inhibit environmental protection?
• Does trade cause income inequality?

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1- Are Foreign ProducersDumping Their Products?

• A firm is dumping when the price it charges in a
  foreign market is either lower than the price it
  charges in its home market or lower than its
  production cost.
• Dumping is illegal under international trade
  agreements hundreds of cases of alleged dumping
  are presented to WTO authorities each year.

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1- Are Foreign ProducersDumping Their Products?
(Continued)

• Charging a lower price in the foreign market is a
  form of price discriminationa strategy that
  maximizes profit.
• A second reason for dumping is predatory pricing
  cutting prices in an attempt to drive rival
  firms out of business. The predatory firm sets
  its price below its production cost.

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1- Are Foreign ProducersDumping Their Products?
(Continued)

• Many economists are skeptical about how
  frequently predatory pricing actually occurs
  versus price discrimination they suspect that
  many nations use their antidumping laws as
  protectionist policies in disguise.
• Professor Thomas Prusa of Rutgers University has
  studied antidumping and found that it is a potent
  weapon for protecting domestic industries.

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2- Do Trade LawsInhibit Environmental Protection?

• Starting in the early 1990s, environmentalists
  began to question whether policies that
  liberalized trade could harm the environment.
• Under current WTO rules, a country can adopt any
  environmental standard it chooses, as long as it
  does not discriminate against foreign producers.
• The United States cannot ban imported goods
  produced by factories that generate air or water
  pollution in other countries.

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Do Trade LawsInhibit Environmental Protection?
(Continued)

• Nations that use trade restrictions to pursue
  environmental goals will encounter resistance
  because WTO rules mean that a nation can pursue
  its environmental goals only within its borders.
• In recent years, a new breed of trade disputes
  have erupted revolving around social problems and
  the role of the government in trying to solve
  them.
• As a world trading community, we will have to
  decide at what point we allow national policy
  concerns to override principles of free trade.

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3- Does Trade Cause Inequality?

• Trade theory suggests a link between increased
  trade and increased wage inequality, but it is
  difficult to distinguish between the effects of
  trade and the effects of other things, such as
  technical progress.
• If new jobs require higher skills, workers will
  eventually move to those jobs and earn higher
  wages. But in the short run, the government
  could facilitate the transition by providing
  unskilled workers education and training.

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Why Do People ProtestAgainst Free Trade?

• Trade and specialization mean that individuals
  and nations must surrender some of their
  independence and sovereignty.
• By not producing precisely what we consume, we
  become dependent on others to trade. By
  cooperating with other nations, we need to
  develop agreed-upon rules that, at times, limit
  our own actions.

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Lari H. Arjomand, Ph.D
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