International economics 20082009

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International economics2008/2009

• Lecture 8 Trade policy

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Outline of the lecture

• arguments for trade protection
• efficiency of trade policy
• partial equilibrium effects of tariffs

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• arguments for trade protection
• efficiency of trade policy
• partial equilibrium effects of tariffs

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Arguments for trade protection

• Terms of trade argument
• Optimal tariff rate argument
• Infant-industry argument
• Product market distortion
• Factor market distortion

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Offer curve

• The locus of the combination of a countrys
  imports and exports
• How much is a country willing to export for a
  quantity of imports at a given international
  price

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Derivation of the offer curve
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Offer curve
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Terms of trade argument
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Terms of trade argument

• Imposing a TARIFF by country 2 yields
• Offer curve of a country 2 shifts downwards (from
  G2 to G2)
• Terms of trade of country 2 increase
  (tariff-levying country needs to export less of
  good A for the imports of good B than before)
• Volume of trade contracts (imports of country 1
  reduces from EB to EB, imports of country 2
  reduces from EA to EA) and
• Terms of trade of country 1 deteriorate (country
  2 improves its welfare on the account of country
  1).

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Optimal tariff rate argument
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Optimal tariff rate argument

• Maximizing own welfare by imposing an optimal
  tariff leads to
• retaliation by the other country
• possible tariff war
• trade reduction
• both countries are worse off comparative to free
  trade
• Imposing an optimal tariff pays off only if
  tariff-levying country has some monopoly power
  (large country)

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Otpimal tariff rate argument
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Infant industry argument

• The oldest theoretical argument for protection
• Two conditions have to be satisfied in order to
  justify this argument
• home firms in the protected industry have to
  develop gradually until they are ready to compete
  internationally (at world prices) and
• if the infant industry has been wisely chosen,
  the gains from trade in the sheltered industry
  after protection has been abandoned have to more
  than compensate for the losses the country had to
  suffer under protection.

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Infant industry argument

• in principle, tariff protection can improve
  growth in domestic sectors
• however, losses under tariffs are higher than
  losses suffered under production subsidies given
  to import-competing sectors
• tariff protection does not necessarily make a
  country become a net exporter of the protected
  goods

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• arguments for trade protection
• efficiency of trade policy
• partial equilibrium effects of tariffs

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Trade policy instruments

• passive protection policy, includes policy
  instruments that aim to protect the home economy
  from foreign imports
• active protection policy, includes policy
  instruments that aim to increase exports thereby
  protecting the home economy in the foreign
  markets (this primarily includes instruments and
  policies enhancing the competitiveness of home
  firms abroad).

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Trade policy instruments
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Efficiency of trade policy

• Competitiveness and protection of the home
  economy have an inverse relationship the more
  competitive the home-country's economic
  structure, less trade protection it requires and
  vice versa.
• Conflict between an efficient economic
  development/growth (the goal) and protection
  policy (as one of the instruments) because
  protection policy instruments
• divert commodity flows from more sensible
  (foreign) to less sensible (domestic) supply
  sources
• divert flows of production factors (capital and
  labor) from less protected to more protected (and
  hence more privileged) sectors.

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Efficiency of trade policy

• Trade protection represents a social cost and
  will in the end run always burden the home
  economy and public regardless of whether the cost
  is covered by domestic (more efficient sectors)
  or foreign sources (foreign debt).
• Increasing the protection of certain sectors
  should become a norm only in cases when the
  sector has potential given cheaper production
  factors and other sources to become internally
  and externally competitive after a given period
  of time.

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• arguments for trade protection
• efficiency of trade policy
• partial equilibrium effects of tariffs

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Partial equilibrium effects (tariff)

• the analysis only includes a partial equilibrium
  effects of a tariff are analyzed only in the
  market of the good directly affected by the
  imposition of the tariff. All other effects (on
  other markets) are disregarded.
• small country assumption the imposition of a
  trade tariff by a small country will not effect
  world prices,
• Assumption of perfect competition foreign
  exporters of a good affected by the imposition of
  the tariffs will not react on the change in
  import prices by lowering the price of their
  exports.

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Partial equilibrium effects (tariff)
S
P
Pwt
Pw
D
q1
q2
q3
q4
Q
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Partial equilibrium effects (tariff)

• consumption effect domestic consumption of the
  commodity decreased by q3q4
• production (or protective) effect domestic
  output increases by q1q2
• import effect imports decrease by an amount
  equal to the sum of the two previous effects,
  that is for q3q4q1q2
• fiscal revenue effect fiscal revenue for the
  government of the levying country calculated by
  multiplying the per unit tariff by the imposed
  quantity, that is tq2q3, which equals area c
• redistribution effect since price has
  increased, there is a redistribution of income
  from consumers to producers.

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Partial equilibrium effects (tariff)
S
P
Pwt
a
b
c
d
Pw
D
Q
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Partial equilibrium effects (tariff)

• Consumer surpluss decreases for area AEFH (sum of
  abcd)
• Increase in fiscal revenue (area c)
• Increase in producer surplus JGH - JBA ABGH,
  which equals area a
• Net costs of imposing a tariff
• production costs area b represents social costs
  of inefficient allocation of production factors
  caused by the imposition of tariffs
• consumer costs the imposition of the tariff
  causes an increase in the relative price of the
  imported goods, this causes consumers to
  relinquish a part of their consumption (d) of the
  good.