International Trade

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International Trade

• Week 9 - Instruments of Trade Policy

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Free enterprise made this country. Free trade
will destroy it. For five years, Ive been
advocating a 20 percent tariff on all imports. We
can either do that, or our industrial base will
erode to the point where we cant build products
to defend ourselves in the event of war. Our
people will walk the streets because we are
exporting jobs and importing welfare.

• June M. Collier, President,
• National Industries, Inc., 1985

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Instruments of Trade Policy

• Tariffs are taxes levied on imported goods.
• Specific Tariff levied as fixed amount on each
  unit of goods imported.
• Ad Valorem Tariff a tax levied as a fraction of
  the value of goods imported.
• Export Taxes or Subsidies are levied on exported
  goods.
• Either as specific tax (subsidy)or as an Ad
  Valorem tax (subsidy) on exports.
• Non-Tariff Barriers (NTBs)
• Import Quotas Limitations on the quantity of
  imports.
• Export Restraints Limitations on quantity of
  exports (usually imposed by exporting country).
• Miscellaneous Restraints Govt Procurement
  Provisions, Domestic Content Rules,
  Administrative Classifications, Border Taxes.

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Partial Equilibrium Analysis

• Will examine effects of trade policy in a partial
  equilibrium framework.
• Ignore interactions across economy, focus on
  single market.
• Assumptions
• Two countries, Home and Foreign.
• One good, which both countries produce and
  consume.
• Good can be costlessly transported between
  countries.
• Exchange rate constant throughout, quote price of
  good in terms of Home currency in both Home
  Foreign.
• Home country assumed to import this good from
  Foreign.
• Equilibrium price determined by Homes Import
  Demand and Foreigns Export Supply Curves.

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Homes Import Demand
Home Market
Imports
Price, P
Price, P
S
D
Quantity, Q
Quantity, Q
6
Foreigns Export Supply
1. Can perform similar exercise for Foreign.
Quote foreign price in Home currency.
Foreign Market
Exports
Price, P
Price, P
S
MC
D
Quantity, Q
Quantity, Q
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World Partial Equilibrium
World Market
Price, P
Quantity, Q
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Effect of a Tariff on Imports

• Tariff drives a wedge between price paid by
  consumers in Home and price received by exporters
  in Foreign.
• Specific Tariff of t per unit.
• Shifts the Export Supply Curve up by t at each
  q.
• New equilibrium price in Home rises by less than
  t.
• Why? Because new price received by Foreign
  exporters falls below initial price (terms of
  trade effect).
• Size of this effect depends on importance of Home
  Country in World market. Generally this effect is
  negligible.
• Small Country Case assumes no change in Foreign
  price, implying Home price rises by full amount
  of tariff.
• Quantity of good traded falls below free trade
  level.

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Tariffs in Large Country
1. Begin in equilibrium at PW with Home imports
equal Foreign exports
4. How burden of tariff distributed between Home
Foreign depends on slopes of MD and XS
curves, i.e. PT and PT relative to initial PW.
Domestic Price
Home Country
World Market
Foreign Country
Foreign Price
Price
SH
DH
DF
SF
XS
PW
MD
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Measuring Amount of Protection

• Height of the average tariff is a measure of
  how much price interference exists in countrys
  tariff schedule.
• Unweighted Average Nominal Tariff rate
• Does not take into account relative importance of
  each good. Tends to overstate true height of
  average tariff.
• Weighted Average Nominal Tariff rate
• Each goods tariff is weighted by the importance
  of the good in the bundle of imports. Tends to be
  biased downwards.
• Prohibitive Nominal Tariff rate
• Tariff rate so high it prevents imports from
  coming into country.
• Effective Rate of Protection (ERP)
• Change in the value-added of an industry
  (relative to free trade) due to imposition of a
  tariff structure on intermediate final
  products.

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Nominal (t) and Effective (g) Tariff rates
Source Deardorf Stern, The Effects of the
Tokyo Round and the Structure of Protection
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Costs and Benefits of Protectionist Policies

• Large Country Analysis
• of a Specific Tariff

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Measuring Market Costs Benefits

• Measure costs/benefits of protection with
  monetary quantities.
• Consumer Costs/Benefits
• Consumer surplus measures the monetary amount
  between price consumer actually pays and price
  she/he willing to pay.
• Calculated as area under the Demand Curve above
  market price.
• Producer Costs/Benefits
• Producer surplus measures the monetary amount
  between price producer actually receives and
  price she/he willing to accept.
• Calculated as area above the Supply Curve but
  below market price.
• Government Costs/Benefits
• Government Revenue measures the monetary amount
  generated by the tariff that government receives
  as revenue.

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Consumer Producer Surplus
Home Market
Price, P
1. Foreign Country has upward- sloping
Export Supply Curve, XS.
P0
Quantity, Q
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Costs and Benefits of a Tariff
Home Market
Price, P
SH
5. Deadweight loss (cost of protection)
b d ( prodn loss consump loss)
PW
6. Terms of Trade Gain e (decline
in export good price to PT
DH
S1
D1
Quantity, Q
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Summary of Import Tariff

• Import Tariff brings three net effects to
  economy.
• Tariff raises domestic price of good above free
  trade level.
• Production Distortion (loss)
• Leads domestic producers to produce too much of
  the import good resulting in an efficiency loss.
• Consumption Distortion (loss)
• Tariff leads domestic consumers to consume too
  little of the import good resulting in a welfare
  loss.
• Terms of Trade Effect (gain)
• Tariff lowers world demand for import good,
  resulting in a fall in the world price of the
  import good. Likely to be small in reality.
• Summary of Import Tariff (Probable Welfare Loss)
• Terms of trade effect negligible, so tariff will
  probably reduce level of welfare in the country
  imposing the tariff.

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Costs and Benefits of Protectionist Policies

• Small Country Analysis
• of a Specific Tariff

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Tariff for a Small Country
Price, P
2. Consumer surplus falls by areas
a b c d
SH
3. Producer surplus rises by area a
4. Government revenue rises by area c
5. Deadweight loss (cost of protection)
b d ( prodn loss consump loss)
DH
PW
D0
S0
Quantity, Q
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Costs Benefits of a Tariff
Price, P
2. Consumer surplus falls by areas a b
c d 60
SH
5
3. Producer surplus rises by area a 15
4
4. Government revenue rises by area c
30
3
5. Deadweight loss (cost of protection)
b d 15
2
DH
1
20
10
30
40
50
60
70
Quantity, Q
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U.S. Example 1978 CB Radio Tariff

• In 1978, import tariffs on CB radios increased
  from 6 to 21.
• FTC estimated this had the following effects
• Price rose from 54 to 62.
• Demand fell 1.53 million
• Domestic Prodn up 221,000
• Assume no effect on world price, analyze effects
  on U.S. welfare.
• Costly to consumers with little benefit to
  producers or number of U.S. jobs created.

Source Morkre Tarr, Effects of Restriction on
U.S. Imports, FTC
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Costs and Benefits of Protectionist Policies

• Large Country Analysis
• of a Specific Export Subsidy

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Export Subsidy in Large Country
4. How burden of subsidy distributed between
Home Foreign depends on slopes of MD and
XS curves, i.e. PS and PS relative to initial PW.
Domestic Price
Home Country
World Market
Foreign Country
Foreign Price
Price
XS
DF
SF
DH
SH
MD
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Effects of an Export Subsidy
Home Market
Price, P
SH
PW
5. Net Welfare Loss given by areas
b d e f g
DH
Quantity, Q
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Summary of Export Subsidy

• Export Subsidy has exact opposite effects to
  import tariff.
• Subsidy raises domestic price of good above free
  trade level.
• Production Distortion (loss)
• Leads domestic producers to produce too much of
  the export good resulting in an efficiency loss.
• Consumption Distortion (loss)
• Subsidy leads domestic consumers to consume too
  little of the export good resulting in a welfare
  loss.
• Terms of Trade Effect (loss)
• Subsidy raises world supply of export good,
  resulting in a fall in the world price of the
  export good. Likely to be small in reality.
• Summary of Import Tariff (Welfare Loss)
• Even if terms of trade effect negligible, subsidy
  will certainly reduce level of welfare in the
  country giving the subsidy.

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Agricultural Subsidies, 1979-1986
Source Rosenblatt et al, The Common Agricultural
Policy of the EC, IMF 1988
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Costs and Benefits of Protectionist Policies

• Non-Tariff Barriers (NTBs)

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Non-tariff Barrier Import Quota

• Most common form of a Non-Tariff Barrier is an
  import quota which restricts the quantity of good
  imported.
• Import Quota
• Restricts quantity of good imported during a
  year.
• Effect is to increase home price of the good over
  free trade.
• Market effects identical to a specific tariff. In
  fact, any quota can be mimicked by an equivalent
  tariff.
• Welfare effects differ because govt does not
  necessarily receive revenue as under a tariff.
  May gain revenue if auctions off import licenses,
  otherwise additional revenue received by foreign
  exporters.
• Voluntary Export Restraint (VERs)
• Foreign supplier voluntarily agrees to restrict
  quantity imported.
• Usually a political agreement so Home does not
  look protectionist.
• Market effects identical to an import quota, but
  welfare effects differ as foreign firms receive
  additional profit, Home govt receives nothing.

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Effects of an Import Quota
World Market
Price, P
3. Market effects of tariff and a quota are
identical but not welfare effects.
4. Consumer surplus, producer surplus and
associated Deadweight loss ( prodn loss
consump loss) are identical.
XS
PW
MD
Quantity, Q
Q0
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Demand Growth Import Quota
1. Import quota level set at Qq with
associated equivalent tariff, tq.
World Market
Price, P
Quota
XS
XS
Pq1
E1
E0
PW
tq
PqW
MD
Quantity, Q
Q0
Qq1
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NTBs on Industrial Country Imports(as of
imports)
Source Grilli Sassoon, The New Protectionist
Wave, 1990.
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Other Forms of NTBs

• Government Procurement Provisions
• Restrict purchase of foreign goods by home govt
  agencies.
• Similar to an Ad Valorem import tax, where home
  producer receives certain percentage of price
  protection.
• Domestic Content Provisions
• Reserve some of value-added product sales to
  home producers.
• European Border Taxes
• Value-added tax (VAT) in EU. Imports to EU must
  pay equivalent VAT, while EU exports receive
  rebate for VAT. Looks like an import tariff an
  export subsidy
• Administrative Classification
• Import duty depends on classification, gives
  leeway to customs.
• Restrictions on Services Trade
• Less visible. Restrict foreign provision of
  certain services.

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Welfare Effects of U.S. Trade Restrictions
Source De Melo Tarr, Welfare Costs of Quotas
on Textile, Steel, Apparel