ECO 6705 Protectionism: Analyzing the Effects of Trade Restrictions

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ECO 6705Protectionism Analyzing the Effects of
Trade Restrictions

• Dr. Jeff Steagall
• September 22, 2003

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Associated Reading

• Van den Berg, chapter 6
• Friedman, chapters 11-13

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Types of Trade Restrictions

• Trade policy
• Set of rules restrictions on international
  trade
• Uses various policy tools (tariffs, quotas, etc.)
• Tariffs (duties)
• On
• Imports
• Exports (atypicalused when a country has market
  global power for the good, such as oil)
• Amounts can be
• Ad velorem ( of value)
• Specific (per unit)
• Combination

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Types of Trade Restrictions

• Non-tariff barriers (NTBs)
• Quantitative restrictions
• Quotas (on imports)
• Voluntary Export Restraints (VERs)
• Voluntary Restraint Agreements (VRAs)
• Export controls (quotas)
• Administrative protection
• Unfair trade statutes
• Antidumping
• Anti-subsidy (countervailing)

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Welfare Effects of Tariffs Small Country in PE

• Assume the country is small
• No global market power in the sector
• Countrys actions cannot affect world price
• Country bears entire cost of its actions
• Not necessary to draw Abroad or World markets to
  analyze effects of small country tariff
• Assume specific tariff for simplicity
• Analysis and results are similar for ad velorem
  or combination duties

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Welfare Effects of Tariffs Small Country in PE

• Effects of tariff
• World price remains unchanged at PFT
• Country is too small to influence world price
• Importers still pay world price on world markets
• Domestic price rises by amount of tariff
• Importers must pay the tariff to get the product
  through customs and into the domestic market
• Consumer prices must rise to match
• Tariff creates a wedge between domestic and world
  prices

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Welfare Effects of Tariffs Small Country in PE

• Effects of tariff, cont.
• Domestic consumer surplus (CS) falls
• Domestic producer surplus (PS) rises
• Government gains tariff revenue
• Area in graph is a rectangle defined by
• Import amount on horizontal axis
• Tariff amount on vertical axis
• Domestic consumers pay this tariff through higher
  prices
• Decrease in CS is bigger than the combined
  increases in PS and tariff revenue (deadweight
  loss)
• Domestic welfare is ALWAYS lower with a tariff
  than with free trade for a small country
• Optimal tariff for small country is zero (i.e.,
  free trade)

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Welfare Effects of Tariffs Large Country in PE

• Assume the country is small
• Has global market power in the sector, by
  definition of being a large country
• Countrys actions do affect world price
• Country does not bear entire cost of its actions
• It is necessary to draw Abroad or World markets
  to analyze effects of large country tariff

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Welfare Effects of Tariffs Large Country in PE

• Effects of tariff
• Domestic price rises due to tariff
• Importers must pay the tariff to get the product
  through customs and into the domestic market
• Consumer prices must rise to match
• Graphically, tariffs decrease international
  supply (left shift)
• Increased domestic prices cause quantity demanded
  to fall
• Since country is large, the units that used to be
  sold in Homeland are put back on the
  international market
• At prevailing international price, those units
  remain unsold
• International suppliers must drop their prices to
  sell these units
• Equilibrium world price with large country tariff
  falls below PFT

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Welfare Effects of Tariffs Large Country in PE

• Effects of tariff, cont.
• Now importers
• Purchase products in international markets at new
  world price
• Bring products through customs, paying the tariff
• Sell the product domestically at a new price that
  is equal to the new international price plus the
  tariff
• Thus, domestic price
• Is higher with the tariff than with FT
• Is lower than the sum of PFT Tariff

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Welfare Effects of Tariffs Large Country in PE

• Effects of tariff, cont.
• Domestic consumer surplus (CS) falls
• Domestic producer surplus (PS) rises
• Government gains tariff revenue
• Area in graph is a rectangle defined by
• Import amount on horizontal axis
• Tariff amount on vertical axis
• Tariff revenue is paid partly by
• Domestic consumers in the form of higher prices
• Foreign producers in the form of a lower
  international price
• Large countries can shift part of tariff burden
  abroad!

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Welfare Effects of Tariffs Large Country in PE

• Effects of tariff, cont.
• Part of CS decrease is offset by PS increase
• It is not clear whether tariff revenue is bigger
  or smaller than the part of CS loss that is not
  offset by the gain in PS
• Thus, it is POSSIBLE that domestic welfare is
  higher or lower with a tariff than with free
  trade for a large country

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Welfare Effects of Tariffs Large Country in PE

• Optimal tariff for large country
• If one chooses the right tariff, it can be
  positive, but only if
• Assumptions
• Government redistributes tariff revenue in a
  welfare-increasing way
• No waste, inefficiency, or administrative costs
• No loss through rent-seeking behavior
• Foreign governments dont retaliate with their
  own tariffs
• Unlikely!

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Lerner Symmetry Theorem

• An import tariff raises opportunity costs for
  domestic exporters (in the other sector), and
  therefore is a tax on both exports and imports
• The price increase induced by the tariff
• Causes import-competing industry to expand
• Bid resources away from export sector
• Increases opportunity cost for export sector
• Decreases supply (left shift) in export sector
• Since export sector has CA, tariffs cause a
  misallocation of resources across sectors
• Some of the gains from specialization are
  unrealized
• Draw export sector PE for a country imposing an
  import tariff to see this formally

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Tariff Effects in GE

• Students are responsible only for Figure 6.7 (not
  appendix)
• Small country case
• Tariff changes domestic prices
• If X-axis represents import-competing product
• Domestic price line gets steeper
• Production point shifts (away from CA product)
• Country still trades according to international
  prices
• Consumers purchase based on domestic prices
• Welfare is reduced

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Summary of Tariff Effects Large Country

• Transfers of welfare occur
• Domestic consumers to domestic producers
• Domestic consumers to domestic government
• Foreign producers to foreign consumers
• Foreign producers to domestic government
• Deadweight losses both domestically and abroad

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Nominal vs Effective Protection

• Nominal tariff
• Reflects tariff on output product only
• Ignores remainder of trade policy (e.g., tariffs
  on inputs)
• Specific tariff dollar amount
• Ad velorem tariff percentage

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Nominal vs Effective Protection

• Effective tariff
• Considers entire trade policy
• All protection that affects the industry
• Tariff on output
• Tariffs on inputs
• Non-tariff protection would also be included, but
  for simplicity, well stick to tariffs only in
  this class
• Effective tariff is the percentage change in
  value added for the industry with the entire
  trade policy in place (vis-à-vis free trade)

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Nominal vs Effective Protection

• Value added output price - cost of inputs
• (VA)

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Calculating Effective Tariff Rate (ETR)

• Calculate free trade VA (VAFT)
• Calculate prices of output inputs with new
  trade policy
• Calculate VA with trade policy (VATP)
• ETR (VATP - VAFT) / VAFT
• This is a fraction
• Multiply by 100 to get the percentage
• Students are responsible for this calculation

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Effective Tariff Rate

• ETR is sometimes called Effective Rate of
  Protection (ERP)
• ETR can be
• Positive
• Trade policy increases value added vis-à-vis FT
• Value of output protection exceeds harm of input
  protection
• Negative
• Trade policy increases value added vis-à-vis FT
• Value of output protection is less than harm of
  input protection
• Zero
• Trade policy has no effect on VA
• Value of output protection equals harm of input
  protection

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Effects of NTBs

• Students are responsible only for small country
  case of NTBs
• Small country version of Figure 6.12 only
• Not for Figures 6.10 and 6.11
• Not for Figure 6.12 for large nation
• All NTB analyses will be for
• Tariff-equivalent quota (TEQ) a quota that has
  the same effects on prices quantities as a
  given tariff
• Refer to tariff as corresponding tariff
• This allows us to focus on differences between
  various trade policy tools

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Effects of Quota, Small Nation

• Some effects same as corresponding tariff
• Decrease in CS
• Increase in PS
• Government revenue can be different
• No tariff, so no tariff revenue
• Allocation of quota can generate some revenue
• Quota leaves country no better off, and most
  likely worse off, than an equivalent
  (corresponding tariff would have)

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Effects of Quota, Small Nation

• Ways to allocate quota rights
• First-come, first-served
• No revenue for government
• Incentive for exporters is to be first into
  market
• Lots of goods available early in year
• No new imports late in year, as quota has been
  used up
• Issue import licenses (i.e., import permits)
• Each license gives firm the right to export some
  amount during the year
• Firm chooses when to export, so goods can be
  available all year
• Selling licenses can generate government revenue

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Effects of Quota, Small Nation

• Ways to allocate import licenses
• Flat fee
• Who sets fee?
• Does fee reflect value of licenses?
• Set requirements for exporters to be eligible
• Require paperwork by exporters to justify why
  they should be able to export
• Lotteries
• Auctions

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Effects of Quota, Small Nation

• Auction, cont.
• If set up efficiently, auction can generate up to
  same amount of government revenue that the
  corresponding tariff would generate
• Firms that have licenses can sell at higher
  prices in the quota-imposing country than it can
  on world markets
• Earn rents on exports
• Total available rent is equal to tariff revenue
  with corresponding tariff
• Firms will pay up to that amount in order to be
  eligible to earn those rents
• Efficient auctions are fairly easy in practice

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Rents and Rent-Seeking

• What happens when import licenses are sold by
  government?
• Government captures rents
• Rent-seekers who feel entitled to having those
  rents transferred to them appear
• Import-competing industry
• Other ways that rents are captured
• Higher profits by subsidiaries producing in the
  protecting country (e.g., Toyota plants in US)

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Rent-Seeking Behavior

• Rent-seeking is the use of scarce resources to
  induce transfers of wealth instead of using them
  to create new wealth
• Lobbying

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Effects of VERs Small Nation

• Same as quota situation, except
• VER is policy of export-nation government, not
  import-nation government
• Import-nation government has no import licenses
  to allocate, since its not actually restricting
  imports
• VER allows no import-country government revenue
• VER leaves country even worse off than with a
  quota

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Relative Rankings of Trade Policies

• So far, we know that
• Free Trade (best)
• Tariff
• Quota
• VER (worst)

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Administrative Barriers to Trade

• Bureaucratic procedures
• Safety requirements
• Foreign ownership restrictions
• Threat of lawsuits (harassment of foreign firms)
• Government procurement (buy domestically)
• State, provincial local restrictions