Chapter Nine The Political Economy of Trade Policy and Borders.

Chapter Nine

The Political Economy of Trade Policy and Borders

© 2003 South-Western/Thomson Learning

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Chapter Nine Outline

1. Introduction

2. The Political Economy of National Trade Policy

3. A Brief History of International Trade Policy

4. Economic Integration and Regional Trading

5. Interregional Trade

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Introduction

• Within each country, processes interact to determine that country’s stance on international trade.– This has advantages and disadvantages:

• Pro example: U.S. constitutional prohibition against tariffs among states undoubtedly contributed to the country’s remarkable growth and stability over last 200 years.

• Con example: National character of trade policy tends to perpetuate the mercantilist view of trade as zero-sum game – one country’s gains must come at its trading partner’s expense rather than from improved efficiency.

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Introduction

• Trade policy occurs at levels other than a national one:– Regional trade blocs: EU and NAFTA– Within different regions of countries: the north

and south of U.S. or Italy (interregional trade).

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The Political Economy of National Trade Policy

• The costs of international trade tend to be concentrated on a relatively small number of individuals.– Benefits, however, come primarily in the form of

lower prices and are spread over a large group, with each individual capturing only a small portion.

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• For producers of good X, the question of tariffs is likely to decide which candidate gets their vote.– For consumers of good X, the small effect the tariff

would have on each individual makes the tariff a lower priority issue.

• As a result, a vote-maximizing candidate will more likely follow the wishes of X producers and support the tariff.

– Implies that pro-protectionist supporters will be more successful in organizing an effective lobbying force than will supporters of unrestricted trade.

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• This systematic pro-protection bias in the policy-making process carries over to laws that govern global trade policy.– Example: Section 201 of the 1974 Trade Act

• “Escape clause” that allows the U.S. to abandon its tariff-reduction obligations under WTO whenever imports cause serious injury or a threat to a domestic industry.

– International Trade Commission in Washington can recommend relief to the president in the form of a tariff, quota, or Trade Adjustment Assistance eligibility for the industry.

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• Given the pro-protection bias in the policy-making process, how does trade liberalization ever get accomplished?1. Informing voters of the often-hidden costs of

protection.

2. Reciprocity involved in international negotiations creates another pro-liberalization constituency: export industries.• A country lowers its trade barriers in exchange for

trading partners lowering theirs.

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Brief History of International Trade Policy

• Mercantilism was the first dominant theory of international trade.– Critical weaknesses:

• Not all countries could conduct successful mercantilist policies at the same time.

• Even when one country succeeded with mercantilist policies, that success could not continue in the long run.

– Mercantilist success caused imports to rise and exports to fall.

• Accumulated specie (money) was useful only if you could purchase goods with it.

– If you import nothing, you drastically decrease your choices of goods to buy.

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• Britain and the rise of the United States– At the close of the 18th century, world events plus

effects of Classical economists’ (Smith, Ricardo, Hume) work moved trade policy toward liberalization.

• Industrial Revolution created many new products for export.

– Britain adopted policies of unrestricted trade.

• American colonies used tariffs to generate revenues before American revolution.

– Post-revolution U.S. was protectionist – protected infant manufacturing industries and retained tariffs.

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– Second half of the 18th century: • Germany and France provided stiff competition for

Britain.– Britain and U.S. used tariff protection through World War I.

– U.S. economy enjoyed phenomenal growth relative to rest of world.

• U.S. Smoot-Hawley tariff bill of 1930– Raised tariffs an average of 53%.

• Other economies retaliated – world trade plummeted.– Great Depression.

SeeFigure

9.1

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Figure 9.1: What Happened to World Trade, 1929-1933 ($Millions)

1932

1931

1930

1929

1933

1,2062,7391,839 9922,998

April

May

June

July

August

SeptemberOctober

November

December

January

March

February

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• Reciprocal Trade Agreements Act of 1934 (RTAA)– U.S. recognized the need for trade liberalization as

a way to emerge from Great Depression.– Reduced Smoot-Hawley-level tariffs.– Also changed institutional arrangements for

making U.S. trade policy:• Tariff authority switched from Congress to executive

branch.• Authorized trade negotiations with other countries.

– RTAA remained in force until the 1962 Trade Expansion Act.

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• Post-Second World War Trade Policy– The United States pushed hard for global postwar

trade liberalization.• U.S. had great industrial strength…export opportunities

could be exploited only in a relatively open environment.

• Strong international economic ties lessened risk of war.

• Desire to rebuild Europe and limit spread of Soviet influence.

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– U.S. also instrumental in establishment of multilateral financial institutions:

• International Monetary Fund (IMF)• World Bank• General Agreement on Tariffs and Trade (GATT)

– Predecessor to WTO

• Congress attempted to reclaim trade authority it previously ceded to president.– 1947: insisted that Escape Clause be included in all

tariff reductions.• Escape clause permitted cancellation of tariff reductions

shown to cause injury to domestic industries.

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• Escape clause, if carried to logical extreme, would eliminate trade – trade always injures some industry while helping others.

– Escape clause is an example of Safeguards imposed in an effort to avoid adjustment costs involved in trade’s reallocation of resources.

– Main U.S. Trade Acts since 1950:• Trade Expansion Act of 1962• Trade Act of 1974• Trade Agreements Act of 1979• Trade and Tariff Act of 1984• Omnibus and Competitiveness Act of 1988• Uruguay Round Agreements Act of 1994

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• Trade policy in the 1960s and 1970s– Trade Expansion Act of 1962 replaced the RTAA.

• Kennedy sought to regain momentum in trade liberalization.– Granted president authority to negotiate 50% reductions in

tariffs.

• Contained 3 items important to world trade:1. Multifiber Agreement (MFA): president agreed to impose

quotas on cotton textile imports and to partially exempt textiles from tariff reductions.

2. Negotiations shifted from product-by-product to across-the-board format.

3. Trade Adjustment Assistance (TAA) added to U.S. safeguard provisions.

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• Trade Adjustment Assistance– Instead of levying tariffs against imports that

resulted in injury to a specific industry, the TAA was an alternate way to deal with the injury:

• Directly compensate injured firms and workers for their losses.

– Extended unemployment benefits

– Retraining

– Relocation assistance

– Low-interest loans

– Even restitution to whole communities harmed by an industry’s decline.

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– Trade Act of 1974• Granted president 60% tariff-reduction authority.• Extended existing set of import quotas from cotton

textiles to cover wool and synthetics.• Strengthened role of International Trade Commission.• Loosened eligibility requirements for compensation

under TAA:– Injury to domestic industry no longer had to be linked directly

to government policy, but only to increased imports.– Competition from imports now only had to constitute an

“important” cause of the injury.

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– Trade Act of 1974 also laid the groundwork for the Tokyo Round of GATT talks (1974 – 1979).

• Resulted in 30% reduction in tariffs of major industrialized economies.

• New policy: U.S. (and others) could reach agreements (called Codes) accepted by only a subset of GATT countries.

• Tokyo Round left several unresolved issues:– Developed-country barriers against developing-country

exports.

– Mutually acceptable interpretations of safeguard provisions.

– Conflict resolution mechanisms.

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• Trade Policy in 1980s and 1990s– Trade and Tariff Act of 1984

• Gave the president authority to negotiate bilateral trade treaties.

– Uruguay Round Agreements Act (GATT talks)• Began 1986…approved 1994

• Major results:– Agricultural: reduced export subsidies; required tariffication

of existing nontariff barriers; reduced existing tariffs an average of 36%; provided for minimum access for new entrants into previously-closed foreign markets.

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– More results of GATT:• Textiles: bilateral quotas of MFA must be removed at

end of 10 years; quotas probably will be replaced by high tariffs.

• Complete elimination of tariffs in several important sectors by industrial countries.

• Clarified distinction between acceptable and unacceptable subsidies.

• Strengthened enforcement of intellectual property rights.

• Established WTO– Member countries must now subscribe to all rules and

responsibilities.

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See Figures9.2 and 9.3

Economic Integration

• Formation of countries into groups (EU, NAFTA)

1. Preferential trading arrangement (PTA)– Member countries agree to erect lower barriers to

trade within the group than to trade with nonmember countries (Figure 9.3).

2. Free trade area– Involves eliminating barriers to intra-group trade

while allowing each country to maintain its own nationally determined barriers to trade with nonmembers.

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3. Customs union– Intra-group trade faces no barriers and members

maintain a common external tariff (CET) on trade with nonmembers.

4. Common market– Extends free trade among members to factors of

production (labor migration and capital flows), as well as to goods and services.

5. Economic union– Most extensive form of economic integration.

– Means common, group-determined economic policies, as well as a common currency.

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Figure 9.2: Levels of Economic Integration

Common market

Preferential tradingarrangement

Free-trade area

Customs union

Economic union

Red

uctio

n of

in

tra-

grou

p ta

riffs

Rem

oval

of

intr

a-gr

oup

tarif

fs

Com

mon

ext

erna

l ta

riff

Intr

a-gr

oup

capi

tal a

nd la

bor

mob

ility

Com

mon

ec

onom

ic p

olic

ies

and

com

mon

cu

rren

cy

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Figure 9.3a: Tariffs Under Different Stages of Integration

t = 10%

t = 5%BA C

t = 20%

(a) Preferential Trade Arrangement

t = 10%

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Figure 9.3b: Tariffs Under Different Stages of Integration

t = 0%

t = 0% BA C

t = 20%

(b) Free-trade Area

t = 10%

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Figure 9.3c: Tariffs Under Different Stages of Integration

t = 0%

t = 0%BA C

CET = 15%

(c) Customs Union

CET = 15%

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• Protectionist element of integration is called Trade Diversion.– Diversion of trade from nonmembers to members

caused by discrimination inherent in integration.

• Trade-liberalization element of integration is called Trade Creation.– Integration eliminates protection among member

countries and allows them to specialize and trade according to comparative advantage and to exploit potential economies of scale.

• If trade diversion dominates trade creation, welfare falls.

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• Figure 9.4 illustrates integration’s trade-creating and trade-diverting effects.– SM denotes supply of good X by member countries.

• SNM is the supply by nonmember countries.

– Formation of a free-trade area causes a move from C to H.• Trade increases as imports rise from X0-X1 to X2-X3.

• Trade also is diverted from nonmember countries toward member countries, causing an efficiency loss represented by area of triangle e.

See Figure 9.4

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Figure 9.4: Welfare Effects on a Free-Trade Area in Good X

PX

E

PX0

PX1

F

0 X3 X0 X2X1

SNM

SM

SNM+ t

SM+ t

D

S

G

a b c d

e

RT

J

X

C

H

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• Additional considerations– Integration may have dynamic effects – i.e., may

cause member economies to evolve differently over time.

• Integration increases size of “domestic” market.– May allow firms to achieve economies necessary to become

competitive in export markets.

• May allow group of countries to exercise some monopoly power in world markets.

• May cause increased competitive pressures on industries within integrated group.

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• Two waves of economic integration:– 1960s

• Most were modeled after European Community.– Attempts among developing countries met only with partial

success.

• Some African and Latin American plans failed.

– Mid-1980s• European Union (EU)

• North American Free Trade Agreement (NAFTA)

• Association of South East Asian Nations (ASEAN)

• Southern Common Market (MERCOSUR)

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• Figure 9.5 indicates that among the EU, NAFTA, ASEAN, and MERCOSUR, the EU has the highest share of intra-group trade.

• The European Union– 1957: Treaty of Rome created European

Commission.• Belgium, Luxembourg, Netherlands, France, Germany,

and Italy.

– 1971: agreed to 10-year plan to achieve full economic union. See Figure 9.5

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Figure 9.5: Intra-Group Trade as Percent of Total Merchandise Trade, 2000

0EU NAFTA

20

40

50

60

70Percent

30

10

ASEAN MERCOSUR

Intra-Group Exports as Percent of Total ExportsIntra-Group Imports as Percent of Total Imports

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– 1986: added Spain and Portugal.– 1987: passed Single Europe Act

• Expanded policy making to include areas of environment, monetary policy, health and safety, and foreign policy.

– 1991: changed name to European Union.• Outlined plan to move to common currency (the euro)

and central bank.

• Figure 9.6 shows the current 15 EU members.

See Figure 9.6

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Figure 9.6: European Union Members and Applicants, 2001

Sweden Finland

Estonia

Latvia

Lithuania

Poland

Czech Rep.Slovakia

Romania

Bulgaria

TurkeyGreece

Italy

Austria

Germany

France

SpainPortugal

Luxembourg

Belgium

Netherlands

Denmark

UnitedKingdom

Ireland

Hungary

Slovenia

Members

Applicants

Malta

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• NAFTA– U.S., Canada and Mexico– Several unique characteristics:

• Mexico asked to join U.S. in free trade area – Canada later asked to join them – took effect 1994.

• Composition of member countries was very different from most trade blocs.– Very different levels of economic development existed. Most

trade bloc members are fairly similar in economic development.

See Figure 9.7

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Figure 9.7: Where Do They Go? U.S., Canadian, and Mexican Exports, 2000

0%

Sh

are

of

U.S

. ex

po

rts

40%

60%

80%

100%Percent

20%

Non-NAFTAcountriesMexicoCanadaU.S.

Sh

are

of

Can

adia

n e

xpo

rts

Sh

are

of

Mex

ican

exp

ort

s

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• NAFTA (continued)– Tariffs on about half of members’ trade were

removed immediately.• Remaining tariffs will be phased out by 2010.

– Rules-of-origin rules dictated that in order to qualify for duty-free treatment, a product must divulge its quantity of North American content (different thresholds for each industry).

• Many Asian firms produce goods in Mexico as a “back door” path to the U.S. market.

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• NAFTA (continued)– Conflict resolution mechanism:

• North American Trade Commission (3 people) created to hear disputes and levy any penalties.

– Opposition to NAFTA from pro-protection forces:1. Agreement’s environmental impact

2. Effects of differences between labor standards and wages in U.S. and Mexico.

3. Possibility of sudden large import surges from Mexico.

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• NAFTA (continued)– Since NAFTA began, imports from Mexico have

risen and those from Asia have decreased.– Chile is on the waiting list to join.

• Free Trade Area of the Americas due to be completed no later than 2005.– 34 countries

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• MERCOSUR– Formed in 1991– Includes Brazil, Argentina, Paraguay, and

Uruguay.– 1994: became a customs union with average CET

of 14%.– Intra-MERCOSUR trade increased 400% in first 4

years.

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Interregional Trade

• Sometimes interregional trade becomes international trade:– Breakup of Soviet Union.– Reacquisition of Hong Kong by China.– Role of factor mobility

• Labor and capital move more easily within than between countries due to both natural and policy-induced barriers to intercountry mobility.

– Role of economic policy• At times, governments show their ambivalent feelings

toward trade by applying different trade rules in different regions of a country.

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Interregional Trade

• Role of economic policy (cont.)– Most common form of subnational trade policy:

• Special Economic Zones (SEZs)– Allow more generous rules for trade and for inward foreign

direct investment than apply in rest of country.

– Example: China

• Export-Processing Zones– Concentrate on attracting firms that assemble products for

export.

– Example: Mexico’s maquiladora program.

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Notes for Case Two

• Do Political/Economics Boundaries Really Matter?– An economic map of China (Figure 9.8) shows

that costal provinces have higher per capita income levels than interior provinces.

• Beginning in 1978, China opened up special economic zones (SEZs), which were located primarily in costal provinces such as Guangdong and Fujian.

• In 1999 all provinces were allowed to create SEZs.

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Figure 9.8: Chinese Per-Capita by Province, 1999

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Notes for Case Three

• Life before the NAFTA– Figure 9.9 depicts the maquiladora establishments

in Mexico in 1996.• The region along the southern side of the U.S.-Mexican

border is a major center of electronic assembly operations.

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Figure 9.9: Maquiladora Establishments, 1996

Mexico City

Tijuana(Canon, Casio,

Hitachi, Hyundai, Iwai, Matsushita,

Pioneer, Samsung, Sanshi,

Sanyo, Toshiba)

Mexicali (Daewoo, LG Electronics, Matsushita, Mitsubishi, Sony, JVC)

San Luis Rio Colorado (Daewoo)

Ciudad Juarez (Canon, Mizumo,TDK, Toshiba, Yozaki, Zenith)

Mexico

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Key Terms in Chapter 9

• Section 201

• Mercantilism

• Smoot-Hawley tariff bill of 1930

• Reciprocal Trade Agreements Act (RTAA)

• International Monetary Fund (IMF)

• World Bank

• General Agreement on Tariffs and Trade (GATT)

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• Escape clause

• Safeguards

• Multifiber Agreement (MFA)

• Trade Adjustment Assistance

• Codes

• Uruguay Round

• Fast Track

• Integration

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• Preferential trading arrangements (PTA)

• Free-trade area

• Customs union

• Common external tariff (CET)

• Common market

• Economic union

• Trade diversion

• Trade creation

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• Special economic zone (SEZ)

• Export-processing zone

Chapter Nine The Political Economy of Trade Policy and Borders.

Documents

trade barriers

international trade

global trade policy

mercantilist view of

regional trade blocs

italy interregional

trade actescape clause

international negotiations