Economics of Trade Liberalization and Integration Jan Fidrmuc Brunel University
Feb 01, 2016
Economics of Trade Liberalization and Integration
Jan Fidrmuc
Brunel University
Import demand curve (MD)price price
HomeSupply
P*
P”
P’
Z’ C’ quantity importsZ” C”
HomeDemand
Home importdemand curve,MDH
P”
P’
M’M”
1
2
3
Import supply curve (MS)
P*
P”
P’
C’ quantity exportsC” X’ X”
price price
Foreign exportsupply curve, XSF, or MSH.
ForeignSupply
ForeignDemand
1
3
Z’ Z”
2
MD-MS Diagram MD-MS diagram permits tracking domestic &
international consequences of trade policy changes.`
euros
imports quantity
MS
MD
Z C
Domestic price, euros
Import (foreignexport) supply curve
Domestic demand curve Domestic supply curve
Imports
Importdemand curve
Imports
Sdom
Ddom
PFT
Non-discriminatory (MFN) Tariff Consider tariff of T euros per unit MFN non-discriminatory tariffs
WTO rules: lowest tariff (most-favored nation) must apply equally to all trading partners
Exception: FTAs Tariff shifts MS curve up by T.
Exporters earn domestic price minus T They would need domestic price of P+T to
continue to offer the same exports.
MFN Tariff Analysis New equilibrium in
Home (MD=MS) is at P’ and M’.
Domestic price P’ now differs from border price (price exporters receive) P’-T.
Domestic price rises.
Border price falls. Imports fall.
Homeimports
MD
Border price
Foreignexports
XS=MSMS
MS with TDomestic price
TP’-T
X’=M’ MFTXFT= MFT
PFTPFT
M’
P’
Welfare effects Foreign loss due to drop in exports equal to
area D (trade volume effect). Foreign loss due to drop in border price
equal to area B (border price effect, a.k.a., ToT effect).
Net effect on Foreign = -D-B. Home loss equal to area -A-C (trade volume
drops and price rises). Home gain due to drop in border price and
tariff revenue equal to area A+B. Net effect on Home = -C+B. World welfare change is -D-C. If Home gains (-C+B>0) it is because it
exploits foreigners by ‘making’ them pay part of the tariff (i.e. area B).
MD
MS
MFT=XFT
PFT
M’=X’
P’A
C
BD
Homeimports
Domestic price
Home and Foreign in one diagram
P’-T
Distributional consequences
Home consumers lose area E+C2+A+C1
Home producers gain E Home tariff revenue: A+B. Net change = B-C2-C1 (this equals B-C in left panel).
Net effect can be positive or negative. Tariffs imposed because they benefit domestic producers
who are often organized and politically influential This comes at a cost to domestic consumers and to
foreigners If Foreign retaliates and also imposes a tariff, everyone loses
With reciprocity, protectionism is not a zero-sum game
Distributional consequences
euros
imports quantity
MS
MD
C
Domestic price, euros
Sdom
Ddom
PFT PFT
Z
P’
P’-T
P’
P’-T
C’Z’
A C
B D B
EC2
AC1
Preferential Trade Liberalization Previous analysis used 2 countries only:
Home and Foreign European integration is discriminatory (or
preferential) and its analysis requires at least three countries: At least two integrating nations. At least one excluded nation.
MD-MS diagram must to allow for two sources of imports.
The PTA Diagram: Free trade
Domestic price
Homeimports
MD
PFT
RoWExports
PartnerExports
XSPXSR MS
M=XP+XR
Partner HomeRoW
Border price Border price
21
XPXR
The PTA Diagram: MFN tariff
Domestic price
Homeimports
MD
PFT
RoWExports
PartnerExports
XSPXSR MS
MSMFN
P’
M’ M=XP+XR
Partner HomeRoW
Border price Border price
T
P’-T
21
X’R X’P
XPXR
Discriminatory unilateral liberalization Assume Home removes T on imports only
from Partner. This liberalization shifts up MS (as with MFN
tariff) but not as far since it applies only to one half of imports. Shifts up MS to half way between MS (free trade)
and MS (MFN tariff) More complex, kinked MS curve with PTA.
If price falls below Pa, RoW will export zero.
Discriminatory, unilateral liberalization
Domestic price
Homeimports
MD
RoWExports
PartnerExports
XSPXSR MS
MSMFN
M’
Partner HomeRoWBorder price Border price
MSPTA
1
Pa
P’
T
T
P” P”
P’-TP”-T
XR” XR’ XP’ XP” M”
p*
Domestic price & border price changes Domestic price falls to P’ from P”. Partner-based firms see border price rise, P’-T to P”. RoW firms see border price fall from P’-T to P”-T.
Domestic price
Homeimports
MD
RoWExports
PartnerExports
XSPXSR
MS
MSMFN
M’
Border price Border price
MSPTA
P’
TP”
P’-T
P”-T
XR” XR’ XP’ XP” M”
P’-T
P”
Quantity changes: supply switching RoW exports fall and Partner exports rise: supply switching: trade diversion Domestic imports rise: trade creation. Partner exports rise more than RoW exports fall.
Domestic price
Homeimports
MD
RoWExports
PartnerExports
XSPXSR
MS
MSMFN
M’
Border price Border price
MSPTA
P’
TP”
P’-T
P”-T
XR” XR’ XP’ XP” M”
P’-T
P”
Impact of customs union formation
0%
20%
40%
60%
80%
100%
19
58
19
59
19
60
19
61
19
62
19
63
19
64
19
65
196
61
967
19
68
19
69
19
70
EEC-6 Other 6 Europe Rest of World
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
195
8195
919
60
1961
1962
1963
196
4196
519
66
1967
1968
1969
1970
$ b
illio
n (
curr
ent
pri
ces)
EEC
Total imports
Note: Left panel shows share of EEC6’s import from the three regions. Other Euro-6 are the 6 countries that joined the EU by the mid 1980s, UK, Ireland, Denmark, Spain, Portugal and Greece. Source: Table 5, External Trade and Balance of Payments, Statistical Yearbook, Recapitulation, 1958-1991, EUROSTAT, 1992, Luxembourg.
Welfare effects Home’s net change = A+B-C ambiguous Partner’s net change = +D. RoW’s net change = -E.
Domestic price
Homeimports
MD
RoWExports
PartnerExports
XSPXSR
M’
Partner HomeRoWBorder price Border price
P’
P”
XR’ XP’ XP” M”
C
B
A
XR”XR”
P’-TP”-T
P’-TP”-T
P”
E
D
Analysis of a Customs Union European integration
involved a sequence of preferential liberalisations, all of them reciprocal: Both Home & Partner
drop T on each other’s exports.
Need to address the 3-nation trade pattern.
Example: each country produces 3 goods, exports 2 and imports 1
Good 1
Good 3
Good 2
Good 2
Good 3
Good 1
HomeHome PartnerPartner
RoWRoW
Analysis of a Customs Union Home and Partner eliminate T on their mutual
trade Both impose T on trade with RoW
Home-Partner CU has Common External Tariff (CET) equal to T
Analysis is simply a matter of recombining results from the unilateral preferential case. In market for good 1, analysis is identical. In market for good 2, Home plays the role of Partner
and Partner plays role of Home.
Welfare effects of a customs union In market for good 1: Home change = A+B-
C1-C2. In market for good 2:
Home change = +D1+D2.
NB: D1=C1. Net Home impact
=A+B-C2+D2 . Partner impact
identical. RoW loses in both
markets. RoW exports fall but
imports stay the same: trade deficit
euros
imports
MD
euros
Exports
XS
M’
A
D2
D1 C1
B
C2
XP”XP’ XR” XR’
P’-T
P”
P’
P”-T
EU Trade Policy
Geographical Structure of Trade
Differences among Member States
Composition of trade
Food & live animals
Other raw materials
Fuel products
Chemical products
Other manufactured
Machinery, transport equipment
Machinery, transport equipment 45% 34%
Other manufactured 26% 26%
Chemical products 16% 9%
Fuel products 3% 18%
Other raw materials 2% 5%
Food & live animals 5% 6%
Misc. 2% 3%
Exports, 2004 Imports, 2004
Manufactured Goods, 87%
Manufactured Goods, 69%
What with whom?
EU’s MFN tariff structure (the CET)
Institutions Trade policy is an exclusive prerogative of
the EU. Customs Union requires agreement.
Commission has responsibility for negotiating Trade Commissioner.
Council of Ministers sets “Directives for Negotiation,” accepts/rejects final deal.
Commission in charge of surveillance and enforcement of 3rd nation commitments. Trade disputes with US, China, etc.
EU External Trade Policy EU has special arrangements with 139 nations; often more
than one per partner. Each can be very complex.
Non-preferential trade
Only about 1/3 EU imports are not granted some sort of preferential treatment Only 9 nations (US, Japan, etc.).