Free Trade – GoodRestriction – Bad Price ($) SdSd F S d+w E f G S d+w+t ab c d e g DdDd h Free Trade: Price = World Price = $8,000 Domestic Production=20;

6,000

6,500

7,000

7,500

8,000

8,500

9,000

9,500

10,000

10,500

11,000

11,500

12,000

0 10 20 30 40 50 60 70 80 90 100 110

Quantity of autos

Free Trade – Good Restriction – BadP

ric

e ($

) Sd

F Sd+w

Ef G Sd+w+t

a b c d

e

g

Dd

h

Free Trade: Price = World Price = $8,000Domestic Production=20; Domestic Consumption=80; Imports=60 Consumer Surplus: a+b+c+d+e+f+g; Producer Surplus = h

6,000

6,500

7,000

7,500

8,000

8,500

9,000

9,500

10,000

10,500

11,000

11,500

12,000

0 10 20 30 40 50 60 70 80 90 100 110

Quantity of autos

Free Trade – Good Restriction – BadP

ric

e ($

) Sd

F Sd+w

Ef G Sd+w+t

a b c d

e

g

Dd

h

Tariff: Price = World Price + Tariff = $8,000 + $1,000 = $9,000Domestic Production=40; Domestic Consumption=60; Imports=20

Reduced Consumer Surplus: a+b+c+d

Increased Producer Surplus = a (Redistributive Effect)

Increased Tax Revenue = c

Deadweight Loss: Inefficient Production = b

Deadweight Loss:Reduced Consumption = d

Costs of import restrictionsDomestic consumers face increased costs

Low income consumers are especially hurt by tariffs on low-cost imports

Overall net loss for the economy (deadweight loss) Production effect: output that costs more than it has to (b) Consumption effect: surplus lost from reduced

consumption (d) Export industries face higher costs for inputs Cost of living increases Other nations may retaliate

So why restrict trade? Benefits of free trade in final goods are spread widely

Tariffs on intermediate inputs tend to be low so producers who use them don’t complain much

Costs of free trade are felt rapidly by domestic producers Lobbying by business and labor“… those persons who demand cheaper coats would be ashamed of

themselves if they could realize that their demands cut the wages of the women who made those coats.”

Benjamin Harrison, Election Campaign of 1888

Strategic trade policy Reduce demand for foreign stuff

lower its price a lot Big gain on what you still buy Ways to restrict trade

Tariffs/Non-Tariff Barriers

5

Flavors of tariffs

Tariff: a tax (duty) on internationally traded products Import tariffs Export tariffs … unconstitutional in US

Raise revenue Favor domestic users of exported commodities In primary goods exporting countries, favor urban over rural areas

Protective tariff – insulate domestic producers Revenue tariff – raise funds for government Specific tariff – Fixed $/Unit Ad valorem tariff – % of product’s value

“Free-on-board” (FOB) as it leaves port Levied “cost-insurance-freight” (CIF) as it arrives in port

Compound tariff - Combination of fixed and ad valorem tariffs Levied on finished goods whose imported inputs are subject to tariff

Fixed portion offsets tariffs on imports paid by domestic producers % portion protects domestic producers against finished good imports

Effective rate of protection For a finished good, the effective rate of tariff

protection enjoyed by a domestic producer is the net tariff on the imported product as a fraction of the producer’s domestic value added. Net tariff = tariff on imported product that competes with his

product minus any tariffs he has to pay on imported inputs

Effective tariff rate = {Nominal tariff – (Value of Imports/Total Value)x(Tariff on Imports)} (Domestic Value Added)/Total Value

The impact of a tariff is often different from its stated amount Tariff Escalation: If domestic value added (domestic content)

is low and tariffs on imports are also low

Effective tariff >> Nominal tariff.

Nominal and Effective Tariff Rates(US and Japan, early 1980s)

US Japan

Nominal Effective Nominal Effective

Agriculture, fish, forest. 1.8% 1.9% 18.4% 21.4%

Food, beverages,tobacco 4.7 10.6 25.4 50.3

Footwear 8.8 15.4 15.7 50.0

Furniture 4.1 5.5 5.1 10.3

Leather products 4.2 5.0 3.0 -14.8

Paper and paper products 0.2 -0.9 2.1 1.8

Textiles 9.2 18.0 3.3 2.4

Wearing apparel 22.7 43.3 13.4 42.2

Wood products 1.6 1.7 0.3 -30.6

Avoiding and postponing tariffs Production sharing special treatment for

foreign assembly using domestic inputs OAP: Offshore Assembly Provision

Maquiladoras

Bonded warehouses Assemble imported components and reexport duty free If sell domestically, tariff is levied only on imported value at

time good leave the warehouse

Foreign trade zones (FTZ) Duties imposed like for bonded warehouse Greater flexibility to process imported components

Arguments for trade restrictions Job protection

… but losses elsewhere

Protect against “cheap” foreign labor… but is foreign labor “cheap”? Worker productivity

Fairness in trade – “level playing field”

Principles of Fair Trade … Trade Not Aid

Democratic organization Producer cooperatives

Recognize unions No child labor Decent working conditions Environmental sustainability Prices that cover production costs

Price guarantees irrespective of world prices Social premiums

Pay premiums to organizations public goods Long-term relationships

Reduce uncertainties

Arguments for trade restrictions Job protection

… but losses elsewhere

Protect against “cheap” foreign labor… but is foreign labor “cheap”? Worker productivity

Fairness in trade – level playing field… but sacrifice gains from trade

Equalization of production costs… but whose costs? [Their low cost producer = Our high cost?]

Infant-industry protection Achieve efficient scale… but protect senile industries too?

Political and social reasons Protect against cultural imperialism National defense/Self–sufficiency…reduce dependence

... but could build strategic reserves instead

Import quotas Quota: how much can be imported in a year

Global quotas Selective quotas

Government loses tariff revenue Quota is insensitive to demand shifts

Tariff-rate quota: a two-tiered tariff More can be imported if demand increases … but

only at a higher tariff rate

Non – Tariff Barriers (NTBs)

Voluntary export restraints (VERs) Impose export quota … or else!

Japanese auto exports unintended consequences Domestic content requirements Subsidies

Domestic subsidy … e.g. R & D “Green jobs”

Export subsidy Government procurement policies Social regulations (health, environmental and safety

rules) Hormones in beef / genetically engineered produce

Sea transport and freight restrictions

Other NTBs

Costs of import restrictions redux

Domestic consumers face increased costsOverall net loss for the economy (deadweight loss)

Production effect: output that cost more than it has to (b) Consumption effect: surplus lost from reduced

consumption (d) Export industries face higher costs for inputs Cost of living increases Retaliation

Problem 4.15 “Australian market for TVs”

In autarky Market clearing price Quantity supplied and bought Consumer surplus Producer surplus

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$500 400 300 250 200 100 0

0102025304050

504030252010 0

503010-

(10)(30)(50)

“Australian market for TVs”

World price = $100 Quantity bought Quantity supplied by Australian producers Consumer surplus Producer surplus

Problem 4.15

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$500 400 300 200 100 0

01020304050

5040302010 0

503010

(10)(30)(50)

“Australian market for TVs”

World price = $100 / Tariff = $100 Quantity bought Quantity supplied by Australian producers Consumer surplus Producer surplus Revenue Redistributive effect Protective effect / Consumption effect / Deadweight loss

Problem 4.15

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$500 400 300 200 100 0

01020304050

5040302010 0

503010

(10)(30)(50)

Problem 5.16

“Venezuelan market for TVs”

World price = $150 / Free trade Quantity bought Quantity supplied by Venezuelan producers Consumer surplus Producer surplus

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$100 150 200 300 400 500

900800 700 500 300 100

0100200400600800

(900)(700)(500)(100)200700

Problem 5.16 “Venezuelan market for TVs”

World price = $150 / Import quota = 300 TVs Price in Venezuela … Quantity bought Quantity supplied by Venezuelan producers Reduced consumer surplus Increased producer surplus Earnings of Venezuelan importers who buy at world price Net loss to Venezuelans

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$100 200 300 400 500

900 700 500 300 100

0200400600800

(900)(500)(100)200700

Problem 5.16 “Venezuelan market for TVs”

World price = $150 / Import quota = 300 TVs Price in Venezuela … Quantity bought Quantity supplied by Venezuelan producers Reduced consumer surplus Increased producer surplus Earnings of foreign monopolists who sell at Venez’n price Net loss to Venezuelans

PriceQuantity

DemandedQuantity Supplied

Export(Import)

$100 200 300 400 500

900 700 500 300 100

0200400600800

(900)(500)(100)200700

Problem 5.16 “Venezuelan market for TVs”

World price = $150 / Subsidy to producers = $100/TV Price in Venezuela … Quantity bought Quantity supplied by Venezuelan producers Increased producer surplus Increased production cost Cost of subsidy to Venezuelan taxpayers Net loss to Venezuelans

Price to Consumers

Quantity Demanded

Quantity Supplied

Export(Import)

$100 200 300 400 500

900 700 500 300 100

200 400 600 8001000

(700)(300)100500900