International Economics Trade policies. Classification of Commercial Policy Instruments Commercial Policy Instruments Trade Contraction Trade Expansion.

International Economics

Trade policies

Classification of Commercial Policy Instruments

Commercial Policy Instruments

Trade Contraction Trade Expansion

Tariff Export tax

Import quotaVoluntary

Export Restraint

(VER)

Import subsidyExport subsidy

Voluntary Import

Expansion (VIE)

Price Quantity Price Quantity

Defining tariffs A tariff is a tax (duty) levied on products as

they move between nations Import tariff - levied on imports Export tariff - levied on exported goods as they

leave the country Protective tariff - designed to insulate domestic

producers from competition Revenue tariff - intended to raise funds for the

government budget (no longer important in industrial countries)

Tariffs

Types of tariff Specific tariff

Fixed monetary fee per unit of the product

Ad valorem tariff Levied as a percentage of the value of the

product

Compound tariff A combination of the above, often levied on

finished goods whose components are also subject to tariff if imported separately

Tariffs

Effective rate of protection The impact of a tariff is often different from

its stated amount The effective tariff rate measures the total

increase in domestic production that the tariff makes possible, compared to free trade Domestic producers may use imported inputs

or intermediate goods subject to various tariffs, which affects the calculation

Tariffs

Effective rate of protection (cont’d)

When tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate

This is referred to as tariff escalation

Tariffs

Tariff welfare effects Consumer surplus

The difference between the price buyers would be willing to pay and what they actually pay

Producer surplus The revenue producers receive above the

minimum amount required to induce them to produce a good

Tariffs

Consumer and producer surplus

Tariffs

Who pays for import restrictions? Domestic consumers face increased costs

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

Overall net loss for the economy (deadweight loss)

Export industries face higher costs for inputs Cost of living increases Other nations may retaliate, further restricting

trade

Tariff effects

Useful definitions: The terms of trade is the relative price of the

exportable good expressed in units of the importable good.

A small country is a country that cannot affect its terms of trade no matter how much it trades with the rest of the world.

Consumer Surplus Producer Surplus

Basic Tariff Analysis

Figure 8-5: A Tariff in a Small Country

SPrice, P

Quantity, Q

D

Price with tariff

Price withouttariff

Imports after tariff

S1 D1

Imports before tariff

D2S2

Basic Tariff Analysis-Small Country

A

B

C

FE

D

G

Tariff trade and welfare effects

Welfare effects of tariffs

Costs and Benefits of a Tariff A tariff raises the price of a good in the

importing country and lowers it in the exporting country.

As a result of these price changes: Consumers lose in the importing country Producers gain in the importing country Government imposing the tariff gains revenue

Effects of a Tariff Assume that two large countries trade with

each other. Suppose Home imposes a tax of $2 on every

bushel of wheat imported. Then shippers will be unwilling to move the wheat

unless the price difference between the two markets is at least $2.

Figure 8-4 illustrates the effects of a specific tariff of $t per unit of wheat.

Basic Tariff Analysis-Large Country

The increase in the domestic Home price is less than the tariff, because part of the tariff is reflected in a decline in Foreign’ s export price. If Home is a small country and imposes a tariff,

the foreign export prices are unaffected and the domestic price at Home (the importing country) rises by the full amount of the tariff.

Basic Tariff Analysis

In the absence of tariff, the world price of wheat (Pw) would be equalized in both countries.

With the tariff in place, the price of wheat rises to PT

at Home and falls to P*T (= PT – t) at Foreign until the price difference is $t.

• In Home: producers supply more and consumers demand less due to the higher price, so that fewer imports are demanded.

• In Foreign: producers supply less and consumers demand more due to the lower price, so that fewer exports are supplied.

• Thus, the volume of wheat traded declines due to the imposition of the tariff.

Basic Tariff Analysis

Costs and Benefits of a Tariff A tariff raises the price of a good in the

importing country and lowers it in the exporting country.

As a result of these price changes: Consumers lose in the importing country and

gain in the exporting country Producers gain in the importing country and

lose in the exporting country Government imposing the tariff gains revenue

The areas of the two triangles b and d measure the loss to the nation as a whole (efficiency loss) and the area of the rectangle e measures an offsetting gain (terms of trade gain). The efficiency loss arises because a tariff distorts

incentives to consume and produce.• Producers and consumers act as if imports were more

expensive than they actually are.• Triangle b is the production distortion loss and triangle

d is the consumption distortion loss. The terms of trade gain arises because a tariff lowers

foreign export prices (or Home import prices). If the terms of trade gain is greater than the efficiency loss, the

tariff increases welfare for the importing country.

Costs and Benefits of a Tariff

Large country model

Costs and Benefits of a Tariff

PT

PW

P*T

b c d

e

D

a

= consumer loss (a + b + c + d)

= producer gain (a)

= government revenue gain (c + e)

QT

D2S2

S

S1 D1

Price, P

Quantity, Q

Figure 8-10: Net Welfare Effects of a Tariff

PT

PW

P*T

b d

e

D

= efficiency loss (b + d)

= terms of trade gain (e)

Imports

SPrice, P

Quantity, Q

Costs and Benefits of a Tariff

Optimal Tariff Small Country: Optimal tariff t=0 Large Country: Optimal tariff (to) maximizes the

gain from tariff

Maximize [e- (b + d)]

t

e-(b+d)

to

Export Subsidies: Theory Export subsidy

A payment by the government to a firm or individual that ships a good abroad

• When the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy.

It can be either specific or ad valorem.

Other Instruments of Trade Policy

ba

Figure 8-11: Effects of an Export Subsidy

Other Instruments of Trade Policy

PS

PW

P*S

Price, P

Quantity, QExports

gfe

Subsidy dc = producer gain (a + b + c)= consumer loss (a + b)

= cost of government subsidy (b + c + d + e + f + g)

D

S

An export subsidy raises prices in the exporting country while lowering them in the importing country.

In addition, and in contrast to a tariff, the export subsidy worsens the terms of trade.

An export subsidy unambiguously leads to costs that exceed its benefits.

Other Instruments of Trade Policy

Figure: Europe’s Common Agricultural Program

Other Instruments of Trade Policy

Price, P

Quantity, Q

S

D

EU price without imports

World price

= cost of government subsidy

Support price

Exports

Import Quotas: Theory An import quota is a direct restriction on the

quantity of a good that is imported. Example: The United States has a quota on imports

of foreign cheese. The restriction is usually enforced by issuing

licenses to some group of individuals or firms. Example: The only firms allowed to import cheese

are certain trading companies. In some cases (e.g. sugar and apparel), the

right to sell in the United States is given directly to the governments of exporting countries.

Other Instruments of Trade Policy

An import quota always raises the domestic price of the imported good.

License holders are able to buy imports and resell them at a higher price in the domestic market. The profits received by the holders of import

licenses are known as quota rents. They accrue to licenses holders

Welfare analysis of import quotas versus that of tariffs The difference between a quota and a tariff is that

with a quota the government receives no revenue. In assessing the costs and benefits of an import

quota, it is crucial to determine who gets the rents.

Other Instruments of Trade Policy

Price in U.S. Market 466

World Price 280b c d

Demand

a

8.456.32

Supply

5.14 9.26

Price, $/ton

Quantity of sugar,million tons

Figure 8-13: Effects of the U.S. Import Quota on Sugar

Import Quota

Import quota:2.13 million tons

= consumer loss (a + b + c + d)

= producer gain (a)

= quota rents (c)

Imposing a tariff

of 186

Equivalence between tariff and quota

Both are equivalent Except that tariff rents accrue to govt. and

Quota rents to license holders If

P.C in domestic market Competitive foreign supply Quota allocated to ensure P.C among quota holders

Voluntary Export Restraints A voluntary export restraint (VER) is an

export quota administered by the exporting country. It is also known as a voluntary restraint agreement

(VRA).

VERs are imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions.

Other Instruments of Trade Policy

A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country.

A VER is always more costly to the importing country than a tariff that limits imports by the same amount. The tariff equivalent revenue becomes rents earned by

foreigners under the VER.• Example: About 2/3 of the cost to consumers of the three major

U.S. voluntary restraints in textiles and apparel, steel, and automobiles is accounted for by the rents earned by foreigners.

A VER produces a loss for the importing country.

Other Instruments of Trade Policy

Arguments for trade restrictions Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons

Reasons for tariffs

Politics of protectionism “Supply” of protectionism (trade policy)

depends on: the cost to society of restricting trade the political importance of the import-competing

industries Magnitude of the adjustment costs from free

trade Public sympathy for those sectors hurt by free

trade

Reasons for tariffs

Politics of protectionism “Demand” for protectionism depends on:

The amount of the import-competing industry’s comparative disadvantage

The level of import penetration The level of concentration in the affected sector The degree of export dependence in the sector

Reasons for tariffs