International Trade 13

5 November 2013

International Trade, WTO, and Trade Policy Issues

Dr. V L Rao, GITAM Chair Professor of International Trade and Finance

Dr. Radha Raghuramapatruni, Associate Professor

GITAM School of International Business

GITAM University

Mercantilism(SS) Keynes

17th and 18th centuries– Discourage imports and encourage exports to

increase country’s wealth.– Zero-sum game

(Positive-sum game or n-sum game)

Q. Mercantilism implies that international trade is a ________ sum game.

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New Mercantilism

(Bergsten and Subramanian)

November 2008: first Summit of G-20

Q. What is G-20? What was its predecessor?

Q. What was the need for the Summit in 2008?

The Summit:• Inter alia, pledged to promote world trade• Yet G-20 countries erected new distortions:

– Raised tariffs: Brazil, India, Russia– New licensing requirements for imports: Argentina,

Indonesia

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– Export subsidies: EU, China– Restriction on government procurement of foreign

products: USA (e.g. on Mexican trucks resulting in retaliation)

Competitive currency depreciation:– Keeping down the value of pound sterling hurt Irish

mfg– Switzerland weakened franc to support exports– Chinese currency considerably undervalued

• This strategy works for a few smaller countries • But not for the world as a whole: someone has to

import if others want to export (Krugman’s comment: export to Mars?) 4

Fallacy of Composition (will refer to this again in Adding-up Problem)

FX reserves:

China: $ 2 trillion

Russia: $ 600 billion

India, South Korea: $250 billion

• For ‘self-insurance’ against a rainy day

Q. Why is it called ‘self insurance’?

G-20 April 2009 Summit

• Pledged to refrain from competitive devaluation of currencies

So multilateral cooperation needed

Alternative: boost domestic demand

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Adam Smith (Absolute Advantage) 1776

(DS, 33-35)

Refuted mercantilism

Advocated:

– laissez-faire

– free trade based on specialization

Canada Wheat

Nicaragua Bananas

Q. What is a banana republic?

1991: Some observers said that India was almost a banana republic

October 2013: USA (not trade-related).

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Canada is more efficient than Nicaragua in producing wheat and vice versa in bananas

Production vs. Productivity

Higher production does not mean higher productivity:• Production will be more if more land or labour is used. • Productivity (i.e. production per hectare or per man-hour)

measures efficiency.

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DS Table 2.1

Output / man-hour

( or Labour Productivity)

US UK

Wheat (bushels) 6 1

Cloth (yds.) 4 5

Q. Why man-hour and not number of workers?

Q. US is more efficient than UK in the production of________

UK is more efficient than US in the production of_________

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Q. US has absolute advantage in _________UK has absolute advantage in _________

Gains from Specialization and Trade

US gains if 6W exchanges > 4CSuppose it exchanges at 6W = 6C.Gain to US is:____ (i.e. ____ labour time)

UK Domestically 1W = 5C, i.e. 6W = 30C Trade with US 6W = 6CSaves ____ (i.e. about __ man-hours)

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Review Questions

Q. Adam Smith _______ (opposed / supported) mercantilism. Explain your answer.

Q. Efficiency is measured by labour productivity (LP). LP is defined as production (i.e. output) per labour hour.

• Why is efficiency measured by productivity and not production?

• Why is output divided by number of hours worked and not number of workers?

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Comparative Advantage (Ricardo 1817)(DS 35-37)

Lawyer-secretary example

Table 2.2Output / man-hourUS UK

Wheat (bushels) 6 1Cloth (yds.) 4 2

US is more efficient than UK in bothIn wheat: _____ timesIn cloth: _____ times

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_______ has absolute advantage in both wheat and cloth_______ has absolute disadvantage in both wheat and

cloth

US has greater absolute advantage in wheat (6:1) than in cloth ( )

Therefore, US has comparative advantage in wheat

UK has lower absolute disadvantage in ______ ( ) than in ______ ( )

Therefore, UK has comparative advantage in ______

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Gains from Specialization and Trade

US should specialize in _________

UK should specialize in _________

Domestically in US 6W = 4C

in UK 1W = 2C or 6W = 12C

US gains only if it gets > 4C for 6WUK gains only if it has to give < 12C for 6W

The range for mutually advantageous trade is:4C < 6W < 12C

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Suppose they exchange at 6W for 6C

US gets domestically 4C for 6WIn trade, it gets 6CSo it gains ________ or ______ man-hours

UK domestically has to give 12C to get 6W. In trade it gives only 6C.

So it saves ________ or_______ man-hours

Q. Compute the gains to both if they exchange at6W = 8C

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Economic Theory as a Political Instrument(K-O)War with France –

1789 French Revolution to 1815 (battle of Waterloo)Napoleon’s comment: nation of shop-keepers

Q. Britain: exporter of ______ (Mfs / ag. products) Why?

Blockade on trade

Q.Relative prices of food in UK _______(increased /decreased)

Q. After war, food prices fell in Britain. Why?

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Influential landowners got Corn Laws passed

Ricardo (London businessman) – argued for:– repeal of Corn Laws– free trade to end tariffs on food imports

Corn Laws Repealed: 1846 (Ricardo died in 1823)

Thomas Hardy

Mayor of Casterbridge(Novel first published in 1886)

One of the events that formed the basis for the novel:– The uncertain harvests which immediately preceded

the repeal of the Corn Laws 

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Review QuestionsTable 2.2

Output / man-hourUS UK

Wheat (bushels) 6 1Cloth (yds.) 4 2

Q. In which product has India comparative advantage and why?

Q. If the exchange rate between the two countries is

6W = 10C, compute the gains for each country in terms of quantity and time saved .

Q. If the exchange rate between the two countries is

6W = 12C, which country won’t be interested in trade and why?

Q. The average productivity of labour in Japanese manufacturing in 1990 was 20 percent  lower than labour productivity in the US. But in automobiles and auto parts industry Japanese productivity was 16 to 24% higher than American productivity.  From this it can be inferred that Japan has _______ (absolute /  comparative) advantage in automobiles and parts. Explain your answer.

Q. (Hypothetical, not actual): The average productivity of labour in Japanese manufacturing in 1990 was 20 percent  lower than labour productivity in the US. But in apparel industry Japanese productivity was 16 percent lower than American productivity.  From this it can be inferred that Japan has _______ (absolute /  comparative) advantage in apparel. Explain your answer.

Merchandise Exports of Select Countries(US $ bn)

Germany China India USA Japan

2001 572 266 43 729 403

2006 1108 969 122 1026 647

2007 1321 1220 150 1148 714

2008 1446 1431 195 1287 781

2009 1120 1202 165 1056 581

2010 1259 1578 220 1278 770

2011 1472 1898 305 1480 823

(Source: WTO, International Trade Statistics 2012, Appendix Tables)

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Case Study – Germany

ULC• Labour cost / Output = w /LP

After reunification in 1990, ULC increasedQ. Why referred as ‘reunification’?Q. Higher wage rate (why?)Q. Lower productivity (why?)

– Exports declinedLater, exports increased

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• Threat of firms moving to central or eastern Europe held wage rates in check

• LP was boosted through training

IHT, 4 August 2010

Exports helped by:– Resisting rise in wages

• Trumpf, a German machine tool mfr, laid off 90 out of 650 in the US

• But no lay off of 4,000 in Germany• Short work (i.e. reduced hours, 85% salary, no

layoffs)– Skill development in spare time

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The Economist, 13 March 2010

Consensus-building management system (Mittelstand)

ULC Annual Average Change (2000-08)

Decline

Germany 1.4%

USA 0.7%

Rise

France 0.8%

Britain 0.7%

Q. Among the four which is most competitive? Why?

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Factor-proportions Theory or Factor-endowments Model or H-O Theory ( Heckscher 1919, Ohlin 1933)

(S-S)

Adam Smith – Absolute advantage

Ricardo - Comparative advantage

(based on efficiency – or productivity of labour)

Source of this efficiency: not explained – Why is it that US has comparative advantage in

machinery?– Why is it that India has comparative advantage in

cloth?

US is K-abundant, machinery is K-intensive. Since K is cheaper in US, it can produce machinery cheaper.

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India is L-abundant, cloth is L-intensive . Since___ is cheaper in India, it can produce cloth cheaper.

Formal explanation:US is K-abundant

1992 $

K / L in US 35,993K / L in India 1,997

Q. Why ratio?(r / w) in US ____ (> or <) (r / w) in India or(w / r) in US ____ (> or <) (w / r) in India

Q. Why ratio? 24

Table 3.1Machine production: more K- intensive both in the US and India compared to cloth production:

K / L ratio in machines ______ in cloth ______

• Machines are more capital intensive in both countries.• But K-intensity is same in both countries for each

product

Q. In reality, for each product, will the ratios be equal in the two countries?In which country do you expect them to be higher?

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FP or H-O Theorem: A country will have comparative advantage in goods whose production intensively uses its relatively abundant factor of production

Factor-Price Equalization Theorem (H-O-S) Theorem

(S – S)

As trade opens, industrial structure changes.

US: demand for machines goes ____ (up / down)

- price of machines goes ____

- Demand for K goes _____ (up / down) (Derived demand)

- r goes up– Vice versa for cloth: w goes down

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India – opposite: w/r goes up

(w/r) in US tends to converge to (w/r) in India

Lesson for MNCs • Investment decisions are based on wage differentials. • But FPE will erode that advantage

Trade Adjustment Assistance (USA)

(S-S)

Samuelson – compensate labour

US – TAA since 1962 for L displaced due to imports

2001: $407 million

Q. TAA is by nature discriminatory – why?

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Wage inequalities in US

(DS, p.135) 1995

Tech. change 38%

Int. trade 10%

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Product Cycle

(DS, 179-181)

Vernon (1966)

Innovation, technology and high-skilled L: new product

Product standardised: mass production with less-skilled labour

Comparative advantage: shifts from developed to developing countries

(+ FDI flows)

Example: Post II War

US firms – dominated in radios (using vacuum tube)

Japan copied US tech. and used cheap labour

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US introduced transistors and then printed circuitsBut comparative advantage shifted to Japan

Stage I: New product phase ( domestic sales)Stage II: Product-growth phase (exports)Stage III: Product-maturity phase (standardised – licensed

to other countries)Stage IV: Price competition, not brand competitionStage V: Imitating country – exporter Innovating country - importer

PC model - extension of the basic H-O model in a technologically dynamic world, not an alternative trade model

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– HO model: L and K are factors– New factor: Technology - Relative factor abundance

(technology) in industrialised countries

Basic H-O model - explains static comparative advantage

PC model – explains dynamic comparative advantage

Recent years:• Diffusion lag shortened• Innovating countries need to act faster

“The United States must run faster and faster to avoid falling behind”

Q. This is similar to which famous statement? 31

Bhagwati: Kaleidoscopic Comparative Advantage

Q. ‘Geography is history’: what does this mean in the context of what Bhagwati said in this paragraph?

The world is flat – there is no comparative advantage left.

Bhagwati counters this argument:• Educated manpower in India

– Only 6% make it to college• Of these, two-thirds graduate• Just a small fraction speak English

• China and India have lower wages

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• But US has:– Better infrastructure– Stronger VC markets– Culture of inventiveness

• i.e. comparative advantage persists

Kaleidoscopic Comparative Advantage• E.g. Boeing – Airbus – Boeing• ‘The proper response to flux is to manage it.’• Strengthen Adjustment Assistance Programmes.

Examples: – Aeronautical to automobile engg. – General engineering skills than specialized ones– Radiologists – cosmetic surgery

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IITS-S

H-O: Interindustry trade - mostly between developed and developing countries

IIT: between developed countries – e.g. cars, based on product differentiation

IIT index = 1 – [IX-MI / (X + M)]

Industry USA_________Machines X=$1m M=0 I = 0Cloth X=0 M=$1m I =___Food X=$50,000 M=$50,000 I =___

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I.e. The index lies between 0 and 1

Industry Dresses

US exports $100,000 (women’s) dresses imports $100,000 (men’s) dresses I = ____

Women’s DressesUS X=$100,000 M=0 I =_____

Men’s DressesUS X=0 M=$100,000 I =_____

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Q. The more broadly we define an industry / product group, the _____ (higher / lower) will be the value of IIT index.

Other examples: Computers and parts; automobiles and parts

IIT in Homogeneous GoodsCement : Transport costServices: Transport, insurance and financial services– US exports computers to Germany &

imports automobiles from Germany : inter-industry trade

– Related services : IIT

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Entrepot tradeOnly storage and distribution

(Singapore)Re-export trade

Small transformation – import, sort, re-pack, label, and export(Singapore, HK-SAR, and the Netherlands)

IIT in Differentiated Products• Horizontally differentiate products: Candy bars

Have same price, but different flavours and ingredients

• Vertically differentiated products: automobilesWide variation in prices and physical characteristics

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Monopolistic competition

Women’s clothing

Oligopoly

Automobiles, TVs, tires

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Tariffs and ERP

(Carbaugh)

Q. Normally countries impose higher tariffs on imports of ______ (inputs / final product). Why?

Q. Examples?

Nominal and effective tariff rates

Import of radio

$

Free trade price of radio 100

Nominal tariff on radio 10

Price incl. tariff 110

(No tariffs on radio parts)

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Incidence on consumers 10% ($10 tariff on import price of $100)

Domestic Competing Radio

Tariff on RadioNil 10%

Imported parts 80 80

Domestic value added

(assembly cost) 20 30

Total 100 110

(No tariffs on radio parts)

Under protection, assembly cost can be $30 instead of $20 to compete with imports. The producers can afford $10 extra cost than under free trade. The extent of protection is: $10 /$20= 50%

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Nominal tariff: 10%

Effective tariff: 50%

Q. While the nominal tariff rate is important to consumers, ERP is important to producers – Explain

Q. The tariff is imposed on inputs is nominal tariff, while the tariff imposed on final products is the effective tariff. What is wrong with this statement?

Duty on Imported Parts

Q. If you are a producer of radios:• what is your preference: tariff on radios or parts?• If there is, say, 5% nominal tariff on parts, ERP to you is

higher or lower than before (i.e. when no tariffs on parts)

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Formula for ERP:

e =

n – ab

1 – a

n = 10%, a = 80%

Q. If b = 0%, e = ______

Q. If b = 5%, e = less or more than above?

Q. If b = 20%, e = _______

Q. As a producer of radios, you want tariffs to be higher for: radios or parts?

Inverted duty structure: negative effective protection

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Case Study: Tyres and Natural Rubber(Economic Times, 12 August 2012)

Import Duties(%)

Tyres 10%

Natural Rubber 20%

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Regional Economic Arrangements

(SS)

WTO consistency

Q. Why inconsistent?• Notify WTO• Substantial coverage• Not to raise trade barriers to non-members, i.e. TC

should be > TD (see p.188)

Substantial coverage• Only non-ag. products, e.g. EU-Israel, EU-Turkey • All merchandise• Trade in G and S, FDI, portfolio investment, e.g. NAFTA

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Degrees / Levels of Economic Integration

PTA - positive list

FTA

Q. Examples?• Negative list• Trade Deflection

– US, Mexico, Japan 4% and 20%• RoO

– To avoid trade deflection– Min. VAD 62.5% for cars in NAFTA

CU: FTA + CET• Harmonization or phasing in - about 15 years• Coverage more comprehensive than FTA

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CM: CU + free movement of L and K

Advantages and disadvantages

EU: CM + some degree of unification in economic policies

Q. Example of a common target for an economic policy?

TC and TD

Fig. 9.1, p188

Mexico substitutes more efficient US cars for less efficient Mexican cars: TC

Mexico substitutes less efficient US cars for more efficient Japanese cars: TD

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International Trade and Economic Development

(DS)Trade as Engine of GrowthQ. In recent years, this concept was applied to which

countries / region?1815 to 1913 • Britain’s GNP increased 10 timesDue to increase in industrial productionQ. Why?• Rising demand for food and raw materials (imports

increased 20 times)• Exports of ‘regions of recent settlement’ to Britain

increased• Helped their growth through ‘accelerator-multiplier’

process.• That is, trade acted as engine of growth (One economist

– Nurkse) 47

Q. ‘Trade as engine of growth’ concept applies to Britain or regions of recent settlement?

Another Economist (Kravis)

The regions of recent settlement were:• Richly endowed with natural resources• Inflow of capital and skilled labour

– Built good local transport facilities• Improvement in sea transportation

So:• Growth was due to favourable internal conditions• Trade played a supportive role (handmaiden)Now (developing countries)Demand side:• Low income elasticity of demand

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• Synthetic substitutes• Tech advances• Growth of demand for services• Trade restrictionsSupply side:• Less endowed with natural resources• Over population• Less inflow of capital• Outflow, not inflow, of skilled labour• Neglect of agriculture

Case Study: Asian Miracle (DS, p. 362)• Supports handmaiden version – exports, high S and I

rates, education and training, technology, etc. caused high growth

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Terms of Trade

(DS, 11.3 A)

Commodity or Net Barter ToT (or simply ToT)

N = (Px / Pm) x 100

Income ToT or purchasing power of exports or export-based capacity to import

I = [(Px x Qx) / Pm] x 100

ToT of Developing Countries

Commodity Terms of Trade

Prebisch-Singer Hypothesis: secular decline 1870 - 1938

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ToT depend on type of products exported and their price trends

• 1972 – 2001: ToT of raw materials exporters increased

Income Terms of Trade of Developing Countries (1953-1983)

• 20% decline in commodity ToT• But 165% increase in income terms of trade

Q. What is the inference?

UN (2012), Figure II.6 ToT• Oil exporters: sharp rise till 2008 and wide fluctuations

thereafter• Minerals: Rise after 2011 due to rising prices of precious

metals because of economic uncertainty• Manufactures exporters: decline

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ER and Impact on Trade

Stable and unstable FX markets

DS, p.555, 16.4A, Fig. 16.3 (excl. the middle figure)

Marshall-Lerner Condition

DS, 16.4B

Estimates

DS, 16.5A

1924 -1938: Sum barely exceeded 1

Elasticity pessimism

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Lags, p.559

Recognition lag

Decision ‘’

Delivery ‘’

Replacement “

Production ‘’

16.5 B • J-Curve• Short-run and long-run elasticities

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GATT / WTORoad Map : 1948-2005

23 Members128 Members 144 Members

1948 GATT Est.

7 Rounds

1986

UruguayRound

1994

1995WTOEst.

1996Singapore

1999Seattle 2001

Doha

Sept‘03 Cancun

Mainly Tariffs (Goods)

+ NTMs (Quotas, Standards, Antidumping and Countervailing Duties, etc), Agriculture, Services,Textiles and Clothing, etc.

+Labour standards+Singapore Issues: Investment, CompetitionPolicy, Trade Facilitation, and Transparency in GovernmentProcurement

+Trade &Environment

[Doha Development Agenda]

1998Geneva

+E-commerce

Prof. V.L.RaoGSIB, GITAM University

July ’04 Package

Dec. ‘05Hong Kong

148 MembersFeb.’05

153 Members Feb.11

GATT WTOStatus Unofficial Legal

Coverage Mainly Goods Goods + (Tariffs) Services, IPRs,

etc.

Agreements Individual Single Undertaking

Article GATT 1948 GATT 1994

Transparency Limited TPR

Dispute Settlement Weak DSB

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PrinciplesNon-discirmination• MFN• National TreatmentQ. RTAs – an exception to MFN or national treatment?

Why? Q. Changing customs duty on an import is not a violation of

national treatment. Why?

Bound Rates and Applied Rates

Q. In developing countries which rates are higher and why?• Policy space• Negotiating tool• Unilateral liberalization and reform• Bilateral and multilateral negotiations 56

Free trade vs. Fair Trade

Plurilateral Agreements• E.g. Agreement on Government Procurement

LDCs

Duty-free quota-free imports for almost all LDC products

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AoA

Three Pillars• Market Access

– Tariffs– Tariffication

• Domestic Support• Export Subsidies

Reductions

For developing countries• Lower• Longer periods

LDCs: no commitments

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SSG: for tariffied products

SSM: demanded by developing countries

Special Products

Modalities• Foresee future limits on product-specific support

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NAMA

NAMA products: account for 90% of world merchandise trade

‘Water’ or ‘binding overhang’

Swiss formula

AX / (A + X)• Reduces

– Tariff peaks, high tariffs, and tariff escalation

A: 5 and 20

Q. Which one will be preferred by the developing countries?

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Services Modes

1 Cross-border supplye.g. international telephone calls

2 Consumption abroade.g. tourism

3 Commercial presencee.g. foreign banks setting up operations in

a country4 Presence of natural persons

e.g. fashion models, consultants , software engineers

Q. Why called ‘natural’ persons?

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FlexibilityMFN exemptions

Commitments + list of services already covered under bilateral or regional agreements

Market-access commitmente. g. foreign banks can operate in domestic market

Market access limitatione. g. on number of branches

Exception to national treatmente. g. less number of branches for foreign banks than domestic banks

Government services: exemptSector-by-sector

Commitments not required on whole set of services sectors

2001: Made part of ‘Single Undertaking’ 62

TRIPSPatents, trade marks, copy rights, etc.

1995: CL already in TRIPs• Doubts expressed by developing countries in

implementation

2001: Separate Declaration on TRIPS and Public Health• CIPLA case (Paragraph 4)• Paragraph 6: In case of no mfg capacities

2003: “Waiver’ adopted by the General Council

2005: Endorsed the Amendment to TRIPS AgreementQ. Why was this needed?

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Cases

India’s generic drugs (BS, Jan. 23, 2012)• Goods in transit seized by EU countries on grounds of

infringing IPR• India to approach DSB• EU promises to settle the issue during bilateral talks

Natco’s cancer drug (BL, 13 March 2012)• First CL• 6% royalty to Bayer• Bayer price: Rs. 2.8 lakhs per a month’s supply• NATCO price: Rs. 8,800

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Novartis’ cancer drug (BL, 13 March 2012)• Evrergreening• Supreme Court verdict awaited

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Contingent Protection (ADD, CVD, Safeguards)

Dumping: export price below ‘normal value’

Normal value:– Price in exporter’s domestic market– Export price in another country– Production costs + normal profits

ADD allowed if:– Show that there is dumping– Calculate the extent of dumping– Establish ‘material’ or ‘serious’ injury

Sunset clause: normally 5 years

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Subsidies

Dumping: action by a company

Subsidies: action by government

Subsidies hurt:– Domestic industry in the importing country– Rival exporters in a third country– Other country exporters competing with domestic

products

Injury test and sunset clause

Exemption: LDCs and developing countries with < $1,000 per capita GNP

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Safeguards: if there is ‘surge of imports’

Already there under GATT, but were ‘grey’– Voluntary export restraints, e.g. automobiles, steel,

T&C – Injury test and sunset clause (4 years)

Q. Why called ‘contingent’?

Q. Difference between this and regular tariffs?

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