Oatley, Chapters 2 and 3
Dec 26, 2015
Oatley, Chapters 2 and 3
The World Trade Organization and the World Trade System – Chapter 2Growth in world tradeWorld merchandise trade; 1953: $84 billion2007: $14 trillionInternationalization of production and
consumptionThis is based on political structures: the WTO
(and its predecessor, GATT)
WTOWTO – commonly negotiated and enforced
rules to govern world tradeIn 1995 GATT became what is now WTOWTO
is a forum for trade negotiationsadministers trade agreementsprovides mechanisms to resolve trade disputes
WTOAs a political system, WTO can be broken
down into 3 parts:A set of principles and rulesAn intergovernmental bargaining processA dispute settlement mechanism
I. WTO principlesWTO is based on 2 core principles:
Market liberalismNon-discrimination
Market liberalismAssertion: Open/liberal trade system raises
world living standardsThis provides the economic logic for WTOPlease check:
http://news.bbc.co.uk/2/hi/europe/country_profiles/2430089.stm
On Doha Round:http://www.theguardian.com/global-
development/2012/sep/03/doha-round-trade-talks-explainer
Non-discriminationIdentical opportunities to trade:
each WTO member faces identical opportunities to trade with other WTO members. This principle takes two specific forms within the WTO.
Most-Favored Nation (MFN) prohibits governments from using trade policies to provide special advantages to some countries and not to others.
It simply requires each WTO member to treat all WTO members the same way as it treats its favourite trading partner.
Non-discrimination but there are exceptions to MFN, including regional
trade arrangements and customs union… there is another exception: the Generalized System
of Preferences (GSP) enacted in late 1960s. It allows the advanced industrialized countries
to apply lower tariffs to imports from developing countries than they apply to the same goods coming from other advanced industrialized countries.
These exceptions aside, MFN ensures that all countries trade on equal terms.
Non-discriminationNational treatment: is the second form of
nondiscrimination found in the WTO. National treatment prohibits governments from using taxes, regulations and other domestic policies to provide an advantage to domestic firms at the expense of foreign firms.
Article 3 of GATT: National treatment requires governments to treat domestic and foreign versions of the same product similarly once they enter the domestic market.
Non-discriminationBeyond this there are hundreds of rules and
more than 60 agreements since 1947, comprising 30,000 pages of text
II. International bargainingDecision making processNegotiate agreements to liberalize trade
TariffsNon-Tariff Barriers (NTBs)
II. International bargainingNon-Tariff Barriers (NTBs) refer to
restrictions that result from prohibitions, conditions, or specific market requirements that make importation or exportation of products difficult and/or costly.
NTBs arise from different measures taken by governments and authorities that protect the domestic industries from foreign competition.
Examples of NTB: Import bans, general or product-specific quotas, unjustified sanitary conditions, state subsidies, state ownership, “buy national" policy
II. International bargainingRather than bargain continously, governments
organize their negotiations in bargaining rounds each with a start date and a target date for conclusion.
GATT and WTO trade rounds
From the 1980s onwards free trade not only included manufactured products but agriculture and services as well.
For example, the 1995 Agreement on Agriculture advocated universal reductions in trade protection, farm subsidies and government intervention.
II. International bargainingWTO Ministerial Conference (MC) (highest level
of WTO decision making)MC establishes an agenda and target dates for
conclusion of the roundResulting agreement is ratified by WTO membersTo date, 8 rounds have been concludedThe 9th, Doha Round, is the latest round of trade
negotiations among the WTO membership. It is yet to be concluded. Its aim is to achieve major reform of the international trading system through the introduction of lower trade barriers and revised trade rules.
II. International bargainingSee Table 2.1 on page 26 for summary of
trade negotiations and Rounds (notice the expanding range of subjects covered).
Rules provide a framework of law for international trade relations
Rule-based systemMultilateral trade system
III. Dispute Settlement MechanismEnsuring compliance by helping governments
resolve disputesIndependent quasi-judicial tribunal
Investigates facts and the relevant WTO rulesGovernments may be required to alter policy or
compensate other countries
Power and interests in the World Trade SystemDistribution of power in the international systemWorld trade system has shifted between open and
liberal periods to periods in which it is closed and discriminatory
Hegemonic Stability TheoryWTO reflects the interests of those who created itHegemon: country that produces a disproportionately
large share of the world’s total output and leads in the development of new technologies
Hegemon has economic interest in open and liberal international trade system
But, as hegemon declines, it becomes less supportive of liberal trade and the system shifts toward greater protectionism
Hegemonic power and the creation of the postwar trade systemGreat Britain as the hegemonic power in 19th
centuryIndustrial RevolutionTrade flourishedLate 19th century: British hegemony in declineEnd of World War 1, US economy was twice as
large as that of BritainDuring transition, however, international
trade system shifted toward discriminatory and protectionist practices
WWI as low point for liberal tradeUS was not willing (though possibly able) to
promote liberalism1929 Great DepressionUS raised tariffs in 1930Trading blocsImperial Preference SystemOther countries followed suit
In 19th century US was not interested in exporting since it could not compete with British firms in foreign markets
Protectionism as preferred policyBut, US industrialization made trade less
threatening to USExports became more attractiveUS industry became increasingly willing to
accept lower tariffs at home in return for lower tariffs abroad
1934: Reciprocal Trade Agreements Act (RTAA)US negotiated bilateral agreements with
countries to lower tariffs1947: GATT1950s: US moved to strengthen GATTMarshall Plan: import of (critical) American
goods into EuropeAsymmetric trade liberalization: US opened
market to Europeans while Europeans continued to discriminate against American goods
By 1960s Europe was ready for trade liberalization
Hegemonic decline and the world trade system Rise of Japan as an industrial power Rise of Western Europe (European Union and common
market, collectively represented at WTO)
US adopts more aggressive trade policy (bilateralism) The United States has bilateral free trade agreements with
Australia, Bahrain, Canada, Chile, Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Jordan, Mexico, Morocco, Nicaragua, Oman, Peru and Singapore
This led to concern that the multilateral trade system was at risk
However, there is also plenty of evidence that multilateral trade flourishes despite apparent US hegemonic decline
Trade rounds continue to be concluded (despite the delay in the Doha round)
WTO was established in 1995, enjoying support of developing countries
How to explain this? Inertia: the US decline is leading to change,
but it is not immediately apparentOR:
Institutions: maybe a hegemon is not required to sustain it!
The Evolving WTO: New Directions, New ChallengesTrends:
Extension of the scope of WTO rulesGrowing difficulty of reaching agreement
within the WTO
Extension of scope of WTO rulesNot just tariffs anymore: early bargaining
rounds focused on tariff reductions, but now average tariff levels is much lower in comparison to 1950s.
Nontariff barriers. WTO rules have begun to regulate areas that traditionally have been the exclusive preserve of national governments.
Nontariff barriersIntellectual property: Governments negotiated
the Agreement on Trade-Related Aspects of Intellectual Property (TRIPs) to protect intellectual property.
Intellectual property: creations of the mind: inventions, literary, and artistic works, symbols, names, images and designs used in commerce.
Nontariff barriersTrade in services: a service is an economic activity
that does not involve manufacturing, farming, or resource extraction.
e.g financial services such as banking and insurance, transportation services such as shipping and tourism, business services such as consulting and accounting etc.
Liberalizing trade in services often requires substantial changes to national policies. The major obstacle to trade in services usually lies in national regulations that prevent foreign service firms from operating in the local market.
Agreement on Trade-Related Aspects of Intellectual Property (TRIPs)
Specifically, TRIPS requires WTO members to provide copyright rights, patents etc.
The key aim is the protection and enforcement of all intellectual property rights.
New rules to govern servicesTrade Related Investment Measures (TRIMs):
limited the ability of governments to regulate certain aspects of MNC activities. (Many governments used regulations to require foreign firms to purchase a certain % of their inputs from domestic producers.
Problems
So, new WTO rules intrude deeply into national policies
Doha Round: Agriculture, subsidies and service sector liberalization
Another problemReaching consensus with so many members is difficultThere were 150 members as of 2007….30 more had
appliedDiverse interests (wealthy, advanced industrialized
countries versus middle-income countries versus developing countries)
Additionally WTO is not popular outside (see the various protest movements mobilizing against the WTO) – problem of legitimacy
Should the decision making mechanism be changed?And shouldn’t civil society be allowed to participate in
the decision-making process?But these are contradictory questions (effectiveness
versus legitimacy) regarding the direction of reform necessary
The Greatest Challenge?: Regional Trade Arrangements and the WTORegional trade arrangement (RTA)
Free trade area (eliminate tariffs on goods, but each member retains independent tariffs on goods entering their market from nonmembers)
Customs union (member governments eliminate all tariffs on goods entering the union from nonmembers)
RTAs are discriminatoryArticle XXIV of the GATT allows for RTAs
(with proviso)But, rapid proliferation of RTAs may threaten
multilateral international trade and WTOBut, do RTAs complement or challenge WTO?
RTAs complement WTO in liberalizing trade, but challenge the WTO through institutionalization of discriminationTrade creation: more trade as a result of RTATrade diversion: more trade between RTA
members at the expense of non-membersCould this all lead to protectionist trade
blocs? Too early to tell where RTAs will take us
The Political Economy of International Trade Cooperation – Chapter 3Why does the WTO exist: interests of the US?Or cooperation between nation states?Cooperation, in turn, requires assurances (trust
and guarantees)Institutions are the usual method to solve this
problemWTOAbstract logic of cooperation:
Trade theory (welfare gains): countries can gain from cooperation with one another.
But governments tend to avoid adopting liberalization (Mercantalist tendencies)
Examine how WTO helps governments cooperate in order to liberalize trade and capture welfare gains
The economic case for tradeWhat are “gains from trade”?Why does trade generate these gains?
(comparative advantage)
The Gains from Trade in Partial EquilibriumTheoretical frameworks:
Partial equilibrium (focus on market for a single commodity – highlights how production and consumption of this commodity change in response to trade)
General equilibrium (focuses on entire economy – change of all goods in response to trade) – concept of comparative advantage (the underlying reason why these gains exist)
The Gains from Trade in Partial EquilibriumFig 3. 1 A. Autarky
D
S
Consumer Surplus
Producer Surplus
Q
P
The Gains from Trade in Partial EquilibriumConsumer surplus: A consumer surplus
occurs when the consumer is willing to pay more for a given product than the current market price.
Producer surplus: the difference between the amount that a producer of a good receives and the minimum amount that he or she would be willing to accept for the good.
The gains from trade in partial equilibrium Examine what happens when a country shifts from autarky to
trade See figure 3.1 on page 49 ‘Consumer surplus’ increases Horizontal line: quantity Vertical line: price
The Gains from Trade in Partial EquilibriumB. Free Trade
S
Consumer surplus
D
Producer SurpluspW
Q ws
Old price
Q wD
imports
The Gains from Trade in Partial EquilibriumTogether, consumer surplus and producer surplus depict the
amount and the distribution of social welfare generated in the market
We assume here that domestic producers and consumers of shirts are ‘world price takers’ – figure 3.1
At the world price, domestic consumers buy more shirts than domestic producers supply
As a result, trade changes the equilibrium shirt production and consumption: domestic shirt production falls, domestic shirt consumption rises, and imports fill the difference between
The Gains from Trade in Partial EquilibriumAggregate social welfare is higher under this
new equilibriumThe improvement in aggregate welfare is the
gain from tradeTrade has made consumers better offBut trade has made producers worse offGains from trade arise because the amount
by which consumers gain is greater than the amount that producers lose
The Gains from Trade in Partial EquilibriumConsumers have more money in their pockets
with trade than withoutAnd producers can be compensated for their
losses through the gains. This is what is meant by the claim that trade
raises social welfare
The Gains from Trade in Partial Equilibrium
We can also calculate the losses from protectionism, known as efficiency losses caused by tariffsConsumption distortion (consumers buy too
few shirts compared with world price of shirts)
Production distortion loss (producers produce too many shirts)
The Gains from Trade in Partial EquilibriumVoluntary Export Restraints: a protectionist
measure in which exporting countries agree to restrict their shipments of a particular product to a country to deter it from imposing even more onerous import quota.
VERs provide quota rents to foreign producers. Quota rents are above-market returns created by the quota. Rents arise because quotas restrict the number of foreign goods that can be sold in the domestic market below the level that domestic consumers want to buy.
The Gains from Trade in Partial EquilibriumWith supply held below demand, foreign producers
can charge a higher price for each good they sell. E.g during the 80s-Americans wanted to buy 4 million
Japanese cars.VER US negotiated with Japan allowed Japan to
export only 2.3 million cars at the market price.Japanese cars will be sold at a higher price with VER.Quota rent is the difference between the high price
Japanese auto producers received for each car with the VER and lower price without the VER.
The Gains from trade in General EquilibriumThe partial equilibrium framework helps us
understand the gains from trade, but it doesn’t help us understand why these gains exist or why these gains must exist for every country.
Nor does it help us think about the broader economic consequences of international trade.
To grasp these issues we need to examine a general equilibrium model of trade.
The Gains from trade in General EquilibriumExamines how trade alters equilibrium
production and consumption in the economy as a whole.
The standard general equilibrium model of trade is called the 2x2x2 model, as it is based on 2 countries, each of which produces 2 goods using 2 factors of production.
The Gains from trade in General EquilibriumBut first we need to establish a few core concepts:Production possibility frontier (PPF) – factors are
finite, so resource allocation decisions must be made.
Any decision to use factors to produce one good means that these factors are not available to produce other goods.
A decision to allocate capital and labor to the production of computers necessarily requires the country to forgo the production of some number of shirts.
The Gains from trade in General EquilibriumThese forgone shirts are what economists call
opportunity costs and the production possibility frontier allows us to measure these opportunity costs quite precisely.
Let us consider an illustrative production possibility frontier for the United States.
Let’s assume that the US has a fixed stock of labor and capital that it can use in combination to produce two goods: shirts and computers.
Shirts millions
Computers millions
A
B
100 m
300 m
Consumption İndifference curve
E
The Gains from trade in General EquilibriumWhat does point A tell us?If the US allocates all of its labor and capital
to computer production, it could produce 100 million computers.
What does point B tell us?If it allocates all labor and capital to shirts, it
can produce 300 million shirts.If we connect A and B with a line, we have
defined a Production Possibility Frontier for the US.
The Gains from trade in General Equilibrium
The slope of the line, called the marginal rate of transformation tells us how many shirts that country forgoes for each computer it produces.
In this example, every computer the United States produces costs three shirts.
Because an autarkic country cannot consume more than it produces, the PPF also defines the limits of possible consumption.
The Gains from trade in General EquilibriumSecond core concept, consumption
indifference curves, helps us to understand what specific combination of computers and shirts American consumers will purchase.
Key assumption: consumers prefer more to less and therefore consumer utility increases as we move away from the origin.
If we connect every combination of shirts and computers that provides our consumer with the same amount of utility with a curved line, we draw an indifference curve.
The Gains from trade in General Equilibrium
Three additional characteristics of indifference curves are important:
Indifference curves typically slope downwards. This slope, called the marginal rate of substitution tells us how much of one good the consumer is willing to give up to acquire an additional unit of the second good.
The Gains from trade in General EquilibriumIndifference curves typically bend towards
the origin. This reflects the assumption of diminishing marginal utility. (first computer provides a large improvement in utility. Each successive computer provides a smaller increase of utility).
When we focus on production and consumption for an entire country, we construct community indifference curves rather than individual indifference curves.
The Gains from trade in General EquilibriumProduction and consumption will occur
where the Production Possibility Frontier and the indifference curve are tangent.
Point e on Figure 3.2Under autarky, equilibrium production and
consumption in the US equals 60 million computers and 120 million shirts
The Gains from trade in General EquilibriumTo appreciate how trade affects the
equlibrium we need another countryChina (figure 3.3)Possibility frontierMarginal rate of transformation is 20Point of tangencyEquilibrium: 13 million computers and 140
million shirts under autarky
The Gains from trade in General EquilibriumHow trade affects equilibrium production and
consumption in both countries (see Figure 3.4)SpecializationUS: computersChina: shirtsUS acquires more shirts per computer when it
buys them from China than when it produces them at home
A computer buys 20 shirts in China whereas at home a computer buys only 3 shirts
The Gains from trade in General EquilibriumHow does trade effects equilibrium
consumption in both countries?We need to know the price at which the US
and China will exchange shirts for computers.The price need to fall between 3 and 20
shirts per computer.Let’s assume that the two agree to trade at 6
shirts per computer
The Gains from trade in General EquilibriumEquilibrium consumption in both countries has
expanded beyond what was possible under autarky.
American consumption expands from 60 million computers and 120 million shirts under autarky to 75 million computers and 150 million shirts.
Chinese consumption expands from 13 million computers and 140 million shirts under autarky to 25 million computers and 250 million shirts.
The Gains from trade in General EquilibriumThis model shows how every country
gains by specializing in goods it produces relatively well and trading them for the goods it produces relatively less well.
The Gains from trade in General EquilibriumWhat determines which goods a particular
country will produce relatively well and which it will produce relatively less well?
The Hecksher-Ohlin (H-O) modelArgues that comparative advantage arises from
differences in countries’ factor endowments.Labor: workersCapital: the entire pysical plant that is used in
production, including the buildings that house factories and the machines on the assembly lines inside these factories.
The Gains from trade in General Equilibrium
A country’s abundant factor will be cheaper to emply than its scarce factor.
US- abundant factor: capitalUS has a comparative advantage in
computersChina-abundant factor: laborChina has a comparative advantage in t-shirts
The politics of trade cooperationWhereas the trade theory introduced suggests
the logic of unilateral trade liberalization, governments adopt the opposite logic
Analyze the domestic politics of trade policyInterests of domestic firms are heavily
represented in domestic trade politics, but the interests of consumers are often overlooked
As a result, governments care little about consumer gains and care a lot about trade’s impact on domestic industries
Not all domestic industries gain from trade liberalization
Trade liberalization becomes possible only through international agreements that provide reciprocal tariff reductions
But, additionally there is an ‘enforcement problem’: governments cannot be certain that other governments will comply with the trade agreements that they conclude. As a result, gvts will be reluctant to enter into trade agreements, even when they recognize that they would benefit from doing so.
Consider Prisoner’s Dilemma (China: PL>LL> PP>LP)
United StatesChina Liberalize Protect
Liberalize LL LP
Protect PL PP
Considering this we note that China’s most preferred outcome is unreciprocated access to the US market; it’s second best outcome is reciprocal tariff reductions
Prisoner’s Dilemma is a symmetric game: payoff order for US is the same
So, ‘protect’ is a dominant strategyThat is, protect yields more utility for China
than liberalize regardless of the US strategyAnd protect is the US’ dominant strategy, too.
Problem: international system does not provide effective enforcement mechanisms (anarchic)
The WTO and Trade CooperationWTO helps iterate the game by creating expectations
of repeated interactionWTO provides information that governments need to
in order to use reciprocity strategiesTransparency means that it is easier for
governments to determine whether a specific trade measure adopted by a particular government is or is not consistent with WTO rules
WTO’s dispute settlement mechanism helps governments use the WTO to enforce trade agreements
See Figure 3.6 on page 67 (outline of standard procedure)
Dispute Settlement Body (DSB) creates a formal panel to investigate complaint
Three expertsFinal reportAppeal of panel’s decisionDSB creates appellate body composed of three to five
people drawn from a list of 7 permanent membersReportGovernment policy may need to be amended or
compensation may be requiredProcess should take less than 15 months to completeE.g. EU’s banana import regime and the WTOThis case demonstrates that WTO helps governments gain
the assurances they need in order to conclude trade agreements required to capture the gains from trade