Free Trade – Good Restriction – Bad

1. Free Trade – Good Restriction – Bad g G e f Sd+w+t a b c d Free Trade: Price = World Price = $8,000 Domestic Production=20; Domestic Consumption=80; Imports=60 Consumer Surplus: a+b+c+d+e+f+g; Producer Surplus = h Sd Price ($) E F Sd+w h Dd

2. Free Trade – Good Restriction – Bad g G e f Sd+w+t a b c d Tariff: Price = World Price + Tariff = $8,000 + $1,000 = $9,000 Domestic Production=40; Domestic Consumption=60; Imports=20 Reduced Consumer Surplus: a+b+c+d Increased Tax Revenue = c Sd Deadweight Loss: Inefficient Production = b Price ($) Deadweight Loss: Reduced Consumption = d E F Sd+w h Dd Increased Producer Surplus = a (Redistributive Effect)

3. Costs of 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) • 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 • Other nations may retaliate

4. So why restrict trade? • Benefits of free trade in final goods are spread widely • Tariffs on intermediate inputs tend to be low • 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 • 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

6. Effective rate of protection • For a finished good, • Effective tariff rate = • {Nominal tariff – (% value Imports)x(Tariff on Imports)} • (% Domestic Value Added) • 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.

7. Nominal and Effective Tariff Rates(US and Japan, early 1980s) USJapan NominalEffectiveNominalEffective 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

8. 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 • Foreign trade zones (FTZ)

9. 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

10. Principles of Fair Trade • 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

11. 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 interdependence ... but could build strategic reserves instead

12. Non – Tariff Barriers (NTBs) 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

13. Other NTBs • Voluntary export restraints (VERs) • export quota by foreign country … or else • Japanese auto exports  unintended consequences • Domestic content requirements • Subsidies • Domestic subsidy … e.g. R & D • Export subsidy • Government procurement policies • Social regulations (health, environmental and safety rules … MGOs) • Sea transport and freight restrictions

14. Costs of import restrictions redux Domestic consumers face increased costs Overall 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