Chapter 5 - Trade & Macro

1. Chapter 5 - Trade & Macro 5.1 Macroeconomic Factors exchange rates interest rates government fiscal balance 5.2 International Agricultural Trade Trade agreements 5.3 Trade Theory Gains from trade Distortions (tariffs & subsidies) Farm programs

2. 1) Exchange Rates Affects the competitiveness of agr. Products Early 1970’s – floating exchange rates Policy – over or under value exchange rate What is the impact of a ER distortion? Example 1: Argentina: Overvalued Exchange Rate (exporter) Shift of excess demand function Lower producer price Lower quantity exported Loss of producer surplus

3. Source: International Monetary Fund -IFS

4. Increase in Exchange Rate P S ED Q

5. Interest Rates: • Why interest rates are important: 1) Value of currency – prices received and paid Most commodities are US$ denominated • 2) Cost of borrowing: • Agriculture is capital intensive (borrowing) • Inputs: seed, fertilizer, machinery 1980’s - high interest rates – low grain prices - debt crisis Cost of borrowing: How is it determined ? Role of central bank (Bank of Canada) Role of the market Government intervention (interest subsidies)

7. 100 Basis points = 1% Src. Globe & Mail - March 8, 2008

8. Government Fiscal Balance Consequences for Agricultural Policy 1 – interest rate - more borrowing = higher rates "crowding out effect" - higher cost for farm borrowing 2001 Average capital/farm = $800,000 Total farm capital = $ 200 Billion 1% change in interest rates => $ 2 Billion (1971 - 2002) - Net market income - 1.8 $B (2002) 3.3 $B (1975) 2 – capacity to fund interventions - deficits = limited marge de manouvre - reduced scope for intervention

12. 5.2 International TRADE Gains from trade: > increase in output due to specialization • based on comparative advantage • each country • concentrates on producing goods and that it produces relatively efficiently • trading to obtain goods that it does not Trade Distortions • many forms of distortion (welfare reducing) • tariffs, taxes, subsidies, quantitative measures • non-tariff barriers (health, safety reg’s) Trade Agreements • institutional arrangement – restraint on behaviour • multi-lateral (regional), bilateral • Levels of cooperation • Range of goods (agr vs industrial) • Scope of instruments included • Customs union – full economic integration (EU)

13. Reasons for Protection • new industry (infant industry argument) • national health + phyto-sanitary • unfair foreign trade policy • Defend domestic programs • improve balance of payments • improve “Terms of Trade” • generate revenue • slow down painful economic adjustment • Political economy benefits of additional trade are spread thinly among many individuals but the cost is high for only a few firms or groups

14. Trade Theory • Why do nations trade? • What are the benefits? • Implications of trade distortions Theory • comparative advantage (Ricardo) • absolute advantage • Ohlin (1933) • comparative advantage • due to resource endowments • Canada land rich, capital poor • => export agr & import manufactures Gains from trade • Trade allows for specialization – increased welfare

15. Gains from Trade P1 W1 W2 Agr. P2 . Manufactures

16. ES/ED Framework • Excess Demand (ED) • Excess Supply (ES) Gains from trade (versus no trade) • depend on the impact of a country on world prices • Small country – no price impact • Large country – prices adjust, impacts smaller 2 Country Model – 1 good • e.g. US/Canada cattle market • Assume: Canada - low cost producer • How are consumers and farmers affected by trade between the two countries? • Winners and losers – distribution effects • US – consumers gains, farmers lose • CA – consumers lose, farmers gain

17. US Canada Trade Sector ES PUS WUS PW WCA PCA ED Trade Gains from Trade .

18. Analysis: Trade Distortions 1 ) Import Tariff • Fixed-tariff rate vs ad valorem • Small country (fixed tariff) • domestic price increases • Supply increases, demand decreases • imports reduced • Net dead weight loss • Large country • domestic price increases • world price decreases • Imports decrease; domestic output increases • Consumers lose; producers gain • Government gains tariff revenue • Net welfare gain • Potential to compensate consumers

19. Import Quota • Binding quota • if it restricts imports below free trade imports • Similar price effects to a tariff • Imports lower • Domestic price higher • World price lower • Rents to importers • Quota value: right to import • Based on difference between new world price and domestic price

20. Large Country – Import Quota . Domestic Market World Market S D ES ED0 PQ Pw PWQ Q IQ

21. Large Country - Tariff . Domestic Market World Market S D ES ED0 Pw TR ED1

22. Import tariff – Small Country S PT G income b a Pw D Government income – few transactions

23. Export Subsidy • Used extensively • Purpose: support domestic income (price) support • Subsidy to export the excess supply • US (EEP) starting in 1985 • EU (ERP) – export restitutions – 1970’s • not unique to agriculture – e.g. Bombardier • price support program – increases ES • Subsidy Impacts • world price falls (large country) • Domestic price falls • Exports expand • Government payments = (Ps-PWs)*exports • value of exports increase relative to free trade • Deadweight loss • Consumers gain • Producers gain • Foreign importers gain • Taxpayer loses

24. Export Subsidy – Large Country S Ps DWL Pw Pws DT Dd Exports Before Exports After Dd – domestic demand DT – total demand – including world demand

25. Export Tax • Tax exporters • Exporting government gain revenue from export taxes • Producers in exporting country lose

26. Export Cartel Assumptions: • 2 countries • Cartel: importer + domestic supplier • Suppliers maximize joint profits • Price according to joint supply function • MR = MC (joint MC) Results: • Domestic price increases • Imports and domestic production decrease • Foreign surplus increases • Deadweight loss

27. Export Cartel . Exporter Importer Sd S ST PC a c Pw b D MR Q QE Qd Sd – domestic supply ST – domestic + foreign supply Exporter gain = (a-b) Deadweight loss = c

28. Decoupled Subsidies • Programs that do not distort trade • within the green box category under GATT • policies that lead to a per-unit payment to producers are not decoupled • trade distorting => affects trade and prices • Is any farm program completely decoupled ?