Chapter Nine

1. Chapter Nine The Political Economy of Trade Policy and Borders

2. Introduction The Political Economy of National Trade Policy A Brief History of International Trade Policy Economic Integration and Regional Trading Interregional Trade Chapter Nine Outline

3. Introduction • Within each country, processes interact to determine that country’s stance on international trade. • This has advantages and disadvantages: • Pro example: U.S. constitutional prohibition against tariffs among states undoubtedly contributed to the country’s remarkable growth and stability over last 200 years. • Con example: National character of trade policy tends to perpetuate the mercantilist view of trade as zero-sum game – one country’s gains must come at its trading partner’s expense rather than from improved efficiency.

4. Introduction • Trade policy occurs at levels other than a national one: • Regional trade blocs: EU and NAFTA • Within different regions of countries: the north and south of U.S. or Italy (interregional trade).

5. The Political Economy of National Trade Policy • The costs of international trade tend to be concentrated on a relatively small number of individuals. • Benefits, however, come primarily in the form of lower prices and are spread over a large group, with each individual capturing only a small portion.

6. The Political Economy of National Trade Policy • For producers of good X, the question of tariffs is likely to decide which candidate gets their vote. • For consumers of good X, the small effect the tariff would have on each individual makes the tariff a lower priority issue. • As a result, a vote-maximizing candidate will more likely follow the wishes of X producers and support the tariff. • Implies that pro-protectionist supporters will be more successful in organizing an effective lobbying force than will supporters of unrestricted trade.

7. The Political Economy of National Trade Policy • This systematic pro-protection bias in the policy-making process carries over to laws that govern global trade policy. • Example: Section 201 of the 1974 Trade Act • “Escape clause” that allows the U.S. to abandon its tariff-reduction obligations under WTO whenever imports cause serious injury or a threat to a domestic industry. • International Trade Commission in Washington can recommend relief to the president in the form of a tariff, quota, or Trade Adjustment Assistance eligibility for the industry.

8. The Political Economy of National Trade Policy • Given the pro-protection bias in the policy-making process, how does trade liberalization ever get accomplished? • Informing voters of the often-hidden costs of protection. • Reciprocity involved in international negotiations creates another pro-liberalization constituency: export industries. • A country lowers its trade barriers in exchange for trading partners lowering theirs.

9. Brief History of International Trade Policy • Mercantilism was the first dominant theory of international trade. • Critical weaknesses: • Not all countries could conduct successful mercantilist policies at the same time. • Even when one country succeeded with mercantilist policies, that success could not continue in the long run. • Mercantilist success caused imports to rise and exports to fall. • Accumulated specie (money) was useful only if you could purchase goods with it. • If you import nothing, you drastically decrease your choices of goods to buy.

10. Brief History of International Trade Policy • Britain and the rise of the United States • At the close of the 18th century, world events plus effects of Classical economists’ (Smith, Ricardo, Hume) work moved trade policy toward liberalization. • Industrial Revolution created many new products for export. • Britain adopted policies of unrestricted trade. • American colonies used tariffs to generate revenues before American revolution. • Post-revolution U.S. was protectionist – protected infant manufacturing industries and retained tariffs.

11. Brief History of International Trade Policy See Figure 9.1 • Second half of the 18th century: • Germany and France provided stiff competition for Britain. • Britain and U.S. used tariff protection through World War I. • U.S. economy enjoyed phenomenal growth relative to rest of world. • U.S. Smoot-Hawley tariff bill of 1930 • Raised tariffs an average of 53%. • Other economies retaliated – world trade plummeted. • Great Depression.

12. Figure 9.1: What Happened to World Trade, 1929-1933 ($Millions) April May March 1929 1930 February 1931 June 1932 1933 2,739 1,206 January July 2,998 1,839 992 August December September November October

13. Brief History of International Trade Policy • Reciprocal Trade Agreements Act of 1934 (RTAA) • U.S. recognized the need for trade liberalization as a way to emerge from Great Depression. • Reduced Smoot-Hawley-level tariffs. • Also changed institutional arrangements for making U.S. trade policy: • Tariff authority switched from Congress to executive branch. • Authorized trade negotiations with other countries. • RTAA remained in force until the 1962 Trade Expansion Act.

14. Brief History of International Trade Policy • Post-Second World War Trade Policy • The United States pushed hard for global postwar trade liberalization. • U.S. had great industrial strength…export opportunities could be exploited only in a relatively open environment. • Strong international economic ties lessened risk of war. • Desire to rebuild Europe and limit spread of Soviet influence.

15. Brief History of International Trade Policy • U.S. also instrumental in establishment of multilateral financial institutions: • International Monetary Fund (IMF) • World Bank • General Agreement on Tariffs and Trade (GATT) • Predecessor to WTO • Congress attempted to reclaim trade authority it previously ceded to president. • 1947: insisted that Escape Clause be included in all tariff reductions. • Escape clause permitted cancellation of tariff reductions shown to cause injury to domestic industries.

16. Brief History of International Trade Policy • Escape clause, if carried to logical extreme, would eliminate trade – trade always injures some industry while helping others. • Escape clause is an example of Safeguards imposed in an effort to avoid adjustment costs involved in trade’s reallocation of resources. • Main U.S. Trade Acts since 1950: • Trade Expansion Act of 1962 • Trade Act of 1974 • Trade Agreements Act of 1979 • Trade and Tariff Act of 1984 • Omnibus and Competitiveness Act of 1988 • Uruguay Round Agreements Act of 1994

17. Brief History of International Trade Policy • Trade policy in the 1960s and 1970s • Trade Expansion Act of 1962 replaced the RTAA. • Kennedy sought to regain momentum in trade liberalization. • Granted president authority to negotiate 50% reductions in tariffs. • Contained 3 items important to world trade: • Multifiber Agreement (MFA): president agreed to impose quotas on cotton textile imports and to partially exempt textiles from tariff reductions. • Negotiations shifted from product-by-product to across-the-board format. • Trade Adjustment Assistance (TAA) added to U.S. safeguard provisions.

18. Brief History of International Trade Policy • Trade Adjustment Assistance • Instead of levying tariffs against imports that resulted in injury to a specific industry, the TAA was an alternate way to deal with the injury: • Directly compensate injured firms and workers for their losses. • Extended unemployment benefits • Retraining • Relocation assistance • Low-interest loans • Even restitution to whole communities harmed by an industry’s decline.

19. Brief History of International Trade Policy • Trade Act of 1974 • Granted president 60% tariff-reduction authority. • Extended existing set of import quotas from cotton textiles to cover wool and synthetics. • Strengthened role of International Trade Commission. • Loosened eligibility requirements for compensation under TAA: • Injury to domestic industry no longer had to be linked directly to government policy, but only to increased imports. • Competition from imports now only had to constitute an “important” cause of the injury.

20. Brief History of International Trade Policy • Trade Act of 1974 also laid the groundwork for the Tokyo Round of GATT talks (1974 – 1979). • Resulted in 30% reduction in tariffs of major industrialized economies. • New policy: U.S. (and others) could reach agreements (called Codes) accepted by only a subset of GATT countries. • Tokyo Round left several unresolved issues: • Developed-country barriers against developing-country exports. • Mutually acceptable interpretations of safeguard provisions. • Conflict resolution mechanisms.

21. Brief History of International Trade Policy • Trade Policy in 1980s and 1990s • Trade and Tariff Act of 1984 • Gave the president authority to negotiate bilateral trade treaties. • Uruguay Round Agreements Act (GATT talks) • Began 1986…approved 1994 • Major results: • Agricultural: reduced export subsidies; required tariffication of existing nontariff barriers; reduced existing tariffs an average of 36%; provided for minimum access for new entrants into previously-closed foreign markets.

22. Brief History of International Trade Policy • More results of GATT: • Textiles: bilateral quotas of MFA must be removed at end of 10 years; quotas probably will be replaced by high tariffs. • Complete elimination of tariffs in several important sectors by industrial countries. • Clarified distinction between acceptable and unacceptable subsidies. • Strengthened enforcement of intellectual property rights. • Established WTO • Member countries must now subscribe to all rules and responsibilities.

23. Economic Integration • Formation of countries into groups (EU, NAFTA) • Preferential trading arrangement (PTA) • Member countries agree to erect lower barriers to trade within the group than to trade with nonmember countries (Figure 9.3). • Free trade area • Involves eliminating barriers to intra-group trade while allowing each country to maintain its own nationally determined barriers to trade with nonmembers. See Figures9.2 and 9.3

24. Economic Integration • Customs union • Intra-group trade faces no barriers and members maintain a common external tariff (CET) on trade with nonmembers. • Common market • Extends free trade among members to factors of production (labor migration and capital flows), as well as to goods and services. • Economic union • Most extensive form of economic integration. • Means common, group-determined economic policies, as well as a common currency.

25. Figure 9.2: Levels of Economic Integration Preferential trading arrangement Free-trade area Customs union Common market Economic union Common economic policies and common currency Intra-group capital and labor mobility Reduction of intra-group tariffs Removal of intra-group tariffs Common external tariff

26. Figure 9.3a: Tariffs Under Different Stages of Integration t = 10% t = 10% A B C t = 5% t = 20% (a) Preferential Trade Arrangement

27. Figure 9.3b: Tariffs Under Different Stages of Integration t = 10% t = 0% A B C t = 0% t = 20% (b) Free-trade Area

28. Figure 9.3c: Tariffs Under Different Stages of Integration CET = 15% t = 0% A C B t = 0% CET = 15% (c) Customs Union

29. Economic Integration • Protectionist element of integration is called Trade Diversion. • Diversion of trade from nonmembers to members caused by discrimination inherent in integration. • Trade-liberalization element of integration is called Trade Creation. • Integration eliminates protection among member countries and allows them to specialize and trade according to comparative advantage and to exploit potential economies of scale. • If trade diversion dominates trade creation, welfare falls.

30. Economic Integration See Figure 9.4 • Figure 9.4 illustrates integration’s trade-creating and trade-diverting effects. • SM denotes supply of good X by member countries. • SNM is the supply by nonmember countries. • Formation of a free-trade area causes a move from C to H. • Trade increases as imports rise from X0-X1 to X2-X3. • Trade also is diverted from nonmember countries toward member countries, causing an efficiency loss represented by area of triangle e.

31. Figure 9.4: Welfare Effects on a Free-Trade Area in Good X P X S E M S + t G C 0 NM P S + t X a b c H d 1 M P S X J e NM S T R D F 0 2 0 X X X 3 1 X X

32. Economic Integration • Additional considerations • Integration may have dynamic effects – i.e., may cause member economies to evolve differently over time. • Integration increases size of “domestic” market. • May allow firms to achieve economies necessary to become competitive in export markets. • May allow group of countries to exercise some monopoly power in world markets. • May cause increased competitive pressures on industries within integrated group.

33. Economic Integration • Two waves of economic integration: • 1960s • Most were modeled after European Community. • Attempts among developing countries met only with partial success. • Some African and Latin American plans failed. • Mid-1980s • European Union (EU) • North American Free Trade Agreement (NAFTA) • Association of South East Asian Nations (ASEAN) • Southern Common Market (MERCOSUR)

34. Economic Integration • Figure 9.5 indicates that among the EU, NAFTA, ASEAN, and MERCOSUR, the EU has the highest share of intra-group trade. • The European Union • 1957: Treaty of Rome created European Commission. • Belgium, Luxembourg, Netherlands, France, Germany, and Italy. • 1971: agreed to 10-year plan to achieve full economic union.

35. Figure 9.5: Intra-Group Trade as Percent of Total Merchandise Trade, 2000 70 Percent Intra-Group Exports as Percent of Total Exports Intra-Group Imports as Percent of Total Imports 60 50 40 30 20 10 0 EU NAFTA ASEAN MERCOSUR

36. Economic Integration • 1986: added Spain and Portugal. • 1987: passed Single Europe Act • Expanded policy making to include areas of environment, monetary policy, health and safety, and foreign policy. • 1991: changed name to European Union. • Outlined plan to move to common currency (the euro) and central bank. • Figure 9.6 shows the current 15 EU members.

37. Figure 9.6: European Union Members and Applicants, 2001 Sweden Finland Estonia Members Latvia Lithuania Denmark Applicants Ireland United Kingdom Poland Netherlands Germany Belgium Czech Rep. Luxembourg Slovakia Austria Hungary France Romania Slovenia Bulgaria Italy Portugal Spain Turkey Greece Malta

38. Economic Integration • NAFTA • U.S., Canada and Mexico • Several unique characteristics: • Mexico asked to join U.S. in free trade area – Canada later asked to join them – took effect 1994. • Composition of member countries was very different from most trade blocs. • Very different levels of economic development existed. Most trade bloc members are fairly similar in economic development.

39. Figure 9.7: Where Do They Go? U.S., Canadian, and Mexican Exports, 2000 Percent 100% 80% Share of U.S. exports 60% Non-NAFTA Share of Canadian exports Share of Mexican exports countries 40% Mexico Canada U.S. 20% 0%

40. Economic Integration • NAFTA (continued) • Tariffs on about half of members’ trade were removed immediately. • Remaining tariffs will be phased out by 2010. • Rules-of-origin rules dictated that in order to qualify for duty-free treatment, a product must divulge its quantity of North American content (different thresholds for each industry). • Many Asian firms produce goods in Mexico as a “back door” path to the U.S. market.

41. Economic Integration • NAFTA (continued) • Conflict resolution mechanism: • North American Trade Commission (3 people) created to hear disputes and levy any penalties. • Opposition to NAFTA from pro-protection forces: • Agreement’s environmental impact • Effects of differences between labor standards and wages in U.S. and Mexico. • Possibility of sudden large import surges from Mexico.

42. Economic Integration • NAFTA (continued) • Since NAFTA began, imports from Mexico have risen and those from Asia have decreased. • Chile is on the waiting list to join. • Free Trade Area of the Americas due to be completed no later than 2005. • 34 countries

43. Economic Integration • MERCOSUR • Formed in 1991 • Includes Brazil, Argentina, Paraguay, and Uruguay. • 1994: became a customs union with average CET of 14%. • Intra-MERCOSUR trade increased 400% in first 4 years.

44. Interregional Trade • Sometimes interregional trade becomes international trade: • Breakup of Soviet Union. • Reacquisition of Hong Kong by China. • Role of factor mobility • Labor and capital move more easily within than between countries due to both natural and policy-induced barriers to intercountry mobility. • Role of economic policy • At times, governments show their ambivalent feelings toward trade by applying different trade rules in different regions of a country.

45. Interregional Trade • Role of economic policy (cont.) • Most common form of subnational trade policy: • Special Economic Zones (SEZs) • Allow more generous rules for trade and for inward foreign direct investment than apply in rest of country. • Example: China • Export-Processing Zones • Concentrate on attracting firms that assemble products for export. • Example: Mexico’s maquiladora program.

46. Notes for Case Two • Do Political/Economics Boundaries Really Matter? • An economic map of China (Figure 9.8) shows that costal provinces have higher per capita income levels than interior provinces. • Beginning in 1978, China opened up special economic zones (SEZs), which were located primarily in costal provinces such as Guangdong and Fujian. • In 1999 all provinces were allowed to create SEZs.

47. Figure 9.8: Chinese Per-Capita by Province, 1999

48. Notes for Case Three • Life before the NAFTA • Figure 9.9 depicts the maquiladora establishments in Mexico in 1996. • The region along the southern side of the U.S.-Mexican border is a major center of electronic assembly operations.

49. Figure 9.9: Maquiladora Establishments, 1996 Mexicali (Daewoo, LG Electronics, Matsushita, Mitsubishi, Sony, JVC) Tijuana San Luis Rio Colorado (Daewoo) (Canon, Casio, Ciudad Juarez (Canon, Mizumo, Hitachi, Hyundai, Iwai, TDK, Toshiba, Yozaki, Zenith) Matsushita, Pioneer, Samsung, Sanshi, Sanyo, Toshiba) Mexico Mexico City

50. Key Terms in Chapter 9 • Section 201 • Mercantilism • Smoot-Hawley tariff bill of 1930 • Reciprocal Trade Agreements Act (RTAA) • International Monetary Fund (IMF) • World Bank • General Agreement on Tariffs and Trade (GATT)