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Ch. 8: The Instruments of Trade Policy

Ch. 8: The Instruments of Trade Policy. What Should A Nation’s Trade Policy Be?. Should a nation protect a vital industry? Who would benefit and who would lose? Would the benefits exceed the losses? What kind of protection yields what kind of benefits and losses? Import tariff Import quota

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Ch. 8: The Instruments of Trade Policy

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  1. Ch. 8: The Instruments of Trade Policy

  2. What Should A Nation’s Trade Policy Be? • Should a nation protect a vital industry? • Who would benefit and who would lose? • Would the benefits exceed the losses? • What kind of protection yields what kind of benefits and losses? • Import tariff • Import quota • Export subsidy • Voluntary export restraints

  3. Tariffs • Specific tariffs are $ amounts per unit, e.g. $15 per case of imported wine. • Ad valorem tariff is percent of the value of the product imposed as tariff, e.g. 50% tariff on imported wine. • Tariffs that were traditionally the main revenue of governments have declined in importance. • Protection nowadays is through quotas, standards and export restraints.

  4. Which Country Will Export Beef and Which Will Import? Pbeef Pbeef S S D D Q Country A Q Country B

  5. Country A’s Import Demand (High Cost Country) Pbeef Pbeef S MD D Q Country A Q Country A

  6. Country B’s Beef Export Supply (Low Cost Country) Pbeef Pbeef XS S D Q Country B Q Country B

  7. Equilibrium Price and Quantity in the World Market Pbeef Pbeef XS XS MD Q Country B Q

  8. Imposing a Tariff S Pt S Pw Pw Pt* D D In a two-country world, imposing a tariff affects both parties. In this case, both countries are large countries: their behavior affects price. As a result, the tariff is shared by both: T=(Pt-Pw)+(Pw-Pt*) or T=Pt-Pt*.

  9. Tariff in a Small Country S Pt Pw D Qd Qs The definition of a small country is a country that cannot affect prices outside. In this case, the price effect of the tariff is solely on the small country.

  10. Effective Rate of Protection • Suppose automobile companies use $3,000 worth of steel to produce a $10,000 worth of car. • If US were to impose an import tariff on cars that raised the price to $12,500, can we say the protection was 25%? • If US were to impose an import tariff on steel that raised the cost to car companies to $4,500, can we say the protection to steel was 50%?

  11. Effective Rate of Protection • Before the tariff on cars, price was $10,000; afterwards, $12,500. • Before tariff, value added was $7,000; afterwards, $9,500. • The effective rate of protection is (9500-7000)/7000 or 2500/7000, which is 35.7%.

  12. Effective Rate of Protection • If steel had $3000 value added before and $4500 after the tariff, the effective rate of protection will be %50. • The impact on autos will be to reduce their value added from $7000 to $5500. • The effective rate of protection for the auto industry will be (5500-7000)/7000 or 1500/7000 or -21.4%.

  13. Costs and Benefits of a Tariff • Tariff raises the price in the importing country. • Producers gain. • Consumers lose. • Government gains revenue. • Tariff lowers the price in the exporting country. • Producers lose. • Consumers gain.

  14. Consumer Surplus • The market demand curve shows at each and every price how many units will be bought in the market. • It also shows to sell a specific amount in the market, what the highest price should be. • If a number of people are willing to pay that price and more, the product must have been worth to them that much. • Some people were willing to pay more than the ongoing price. They have a windfall: consumer surplus.

  15. Consumer Surplus P The 127th unit can only be sold if the price were $5.81. All the previous units could be sold at higher prices. The people who paid $5.81 for those got a bargain. The windfall they got is equal to the triangle above the price. $5.81 $3.54 D 439 127 Q

  16. Consumer Surplus $6.54 Calculate the consumer surplus. $750 Calculate the additional consumer surplus. $3.54 $584 $2.54 D 500 667 Q

  17. Producer Surplus • Supply curve shows the amount brought to the market at each and every price. • In order to have more units brought to the market, the price has to rise to cover the increased cost of producing one more unit; i.e., MC is upward sloping. • If the cost of last unit sold just matches the price earned, the cost of previous units will be lower than the price. • The producers will earn profits on each previous unit.

  18. Producer Surplus In order to produce the 396th unit the price has to be at least $4.07. To produce more requires a higher price. All the units before 396 cost less than $4.07 to produce yet they are sold at $4.07. The producer surplus is the triangle between the price and the supply curve. S $4.07 396

  19. Producer Surplus Calculate the producer surplus at $4.50 and at $7.50. $7.50 $450 $4.50 $150 $1.50 100 200

  20. Import Tariff in a Small Country S Identify producer gain, government gain, and consumer loss. Pt Pw D Q2 Q1 Q4 Q3

  21. Import Tariff in a Small Country • Consumer loss is greater than the gains of the producer and the government. • The efficiency (deadweight) loss is composed of production distortion and consumption distortion. • Production is distorted because high cost producers are allowed to produce instead of low cost producers. • Consumption is distorted because consumers are forced to consume less at higher price.

  22. Import Tariff in a Large Country S Terms of trade effect may compensate for the deadweight loss. Pt Pw Pt* D Q4 Q1 Q2 Q3

  23. Average EU tariff on selected products, 1997 Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  24. European anti-dumping duties on selected products, 1997 Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  25. Export Subsidy in a Small Country When there is no terms of trade effect, identify the welfare gains and losses. S Ps c a b d Pw D Q1 Q2 Q3 Q4

  26. Export Subsidy in a Small Country • There is no terms of trade effect. • Consumers lose a+b. • Producers gain a+b+c. • Government “loses” b+c+d. • Net loss b+d. • Consumption distortion is b. • Production distortion is d.

  27. Export Subsidy in a Large Country Negative terms of trade effect. Show welfare results. Ps Pw Ps*

  28. Export Subsidy in a Large Country • Export price falls; negative terms of trade effect. • Government subsidy is larger than in a small country case. • Net loss is greater than the small country case.

  29. EU’s Common Agricultural Policy • EU countries are a net importer of agricultural products. • To protect the incomes of the farmers initially support prices were established and import tariffs imposed to keep prices high. • The support prices are so high that it works as an export subsidy.

  30. EU’s Common Agricultural Policy Ps Pw Show benefit to farmers, cost to consumers and export subsidy.

  31. Common Agricultural Policy • Over half of EU's budget goes to CAP. (The Economist, May 8, 1999, p. 18.) • European beef farmers benefit from tariffs up to 125% on beef imports and from the ban on hormone-treated beef, which keeps out most American and Canadian produce. The cost is $14.6 billion a year in higher prices and taxes, or around $1.60 per kilo of beef. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  32. Common Agricultural Policy • European import restrictions more than double the price of many foods, such as milk, cheese and wheat. The duty on offal imports peaks at 826%. The cost of protecting European farming could be as much as 10-15% of value added in agriculture. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  33. Saving Jobs in EU • Europe's costs of protection in 1999 was about 7% of EU's GDP - some $600 billion. • With nearly 17 million Europeans out of work in 1999, politicians were susceptible to claims that competition from imports is costing jobs. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  34. Saving Jobs in EU • Protection in 22 heavily protected sectors safeguards only 200,000 jobs at a cost of $43 billion a year - or some $215,000 per job, enough to buy each lucky worker a new Rolls-Royce every year. • Since most workers in import-competing industries eventually find jobs elsewhere, the true number of jobs "saved" is tiny - and the annual cost of preserving them astronomical. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  35. Protection in Industry in EU • The average tariff (not effective tariff) on non-agricultural goods imported in 1997 was 5.1%. • It excludes the impact of other import restrictions. For example, anti-dumping duties on "unfairly" cheap imports of products like steel, textiles and video recorders; quotas on imports from China and Russia; Japan's "voluntary" agreement to restrict its car exports all add to protection costs. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  36. Protection in Industry in EU • Taking these into account, the true overall rate of industrial protection is at around 9% in 1997. The cost of that protection comes to as much as 8-12% of the value added in industry. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84.

  37. Protection in Services in EU • A thicket of regulations whose costs cannot easily be estimated protects service sectors such as health care, telecommunications, financial services and airlines. But Mr. Messerlin estimates cost of protection could amount to 10-15% of value added in services. Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics, 1999as quoted in The Economist, May 24, 1999, p. 84

  38. Import Quota on Sugar in USA • In 1990, US had import quota of 2.13 million tons on sugar; in 2002, it was 1.4 million tons. • The world price of sugar was $280 per ton in 1990; it was $157.60 in 2002. • The quota raised the US price to $466/ton in 1990; in 2002, it was $417.40. • Given the demand curve and the local production of 5.14m tons at $280/ton, the quota created a shortage of 1.99m tons in 1990. • Price increase to $466 eliminated the shortage by providing domestic incentives to increase production to 6.32m tons in 1990. • For 2002 results, see Figure 8-13 in the text.

  39. Import Quota on Sugar in USA, 1990 b=.5*186*1.18=$110m d=.5*186*0.81=$75m $466 a = 186*5.14 + (186*1.18)/2 =$1066m c=186* 2.13= $396 b d $280 5.14 6.32 9.26 8.45

  40. Import Quota on Sugar in USA, 1990 • Producer gains of $1066 million for 12,000 workers means a subsidy of $89,000 per worker. • Consumer loss is 1066+110+396+75 = $1647 million or $6 per capita. • If because of the quota 2500 extra people are employed in the industry, the cost of per job “saved” is $1,647,000,000/2,500 or $658,800.

  41. Update on Sugar Quotas • According to GAO, the cost to consumers in 1998 was $1.9 billion in higher prices. • Artificially high prices led to overproduction where $1.4 million a month is paid by taxpayers to store one million pounds of sugar. • That is enough sugar to sweeten 180 billion donuts. • The chief beneficiaries are beet and cane growers. Source: http://www.nytimes.com/2001/05/06/business/06SUGA.html?ex=990249498&ei=1&en=70dd040d727a9c94

  42. Update on Sugar Quotas • The present program was put in place in 1981, during Reagan presidency. • In recent years, helped by technology and weather, production has exploded. • A record 8.5 million tons of sugar was produced in the US in 1999. • Excess supply forced raw sugar price down to 18 cents/lb, lowest level in 20 years. • The Agriculture Dept bought 132,000 tons in July 2000 at a cost of $54 million, 20 cents/lb.

  43. Update on Sugar Quotas • The largest producer of raw sugar, Flo-Sun of Palm Beach, FL, is owned by two Cuban exiles and are big donors to both Republican and Democratic parties. • They want to restrict beet and cane production to control supply and limit imports of sugar. • The US sugar supports provide direct payments by taxpayers to sugar growers.

  44. Update on Sugar Quotas • Under 1994 Uruguay Round agreement, US is required to import about 1.1 million tons. • NAFTA requires unlimited access to American market in 2008. • In 2001, American officials claim 100,000 tons will be allowed in from Mexico. Mexicans claim the amount should be 500,000 tons.

  45. Voluntary Export Restraints (VER) • Quotas imposed by the exporting country. • It is similar the import quota where quota rents are reaped by the exporting country. • Multi-Fiber Agreement on textiles and the Japanese auto VERs in early 1980s are examples. • According to the US government estimates Japanese VERs cost the US $3.2 billion in 1984.

  46. Local Content Requirements • Laws that require a fraction of the final good to be locally produced. • It protects the local producers similar to an import quota. • The firms that are required to buy locally will have an increase in cost of production. • Unlike an import quota, it does not restrict imports; the increased cost is passed to the consumers. • Sometimes, local content laws accept exports by the firms to replace local content.

  47. Other Trade Policy Instruments • Export credit subsidies: low interest loan given by the exporter to the importer. • National procurement: requirements that governments have to buy domestically produced goods. • Red-tape barriers: increasing health, safety or customs regulations to discourage imports.

  48. Summary of Trade Policies

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