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Economics of Trade Liberalization and Integration

Economics of Trade Liberalization and Integration. Jan Fidrmuc Brunel University. Import demand curve (MD). Home Supply. price. price. 1. P*. 2. P”. P”. 3. P’. P’. Home import demand curve, MD H. Home Demand. quantity. imports. Z’. Z”. C”. C’. M”. M’. price. price.

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Economics of Trade Liberalization and Integration

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  1. Economics of Trade Liberalization and Integration Jan Fidrmuc Brunel University

  2. Import demand curve (MD) Home Supply price price 1 P* 2 P” P” 3 P’ P’ Home import demand curve, MDH Home Demand quantity imports Z’ Z” C” C’ M” M’

  3. price price Foreign Supply Foreign export supply curve, XSF, or MSH. 3 P” P’ 2 P* 1 Foreign Demand exports C” C’ Z’ Z” X’ X” quantity Import supply curve (MS)

  4. Domestic demand curve Domestic supply curve Domestic price, euros euros Sdom Import (foreign export) supply curve MS PFT MD Ddom Import demand curve Imports imports quantity Z C Imports MD-MS Diagram • MD-MS diagram permits tracking domestic & international consequences of trade policy changes.`

  5. Non-discriminatory (MFN) Tariff • Consider tariff of T euros per unit • MFN non-discriminatory tariffs • WTO rules: lowest tariff (most-favored nation) must apply equally to all trading partners • Exception: FTAs • Tariff shifts MS curve up by T. • Exporters earn domestic price minus T • They would need domestic price of P+T to continue to offer the same exports.

  6. MFN Tariff Analysis • New equilibrium in Home (MD=MS) is at P’ and M’. • Domestic price P’ now differs from border price (price exporters receive) P’-T. • Domestic price rises. • Border price falls. • Imports fall. Border price Domestic price MS with T MS XS=MS P’ PFT PFT T P’-T MD Foreign exports Home imports M’ MFT X’=M’ XFT= MFT

  7. Foreign loss due to drop in exports equal to area D (trade volume effect). Foreign loss due to drop in border price equal to area B (border price effect, a.k.a., ToT effect). Net effect on Foreign = -D-B. Home loss equal to area -A-C (trade volume drops and price rises). Home gain due to drop in border price and tariff revenue equal to area A+B. Net effect on Home = -C+B. World welfare change is -D-C. If Home gains (-C+B>0) it is because it exploits foreigners by ‘making’ them pay part of the tariff (i.e. area B). Welfare effects

  8. Distributional consequences • Home consumers lose area E+C2+A+C1 • Home producers gain E • Home tariff revenue: A+B. • Net change = B-C2-C1 (this equals B-C in left panel). • Net effect can be positive or negative. • Tariffs imposed because they benefit domestic producers who are often organized and politically influential • This comes at a cost to domestic consumers and to foreigners • If Foreign retaliates and also imposes a tariff, everyone loses • With reciprocity, protectionism is not a zero-sum game

  9. Domestic price, euros euros Sdom P’ P’ MS A E A C C2 C1 PFT PFT B D B P’-T P’-T MD Ddom imports quantity Z’ C’ Z C Distributional consequences

  10. Preferential Trade Liberalization • Previous analysis used 2 countries only: Home and Foreign • European integration is discriminatory (or preferential) and its analysis requires at least three countries: • At least two integrating nations. • At least one excluded nation. • MD-MS diagram must to allow for two sources of imports.

  11. The PTA Diagram: Free trade RoW Partner Home Border price Border price Domestic price MS XSP XSR 1 2 PFT MD XP Partner Exports RoW Exports XR Home imports M=XP+XR

  12. RoW Partner Home Border price Border price Domestic price MSMFN MS XSP XSR P’ T 1 2 PFT P’-T MD XP Partner Exports RoW Exports XR Home imports X’P X’R M’ M=XP+XR The PTA Diagram: MFN tariff

  13. Discriminatory unilateral liberalization • Assume Home removes T on imports only from Partner. • This liberalization shifts up MS (as with MFN tariff) but not as far since it applies only to one half of imports. • Shifts up MS to half way between MS (free trade) and MS (MFN tariff) • More complex, kinked MS curve with PTA. • If price falls below Pa, RoW will export zero.

  14. Discriminatory, unilateral liberalization Border price Border price Domestic price Partner MSMFN RoW Home MSPTA XSP MS XSR P’ P” P” T P’-T P”-T Pa 1 T MD p* Partner Exports RoW Exports Home imports M’ XP’ XP” M” XR” XR’

  15. Domestic price falls to P’ from P”. Partner-based firms see border price rise, P’-T to P”. RoW firms see border price fall from P’-T to P”-T. Domestic price & border price changes Border price Border price Domestic price MSMFN XSP XSR MSPTA MS P’ P” P” T P’-T P’-T P”-T MD XR” XR’ XP’ XP” M’ M” Home imports Partner Exports RoW Exports

  16. RoW exports fall and Partner exports rise: supply switching: trade diversion Domestic imports rise: trade creation. Partner exports rise more than RoW exports fall. Border price Border price Domestic price MSMFN XSP XSR MSPTA MS P’ P” P” T P’-T P’-T P”-T MD XR” XR’ XP’ XP” M’ M” Home imports Partner Exports RoW Exports Quantity changes: supply switching

  17. Impact of customs union formation

  18. Home’s net change = A+B-C  ambiguous Partner’s net change = +D. RoW’s net change = -E. Border price Border price Domestic price Home RoW Partner XSR A XSP P’ P” P” D C P’-T P’-T E P”-T P”-T B MD XR” XR’ XR” M’ M” RoW Exports Partner Exports Home imports XP’ XP” Welfare effects

  19. Analysis of a Customs Union • European integration involved a sequence of preferential liberalisations, all of them reciprocal: • Both Home & Partner drop T on each other’s exports. • Need to address the 3-nation trade pattern. • Example: each country produces 3 goods, exports 2 and imports 1

  20. Home and Partner eliminate T on their mutual trade Both impose T on trade with RoW Home-Partner CU has Common External Tariff (CET) equal to T Analysis is simply a matter of recombining results from the unilateral preferential case. In market for good 1, analysis is identical. In market for good 2, Home plays the role of Partner and Partner plays role of Home. Analysis of a Customs Union

  21. In market for good 1: Home change = A+B-C1-C2. In market for good 2: Home change = +D1+D2. NB: D1=C1. Net Home impact =A+B-C2+D2 . Partner impact identical. RoW loses in both markets. RoW exports fall but imports stay the same: trade deficit euros euros A XS D P’ 2 P” D 1 C C2 MD 1 P’-T B P”-T XP’ XP” XR” XR’ M’ Exports imports Welfare effects of a customs union

  22. EU Trade Policy

  23. Geographical Structure of Trade

  24. Differencesamong Member States

  25. Composition of trade

  26. What with whom?

  27. EU’s MFN tariff structure (the CET)

  28. Institutions • Trade policy is an exclusive prerogative of the EU. • Customs Union requires agreement. • Commission has responsibility for negotiating • Trade Commissioner. • Council of Ministers sets “Directives for Negotiation,” accepts/rejects final deal. • Commission in charge of surveillance and enforcement of 3rd nation commitments. • Trade disputes with US, China, etc.

  29. EU External Trade Policy • EU has special arrangements with 139 nations; often more than one per partner. Each can be very complex.

  30. Non-preferential trade • Only about 1/3 EU imports are not granted some sort of preferential treatment • Only 9 nations (US, Japan, etc.).

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