SPECIAL ISSUES

countries trade, if the price differs by more than the transport cost

A country has a comparative advantage in a good, relative to another good and another country, if its relative cost of producing the good is lower than the other country’s.

Comparison should be done in autarky, i.e., when they do not trade, because costs may change as a result of trade

cost of producing sth. measures the cost of not being able to produce something else because resources have already been used

-          country A has lower opportunity cost than country B

-          uses its resources more efficiently compared to producing other goods

-          Production uses only labor

-          Constant unit labor requirements and productivity (konstante Skaleneffekte)

-          Two countries only

The production possibility frontier (PPF) of an economy shows the maximum amount of a goods that can be produced for a fixed amount of resources. It is the following:

• hourly wages of C makers are equal to the market value of C produced in an hour: Wages=

Same for wine

• no transport cost

• labor = mobile betw. sectors but not countries

• identical preferences

Benefits from trade:

• relative quantities from world production

• Workers (domestic & foreign) earn higher wages because the relative price for the good they specialize on increases, while the other good’s relative price decreases with trade

(Heckscher-Ohlin)

Countries have comparative advantage in, and therefore export, goods that use relatively intensively their relatively abundant factors.

• 2 goods

• 2 countries

• 2 Production factors: Capital and labor

• Prod. factors are fully emplooyed, freely mobile across sectors and immobile across countries

• Constant returns to scale

• goods markets and factor markets are perfectly competitive

• Identical and homothetic preferences of consumer

• trade is balanced

• All labor is paid the same wage

1. Factor price equalization: Trade causes prices of factors in different countries to move together, becoming equal across countries

2. Stolper-Samuelson Theorem: Real price (wage in terms of goods it can buy) of a country’s abundant factor rises due to trade; Real price (wage) of its scarce factor falls

—> losers from trade are the owners of a country’s scarce factor

1.       No returns to scale, size does not matter neither for specialization nor for the direction of trade

—> we observe increasing returns to scale (economies of scale)

2.       Perfect competition, trade does not increase competition

3.       They predict exchanges of different goods between different countries

• scale effects

• pro-competitive effect: increase of competition, decrease of prices

• Rationalization effect: selection within the industry

• Variety effect: more varieties available for consumption

• External economies of scale may result if a larger industry allows for more efficient provision of services or equipment to firms in the industry.

• Internal economies of scale result when large firms have a cost advantage over small firms, causing the industry to become uncompetitive.

• 1 good, several varieties horizontally differentiated w/o quality-differences

• Internal increasing returns + no differentiation cost —> each producer is in monopoly on its variety

• Free entry in the industry —> long run equilibrium w/ large no. of firms, each making zero profit = perfect competition

• but price > marginal cost: operating profits just sufficient to cover fixed cost

By having fixed production cost

• Consumers benefit from increased variety

• In equilibrium, and assuming all firms have same demand and cost functions:

Autarky equilibrium

1. Supply condition: Average cost

1. Demand conditions & profit maximization yield:

—> markup over MC: decreasing function of no. of competitors

1. Zero profit in equilibrium requires P = AC

• 2 identical counries open up to reciprocal trade:

  • size of market x2

  • no. of firms x2

• higher competition —> price war

• All firms lose

  • no. of firms decreases

  • size of firms increases

Effects of trade:

• Lower price for each variety

• Larger no. of available varieties in each country

  • Global no. of varieties produced decreases

  • Uniformization process through trade

• More efficient scale of operation for all surviving firms

• Reallocation of resources within each industry: fewer firms, but each surviving is larger

• Net effect only, we do not observe which firms exit

1. Gains from inter-industry trade reflect comparative advantage

2. Gains from intra-industry trade reflect economies of scale (lower costs) and wider consumer choices

3. monopolistic competition model does not predict in which country firms locate, but a comparative advantage in producing the differentiated good will likely cause a country to export more of that good than it imports

4. Countries with similar / different relative amounts of factors of production are predicted to have intra / inter-industry trade

5. Unlike inter-industry trade in the Heckscher-Ohlin model, income distribution effects are not predicted to occur with intra-industry trade

-          Cost of 100.000 jobs / 5% of manufacturing employment

-          Some industries had employment fall by ca. 12% due to tariff cuts

-          Over time, more new jobs elsewhere in manufacturing

-          No long run job losses

—> These findings support the monopolistic competition model

• Tariffs on U.S. goods fell to 1% and visa verca

• Productivity increased, esp. for Maquiladora plants

• agricultural sector didn’t suffer because:

  • Poorest farmer are self-catering

  • Mex. Government was able to use subsidies to offset the reduction in income for other corn farmers

  • Total production of corn rose

• Employment in Maquiladora plants grew rapidly, fall after 2000 due to recession in US and competition with China

• Hard to identify since Mexiko and Canada only two of many trading partners

• Expansions of import varieties:

  • Number of product varieties increased 4 times

  • Reduction in import prices by 1.2%/a

• From 1994–2002, about 525,000 workers, or about 58,000 per year, lost their jobs and were certified as adversely affected by trade under the NAFTA-TAA program

1. Exporting firms are in the minority, are larger & more productive than non-exporting firms

2. Firms exporting to more than one country are larger and more productive than the average exporter

3. Multinational firms are larger and more productive than exporting firms

4. Trade liberlaization is generally associated with reallocation of resources towards more productive firms

• Export behavior is mainl based on a firms’ sales profit in different markets

• Sales profits dependent on productivity, demand in the respective markets, and (fixed) costs

• Demand dependent on demand curve position, price and price elasticity

• Marginal cost

• fixed cost

• Price dependent on productivity and price elasticity (infinitely high elasticity = perfect competition)

• Sales profits in domestic market:

—> B: proxy for domestic demand

—> Omega: proxy for productivity

• Profits of domestic firm in domestic market:

• Profits of domestic firms in foreign market:

—> with higher marginal cost , because variable trade cost must be included:

—> leads to higher price in foreign market

• One big and one small foreign countries

Domestic firms’ sales profits

—> small markets hardly profitable

• export vs FDI decision

• Production abroad: save trade cost but duplicate production plant fixed cost

—> going multinational is costly in terms of fixed costs, whereas exporting is costly in terms of variable costs

• foreign sales profits for multinational firm:

with

• Relax assumption that A (position of demand curve) is constant

  —> depends on trade regime

• Trade liberalization reduces domestic firms’ profits in domestic market

• for exporters: loss of domestic market share is overcompensated by foreign sales —> expansion

• Positive net gain for society at expense of low-productivity firms and individuals

Globalization makes simple things (selling to your neighbor) harder (due to foreign competition) and hard things (selling to distant consumers) possible (due to the fall of trade barriers).

o   Trade war US – China (placing tariffs on exports)

o   NAFTA renegotiation

o   Brexit

o   Sanctions related to Russia – Ukraine war

• example for large countries:

  • Ukraine & Russia amount for 53% of global sunflower oil and seeds trade (and high shares of other agrifood goods)

  • With start of the war, global prices of these goods increased significantly

Net loss because Demanders & suppliers behave as if the good’s value were PW+t when in fact the country can buy or sell for PW

Assumptions:

• Perfect competition (all buyers, sellers are too small to have an individual effect on prices)

• Partial equilibrium (markets don’t affect each other)

• Homogeneous products (imported good = perfect substitute for domestically produced good)

world price falls

—> possibility of gain is called:

• “terms of trade” effect of a tariff

• “monopoly” effect of a tariff

• “optimal tariff”

Assumptions:

• Perfect competition (all buyers, sellers are too small to have an individual effect on prices)

• Partial equilibrium (markets don’t affect each other)

• Homogeneous products (imported good = perfect substitute for domestically produced good)

• Definition: price of exports relative to imports:

• If TOT rises, “terms of trade improves”

• Tariff by large country drives down world price of its imports —> improves TOT

• monopoly firm increases its profits by

  • selling less —> increasing prices

• Large country can increase its welfare by

  • buying less from market (via tariff) —> lowering price it pays

• (Large countries can also gain by restricting exports)

• Harms other countries (or rest of the world)

• Lowers world welfare; world loses more than tariff-levying country gains

• Other coutries may tealiate with own tariffs —> both lose

• Any institutional or policy arrangement that interferes w/ trade, other than tariffs

• Also: policies that artificially expand trade (e.g., export subsidies)

• Sometimes “Nontariff Measures)

• Main types:

  • Quotas: Effects equivalent to tariffs

  • Other NTBs

    • Tariff-Rate Quotas

    • Voluntary Export Restarints (VERs)

    • Gov’t Procurement Regulations

    • Customs Procedures

    • Standards

    • …

  • Subsidies

an import quota is a direct restriction on the quantity of an import

• Until Jan-1, 2005 elaborate quotas on many textile and apparel products from developing countries in US & EU

• Still quotas on many agricultural products, e.g., sugar, cheddar cheese, dried milk, …

• (if quota quantity < imports in free trade):  Creates scarcity à raises prices above world price

• Example: US quota on sugar:

• Rent seeking:

  • =use ressources to get rent

  • Faster (=more costly) transport to win first come, first serve

  • Lobbying

  • Inefficient production to get quota allocation based on market share

• Quality upgrading

  • Limited quantity —> foreign expoerts seek higher value by improving quality

• Suppliers +a

• Demanders -(a+b+c+d)

• Someone: +c

c= “quota rents” profits from buying at world price & selling at domestic price

—> who gets quota rents?

• first come, first served: whoever gets there first

• auction import licenses: gov’t gets rent as revenue from license sale

• give away licenses to domestic or foreign firms/persons: those people

• most common: give licenses to foreigners in proportion to their historical exports

• Effects on price and quantity are the same

• Like tariffs quota may induce foreign firms to produce here

• Effect on welfare is different

  • For large country: same, but if quota rent is lost or goes to foreigners, importing country cannot gain

• unlike tariff, quota becomes more restrictive if foreign supply increases or world price drops

Fall in world price:

Rise in world price:

• if small: reverse of fall

• If large enough (PW>=PQ):

  • quota ceases to be binding

  • tariff equivalent of quota becomes 0

  • domestic price = world price

• Works like import quota, but imposed by exporting country

• Usually requested by importing country

• Profits are earned by foreign gov’ts or producers (sell restricted quantity at increased price)

= gov’t assistance to producers

• Export subsidy: paid only for exports

• Domestic subsidy: paid for all production

Use:

• US, EU, Japan have large subsidies on agricultural products

  • hurt producers in developing countries

  • E.g.: EU-subsidies hurt:

    • Corn - Mexico

    • Sugar - Carribean

    • Cotton - certain african countries

• In competitive industries: country loses

• Subsidies are usually intended to benefit producers

• In non-competitive industries result might be different

• large country: reduce world price of exported goods

• Effect on other countries:

  • importer gains

  • exporter loses

• After WWII, 44 country-representatives met to discuss rebuilding of Europe & issues w/ high trade barriers & unstable exchange rates

• Outcome: agreement outlining intl. economic system of convertible currencies, fixed exchange rates

• Proposal: International Trade Organization (ITO) to promote free trade

  —> strong opposition, esp. in US, never established

• 1949: General Agreement on Tariffs and Trade (GATT) incl. 23 countries

  • Periodic meetings to negotiate lower trade barriers

  • At Uruguay round (in Uruguay), WTO was established

• WTO greatly expanded GATT by adding rules for global interactions through binding agreements

• Most recent round: Doha round (began Nov. 2001)

• GATT: covers trade in goods

• GATS: covers trade in services

• TRIMs: covers foreign investment

• TRIPs: covers international property rights

• non-discrimination ((reductions in) tariffs must apply to all members)

• elimination of NTOs

• Dispute settlement procedure: formal procedure to resolve trade disputes through ruling by WTO panel. Countries not adhering to decision may be punished through trade restrictions

  • Exception: temporary tariff raise for certain products: safeguard provision / escape clause (Article XIX); if domestic producers are suffering due to import competition

  • Exception: regional trade agreements: permitted under XXIV of GATT

Customs union:

• free trade between members, identical tariffs to rest of world (EU)

  • difficult to negotiate, but reduce trade barriers more than FTA

Free trade are:

• free trade between members, each member sets own tariffs against rest of world

  • Origin of good must be documented at border

• PTAs increase national welfare when new trade is created, but not when existing trade from outside world is diverted to trade w/ member countries

• Trade creation: when high cost domestic production is replaced by low cost imports from other members

• Trade diversion: when low cost imports from non-members are diverted to high cost imports from members

Assumptions:

• 3 countries, home, partmer 1 & 2

• trading homogeneous good

• home = small country, taking prices as given, partner 1 & 2 large countries

• home could satisfy entire demand through imports

• w/o PTA: home applies same tariff to both partners —> gets all imports from most efficient country

Trade creation:

• gains & losses:

  • consumer +(a+b+c+d)

  • Producer: -a

  • Gov’t: -c

  • Net effect: +(b+d)

Trade diversion:

• Gains & losses:

  • consumer: +(a+b+c+d)

  • producers: -a

  • Gov’t: -c

  • diversion: -e (trade diverted away from Partner 1; home suffers efficiency loss)

  • Net effect: +(a+b)-e —> gain or loss depending on size of e, a, b. usually net loss