7 The economics of trade policy

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 retaliate 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 —> 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