Chapter 5 - Trade & Macro

5.1 Macroeconomic Factors

– exchange rates – interest rates – government fiscal balance

5.2 International Agricultural Trade

–Trade agreements

5.3 Trade Theory

–Gains from trade –Distortions (tariffs & subsidies) –Farm programs

1) Exchange Rates

Affects the competitiveness of agr. Products Early 1970’s – floating exchange rates Policy – over or under value exchange rate What is the impact of a ER distortion?

Example 1:

Argentina: Overvalued Exchange Rate (exporter) Shift of excess demand function Lower producer price Lower quantity exported Loss of producer surplus

Source: International Monetary Fund -IFS

P

Increase in Exchange Rate

ED S Q

Interest Rates:

Why interest rates are important:

1) Value of currency

– prices received and paid Most commodities are US$ denominated

2) Cost of borrowing:

Agriculture is capital intensive (borrowing) Inputs: seed, fertilizer, machinery 1980’s - high interest rates – low grain prices - debt crisis

Cost of borrowing

: How is it determined ?

Role of central bank (Bank of Canada) Role of the market Government intervention (interest subsidies)

20 18 16 14 12 10 8 6 4 2 0 1960 1965 1970

Canadian Prime Rate % (1960-2004)

1975 1980 1985 1990 1995 2000

100 Basis points = 1% Src. Globe & Mail - March 8, 2008

Government Fiscal Balance

Consequences for Agricultural Policy

1 – interest rate

- more borrowing = higher rates

"crowding out effect"

- higher cost for farm borrowing 2001 Average capital/farm = $800,000 Total farm capital = $ 200 Billion 1% change in interest rates => $ 2 Billion (1971 - 2002) - Net market income - 1.8 $B (2002) 3.3 $B (1975)

2 – capacity to fund interventions

- deficits = limited marge de manouvre - reduced scope for intervention

Debt/GDP Canada (61-2003)

80 70 60 50 40 30 20 10 0 1961-62 1969-70 1977-78 1985-86 1993-94 2001-02

-8 -10 -4 -6

Deficit/GDP Canada (1961-03)

4 2 -2 0 1961-62 1966-67 1971-72 1976-77 1981-82 1986-87 1991-92 1996-97 2001-02

Fiscal Deficit - Debt Service (1961-2003) ($Millions)

60000 50000 40000 30000 20000 10000 0 1961-62 -10000 -20000 -30000 -40000 1966-67 1971-72 1976-77 1981-82 1986-87 1991-92 1996-97 2001-02

5.2 International TRADE

Gains from trade:

•

> increase in output due to specialization



based on comparative advantage each country

– –

concentrates on producing goods and that it produces relatively efficiently trading to obtain goods that it does not

• • •

Trade Distortions many forms of distortion (welfare reducing) tariffs, taxes, subsidies, quantitative measures non-tariff barriers (health, safety reg’s)

• •

Trade Agreements institutional arrangement – restraint on behaviour multi-lateral (regional), bilateral

•

Levels of cooperation

– – –

Range of goods (agr vs industrial) Scope of instruments included Customs union – full economic integration (EU)

Reasons for Protection

•

new industry (infant industry argument)

•

national health + phyto-sanitary

•

unfair foreign trade policy

•

Defend domestic programs

•

improve balance of payments

•

improve “Terms of Trade”

•

generate revenue

•

slow down painful economic adjustment

•

Political economy

benefits of additional trade are spread thinly among many individuals but the cost is high for only a few firms or groups

Trade Theory

• Why do nations trade? • What are the benefits?

• Implications of trade distortions

Theory

• comparative advantage (Ricardo) • absolute advantage  

P P M A

 

US

• Ohlin (1933) • comparative advantage – due to resource endowments – Canada land rich, capital poor   

P P M A

 

CA

– => export agr & import manufactures

Gains from trade

• Trade allows for specialization – increased welfare

.

Agr.

P 2 P 1

Gains from Trade

W 1 W 2 Manufactures

ES/ED Framework

• Excess Demand (ED) • Excess Supply (ES)

Gains from trade (versus no trade)

• depend on the impact of a country on world prices • Small country – no price impact • Large country – prices adjust, impacts smaller

2 Country Model – 1 good

• e.g. US/Canada cattle market • Assume: Canada - low cost producer • How are consumers and farmers affected by trade between the two countries?

• Winners and losers – distribution effects – US – consumers gains, farmers lose – CA – consumers lose, farmers gain

.

Canada

Gains from Trade

Trade Sector US ES P US W US P W P CA W CA ED Trade

Analysis: Trade Distortions

•

1 ) Import Tariff

Fixed-tariff rate vs ad valorem

• – – – –

Small country (fixed tariff)

domestic price increases Supply increases, demand decreases imports reduced Net dead weight loss • – – – – – – –

Large country

domestic price increases world price decreases Imports decrease; domestic output increases Consumers lose; producers gain Government gains tariff revenue Net welfare gain Potential to compensate consumers

Import Quota

•

Binding quota

–

if it restricts imports below free trade imports

•

Similar price effects to a tariff

– – – –

Imports lower Domestic price higher World price lower Rents to importers

•

Quota value: right to import

–

Based on difference between new world price and domestic price

P Q P w .

Large Country – Import Quota

Domestic Market D S World Market ES ED 0 P WQ Q I Q

Large Country - Tariff

.

P w Domestic Market D S ED 0 World Market ES TR ED 1

Import tariff – Small Country

S P T P w b G income a Government income – few transactions D

Export Subsidy

•

Used extensively

– Purpose: support domestic income (price) support – Subsidy to export the excess supply – US (EEP) starting in 1985 – EU (ERP) – export restitutions – 1970’s – not unique to agriculture – e.g. Bombardier •

price support program – increases ES

•

Subsidy Impacts

– world price falls (large country) – Domestic price falls – Exports expand – Government payments = (P s -P Ws )*exports •

value of exports increase relative to free trade

•

Deadweight loss

– Consumers gain – Producers gain – Foreign importers gain – Taxpayer loses

Export Subsidy – Large Country

S P s DWL P ws P w D T D d Exports Before Exports After Dd – domestic demand D T – total demand – including world demand

Export Tax

•

Tax exporters

•

Exporting government gain revenue from export taxes

•

Producers in exporting country lose

Export Cartel

Assumptions:

• 2 countries • Cartel: importer + domestic supplier • Suppliers maximize joint profits • Price according to joint supply function • MR = MC (joint MC)

Results:

• Domestic price increases • Imports and domestic production decrease • Foreign surplus increases • Deadweight loss

Export Cartel

.

P C P w S Exporter b a Q E Q d S d S T – domestic supply – domestic + foreign supply Exporter gain = (a-b) Deadweight loss = c c S d Importer S T MR D Q

Decoupled Subsidies

•

Programs that do not distort trade

–

within the green box category under GATT

•

policies that lead to a per-unit payment to producers are not decoupled

•

trade distorting => affects trade and prices

•

Is any farm program completely decoupled ?