Transcript Slide 1

Ch. 8: The Instruments of Trade Policy
1
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

2
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.
3
Which Country Will Export Beef
and Which Will Import?
Pbeef
Pbeef
S
S
D
D
Country A
Q
Country B
Q
4
Country A’s Import Demand
(High Cost Country)
Pbeef
Pbeef
S
MD
D
Country A
Q
Country A
Q
5
Country B’s Beef Export
Supply (Low Cost Country)
Pbeef
Pbeef
XS
S
D
Country B
Q
Country B
Q
6
Equilibrium Price and Quantity
in the World Market
Pbeef
Pbeef
XS
XS
MD
Country B
Q
Q
7
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*.
8
Tariff in a Small Country
S
Pt
Pw
D
Qs
Qd
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.
9
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%?
10
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 (95007000)/7000 or 2500/7000, which is
35.7%.

11
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%.

12
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.

13
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.
14
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
127
439
Q
15
Consumer Surplus
$6.54
Calculate the consumer surplus.
$750
$3.54
$2.54
Calculate the additional
consumer surplus.
$584
D
500
667
Q
16
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.
17
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
18
Producer Surplus
Calculate the producer surplus at $4.50 and at $7.50.
$7.50
$450
$4.50
$150
$1.50
100
200
19
Import Tariff in a Small Country
S
Identify producer
gain, government
gain, and consumer
loss.
Pt
Pw
D
Q1
Q3
Q4
Q2
20
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.
21
Import Tariff in a Large Country
S
Terms of trade effect may
compensate for the deadweight
loss.
Pt
Pw
Pt*
D
Q1 Q2
Q3
Q4
22
Average EU tariff on selected
products, 1997
Beef and lamb
Beverages
Cereals
Clothing
Dairy products
Food products
Sugar
Tobacco
87.7%
22.2
67.8
12.0
57.7
26.9
61.8
58.8
Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics,
1999 as quoted in The Economist, May 24, 1999, p. 84.
23
European anti-dumping duties on
selected products, 1997
Footwear
Industrial chemicals
Iron and steel
Leather products
Metal products
Motorcycles and bicycles
Office and computing equipment
Printing and publishing
Radio, TV and communication
29.1%
28.3
29.3
22.9
44.4
28.4
19.5
18.6
23.2
Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics,
1999 as quoted in The Economist, May 24, 1999, p. 84.
24
Export Subsidy in a Small Country
When there is no terms of trade effect, identify the
welfare gains and losses.
S
Ps
Pw
a
c
b
d
D
Q1
Q2
Q3
Q4
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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.

26
Export Subsidy in a Large Country
Negative terms of trade effect. Show welfare results.
Ps
Pw
Ps*
27
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.

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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.

29
EU’s Common Agricultural Policy
Ps
Pw
Show benefit to farmers, cost to consumers and export subsidy.
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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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
31
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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
32
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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
33
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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
34
Protection in Industry in EU


The average tariff (not effective tariff) on nonagricultural 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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
35
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,
1999 as quoted in The Economist, May 24, 1999, p. 84.
36
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 1015% of value added in services.
Patrick Messerlin, Measuring the Cost of Protection in Europe, Institute of International Economics,
1999 as quoted in The Economist, May 24, 1999, p. 84
37
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.
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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
$280
=$1066m
c=186*
2.13=
b
$396
d
5.14 6.32 8.45 9.26
39
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.

40
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
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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.
42
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.

43
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.
44
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.
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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
Tariff Export SubsidyImport Quota VER
Producer Surplus
+
+
+
+
Consumer Surplus
Government revenue +
0
0
Rents
0
0
Licenses Foreigners
Overall welfare ?; - small
?; - small
49