Transcript Slide 1

Trade Policy
The Canadian economy is strongly integrated
into the world economy
• Exports stood at 38% of GDP in 2007
• Foreign affiliates account for roughly 50% of
manufacturing output and Canadians have
significant investment abroad
• Most international transactions are with the
U.S. (84% of exports are to the U.S. and the
U.S. has 64% of the foreign direct investment in
Canada)
Gains from trade
• Comparative advantage
• Economies of scale
• Increased competition
– When markets are imperfectly competitive, international trade
will increase competition which leads to lower prices and a
reduction in deadweight loss.
– The “disciplining hand” of greater competition can “weed out”
inefficient firms and induce firms to work harder to increase
productivity.
– One researcher estimates that Canadian tariff reductions under
the Canada-U.S FTA increased value-added per worker by 0.6
percent per year from 1988 to 1996. For highly impacted
industries, the top third in terms of tariff cuts, the annual effect
was 3.2 percent.
Canada has embraced free trade
• Canada is a member of the World Trade
Organization and has signed free trade
agreements with the United States
(1988), Mexico (1993), Israel (1997),
Chile (1997), and Costa Rica (2001).
• Free trade with the U.S. has created
substantial trade.
FTA Tariff Effects on Exports
Figure 5: Export Growth, 1988-1998
percent change
450
400
U.S.
350
ROW
300
250
200
150
100
50
0
-50
0-0.9
1.6-2.7
2.9-3.7
U.S. tariff category
3.8-4.7
4.9-20.7
FTA Tariff Effects on Imports
Figure 6: Import Growth, 1988-1998
350
300
percent change
250
U.S.
ROW
200
150
100
50
0
0-2.6
2.9-5.9
6.0-7.5
Canadian tariff category
7.6-9.5
10.0-23
Mfg employment, Canada
(1991=100)
140
120
100
80
Mfg
Textiles
60
40
20
0
199119921993199419951996199719981999200020012002200320042005200620072008
Import restricting policies
• Tariffs
• Quotas: A quota is a fixed limit on the quantity of
imports. Quotas are illegal under the General
Agreement on Tariffs and Trade.
• Non-tariff barriers
– Administrative barriers: administrative procedures that
make it more difficult (and costly) for exports.
– Regulatory barriers: These include consumer health
and safety regulations and technical standards.
– Government procurement policies
Import tariff
Impact of an import tariff
domestic
supply
P*+t
A
B
P*
C
Import supply
D
domestic
demand
w
x
y
z
Quota
Impact of a quota
domestic
supply
P*+e
A
B
P*
C
Import supply
D
domestic
demand
w
x
quota
y
z
Trade policies under
perfect competition
• Under perfect competition, tariffs
and quotas reduce welfare and
redistribute wealth.
Normative rationales for trade policy
•
•
•
•
•
Revenue: (2% for Canada)
Non-economic: national defense, culture
Profit shifting
Infant industry protection
Increasing employment
Imperfect competition and rent-shifting
• Economic rents (profits in excess of
"normal" returns to factors) may exist in
imperfectly competitive industries.
• Governments naturally desire that
industries with economic rents reside
within their borders and institute policies to
promote these industries.
Imperfect competition and rent-shifting
Initial situation
Airbus
Boeing
Enter
Not enter
Enter
-5, -5
100, 0
Not enter
0, 100
0, 0
Airbus given subsidy of 10
Airbus
Boeing
Enter
Not enter
Enter
-5, 5
100, 0
Not enter
0, 110
0, 0
Infant Industry Protection
• A government may need to promote
industries when market failures prevent
valuable industries from emerging.
• The idea behind infant industry protection
is that a new industry needs time to move
down the learning curve and attain
production efficiency
Infant Industry Protection
Why would a nation prefer to have its own industry as
opposed to importing the good from abroad?
• (1) The country may have comparative advantage for
producing the good
• (2) Consumers can save transportation costs
• (3) The industry may confer positive externalities (such
as national defense or knowledge spillovers to related
industries).
• Note that efficient capital markets would finance the
industry in the case of (1) and (2). Thus, market
failure--imperfect capital markets or externalities--must
exist if infant industry protection is justified.
Protecting industries
Policies that promote one sector of the
economy will likely have harmful effects on
other sectors:
• (1) Industries using protected industry's
product as input face higher prices.
• (2) Workers will be drawn into protected
industry and out of other industries.
• (3) Other countries may retaliate and protect
their own industries.
Protecting industries
• (4) Protection can lead to appreciation:
Protection (say, a tariff) reduces the
amount of foreign goods bought by
Canadians. Thus, there will be fewer
Canadian dollars supplied in foreign
exchange markets and the Canadian
dollar will appreciate. Appreciation will
raise the cost of Canadian goods to
foreigners and harm export industries.