The Political Economy of International Trade

1. The Political Economy of International Trade with elements from Ch. 8 – Regional Economic Integration Chapter 6

2. Last sessions: Trade theory, Political economy • Political systems: differ radically from one country to the next • The ease of doing business varies with the system • You have to understand the rules where you are • Level and nature of economic development also differs radically from one place to the next • Gross National Income (GNI) and Purchasing Power Parity GNI measure the differences

3. Mercantilism called for protectionism Economists showed we could produce more throughfree trade (no barriers) Comparative advantage theory shows trade improves productivity even when one nation is more efficient in everything Over time, competition can increase benefits further Review of basic trade theory

4. Understand how government policies impact trade today Review methods of trade restriction and regulation Examine effects of pressure groups Understand how government action can hurt And how it can possibly help Understand the emergence of today’s world trade system Objectives for this hour

5. WARNING: Many students assume that because we discuss these many ways of restricting trade, trade restrictions must be good tools for countries to use. Most economists believe countries should notrestrict trade If you advocate trade restriction in an essay, be sure you have a good reason why you believe in it.

6. Tariffs are the oldest form of trade policy; they are taxes on imports They fall into two categories Specific tariffs are levied as a fixed chargefor each unit Ad valorem tariffs are levied as a proportion of the valueof the imported good Tariffs protect domestic producers Tariffs are good for government because they generate revenue Tariffs are bad for consumers because they increase the cost of goods Instruments of Trade Policy:Tariffs

7. A crucial effect of a tariff or any other trade restriction is to reduce efficiency by encouraging consumers to buy from producers who do not have comparative advantage. Tariffs are usually not needed to support industries that have comparative advantage because such industries can sell at competitive prices under free trade and earn profits. Tariffs reduce efficiency

8. Government payment to a domestic producer Cash grants Low-interest loans Tax breaks Government equity participation in the company Subsidy revenues are generated from taxes Generally, subsidies encourage over-production, inefficiency and reduced trade Japanese subsidy on wheat U.S. subsidies on cotton, sugar Instruments of Trade Policy:Subsidies

9. Import quota Restriction on the quantity of some good imported into a country Clothing import quotas till 2004 Cheese, cotton today “Voluntary” export restraint (VER) Quota on trade imposed by exporting country, typically at the request of the importing country In 2005, China was asked to “voluntarily” limit clothing exports Instruments of Trade Policy:Quotas

10. In recent years, World Trade Organization rules have made them less common Tariffs, subsidies, and quotas are the most directinterventions

11. Requires some specific fraction of a good to be produced domestically Percent of component parts Percent of the value of the good Initially used by developing countries to help shift from assembly to production of goods. Developed countries such as US use in government purchasing Instruments of Trade Policy: Local Content

12. Bureaucratic rules designed to make it difficult for imports to enter a country France – required all video recorders to enter through one remote, understaffed location Japanese administrative rules Tulip bulbs – have to “inspect” by cutting the bulbs Federal Express – have to open many packages to check for pornography Instruments of Trade Policy:Administrative Policies

13. “Dumping” is defined as either Selling goods in a foreign market below production costs Selling goods in a foreign market below “fair market value” Result of Predatory behavior Unloading excess production Remedy: seek imposition of tariffs Instruments of Trade Policy:Antidumping Policies

15. Protecting jobs and industries Common Agricultural Policy in Europe Tariffs, quotas, administrative policies keep farm prices high, keep European farmers in business National security Defense industries - semiconductors Retaliation Punitive sanctions – US sought to punish Saddam Hussein for plotting against neighbors Political Reasons for Intervention

16. Political Reasons for Intervention • Protecting consumers • Genetically engineered seeds and crops • Hormone treated beef • Furthering foreign policy objectives • Helms-Burton Act – Americans can sue firms that use property confiscated in Cuba • Protecting human rights • Restrictive trade rules toward China after Tiananmen confrontation in 1989

18. Infant industry Oldest argument - Alexander Hamilton, 1792 Protected under the WTO Only good if it makes the industry efficient Japanese automakers – were protected with ‘infant industry’ tariffs for 20+ years, became world leaders Brazil automakers - 10th largest - wilted when protection eliminated Economic Arguments - When Intervention May Help

19. Strategic trade policy (often based on ‘New Trade Theory,’ [Chapter 5]) Government should use subsidies to protect promising firms in newly emerging industries with substantial scale economies Governments may benefit if they support domestic firms to overcome barriers to entry created by existing foreign firms Airbus in Europe Didn’t work for U.S. in flat panel displays Economic Arguments - When Intervention May Help

21. Intellectual arguments for free trade Adam Smithand David Ricardo Free trade emerged gradually as government policy in Britain, the leading nation in the 19th century Repeal of the Corn Laws (1846) allowed free trade in food Leading European nations maintained free trade through late 19th Century to WW I Development of the World Trading System

22. Great Depression US stock market collapse (1929) Partial recovery Congress adopted the Smoot-Hawley tariff (1930) Almost every industry had its “made to order tariff” Foreign response was to impose own barriers Everyone’s exports tumbled Depression continued almost till World War II Development of the World Trading System

23. No one wanted to repeat the mistakes of the 1930s General Agreement on Tariffs and Trade (GATT) - multilateral agreement established in 1948 under US leadership Big conference at Bretton Woods, NH, during WW II Objective was to liberalize trade by eliminating tariffs, subsidies, and import quotas 19 original members grew to 120 Development of the World Trading System

24. GATT used ‘rounds of talks’ to gradually reduce trade barriers Mutual tariff reductions negotiated Dispute resolution only if complaints were received Uruguay Round GATT 1986-93 Development of the World Trading System

25. Pressure for greater protectionism in 1980s due to Increase in the power of Japan and closed Japanese markets US trade deficit GATT circumvented by many countries through use of “voluntary” export restraints Disturbing Trends in the World Trading System

26. The WTO was created (1995) during the Uruguay Round of GATT to police and enforce GATT rules Most comprehensive trade agreement in history Formation of WTO had an impact on Agriculture subsidies (stumbling block: US/EU) Applying GATT rules to services and intellectual property Strengthening of monitoring and enforcement The World Trade Organization

27. 156 members in 2012 Represents at least 95% of world trade 9 of 10 disputes satisfactorily settled Under GATT and WTO Tariff reduction from average 40% to average 5% Trade volume of manufactured goods has increased 20-fold The WTO

28. 196 disputes handled by GATT in its 50 year history 280 disputes brought to WTO between 1995 and 2003 US is biggest WTO user Big wins: beef, bananas Big loss: Kodak vs. Fuji Film WTO at Work

29. Telecommunications (1997) 68 countries - 90% of world telecommunications revenues Pledged to open their market to fair competition Financial Services (1997) 95% of financial services market 102 countries open their markets to varying degrees The WTO - Achievements

30. “Millennium round” was aimed at further reduction of trade barriers in agriculture and services WTO meeting disrupted by Human rights groups Trade unions Environmentalists Anti globalization groups No agreement was reached WTO still struggling for liberalization today WTO in Seattle (1999)

31. China joined the World Trade Organization in 2001 • It seems to have contributed to a liberalization in China’s economy • Many disputes between China, others, but China mostly follows the rules in settling them • 9 of 10 WTO disputes satisfactorily settled

32. Russia joined Aug. 22, 2012 • This means it agreed to ‘liberalize’ a lot of its economy • Must effectively enforce contracts agreed by foreigners • Has to allow Hollywood movies, etc. • Will it fulfill promises?

34. While trade was growing freer globally, some regions focused on reducing barriers within themselves “Regional economic integration” refers to agreements in a geographic region to reduce, and ultimately remove, tariff and non-tariff barriers for goods, services, and factors of production (people, investment capital) Regional Integration

35. Despite the trend toward freer trade, it is hard to get the whole world to agree on changes Neighbors can often make more comprehensive agreements Europe has open borders Rest of world hasn’t been able to develop that People change jobs, capital can move freely around Europe, too Why Regional Integration?

36. In a Free Trade Area all barriers to the trade of goods and services among member countries are removed A Customs Union eliminates trade barriers between member countries and adopts a common external trade policy A Common Market has no barriers to trade between member countries, includes a common external trade policy, and allows factors of production to move freely between members Levels of Economic Integration

37. An Economic Union involves the free flow of products and factors of production between member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members’tax rates, and a common monetary and fiscal policy A Political Union occurs when centralized political institutions coordinates the economic, social, and foreign policy of the member states Levels of Economic Integration

38. Member States of the European Union in 2010 Regional Economic Integration In Europe

39. The North American Free Trade Agreement (NAFTA) was ratified by the governments of the United States, Canada, and Mexico in 1993; it became law January 1, 1994 NAFTA includes reduced tariffs (99% of goods traded) removal of most barriers on cross border flow of services Removal of restrictions on FDI except in certain sectors Mexican railway and energy US airline and radio communications Canadian culture A customs union, not full economic union The North American Free Trade Agreement

42. How Comparative Advantage works Ghana has absolute advantage in both cocoa and rice, but its comparative advantage is in cocoa. Korea has comparative advantage in rice . Cocoa 20 tons Let Korea specialize in rice – Ghana expands cocoa production to replace all Korean cocoa production lost 15 tons Ghana Then Ghana can replace all Korean cocoa production and the countries have more of both goods. 5 tons Korea 15 tons 10 tons 18 tons 3.75 tons Rice

43. Your country has comparative advantage in the product or service where the ratio Resources required in your country . Resources required in the other countryis lowest

45. Plan for written assignments Be sure you understand the question Essays for the midterms will be distributed in advance If you don’t understand something … ask in class ask a friend visit the instructor call the instructor Be sure you’re answering the question asked No credit for saying interesting things that aren’t relevant to what was asked Our goal: Everyone gets a good grade for good work

46. Show you understand the concepts In this case – Free trade Comparative advantage Possibly ideas like infant industries, etc. Your argument (whether you agree with what’s in the text or not) is based on and follows logically from facts and plausible existing theories. Critical thinking

48. Hypothetical Tariff Rate Quota