INTERNATIONAL ECONOMICS

1. INTERNATIONAL ECONOMICS Lectures 19 & 20 | Lucía Rodríguez| Preferential and Multilateral Trade Liberalization

2. PREFERENTIAL TRADE AGREEMENTS • We have assumed that trade restrictions are non-discriminatory, however: • Most countries implement discriminatory trade regulations. • Trading blocks emerge as a key actor in international trade: there were already more than 400 PTA's by 2010. • There are different levels of integration: • Free-Trade Area: NAFTA (1994) • Tariffs and other barriers to trade are removed among the member states. • Each country retains its own tariff schedule with respect to non-member states, encouraging competence and reshiping. • Customs Union: EEC (1968) and neoprotectionism/eurosclerosis • There is a common external barrier (tariffs and other barriers) to imports from outside the area.

3. PREFERENTIAL TRADE AGREEMENTS • Common Market: Portugal and Spain join the EEC and the Single European Act is signed (1986) • We allow the free mobility of inputs among members • Single Market: Maastricht Treaty (1993) EU is created (although not fully achieved yet). • Technical and fiscal obstacles are removed (eg: labelling) • Economic Union: • Coordination of economic policies and cohesion as well as regional development policies. • Economic and Monetary Union: EMU (1998 starting point) • Single monetary/exchange rate policy. • Coordinated fiscal policy. • Single Currency.

4. PREFERENTIAL TRADE AGREEMENTS • Economic effects of a custom union: is it a movement towards free trade? • Discriminatory tariffs create the possibility for a loss in efficiency and a worse allocation of resources. • There is a need for compensatory taxes and subsidies to ensure an increase in global welfare.. • Viner analysis (1953) adds 2 key concepts to the classical analysis of comparative advantage: • Trade creation: Benefitial effect of a PTA on its members. There is a substitution of inefficient domestic production for newly imported goods from the inner countries. • Trade diversion: efficiency-reducing effect as trade is diverted from low cost non-member countries to higher-cost sources.

5. PREFERENTIAL TRADE AGREEMENTS • Partial Equilibrium Analysis in a small country: • The industry is small compared to the rest of the economy. • Perfect Competition; no firm is big enough to affect the final result • Market for shoes : • Free-Trade Equilibrium: China is the more efficient producer: Pchina < Pgermany < Pchina(1+T) • Customs Union: • Lower price wrt the tariff: higher C and less P. • More imports. • Welfare effects: • Consumer Surplus increases: a+b+c+d • Producer Surplus decreases: a • Tariff revenues lost: c+e • Trade diversion: e • Net welfare effect: b+d-e • What factors determine the final result? Elasticities, size, pre-tariff, transportation costs (-), complementarity in production P Supply Sch+T P a b c d P’ Sg e Sch Pch Demand Q Q Q’ Q’’ Q’’’

6. PREFERENTIAL TRADE AGREEMENTS • Economic effects of a custom union: broader considerations, dynamic effects: • Higher competition: greater efficiency, lower margins, consumer benefits from lower prices. • Bigger markets: higher economies of scale. There is a need for Competition Defense Policies to avoid abusive behavior from firms. • Non-price effects: R&D stimulus, higher quality products, greater variety, technological spillover

7. PREFERENTIAL TRADE AGREEMENTS • How to measure the gains? • Measure the trade that occurs once the PTA is created, but we need to compare it with the potential that would have happened in the absence of the PTA. • Gravity models:

8. PREFERENTIAL TRADE AGREEMENTS • Some figures for NAFTA: • Precursor: Canada - U.S. free trade agreement, 1989. • Already the largest bilateral trade flow in the world • 1/10 the size of the U.S. market and similar wages  U.S. industry anticipated neither major gains nor losses. • Within Canada: controversy. • Ontario: large manufacturing sector but small scale and high costs, opposed the pact. • Western provinces: specialized in natural-resource-based products exported to the U.S. favored it. • Empirical studies say there were significant gains to Canada: substantial EoS were realized by exporting to a much larger market. • Mexico-U.S. issues (1992-1994): • Against: U.S. unskilled workers, owners of firms that produced labor-intensive goods, farmers in California and Florida. Fears that U.S. firms will shift production to Mexico. • In favor: the rest of U.S. farmers, high-tech / capital-intensive industries. • A major U.S. objective: promote rapid economic growth in Mexico and reforms initiated in 1990.

9. PREFERENTIAL TRADE AGREEMENTS • Mexico-U.S. issues (1992-1994). NAFTA’s effects: • Trade creation effects increased GDP in Mexico by 0.3%. • Adding EoS raised that figure to 1.6-3.4% • Adding capital accumulation (investment rules were liberalized in Mexico) raised it further to 4.6-5.0% • The gain to the U.S. was roughly 0.1 % of GDP (indication of the relatively small size of the Mexican market) • Evidence of trade diversion. Example: apparel industry. • Between 1993-1998, U.S. consumption rose by 20%. • Imports from all sources rose to 45% of domestic consumption • The Mexican share of those imports doubled from 6.6% to 13.4%

10. PREFERENTIAL TRADE AGREEMENTS Exercise 3 page 270: Consider the import market for country C, where import demand is given by the difference between total demand for the product and its domestic supply: Md = Qd – Qs, with Qd= 140 – P, and, Qs = -100 +2P a. If country C trades with both countries A andB, but imposes a specific tariff of 20 on imported goods, solve for the equilibrium price and quantity in the import market if the constant foreign prices exclusive of the tariff are Pa = 50 and Pb = 40. b. If country C forms a PTA with country A and eliminates this tariff on imports from A while maintaining it on imports from B, what is the new equilibrium in the import market? Calculate the gains from trade creation and the losses from trade diversion. How much better off are consumers in C? By how much do profits in the import-competing industries fall?

11. PREFERENTIAL TRADE AGREEMENTS Exercise 3 page 270: Consider the import market for country C, where import demand is given by the difference between total demand for the product and its domestic supply: Md = Qd – Qs, with Qd= 140 – P, and, Qs = -100 +2P a. If country C trades with both countries A and B, but imposes a specific tariff of 20 on imported goods, solve for the equilibrium price and quantity in the import market if the constant foreign prices exclusive of the tariff are Pa = 50 and Pb = 40. 80 Pb + 20 Pa = 50 Pb = 40 20 80

12. PREFERENTIAL TRADE AGREEMENTS b. If country C forms a PTA with country A and eliminates this tariff on imports from A while maintaining it on imports from B, what is the new equilibrium in the import market? Calculate the gains from trade creation and the losses from trade diversion. How much better off are consumers in C? By how much do profits in the import-competing industries fall? • If Qd= 140 – P, and, Qs = -100 +2P, then at the new equilibrium  Md = 80 • Gains from trade creation = b + d = (0.5*20*10) + (0.5*10*10) = 150 • Losses from trade diversion = e = (60*10) = 600 • Consumers are better off by areas a+b+c+d = 150 + (60*10) + (0.5*20*10) = 850 • Producers in the import-competing industries have lost profits by area a = 100. 80 Pb + 20 a c b d Pa = 50 e Pb = 40 20 80 90 0

13. MULTILATERAL LIBERALIZATION • Precursors: • By 1850 virtually all British tariffs and other restrictions on imports had faded out and was followed by other European countries. • The most favoured nation principle acelerated trade: automatic extension of the lowest tariffs granted in the future to other countries. • After WWI the US emerged as a major market but highly protected (Smoot-Hawley Tariff Act of 1930 imposed an average rate of 50%), this added to world recession, shrank trade volumes. • The Reciprocal Trade Agreement Act in 1934 meant the beginning of a new era of bilateral trade agreements with chief suppliers, without trade diversion considerations.

14. MULTILATERAL LIBERALIZATION • The GATT (General Agreement on Tariffs and Trade): • The multilateral wave that followed WWII created the main international institutions (Bretton Woods agreement): The IMF, the IBRD, and the ITO???? • There was strong political opposition to its creation (protectionist ideas were strong), therefore a minimum agrement was reached: the GATT was adopted in 1947.

15. MULTILATERAL LIBERALIZATION • The GATT (General Agreement on Tariffs and Trade): • GATT principles as a code of conduct for international trade and a basis for multilateral trade negotiation of trade agreements: • Unconditional MFN clause (with an exception for customs areas). • National Treatment of foreign and domestic goods (keeping discriminatory domestic taxes and regulations from protecting domestic producers). • Opposition to quantitative restrictions (quotas). • Escape clause: a provision to allow the country to assist an industry badly injured by tariff reductions, by claiming for some period of relief to retrain, adjust, etc.

16. MULTILATERAL LIBERALIZATION • The GATT (General Agreement on Tariffs and Trade): • Tariff reductions: series of negotiations in which countries bargained to reduce their tariffs and other trade barriers: See table 10.2 on page 281. • First with closed lists of concessions that the country was willing to offer and wanting to obtain: complicated and lengthy. Until 1961 large cumulative effect (Average tariff of the U.S. declined from 53% to 10%. Large disparities however…) • Under the Kennedy Round (1968), most tariff reductions occurred across the board with lists of sensitive items requiring special treatment, but there was a general reduction by a uniform percentage. Tensions wrt the formula for tariff reductions. • In order to reduce non-tariff barriers involving elements of domestic policy, the Tokyo Round was key to implement separate codes and agreements on: subsidies, technical barriers, dumping, etc. But not all countries signed those codes! • GATT à la carte. • The Uruguay Round treated then the various agreements as a single take-it-or-leave-it package.

17. MULTILATERAL LIBERALIZATION • The WTO (World Trade Organization) • Difficult Establishment (1986-1992). • Important areas that had escaped the GATT discipline were addressed: • Agriculture: export subsidies, import barriers, domestic farm supports were to be reduced. Quantitative restrictions were transformed into tariffs and then cut by 36%. Minimum import access equal to 3% of domestic production. • Textiles and Clothing: Multi-Fibre agreement to phase-out country-specific quotas. • Trade-related Investment Measures (TRIMs): prohibition of domestic content requirement and trade balance requirement (X=M) in order to minimise obstacles to FDI and technology transfers. • General Agreement on Trade in Services (GATS): backed by services exporters, although not really deep compared to the GATT. • Trade-related aspects of Intellectual property Rights (TRIPs). Particularly contentious: the adoption of common intellectual property standards may leave developing countries worse off but it was pushed forward by innovating firms coming from developed countries to ensure that profitable innovation goes on.

18. MULTILATERAL LIBERALIZATION • The WTO (World Trade Organization) • Trade disputes: Is it successful? • Request consultations with a specific country that 'apparently' is not following WTO rules. • If no satisfactory resolution is reached: request that a Panel be formed to hear the case. (Deliver a resolution in 1 year). • It's possible to appeal the panel's decisions to a recently created Appellate Body, which conclusions are adopted regardless the degree of consensus (this contrasts with the previous GATT procedure). • Offending countries cannot be forced by the WTO to offer satisfactory compensation or bring their practices into compliance. In case, they don't bring their practices into conformity with WTO regulation, an arbitration Panel may grant the complaining country the right to retaliate to restore the prior balance of concessions. • How could a small country retaliate against a large one? Proposals have been made to impose fines or auction off retaliation rights. • The WTO Trade Policy Review Body is in charge of checking member countries trade policies and their compliance with WTO standards.

19. MULTILATERAL LIBERALIZATION • The WTO (World Trade Organization) • The Doha Development Agenda (2001- ) • Developing countries were reluctant because little benefits emerged from the Uruguay Round. • Most negotiating items made specific reference to 'special and differentiated treatment' for developing and least developed countries. • Divergent opinions even among the different developing countries have delayed a final agreement that has not been reached yet. • Other open issues: membership. China joined in 2001, Vietnam (150th member) in 2007. Russia is not likely to do it soon. Why? It's in both parties' interest.

20. MULTILATERAL LIBERALIZATION • Regionalism vs Multilateralism • Lawrence: Both complementary • Regionalism acts as a catalyst for multilateral liberalization through progressive reduction of trade barriers [WTO official version] • Baghwatti: Substitutes • The Least Developed countries are left outside, multilateral trade is impeded, and trade diversion as well as neoprotectionism are to be considered. Real Danger: Regionalism à la carte…

21. OPEN ISSUES: ENVIRONMENTAL EXTERNALITIES • Marginal Benefits and Marginal Costs of Pollution Clean-up • C* gives the optimal amount of environmental clean-up. • We are assuming that all countries value a cleaner environment in the same way and face the same clean-up costs. What if they don’t? • Environmental quality tends to be a luxury good: growth using human capital intensively rather than physical capital. (Environmental Kuznets Curve) C,B Mg costs Environmental damage a Mg benefits 100% Pollution Reduction C* C’ Income per capita

22. OPEN ISSUES: ENVIRONMENTAL EXTERNALITIES • The tragedy of commons and Global Warming • Environmental externalities have to be considered worldwide: Global climate conditions are a common resource. • Addressing the Global Warming challenge is difficult from an individual country's point of view. • The Kyoto Protocole to the Climate Change agreed to in December 1997 called for industrialized countries to curb greenhouse gas emissions from their 1990 levels by 2012. • Durban?? • Designers of a new agreement are particularly constrained by the self-interest of two countries: US (accounted for 23% of GHG emmissions in 1990) and China (projected to account for 24.5% in 2030).