Implications of the HO model

1
Implications of the H-O model

• Factor price equalisation.
• With trade international prices converge.
• If country A exports cloth because it is
  labour-intensive and labour is abundant (cheap),
  trade will increase relative price of labour in
  coutry A.
• If country B exports food because it is
  land-intensive and land is abundant (cheap),
  trade will increase relative price of land in
  country B.

2
And...

• Biased specialisation.
• An increase in the supply of one factor expands
  production possibilities but in favour of the
  output of the good intensive in that factor.
• What about Syria. Which factor has increased its
  supply? What would happen if this supply suddenly
  goes down?

3
International trade theory (II)
4
Economies of scale

• Many industries are characterised by increasing
  returns or economies of scale.
• Economies of scale may be
• Internal to the firm.
• External to the firm but internal to the
  industry.
• Economies of scale can be given by history or
  accident.

5
Imperfect competition

• Economies of scale usually lead to imperfect
  competition.
• A case of imperfect competition is dumping.
• A case of dumping is reciprocal dumping two
  monopolistic firms dump into each others home
  market.

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Intra-industrial trade

• One-way trade Inter-industrial trade.
• Two-way trade intra-industrial trade.
• Two-way trade seems good
• Larger choice of varieties.
• Less strong effect on income distribution.

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Two reasons for two-way trade
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One-way trade of selected countries
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Some theory for preferential trade

• Assume three countries with the following costs
  for wheat
• US 80US/t, EU 120US/t Morocco 160US/t
• Suppose that formerly Morocco applies a 60US/t
  tariff.
• Assume that the tariff is phased out on EU
  imports.
• Trade deviation the efficient supplier is
  removed. Significant risk in some cases.
• Trade creation the partner replacing domestic
  production. This improves efficiency.

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FDI and regional integration

• Two strategies for TNCs
• Vertical or outsourcing. Needs incentives to
  attract FDI such as low production costs or
  market access in industrial economies.
• horizontal or market seeking. Needs large
  consumer markets. Again this calls for
  South-South integration.
• Domestic factors
• Institutional background and investment climate.
• Endowment of human resources.
• Presence of efficient local firms.
• Fiscal incentives

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Trade policy interventions
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Types of policies with impact on trade
13
Producer surplus

14
Consumer surplus

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Analysis of tariffs

• Tariffs can be specific, ad valorem, or more
  complex.
• Basic analysis of the economic impact of
  tariffs

Small country case
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Welfare analysis of the tariff

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Quotas

• Quantitative limits. In some cases even
  voluntary (VER).
• Prices keep high, like tariffs.
• But, there is no tariff revenue a quota-rent
  appears.
• License holders get rights to take the
  quota-rent

• Transparency is not a quality of the quotas
• Isolation from trade intensified.

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An example of VER
Source Procotol 1, annexed to the Euro-Egyptian
Association Agreement.
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Tariff-Rate Quotas (TRQs)

• TRQs an amount of imports benefitting from
  lower tariffs.
• Created with good intentions avoid that
  tariffication becomes prohibitve.
• In practice, a great deal of managed trade
  remains in the TRQs.

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WTO members applying TRQs
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Binding tariff levels (averages)

• Applied tariffs are often lower than the
  bindings.
• World average in-quota tariff is 62.
• Over-quota tariffs are often prohibitive.

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Political Economy ofTrade Policies
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Why protection?

• Economic reasons.
• Non Economic reasons
• Political process
• Food Security

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Economic arguments (I)

• Protection of infant industry.
• Market failures
• Domestic distorsions in factor markets
  externalities. Protection leading to second-best
  solutions.
• Two objections to this argument
• Addressing the source of the problems may be
  more efficient.
• Responses to protection policies are unknown.

25
Economic arguments (II)

• Protection may improve terms of trade
• Optimum tariff.
• Contingent protection
• Counteract unfair trading actions of other
  countries.

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Political arguments

• Industrial countries protect agriculture, at a
  high cost for their societies. Is democracy
  failing?
• Public fails to understand the true costs.
• Political activities as a public good. The costs
  for collective action are very high for
  particular individuals (Olsons paradox).
• Interest groups buy policies.
• A negative outcome protection encourages
  rent-seeking.

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Food Security (FS)

• FAO definition of FS is based on availability,
  stability and access.
• Trade can contribute to improve FS.
• But, trade-reliance may bring some problems.
• Trade-reliance does not rule out a food
  self-reliance policy.
• Self-sufficiency does not solve all FS problems.

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Some basic recommendations

• Be aware of political factors,
• But, there may be alternatives cheaper than the
  existing policies.
• And think about the most direct ways of
  addressing market failures.

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Domestic policies in an open economy
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Decoupling

• Decoupled policies mean no to encourage farmers
  incentives to increase yields or production.
• No measure is fully decoupled.
• However, WTO negotiators agreed on a green box
  with a list of seemingly decoupled measures.

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Buying interventions

• Market price support by state or parastatal
  agencies. Examples CCC, FEOGA, ..
• Gradually eliminated but still important.
• High cost of operation how disposing surpluses?
• Economic effects are similar to export
  subsidies, but at a higher cost.

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Direct payments

• Growing importance in industrial economies
• Typical example deficiency payment system.
• It is even more costly than intervention buying.
• Usually accompanied with supply controls.
• Recent moves to further decoupling in the EU and
  the US

• 1992 CAP reform,
• Agenda 2000
• US Farm Bill (FB) 1996
• A move back? US FB 2001

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Why do direct payments distort international
markets?

• Surpluses tend to increase.
• However, budget support is more transparent than
  intervention buying this makes reform
  politically easier.

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General criticisms on EU and US domestic policies

• "Intense disappointment" over the 180 billion
  farm bill (Cairns Group).
• the new American agriculture policy has created
  the "most profound" division between Europe and
  the United States (Javier Solana, EU).
• One of the biggest obstacles to creating vital
  opportunities for poor farmers (Developing
  countries at the Food Summit.
• The 15-nation European Union is notorious for
  giving lavish subsidies to its seven million
  farmers (US authorities).
• . "We're all free traders and we're all
  hypocrites (Peter Scher, former trade
  negotiator, Clinton Administration).

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Measures of protection and support
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Measuring protection

• Protection indicators measure distortions due to
  trade policy interventions.
• Some indicators
• Nominal Protection Coefficient (NPC)
• OECD support estimates (PSE, CSE, TSE)
• WTO Aggregate Measure of Support

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Nominal Protection Coefficient

• Ratio between (average) domestic price and
  border parity prices.
• Adjustments are needed by transport and
  marketing costs to make comparison possible at
  the same spot.
• NPC can be adjusted by exchange rate (ER)
  distortions
• Gross NPC (or simply NPC). Official ER.
• Net NPC border prices are converted by
  equilibrium or shadow ER.

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Producer Support Estimate (PSE)

• Gross transfers from consumers and taxpayers to
  support agricultural producers arising from
  agricultural policies.
• Two types of components
• Market Price Support (MPS) Price gap x
  Total production
• Other transfers from taxpayers to producers
• Net of feed costs.
• Percentage PSE

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General Services Support Estimate

• Transfers to general services provided to
  agriculture collectively.
• GSSE represents transfers that are not received
  by producers individually, and do not affect farm
  revenues.
• Examples
• Agricultural training and extension.
• Improvement of off-farm collective
  infrastructures.
• Depreciation of Public storage.

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Consumer Support Estimate (CSE)

• gross transfers to (from) consumers of
  agricultural commodities, arising from policy
  measures which support agriculture.
• Includes MPS Transfers from consumers to the
  budget and quota-rents.
• But it is net of
• transfers from taxpayers
• excess feed cost MPS on crops used in animal
  feeding.

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Total Support Estimate (TSE)

• All transfers from taxpayers and consumers
  arising from agricultural policies, net of
  budgetary receipts.
• Including
• Transfers from consumers to producers
• Transfers from taxpayers to producers
• Transfers from taxpayers to general services
• Transfers from taxpayers to consumers
• Also TSE PSE GSSE transfers from taxpayers
  to consumers.
• Also TSE transfers from consumers transfers
  from taxpayers - import receipts (or
  renta-quotas).

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A particular case MPS consumer subsidies
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WTO Aggregate Measure of Support

• Indicator used in WTO negotiations
• AMS is different from the PSE. The AMS
• excludes green box and blue box
• only defines MPS when administered prices exist.
• uses fixed reference (international) prices.
• ignores negative transfers. Also, de minimis
  clause.
• Does not adjust for excess feed costs.

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Selected topics
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Allocation of import quotas. The banana case

• 1993 Creation of the Single Market in the EU
  need for a common import regime.
• Two tariff quota
• For traditional ACP countries (preference)
• For Latin America and non-traditional ACP.
• Traditional operators of domestic banana and ACP
  suppliers were allocated 30 percent of licenses
  for importing from Latin America.
• The banana Framework Agreement
• The panel. Towards a tariff-only regime.

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Tariff escalation (TE)

• Low tariffs on intermediate goods and high
  tariffs on final product.
• Increases effective protection of value added.
• Encourages final goods.
• In industrial economies, TE difficulties export
  diversification of developing countries.
• In developing countries textile case.

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Variable tariffs the entry prices

• Ideally, tariffs should be constant and
  predictable.
• Entry price applies to some fruit and vegetables
  and seasons and.
• Additional tariffs when import value undercuts
  the entry prices.
• Administrative problems Importers tend to
  declared higher CIF prices than the entry prices.
• Possible co-ordination in the exporting country
  for increasing export prices.

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Rules of origin (ROO) making preferences complex

• FTAs needs ROO
• Products adquire origin with sufficient
  transformation
• What is sufficient transformation?
• Bilateral cumulation.
• Problems with ROO
• Administrative costs
• Possible trade diversion
• Hub and spoke trade
• Easing the ROO diagonal cumulation.