Ch. 8: The Instruments of Trade Policy

1
Ch. 8 The Instruments of Trade Policy
2
What Should A Nations 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

3
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.

4
Which Country Will Export Beef and Which Will
Import?
Pbeef
Pbeef
S
S
D
D
Q
Q
Country A
Country B
5
Country As Import Demand (High Cost Country)
Pbeef
Pbeef
S
MD
D
Q
Q
Country A
Country A
6
Country Bs Beef Export Supply (Low Cost Country)
Pbeef
Pbeef
XS
S
D
Q
Q
Country B
Country B
7
Equilibrium Price and Quantity in the World Market
Pbeef
Pbeef
XS
XS
MD
Q
Q
Country B
8
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 TPt-Pt.
9
Tariff in a Small Country
S
Pt
Pw
D
Qd
Qs
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.
10
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?

11
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
  (9500-7000)/7000 or 2500/7000, which is 35.7.

12
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.

13
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.

14
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.

15
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
439
127
Q
16
Consumer Surplus
6.54
Calculate the consumer surplus.
750
Calculate the additional consumer surplus.
3.54
584
2.54
D
500
667
Q
17
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.

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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
19
Producer Surplus
Calculate the producer surplus at 4.50 and at
7.50.
7.50
450
4.50
150
1.50
100
200
20
Import Tariff in a Small Country
S
Identify producer gain, government gain, and
consumer loss.
Pt
Pw
D
Q2
Q1
Q4
Q3
21
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.

22
Import Tariff in a Large Country
S
Terms of trade effect may compensate for the
deadweight loss.
Pt
Pw
Pt
D
Q4
Q1
Q2
Q3
23
Average EU tariff on selected products, 1997
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
European anti-dumping duties on selected
products, 1997
Patrick Messerlin, Measuring the Cost of
Protection in Europe, Institute of International
Economics, 1999 as quoted in The Economist, May
24, 1999, p. 84.
25
Export Subsidy in a Small Country
When there is no terms of trade effect, identify
the welfare gains and losses.
S
Ps
c
a
b
d
Pw
D
Q1
Q2
Q3
Q4
26
Export Subsidy in a Small Country

• There is no terms of trade effect.
• Consumers lose ab.
• Producers gain abc.
• Government loses bcd.
• Net loss bd.
• Consumption distortion is b.
• Production distortion is d.

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Export Subsidy in a Large Country
Negative terms of trade effect. Show welfare
results.
Ps
Pw
Ps
28
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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EUs 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.

30
EUs Common Agricultural Policy
Ps
Pw
Show benefit to farmers, cost to consumers and
export subsidy.
31
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.
32
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.
33
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.
34
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.
35
Protection in Industry in EU

• The average tariff (not effective tariff) on
  non-agricultural 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.
36
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.
37
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
  10-15 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
38
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.51861.18110m d.51860.8175m
466
a 1865.14 (1861.18)/2 1066m
c186 2.13 396
b
d
280
5.14
6.32
9.26
8.45
40
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 106611039675 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.

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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?ex990249498ei1en70dd040d727a9c94
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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.

43
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.

44
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.

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46
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.

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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.

49
Summary of Trade Policies