Why%20Do%20Governments%20Restrict%20Trade?

1
Why Do Governments Restrict Trade?

• I think an American private citizen or an
  American company should have the right to visit
  any place on earth and the right to trade with
  any other purchaser or supplier on earth.
• (Jimmy Carter, 2002)

2
The Goals of This Chapter

• Review the partial equilibrium, general
  equilibrium, and growth models and distinguish
  the distribution of the welfare gains and losses
  from international trade.
• Explain the strategic trade and infant industry
  arguments for protection.
• Distinguish the assumptions that must be
  satisfied for the strategic trade and infant
  industry arguments for protection to be valid.
• Introduce the political economy models that can
  help to explain trade policy.

3
The General Equilibrium Effects of Trade

• The shift to free trade means that the economy
  specializes in the production of Y, and
  production shifts from A to P.
• The movement of factors from one industry to
  another implies moving expenses and other costly
  adjustments.
• Even if factors do move quickly and with few
  adjustment costs, their prices will change,
  thereby changing the incomes of their owners.

4

• A sudden change in relative prices from P to Pw
  may, in the short run, greatly reduce production
  of X but not increase output of Y very much.
• Production thus moves to Ps, below the PPF.
• Output of X falls from h to m, and output of Y
  rises only slightly from g to f.

5

• When production moves to Ps, below the PPF, the
  best consumers can do is to consume at Cs.
• With production at Ps, the economy can no longer
  reach even the no-trade indifference curve.
• Thus, in the short run a shift to free trade may
  reduce welfare!

6

• Only in the long run does the economy reach the
  standard free trade triangle linking points P and
  C.
• The orange arrows trade dynamic paths from A to P
  and from A to C.
• In the short run, welfare declines, in the long
  run it rises from its pre-trade level.

7

• The dynamic path of trade and specialization
  after trade liberalization implies a gradually
  changing trade pattern.
• In the short run, the brown trade triangle
  results.
• In the long run, the economy trades according to
  the larger orange trade triangle.

8

• Suppose that free trade increases output of Y and
  decreases output of X.
• Suppose also that the Y industry employs
  relatively more labor than the X industry for
  given factor prices.
• All other things equal, the increase in industry
  Ys output therefore increases demand for labor
  from D to Dy.
• The decrease in industry Xs output causes the
  demand for labor to decline by a smaller
  proportion from D to Dx, all other things equal.

9

• The effect of industry Ys greatly increased
  labor demand and industry Xs smaller decrease in
  labor demand is a net increase in overall labor
  demand from D to Dt.
• That is, if trade expands the output of the
  relatively labor intensive industry, the return
  to labor (the wage w) increases.

10

• In the market for capital, the opposite effects
  occur as a result of the trades expansion of the
  Y industry.
• The effect of the growing industry Ys modestly
  increased demand for capital and the contracting
  industry Xs larger decrease in demand is a net
  decrease in overall capital demand from d to dt.
• That is, if trade expands the output of the
  relatively labor intensive industry, the return
  to capital (the return r) decreases.

11
The Stolper-Samuelson Theorem

• The results in the previous slides have been
  incorporated into what is known as the
  Stolper-Samuelson theorem.
• This theorem states that when an economy shifts
  from self-sufficiency to free trade the real
  income accruing to the factor used relatively
  intensively in the growing export industry rises
  and the real income to the factor used relatively
  more intensively in the shrinking
  import-competing industry falls.
• The theorem states that not only does the price
  of abundant factor rise with free trade, but the
  real value of the income earned by the abundant
  factor rises.

12
Estimating the Distributional Effects of Trade

• Many studies have estimated the effects of
  international trade on income distribution, and
  international trade has only a modest effect on
  income distribution.
• One reason for the modest distributional effect
  is that a portion of international trade among
  developed economies that is driven by increasing
  returns to scale rather than factor endowments.
• Another reason is that most people own more than
  one kind of factor of production.
• Furthermore, in the long run, factor price
  changes cause behavioral changes that mitigate
  the short run income.
• Also, in the long run, technological progress and
  factor accumulation have much greater effects on
  factor returns than do the short run shifts in
  production induced by trade.

13
The Assumptions Underlying the Infant Industry
Argument

• The industry to be protected eventually becomes
  competitive and gains a comparative advantage
  (the Mill test).
• The short run costs of protection are less than
  the discounted future benefits from enabling the
  industry to survive (the Bastable test).
• There is some market failure that prevents
  private individuals from carrying out investments
  in industries that will become competitive in the
  future.
• The government has accurate information about
  future comparative advantage at home and abroad,
  and it objectively acts on this information.
• There is no foreign retaliation.

14
The Strategic Trade Argument for Protection

• Recall the model of increasing returns from
  Chapter 3.
• Increasing returns imply that an industry becomes
  more competitive the higher its level of output.
• Increasing returns imply that the PPF curve is
  convex to the origin (bowed in), as shown in the
  figure on the right.

15
The Strategic Trade Argument for Protection

• Recall also how, under increasing returns, two
  otherwise-identical economies can gain from trade
  by specializing.
• It did not seem to matter which country chose to
  produce books and which one chose pizza.
• By arbitrarily concentrating on producing one
  product and then exchanging output, both
  countries gained welfare.

16
The Strategic Trade Argument for Protection

• Notice that each country reaches a higher
  indifference curve.
• Each country produces only one good, but both
  countries seem to consume the same bundle of two
  different goods.
• But, do imperfectly competitive increasing
  returns countries always share the gains from
  trade so equally?

17
The Strategic Trade Argument for Protection

• What if the relative prices at which the trade
  occurs brings two countries very different gains
  from trading books and pizza, with Country A
  gaining relatively less than Country B?
• Such a case is illustrated in the Figure on the
  right.

18
The Strategic Trade Argument for Protection

• Notice that Country B is able to use trade and
  specialization to increase its welfare much more
  than Country A.
• Country As citizens would have been better off
  if their country had chosen to specialize in
  producing pizza.
• Strategic trade policies are protectionist trade
  policies to influence the growth of preferred
  domestic industries.

19
The Assumptions Underlyingthe Strategic Trade
Argument

• Governments have accurate information with which
  to predict the future performance of industries
  so that they can correctly pick winners.
• Governments make economic decisions objectively
  and free from the influence of special interests.
• Other countries do not retaliate by protecting
  the same targeted industries.

20
The Strategic Trade Argument for Protection
Some Difficult Questions

• Can governments make an informed, unbiased choice
  between the book industry and the pizza industry?
• Does anyone know which industry will be most
  profitable in the future?
• What happens when both Countries A and B ban
  imports of pizza in order to promote pizza
  production at home?

21
Comparing the Arguments for Protection

• The strategic trade and infant industry arguments
  for protection are logically sound and do not
  deny the gains from comparative advantage.
• The infant industry and strategic trade arguments
  require that the discounted value of the gains to
  the overall economy outweigh the discounted value
  of the costs incurred.
• The infant industry and strategic trade arguments
  assume that government policy makers have
  accurate and complete information about economic
  variables today and in the future.
• All protectionist arguments assume that
  government policy makers use information
  objectively and are not influenced by special
  interests and short-run political expediency.
• All protectionist arguments assume that there
  will be no foreign retaliation.

22
The Political Economy of International Trade

• The arguments for infant industry protection,
  strategic trade promotion, sanctions, or
  national security do not seem firm enough to
  justify the widespread protectionism that we
  observe throughout the world.
• Therefore, in order to understand why governments
  impose trade barriers we need logical models that
  explain why national policy makers can institute
  policies that most likely reduce total national
  welfare.
• Several popular models from the field of
  political economy are useful for understanding
  trade policy.

23
Political Economy ModelsThis chapter presents
several models to Explain Welfare-Reducing Trade
Protection

• The median voter model
• The uninformed voter model
• The endogenous tariff model
• The adding machine model

24
The median voter model predicts that the
candidate who proposes policies that favor
slightly more than half of the voters, regardless
of the size of the gains or losses involved, will
win office.

• The diagram on the right assumes that 60 of the
  voters each lose welfare from protectionist
  policies, and 40 each gain an equal amount of
  welfare.
• Thus the median voter opposes welfare, and the
  winning policymaker will be a free trader.
• Under this scenario, national welfare is
  enhanced, as the total losses from protection
  would have exceeded the total gains.

25
The median voter model does not predict that the
winning policymaker will necessarily maximize
total national welfare, however.

• Suppose that 40 of the voters each suffer very
  large welfare losses from protectionist policies,
  and 60 gain only a little welfare.
• The median voter model predicts that
  protectionist policymakers will be elected.
• The total losses clearly exceed the total gains
  under protection.
• National welfare losses are a possible democratic
  outcome because votes do not register voter
  intensity on issues.

26
The uninformed voter model predicts that the
candidate who proposes policies that are very
important to some voters will be elected,
implying that small special interest groups can
have disproportionate political influence.

• Small special interest groups have a large
  influence on policies because most voters have
  little information on most issues that do not
  directly affect them.
• As illustrated in Figure 7.7, if the 10 of
  voters who care a lot about an issue get their
  way, national welfare may fall the grey losses
  area is greater than the green gains area.

27
The Endogenous Tariff Model

• By increasing protection, policy makers increase
  campaign funds to influence uninformed voters.
• However, higher levels of protection lead
  uninformed voters to become more informed about
  the welfare losses from protection.
• The tariff level settles where the votes gained
  because of special interest campaign financing is
  equal to marginal votes lost because people
  become aware of the cost of tariffs.
• The model suggests that the political process
  leads to some protection despite the welfare loss.

28
The Adding Machine Model

• The adding machine model links the likelihood
  that a policy is enacted to the absolute number
  of people that are directly affected by the
  policy.
• This model implies simply that policy makers will
  prefer to deal with issues that are of concern to
  large numbers of people rather than issues of
  importance only to few people.
• This model contradicts the uninformed voter model
  and the endogenous tariff model.
• Evidence does suggest that in the U.S. large
  industries that employ large numbers of people in
  concentrated areas tend to enjoy more protection
  than small, scattered industries.

29

• The U.S. sugar quota is an example of a small
  group of farmers who gain a lot from protection
  influencing trade policy over the interests of a
  very large groups of people, each of which stands
  to lose a little from protection.
• A small number of producers gains are a in the
  Figure 280 million consumers lose areas abcd.
• The nation loses bcd.