International Trade Policy Quiz

Economic Environment Analysis - Lecture 4

• Trade is a significant and growing economic phenomenon.
• Trade patterns are influenced by factors like size and distance (gravity model), productivity (Ricardian model), and resource availability (Heckscher-Ohlin model).
• Trade often results in both winners and losers.

This Week's Topics

• Brief history of the global trade system
• Overview of trade policy instruments
• Analysis of free trade's advantages and disadvantages

The Issue in a Nutshell (Trade Wars)

• Negotiated agreements can prevent trade wars.
• A trade war occurs when each country independently seeks protection, regardless of other countries' actions.
• Without an agreement, all countries can enact trade restrictions, even if free trade benefits everyone.
• Agreements are needed to prevent or resolve trade wars.
• Example: During trade negotiations, the U.S. agreed to refrain from imposing quotas on Japanese goods in exchange for Japan removing barriers against U.S. agricultural and technological products.

The Issue in a Nutshell (Game Theory)

• Game theory helps understand the actions of economic agents based on their constraints and beliefs about others' actions.
• Agents interact strategically.
• Nash Equilibrium: A situation where everyone is making the best possible decision, given the decisions of others.

The Issue in a Nutshell (Country Example)

• In a hypothetical example, countries individually benefit from protectionism (20 > 10), but a collective agreement on free trade is more beneficial than protectionism (10 > -5).
• Binding agreements can encourage free trade and benefit both parties.

International Negotiations

• International negotiations involve governments agreeing to mutually reduce tariffs.
• Each government reduces tariffs on goods imported from the other country.
• Negotiated agreements can prevent trade wars resulting from unfavorable actions.

The U.S. Tariff Rate

• After sharply rising in the early 1930s, the average U.S. tariff rate has steadily declined since 1938.
• Much of the reduction in tariffs and trade restrictions followed international negotiations starting in 1944.

International Negotiations (Smoot-Hawley Act)

• The Smoot-Hawley Act of 1930 significantly increased U.S. tariffs, leading to a substantial decline in U.S. trade.
• Retaliatory responses from other countries followed, resulting in a decline in global trade.

International Negotiations (Reciprocal Trade Agreement Act)

• In 1934, the Reciprocal Trade Agreement Act was introduced to mitigate the negative effects of the large increase in tariffs by bilateral negotiations.
• The act's intent was to counter the effects of the large rise in tariffs.

International Negotiations (WTO and GATT)

• The GATT (General Agreement on Tariffs and Trade) was formed in 1947 to facilitate international trade negotiations.
• The WTO (World Trade Organization) was established in 1995 to implement and enforce multilateral trade agreements.

The World Trade Organization (WTO)

• The WTO aims to promote open trade benefiting all members.
• 164 members, with 117 being developing countries.
• Based in Geneva, Switzerland, with a budget of approximately CHF 200 million (approx. 211 million EUR).
• Decision-making involves member governments (ministers or ambassadors).

The WTO (Negotiations)

• WTO negotiations focus on reducing trade restrictions.
• Binding tariff rates prevent increases to tariffs in the future (for an imposed tariff).
• Eliminate nontariff barriers, such as quotas and export subsidies, replaced by tariffs for greater clarity and negotiation.
• The "most favored nation" (MFN) principle ensures that all countries receive the lowest tariff rates.
• Exceptions to the MFN principle can be made if the lowest tariff is set at zero.
• The WTO deals with trade in goods, services (insurance, consulting, legal, banking), and intellectual property (patents, copyrights).

The WTO (Dispute Settlement)

• The WTO has a formal dispute settlement procedure allowing countries in disagreements about trade agreements to bring their case to a panel of experts.
• The panel decides whether members are adhering to agreements.
• Countries that do not comply can face trade restrictions from other WTO members.

Preferential Trading Agreements (PTAs)

• PTAs are trade agreements between countries giving preferential treatment to each other while not necessarily doing so for the rest of the world.

• PTAs are often not allowed under WTO rules.

• Most favored nation (MFN) principle permits exception only if the lowest tariff is zero.

• Two types of PTAs:

• Free Trade Area: Countries have free trade among themselves and independent trade policies with non-members

• Example: USMCA (US-Mexico-Canada Agreement)

• Customs Union: Countries have free trade among themselves and common trade policies toward non-members.

• Example: The European Union

• PTAs may decrease national welfare when diverting trade from the outside world to FTA/CU members.

• Trade creation: Replacing high-cost domestic producers with low-cost imports from other members.

• Trade diversion: Replacing low-cost imports from non-members with high-cost imports from members.

Instruments of Trade Policy

• Tariffs are taxes imposed on imported goods.
• Specific tariffs: fixed charge per unit of good (e.g., $3/barrel oil)
• Ad valorem tariffs: percentage of the good's value (e.g., 25% on trucks)
• Tariffs are a major source of income in pre-modern taxation systems and in developing countries.
• Tariffs are designed to protect domestic industries by increasing the price of foreign goods (e.g., British Corn laws).
• Tariffs can also be used to protect infant industries.

Tariff Analysis

• Tariffs affect prices and quantities in domestic and foreign markets.
• An import demand curve shows the difference between the quantity of a good demanded by domestic consumers and the quantity supplied by domestic producers at various prices.
• An export supply curve shows the difference between domestic producers' supply amount and the amount foreign consumers buy at various prices..
• In equilibrium, import demand equals export supply (world demand = world supply), and domestic demand + foreign demand equals domestic supply + foreign supply.

Tariff Analysis (Small Country)

• In a "small" country, the tariff placed on products has little effect on the world price.
• Price in importing country rises by full amount of tariff imposed.
• The price in the exporting country does not fall at all.

Tariff Analysis (Summary)

• Tariffs reduce the overall quantity of exchanged goods, compared to the unrestricted market.
• The rise in price in the importing country can be less than the tariff amount.
• Other countries' exports to the importing country may decline in response to the import tariff.
• Prices in both countries lie between the autarky price of the importing country and the free-trade price
• Exporters often decrease the price of goods they sell to absorb a portion of the tariff.

Costs and Benefits of Tariffs (Consumer Surplus)

• Consumer surplus represents the difference between maximum amount that consumers would pay and the amount they actually pay for the good demanded.
• Consumers experience a loss of consumer surplus as prices increase.

Costs and Benefits of Tariffs (Producer Surplus)

• Producer surplus is the difference between the minimum amount that producers will accept to sell their goods/services and what they actually get.
• When prices increase, producers' surplus rises.

Costs and Benefits of Tariffs

• Tariffs damage consumers as they pay more for goods, while producers benefit from the higher prices.
• The government reaps revenue through tariffs.
• The overall welfare effect of a tariff is ambiguous (may increase or decrease depending on terms of trade gains vs. efficiency losses).
• Foreign countries may retaliate.

The Trump Trade War

• The Trump administration increased tariffs on specific goods and partners.
• This led to retaliatory tariffs from other countries, impacting various goods and industries.
• Tariffs significantly affected U.S. consumers (higher prices) and U.S. firms.

Free Trade: Good or Bad?

• Free trade is efficient, allocating resources more effectively.
• Tariffs interfere with producers' and consumers' incentives, potentially leading to higher prices and reduced welfare.
• Free trade encourages economies of scale and competition, potentially reducing costs and improving quality of goods/services.
• Free trade can encourage innovation because businesses have incentives to look for new ways to export or compete with imports.

The Case Against Free Trade

• For larger countries, tariffs may reduce global prices, leading to a gain in trade terms for the importing country.
• Optimal import tariffs may exist (probably low).
• Retaliatory trade measures are possible.
• Domestic market failures, such as unemployment and low wages, can arise from free trade.
• Other factors, like lack of environmental protection or property rights, may also negatively affect countries using free trade.

Summary (International Trade)

• International negotiations are crucial to avoid trade wars.
• The WTO has played a significant role in reducing tariffs over the past 50 years.
• Tariffs may cause efficiency losses, but sometimes the resulting trade gain can outweigh the losses.
• The Trump trade war led to significant welfare losses for the U.S.

Test your knowledge on essential concepts of international trade policy, focusing on productivity impacts, protectionism, and trade agreements. This quiz also covers models such as the Gravity model and discusses the significance of Nash Equilibrium in trade negotiations. Explore the historical context of trade policies since 1944.