Chapter 5 International Trade Policy PDF

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 5 INTERNATIONAL TRADE POLICY STUDY OUTLINE: THE INSTRUMENTS OF TRADE POLICY ⚫ 5.1 Tariff Trade Barriers ⚫ 5.2 Nontariff Trade Barriers  INTRODUCTION Free trade refers to a situation where a government does not a...

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 5 INTERNATIONAL TRADE POLICY STUDY OUTLINE: THE INSTRUMENTS OF TRADE POLICY ⚫ 5.1 Tariff Trade Barriers ⚫ 5.2 Nontariff Trade Barriers  INTRODUCTION Free trade refers to a situation where a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another country While many nations are nominally committed to free trade, they tend to intervene in international trade to protect the interests of politically important groups  INSTRUMENTS OF TRADE POLICY Question: How do governments intervene in international trade? Answer: There are seven main instruments of trade policy 1. Tariffs 2. Subsidies 3. Import quotas 4. Voluntary export restraints 5. Local content requirements 6. Antidumping policies 7. Administrative policies  TARIFFS A tariff - a tax levied on imports that effectively raises the What Is an Example of a Tariff? An example of a tariff would be a tax on a good imported from another country. For example, a 3% tariff on corn would be a 3% tax added to the cost of corn paid by any domestic importer of corn from a foreign country. This would increase the cost of importing corn, resulting in an increase in the price of corn being sold domestically by the importer in order to cover the costs and earn a profit. This hurts domestic consumers as well as businesses as consumers may look for cheaper competitors that are selling domestic corn and not the more expensive imported corn.cost of imported products relative to domestic products  TARIFFS A tariff - a tax levied on imports that effectively raises the cost of imported products relative to domestic products – Specific tariffs are levied as a fixed charge for each unit of a good imported – A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff can vary according to the type of goods imported. For example, a country could levy a $15 tariff on each pair of shoes imported, but levy a $300 tariff on each computer imported.  TARIFFS – Ad valorem tariffs are levied as a proportion of the value of the imported good – Tariffs are a type of protectionist trade barrier that can come in several forms. – The phrase "ad valorem" is Latin for "according to value," and this type of tariff is levied on a good based on a percentage of that good's value. An example of an ad valorem tariff would be a 15% tariff levied by Japan on U.S. automobiles. – The 15% is a price increase on the value of the automobile, so a $10,000 vehicle now costs $11,500 to Japanese consumers. This price increase protects domestic producers from being undercut but also keeps prices artificially high for Japanese car shoppers.  TARIFFS – While tariffs may benefit a few domestic sectors, economists agree that free trade policies in a global market are ideal. – Tariffs are paid by domestic consumers and not the exporting country, but they have the effect of raising the relative prices of imported products. – In simplest terms, a tariff is a tax. It adds to the cost borne by consumers of imported goods and is one of several trade policies that a country can enact. Tariffs are paid to the customs authority of the country imposing the tariff.  TARIFFS Question: Why do governments impose tariffs? Answer: Tariffs – increase government revenues – provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods force consumers to pay more for certain imports So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy  TARIFFS Why Are Tariffs and Trade Barriers Used? Tariffs are often created to protect infant industries and developing economies but are also used by more advanced economies with developed industries. Here are five of the top reasons tariffs are used: Protecting Domestic Employment The levying of tariffs is often highly politicized. The possibility of increased competition from imported goods can threaten domestic industries. These domestic companies may fire workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. The unemployment argument often shifts to domestic industries complaining about cheap foreign labor, and how poor working conditions and lack of regulation allow foreign companies to produce goods more cheaply. In economics, however, countries will continue to produce goods until they no longer have a comparative advantage (not to be confused with an absolute advantage).  TARIFFS Why Are Tariffs and Trade Barriers Used? Protecting Consumers A government may levy a tariff on products that it feels could endanger its population. For example, South Korea may place a tariff on imported beef from the United States if it thinks that the goods could be tainted with a disease. Infant Industries The use of tariffs to protect infant industries can be seen by the Import Substitution Industrialization (ISI) strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods while protecting those industries from being forced out by more competitive pricing. It decreases unemployment and allows developing countries to shift from agricultural products to finished goods.  TARIFFS Why Are Tariffs and Trade Barriers Used? National Security Barriers are also employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection. For example, while both Western Europe and the United States are industrialized, both are very protective of defense-oriented companies. Retaliation Countries may also set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines "Champagne" (a name specific to the Champagne region of France) for too long, it may levy a tariff on imported meat from the United States. If the U.S. agrees to crack down on the improper labeling, France is likely to stop its retaliation. Retaliation can also be employed if a trading partner goes against the government's foreign policy objectives.  WHO BENEFITS FROM TARIFFS? The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased revenue as imports enter the domestic market. Domestic industries also benefit from a reduction in competition, since import prices are artificially inflated. Unfortunately for consumers—both individual consumers and businesses— higher import prices mean higher prices for goods. If the price of steel is inflated due to tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that they use to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer.  WHO BENEFITS FROM TARIFFS? The effect of tariffs and trade barriers on businesses, consumers, and the government shifts over time. In the short run, higher prices for goods can reduce consumption by individual consumers and by businesses. During this period, some businesses will profit, and the government will see an increase in revenue from duties. In the long term, these businesses may see a decline in efficiency due to a lack of competition, and may also see a reduction in profits due to the emergence of substitutes for their products. For the government, the long-term effect of subsidies is an increase in the demand for public services, since increased prices, especially in foodstuffs, leave less disposable income.  HOW DO TARIFFS AFFECT PRICES? Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced to reduce their prices from increased competition, and domestic consumers are left paying higher prices as a result. Tariffs also reduce efficiencies by allowing companies that would not exist in a more competitive market to remain open.  HOW DO TARIFFS AFFECT PRICES? The figure above illustrates the effects of world trade without the presence of a tariff. In the graph, DS means domestic supply and DD means domestic demand. The price of goods at home is found at price P, while the world price is found at P*. At a lower price, domestic consumers will consume Qw worth of goods, but because the home country can only produce up to Qd, it must import Qw-Qd worth of goods.  HOW DO TARIFFS AFFECT PRICES? When a tariff or other price-increasing policy is put in place, the effect is to increase prices and limit the volume of imports. In the figure below, price increases from the non-tariff P* to P'. Because the price has increased, more domestic companies are willing to produce the good, so Qd moves right. This also shifts Qw left. The overall effect is a reduction in imports, increased domestic production, and higher consumer prices.  DO TARIFFS CAUSE INFLATION? Theoretically, tariffs can cause inflation. Tariffs increase the price of goods and services in domestic markets by applying a tax on imported goods that is paid by the domestic importer. To cover the increased costs, the domestic importer then charges higher prices for the goods and services. Tariffs are typically applied to specific products or industries, so may not have a wide-scale effect, which, otherwise, would cause all prices to increase, resulting in inflation.  TARIFFS AND MODERN TRADE The role tariffs play in international trade has declined in modern times. One of the primary reasons for the decline is the introduction of international organizations designed to improve free trade, such as the World Trade Organization (WTO). Such organizations make it more difficult for a country to levy tariffs and taxes on imported goods, and can reduce the likelihood of retaliatory taxes. Because of this, countries have shifted to non-tariff barriers, such as quotas and export restraints.  TARIFFS AND MODERN TRADE Organizations like the WTO attempt to reduce production and consumption distortions created by tariffs. These distortions are the result of domestic producers making goods due to inflated prices, and consumers purchasing fewer goods because prices have increased. Since the 1930s, many developed countries have reduced tariffs and trade barriers, which has improved global integration and brought about globalization. Multilateral agreements between governments increase the likelihood of tariff reduction, while enforcement of binding agreements reduces uncertainty.  NON-TARIFF BARRIERS TO TRADE SUBSIDIES A subsidy - a government payment to a domestic producer Subsidies help domestic producers – compete against low-cost foreign imports – gain export markets Consumers typically absorb the costs of subsidies  NON-TARIFF BARRIERS TO TRADE LICENSES A license is granted to a business by the government and allows the business to import a certain type of good into the country. For example, there could be a restriction on imported cheese, and licenses would be granted to certain companies allowing them to act as importers. This creates a restriction on competition and increases prices faced by consumers. IMPORT QUOTAS An import quota is a restriction placed on the amount of a particular good that can be imported. This sort of barrier is often associated with the issuance of licenses. For example, a country may place a quota on the volume of imported citrus fruit that is allowed. Import quotas benefit domestic producers by limiting import competition, but they raise the prices of imported goods for consumers  NON-TARIFF BARRIERS TO TRADE VOLUNTARY EXPORT RESTRAINTS (VER) This type of trade barrier is "voluntary" in that it is created by the exporting country rather than the importing one. A voluntary export restraint (VER) is usually levied at the behest of the importing country and could be accompanied by a reciprocal VER. For example, Brazil could place a VER on the exportation of sugar to Canada, based on a request by Canada. Canada could then place a VER on the exportation of coal to Brazil. This increases the price of both coal and sugar but protects the domestic industries. Voluntary export restraints benefit domestic producers by limiting import competition, but they raise the prices of imported goods for consumers  NON-TARIFF BARRIERS TO TRADE LOCAL CONTENT REQUIREMENT Instead of placing a quota on the number of goods that can be imported, the government can require that a certain percentage of a good be made domestically. The restriction can be a percentage of the good itself or a percentage of the value of the good. For example, a restriction on the import of computers might say that 25% of the pieces used to make the computer are made domestically, or can say that 15% of the value of the good must come from domestically produced components. A local content requirement demands that some specific fraction of a good be produced domestically can be in physical terms or in value terms Local content requirements benefit domestic producers and jobs, but consumers face higher prices  NON-TARIFF BARRIERS TO TRADE ADMINISTRATIVE POLICIES Administrative trade polices - bureaucratic rules that are designed to make it difficult for imports to enter a country These polices hurt consumers by denying access to possibly superior foreign products Dumping - selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their “fair” market value a way for firms to unload excess production in foreign markets may be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits  NON-TARIFF BARRIERS TO TRADE ADMINISTRATIVE POLICIES Antidumping polices - designed to punish foreign firms that engage in dumping – the goal is to protect domestic producers from “unfair” foreign competition U.S. firms that believe a foreign firm is dumping can file a complaint with the government – if the complaint has merit, antidumping duties, also known as countervailing duties may be imposed  SUMMARY Free trade benefits consumers through increased choice and reduced prices, but because the global economy brings with it uncertainty, many governments impose tariffs and other trade barriers to protect the industry. There is a delicate balance between the pursuit of efficiencies and the government's need to ensure low unemployment. Welcome Queries…