GPE Final Study Guide PDF

GPE FINAL STUDY GUIDE​ EU Industrial Policy Defining Industrial Policy ​ Protectionism may be part of a broader policy, generally named industrial policy ​ Industrial Policy refers to any type of selective government intervention that attempts to alter the structure of production in fa...

GPE FINAL STUDY GUIDE​ EU Industrial Policy Defining Industrial Policy ​ Protectionism may be part of a broader policy, generally named industrial policy ​ Industrial Policy refers to any type of selective government intervention that attempts to alter the structure of production in favor of specific activities or sectors ​ Industrial policies cover the business sector beyond manufacturing and comprise a vast set of instruments ranging from the design of intellectual property systems to public procurement, R&D incentives, or public provision of skills Types and Tools of Industrial Policy ​ 2 broad categories: ○​ Horizontal Industrial Policy: supports elected economic activites, such as R&D, without any sector-based selectivity or non-tradable sectors that are broadly used by domestic firms such as transportation infrastructure, broadband networks ○​ Vertical Industrial Policy: aims at developing specfic sectors such as aerospace, shipbuilding, automotive, semiconductors… considered “real” industrial policy ​ Industrial policy is generally achieved through a range of tools such as subsidies, tax incentives, infrastructure development, protective regulations, government procurement (goods and services that governments buy) and tariffs ​ When industrial policy provides favorable treatment to domestic firms and/or domestic production (so-called “national preference”), it is a tool of protectionism The Aims of Industrial Policy ​ A public institution, such as the government, may adopt an industrial policy because of: ○​ National Security: by supporting the production of essential/critical goods in order to guarantee the satisfaction of the physiological and safety needs of the population (food, electricity, medicine, etc). This is the case of “import substitution” strategy that can solve the problem of import disruptions such as PPEs and medicines during the Covid-19 pandemic ○​ Well-Being of Society: by supporting the production of merit goods and services that are considered to be beneficial to individuals and society, but are often under-consumed in a free market economy (education, health, public transportation, etc) ○​ Competitiveness: by supporting the production of strategic goods in order to guarantee the competitiveness of the economy. This can be the case of Boeing and Airbus where foreign competition and economies of scale are relevant ○​ Cohesion: by supporting the production in specific geographical areas or specific sectors in order to increase capital stock and/or employment The Rationale of Industrial Policy ​ Competitiveness: industrial policy is expected to offer better prospects for economic growth in a way that would not occur in the absence of such intervention in the market equilibrium ○​ Minimum scale to be competitive: new industries and firms, especially in developing countries, need protection against international competition until they  mature and develop economies of scale that can rival their competitors (EX: “infant industry”) ○​ Learning externalities: firms may not now ex ante which products are most likely to succeed in a given environment. A firm entering a new sector will bear the risk of discovering its eventual cost structure and whether production is viable. If it fails, it will bear the full cost of the experiment. Hence, uncoordinated actions may lead to sub-optimal entry and too little “self discovery” (EX: hydrogen-powered cars) ○​ Coordination failures: new sectors need to achieve a critical scale to be viable, and this may require coordinated action by different producers and suppliers. A group of hotels in a potential tourism site would be profitable if restaurants and an access road were to be constructed, but in isolation none of the elements listed would be profitable (EX: electric cars and charging stations) Examples of Industrial Policy: Infant Industry ​ Prof. Ha-Joon Chang (University of Cambridge): “In the same way that we protect our children until they grow up and are able to compete with adults in the labor market, developing country governments need to protect their newly emerging industries until they go through a period of learning and become able to compete with the producers from more advanced countries.” (From the book Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, 2007). ​ The infant-industry argument is usually attributed either to the first secretary of the treasury of the U.S. Alexander Hamilton (1755-1804), or to the German economist Friedrich List (1789-1846). List argued the transition of a country’s economy from the agricultural to the industrial stage would not occur through the “natural course of things.” The Industrial Policy of the EU ​ EU industrial policy is mainly horizontal since it intends to create conditions that favor business activity without setting differentiated treatment for firms depending on the sector to which they belong ​ EU prefers horizontal policy because: ○​ Protection granted by the government may reduce the inventive towards efficiency and the firm’s ability to compete in the global market ○​ The EU is a market economy where it is not broadly accepted that a public authority enjoys superior knowledge, vis-a-vis private firms, about which sector will boost the economy in years ahead. Markets have their failures (EX: positive externalities; however, governments also have their own failures ○​ An erroneous government intervention causes for a loss for citizens both as taxpayers (EX: direct subsidies or tax discounts” and as consumers (EX: tariffs on imported goods) ○​ Market forces have already “verticalized” the EU. The single market and single currency, by integrating national markets and fostering competition, have allowed a growing specialization of the member countries, that is a less homogeneous distribution of the sectors throughout the continent consistent with the specialization process proposed, in primis, by David Ricardo. A rigid vertical approach would favor some countries creating political tension within the EU  ○​ Industrial policy may clash with competition. The creation of “big” firms can increase their competitiveness (thanks to economies of scale) but can reduce competition (why mergers and acquisitions may be prohibited); state aids, due to their selectivity, are forbidden in the EU ○​ Industrial policy may clash with trade policy. Increase in tariffs and market-distortive subsidies - state aids in EU jargon - are not compatible with the WTO rules ○​ Vertical intervention is not usually warmly welcomed by other countries and can trigger a tit-for-tat reaction spiraling to strong protectionism and it harms smaller economies that cannot afford to subsidize Examples of Industrial Policy: Infant Industry ​ In the early 1960s the Republic of Korea, while continuing to pursue export-oriented industrialization based on cheap labor, did not just wait for its income and skill levels to rise before developing potential comparative advantage in more sophisticated industries ​ The government provided subsidies and other assistance if firms in specific industries managed to achieve certain goals. ​ The corporate histories of Samsung, Hyundai, LG all suggest they worked in conjunction with government policy especially when they ventured into unrelated industries. ​ In the 1990s and 2000s, the government shifted to ‘indicative’ targeted industries as it became increasingly difficult to directly support specific industries also because of concerns for potential international conflict. Assistance was confined to R&D efforts and financial guarantees to support private loans from financial institutions. ​ Samsung started out as an exporter of fish, vegetables and fruit in 1938; until the 1970s, its main lines of business were sugar refining and textiles that it set up in the mid-1950s. Examples of Industrial Policy: Coordination ​ According to Michael Spence, the Defense Advanced Research Projects Agency (DARPA) is a case of successful industrial policy. ​ DARPA , has an impressive track record in driving technological development for the U.S. military through partnerships with universities and private-sector players, with massive positive spillovers to the broader economy. ​ DARPA built a system that supported not just the research but the development, prototyping, testing, and demonstration, and often created the initial market. ​ It played a central role in launching the Information Revolution by inventing, among others, the digital protocols that gave birth to the Internet. ​ It also provided many of the essential advances that made possible today’s computers and communications systems, including seminal technological achievements that support the speech recognition, touch-screen displays, accelerometers, and wireless capabilities at the core of today’s smartphones and tablets. Problems with the Industrial Policy: the Concorde ​ 1962 - France and the UK signed a treaty establishing the development of Concorde, manufactured by Sud Aviation and the British Aircraft Corporation (BAC) ​ The airliner could maintain a speed of 2,170 km/h (1,348 mph). A typical London to NY flight would take slightly less than 3.5 hours as opposed to 8 hours for a subsonic flight  ​ The market was predicted for 350 aircraft, and the manufacturers received up to 100 option orders from many major airlines. ​ Concorde entered service in 1976 with Air France from Paris-Roissy and British Airways from London Heathrow ​ However: ○​ Compared to the estimated cost in 1962, the effective cost in 1976 was ca.10 times higher. ○​ Sonic booms over the ground limited it to transoceanic flights only. ○​ High operating costs (oil crises in the 1970s), supersonic safety perceptions, and noise pollution restrictions hampered its success. ○​ Air France and British Airways remained the sole customers with 7 planes each ○​ Concorde aircraft were retired in 2003 Problems with the Industrial Policy: Quaero ​ Quaero was announced as the European answer to Google Search by France and Germany in 2004. ​ The project involved French and German partners such as: Thomson SA, France Télécom, Bertin Technologies, Grass Valley GmbH, Vecsys, Vocapia Research, LTU Technologies, Synapse Développement, National Institute for Research in Computer Science and Control, Laboratoire d'informatique pour la mécanique et les sciences de l'ingénieur, IRCAM, RWTH Aachen, University of Karlsruhe, Institut de recherche en informatique de Toulouse, Clips Imag, Groupe des Écoles des Télécommunications, Institut National de la Recherche Agronomique, Institut national de l'audiovisuel, Bibliothèque nationale de France, Direction Générale de l'Armement. ​ Since the field covered is extensive and given the differing perception of the two countries, in 2006 Germany started its own search technology project called Theseus. ​ Quaero has retained the Franco-German dimension in that the program involves German research enterprises and bodies aided by France. In addition, the teams of Quaero and Theseus agreed to maintain a consultation structure and to collaborate on a case-by-case basis when the opportunity arises. ​ EU Commission approved State aids to Theseus by the German government (120 million EUR in 2007) and to Quaero by the French government (99 million EUR in 2008) ​ The project ended in 2013. Problems with the Industrial Policy: Fido ​ Fido was a project conceived by Telecom Italia (Italian incumbent telecom operator) in the 1990s. It aimed to extend the mobile radio coverage of cordless telephones equipped with DECT technology (acronym for Digital Enhanced Cordless Telecommunication) on an urban scale. ​ It envisaged the road coverage of the network of some of the major Italian cities (Rome and Milan) through appropriate dedicated antennas and arranged on city poles at a distance of a few hundred meters from each other, acting as wireless transceivers in a similar way to a radio base station in cellular networks, and therefore connected to the landline telephone network.  ​ The main advantage for use was its cost: much lower compared to the mobile telephony of the time. However, the quick adoption of mobile phones, also due to competition triggered by newcomers, evaporated that advantage. The project ended in 2001 Chips are Ubiquitous ​ Semiconductor chips are essential components of electronic devices thanks to transistors ​ The first silicon transistor was made in 1947. Before that, the mechanics of computing had been performed by vacuum tubes, which were slow and bulky. Silicon miniaturized chips and made them faster and much more affordable for everybody. ​ According to estimates, the average modern car has between 1,400 and 1,500 chips. ​ Chip firms generally organize their activities around the two main stages of semiconductor production: design and manufacturing. ​ Firms that focus only on design are referred to as “fabless” firms, while companies that focus only on manufacturing are called “foundries.” ​ Manufacturing takes place mainly in a few Asian countries ​ No region dominates the market from design to manufacturing ​ However, for valuable chips the supply is highly concentrated Industrial Policies for Chips ​ 2023 - EU approved the EU Chips Act to reinforce the whole EU chips value chain. ​ The EU will mobilize more than € 43 billion up to 2030 of public+private investments to: ○​ Strengthen Europe’s research and technology leadership towards smaller and faster chips. ○​ Put in place a framework to increase production capacity to 20% of the global market by 2030 (now it is 9%). ○​ Address the skills shortage, attract new talent and support the emergence of a skilled workforce. ​ In August 2022, the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS and Science Act) was signed into law to boost U.S. competitiveness, innovation, and national security ($ 52 billion up to 2026). ​ China is on course to invest $ 143 billion in chips between 2015 and 2025. EU Industrial Policy for Chips ​ August 2024: European Commission approved, under EU State aid rules, a €5 billion German measure to support a joint venture between TSMC (Taiwan), Bosch (Germany), Infineon (Germany), and NXP (Netherlands). ​ The aim of the joint venture is to build and operate a new semiconductor production facility in Dresden (Saxony, Germany). ​ The facility will operate as an open foundry, meaning that any customer – including but not limited to the three other shareholders besides TSMC – can place orders for the production of specific chips. ​ According to Commission, German measure is compatible with EU State aid rules since it facilitates the development of certain economic activities subject to certain conditions Chips in the US: Industrial Policy and Trade Policy ​ October 2022. The US Department of Commerce released rules prohibiting U.S. companies from exporting to China the technology, software, and equipment used in  producing advanced computing chips and supercomputers. The measures also bar US persons from supporting certain China-based chip companies without a license from the US government. ​ These rules were introduced in an effort to slow China’s progress in artificial intelligence and supercomputers and make it harder for China to manufacture advanced semiconductors that can also be used in nuclear and hypersonic weapons. ​ For the restrictions to be effective, the U.S. needed to bring on board other countries such as Korea, the Netherlands and Japan. ​ The Dutch ASML is the only company in the world that manufactures a specific machine needed to make the most advanced chips. ​ In September 2024, China announced its latest lithography scanner could support a resolution of 65 nanometers or better, a significant improvement from the 90-nanometers machine it developed in 2022. ​ But still way behind ASML’s machines with resolutions below 10 nanometers: smaller resolutions enable the production of more powerful chips. ​ China's central government launched state-backed investment fund for chips. But China’s economic slowdown has made it more difficult for local governments to support Beijing’s ambitions for self-reliance in the chip technology. Trade Policy, Tools, and Effects Basics ​ Trade statistics are country-based (EX: Italy’s export, US’s trade deficit) ​ But trade is made by economic agents (households, firms, public authorities) ​ The starting point is the demand; in peacetime it is hard to impose domestic products abroad if no one is interested in buying them ​ If there is demand for foreign products, that means that purchasers have preference for them vis-a-vis domestic products, if available ​ The beauty of trade is usually perceived focusing on export, but for some products/services, there is no export without import ​ Trade has an international perspective, but its rationale is not so different from what we do every day when we go to work and/or when we buy something ​ Participants in voluntary exchanges mutually benefit one another Trade Policy ​ Countries adopt a trade policy to “shape” trade flows (imports and exports) ​ Trade policy (that gives preferential treatment to some countries instead of others) can be a tool of a country’s foreign policy ​ There are 2 extremes in regards to imports: ○​ Free Trade: no restriction to import and export ○​ Full Protection: Autarky is the highest level of protectionism (no import allowed) as it leads to the closed-economy equilibrium ○​ Middle - Protectionism: ​ Tariff/custom duties ​ Quantitative restrictions ​ Standards/regulations The Tools of Protectionism ​ A tariff is a tax on imported goods paid to the customs authority of the country imposing the tariff. A tariff makes foreign goods more expensive relatively to domestic goods ○​ EX: If you buy a pair of shoes from the U.S. that costs 200 USD and the EU applies a 16.90% tariff, thus, the shoes will cost you 233.80 USD. ​ Quantitative restrictions (quotas) to imports set by a country. Instead of setting a tariff, a country can decide to limit the total import to a pre-defined quantity without any intervention on prices ○​ EX: EU establishes that import of shoes from the U.S. cannot exceed 10,000 pairs per year. No way to import the 10,001th pair of shoes in that year. ​ A tariff quota establishes a tariff (or no tariff) for a quota, and a higher tariff (or a tariff) beyond that quota ○​ EX: EU establishes the first 10,000 pairs of shoes imported from the US enter tariff-free and, after that quota, the tariff goes to 16.9%. Thus, the first 10,000 pairs will cost 200 USD; starting from the 10,001th it will cost you 233.80 USD. The Effects of Protectionism: A Model ​ Assumptions: ○​ One country Home (H) and homogeneous goods (EX: gadgets) ○​ Upward sloping domestic supply Sh, downward sloping domestic demand Dh  ○​ Ph = internal equilibrium price of country H; Pw = world prices < Ph ○​ Rest of World (RoW) supply is flat (perfectly elastic; this means that country H is small relatively to supply of RoW ○​ Negligible transport costs From Autarky (Max Protectionism) to Free Trade ​ Autarky ○​ Pw = price of RoW but consumers cannot buy foreign products ○​ Ph = price paid by consumers ○​ QH = quantity demanded and the quantity domestically produced ​ Free Trade ○​ Pw = price of gadgets made in RoW ○​ Pw = price paid by consumers ○​ OB = domestic demand ○​ OA = Domestic Supply ○​ AB = quantity imported from the RoW ​ The net effect is positive, a gain of welfare thanks to trade creation ​ Vice versa (free trade → autarky) = net effect is negative, a loss of welfare due to trade suppression From Free Trade to Protectionism (With a Tariff) ​ Free trade ○​ Pw = price of gadgets made in the RoW ○​ Pw = price paid by consumers ○​ OB = Domestic demand ○​ OA = Domestic supply ○​ AB = Quantity imported from the RoW  ​ Protectionism with a tariff ○​ T = the tariff on imported goods ○​ Pt = pw + T is the price paid by consumers ○​ 0C = Domestic supply ○​ 0D = Domestic demand ○​ CD = Imports from RoW (CD < AB due to T) ​ Final Effects of a Tariff ○​ Less quantities consumed (from 0B to 0D). ○​ Higher price (from pw to Pt ) paid by consumers are beneficial for local producers. ○​ The government gets tariff revenues (yellow rectangle). From Protectionism to Free Trade Two Types of Tariff ​ A tariff can be calculated according to two main formulas ○​ Ad valorem: Pt = Pw (1+t) ​ If Pw = 40 EUR and t = 20% -> Th = 40 EUR (1 + 0.20) = 48 EUR ○​ Specific: Pt = Pw + T ​ If Pw = 40 EUR and T = 8 EUR -> Th = 40 + 8 = 48 EUR From Free Trade to Protectionism (with a quota)  ​ Less quantities consumed (from 0B to 0F) ​ Higher price (from Pw to Pq ) paid by consumers and got by local producers. ​ AE = the max quantity of annual import ​ 0A = Domestic supply ​ AE = Imports from the RoW ​ EF = Domestic supply ​ 0F = Domestic demand ​ Pq = price paid by consumers Protectionism with a Tariff Rate Quota (TRQ) Non-Tariff Barriers ​ Non-tariff Barriers (NTBs) might be imposed by countries to norm industrial production methods, safety standards, environment, consumer protection ​ Sanitary + phytosanitary measures refer to restrictions for substances + measures preventing the dissemination of disease (certification, testing, inspection, quarantine) ○​ EX: EU prohibits the placing on the market and the import of meat treated with certain hormones and chlorine-washed chicken ​ Technical measures refer to labeling and other measures protecting the environment, standards on technical specifications/quality requirements (EX: flammability, azo dyes) ​ These requirements (legitimate when they aim to preserve consumers’ health) constitute a burden on producers and build a complex layer of multiple requirements constituting additional costs (thus higher prices) ​ EX: The Kinder Surprise egg (produced by Ferrero) is banned in the US because of safety concerns as the embedded non-nutritive objects in these confectionary products may pose a public health risk as the consumer may unknowingly choke on the object Export Subsidies ​ Exporting firms can get government funds that enable them to offer their products or services to other countries at lower prices ​ The objective of this support is to enable domestic producers to “win” sales by undercutting the prices charged by producers in foreign countries  ​ In the exporting country: subsidies are paid by taxpayers and benefit exporters ​ In the importing country: cheap products for consumers, unfair competition for domestic producers ​ In 2015 at the WTO 10th Ministerial Conference in Nairobi, members agreed to abolish export subsidies for agriculture: they are a form of unfair competition (Government’s intervention in the market) and undermine competitiveness of food production in developing countries (The phasing-out in the EU) Export Restrictions ​ Export-restrictive measures are typically: prohibitions, quotas, licensing, duties, or tariffs ​ Reasons for export restrictions ○​ Security: guaranteeing the availability of critical goods (food, PPEs, vaccines) and avoiding the ‘empowerment’ of other countries (arms and munitions) ○​ Competitiveness: retaining a strategic asset for national competitiveness (EX: rare earths, technological innovation) ○​ Environmental protection: countries may restrict export of forest products or other natural resources to prevent or slow down resource depletion ○​ International policies: countries may use those restrictions as sanctions and as retaliatory measures (where other countries impose their own export restrictions) Export restrictions: China and Rare Earths ​ China has about 30% of global deposits of rare-earth elements (and tungsten and molybdenum) but accounts for more than 90% of production. ​ Rare earths are 17 minerals used to make goods including hybrid cars, weapons, flat-screen TVs, mobile phones, mercury-vapour lights and camera lenses ​ 2009 China imposed export limits while it tried to build up domestic manufacturers to capture more of the profits that go to Western and Japanese producers of mobile phone batteries and other products. ​ In 2014, the WTO ruled against this policy since restrictions are not “justified” Export Restrictions: PPEs ​ Covid-19 pandemic demand for medical products (such as personal protective equipment) to fight the pandemic is unprecedented. ​ The situation has been exacerbated by export prohibitions and restrictions that some members have introduced to mitigate critical shortages at the national level. The Effects of a Tariff ​ Two countries have the same supply curve and different demand curves: in country 1 is more elastic than in country 2. ○​ Supply of RoW in country 1 is less steep than country 2 ○​ The two countries adopt a free trade policy and import AB from the rest of the World at Pw. ○​ The countries decide to adopt a specific tariff T on imported goods. ○​ In country 1 T is ‘prohibitive’ and the country stops importing from the RoW. ○​ In country 2 T is ‘less-than prohibitive’ and the country is still importing CD. Trade Agreements Between Countries ​ 2 countries: Home (H) and Partner (P) ​ Starting point: protectionism with other trade partners  ○​ H and P maintain positive tariffs Th and Tp between themselves ○​ Th,p > 0 ​ H and P now sign a Free Trade Agreement (FTA) to create a Free Trade Area (FTA) ○​ Th,p = 0 ​ Free Trade Area (FTA) between H and P Countries liberalize trade between themselves, and maintain individual tariffs TH , TP with the RoW ​ Customs Union (CU) between H and P Countries adopt free trade between themselves (no tariffs), and agree on a common tariff with the RoW ​ The EU is free trade (inside) and a customs union (with the rest of the world) ○​ A product imported from another country has the same treatment (tariff) independently of the point of entry in the EU A Peculiarity of Free Trade Areas ​ Suppose that countries H and P are part of a free trade agreement. ○​ Country P autonomously decides to sign a free trade agreement with country C. ○​ Therefore: ​ Free trade between H and P ​ Free trade between P and C ​ Protectionism between H and C ​ Country P is Mexico, which has a free trade agreement with the US (Country H) and with the European Union (Country C). There is no free trade agreement between the EU and the US, so there are still tariffs between them. ○​ If you are based in Europe, you can export duty-free in Mexico ○​ However, if you want to export from Europe to the US, you have to pay a tariff ○​ What if, to avoid the American tariff, first you export duty-free to Mexico, and then you re-export the same product duty-free from Mexico to the US? ​ This is called: trade deflection The Rules of Origin in Free Trade Areas ​ To prevent the trade deflection phenomenon that shrinks the US tariff revenues, the FTA (NAFTA/USMCA) writes down rules of origin to assess the nationality of traded goods ​ Only goods that have “origin” in the FTA (US and Mex) can freely circulate between US and Mex (the same applies to EU and Mex) ​ Goods having origin in EU entering US, directly or indirectly (via Mex), have to pay tariff ​ Free trade (ie, tariff-free) is only for products made in the FTA The Rules of Origin in Free Trade Agreements ​ No harmonized set of rules of origin but are some common provisions entailed in FTAs ​ While product-specific rules of origin differ between different sectors, general rules of origin normally apply to all sectors ​ There are two basic criteria for determining the origin of products ○​ Wholly obtained or produced: it applies to commodities and related products that have been entirely grown, harvested, or extracted from the soil in the territory of that member country or have been manufactured exclusively from these products (plants, animals born and raised, fish when caught in territorial waters)  ○​ Sufficient working or processing (sufficiently transformed): for complex products there are different criteria such as changes in tariff classification and percentage of regional value content From NAFTA to USMCA ​ President Trump called the NAFTA the worst trade deal the US ever signed and proposed to renegotiate the deal and to tighten the “rules of origin” in the new USMCA. ​ For cars: the regional value content moves from 62.5% (NAFTA) to 75% (USMCA) of the final value. Moreover, 40% of it must be made by workers who earn at least $16 an hour. ​ Effects? ○​ To avoid a tariff entering the U.S. (2.5% on cars, but 25% on pick-up trucks) manufacturers should reduce extra North American inputs (from the EU, Japan, China..) and increase North American inputs. ○​ In both cases, car manufacturing in North America will be more expensive. This will negatively affect the competitiveness of the sector. ○​ Less export, more unemployment in North America (also due to robotics). ○​ German and Asian automakers were the most affected by the new Rules of Origin: 22 of their vehicles had a Regional Value Content (RVC) lower than required when the agreement came into force. ○​ BMW, Mercedes Benz, and Audi are in this situation, as their engines and transmissions come from Hungary and Germany. ○​ Opening a new internal combustion engine plant in the USMCA region does not make sense because of the technological change towards electromobility. ○​ Therefore, paying a 2.5% tariff and increasing the car’s price in the US market may be an option for premium brands (low demand elasticity) -> no job increase in USMCA area and higher prices for consumers. The Case of Trade Diversion ​ The EU imports sheepmeat from NZ, the most efficient exporter in the World. ​ Between the EU and NZ there is no trade agreement, so the EU imposes a tariff T on imported NZ sheepmeat; hence, the final price for consumers in the EU is Tnz ​ In the EU, OA is sheepmeat produced domestically, AB is imported from NZ.  ​ EU signs a FTA with Argentina and sheepmeat from Argentina enters the EU duty-free ​ Even though NZ is more efficient than Argentina (Pnz < Pa ), the tariff on NZ imports makes NZ sheepmeat less convenient: Pnz + T = Tnz > Pa. ​ EU substitutes imports from NZ with imports from Argentina. ​ The price for EU consumers drops (from Tnz to Pa ) and the quantity imported increases (from AB to CD). More consumers’ welfare, less producers’ welfare, but NO tariff revenues for the Government in H (since now imports are from a free-trade partner) ​ Consumers’ welfare is larger, producers’ welfare is smaller, but tariff revenue disappears. ​ More consumers’ welfare, less producers’ welfare, but NO tariff revenues for the EU since now imports are from a free-trade partner, Argentina. ​ EU used to import AB from the most efficient source (NZ), now the same quantity (part of larger CD) is imported from a less efficient source (Argentina) simply because the latter signed a FTA with the EU. ​ Trade diversion provides a measure of this loss of efficiency The Rules of Origin in Free Trade Areas ​ In free trade agreements, we need rules of origin that check the nationality of goods traded (otherwise EU exporters can reach US market via Mexico without paying tariff) ​ In customs unions, there is no need for rules of origin: all countries involved in this agreement adopt the same tariff (there is no way to find a tariff-free access via a country that is part of the customs union)  ​ Starting from 2022 British businesses exporting into the EU face inspections to establish they have clear and sufficient evidence that goods meet the required threshold of 50% British or EU-sourced content, or risk paying duties. ​ Some businesses have found it difficult to interpret rules or provide sufficient evidence ​ Some businesses have chosen to ignore new arrangements due to added administrative burden placed upon them, creating additional import customs duty liabilities Brexit and Electric Cars ​ Under the UK’s post-Brexit Trade and Cooperation Agreement with the EU, from 1 January 2024 some 45% of an electric vehicle (EV) must come from the UK or EU to avoid tariffs when sold across the Channel, but 60% of a battery pack must originate from Europe or the UK for the whole battery to qualify as “local”. ​ Before Brexit, Stellantis and other automakers (Nissan and Toyota) opened in the UK in order to export vehicles to continental Europe. ​ Stellantis owns plants in the UK and across Europe and, in May 2023, warned the UK Government that its commitment to build EVs in the UK is at risk. ​ Stellantis currently imports batteries from China’s CATL and does not meet the rules of origin to export tariff-free from the UK to the EU. Final Notes on this Section: 1. Trade Creation = Positive When trade barriers are removed, imports from more efficient producers increase. This results in lower consumer prices, greater availability of goods, and overall welfare gain (net positive) 2. Trade Suppression = Negative Moving away from free trade to autarky or high protectionism suppresses trade. This leads to inefficiency, higher prices, less consumer choice, and a welfare loss. 3. Trade Deflection = Negative Products bypass trade restrictions by rerouting through free-trade partner countries. This undermines the intended tariff system, causes revenue loss for govs, and distorts trade flows. 4. Trade Diversion = Negative Due to preferential trade agreements, countries may shift from importing from the most efficient producer to a less efficient one. This results in a loss of economic efficiency despite potential gains for consumers (lower prices). The WTO and EU Trade Policy EU Trade Policy and its Single Market ​ With the Treaty of Rome, the EU member States decided: ○​ To start the process of forming a common/single market by abolishing legal restrictions to trade within the EU. ○​ To set up a Customs Union, which is a unique EU trade policy with the rest of the World with the aim to liberalize trade (see EU involvement in WTO and trade bilateral agreements) ​ The EU adopts a consistent approach for the internal and the external dimension, ie, inside and outside the single market: free and fair trade EU Trade Policy Goals and Tools ​ The EU is the world’s biggest trader. ​ Open trade among EU countries (the common market) is the cornerstone of the EU and has brought prosperity to all its member states. ​ EU believes increased trade+comp will boost world growth to everyone’s advantage ​ Globalization can bring economic benefits to all, including developing countries, provided appropriate rules are adopted at the multilateral level and efforts are made to integrate developing countries in world trade ​ That is why the EU: ○​ Is a member of the World Trade Organization (WTO) ○​ Negotiates and signs (bilateral/regional) trade agreements with third countries ​ EU Trade Policy has always been one of the most effective foreign policy tools ​ Lisbon Treaty explicitly considers trade policy as integral part of the EU's external action ​ “...It shall contribute to peace, security, the sustainable development of the Earth, solidarity and mutual respect among peoples, free and fair trade, eradication of poverty and the protection of human rights…” EU’s Exclusive Competence for Trade Policy ​ The customs union was the EU’s first big step towards economic integration ​ Customs union requires political coordination: defines external dimension of the Union ​ The Treaty of Rome granted supranational powers to the EU’s institutions: ‘exclusive competence’ - EU has exclusive power to set the trade policy with third nations (individual Member States cannot sign independent trade agreements) ​ 20th century: EU’s power on trade policy was limited to tariffs. As the range of important trade barriers broadened, the competence of the EU has been extended (to foreign investment, services, property rights): big step forward with Lisbon Treaty (2009) Not Only Trade ​ The EU's exclusive competence covers the following matters: ○​ Trade in goods, including regulatory matters ○​ Trade in services, including mutual recognition agreements+all transport services ○​ Trade related aspects of Intellectual Property (IP) ○​ Public procurement ○​ Market access in the area of FDI ○​ Investment protection as far as it concerns FDI ○​ Trade and sustainable development in its entirety  ○​ Termination of member State bilateral investment agreements for the parts concerning exclusive competence. The Trade Negotiation Process ​ The process towards a trade agreement begins with a Commission “scoping exercise”, during which the Commission opens discussions with stakeholders, including businesses, NGOs, civil society, the Council and the Parliament. This could be done by the Commission on its own initiative, or at the request of the European Council. ​ Then Commission issues a recommendation to the Council (with draft negotiating directives and supporting analysis). If the Council approves the Commission’s proposal, it issues a mandate with the directives for the negotiations. The Council decides with the qualified majority vote (QMV). ​ Council must make decisions by unanimity when the issue requires unanimity for the internal rules of the EU single market (some aspects of services, intellectual property, and foreign direct investment) and in the field of trade in cultural and audiovisual services where there is a risk of prejudicing the Union's cultural diversity. ​ When Commission reaches an agreement with its negotiating partner, the Council is responsible for ratifying the agreement (still with QMV) and Parliament has to give its consent (Parliament cannot amend the text, but it has influence due to its veto power) ​ The consent power of the Parliament is similar to the procedure in the US when the President gets the Trade Promotion Authority (TPA), also called “fast track authority”, or the power to negotiate trade agreements, draft implementing legislation to change US law, and sign agreements into international law. Congress’s involvement is restricted to an up or down vote on the final bill with no amendments allowed. ​ When agreements cover policy areas that are not only of EU’s exclusive competence are named ‘mixed’ and, along with the EU approval, it is needed the ratification of European national parliaments (36 chambers). For example, in the EU-Singapore FTA and in the EU-Canada FTA, rules for portfolio investments and the investor-State dispute settlement (ISDS) procedure are not exclusive competence of the EU. ​ For mixed agreement, the EU-part enters into force provisionally once approved by the Council and the European Parliament, without waiting for the ratification by all European national parliaments. Once all national parliaments approve it, the EU applies the agreement in full. The Objectives of the WTO ​ World Trade Organization is an international organization concerned with the regulation of trade between nations ​ WTO replaced the General Agreement on Tariffs and Trade (GATT) ​ The objectives of the WTO are: ○​ International economic relations should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand ○​ Expanding the trade in goods and services ○​ Allowing for the optimal use of the world’s resources in accordance with the objectives of sustainable development, seeking both to preserve the environment  and to enhance the means of doing so in a manner consistent with their respective needs and concerns at different levels of economic development. WTO in Practice ​ 1) The WTO as a negotiating forum. ○​ WTO members (countries) negotiate and adopt agreements with aim to promote free and fair trade. 164 countries are in the WTO; the observers: Algeria, Belarus, Ethiopia, Iran, Serbia, Somalia, Sudan; not even observers: North Korea, Eritrea ○​ Scope is not limited to tariffs reduction but also to trade-related issues (services, standards, labour, competition, IPRs). ○​ Agreements can be multilateral (all WTO members) + plurilateral (some members) ○​ The bulk of WTO's current work comes from the 1986-94 negotiations called the Uruguay Round and earlier negotiations under the GATT. ○​ WTO members launched a new round of negotiations in 2001 “Doha Development Agenda” (after Seattle 1999); still going, but future is uncertain ​ 2) The WTO as a resolution mechanism for trade disputes that arise, for example, when a member government believes another member government is violating an agreement or a commitment that it has made in the WTO. Principles of WTO ​ Reciprocity. WTO members have symmetric rights and obligations, and should obtain mutually beneficial reductions of trade barriers. ​ Consensus. Nothing gets decided unless there is ‘consensus’: if no Member, present at the meeting when the decision is taken, formally objects. 164 members, but they often negotiate in coalitions (eg, agricultural exporting countries such as the Cairns group). ​ Single undertaking. Every item of the negotiation is part of a whole and indivisible package and cannot be agreed separately. Nothing is agreed until everything is agreed. ​ Non-discrimination. Once foreign products enter into an importing country, they should be treated equal to the one guaranteed to similar national products (National treatment); all WTO members should receive the same treatment as the one accorded to the partner country that receives the best treatment (Most favoured nation, MFN). ​ Tariff bindings. Once a tariff reduction has been negotiated and accepted, it becomes “bound” at the negotiated rate. The MFN Treatment ​ 1) Country A is not in the WTO so it can set different tariffs on imports coming from other countries (B and C are already members of the WTO). ​ 2) Country A joins the WTO, then it is obliged to apply to every member of the WTO the “best conditions” (in our case 15% applied to goods coming from C) Some Caveats ​ Countries enter the WTO with their own tariff profiles and they can keep tariffs once member; tariff elimination is a long-term aim of the WTO members. ​ MFN tariffs are what countries promise to impose on imports from other members of the WTO, unless the country is part of a preferential trade agreement (such as an FTA). Thus, MFN tariffs are the highest that WTO members charge, by default, one another.  ​ The tariffs that country A adopts against import from country B is different from the tariffs country B adopt against import. Reciprocity has more a ‘dynamic’ understanding (thus about the change) rather than the absolute value of respective tariffs. MFN: Bound vs. Applied Tariff ​ When countries join the WTO, or when WTO members negotiate tariffs with each other during trade rounds, it is about MFN bound tariffs. ​ The bound tariff is the maximum MFN tariff level for a given product. ​ However, bound tariffs are not necessarily the rate that a WTO member applies in practice to other WTO members' products. ​ Members have the flexibility to increase or decrease their tariffs (on a nondiscriminatory basis) as long as they don't raise them above their bound levels (MFN applied tariff). ​ If one WTO member raises applied tariffs above their bound level, other WTO members can take the country to dispute settlement. ​ Three types of tariff for a given product: bound, MFN applied, preferential EU Bilateral Agreements ​ EU negotiates bilateral trade agreements with countries/regional groups of countries ​ If a country negotiates agreements with other countries, the tariffs that both parties are committed to set are below the MFN tariff (default tariff set for WTO members), this is why they are also named preferential trade agreements (PTAs). ​ EX: EU signed FTA agreements with: Balkan States (Albania, Serbia) and other European States (Norway, Iceland, Switzerland), Mexico, South Africa, Chile, South Korea, Colombia, Peru, Canada, Japan, Singapore; and CU agreements with Andorra, San Marino and Turkey. ​ Recently the EU has started negotiating Deep and Comprehensive FTAs involving, along with tariffs drop, FDI, services, protection of intellectual property rights etc Fair Trade; EU’s GSP ​ WTO tariff is default tariff (MFN, aka ‘erga omnes’); reduced in case of free trade agreements. FTA are symmetrical. ​ WTO allows to violate the MFN rule to give a special and differential treatment to developing countries (see EU, US). In the EU: ○​ The ‘Generalized Scheme of Preferences’ is a unilateral reduced MFN tariffs for a list of developing countries. This applies to Indonesia, India, Kenya, Vietnam ○​ The “GSP+” enhanced preferences implies deep cuts or full removal of tariffs for the same product categories as in standard GSP. This can be granted to countries which implement international agreements on human rights, labor rules, environmental issues and good governance. This applies to Bolivia, Mongolia, Pakistan, Philippines, Sri Lanka ○​ ‘Everything but Arms’ initiative is a special exemption granting to least developed countries (LDCs) a zero-tariff access to the EU for all their products but arms. This applies to Bangladesh, Eritrea, Ethiopia, Gambia, Haiti, Nepal, Senegal Tariff Structure of the EU ​ When declared to customs in the EU, goods are classified according to the Combined Nomenclature (CN). This determines which rate of customs duty (tariff) applies and how the goods are treated for statistical purposes.  ​ The CN is based on an international classification of products known as the Harmonized System Nomenclature (HS): it comprises about 5,000 commodity groups which are identified by a 6-digit code and arranged according to a legal and logical structure based on fixed rules common to all countries in the world. ​ The tariff structure of the EU (TARIC database) indicates the tariff for every single detailed product classified in the HS nomenclature (eg, “men’s cotton shirts” - 610510, are different from “women’s cotton shirts” – 610610, or from “men’s artificial fibers shirts” - 610520 , etc.) ​ Some products have relatively high tariffs amidst generally low tariff levels, known as tariff ‘peaks’ , ie, an ad valorem tariff > 15% (eg, sports footwear) WTO and Trade Remedy Measures ​ Free trade is beneficial: improves efficiency, reduces costs/prices, boosts innovation ​ However, competition should favor the best suppliers that compete “fairly”, avoiding: ○​ Dumping: when a firm exports a product to another WTO member at a price that is lower than the normal value of a product (the domestic prices of the same product or cost of production + a reasonable profit) and the domestic industry of the importing country is (or risks to be) seriously injured ○​ Subsidies: when a government or any public body of a WTO member confers a financial benefit to a firm or group of firms. Subsidies are frequently used to promote legitimate objectives (EX: social policies). However, they may also have adverse effects giving favorable treatment to specific firms that other firms in the same market (domestic or foreign) do not get ○​ Putting the national security of the importing country at risk International Trade: Dumping vs. Subsidy ​ Price of EV in EU = 100, Price of gadget in China = 80, Export price China to EU = 50 ○​ Dumping 80-50 = 30 ○​ Anti-dumping tariff charged by the EU on import from China 30 ​ Price in the EU = 100, Price in China = 50, Export price from China to EU = 50 ○​ Dumping = 0 ○​ If the EU gets evidence that the price in China is as low as 50 due to public subsidies, then the EU, according to the WTO rules, can charge a tariff as a countervailing measure such an additional tariff on import from China. Illegal Subsidies are not so Visible ​ From more precise, less complex to less precise, more complex ○​ Grants, tax concessions, below-market borrowings, below-market equity Fair Trade: Restoring the Right Price ​ What happens if a WTO member country is negatively affected by alleged dumping or subsidization? It can adopt: ○​ Dumping → Anti-Dumping Duties: a temporary increase of the price of the tariff to fill the gap caused by the dumping (difference between the normal value and the export price of the product at issue) ○​ Subsidies → Countervailing Duties: a temporary increase of tariffs to counteract the injurious effects of subsidized imports and restore fair competition. The level  of an anti-subsidy duty should correspond to the difference between a subsidized export price and non-subsidized export price A Case of Anti-Dumping: Leather Shoes from East Asia ​ May 2005: Commission received a complaint lodged on by the European Confederation of the Footwear Industry on behalf of producers representing more than 40% of total EU production of certain footwear with uppers of leather. ​ The product allegedly being dumped is footwear “with uppers of leather or composition leather other than: footwear which is designed for a sporting activity and has, or has provision for the attachment of, spikes, sprigs, stops, clips, bars or the like, skating boots, ski-boots and cross-country ski footwear, snowboard boots, wrestling boots, boxing boots and cycling shoes, slippers and other indoor footwear, and footwear with a protective toecap” originating in the China and Vietnam. ​ According to Commission's investigation (undertaken in factories jointly agreed with Vietnamese and Chinese governments): There is dumping flowing from evident state intervention (cheap finance, tax holidays, non-market land rents, improper asset valuation) ○​ Change in leather shoe exports to EU (04-05) +450% China, -1% Vietnam ○​ Change in leather shoe exports to EU (01-05) +1,000% China, +95% Vietnam ○​ Change in price of the exported shoes (01-05) -32% China, -20% Vietnam ○​ Change in local consumer prices for shoes (01-05) Stable or risen slightly ​ The Commission concluded that there is clear evidence of injury to EU producers ​ Since 2001, closely tracking the rise in dumped imports, European footwear production has contracted by about 30% ​ February 2006. Provisional duties: 19.4% for China and 16.8% for Vietnam ​ October 2006. Definitive duties: 16.5% for China and 10% for Vietnam ​ December 2009. 15-month extension of duties (instead of 5 years, the max allowed) Subsidies: Boeing and Airbus ​ Since 2004 there is a dispute between US and EU over subsidies to respective airplane makers: Boeing and Airbus. ○​ 1. US against EU: Airbus received unfair subsidies via government loans (from France, Germany, Spain and Britain) for A350 jetliner and A380 superjumbo ○​ 2. EU against US: Boeing received support from the US government, NASA and various states and municipalities; in particular for the twin-engined 777X Boeing got a tax break of 8.7 billion USD from Washington state. ​ For the first case, the WTO confirmed Airbus received illegal subsidies and authorized the U.S. to increase its tariffs on goods imported from the EU up to 7.5bn USD (2019) ​ For the 2nd case, the WTO confirmed Boeing received illegal subsidies and authorized the EU to increase its tariffs on goods imported from the U.S. up to 4bn USD (2020) ​ On 15 June 2021, the U.S. and the EU agreed to suspend retaliatory tariffs for five years, and they committed to ensuring a level playing field for Boeing and Airbus. The Case of US Protection on Steel and Aluminum ​ March 2018: US introduced additional tariffs of 25% and 10% on some steel and aluminum products.  ​ As a member of the WTO, the US had to justify these additional tariffs. Without any evidence of dumping or subsidies, they called into question national security: the need to protect domestic producers of steel and aluminum from market distortions caused by overproduction on a global scale. ​ In cases of dumping and subsidies, the country concerned has a clear burden of proof, the definition of national security is less quantifiable and leaves much discretion to individual countries. ​ For this reason, for 7 decades, WTO members avoided invoking national security whose destructive potential for free trade has been equated to 'Pandora's box' and 'black hole' ​ EU asked US for an exemption like that obtained by Argentina, Australia, Brazil, South Korea, Canada and Mexico, but it did not work. Thus, the EU joined other countries – China, India, Norway, Russia, Switzerland, Turkey - that activated the WTO dispute resolution procedure to 'invite' the U.S. to desist. ​ While the WTO panel worked on the case, on 22 June 2018 the EU introduced additional ‘retaliatory’ duties on some American products to compensate for the damage suffered. ​ Among others, EU increased the tariff on American motorcycles from 6% to 31%. After just 3 days, Harley-Davidson announced its intention to move part of the American production elsewhere to continue selling in rich European market, bypassing the new retaliatory duties. ​ 9 December 2022, the WTO panel declared the 2018 U.S. tariffs on steel and aluminum products are against WTO rules. ​ 26 January 2023, US notified the DSB of its decision to appeal to the (nonfunctioning) Appellate Body ​ 2022, EU suspended these measures until December 2023 to provide time to work together on a longer-term solution. ​ US replaced the US Section 232 tariffs with a tariff-based quota system based on historical trade volumes, resulting in above-quota EU steel and aluminum still being subject to tariffs. ​ December 2023, the EU, after reaching an agreement with the US, extended the suspension of its rebalancing tariffs on US products in the context of the steel and aluminum dispute until 31 March 2025. Consequences of Higher Tariffs ​ Higher import prices → higher domestic inflation ​ Expenditure switching toward domestic goods → reallocation of market shares towards less efficient domestic producers → lowering aggregate productivity ​ Lower capital investment due to higher price of investment (captial goods include both domestic and imported goods) ​ Since hourseholds spend more in real terms to consume any given amount of imports, the demand for domestic goods declines ​ Lower aggregate demand → decline in real economic activity ​ Cascading protection to downstream products. In US car bumpers and steel nails domestic producers asked for tariffs as they were hurt by steel/aluminum tariffs in 2018 Bilateral Agreements Violate the WTO’s MFN Principle ​ EU and NZ are members of WTO. For ex, NZ applies a 9.7% MFN tariff, EU 11.5%  ​ NZ and EU are negotiating a free trade agreement to eliminate bilateral tariffs on clothing ​ According to the MFN principle, as soon as the FTA enters into force, that tariff elimination should be extended to all other WTO members (a zero tariff is the best treatment possible) ​ If NZ and the EU do not extend this treatment to other WTO members, it is a violation of the principle of non-discrimination ​ WTO allows those preferential bilateral agreements as an exception to the MFN principle if 2 conditions are fulfilled: ○​ Tariffs/other trade barriers should be reduced or removed in all sectors ○​ Countries that are not part of the agreement should not find trade with the newly created group any more restrictive than before the group was set up WTO and Bilateral/Regional Agreements ​ Why WTO members are so active in negotiating bilateral/regional trade agreements? ○​ After 1995 (when WTO as an institution was created) multilateral negotiations are not progressing: failure of the Millennium Round (Seattle, 1999) and deadlock of the Development Round (Doha, 2001). ○​ Agreements among 164 countries are extremely complicated to negotiate (consensus as a principle). ○​ Negotiations are not focused anymore on tariffs, but more sensitive issues are at stake such as environment and labour standards. ○​ Coalitions might facilitate decision-making but divide countries in separate fields like free vs protected agriculture, developed vs developing countries ​ Why a network of bilateral/regional trade agreements is not a perfect substitute for a WTO multilateral agreement? ○​ In bilateral negotiations, unilateral bargaining power matters (powerbased trade thanks to divide et impera). ○​ Non synchronization of bilateral trade agreements generates (negative) trade diversion, efficient exporters lose market shares abroad simply because their respective countries of origin are not part (yet) of FTAs. ○​ A network of FTAs increases the complexity of trade since each agreement has its own rules and administrative requirements (see the rules of origin). Global Value Chains ​ A value chain is the full range of activities that firms engage in to bring a product to the market, from conception to final use (from design, production, marketing, logistics and distribution to support the final customer). ​ There are many tiers (very specific to very broad) iPhone’s GVC ​ Apart from software and product design, the production of iPhone components and assembly of iPhones takes place primarily outside the US. ​ The manufacture of 3G iPhones involves nine companies, located in China, Korea, Japan, Germany, and the US. ​ The major producers + suppliers of iPhone parts/components include Toshiba, Samsung, Infineon, Broadcom, Numonyx, Murata, Dialog Semiconductor, Cirrius Logic  ​ All iPhone components produced by these companies are shipped to Foxconn, a Taiwan-based company, for assembly into final products in Shenzhen, China and export to the global market. ​ Apple sets product standards, decides where to outsource the manufacturing tasks, and controls distribution and retailing through Apple stores as well agreements with mobile service providers in all target countries. ​ Apple has relied on China to manufacture all of its products, but due to pandemic and ongoing trade tension between US and China, Apple is moving production out of country ​ Apple moved production of iPhone to India and will have Macbooks produced in Vietnam Future of Value Chains ​ GVCs have brought benefits by allowing firms to source their inputs more efficiently, to access knowledge and capital beyond the domestic economy and to expand their activities into new markets (consistent w Ricardo’s theory comparative advantage) ​ GVCs have also played a pivotal role in reducing poverty and offering an opportunity for developing countries to grow and catch up with richer countries. ​ Enter Covid-19. The closure of factories in China at the end of January 2020 drew attention to the reliance of many manufacturing value chains on inputs from China. The subsequent lockdowns implemented all over the world have re-ignited the debate on the risks associated with international production. ​ Enter Russia’s invasion of Ukraine. Many European countries discovered that they were highly dependent on Russian energy resources. Moreover, even the dependence on China became an issue that you cannot underestimate. ​ Why in countries like US + EU the word ‘resilience’ (ability to withstand disruptions) has become more important than ‘efficiency’ (producing wherever is cheapest) ​ To improve resilience, the immediate reaction was stockpiling: from the ‘just-in-time’ (parts delivered to factories right as they were required were keeping inventories thin and cheap) to the ‘just-incase’ model. ​ Resilience will inspire also the geographical re-design of supply chains along with the technological revolution (3D printing, robotics), climate change and sustainability (ESG), the rise of economic nationalism, and the fading of China’s cost advantage. ​ Responding to these challenges, a new vocabulary for global trade has emerged: ○​ Diversification: Enlarging the # of suppliers/countries involved in value chain ○​ Nearshoring: bringing operations nearer to the main production hub or the end customer, shortening the value chain, and mitigating the risk of trade disruptions. ○​ Reshoring: bringing productive activities “home.” ○​ Friendshoring: strengthening trade relationships with allies and trusted countries. ○​ De-coupling: complete cutting off between US-centered economies and China-centered ones. ○​ De-risking: a soft decoupling Friendshoring ​ U.S. Secretary of the Treasury Janet Yellen (April 13th 2022): ○​ “… The power of working together with our partners has been essential in confronting Russia; we need to take that lesson on board as we tackle the most pressing global issues we face today.”  ○​..We need to modernize the multilateral approach we have used to build trade integration. Our objective should be to achieve free but secure trade…. ○​ Let’s build on and deepen economic integration and the efficiencies it brings— on terms that work better for American workers. And let’s do it with the countries we know we can count on. Favoring the “friend-shoring” of supply chains to a large number of trusted countries, so we can continue to securely extend market access, will lower the risks to our economy, as well as to our trusted trade partners….” ​ National Security Advisor of the United States Jake Sullivan (April 27th 2023): ○​ “After the Second World War, the United States led a fragmented world to build a new international economic order. (...) it helped the United States and many other nations around the world achieve new levels of prosperity. ○​ But the last few decades revealed cracks in those foundations. A shifting global economy left many working Americans and their communities behind. ○​ That’s why the United States, under President Biden, is pursuing a modern industrial and innovation strategy—both at home and with partners around the world. One that invests in the sources of our own economic and technological strength, that promotes diversified and resilient global supply chains, that sets high standards for everything from labor and the environment to trusted technology and good governance, and that deploys capital to deliver on public goods like climate and health. (...) ○​ (…) We can work to lift up all of America’s people, communities, and industries, and we can do the same with our friends and partners everywhere around the globe as well. (…) ​ Economic Rational: Diversification, Nearshoring ​ Political Rational: De-risking, De-coupling, Friendshoring The Budget of the EU The EU is Expensive ​ The EU manages some policies according to the treaties:  ○​ Single Market Competition: abolishing restrictions on the four fundamental freedoms within the EU ○​ Competition Policy: monitoring behavior of big firms and government in the European single market ○​ Trade Policy: setting the common external tariff via third countries and striking trade deals bilaterally (EX; with South Korea and Mexico) and within the WTO ○​ Agricultural Policy: financially supporting European farmers and the multi-functionality of European agriculture ○​ Cohesion Policy: financially supporting poor territories (states, regions) of EU ○​ Infrastructure: funding backbones of the single market (EX: rail tracks crossing the continent) ○​ R&D: funding activities that might lead to innovation What is the EU Budget? ​ Expenditures of the EU Budget: most is spent in EU countries ​ Revenues of the EU Budget: financed either directly from levies paid by individual taxpayers or indirectly from contributions paid by the member states. EU resident taxpayers are the ultimate resource for the money available to the EU budget ​ EU budget uses money raised in the EU to give them back to the EU Rationale for an EU Budget ​ The rationale for the EU budgetary expenditure is in a ‘double market failure’ = when the private market (first failure) and the national public authorities via the national budgets (second failure) would provide a suboptimal amount (subsidiarity principle) ​ The subsidiarity principle aims to ensure that decisions are taken as closely as possible to the citizen and that constant checks are made to verify that action at EU level is justified in light of the possibilities available at national, regional or local level. ​ Example #1: Transport ○​ 1st market failure: public institution is more effective/efficient than the private one. The private sector would not supply the optimal quantity (some less populated routes would not be covered) → national governments intervene ○​ 2nd market failure: the EU is more effective than the national state. Trans-European networks benefit all countries (positive externalities). Single countries alone would invest in a sub-optimal way (too litt;e) because they do not reap all the benefits (like a tunnel between France and Italy benefits Spain as well) → role for EU-level expenditure activated within EU budget ​ Example #2: R&D ○​ 1st market failure: public institution is more effective/efficient than private. Companies do not capture the whole benefits of their R&D (other firms/society could benefit as well), thus sub-optimal quantities produced by market (national governments intervene) ○​ 2nd market failure: EU level research networks are more efficient and benefit all countries (positive externaltieis) The Size of EU-Level Expenditure ​ Amounting to €159 billion in 2019, EU budget accounted for around 1% of EU-28 GDP ​ Same year: Member States' public spending represented on average 43% of their GDP  ​ The size of the EU budget reflects the fact that spending competences and resources in most policy areas lie mainly at national and/or local levels. ​ The EU budget is too small to make a serious economic impact but big enough for member states to fight over it like polecats. The Size of Expenditure as % of GDP Federal / EU-level 29% 1% State and Local / EU 15% 43% member State ​ Only 1% of EU’s GDP is from EU level; majority is from the member states The MFF as the Key Financial Document of the EU ​ There are two relevant financial documents in the EU: ○​ Multiannual Financial Framework (MFF) that covers 7-year period EX: 2021-27 ​ MFF sets the guidelines for both revenues and expenditures: how to broadly allocate money every year and where to source the money from (EX: how much money to agriculture in 2021?) ​ The MFF is adopted by the Council of the EU at unanimity. ○​ The annual budget of the EU starts from the sums agreed within the MFF and fixes in detail the annual authorized expenditure for any single policy item (EX: how much money to beekeepers and olive growers in Portugal in 2021?) ​ Annual budget is adopted by the Council of the EU and the Parliament ​ Every year, budget must be balanced: no deficit, no debt at EU level. Annual Budget: Principles ​ Unity: all expenditures and revenues must be found in one document ​ Universality: total budget revenue covers total budget expenditure, none set aside so no use of a specific revenue (EX: VAT provisions from France) to finance specific expenditure (EX: agricultural policy) ​ Annuality: one yearly budget within the multi-annual programming period ​ Specification: every committed expenditure has to have a definite scope and purpose. The budget is divided into sections, titles, chapters, articles, and items ​ Unit of account: the budget is denominated in Euro ​ Equilibrium: The revenue+expenditure shown in budget shall be in balance. Any deficit or surplus should be corrected by increase/reduction of member state contributions Equilibrium Principle ​ EU budget must always be balanced in each and every year (revenue = expenditure) ​ Total lack of inter-temporal flexibility: no deficit, no debt; cannot be deficit in the EU ​ EU budget cannot be used as tool for fiscal policy (smoothing effects of the business cycle on the economy by increasing expenditure when the economy slows down) ​ This requirement is the result of a politically conscious choice of limiting the financial autonomy of the EU. Member states wanted to prevent the EU institutions from misusing a non-balanced budget as an additional budgetary resource (EU could borrow to spend instead of using resources from member states) ​ The rigidity of the EU budget limits the growth potential of the EU as a whole  ​ COVID temporary exception: EU debt and bonds ​ Only way to spend more than you get is to raise more money Evolution of EU Expenditure ​ Tiny budget in early years, mostly spent in administration. ​ Steady growth in budget over time, but always below 1.2% of EU GDP. ​ Agricultural expenditure started in 1965, soon dominated budget, peak of 92% in 1970. ​ Cohesion spending (poor regions) grew significantly from the 80s, with parallel decline in the relative importance of agriculture. ​ More spending on research and internal policy for growth in the 90s. ​ Cohesion + Agriculture: around 70% - 80% of total. Where do revenues come from? ​ “Marginal resource “ = amount paid by Member States is set at the end of the year to cover the difference between expenditure and the revenues raised by the other resources. Don’t forget: the EU budget must be balanced every year! ​ VAT own resource = 10.7% ​ Traditional own resources = 11.8% ​ Surplus from previous year = 1.1% ​ Other = 6.2% ​ GNI own resource = 70.3% National Contributions to the EU Budget ​ Contributions as a share of GDP do not vary according to GDP per capita in PPS: no progressive contribution ​ National contribution to EU budget (VAT + GNI - UK rebate) as a % of GNI (2019) Net Balances Issue ​ The issue of net balances has become in the last few years an unavoidable stumbling block of nearly every EU negotiations ​ Member States ask: As a country, am I receiving more from the EU Budget than what I am contributing to? This approach: ○​ Reflects a non-solidaristic vision of Europe ○​ Based on the idea that the EU is a zero-sum game where the gain of one player always comes at the expense of another, forgetting about the benefits that are not recorded by the EU budget. ○​ EX 1: If Romania receives EU funds for wind farms, that is in the EU budget; if Romania buys all wind turbines in Denmark, that is not in the EU budget. ○​ EX 2: The EU-Korea Free trade agreement that allows BMW to export more cars in Korea is not in the EU budget A Watershed Moment: European Council on 17-21 July 2020 ​ The Council is the EU institution that defines the overall political directions and priorities of the EU. It comprises the heads of state or government of the EU member states, along with the President of the European Council and the President of the Commission. ​ Usually Council meetings last one evening and the morning after. ​ July 2020: leaders had intense debates over the size of the recovery fund for countries hit hardest by the pandemic and the EU’s 7-year budget, known as the multi-financial framework (MFF) from 2021 to 2027.  ​ There were stark differences over the nature of the conditions attached to the emergency funding and the balance between grants and loans on offer. ​ EU leaders agreed on MFF deal + recovery package named “Next Generation EU” Main Expenditures in MFF ​ MFF 2021-27 implies a rebalancing of resources between broad expediture categories ​ The shares of the MFF devoted to both traditional policies – agriculture and cohesion – decrease, while the resources for new and reinforced priorities rise. ​ Agriculture → Cohesion → Single Market, Innovation and Digital; Migration and Border Management; Security and Defence → Administration Next Generation EU ​ Next Generation EU (NGEU) is a new common instrument that will provide €750 billion for the economic recovery on top of MFF resources. ​ NGEU aims to address socio-economic consequences of the pandemic and make the EU economy more resilient and sustainable through investment and reforms ​ NGEU resources are composed of grants (€390 billion) and loans (€360 billion). ○​ Grants will provide additional resources for the EU budget; ○​ Loans will be transferred to the Member States that have requested them ​ NGEU has been designed as a temporary instrument, with a shorter timespan than the MFF 2021-2027: commitments under NGEU must be carried out over the 2021-2023 period, while payments must be finalised by 2026. Main Expenditures in MFF + NGEU ​ Single Market, Innovation and Digital; Migration and Border Management; Security and Defense → GROWTH FROM 30.5% to 45/3% ​ Recovery and Resilience Facility (RRF) will be the main implementing tool for the recovery instrument, channeling 80% of NGEU grants and all NGEU loans ○​ RRF spending will total €672.5 billion over the 2021- 2023 period if Member States decide to use the loan component fully The RRF and the National Plans ​ Member States are to prepare national recovery and resilience plans ​ Each plan should address issues that require significant investment to create jobs and growth, and earmark at least 37% of the resources for the green transition and at least 20 % for the digital transformation. ​ Commission has encouraged national authorities to focus plans on 7 flagship areas: ○​ 1. clean technologies and renewables ○​ 2. energy efficiency of buildings ○​ 3. sustainable transport and charging stations; rapid broadband services ○​ 4. digitalization of public administration ○​ 5. data cloud capacities and sustainable processors ○​ 6. education and training to support digital skills EU as a Borrower ​ Commission is empowered by the EU Treaties to borrow from the capital markets on behalf of the EU.  ​ To finance the NGEU, the Commission has issued bonds. About 30% of these bonds are ‘green bonds’: coherent with EU's Environmental, Social and Governance (ESG) strategy and will provide a robust contribution to sustainability. ​ Bonds repayments are scheduled to commence in 2028. ​ Where does the EU find the money? ○​ Loans given to EU Member States are not a problem since Member States that received loans under NGEU are responsible for repaying these amounts ○​ The problem is with the grants given to EU Member States: the EU budget has to cover the repayment of funds allocated as grants. New Own Resources for the EU? ​ Council meeting July 2020: EU leaders agreed on introduction of new own resources ​ Own resources are revenue streams directly allocated to the EU’s central budget (like customs duties). The Commission proposed: ○​ an expansion of the EU’s emissions trading scheme (ETS) ○​ a new carbon border adjustment mechanism (CBAM) ○​ a levy on digital companies. ​ The fact that EU budget is financed mainly by national contributions (GNI marginal resource) exacerbates the focus of negotiations on budgetary balances. ​ Despite agreement, not every EU State is in favor of new resources (Ireland is disproportionately impacted by the digital levy, whereas Poland would be far more heavily affected by the expansion of the ETS). ​ Taxation needs unanimity in the Council of the EU The EU’s Emission Trading Scheme ​ For climate action, EU set up emissions trading system (ETS) in 2005, the world's first and major international 'cap and trade' scheme ​ EU sets a cap on how much CO2 heavy industry and power stations can emit. Within the cap, firms receive emission allowances (auctioned and/or for free) ​ If a firm emits more, then it needs to buy allowances from another firm. ​ If a firm emits less, then can keep allowances for future needs or sell to another firm in short of allowances. ​ The limit on the total number of allowances available ensures that they have a value. ​ After each year a company must surrender enough allowances to cover all its emissions, otherwise heavy fines are imposed. ​ Trading brings flexibility that ensures emissions are cut where it costs least to do so ​ Currently, the sectors covered are: electricity generation, energy-intensive industries such as refineries, aluminium and steel mills. ​ Though other countries give a price to carbon emissions, EU is a net carbon importer: the carbon content of exported goods is lower than that of imported goods. ​ If other countries have fewer restrictions on emissions, the purchase of ETS allowances is an additional burden on European firms squeezing their international competitiveness. ​ European firms may find convenient to shift operations where legislation is less strict. The act of replacing internal production/emissions with foreign ones is ‘carbon leakage’. ​ This negatively affects the European economy and employment.  ​ Foreign productions will be more polluting due to less stringent constraints on top of the additional emissions related to transport (more exports from non-EU countries to the EU) ​ To prevent carbon leakage, European firms most exposed to international competition have benefited from free ETS allowances (not purchased at national auctions). ​ This exception creates intra-EU asymmetries and is not consistent with commitment to reduce emissions. The Price of Pollution ​ ⅘ of global emissions remain unpriced and global average emissions price is only $3/ton ETS and Trade: the CBAM ​ To close the competitive gap to the detriment of European industry, in 2021 the European Commission proposed a carbon border adjustment mechanism (CBAM) ​ October 2023: EU’s CBAM entered into application in its transitional phase to contrast the so-called ‘carbon leakage’. ​ Non-EU imports produced with a price for greenhouse gases (GHG) emissions lower than the European one based on the ETS will have to pay the differential. ​ It is about restoring fair competition between European productions burdened by the ETS and imports from non European exporters. ​ What is the EU’s real objective? ○​ Even if the CBAM provides additional revenues to the EU budget, the EU’s real objective is to wipe out the CBAM as soon as possible. When the CBAM is not effective (ie, when it won’t generate revenue for the EU), that means that all countries have adopted legislation on GHG at least equivalent to that of the EU. ​ In 2021, the US and the EU launched negotiations to reach an agreement to increase trade in “green” steel and aluminum. The pledge to collaborate on limiting steel imports from countries with production deemed to be “dirty” or contributing to global oversupply may be challenging for the Asian steel industry, for example, because it has higher emissions per unit of production than peers. Agricultural Policy Why Agriculture? ​ EU gives enough subsidies to farmers to fly each cow in Europe around the world first class and still have money left over.  ​ Agriculture is not a big economic sector in the EU: 2023: 1.6% of EU GDP and 4.1% of labor force ​ Today, CAP weighs 38% of the EU budget (>70% in the Seventies). ​ CAP was born as the only entirely communitarian policy, financed entirely by the EU ​ It is a family business. Even though the situation varies from one Member State to another, the holder + family members provide over 90% of work in Ireland, Malta, Poland ​ Agriculture is a hot issue when it comes to poverty reduction, international trade, and development cooperation and accounts for many of the quarrels among EU members ​ Agriculture is “old economy”, but we still need food ​ In the EU, agriculture is not just agriculture. The Call for Policy ​ Common Agricultural Policy (CAP)'s origins relate to transition of the post-war European economy from economy based on agriculture to one based on industry + services ​ The growing labor demand from the post-war booming industrial sector was creating increasing pressures for a massive outflow of people from the rural areas towards the new urban industrial centers ​ Farming is a risky business: Agriculture is more dependent on the weather and climate. There is a time gap between consumer demand and farmers being able to increase supply as growing more wheat or producing more milk takes time and investment ​ EU farmers generate a positive externality by supplying public goods which cannot be provided by the market alone: rural communities, natural resources, environmental protection, animal welfare, high-quality and safe food, in one word “multi-functionality” ​ Two main options: ○​ No intervention: let the market do the necessary adjustment, which would have translated into massive emigration out of the countryside into the cities ○​ Intervention: find ways to accompany this transformation (from agriculture to industry and services), while protecting the multifunctional role of agriculture ​ Ad Hoc policy: Europe needed a strong and healthy agricultural sector and the memory of food shortages over WWII was still vivid ​ Treaty of Rome defined the general objectives of a common agricultural policy. The principles of the CAP were set out at the Stresa Conference ​ In 1960, the CAP mechanisms were adopted by the six founding Member States and two years later… in 1962 the CAP came into force The Objectives of CAP in the Treaty ​ To increase agricultural productivity by promoting technical progress and by ensuring the rational development of agricultural production and the optimum utilisation of the factors of production, in particular labour ​ To ensure a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture ​ To stabilize markets ​ To ensure the availability of supplies ​ To ensure that supplies reach consumers at reasonable prices. The Original Tool: Price Support Mechanism  ​ A price floor was set and implemented with tariffs to ensure that imports never pushed EU prices below the price floor. As world prices were changing, tariffs were adjusted to guarantee price stability in the EU ​ As the world price changes, only tariffs change (and the level of protectionism). EU consumption and imports are stable. ​ Loss in consumers’ surplus: A+C1+B+C2 ​ Area A is captured by producers who benefit from price support ​ Area B is tariff revenues going to EU budget ​ Areas C1 and C2 = net welfare loss Early Results and Subsequent Problems ​ Initally, the CAP was well received in the EU ○​ Higher and stable prices to farmers, higher farmers’ income ○​ Growing receipts of tariff revenues for EU budget ○​ Pros and cons for consumers: higher prices with respect to RoW but also more food and lower dependence on food imports; empathy with farmers; high food prices more than compensated by rising incomes ​ Post war period saw productivity gains ○​ High guaranteed prices encouraged investment ○​ Agrochemical industry sprang up (pesticides, herbicides, fertilizers) ○​ Since CAP rewarded output, output rose much faster than consumption ○​ No price fall: price still set above world price ​ EU became a net exporter of agricultural goods Excess of Supply ​ Positive supply shock (supply shift right) combined with fixed price floor→ excess supply ​ Price floor is now above equilibrium price: more than a prohibitive tariff Problem of Excess of Supply ​ The CAP price support meant that producers could produce any quantity… and they would always get their sales at the (high) price floor guaranteed!!! ​ EU farmers were producing more than the market could bear, creating excess supply, that had to be dealt with through the EU budget: ○​ Instead of earning money by imposing tariffs on imports EU money was spent on “Direct Purchases” at the floor price and stocking (the famous “wheat, beef and butter mountains”... mostly wasted) ○​ 1985: EU had 18.5 million tons of cereals stored, ~70 kg for each of its citizens  ○​ To reduce disposal problems: EU also started buying at price floor and selling cheap abroad. This form of dumping was called “Export Subsidies”. ○​ All these market interventions started to raise cost of CAP for the EU Budget ​ To reduce the budget expenditure and disposal problems, the EU started to export at the World price what was buying at the Price floor (dumping) Price Support Mechanism: The Need for Reform ​ EU producers did not respond anymore to market signals (price as key information). Farmers got closer to the EU governments than to EU consumers. ​ Producers worldwide were damaged by the EU market closure and the negative effect of EU subsidies (dumping) ​ Under WTO rules dumping is not permitted, especially when driven by government subsidies. However, before 1994 Uruguay Round agreement, the WTO placed no restrictions on the dumping of agricultural goods. ​ Consumers were facing high prices, with regressive effects (poorer consumers spend a larger part of their income on food products than richer consumers do) ​ Environmental problems and declining quality, as producers just had an incentive to produce as much as possible, no matter what! From Price Support to Income Support: Reducing Market Distortions ​ A reform started in 1992 reduced price support (and Common External Tariff - CET on imported agricultural products) and compensated farmers for their income loss ​ The attractiveness of Direct Income Support instead of Original Price Support is: ○​ It does not entail market distortions since the price is not set by the EU authorities but by market forces ○​ It is fairer than price support from a distributive standpoint: citizens do not pay as consumers but as taxpayers progressively via EU budget ○​ It opens the EU market to extra-EU imports: as CET decreases, more foreign products can be bought by EU consumers ​ According to the reform, the amount of income support available to farmers was directly proportional to the actual production (maintaining for the farmers the incentive to maximize production) ​ Price in the EU ≈ EU price floor ≠ price in the US; NOW Price in the EU = price in the US Common Agricultural Policy Today ​ Decoupling: linking aid to the potential fair income of the farmer, and not to actual production (EX: size of the land, number of cattle, type of soil). A ‘fair income’ should be resulting from correct exploitation of the assets available to the farmer, taking into account the need to preserve the environment and the guarantee of food quality and safety (multifunctional role of agriculture). ​ Cross-compliance: links income support to farmers’ compliance with basic standards concerning the environment, food safety, animal and plant health, and animal welfare ​ Degression: reduces direct payments for bigger farms, while new measures are introduced to favor young farmers ​ Rural development: co-financed by member States and grants funds to promote diversification and to help farmers meet EU production standards ​ Average farm income remains significantly below average incomes in rest of EU econ What is Geographical Indication? ​ Geographical Indication (GI) is a sign used on products that have a specific geographical origin and possess qualities, reputation, or characteristics inherent to that location ​ GIs are commonly used for agricultural products, foodstuffs, wines, spirits, and handicrafts, and they provide legal protection against misuse of the name. ​ GIs reduce the information asymmetry: they enable consumers to trust and distinguish quality products while also helping producers to market their products better GIs in the EU ​ Protected Designation of Origin (PDO): gives status to a food product which is produced entirely within a defined geographical area using recognised skills and ingredients from the region and is linked to its geographical origin. This includes Aceto Balsamico Tradizionale di Modena, many cheeses (Queso manchego, Feta, Gorgonzola, Parmigiano Reggiano), meats (Prosciutto di San Daniele), olive oil, wines ​ Protected Geographical Indication (PGI): denotes a food linked by its quality and reputation to a region in which at least one stage of production, processing or preparation took place. This includes Aceto Balsamico di Modena, beers (Münchener Bier, Ceskobudejovické Pivo), meat (Scotch beef, many types of French poultry), fish (Scottish farmed salmon) and bakery (Turrón de Alicante). ○​ US EX: Idaho potat