Instruments in Trade Policy (Final) PDF

INSTRUMENTS IN INTERNATIONAL TRADE POLICIES LECTURER: Ms. Resa Mae C. Laygan LESSON OBJECTIVE: At the end of this lesson, you will be able to:  Evaluate the costs and benefits of tariffs, quota, subsidies, their welfare effects, and winners and losers of these trade...

INSTRUMENTS IN INTERNATIONAL TRADE POLICIES LECTURER: Ms. Resa Mae C. Laygan LESSON OBJECTIVE: At the end of this lesson, you will be able to:  Evaluate the costs and benefits of tariffs, quota, subsidies, their welfare effects, and winners and losers of these trade policies.  Assess what export subsidies are and examine how they affect trade.  Analyze the effect of voluntary export restraints (VERs) on both importing and exporting countries.  Examine how the welfare effects of these VERs compare with tariff and quota policies. 2 Partial Equilibrium Analysis of Tariffs: Single Industry Tariff – a tax levied when a good is imported  Specific tariffs are levied as a fixed charge for each unit of goods imported. Example: $3 per barrel of oil  Ad valorem tariffs are taxes that are levied as a fraction of the value of the imported goods. Example, a 25 percent U.S. tariff on imported trucks 3  Partial Equilibrium Analysis of Tariffs: Single Industry Deriving Home’s Import Demand Curve As the price of the good increases, Home consumers demand less, while Home producers supply more, so that the demand for imports declines. 4  Partial Equilibrium Analysis of Tariffs: Single Industry Deriving Foreign’s Export Supply Curve As the price of the good rises, Foreign producers supply more while Foreign consumers demand less, so that the supply available for export rises. 5  Partial Equilibrium Analysis of Tariffs: Single Industry World Equilibrium The equilibrium world price is where Home import demand (MD curve) equals Foreign export supply (XS curve). 𝐇𝐨𝐦𝐞 𝐃 − 𝐇𝐨𝐦𝐞 𝐒 = 𝐅𝐨𝐫𝐞𝐢𝐠𝐧 𝐒 − 𝐅𝐨𝐫𝐞𝐢𝐠𝐧 𝐃 𝐇𝐨𝐦𝐞 𝐃 + 𝐅𝐨𝐫𝐞𝐢𝐠𝐧 𝐃 = 𝐇𝐨𝐦𝐞 𝐒 + 𝐅𝐨𝐫𝐞𝐢𝐠𝐧 𝐒 𝐖𝐨𝐫𝐥𝐝 𝐃𝐞𝐦𝐚𝐧𝐝 = 𝐖𝐨𝐫𝐥𝐝 𝐒𝐮𝐩𝐩𝐥𝐲 6 Partial Equilibrium Analysis of Tariffs: Single Industry Producer surplus is equal to Consumer surplus is equal to the area above the supply the area under the demand curve and below the price. curve and above the price. 22  Partial Equilibrium Analysis of Tariffs: Single Industry Effects of a Tariff A tariff raises the price in Home while lowering the price in Foreign. The volume traded thus declines. 7  Partial Equilibrium Analysis of Tariffs: Single Industry A Tariff in a Small Country When a country is small, a tariff it imposes cannot lower the foreign price of the good it imports. As a result, the price of the import rises from 𝑃𝑤 to 𝑃𝑤 + 𝑡 and the quantity of imports demanded falls from 𝐷1 − 𝑆 1 to 𝐷2 − 𝑆 2. 8  Partial Equilibrium Analysis of Tariffs : Single Industry Costs and Benefits of a Tariff for the Importing Country The costs and benefits to different groups can be represented as sums of the five areas a, b, c, d, and e. NET COST OF A TARIFF =Consumer loss - producer gain - government revenue 14  Partial Equilibrium Analysis of Tariffs : Single Industry Net Welfare Effects of a Tariff The colored triangles represent efficiency losses, while the rectangle represents a terms of trade gain. 15  The Theory of Tariff Structure: The Rate of Effective Protection Rate of Effective protection This measures the total effect of the tariff structure on the value added per unit of output in each industry, when both intermediate and final goods are imported. The rate of effective protection is usually calculated by the following formula: The Theory of Tariff Structure: The Rate of Effective Protection (Example 1) Problem: Suppose that $80 of imported wool goes into the domestic production of a suit. Assume also that the free trade price of the suit is $100 but the nation imposes a 10 percent nominal tariff on each imported suit. The price of suits to domestic consumers would then be $110.Of this, $80 represents imported wool, $20 is domestic value added, and $10 is the tariff. Compute the rate of effective protection. $80 Given: 𝑡 = 10% 𝑜𝑟 0.1; αi = $100 = 0.8; t i = 0 Answer: Rate of Effective Protection = 50% The Theory of Tariff Structure: The Rate of Effective Protection (Example 2) Problem: Suppose that $80 of imported wool goes into the domestic production of a suit. Assume also that the free trade price of the suit is $100 but the nation imposes a 10 percent nominal tariff on each imported suit. The price of suits to domestic consumers would then be $110.Of this, $80 represents imported wool, $20 is domestic value added, and $10 is the tariff. Suppose that the nominal tariff of 5% is imposed on the imported input. Compute the rate of effective protection. $80 Given: 𝑡 = 10% 𝑜𝑟 0.1; αi = $100 = 0.8; t i = 5% or 0.05 Answer: Rate of Effective Protection = 30% The Theory of Tariff Structure: The Rate of Effective Protection (Example 3) Problem: Suppose that $80 of imported wool goes into the domestic production of a suit. Assume also that the free trade price of the suit is $100 but the nation imposes a 10 percent nominal tariff on each imported suit. The price of suits to domestic consumers would then be $110.Of this, $80 represents imported wool, $20 is domestic value added, and $10 is the tariff. Suppose that the nominal tariff of 10% is imposed on the imported input. Compute the rate of effective protection. $80 Given: 𝑡 = 10% 𝑜𝑟 0.1; αi = $100 = 0.8; t i = 10% or 0.10 Answer: Rate of Effective Protection = 10% = t The Theory of Tariff Structure: The Rate of Effective Protection (Example 4) Problem: Suppose that $80 of imported wool goes into the domestic production of a suit. Assume also that the free trade price of the suit is $100 but the nation imposes a 10 percent nominal tariff on each imported suit. The price of suits to domestic consumers would then be $110.Of this, $80 represents imported wool, $20 is domestic value added, and $10 is the tariff. Suppose that the nominal tariff of 20% is imposed on the imported input. Compute the rate of effective protection. $80 Given: 𝑡 = 10% 𝑜𝑟 0.1; αi = = 0.8; t i = 20% or 0.20 $100 Answer: Rate of Effective Protection = -30% The Theory of Tariff Structure: The Rate of Effective Protection (Example 4) QUICK QUESTION: What have you observed in the rate of effective protection when the imposed nominal tariff rate for imported input increases? Generalization and Evaluation of the Theory of Effective Protection Partial Equilibrium Analysis of Quota: Single Industry Import quota  This is a direct restriction on the quantity of some good that may be imported.  An import quota always raises the domestic price of the imported good. 26 Partial Equilibrium Analysis of Export Subsidies: Single Industry An Import Quota in Practice: U.S. Sugar The United States has been able to keep domestic prices at the target level with an import quota on sugar. A special feature of the import quota is that the rights to sell sugar in the United States are allocated to foreign governments. As a result, rents generated by the sugar quota accrue to foreigners. The quotas restrict the imports of both raw sugar (almost exclusively, sugar cane) as well as refined sugar. 27 Partial Equilibrium Analysis of Export Subsidies: Single Industry An Import Quota in Practice: U.S. Sugar The quota limits imports of raw sugar to 3 million tons. Without the quota, imports of sugar would be 66 percent higher, or 5.1 million tons. The result of the quota is that the price of sugar is $426 per ton, versus the $275 price on world markets. 28 Partial Equilibrium Analysis of Export Subsidies: Single Industry Export subsidy  This is a payment to a firm or individual that ships a good abroad. 33 Partial Equilibrium Analysis of Export Subsidies: Single Industry Effects of an Export Subsidy An export subsidy raises prices in the exporting country while lowering them in the importing country. 34 Partial Equilibrium Analysis of Export Subsidies: Single Industry Case: Europe’s Common Agricultural Policy Agricultural prices are fixed not only above world market levels but also above the price that would clear the European market. An export subsidy is used to dispose of the resulting surplus. 35 Partial Equilibrium Analysis of Export Subsidies: Single Industry Case: Europe’s Common Agricultural Policy Effect of European Union (EU) on trade policy: 1.) Removal of all tariffs with respect to each other, thus creating a customs union. 2.)The agricultural policy of the European Union has developed into a massive export subsidy program. 36 Voluntary Export Restraint A variant on the import quota.  This is a quota on trade imposed from the exporting country’s side instead of the importer’s.  Generally imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions 37 Partial Equilibrium Analysis of Export Subsidies: Single Industry A Voluntary Export Restraint in Practice: Japanese Autos In 1979, sharp oil price increases and temporary gasoline shortages caused the U.S. market to shift abruptly toward smaller cars. Japanese producers, whose costs had been falling relative to those of their U.S. competitors in any case, moved in to fill the new demand. 38 Partial Equilibrium Analysis of Export Subsidies: Single Industry A Voluntary Export Restraint in Practice: Japanese Autos As the Japanese market share soared and U.S. output fell, strong political forces in the United States demanded protection for the U.S. industry. The U.S. government asked the Japanese government to limit its exports. The Japanese agreed to limit their sales. 39 Partial Equilibrium Analysis of Export Subsidies: Single Industry A Voluntary Export Restraint in Practice: Japanese Autos The first agreement, in 1981, limited Japanese exports to the United States to 1.68 million automobiles. In 1984, a revision raised that total to 1.85 million. In 1985, the agreement was allowed to lapse. 40 Partial Equilibrium Analysis of Export Subsidies: Single Industry What do you think are the effects of this voluntary export restraint on the Japanese Autos? The price of Japanese cars in the United States rose, with the rent captured by Japanese firms. The U.S. government estimates the total costs to the United States to be $3.2 billion in 1984, primarily in transfers to Japan rather than efficiency losses. 41 Partial Equilibrium Analysis of Export Subsidies: Single Industry A Voluntary Export Restraint in Practice: Japanese Autos The effects of this voluntary export restraint were complicated by several factors: 1. Japanese and U.S. cars were clearly not perfect substitutes. 2. The Japanese industry to some extent responded to the quota by upgrading its quality and selling larger autos with more features. 3. The auto industry is clearly not perfectly competitive. 42 Winners and Losers of Trade barriers Tariff Export Subsidy Import Quota Voluntary Export Restraint Producer Surplus Increases Increases Increases Increases Consumer Surplus Falls Falls Falls Falls Government Revenue Increases Falls (Govt. spending No change (rents to No change (rents to rises) license holders foreigners Overall national Ambiguous Falls Ambiguous Falls welfare (falls for small country) (falls for small country) Winners Producers in the Producers in Domestic Producers Producers in the importing country exporting country importing country Consumers in the exporting country Losers Producers in the Consumers in Domestic Producers in exporting country exporting country Consumers the exporting co Consumers in the Government untry importing country 52 QUESTIONS??? REFERENCES Krugman, P.R., Obstfeld, M., Melitz, M.J. (2012). International Economics: Theory and Policy. (Ninth Ed.). United States of America: Pearson. Appleyard, D.R., Field, A.J. (2014). International Economics. (Eight Ed.). New York: The McGraw-Hill Companies, Inc. 50  END Thank you for listening ☺ 51