International Trade - Theory and Policy, 2010a

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The key question of interest concerning the formation of preferential trade arrangements is whether these arrangements are a good thing. If so, under what conditions? If not, why not? One reason supporters of free trade may support regional trade arrangements is because they are seen to represent movements toward free trade. Indeed, Section 24 of the original GATT allows signatory countries to form free trade agreements and customs unions despite the fact that preferential agreements violate the principle of nondiscrimination. When a free trade area or customs union is formed between two or more WTO member countries, they agree to lower their tariffs to zero between each other but will maintain their tariffs against other WTO countries. Thus the free trade area is a discriminatory policy. Presumably, the reason these agreements are tolerated within the WTO is because they represent significant commitments to free trade, which is another fundamental goal of the WTO. However, there is also some concern among economists that regional trade agreements may make it more difficult, rather than easier, to achieve the ultimate objective of global free trade. The fear is that although regional trade agreements will liberalize trade among their member countries, the arrangements may also increase incentives to raise protectionist trade barriers against countries outside the area. The logic here is that the larger the regional trade area relative to the size of the world market, the larger will be that region’s market power in trade. The more market power, the higher would be the region’s optimal tariffs and export taxes. Thus the regional approach to trade liberalization could lead to the formation of large “trade blocs” that trade freely among members but choke off trade with the rest of the world. For this reason, some economists have argued that the multilateral approach to trade liberalization, represented by the trade liberalization agreements in successive WTO rounds, is more likely to achieve global free trade than the regional or preferential approach. Much has been written on this subject recently. Here we have merely scratched the surface. In what follows, we present the economic argument regarding trade diversion and trade creation. These concepts are used to distinguish between the effects of free trade area or customs union formation that may be beneficial and those that are detrimental. As mentioned, preferential trade arrangements are often supported because they represent a movement in the direction of free trade. If free trade is economically the most efficient policy, it would seem to follow that any movement toward free trade should be beneficial in terms of economic efficiency. It turns out that this conclusion is wrong. Even if free trade is most efficient, it is not true that a step in that direction necessarily raises economic efficiency. Whether a Saylor URL: http://www.saylor.org/books Saylor.org 513
preferential trade arrangement raises a country’s welfare and raises economic efficiency depends on the extent to which the arrangement causes trade diversion versus trade creation. Trade Creation and Trade Diversion In this section, we present an analysis of trade diversion and trade creation. The analysis uses a partial equilibrium framework, which means that we consider the effects of preferential trade liberalization with respect to a representative industry. Later in the section we consider how the results from the representative industry cases can be extended to consider trade liberalization that covers all trade sectors. We assume in each case that there are three countries in the world: Countries A, B, and C. Each country has supply and demand for a homogeneous good in the representative industry. Countries A and B will form a free trade area. (Note that trade diversion and creation can occur regardless of whether a preferential trade agreement, a free trade area, or a customs union is formed. For convenience, we’ll refer to the arrangement as a free trade area [FTA].) The attention in this analysis will be on Country A, one of the two FTA members. We’ll assume that Country A is a small country in international markets, which means that it takes international prices as given. Countries B and C are assumed to be large countries (or regions). Thus Country A can export or import as much of a product as desired with Countries B and C at whatever price prevails in those markets. We assume that if Country A were trading freely with either B or C, it would wish to import the product in question. However, Country A initially is assumed not to be trading freely. Instead, the country will have an MFN-specific tariff (i.e., the same tariff against both countries) applied on imports from both Countries B and C. In each case below, we will first describe an initial tariff-ridden equilibrium. Then, we will calculate the price and welfare effects that would occur in this market if Countries A and B form an FTA. When the FTA is formed, Country A maintains the same tariff against Country C, the non-FTA country. Trade Diversion In general, a trade diversion means that a free trade area diverts trade away from a more-efficient supplier outside the FTA and toward a less-efficient supplier within the FTA. In some cases, trade diversion will reduce a country’s national welfare, but in some cases national welfare could improve despite the trade diversion. We present both cases below. Saylor URL: http://www.saylor.org/books Saylor.org 514
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This text was adapted by The Saylor
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Chapter 1 Introductory Trade Issues
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However, rapid growth in the value
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As of 2009, 153 countries were memb
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International trade is a field in e
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imported, the U.S. government colle
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Kenya 12.7 Ghana 13.1 Generally spe
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Average tariffs can be measured as
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When the bubble bursts, the demand
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missed deadlines are commonplace in
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a well-known “bicycle theory” a
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But at the same time that many deve
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Recent opposition to trade liberali
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ought back to the United States and
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conference attended by the main all
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One of the key principles of the GA
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arriers. [1] The trade remedy laws
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ound tariff rate the country reache
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instead, they are put into place ov
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5. The WTO principle to treat an im
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subsidies. Recall that export subsi
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As a result of Uruguay Round negoti
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Agreement, or TRIPS. The TRIPS inte
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1.7 The World Trade Organization LE
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1. Consultations. The DSB first dem
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countries from choosing more destru
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P, P+ CAFTA-DR FTA PE MA OM R SG U.
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0806.10.20 $1.13/m 3 (Feb. 15-Mar.
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Tariffs vary according to time of e
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1.9 Appendix B: Bound versus Applie
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EXERCISE 1. Jeopardy Questions. As
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2.1 The Reasons for Trade LEARNING
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For example, the Ricardian model of
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2. Learn the major historical figur
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could end up with more of both good
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The primary issue in the analysis o
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Real wages (and incomes) of individ
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he begins planting seeds in the sec
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In this way, we might raise the wel
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2.3 Ricardian Model Assumptions LEA
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Utility Maximization and Demand In
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United States L C + L W = L France
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2. Suppose that the unit labor requ
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KEY TAKEAWAYS The equation aLC QC
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comparative advantage in newspaper
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−aLCaLW⎡⎣⎢hrslbhrsgal=gallb
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KEY TAKEAWAYS Labor productivity i
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2.6 A Ricardian Numerical Example L
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With full employment of labor, prod
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At this point, we can already see a
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The answer to some of these questio
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wC=PCaLC. If production occurs in t
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Thus a good way to think about how
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Similarly, by rearranging the above
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production. But where will they fin
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The focus on real wages allows us t
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Real Wages in Autarky To calculate
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exchange. Thus the real wage of che
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2.11 The Welfare Effects of Free Tr
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Free trade will raise aggregate wel
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Chapter 3 The Pure Exchange Model o
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A Simple Example of Trade Suppose t
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3.2 Determinants of the Terms of Tr
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Persuasion The art of persuasion ca
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KEY TAKEAWAY The terms of trade is
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two individuals make a voluntary ex
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3.4 Three Traders and Redistributio
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is not motivated by profit but inst
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The changes described above assume
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3.6 The Nondiscrimination Argument
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clothing worker. The same applies i
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the page, scroll down to the “Bou
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4.1 Factor Mobility Overview LEARNI
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argument that free trade can only b
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them, but only if the prices are ve
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4.3 Time and Factor Mobility LEARNI
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factor to be moved and become produ
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KEY TAKEAWAY The immobile factor m
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wine workers and cheese workers. Th
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In autarky, the quantity demanded o
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4.7 Depicting a Free Trade Equilibr
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0 the variable does not change A th
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Thus cheese workers are most likely
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Real Wage of Wheat Workers in Terms
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wages. However, these extra profits
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French production and consumption i
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5.1 Chapter Overview LEARNING OBJEC
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less-developed countries have much
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would rise, while the wage rate wou
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Ricardian model, then factor prices
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4. This is by which industries diff
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where KC and KS are the quantities
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Let aLC[labor−hrsrack] represent
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The capital-labor ratio in an indus
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that would employ all the capital i
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The Relationship between Endowments
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Suppose the exogenous variables of
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Adding these two equations vertical
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3. Write the magnification effect f
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tariffs or other government regulat
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If the price of clothing had risen,
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Table 5.6 Numerical Values for Exog
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w∧>PC∧>PS∧>r∧. The effect i
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2. Suppose the price of cheese fall
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this requires a fair amount of adva
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workers per unit of capital in the
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of quantities CS″/CC″. Since CS
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In Figure 5.8 "Free Trade Equilibri
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5.11 National Welfare Effects of Fr
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calculating changes in real income
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who has deposits in a pension plan
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export industry in order to benefit
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Income is redistributed among indiv
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Thus it is always possible to find
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affects the capital-labor ratios in
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1. Describe the pattern of factor f
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assumed to be freely and costlessly
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expansion of output in the export s
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[1] See R. W. Jones, “A Three-Fac
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product line for a representative t
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The total amount of revenue earned
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The horizontal length of Figure 5.1
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Our prime concern, however, is the
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An alternative version of the magni
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8. The magnification effect for pri
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can be used to transport tomatoes o
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esponds to the excess supply of wor
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The effect on workers is, in genera
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Factor Rewards over Time Now let’
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Figure 5.20 Dynamic Import-Capital
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In summary, the models suggest that
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[1] See J. P. Neary, “Short-Run C
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6.2 Economies of Scale and Returns
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produced and if the costs of this e
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6.3 Gains from Trade with Economies
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United States aLC = 1 L = 100 Franc
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thirty racks of clothing, then each
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model best describes markets in whi
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2. Each firm produces a product tha
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2. The demand assumption in which e
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Keep in mind that this is the equil
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KEY TAKEAWAYS A market equilibrium
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1. If the product is such that an i
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varieties may increase aggregate we
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7.1 Basic Assumptions of the Partia
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2. The term used to describe a coun
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where XSUS(.) is the export supply
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This implies also that world supply
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1. The price that equalizes one cou
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The price that ultimately prevails
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Surplus", some firm would be willin
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Changes in Producer Surplus Suppose
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2. The term used to describe a meas
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the same price for their product re
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to purchase the Mexican wheat at $1
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The effect on the foreign price is
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The quantity of imports and exports
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the sum of the gains exceeds the su
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indicate the effect of each policy
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7.6 The Optimal Tariff LEARNING OBJ
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zero. Somewhere between a zero tari
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3. The tariff rate that corresponds
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KEY TAKEAWAYS An import tariff wil
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7.8 Import Tariffs: Small Country W
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3. The tariff causes a redistributi
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1. Where on the graph is the level
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We examine the effects of optimal t
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3. Given player one’s optimal pol
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The goal of a cooperative equilibri
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1. Use the information provided in
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7.10 Import Quotas: Large Country P
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An import quota will reduce the qua
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KEY TAKEAWAYS To administer a quot
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demand is equal to the quota level.
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market decreases producer surplus i
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Foreign National Welfare 2. Suppose
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This implies that, in the case of a
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Quota Rents National Welfare + C
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Import Quota (Administered by Givin
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to as tariffication. In this way, f
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Next, consider the effects in this
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In situations where market changes
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where S is the specific export subs
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7.17 Export Subsidies: Large Countr
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the subsidy payments are made, then
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An export subsidy of any size will
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2. Identify the effects of a counte
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Table 7.12 "Welfare Effects of the
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Consumer Surplus − (G + H + I + J
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KEY TAKEAWAYS An antisubsidy law,
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9. What is the change in government
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Notice that a unique set of prices
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in the import country and in the ca
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Figure 7.36 Welfare Effects of a VE
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the quota rents will benefit, but p
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A the variable change is ambiguous
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Mexico, and all wheat sold in Mexic
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7.23 Export Taxes: Large Country We
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Because there are both positive and
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− the variable decreases 0 the va
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If a domestic consumption tax is im
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Equivalency between Domestic and Tr
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An import tariff applied on an impo
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KEY TAKEAWAYS Domestic production
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a Domestic Production Subsidy", whi
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Domestic policies can affect trade
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+ the variable increases − the va
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Domestic consumption taxes are ofte
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Figure 8.3 Inducing Exports with a
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8.7 Consumption Tax Effects in a Sm
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Since the cost to consumers exceeds
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When a specific consumption tax “
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time of the founding of the nation,
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Chapter 9 Trade Policies with Marke
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Market imperfections or market dist
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firm’s welfare) by restricting su
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are neatly kept and homes are well
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Policy-Imposed Distortions Another
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In this section, we will provide an
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Welfare-Improving Policies in a Sec
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Summary of the Theory of the Second
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9.4 Unemployment and Trade Policy L
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Suppose that international market c
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9.2 "Welfare Effects of an Import T
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Begin with the same surge of import
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eliminate the same unemployment imp
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Page 468 and 469: Suppose that the infant industry ar
Page 470 and 471: This means that in the second perio
Page 472 and 473: The Economic Argument against Infan
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Page 476 and 477: 9.6 The Case of a Foreign Monopoly
Page 478 and 479: Assuming the monopolist maximizes p
Page 480 and 481: Import tariff effects on the import
Page 482 and 483: This shows that although a tariff c
Page 484 and 485: 2. Recognize that a trade policy ca
Page 486 and 487: consider a large importing country
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Page 490 and 491: 9.8 Public Goods and National Secur
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Page 506 and 507: This statement points out that many
Page 508 and 509: noneconomists, providing permits th
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Page 512 and 513: product categories. This type of tr
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Page 518 and 519: Free trade area effects on Country
Page 520 and 521: We assume that A has a specific tar
Page 522 and 523: The simple way to do that is to ima
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Page 526 and 527: do indeed seek to maximize national
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Page 530 and 531: 3. This type of lobbying does not i
Page 532 and 533: much larger than the number of firm
Page 534 and 535: We can now ask whether a household
Page 536 and 537: Large groups are much less effectiv
Page 538 and 539: Because the per-producer benefit of
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Page 544 and 545: Chapter 11 Evaluating the Controver
Page 546 and 547: the results from any one model. Ins
Page 548 and 549: increase in national welfare. This
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Page 552 and 553: of the real world. The real world c
Page 554 and 555: Another way to deflect the concern
Page 556 and 557: For example, an optimal tariff or o
Page 558 and 559: Stuart Mill in hisPrinciples of Pol
Page 560 and 561: 11.5 The Economic Case against Sele
Page 562 and 563: to eliminate some of the inefficien
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effects, it would then need to meas
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to avoid the use of any such policy
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Selected protection requires detail
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11.6 Free Trade as the “Pragmatic
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