Chapter 33 International trade and commercial policy David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith Exports as % of GDP 80 1967 1998 60 % 40 20 33.2 Destination of world exports, 1996 North America 17% Africa Other 2% 7% EU 38% Latin America 5% Middle East 3% Asia 28% Source: Direction of Trade Statistics 33.3 The composition of world exports 100% 80% 60% 40% 20% 0% 1955 Food, ag Fuels 1995 Other primary Manufactures 33.4 Some important issues ■ Raw materials prices – Less-developed countries (LDCs) have claimed exploitation by industrial countries ■ ■ ■ e.g by buying raw materials cheaply & selling manufactures dear Manufactured exports from LDCs – some LDCs have had success in exporting manufactures – leading to complaints that jobs are under threat in the industrial countries Trade disputes between industrial countries – In some countries , established producers of certain goods are being undercut by efficient modern producers – especially from Japan & East Asia – should such exports be restricted? 33.5 Comparative advantage ■ ■ Trade offers benefits when there are international differences in the opportunity cost of goods Opportunity cost of a good – ■ the quantity of other goods sacrificed to make one more unit of that good The law of comparative advantage – states that countries should specialize in producing and exporting the goods that they produce at a lower relative cost than other countries 33.6 The source of comparative advantage ■ An important difference between countries is in factor endowments ■ which will be reflected in different relative factor prices ■ – e.g if the UK has relatively abundant capital but relatively scarce labour as compared with India, – then the UK would tend to specialize in capital-intensive goods, – and India would tend to specialize in labour-intensive products Comparative advantage may also reflect a relative advantage in technology 33.7 Gainers and losers ■ Countries may gain from specialization and trade – ■ but not all countries may gain equally Commercial policy – is government policy that influences international trade through taxes or subsidies ■ e.g – tariffs or through direct restrictions on imports and exports 33.8 The effect of a tariff Price SS DD and SS show the domestic demand and supply for a good If the world price is Pw, and there is free trade, domestic firms supply Qs Pw + T domestic demand is Qd Pw and the difference is imported DD A tariff can stimulate domestic supply and restrict imports Qs Qs' Qd' Qd Quantity At a domestic price Pw + T, where T is the size of the tariff Domestic demand falls to Qd', domestic supply rises to Qs' and imports fall 33.9 Price The welfare costs of a tariff The tariff leads both to transfers and net social losses Pw + T The government raises revenue – i.e there is a transfer to the government SS Pw DD Qs Qs' Qd' and there is a transfer in the form of extra profits to producers Qd Quantity There is a social cost from production inefficiency, given that the good could be imported at Pw There is also a loss of consumer surplus 33.10 Tariffs ■ The deadweight burden of a tariff suggests that society suffers from this method of restricting trade ■ This is the case for free trade ■ Tariffs have fallen substantially under the GATT – General Agreement on Tariffs and Trade 33.11 The case for tariffs – good arguments ■ Optimal tariff – – ■ a first-best argument only valid where the importing country is large enough to affect the world price This policy fulfils the principle of targeting – – which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities 33.12 The case for tariffs – second-best arguments ■ Way of life – – ■ Suppressing luxuries – – ■ – an attempt to nurture new activities via learning by doing a temporary production subsidy probably better Revenue – – ■ an attempt to curb consumption patterns of the rich in a poor society better achieved by a consumption tax Infant industries – ■ an attempt to preserve ‘traditional’ ways a production subsidy would be better tariffs raise government revenue but there are better ways Cheap foreign labour – a non-argument – denies benefits of comparative advantage 33.13 Other commercial policies ■ Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions – – quotas non-tariff barriers ■ administrative regulations that discriminate against foreign goods – export subsidies 33.14 An export subsidy S Pw+ s B G E Subsidy World price Price Pw A DD Q d' Q d Qs Q`s' Quantity Under free trade, with the world price at Pw, consumers demand Qd production is Qs exports are GE With a subsidy, producers supply Qd' to the domestic market and produce Qs' Exports are now AB Social costs arise from production inefficiency and consumer surplus 33.15