Chapter Four.pptx; Public Policy Analysis

Chapter 4:
Trade Policy Analysis

Today’s focus
Introduction
 Introduction to Trade Policy Measures
 Anti-Dumping and Countervailing Measures
 A Quota and A Tariff Rate Quota
 Comparative Advantage Models
 The Imperfect Substitutes Model
 Problems of the Dual Economy
Useful read
 Paul R. Krugman, Maurice Obstfeld, Marc Melitz International
Economics, 9th Edition.pdf

Introduction
 There is a great diversity among the
developing countries in terms of their
income per capita.
 Why are some countries so much poorer than
others?
 For about 30 years after World War II trade
policies in many developing countries were
strongly influenced by the belief that the key to
economic development was creation of a strong
manufacturing sector.
 The best way to create a strong manufacturing sector
was by protecting domestic manufacturers from
international competition.

Introduction
 What is the international trade policies?
 International Trade policies are policies that
governments adopt toward international trade.
 It involve a number of different actions including:
a. Taxes on some international transactions
b. Subsidies for other transactions
c. Legal limits on the value or volume of particular
imports, and many other measures.

Cont…
 An export subsidy is a payment to a firm or
individual that ships a good abroad.
 The effects of an export subsidy on prices
are exactly the reverse of those of a tariff.

Import-Substituting
 From World War II until the 1970s many
developing countries attempted to accelerate
their development by limiting imports of
manufactured goods to foster a manufacturing
sector serving the domestic market.
 The most important economic argument for
protecting manufacturing industries is the infant
industry argument.
 It implies that it is a good idea to use tariffs or
import quotas as temporary measures to get
industrialization started.

Import-Substituting
 Promoting Manufacturing Through Protection
 Import-substituting industrialization
 The strategy of encouraging domestic industry
by limiting imports of manufactured goods
 Many less-developed countries have
pursued this strategy.
 Has import-substituting industrialization promoted
economic development?
 Many economists are now harshly critical of
the results of import substitution, arguing that it
has fostered high-cost, inefficient production.

Why didn’t import-substituting industrialization
work the way it was supposed to?
 The infant industry argument was not as
universally valid as many people assumed.
 Import-substituting industrialization
generated:
 High rates of effective protection
 Inefficient scale of production
 Higher income inequality and
unemployment

Problems of the Dual Economy
 Most developing countries are characterized by
economic dualism.
 A high-wage, capital-intensive industrial sector
coexists with a low-wage traditional sector.
 Dualism is associated with trade policy for two
reasons:
 Dualism is probably a sign of markets working poorly
(market failure case for deviating from free trade).
 The creation of the dual economy (an economy that
is characterized by economic dualism) has been
helped by import-substitution policies.

Trade Policy Measures:
 Trade barriers is trade restrictions that prevent foreign
products or services from freely entering a nation’s
territory
 Import quotas is limits on the amount that can be
imported
 A country can grant import protection to a sector of its
economy in form of either
 Tariffs: a tax on imports
 Specific tariff is a fixed tax per physical unit of the
import
 Ad valorem tariff is a percentage tax applied to the
value of the import
 Non-tariff measures
 Governments employ both types of measures

International Trade Agreements and Trade Barriers
 Recent trends are encouraging free trade…why?
 Raises living standards
 Encourages world peace
 Promotes competition
International Free Trade Agreements
 Cooperation of two or more countries to reduce
trade barriers
 Tariffs is taxes on imported goods
 Customs duty
 Used to encourage purchasing of domestic products
 Other Trade Barriers
 Licenses
 Standards of production

 A tariff increases
domestic price of
imported product above
world price
 In the case of Japanese
rice, domestic price is
many times larger than
world price
 Causes an increase in
Japan’s production of
rice which is desired
effect from Japanese
rice farmers
 Domestic consumption of
rice falls
 Imports fall Figure 4.0: A Tariff on Japan’s Imports of Rice

Tariff Effects
 Welfare and revenue effects also occur from the tariff
 Consumer surplus of Japanese households fell
 Japanese rice consumers are paying more and
consuming less
 Producer surplus of Japanese firms has increased
 Japanese rice producers are receiving more for
their product and producing more
 Japanese government is receiving revenue from
import tax

Anti-Dumping
 Anti-dumping: a product has been sold at less than
“normal” value
 Tariff can be applied against “dumped” goods if the
dumping causes “material injury” to the domestic
competing sector producing a “like product.”
 Anti-dumping is consistent with obligations under the
WTO
 Determination of dumping:
 Price-based dumping: determined with evidence that an
exporter is selling a good in the importing country at a price
below what it charges in its own country.
 Cost-based dumping: determined with evidence that an
exporter is selling a good in the importing country below its
costs of production

Terms of Trade Effects
 When Japan imposes a
tariff on its imports from
Vietnam, amount of these
imports decreases
 As Japan’s imports of rice
decrease, there will be
excess supply in the world
market for rice
 Will cause the world price
to fall
 Since Japan is importing
rice, this is a good thing for
this country
Figure 4.2: The Terms-of-Trade Effects of Japan’s Tariffs

A Quota and A Tariff Rate Quota
 Import quota—a quantitative restriction on imports
 Type of non-tariff measure
 A quota results in a shortage of a good relative to initial
situation without quota, causing price of good to rise
 Known as quota premium
 Consumer surplus falls and producer surplus increases
 A Tariff Rate Quota (TRQ) involves two tariff levels
 A lower tariff for levels of imports within the quota
 A higher tariff for levels of imports above the quota
 TRQs are used to implement minimum access
levels (MALs) in agricultural sectors

A Quota
 Policy usually administered
via a system of import
licenses
 Quota has restricted supply
of import licenses
 Extra value of the right to
import an amount of a good
is known as quota rents
(area C)
Figure 4.3: A Quota on Japan’s Rice Imports

Comparative Advantage Models
 In many instances, the effects of trade
policies go beyond a single sector
 In these cases, trade policy analysts turn to
trade policy models based on comparative
rather than absolute advantage
 The central insight of these models is that a
protective measure in one sector acts as an
implicit tax on production in other sectors

The Imperfect Substitutes Model
 The standard absolute advantage models
assumes that imported goods and domestic
competing goods are perfect substitutes
 In applied trade policy analysis, this assumption
is often relaxed and imported goods and
domestic competing goods become imperfect
substitutes

Regional Economic Integration
 Regional economic integration refers to trade
policy of discriminatively reducing or eliminating
trade barriers only among nations joining together.
 Main Forms Of Economic Integration:
 Preferential trading club (trade arrangement): is an
arrangement between two or more nations to reduce tariffs and
other restrictions on imports from one to the other.
 Free trade area: Member countries remove tariffs and
other trade barriers among themselves, but each member
retains its own tariff, trade restrictions and other commercial
policies with non- member countries.

Cont ……
 Customs Unions: Member countries adopt
common external tariff and commercial policy on
imports from the rest of the world; abolish all tariffs
and restrictions among themselves.
 Economic Union: is the highest form of economic
integration among nations.
 It is formed when two or more countries form a common market
and in addition, proceeds to harmonize and unify their fiscal
policy, monetary policy, exchange rate policy, industrial and
other socio-economic policies.
Example: BENELUX which was formed by Belgium,
Netherlands and Luxembourg.

Review questions
1. Explain why trade custom union increase the
welfare of the nation forming it as well as the
welfare of the rest of the world
2. Explain why trade diversion union will reduce the
welfare of the rest the world and may reduce the
welfare of the nation forming the custom union
3. Discuss the Inward oriented strategy vs Outward
oriented strategy

Chapter Four.pptx; Public Policy Analysis

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Chapter Four.pptx; Public Policy Analysis