L 3 Free Trade The Real World

L 3 Free Trade & The Real World Sloman Chapter 23, p 664668 Swann Chapter 1

Free Trade & the Real World There a number of key influences affecting world trade today 1. Historical Protectionism, exacerbated by the great recession between the world wars, led to very low levels of international trade. 2. Post WWII, 23 nations formed the GATT with the object of reducing tariffs and, more recently, other trade barriers. - Slow progress, and some continuing, and highly contentious, stumbling bocks, e. g. Agriculture and Textiles 3. These problems have led some regions (most notably the EU) to go down the path of Preferential Trading Arrangement as a sort-of Free Trade ‘half-way house’

PREFERENTIAL TRADING • Preferential Trading Arrangement as a form of Free Trade: – free trade areas – customs unions – common markets

PREFERENTIAL TRADING • Preferential Trading Arrangement as a form of Free Trade: • Free Trade Areas – Each country maintains its pre-existing tariffs against third countries (NAFTA, ASEAN). – Need to prevent back-door trades. • Customs Union – Adopt a common EXTERNAL tariff.

PREFERENTIAL TRADING • Common Market – A common system of regulations governing production, employment and trade – Free movement of labour & capital markets and a common market for services and government procurement – Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate.

Reminder - Why we trade • 1. Different tastes – (same Technology & Factors) • 2. Different technology or physical capabilities – (Patented R&D, Land/Minerals) • 3. Differences in Factor Endowments – Labour/Capital • 4. Differences in Taxes - e. g. Corporation tax, alcohol, • 5. (Differences in, or restrictions on) Competition – (Monopoly pushes prices up) • 6. One Special case: Can trade even if we are identical – Increasing Returns to Scale

Applying Free Trade Analysis to the EU • Trade due to differences in tastes – clearly an element but hard to measure. But when combined with other factors clearly welfare enhancing • Trade due to differences in technology – Would clearly have been an issues in the early stages of EU (1960’s & 70’s). Liberalisation of capital flows, the ability of firms to locate and reverse engineer traded goods has reduced this issue. Patents and IP still an issue. Clearly still an issue for emerging economies.

Trade due to differences in endowments • • – Originally regarded as the key motive for trade, and even with original 6 : Germany, France, Italy, Belgium Luxembourg & Netherlands seen as a factor. When UK, Ireland & Denmark join, followed by Spain Portugal & Greece trade still seen as shake out of comparative advantage due to vague factor endowment reasons But factor endowments are also endogenous and improved financial capital flows makes endowment of physical capital less crucial. – Now endowment of skilled capital versus unskilled capital seen to be more crucial. Hence Lisbon Agenda – But no longer sure how important differences are

Trade due differences in taxes • – this is a mildly important issue in the EU. – Technically this sort of trade is a distortion. – In a true single market the ‘cheapest’, most efficient producer should win out but if exercise taxes, local rates, or low corporate tax rates or financial taxes and/or regulatory regimes affects production (firm location) and consumption patterns (alcohol, cigs & petrol) then this might be a problem. • But US, Canada, Australia or even UK & German regions no different.

Appling Free Trade Analysis to the EU • Trade due to increasing returns to scale • This was seen as the major advantage of the ‘ 1992’ single market exercise. – Abolitions of non-tariff barriers to trade crucial. Common technical specifications and requirements – Estimates 6 -12% of GNP. Big bang!! – Larger Market allows greater specialisation AND improves our competitive position v. v. the rest of the world. • But again skills, patents & IP crucial for Increasing Returns to scale– Lisbon Agenda

Single market versus Fortress Europe • But our arguments above were for freer trade. • PTA is not free trade, just a sub-set of countries with free trade towards themselves and trade restrictions on everyone else • In addition, in the case of the EU some very special types of distortions/restrictions e. g. Agriculture (CAP) and Textiles (Multi-Fibre Agreement). • So is a PTA a move towards Free Trade? • Or have we created Fortress Europe? • And does that matter?

Consumer and Producer Surplus Chapter 4 Sloman p 94 &95 Chapter 11 p 292 & 299

Demand Curve with market Price of £ 8 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

However, some consumers were prepared to pay £ 20 for the good E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

However, some consumers were prepared to pay £ 20 for the good E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

So all these people have essentially saved £ 12 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

Similarly, some people were prepared to pay £ 16 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

Similarly, some people were prepared to pay £ 16 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

Similarly, some people were prepared to pay £ 16 E Price (£ per kg) D So they have all saved £ 8 C B A Demand Quantity (tonnes: 000 s)

Similarly, some people were prepared to pay £ 12 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

Similarly, some people were prepared to pay £ 12 E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

In general, everyone along the demand curve who was willing to pay more than £ 8 is gaining E Price (£ per kg) D C B A Demand Quantity (tonnes: 000 s)

Price (£ per kg) In general, everyone along the demand curve who was willing to pay more than £ 8 is gaining B Demand Quantity (tonnes: 000 s)

Pmax P x* This area represents the gain of the Consumer OR Consumer Surplus B Demand X*

Pmax This area represents the gain of the Consumer OR Consumer Surplus CS = ½ X(Pmax-Px*) Px* B Demand X* X*

The cost of protection P Sdom (=MC) Pw Similarly, firms also gain from selling at market price compared with the price they were prepared to supply D at dom O Q

The cost of protection P Sdom (=MC) Pw Similarly, firms also gain from selling at market price compared with the price they were prepared to supply D at dom O Q

• Market Consumer Surplus

The cost of protection P Sdom (=MC) Ddom O Q

The cost of protection P Sdom (=MC) PW S world Ddom O Q

The cost of protection P Sdom (=MC) S world PW Ddom O Q 1 Q 2 Q

The cost of protection P Sdom (=MC) a PW c b S world Ddom O Q 1 Q 2 Q

The cost of protection P Consumer Surplus a PW c Sdom (=MC) b Producer Surplus O Q 1 S world Ddom Q 2 Q

The cost of protection P Sdom (=MC) • New Diagram a PW + t Tariff c PW b S world + tariff S world Ddom O Q 1 Q 2 Q

The cost of protection P Sdom (=MC) a PW + t Tariff c PW b S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection P Sdom (=MC) Consumer Surplus a PW + t e Tariff c PW d b S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection P Loss of CS=1+2+3+4 a Sdom (=MC) Gain of PS =1 PW + t e Tariff c PW d 1 2 3 4 b f S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection P Tariff Revenue =3 a PW + t e Tariff c PW Sdom (=MC) d 1 2 3 4 b f S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection P a PW + t e Tariff c PW Welfare Loss = 2+ 4 d 1 2 3 4 b f Sdom (=MC) S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection Overall Loss of CS=1+2+3+4 P a Gain in PS=1 Tariff Revenue=3 Welfare Loss = 2+ 4 PW + t e Tariff c PW d 1 2 3 4 b f S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

The cost of protection Overall Loss of CS=1+2+3+4 P a Gain in PS=1 Tariff Revenue=3 Welfare Loss = 2+ 4 PW + t e Tariff c PW d 2 3 4 b f S world + tariff S world Ddom O Q 1 Q 3 Q 4 Q 2 Q

Preferential Trading: Trade creation P SUK P 1 PEU + tariff DUK O Q

Trade creation P SUK P 1 PEU + tariff DUK O Q 2 Q 1 Q

Trade creation P SUK P 1 PEU + tariff P 2 PEU DUK O Q 2 Q 1 Q

Trade creation P SUK P 1 PEU + tariff P 2 PEU DUK O Q 4 Q 2 Q 1 Q 3 Q

Trade creation P SUK P 1 P 2 1 2 3 PEU + tariff 4 PEU DUK O Q 4 Q 2 Q 1 Q 3 Q

Trade creation P SUK Gains P 1 P 2 1 2 3 PEU + tariff 4 PEU DUK O Q 4 Q 2 Q 1 Q 3 Q

Trade diversion P SUK PEC+ tariff P 1 PNZ + tariff PEC PNZ P 3 DUK O QSUK QDUK Q

Trade diversion P SUK PEC+ tariff P 1 PNZ + tariff P 2 PEC PNZ P 3 DUK O Q*SUK QDUK Q*DUK Q

Trade diversion P SUK P 1 P 2 1 2 3 4 P 3 PNZ + tariff PEC PNZ DUK O Q*SUK QDUK Q*DUK Q

Trade diversion P SUK Gains Losses P 1 P 2 1 2 3 4 5 P 3 PNZ + tariff PEC PNZ DUK O Q*SUK QDUK Q*DUK Q

Trade diversion P Gains SUK Losses P 1 P 2 P 3 PNZ + tariff 1 2 3 5 4 PEC PNZ DUK O Q 4 Q 2 Q 1 Q 3 Q

THE EUROPEAN UNION • Non-tariff barriers pre 1993 – quotas and other quantitative restrictions ² Airline restrictions ² Government procurement – cost-increasing barriers ² Taxing foreign products more ² Subsidies to domestic firms – barriers to entry ² Technical regulations ² Non-recognition of qualifications

THE EUROPEAN UNION • Non-tariff barriers pre 1993 – quotas and other quantitative restrictions – cost-increasing barriers – barriers to entry • The single market • the Single European Act • (1987) 300 measures - implementation in ‘ 1992’

PREFERENTIAL TRADING • free trade areas • customs unions • common markets – A common system of regulations governing production, employment and trade – Free movement of labour & capital markets and a common market for services and government procurement – Other issues are possibly law, macroeconomic policy and a common currency/fixed exchange rate.

THE EUROPEAN UNION • Non-tariff barriers pre 1993 – quotas and other quantitative restrictions – cost-increasing barriers – barriers to entry • The single market – the Single European Act – (1987) 300 measures - implementation in ‘ 1992’ • Mutual recognition, • race to the bottom & Majority Voting (but not taxes)

THE EUROPEAN UNION • The benefits of the single market – trade creation – reduction in the direct costs of barriers – economies of scale – greater competition: short run – greater competition: long run • Criticisms of the single market – radical economic change is costly – adverse regional multiplier effects – development of monopoly / oligopoly power – trade diversion • The future of the EU?

Win. Econ Links • Win. Econ does not have many links relevant to the material in these lectures but there a few that may be beneficial. • A good link is Understanding Consumer Surplus • 5. 4. 5 Looks at The Effect of a Tariff on Imports But this largely repeats what is covered in the lecture • 17. 5. The Direction of International Trade gives a good background on World Trade patterns. • Remember for these links to work you must have Win. Econ on your machine or be in the Strathcona Labs or insert your Win. Econ CD from the Sloman textbook.