Trade Policy Pierre-Louis Vézina p. vezina@bham. ac. uk
Intro • Previous chapters have answered the question, “Why do nations trade? ” • The next ones: “What should a nation’s trade policy be? ” – Should the UK use a tariff to protect its car industry against competition from Japan and South Korea? – Who will benefit and who will lose? Will the benefits outweigh the costs?
Intro • Tariffs are the oldest form of trade policy • Their true purpose has usually been twofold – provide government revenue – protect domestic sectors
Intro • In the early 19 th century, for example, the UK used tariffs (the famous Corn Laws) to protect its agriculture from import competition. • In the late 19 th century, both Germany and the US protected their new industrial sectors by imposing tariffs on imports of manufactured goods
Types of Tariffs • A tariff is a tax on imports • A specific tariff is levied as a fixed charge for each unit of imported goods. – For example, $3 per barrel of oil. • An ad valorem tariff is levied as a fraction of the value of imported goods. – For example, 25% tariff on the value of imported trucks.
Import Demand Curve • An import demand curve is the difference between the quantity that Home consumers demand minus the quantity that Home producers supply, at each price: MD = D – S
Import Demand Curve
Import Demand Curve
Export Supply Curve • An export supply curve is the difference between the quantity that Foreign producers supply minus the quantity that Foreign consumers demand, at each price. XS* = S* – D*
Export Supply Curve
World Equilibrium
The Effects of a Tariff • The independent, LUANDA, 23 APRIL 2014: • In Luanda’s Jumbo supermarket, a half-litre tub of imported vanilla ice-cream used to cost $25 (£ 15), testament to the Angolan capital’s rank as one of the world’s most expensive cities. • With new import tariffs imposed last month, that price has jumped to $31, enough to make even wealthy locals and expatriates pause and putting the treat even further beyond the reach of millions of poor Angolans struggling to feed their families.
The Effects of a Tariff • The independent, LUANDA, 23 APRIL 2014: • In Luanda’s Jumbo supermarket, a half-litre tub of imported vanilla ice-cream used to cost $25 (£ 15), testament to the Angolan capital’s rank as one of the world’s most expensive cities. • With new import tariffs imposed last month, that price has jumped to $31, enough to make even wealthy locals and expatriates pause and putting the treat even further beyond the reach of millions of poor Angolans struggling to feed their families. How does that happen?
The Effects of a Tariff • A tariff acts like a shipping cost, making sellers unwilling to ship ice cream unless the Angola price exceeds the UK price by the amount of the tariff: P T – t > P *T
The Effects of a Tariff • If PT – t < P*T , no ice cream is being shipped • There is excess demand in Luanda and excess supply in the UK. • The price in Luanda will rise and that in the UK will fall until the price difference is t.
The Effects of a Tariff Angola UK
The Effects of a Tariff • The quantity of imports equals the quantity of exports when PT – P*T = t
The Effects of a Tariff • Because the price in Luanda rises from PW under free trade to PT with the tariff, – Luanda producers supply more and Home consumers demand less, so – the quantity of imports falls from QW under free trade to QT with the tariff.
The Effects of a Tariff • Because the price in the UK falls from PW under free trade to PT* with the tariff, – UK producers supply less, and UK consumers demand more, so – the quantity of exports falls from QW to QT.
The Effects of a Tariff • The increase in the price in Luanda is less than the amount of the tariff and… • The Angola tariff causes the UK export price to decline • Is this really possible?
The Effects of a Tariff in a Small Country • When a country is “small, ” it has no effect on the foreign (world) price because its demand is an insignificant part of world demand for the good. – The foreign price does not fall, but remains at Pw – The price in the home market rises by the full amount of the tariff, to PT = Pw + t.
A Tariff in a Small Country
A Tariff in a Small Country Back in Angola, the government imposed higher import tariffs in March 2014 on hundreds of items, from garlic to cars. The stated aim is to try to diversify the heavily oil-dependent economy and nurture farming and industry, sectors which have remained weak. But this is expected to hike prices for consumers, hitting the less privileged sectors of society especially hard.
Effective Rate of Protection • The effective rate of protection measures how much protection a tariff (or other trade policy) provides. – It represents the change in value that firms in an industry add to the production process when trade policy changes, which depends on the change in prices the trade policy causes. • Effective rates of protection often differ from tariff rates because tariffs affect sectors other than the protected sector, causing indirect effects on the prices and value added for the protected sector.
Effective Rate of Protection • For example, suppose that cars sell in world markets for $8, 000, and they are made from factors of production worth $6, 000. – The value added of the production process is $8, 000 – $6, 000 = $2, 000 • Suppose that a country puts a 25% tariff on imported cars so that home auto assembly firms can now charge up to $10, 000 instead of $8, 000.
Effective Rate of Protection • The effective rate of protection for home car assembly firms is the change in value added: ($4, 000 – $2, 000)/$2, 000 = 100% • In this case, the effective rate of protection is greater than the tariff rate.
Effective Rate of Protection • Now suppose that the country, to encourage domestic production of car parts, imposes a 10% tariff on imported parts, raising the cost of parts for domestic assemblers from $6, 000 to $6, 600. • Even though there is no change in the tariff on assembled cars, this policy makes it less advantageous to assemble domestically.
Effective Rate of Protection • Before the tariff it would have been worth assembling a car locally if it could be done for $2, 000 ($8, 000 - $6, 000) • After the tariff, local assembly takes place only if it can be done for $1, 400 ($8, 000 - $6, 600). • The tariff on parts, then, while providing positive protection to parts manufacturers, provides negative effective protection to assembly at the rate of -30% ( -600/2, 000).
Costs and Benefits of Tariffs • A tariff raises the price of a good in the importing country, so it hurts consumers and benefits producers there. • In addition, the government gains tariff revenue. • How to measure these costs and benefits?
Consumer Surplus • Consumer surplus measures the amount that consumers gain from purchases by computing the difference in the price actually paid from the maximum price they would be willing to pay for each unit consumed. • If, for example, a consumer would have been willing to pay $8 for an ice cream but the price is only $3, the consumer surplus gained by the purchase is $5.
Consumer Surplus When the price increases, the quantity demanded decreases as well as the consumer surplus.
Producer Surplus • Producer surplus measures the amount that producers gain from sales by computing the difference in the price received from the minimum price at which they would be willing to sell.
Producer Surplus
Costs and Benefits of a Tariff for the Importing Country
Costs and Benefits of a Tariff for the Importing Country Consumers worse off Producers better off Government better off
Net Welfare Effects of a Tariff Change in welfare due to the tariff is e – (b + d)
Costs and Benefits of Tariffs • For a “large” country, whose imports and exports affect world prices, the welfare effect of a tariff is ambiguous. • The triangles b and d represent the efficiency loss. – The tariff distorts production and consumption decisions: producers produce too much and consumers consume too little. • The rectangle e represents the terms of trade gain. – The tariff lowers the Foreign price, allowing Home to buy its imports cheaper.
Tariffs for the Long Haul • Tariffs can be fiendishly hard to remove even after economic conditions have completely changed • The “Chicken Tax” tariff lasted for so long (47 years, and counting) that it ended up hurting the producers that had intensively lobbied to maintain the tariff in the first place! • This tariff was a retaliation by the US against a tariff on US chicken imposed by Western Europe in the 1960 s. • The US retaliation, focusing on Germany (one of the main political forces behind the original chicken tariff), imposed a 25% tariff on imports of light commercial trucks
Tariffs for the Long Haul • At the time, Volkswagen was a big producer of such vehicles and exported many of them to the US. • As time went by, Volkswagen stopped producing those vehicles, but the US “big three” lobbied to keep the tariff to protect themselves against Japanese producers • 40 years later, the latest company to be hit by the consequences of the tariff is Ford, one of those “big three”
Tariffs for the Long Haul • Ford produces a commercial van in Europe, the “Transit Connect, ” designed (with its smaller capacity and ability to navigate old, narrow streets) for Europe. • The recent spike in fuel prices sharply increased demand in some US cities for this van. • In 2009, Ford started selling these vehicles in the US. – To get around the 25% tariff, Ford installs rear windows, rear seats, and seat belts prior to shipping. These vehicles are no longer classified as commercial trucks but as passenger vehicles, subject to the much lower 2. 5% tariff. – Upon arrival in Baltimore, the rear seats are promptly removed and the rear windows replaced with metal panels—before delivery to the Ford dealers
Tariff evasion • Large tariffs can induce producers to behave in many creative—though wasteful and sometimes illegal —ways in order to avoid them.
Tariff evasion • Declare rice as mung beans • Two Philippine companies, Plum Blossom Import-Export Food Corp. and Full Story Source Marketing were apparently importing rice from Vietnam and Thailand but misdeclaring it as mung beans to a corrupt customs agent. Why? White rice imports require an import license from the National Food Authority and are subject to a 50% duty and 12% VAT. Mung beans, meanwhile, are zero-rated in both customs duties and VAT under the ASEAN Free Trade Agreement. . . Source: Philippines Daily Inquirer
Tariff evasion • Evading antidumping duties • What happens to Chinese steel exporters when the US beefs up its protection for domestic steel industries with high-profile antidumping duties? • The Global Times reports: The US Coalition for Enforcement of Antidumping and Countervailing Duty Orders said it had gathered "compelling evidence of how certain manufacturers (in China) are evading duties". . . Chinese manufacturers of steel wire products evade antidumping duties via third countries. . .
Tariff evasion • Undervalue motorcycles: • 48 brand new Yamaha motorcycles arrived at the Port of Manila in December 2013 • According to import documents, the motorcycles were "in knocked-down condition" from Thailand, and valued $212 each • Customs conducted an inspection and found the motorcycles were new and came from India! • The suggested selling price of a brand new Yamaha in India is $1, 812, about 85% higher than the declared value
Tariff evasion
Export Subsidy • An export subsidy can also be specific or ad valorem: – A specific subsidy is a payment per unit exported. – An ad valorem subsidy is a payment as a proportion of the value exported. • When the government offers an export subsidy, shippers will export the good up to the point at which the domestic price exceeds the foreign price by the amount of the subsidy. • An export subsidy raises the price in the exporting country, decreasing its consumer surplus (consumers worse off) and increasing its producer surplus (producers better off).
Export Subsidy • Also, government revenue falls due to paying s XS* for the export subsidy. • An export subsidy lowers the price paid in importing countries PS* = PS – s. • In contrast to a tariff, an export subsidy worsens the terms of trade by lowering the price of exports in world markets.
Effects of an Export Subsidy
Effects of an Export Subsidy Welfare loss: b + d + e + f + g
Europe’s Common Agricultural Program • The EU has a massive export subsidy program • The CAP began not as an export subsidy, but as an effort to guarantee high prices to farmers by having the EU buy products when prices fell below support levels • To prevent this policy from drawing in imports, it was initially backed by tariffs that offset the difference between European and world prices to make imports more expensive
Europe’s Common Agricultural Program • Since the 1970 s, however, the support prices set by the EU have turned out to be so high that Europe—which, under free trade, would be an importer of most agricultural products— was producing more than consumers were willing to buy
Europe’s Common Agricultural Program • The EU found itself obliged to buy and store huge quantities of food. • In 1985, it had stored 780, 000 tons of beef, 1. 2 million tons of butter, and 12 million tons of wheat. • To avoid unlimited growth in these stockpiles, the EU turned to a policy of subsidizing exports to dispose of surplus production
Europe’s Common Agricultural Program The cost of this policy is almost $30 billion more than its benefits (in 2007).
Europe’s Common Agricultural Program • So why does the EU continue with this policy?
Europe’s Common Agricultural Program
Europe’s Common Agricultural Program
So why does the EU continue with this policy?
Europe’s Common Agricultural Program • In the US and Japan, farmers are also protected: – Japan’s 1000% tariff on imported rice – America’s sugar quota
Import Quota • An import quota is a restriction on the quantity of a good that may be imported. • This restriction is usually enforced by issuing licenses or quota rights. • A binding import quota will push up the price of the import because the quantity demanded will exceed the quantity supplied by Home producers and from imports.
Import Quota • When a quota instead of a tariff is used to restrict imports, the government receives no revenue. – Instead, the revenue from selling imports at high prices goes to quota license holders. – These extra revenues are called quota rents.
Effects of the US Import Quota on Sugar
Import Quota • Quotas on Clothing: Until 2005, quota licenses granted to textile and apparel exporters were specified in the Multi-Fiber Agreement between the US and many other nations.
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Voluntary Export Restraint • A voluntary export restraint works like an import quota, except that the quota is imposed by the exporting country rather than the importing country. • These restraints are usually requested by the importing country. • The profits or rents from this policy are earned by foreign governments or foreign producers. – Foreigners sell a restricted quantity at an increased price.
A Voluntary Export Restraint in Practice: Japanese Cars • For much of the 1960 s and 1970 s, the US car industry was largely insulated from competition by the different kind of cars bought by US and foreign consumers • US buyers, living in a large country with low gasoline taxes, preferred much larger cars than Europeans and Japanese • In 1979, however, sharp oil price increases and temporary gasoline shortages caused the U. S. market to shift abruptly toward smaller cars.
A Voluntary Export Restraint in Practice: Japanese Cars • Japanese producers moved in to fill the new demand. • As the Japanese market share soared and US output fell, strong political forces in the US demanded protection • Rather than act unilaterally and risk creating a trade war, the US government asked the Japanese government to limit its exports • The Japanese, fearing unilateral US protectionist measures, agreed to limit their sales
A Voluntary Export Restraint in Practice: Japanese Cars • The first agreement, in 1981, limited Japanese exports to the US to 1. 68 million cars. • The price of Japanese cars in the US rose, with the rent captured by Japanese firms. • The US government estimates the total costs to the US to be $3. 2 billion in 1984, primarily in transfers to Japan rather than efficiency losses.
Local Content Requirement • A local content requirement is a regulation that requires a specified fraction of a final good to be produced domestically. • It may be specified in value terms, by requiring that some minimum share of the value of a good represent home value added, or in physical units.
Local Content Requirement • From the viewpoint of domestic producers of inputs, a local content requirement provides protection in the same way that an import quota would. • From the viewpoint of firms that must buy home inputs, however, the requirement does not place a strict limit on imports, but allows firms to import more if they also use more home parts.
Local Content Requirement • Local content requirement provides neither government revenue (as a tariff would) nor quota rents. • Instead, the difference between the prices of home goods and imports is averaged into the price of the final good and is passed on to consumers.
American buses, made in Hungary • In 1995, sleek new buses began rolling onto the streets of Miami and Baltimore. • Probably very few riders were aware that these buses had been made in Hungary, of all places. Why Hungary? • Some clever Hungarian investors’ realised that there is a loophole in the Buy American Act, originally passed in 1933.
American buses, made in Hungary • The Buy American Act affects procurement (purchases by government agencies, including state and local governments) by requiring that American firms be given preference. • A bid by a foreign company can be accepted only if it is at least 25% below the domestic bid, effectively shutting out foreign producers in most cases • “American” products can contain some foreign parts but 51% of the materials must be domestic.
American buses, made in Hungary • The Hungarians realized they could set up a production chain that just met this criterion. • American axles and tires were shipped to Hungary, where they were put onto the bus shells; these were then shipped back to the US, where US-made engines and transmissions were installed. • The whole product was slightly more than 51% American, and these buses were thus legally “American” • The advantage of the scheme was to use inexpensive Hungarian labour
Other Trade Policies • Export credit subsidies – A subsidized loan to exporters – US Export-Import Bank subsidizes loans to US exporters. • Government procurement – Government agencies are obligated to purchase from home suppliers, even when they charge higher prices (or have inferior quality) compared to foreign suppliers. • Bureaucratic regulations – Safety, health, quality, or customs regulations can act as a form of protection and trade restriction.
Doing Business
Doing Business Country France Ireland Canada Denmark Hong Kong … Tajikistan Côte d'Ivoire Nigeria Uzbekistan Central African Republic Documents to import 2 2 3 3 3 12 13 13 13 17
Doing Business Country Singapore Denmark Hong Kong Estonia United States … Iraq Chad Afghanistan Uzbekistan South Sudan Days to import 4 5 5 82 90 91 104 130
Other Trade Policies Sanctions, bans, and the politics of trade policies
Other Trade Policies Sanctions, bans, and the politics of trade policies • “Western countries” this year imposed sanctions on Russia over the Ukraine crisis • One Russian reaction was a ban on farm imports from EU nations • Russia was the main apple export market for Poland, the leading EU producer of the fruit. • The price of Polish apples fell sharply in October, by 77% year-on-year • Poles have responded by celebrating the forbidden fruit, encouraging people via a social-media campaign on Facebook and You. Tube to “Eat apples to annoy Putin”
Other Trade Policies Sanctions, bans, and the politics of trade policies • Why does Russia’s trade policy affect the price of apples in Poland? • Why does Poland react with an applepromotion campaign?
Recap: The Effects of Trade Policy 1. Tariffs generate government revenue; export subsidies drain it; import quotas do not affect government revenue. 2. All these trade policies create production and consumption distortions. 3. Large countries can influence foreign prices
Effects of Alternative Trade Policies
Global Trade Alert
Global Trade Alert
Trade Policy in Developing Countries
Trade Policy in Developing Countries 1. Import-substituting industrialization 2. Trade liberalization since 1985 3. Trade and growth: Takeoff in Asia
Import-Substituting Industrialization • Import-substituting industrialization was a development strategy adopted by many low- and middle-income countries before the 1980 s. • The policy aimed to encourage domestic industries by limiting competing imports infant industry argument
Import-Substituting Industrialization • The infant industry argument: – a potential comparative advantage in some industries – governments should temporarily support them until they’re strong enough to compete
Import-Substituting Industrialization 9 -98
Effective Protection of Manufacturing
Import-Substituting Industrialization • Problems with the Infant Industry Argument: 1. With protection, infant industries may never “grow up” 2. It may be wasteful to support industries now that will have a comparative advantage in the future.
Import-Substituting Industrialization • Import-substituting industrialization in Latin America worked to encourage manufacturing in the 1950 s and 1960 s • But did import-substituting industrialization promote economic development? – No, countries adopting these policies grew more slowly than others.
Import-Substituting Industrialization • Pakistan and India have protected their manufacturing sectors for decades • The goods they export, however, are light manufactures like textiles, not the heavy manufactures that they protected – They would have developed their manufactured exports even if they had never protected manufacturing
Import-Substituting Industrialization • Import-substitution industrialization involved costs and promoted wasteful use of resources: – It involved complex, time-consuming regulations – It set high tariff rates for consumers, including firms that needed to buy imported inputs for their products. – It promoted inefficiently small industries.
Trade Liberalization • By the mid-1980 s, many governments had lost faith in import substitution and began to liberalize trade.
Trade Liberalization • Trade liberalization in developing countries occurred along with a dramatic increase in the volume of trade.
Mexico Abandons Import-Substituting Industrialization • Mexico’s turn toward free trade in 1980 s reversed a halfcentury of history • Throughout the 1950 s and 1960 s, trade barriers were high • Mexican industry produced very little for export
Mexico Abandons Import-Substituting Industrialization • 1982: Debt crisis
Mexico Abandons Import-Substituting Industrialization • In 1980, Mexican exports were only 10. 7% of GDP—and much of that was oil. • Between 1985 and 1988, Mexico drastically reduced tariffs and removed most of the import quotas that had previously protected its industry. • 1994 NAFTA • By 2008, exports were up to 28. 3% of GDP, primarily manufactures
Mexico Abandons Import-Substituting Industrialization
Trade Liberalization • Has trade liberalization promoted development? The evidence is mixed. – Growth rates in Brazil and other Latin American countries have been slower since trade liberalization than they were during importsubstituting industrialization. • But unstable macroeconomic policies and financial crises contributed to slower growth since the 1980 s.
Trade Liberalization – Other countries like India have grown rapidly since liberalizing trade in the 1980 s, but it is unclear to what degree liberalized trade contributed to growth. – Some economists also argue that trade liberalization has contributed to income inequality, as the Heckscher-Ohlin model predicts.
Trade Policy in Developing Countries • Do countries with lower barriers to trade experience faster economic progress? • World Bank, IMF, and the OECD regularly promulgate advice predicated on the belief that openness generates predictable and positive consequences for growth
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Import-Substituting Industrialization • Kicking Away the Ladder, Ha-Joon Chang • Based on economic history, all major developed countries, including the UK, used interventionist economic policies to promote industrialization • Protected national companies until they had reached a level of development in which they were able to compete in the global market
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Trade and Growth: Takeoff in Asia • Instead of import substitution, several countries in East Asia adopted trade policies that promoted exports in targeted industries. – Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia, and China have experienced rapid growth in various export sectors and rapid economic growth
Asia’s Surging Trade
The Asian Takeoff
Trade and Growth: Takeoff in Asia • So it is possible to develop through export-oriented growth. • However, Latin American nations such as Mexico and Brazil, which also sharply liberalized trade and shifted toward exports, did not see comparable economic takeoffs.
Trade and Growth: Takeoff in Asia • It’s unclear if the high volume of exports and imports caused rapid economic growth or was merely correlated with rapid economic growth. – High saving and investment rates could have led to both rapid economic growth in general and rapid economic growth in export sectors. – Rapid growth in education led to high literacy and numeracy rates important for a productive labor force. – These nations also undertook other economic reforms.
Recap 1. Import-substituting industrialization aimed to promote economic growth by restricting imports that competed with domestic products in low- and middle-income countries. The infant industry argument 2. Import-substituting industrialization was tried in the 1950 s and 1960 s but by the mid-1980 s it was abandoned for trade liberalization. 3. Trade and growth go together, yet the role of trade policy in growth and welfare is still being debated.
The international political economy of trade policy
International Negotiations of Trade Policy • Since 1944, much of the reduction in tariffs and other trade restrictions has come about through international negotiations.
International Negotiations of Trade Policy • Why are there such negotiations? – Multilateral negotiations help avoid a trade war between countries, where each country enacts trade restrictions.
The Problem of Trade Warfare
World Trade Organization • In 1947, a group of 23 countries began trade negotiations under the General Agreement on Tariffs and Trade, or GATT. • In 1995, the World Trade Organization, or WTO, was established as a formal organization for implementing multilateral trade negotiations (and policing them).
World Trade Organization
World Trade Organization • 160 members as of 2014
World Trade Organization • WTO negotiations address trade restrictions in at least 3 ways: 1. Reducing tariff rates through multilateral negotiations. 2. Binding tariff rates: a tariff is “bound” by having the imposing country agree not to raise it in the future. 3. Eliminating nontariff barriers: quotas and export subsidies (subsidies for agricultural exports are an exception)
World Trade Organization • The Uruguay Round in 1994: – Launched the WTO – agreed that all quantitative restrictions (quotas) on trade in textiles and clothing as previously specified in the Multi-Fiber Agreement were to be eliminated by 2005.
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World Trade Organization • "Battle in Seattle" in 1999 • Activists tried to shut down the meeting that was supposed to launch the WTO's new round of trade talks. • The activists succeeded. That's why it's the Doha round, not the Seattle round.
World Trade Organization • The frequency – and virulence – of anti-WTO protests have died off gradually since 1999, perhaps because the round doesn't seem to be going anywhere • The Doha negotiations have not yet produced an agreement. – Most of the remaining forms of protection are in agriculture, textiles, and clothing—industries that are politically well organized.
World Trade Organization
World Trade Organization • Why the Trade Talks Collapsed • Wall Street Journal, July 7, 2007
World Trade Organization • Why the Trade Talks Collapsed • Wall Street Journal, July 7, 2007 • “In truth, the breakdown of the Doha Round in Potsdam, Germany, had less to do with India and Brazil's protectionism than with the US' paralyzing inability to respond to longstanding, worldwide demands for the reduction of its (and the EU's) agricultural subsidies. Until we confront this central fact, success will remain beyond our grasp. ”
World Trade Organization • The Doha round is based on the idea of a single undertaking, which means that, in effect, "nothing is agreed until everything is agreed“ • The Economist has more than 100 articles on the Doha Round since it was launched • The gridlock analysis goes on…
Do Agricultural Subsidies Hurt developing countries? • The US cotton subsidy depresses world cotton prices and hurts cotton growers in West Africa • But we learned that an export subsidy raises the welfare of the importing country, which gets to buy goods more cheaply. • So shouldn’t export subsidies by rich countries actually help poorer countries?
Do Agricultural Subsidies Hurt developing countries? • China, which exports manufactured goods and imports food and other agricultural products, would be hurt by the removal of agricultural subsidies.
World Trade Organization – The WTO is not completely irrelevant… – The dispute settlement procedure: a formal procedure where countries in a trade dispute can bring their case to a panel of WTO experts to rule upon. • The panel decides whether member counties are breaking their agreements. • A country that refuses to adhere to the panel’s decision may be punished by the WTO allowing other countries to impose trade restrictions on its exports.
Testing the WTO’s Mettle • In 2002 the US imposed 30% tariffs on a range of steel products. • The official reason was that the US faced a surge in imports, and needed time to restructure. • But the real reason, almost everyone agreed, was politics: West Virginia, Ohio, and Pennsylvania, where the steel industry is concentrated, were widely expected to be crucial “swing states” in the 2004 election.
Testing the WTO’s Mettle • Europe, Japan, China, and South Korea filed suit against the US steel tariff with the WTO • The US complied with the ruling, lifting the steel tariffs in December 2003 • Most observers believed, that the key motivation was a threat by the EU, which had received WTO clearance to take retaliatory action, and was getting ready to impose tariffs on more than $2 billion in US exports. • The EU policymakers even targeted their tariffs on goods produced in—you guessed it—political swing states.
Craft Brewers at the WTO • "Australia is in a very unfair position because other countries are providing substantial reduced tax rates for their small brewers, and that is deemed a government subsidy" • "We've had quite a few members say they've lost taps at hotels or fridge space to Sierra Nevada products“ • More here.
World Trade Organization • Recap – The WTO’s negotiations are not going anywhere – The Dispute Settlement Mechanism does help maintain global cooperation
Preferential Trading Agreements • Trade liberalization has not stopped since 2001 • Preferential trading agreements – countries lower tariffs for each other but not for the rest of the world. • Under the WTO, such discriminatory trade policies are generally not allowed: – Each country in the WTO promises that all countries will pay tariffs no higher than the nation that pays the lowest • the “most favored nation” (MFN) principle – An exception is allowed only if the lowest tariff rate is set at zero
Preferential Trading Agreements • There are two types of preferential trading agreements in which tariff rates are set at or near zero: 1. A free trade area: an agreement that allows free trade among members, but each member can have its own trade policy towards non-member countries. – An example is NAFTA.
Preferential Trading Agreements 2. A customs union: an agreement that allows free trade among members and requires a common external trade policy towards non-member countries. – An example is the European Union.
Do Trade Preferences Have Appeal? • The EU has slipped into bunches of trouble over the question of trade preferences for bananas. • Most of the world’s banana exports come from several small Central American nations—the original “banana republics. ”
Do Trade Preferences Have Appeal? • Several EU nations have traditionally bought their bananas instead from their colonies in the Caribbean. • To protect the island producers, France and the UK have historically imposed import quotas against the “dollar bananas” of Central America, which are typically about 40% cheaper • Germany, however, has never had Caribbean colonies, and allowed free entry to dollar bananas. • The EU common trade policy forced Germany into higherpriced bananas
Do Trade Preferences Have Appeal? • The Europeans were hurting the interests not only of Central American nations but also those of a powerful US corporation
Do Trade Preferences Have Appeal? • In 1997 the WTO found that Europe’s banana import regime violated international trade rules • In 2001, Europe and the US agreed on a plan to phase out the banana import quotas • The plan created much distress in Caribbean nations, which feared losing privileged access to the EU market. • In 2005, the EU announced that it would eliminate import quotas on bananas, but that it would triple the tariff on bananas that did not come from… former European colonies
Do Trade Preferences Have Appeal? • In December 2007 the WTO ruled that Europe’s latest banana regime, like its predecessor, was illegal • Chiquita’s stock price jumped with the news
Preferential Trading Agreements • Can preferential trading agreements reduce national welfare? • Yes. Rather than gaining tariff revenue from inexpensive imports from world markets, a country may import expensive products from member countries but not gain any tariff revenue.
Preferential Trading Agreements • Preferential trading agreements increase national welfare when new trade is created, but not when existing trade from the outside world is diverted to trade with member countries. • Trade creation – occurs when high-cost domestic production is replaced by low-cost imports from other members. • Trade diversion – occurs when low-cost imports from nonmembers are diverted to highcost imports from member nations.
Trade Diversion in South America • In 1991, Argentina, Brazil, Paraguay, and Uruguay formed Mercosur • Within four years, the value of trade among the nations tripled
Trade Diversion in South America • A World Bank report argued that member countries were being induced to buy expensively produced manufactured goods from their neighbours rather than cheaper but heavily tariffed goods from other countries • Brazil’s highly protected and somewhat inefficient car industry had in effect acquired a captive market in Argentina
Recap 1. Multilateral negotiations make countries agree not to engage in a trade war. 2. The WTO and its predecessor have reduced tariffs substantially in the last 50 years, and the WTO has a dispute settlement procedure for trade disputes. 3. A preferential trading agreement is beneficial for a country if it creates new trade but is harmful if it diverts existing trade to higher-cost alternatives.
Spaghetti Bowls as Building Blocs on the Path to Global Free Trade • World trade is regulated by a motley assortment of unilateral, bilateral and multilateral trade agreements – a ‘spaghetti bowl’ of trade deals • No one argues that this tangle of trade deals is the best way to organise world trade. • Taking the world to global duty-free trade will require a multilateralisation of the world’s existing and emerging regionalism.
Trade agreement dominos • China-ASEAN trade agreement – 1 Jan 2010 • India competes against ASEAN countries with its exports to China (fruit, vegetables, grains) – India faces tariffs between 10 -12% – ASEAN countries get (almost) duty-free access • This forces India to sign a similar agreement with China
Trade agreement dominos • Suzuki, the largest foreign carmaker in India, with annual sales of 1 m vehicles, pays around 12% tariffs on parts imported from Japan. • South Korea’s FTA with India means that Suzuki’s rival, Hyundai, pays just 1 -5%. • Osamu Suzuki, the Japanese company’s boss, feels “handicapped”. – The Economist 2010, Japan’s big companies are shipping production abroad
The noodle bowl • Why trade agreements are all the rage in Asia • The Economist, Sep 3 rd 2009
The noodle bowl • Can you find one reason why trade agreements are not that amazing for trade?
The noodle bowl • Can you find one reason why trade agreements are not that amazing for trade? • “Bilateral deals come laden with complicated rules about where products originate —rules which impose substantial costs of labelling and certification on firms. The more overlapping deals there are, the more complex the rules and the higher the costs. Those who follow Asia’s FTA mania refer to this as the “noodle bowl”. No wonder few firms actually want to use FTAs. An ADB survey of exporters in Japan, South Korea, Singapore and Thailand in 2007 -08 found that only 22% took advantage of them. ”
The noodle bowl • Customs officers need to impose different tariffs on the same good from different nations • This requires elaborate rules of origin – These are costly for both customs and manufacturers— especially with international supply chains
The noodle bowl Multilateralise regionalism, i. e. , harmonize PTA in various ways, effectively turning the individual strands in the spaghetti bowl into “lasagna”
The future of trade policy The Trans Pacific Partnership
The future of trade policy • The Transatlantic Trade and Investment Partnership
The future of trade policy • 21 st century regionalism is not primarily about preferential market access • It is about disciplines that underpin the trade-investmentservice nexus • The basic bargain is “foreign factories for domestic reforms” – not “exchange of market access”. • 21 st century regionalism is largely about regulation rather than tariffs • 21 st century regionalism is a threat to the WTO’s role as a rule writer
Extra Readings • Baldwin, Richard (2014), “ 21 st century regionalism and global trade governance”, Vox. EU. org
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