Unilateral Trade Policy
Professor Ralph Ossa
33501 International Commercial Policy
International Commercial Policy
Unilateral Trade Policy
Introduction
So far, we compared two extreme scenarios, autarky
and free trade, and concluded that countries are usually
better off under free trade.
But is free trade also a country’s optimal trade policy?
And why do governments engage in trade policy in
practice?
In this lecture we look at unilateral trade policy only. In
the next lecture we will then consider multilateral trade
negotiations.
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments
Governments use a wide range of trade policy
instruments in practice. The most important ones are:
(i)  import tariffs,
(ii)  export subsidies,
(iii)  import quotas,
(iv)  voluntary export restraints, and
(v)  local content requirements
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – import
tariffs
Import tariffs are simply taxes on imported goods.
Governments usually impose one of two types of import
tariffs:
A specific tariff, i.e. a tariff charged per unit of imports,
say $1,000 per imported automobile.
An ad valorem tariff, i.e. a tariff charged per value of
imports, say $.1 per $1 worth of imported automobiles
(or simply 10 percent).
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – import
tariffs (cont.)
In the U.S., tariffs are relatively modest by international
standards. Currently, the U.S. average (ad valorem
equivalent) tariff is less than 2 percent.
However, this does not imply that U.S. tariffs are low in
all sectors. Indeed, the U.S. imposes much higher tariffs
in sectors such as clothing and apparel, leather and
footwear, and agriculture. Remember also our
discussion on antidumping duties.
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – export
subsidies
Export subsidies are simply subsidies on exported
goods. Governments again usually impose one of two
types of export subsidies:
A specific export subsidy, i.e. a subsidy paid per unit of
exports, say $1,000 per exported automobile.
An ad valorem export subsidy, i.e. a subsidy paid per
value of exports, say $.1 per $1 worth of exported
automobiles (or simply 10 percent).
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – export
subsidies (cont.)
In the U.S., export subsidies are mainly applied in
agriculture. An example is the Department of
Agriculture’s Dairy Export Incentive Program (DEIP).
The DEIP is designed to help “exporters of dairy
products meet prevailing world prices for targeted dairy
products and destinations”.
The E.U.’s Common Agricultural Policy is another wellknown agricultural export subsidy program (more on
that later).
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – import
quotas
An import quota is a restriction on the quantity of a
good that may be imported.
This restriction is usually enforced through import
licenses. While these are usually issued to importers in
the importing country, they are also sometimes issued
to governments of exporting countries.
In the U.S., the quota on sugar imports is an example of
the latter kind. It restricts yearly sugar imports to
approximately 1.4 million tons.
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – voluntary
export restraint
A voluntary export restraint (VER) is essentially an
export quota. Despite its name it is typically not fully
voluntary but instead requested by an importing country.
The Japanese VER on auto exports to the U.S. between
1981 and 1985 is perhaps the best known example. It
restricted Japanese auto exports to the U.S. to 1.68
million units initially and 1.85 million units eventually.
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – local
content requirement
A local content requirement is a regulation that
requires a specific fraction of the final good to be
produced domestically. In may be specified in terms of
value or of physical units.
In the U.S., the Buy American Act is a good example. It
was originally passed in 1933 and requires government
agencies to give preference to U.S. firms in their
procurement. In particular, a bid by a foreign company
can only be accepted if it is a specified percentage
below the lowest bid by a U.S. firm.
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International Commercial Policy
Unilateral Trade Policy
Overview of trade policy instruments – local
content requirement (cont.)
Also, American firms are not allowed to simply act as
sales agents for foreign firms. While “American”
products may contain some foreign parts, 51 percent of
the materials must be domestic.
This requirement can lead to some curious situations.
For example, the “made in the USA” buses bought in
1995 by the cities of Miami and Baltimore were really 49
percent “made in Hungary”.
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International Commercial Policy
Unilateral Trade Policy
Overview of the lecture
Unfortunately, we cannot discuss all effects of all these
trade policy instruments in detail.
We only analyze import tariffs and export subsidies in a
simple perfectly competitive environment:
(i)  What is a country’s optimal import tariff? Why do
governments impose import tariffs in practice?
(ii)  What is a country’s optimal export subsidy? Why do
governments impose export subsidies in practice?
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework
Consider an industry in which Home is an importer and
Foreign is an exporter.
It is useful to illustrate the (partial) equilibrium using
import demand and export supply curves.
Home’s import demand curve measures the quantity
Home’s consumers demand minus the quantity Home’s
producers supply for any given Home price.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Price
No-trade
equilibrium
Price
S
PA
A'
Each
point
on
the
import
demand
curve
is
a
point
that
corresponds
to
Home
imports
at
a
given
Home
price
A
B
PW
D
S1
Q0
D1
Quantity
14
Imports,
M1
Import
demand
curve,
M
M1
Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Foreign’s export supply curve measures the quantity
Foreign’s producers supply minus the quantity Foreign’s
consumers demand for any given Foreign price.
Home is typically referred to as small, if changes in
Home’s import demand have only a negligible effect on
Foreign’s price so that Foreign’s export supply curve
facing Home is flat.
Home is typically referred to as large, if changes in
Home’s import demand have a non-negligible effect on
Foreign’s price so that Foreign’s export supply curve
facing Home is upward sloping.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Price
No-trade
equilibrium
Case
1:
Home
is
small
Price
S
PA
A'
A
B
PW
D
S1
Q0
D1
Quantity
16
Imports,
M1
Foreign
export
supply,
X*
Import
demand
curve,
M
M1
Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Price
No-trade
equilibrium
Case
2:
Home
is
large
Price
S
PA
A'
Foreign
export
supply,
X*
A
B
PW
D
S1
Q0
D1
Quantity
17
Imports,
M1
Import
demand
curve,
M
M1
Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Consumer welfare can be measured by consumer
surplus, in this supply and demand framework.
Consumer surplus is given by the difference between
what consumers would be maximally willing to pay and
what they actually pay.
Graphically, it can be represented by the area below the
demand curve and above the price.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Producer welfare can be measured by producer
surplus in this supply and demand framework.
Producer surplus is given by the difference between
what producers would be minimally willing to charge
and what they actually charge. We can loosely refer to
this difference as profits.
Graphically, it can be represented by the area above the
supply curve and below the price.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – basic framework (cont.)
Suppose now that Home’s government imposes a
specific import tariff.
Notice that the tariff drives a wedge between the price in
Home and the price in Foreign.
For example, if the tariff is $1,000 per unit, PT = PT* +
1,000. In general, PT = PT* + t.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – overview
The effects of Home’s tariff differ in important ways
between the small country and the large country case
and we discuss both cases in turn.
First, we demonstrate that the optimal tariff of a small
country is zero.
Second, we show that the optimal tariff of a large
country is positive.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case
Home
price
rises
by
the
amount
of
the
tariff
No-trade
equilibrium
Price
Price
S
Home
supply
increases
and
Home
demand
decreases

imports
fall
to
M2
Foreign
producers
still
receive
the
net-of-tariff
price
PW
A
C
PT=PW+t
B
PT*=PW
PW
X*+t
D
D
D
S1
S
2
2
1
M2
24
Quantity
Foreign
export
supply,
X*
M
M2 M1 Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
No-trade
equilibrium
The
loss
in
consumer
surplus
due
to
the
higher
price
with
the
tariff
is
equal
to
the
shaded
area
(a+b+c
+d)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
25
M2
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
No-trade
equilibrium
The
gain
in
producer
surplus
due
to
the
higher
price
with
the
tariff
is
equal
to
the
shaded
area
(a)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
26
M2
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
No-trade
equilibrium
The
gain
in
government
revenue
due
to
the
tariff
is
equal
to
the
shaded
area
(c)
Price
S
This
equals
the
tariff,
t,
times
the
quantity
of
imports,
M2
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
27
M2
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
The optimal tariff of a small country is therefore zero:
Fall
in
consumer
surplus Rise
in
producer
surplus
Rise
in
government
revenue
Net
effect
on
Home
welfare -(a+b+c+d)
+(a)
+(c)
-(b+d)
The area (b+d) is referred to as deadweight loss or
efficiency loss. It arises because the tariff distorts
consumption and production decisions.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
No-trade
equilibrium
(a)
is
a
transfer
from
consumers
to
producers
Price
(c)
is
a
transfer
from
consumers
to
the
government
(b+d)
is
deadweight
loss
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
29
M2
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – small country case (cont.)
The
deadweight
loss
can
also
be
illustrated
in
the
import
demand
and
export
supply
diagram
Price
Dead
weight
loss
due
to
tariff,
b+d
X*+
t
C
X*
M
M2
30
M1 Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case
Home
price
now
rises
by
less
than
the
amount
of
the
tariff
Price
Price
No-trade
equilibrium
Foreign
producers
are
absorbing
part
of
the
tariff
X*+t
S
A
PT*+t
t
t
PW
PT*
D
X*
t
C
B*
C*
M
S1
S2
D2
D1
Quantity
M2
M1
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M2
M1
Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
No-trade
equilibrium
Price
Price
X*+t
S
b+d
A
PT*+t
PW
PT*
a
e
t
X*
C
c
b
-(a+b+c+d)
+(a)
+(c+e)
-
(b+d)
+
(e)
Fall
in
consumer
surplus
Rise
in
producer
surplus
Rise
in
government
revenue
Net
effect
on
Home
welfare
d
B*
D
e
C*
M
S1
S2
D2
D1
Quantity
32
M2
M1
Imports
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
The net effect on Home welfare is therefore ambiguous.
It is positive if e > b + d and negative if e < b + d.
On the one hand, there is again a deadweight loss (b
+ d) just as in the small country case. It again arises
because the tariff distorts Home’s consumption and
production decisions.
But on the other hand, there is now also a terms-oftrade gain (e). It arises because the tariff lowers
Foreign’s export prices.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
It can be shown that the terms-of-trade gain dominates
the deadweight loss for a sufficiently small tariff so that
the optimal tariff of a large country is positive.
The derivation of this result is actually not too difficult. If
you are interested, you can take a look at the appendix
to chapter 9 in K-O.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
The
optimal
tariff
maximizes
the
importer’s
welfare,
point
C
Too
high
of
a
tariff
will
decrease
importer’s
welfare
and
can
increase
to
the
point
where
there
is
no
trade
Terms
of
trade
gain
exceeds
deadweight
loss
Importer’s
Welfare
C
Free
Trade
B'
B
A
No
Trade
35
Terms
of
trade
gain
is
less
than
deadweight
loss
Optimal
Tariff
Prohibitive
Tariff
Tariff
International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
It turns out that the optimal tariff is just the inverse of the
elasticity of Foreign export supply:
Optimal tariff = 1/EX*
EX* is the percentage increase in the quantity exported
in response to a percentage increase in the world price
of the export.
Intuitively, the optimal tariff is decreasing in EX* since
Home’s monopsony power in world markets is
decreasing in EX*.
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International Commercial Policy
Unilateral Trade Policy
Optimal import tariff – large country case (cont.)
As is easy to verify, Home’s gain from a tariff comes
directly at Foreign’s expense. This is because Home’s
terms-of-trade gain is Foreign’s terms-of-trade loss.
The optimal tariff is therefore a beggar-thy-neighbor
policy.
This observation will play a crucial role in our discussion
of trade negotiations next week.
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff
This model can be used to estimate how costly tariffs
are in practice.
We illustrate this using the case of U.S. steel tariffs,
which were in place from March 2002 until December
2003. For simplicity, we consider only the small country
case.
Of course, this estimate is very rough since it relies on
many special assumptions (small country, no variety
effects, no productivity effects, etc.). However, it is a
useful starting point for more sophisticated calculations.
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
During the 2000 presidential campaign, George W.
Bush promised to protect the U.S. steel industry. To
deliver on this promise, he requested that the
International Trade Commission (ITC) initiate a Section
201 investigation into the steel industry.
As we will discuss in more detail next week, Section 201
of the U.S. Trade Act of 1974 mirrors Article XIX of the
General Agreement on Tariffs and Trade (GATT),
known as the “safeguard” or “escape clause”. It allows a
temporary tariff to be used under certain circumstances.
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
After investigating, the ITC determined that the
conditions of section 201 and Article XIX were met and
recommended that tariffs be put in place to protect the
U.S. steel industry.
The tariffs recommended by the ITC varied across
products, ranging from 10 percent to 20 percent for the
first year and then falling over time so as to be
eliminated after three years. President Bush accepted
the ITC’s recommendation but applied even higher
tariffs.
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
Knowing that U.S. trading partners would be upset by
this action, President Bush exempted some countries
from the tariffs on steel.
The countries exempted included Canada, Mexico,
Jordan, and Israel, all of which have free-trade
agreements with the U.S., and 100 small developing
countries that were exporting only a very small amount
of steel to the U.S..
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
Recall
that
the
DWL
is
given
by
the
area
of
the
triangle
(b+d)
Price
Deadweight
loss
due
to
the
tariff,
b+d
PW(1+τ)
ΔP=PWτ
c

DWL
=
½
PWτ
ΔM
PW
M
M2
M1
Imports
43
In
our
calculation,
we
have
to
take
into
account
that
the
steel
tariff
is
quoted
as
an
ad
valorem
tariff
ΔM
International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
It is convenient to first compute the DWL relative to the
import value in the year prior to March 2002:
DWL ⎛ 1 ⎞ ⎛ PW τ ⎞ ⎛ ΔM ⎞ ⎛ 1 ⎞
=
⎜
⎟⎜
⎟ = ⎝ ⎠ (τ )(%ΔM )
⎝
⎠
PW M1
2 ⎝ PW ⎠ ⎝ M1 ⎠
2
Since the most commonly used steel products had a
tariff of 30 percent in the year following March 2002, we
set τ = .3.
Since the quantity of steel imports in the year following
March 2002 was about 25 percent less than in the year
prior to March 2002, we set %ΔM = -.25.
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International Commercial Policy
Unilateral Trade Policy
Application – U.S. steel tariff (cont.)
Hence, DWL = ⎛ 1 ⎞ (τ )(%ΔM ) = ⎛ 1 ⎞ (.3)(−.25) = −.0375
PW M
⎝ 2⎠
⎝ 2⎠
The welfare loss in the year after March 2002 was
therefore equal to around 3.75 percent of the import
value in the year prior to March 2002.
Since the import value in the year prior to March 2002
was equal to around $4.7 billion, the net welfare loss to
the U.S. economy in the year after March 2002 was
equal to around $176 million.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice
The above analysis suggests three motives for
governments to impose import tariffs:
(i)  raising government revenue,
(ii)  increasing producer welfare,
(iii)  increasing overall welfare.
All these motives appear to be relevant in practice.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – raising government
revenue
Recall that one effect of an import tariff is to generate
government revenue.
While tariffs are more distortionary than income or
value-added taxes, they are also much easier to collect.
This makes them an attractive source of government
revenue especially for poor countries.
Even in the U.S., tariff revenue was the main source of
federal government revenue from the 1790s until the
1910s.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – raising government
revenue (cont.)
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – increasing producer
welfare
Recall that another effect of an import tariff is to
increase producer welfare.
Producers are usually better organized politically than
consumers and therefore lobby the government more
effectively so that the government puts more weight on
producer surplus in its trade policy decisions.
One reason for this asymmetry is that the political
collective action problem is easier to overcome the
smaller is the number of benefitting individuals.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – increasing producer
welfare (cont.)
Most economists believe such special interest politics to
be at the heart of most trade policy decisions.
In a famous study, Princeton professor Penny Goldberg
and Yale professor Giovanni Maggi (1999) find that the
degree of import protection is systematically related to
campaign contributions in the U.S..
In particular, industries donating more generously tend
to receive more import protection in return.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – increasing overall
welfare
Recall that a small import tariff can also increase overall
welfare in the large country case.
While the optimal tariff argument is analytically
impeccable, most economists believed it to be of little
relevance in practice.
Very recent evidence provided by Chicago Booth
professor Christian Broda together with coauthors,
however, suggests that this is not the case.
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International Commercial Policy
Unilateral Trade Policy
Import tariffs in practice – increasing overall
welfare (cont.)
For a sample of non-World Trade Organization (WTO)
member countries, Broda et al. (2009) find that import
tariffs are systematically related to export supply
elasticties.
In particular, import tariffs tend to be higher in
industries, which face a lower export supply elasticity,
just as predicted by the optimal tariff formula.
The reason they focus on non-WTO countries will
become apparent in the next lecture.
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International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – basic framework
Consider now an industry in which Home is an exporter
and Foreign is an importer.
We can again illustrate the equilibrium in this industry
using import demand and export supply curves.
Analogous to our above discussion, Foreign’s import
demand curve facing Home is flat if Home is a small
country and downward sloping if Home is a large
country.
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International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – basic framework (cont.)
Case
1:
Home
is
small
Home
Price
World
Price
S
D
Home
export
supply
X
B
PW
Foreign
import
demand
PA
A
D 1
54
X1
S1
Quantity
X1
Exports
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – basic framework (cont.)
Case
2:
Home
is
large
Home
Price
World
Price
S
D
Home
export
supply
X
B
PW
Foreign
import
demand
PA
A
D 1
55
X1
S1
Quantity
X1
Exports
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – basic framework (cont.)
Suppose now that Home’s government imposes a
specific export subsidy.
Notice that the subsidy again drives a wedge between
the price in Home and the price in Foreign.
For example, if the subsidy is $1,000 per unit, P*S = PS 1,000. In general, PS = PS* + s.
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International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – overview
The effects of an export subsidy again differ between
the small country and the large country case.
However, the differences matter less for the overall
result.
In particular, the optimal export subsidy is zero in both
cases.
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International Commercial Policy
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Optimal export subsidy – small country case
Home
price
rises
by
the
amount
of
the
subsidy
Home
Price
World
Price
Foreign
consumers
still
pay
PW
S
D
Home
supply
increases
and
Home
demand
decreases

exports
increase
to
X2
C
PS=PW+s
s
X
X–s
B
PS*=PW
PW
C'
s
A
D 2
D 1
58
X1
X2
S1
S2
Quantity
X1
X2
Exports
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – small country case
(cont.)
Home
Price
PW+s
s
S
D
b
a
World
Price
Total
deadweight
loss,
b+d
d
X–s
C
B
c
PW
X
C'
s
A
D 2
D 1
59
X2
S1
S2
Quantity
X1
X2
Exports
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – small country case
(cont.)
The optimal export subsidy of a small country is
therefore zero:
Fall
in
consumer
surplus
Rise
in
producer
surplus
Fall
in
government
revenue
Net
effect
on
Home
welfare
-
(a+b)
+(a+b+c)
-
(b+c+d)
-
(b+d)
The area (b+d) is again a deadweight loss arising
because of consumption and production distortions.
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International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – large country case
Home
price
now
rises
by
less
than
the
amount
of
the
subsidy
Home
Price
World
Price
D
X2
PS*+s
s
Foreign
consumers
are
absorbing
part
of
the
subsidy
Home
exports
supply,
X
S
s
X1
X–s
PW
PS*
Foreign
import
demand,
M*
D 2
D 1
61
S1
S2
Quantity
X1
X2
Exports
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – large country case (cont.)
Fall
in
consumer
surplus Rise
in
producer
surplus Fall
in
government
revenue
Net
effect
on
Home
welfare
Home
Price
D
PS*+s
s
b
d
S
c
a
PW
e
PS*
D 2
D 1
62
S1
S2
Quantity
-
(a+b)
+(a+b+c)
-
(b+c+d+e)
-
(b+d+e)
International Commercial Policy
Unilateral Trade Policy
Optimal export subsidy – large country case (cont.)
The optimal export subsidy of a large country is
therefore also zero. The welfare costs are even larger
than for a small country because of an additional termsof-trade loss.
As is easy to verify, Foreign gains from Home’s export
subsidy in this case. This is because Home’s terms-oftrade loss is Foreign’s terms-of-trade gain.
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International Commercial Policy
Unilateral Trade Policy
Application – Europe’s CAP
The E.U.’s Common Agricultural Policy (CAP) provides
financial support to European farmers at a massive
scale through a variety of policy instruments.
CAP expenditures were 49.8€ billion in 2006,
accounting for 48 percent (!) of the E.U.’s entire budget.
The CAP began as an effort to guarantee high prices to
European farmers by having the E.U. buy agricultural
products whenever the prices fell below specified
support levels.
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International Commercial Policy
Unilateral Trade Policy
Application – Europe’s CAP (cont.)
To prevent this policy from drawing in large quantities of
imports, it was initially backed by tariffs that offset the
difference between European and world agricultural
prices.
The result was that the E.U. found itself obliged to store
huge quantities of food. At the end of 1985, European
nations had stored 780,000 tons of beef, 1.2 million tons
of butter, and 12 million tons of wheat.
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International Commercial Policy
Unilateral Trade Policy
Application – Europe’s CAP (cont.)
To avoid unlimited growth in these stockpiles, the E.U.
turned to a policy of subsidizing exports to dispose of
surplus production.
In view of our analysis of export subsidies above, who
gained and lost from these export subsidies, assuming
(realistically) that the E.U. is a large country?
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International Commercial Policy
Unilateral Trade Policy
Application – Europe’s CAP (cont.)
European farmers gained, European consumers lost,
and European governments had to incur the subsidy
costs. On balance, Europe lost from these export
subsidies.
Farmers in the rest of the world lost and consumers in
the rest of the world gained. On balance, the rest of the
world gained from these export subsidies.
The negative effect on farmers in developing countries
was often criticized.
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International Commercial Policy
Unilateral Trade Policy
Application – Europe’s CAP (cont.)
Starting in 1992, the CAP has been reformed
substantially. It is now much less based on price
support and much more on direct payments to farmers,
which are often independent of the amount of
production.
Nevertheless, agricultural protectionism is still a highly
controversial issue in multilateral trade negotiations. In
fact, the Doha Round of trade negotiations is currently
suspended mainly because of disagreement over such
protectionism, as we will discuss in more detail next
week.
68
International Commercial Policy
Unilateral Trade Policy
Export subsidies in practice
The above analysis suggests only one motive for
governments to impose export subsidies: raising
producer surplus as discussed in the case of import
tariffs.
While this is likely to be a critical driving force of
government’s trade policy decisions, other motives for
export subsidies can arise in imperfectly competitive
environments. This is also the case for import tariffs.
Some of these other motives are discussed in the two
Krugman articles on the reading list.
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