Chapter 6
The Political Economy of
International Trade
with elements from Ch. 8 –
Regional Economic
Integration
6-2
Last sessions: Trade theory,
Political economy
• Political systems: differ radically from one country to the next
- The ease of doing business varies with the system
- You have to understand the rules where you are
• Level and nature of economic development also differs
radically from one place to the next
- Gross National Income (GNI) and Purchasing Power Parity GNI
measure the differences
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6-3
Review of basic trade theory
• Mercantilism called for protectionism
• Economists showed we could produce more through
free trade (no barriers)
- Comparative advantage theory shows trade improves
productivity even when one nation is more efficient in
everything
• Over time, competition can increase benefits further
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6-4
Objectives for this hour
• Understand how government policies impact trade
today
• Review methods of trade restriction and regulation
• Examine effects of pressure groups
• Understand how government action can hurt
- And how it can possibly help
• Understand the emergence of today’s
world trade system
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• WARNING: Many students assume that
because we discuss these many ways of
restricting trade, trade restrictions must be
good tools for countries to use.
• Most economists believe countries should not
restrict trade
- If you advocate trade restriction in an essay, be sure you have a
good reason why you believe in it.
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Instruments of Trade Policy:
Tariffs
• Tariffs are the oldest form of trade policy; they are
taxes on imports
• They fall into two categories
- Specific tariffs are levied as a fixed charge for each unit
- Ad valorem tariffs are levied as a proportion of the value
of the imported good
• Tariffs protect domestic producers
• Tariffs are good for government because they
generate revenue
• Tariffs are bad for consumers because they increase the
cost of goods
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Tariffs reduce efficiency
• A crucial effect of a tariff or any other trade restriction is
to reduce efficiency by encouraging consumers to buy
from producers who do not have comparative
advantage.
• Tariffs are usually not needed to support industries that
have comparative advantage because such industries can
sell at competitive prices under free trade and earn profits.
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Instruments of Trade Policy:
Subsidies
• Government payment to a domestic producer
-
Cash grants
Low-interest loans
Tax breaks
Government equity participation in the company
• Subsidy revenues are generated from taxes
• Generally, subsidies encourage over-production,
inefficiency and reduced trade
- Japanese subsidy on wheat
- U.S. subsidies on cotton, sugar
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Instruments of Trade Policy:
Quotas
• Import quota
- Restriction on the quantity of some good imported into
a country
• Clothing import quotas till 2004
• Cheese, cotton today
• “Voluntary” export restraint (VER)
- Quota on trade imposed by exporting country, typically
at the request of the importing country
• In 2005, China was asked to “voluntarily” limit clothing
exports
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Tariffs, subsidies, and quotas are
the most direct interventions
• In recent years, World Trade Organization rules have
made them less common
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Instruments of Trade Policy:
Local Content
• Requires some specific fraction of a good to be
produced domestically
- Percent of component parts
- Percent of the value of the good
• Initially used by developing countries to help shift
from assembly to production of goods.
• Developed countries such as US use in government
purchasing
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Instruments of Trade Policy:
Administrative Policies
• Bureaucratic rules designed to make it difficult for
imports to enter a country
- France – required all video recorders to enter through
one remote, understaffed location
• Japanese administrative rules
- Tulip bulbs – have to “inspect” by cutting the bulbs
- Federal Express – have to open many packages to
check for pornography
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Instruments of Trade Policy:
Antidumping Policies
• “Dumping” is defined as either
- Selling goods in a foreign market below production
costs
- Selling goods in a foreign market below “fair market
value”
• Result of
- Predatory behavior
- Unloading excess production
• Remedy: seek imposition of tariffs
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Political Reasons
for Intervention
• Protecting jobs and industries
- Common Agricultural Policy in Europe
• Tariffs, quotas, administrative policies keep farm prices
high, keep European farmers in business
• National security
- Defense industries - semiconductors
• Retaliation
- Punitive sanctions – US sought to punish Saddam Hussein
for plotting against neighbors
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Political Reasons
for Intervention
• Protecting consumers
- Genetically engineered seeds and crops
- Hormone treated beef
• Furthering foreign policy objectives
- Helms-Burton Act – Americans
can sue firms that use property
confiscated in Cuba
• Protecting human rights
- Restrictive trade rules toward China after Tiananmen
confrontation in 1989
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Economic Arguments - When
Intervention May Help
• Infant industry
-
Oldest argument - Alexander Hamilton, 1792
Protected under the WTO
Only good if it makes the industry efficient
Japanese automakers – were protected with ‘infant
industry’ tariffs for 20+ years, became world leaders
- Brazil automakers - 10th largest - wilted when
protection eliminated
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Economic Arguments - When
Intervention May Help
• Strategic trade policy (often based on ‘New Trade Theory,’ [Chapter 5])
- Government should use subsidies to protect promising
firms in newly emerging industries with substantial
scale economies
- Governments may benefit if they support domestic
firms to overcome barriers to entry created by
existing foreign firms
• Airbus in Europe
• Didn’t work for U.S. in flat panel displays
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Development of the
World Trading System
• Intellectual arguments for free trade
- Adam Smith and David Ricardo
• Free trade emerged gradually as government policy
in Britain, the leading nation in the 19th century
- Repeal of the Corn Laws (1846) allowed free trade
in food
- Leading European nations maintained free trade
through late 19th Century to WW I
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Development of the
World Trading System
• Great Depression
- US stock market collapse (1929)
• Partial recovery
- Congress adopted the Smoot-Hawley tariff (1930)
• Almost every industry had its “made to order tariff”
• Foreign response was to impose own barriers
• Everyone’s exports tumbled
- Depression continued almost till World War II
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Development of the
World Trading System
• No one wanted to repeat the mistakes of the 1930s
• General Agreement on Tariffs and Trade (GATT) multilateral agreement established in 1948 under US
leadership
- Big conference at Bretton Woods, NH, during WW II
- Objective was to liberalize trade by eliminating tariffs,
subsidies, and import quotas
- 19 original members grew to 120
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Development of the
World Trading System
• GATT used ‘rounds of talks’ to gradually reduce
trade barriers
- Mutual tariff reductions negotiated
- Dispute resolution only if complaints were received
• Uruguay Round GATT 1986-93
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Disturbing Trends in the
World Trading System
• Pressure for greater protectionism in 1980s due to
- Increase in the power of Japan and closed
Japanese markets
- US trade deficit
- GATT circumvented by many countries
• through use of “voluntary” export restraints
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The World Trade Organization
• The WTO was created (1995) during the Uruguay Round
of GATT to police and enforce GATT rules
• Most comprehensive trade agreement in history
• Formation of WTO had an impact on
- Agriculture subsidies (stumbling block: US/EU)
- Applying GATT rules to services and intellectual property
- Strengthening of monitoring and enforcement
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The WTO
• 156 members in 2012
• Represents at least 95% of world trade
• 9 of 10 disputes satisfactorily settled
• Under GATT and WTO
- Tariff reduction from average 40% to average 5%
- Trade volume of manufactured goods has increased
20-fold
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WTO at Work
• 196 disputes handled by GATT in its 50 year history
• 280 disputes brought to WTO between 1995 and 2003
• US is biggest WTO user
- Big wins: beef, bananas
- Big loss: Kodak vs. Fuji Film
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The WTO - Achievements
• Telecommunications (1997)
- 68 countries - 90% of world telecommunications revenues
- Pledged to open their market to fair competition
• Financial Services (1997)
- 95% of financial services market
- 102 countries open their markets to varying degrees
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WTO in Seattle (1999)
• “Millennium round” was aimed at further reduction of
trade barriers in agriculture and services
• WTO meeting disrupted by
-
Human rights groups
Trade unions
Environmentalists
Anti globalization groups
• No agreement was reached
- WTO still struggling for liberalization today
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China joined the World Trade
Organization in 2001
•It seems to have contributed to a
liberalization in China’s economy
- Many disputes between China, others, but China
mostly follows the rules in settling them
•9 of 10 WTO disputes satisfactorily settled
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- Russia joined Aug. 22, 2012
- This means it agreed to ‘liberalize’ a lot of its
economy
• Must effectively enforce contracts agreed by
foreigners
• Has to allow Hollywood movies, etc.
- Will it fulfill promises?
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Regional Integration
• While trade was growing freer globally, some regions
focused on reducing barriers within themselves
- “Regional economic integration” refers to agreements
in a geographic region to reduce, and ultimately
remove, tariff and non-tariff barriers for
• goods,
• services, and
• factors of production (people, investment capital)
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Why Regional Integration?
• Despite the trend toward freer trade, it is hard to get
the whole world to agree on changes
• Neighbors can often make more comprehensive
agreements
- Europe has open borders
• Rest of world hasn’t been able to develop that
- People change jobs, capital can move freely
around Europe, too
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Levels of Economic Integration
• In a Free Trade Area all barriers to the trade of goods
and services among member countries are removed
• A Customs Union eliminates trade barriers between
member countries and adopts a common external trade
policy
• A Common Market has no barriers to trade between
member countries, includes a common external trade
policy, and allows factors of production to move
freely between members
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Levels of Economic Integration
• An Economic Union involves the free flow of
products and factors of production between member
countries and the adoption of a common external trade
policy, but it also requires a common currency,
harmonization of members’ tax rates, and a common
monetary and fiscal policy
• A Political Union occurs when centralized political
institutions coordinates the economic, social, and
foreign policy of the member states
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Regional Economic Integration In Europe
Member States of the European Union in 2010
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The North American Free
Trade Agreement
• The North American Free Trade Agreement (NAFTA) was
ratified by the governments of the United States, Canada,
and Mexico in 1993; it became law January 1, 1994
• NAFTA includes
- reduced tariffs (99% of goods traded)
- removal of most barriers on cross border flow of services
- Removal of restrictions on FDI except in certain sectors
• Mexican railway and energy
• US airline and radio communications
• Canadian culture
• A customs union, not full economic union
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How Comparative Advantage works
Ghana has absolute advantage in both cocoa and
rice, but its comparative advantage is in cocoa.
Cocoa Korea has comparative advantage in rice .
20 tons
15
tons
5 tons
Let Korea specialize
in rice – Ghana expands
Ghana
cocoa production to replace
all Korean cocoa production
lost
Then Ghana can replace all Korean
cocoa production and the countries
have more of both goods.
Korea
10 tons
3.75
tons
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15
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Rice
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• Your country has comparative advantage in the
product or service where the ratio
Resources required in your country .
Resources required in the other country
is lowest
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Our goal: Everyone gets
a good grade for good work
• Plan for written assignments
- Be sure you understand the question
• Essays for the midterms will be distributed in advance
• If you don’t understand something …
-
ask in class
ask a friend
visit the instructor
call the instructor
- Be sure you’re answering the question asked
• No credit for saying interesting things that aren’t relevant to
what was asked
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Critical thinking
• Show you understand the concepts
- In this case –
• Free trade
• Comparative advantage
• Possibly ideas like infant industries, etc.
• Your argument (whether you agree with what’s in the text or
not) is based on and follows logically from facts and plausible
existing theories.
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Hypothetical Tariff
Rate Quota
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Evolution of the
European Union
• Product of two political factors:
- Devastation of WWI and WWII and desire for peace
- Desire for European nations to hold their own, politically
and economically, on the world stage
• 1951 - European Coal and Steel Community.
• 1957- Treaty of Rome establishes the European
Community
• 1994 - Treaty of Maastricht changes name to the
European Union
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