Global Trade:6
Global Trade: Lessons
Lessons
Topics
Lesson 1
The World Economy and Global Trade:
An Overview and Stylized Facts on Global Trade
Lesson 2
Lesson 3
Lesson 4
Lesson 5
Lesson 6
Theories of International Trade-I:
The Ricardian Model:
Labor Productivity and Comparative Advantage:
Theories of International Trade-II:
The Heckscher-Ohlin Model:
Factor Endowments and Comparative Advantage
Theories of International Trade-III:
The Standard Trade Model and Gains from Trade
Combination of Labor Productivity and Factor Endowments
Policy Instruments of International Trade:
Tariffs, Export Subsidies, Import Quotas, Export Restraints
Policy Issues of International Trade:
1) Free Trade vs. Protectionism
2) Liberalization in Developing Countries
3) The Role of the World Trade Organization
Texts
Main Text: Required:
1. International Economics: Theory & Policy, Krugman, P.R., and Obstfeld, M.,
8th Edition, Pearson-Addison-Wesley.
Recommended:
1.
International Economics, Husted, S., and Melvin, M., 8th Edition, AddisonWesley.
2.
International Economics, Gerber, J., 5th Edition, Addison-Wesley.
3.
World Trade and Payments: An Introduction, Caves, R.E., Frankel, J.A., and
Jones, R.W., 10th Edition, Pearson-Addison-Wesley.
4.
The World Economy: International Trade, Yarbrough, B.V., and Yarbrough,
R.M., 7th Edition, Thomson-South-Western.
5.
Principles of Microeconomics, Only Chapter 3: Interdependence and the
Gains from Trade, Mankiw, N.G., 5th Ed., South-Western Cengage Learning.
Lesson 6



Lesson 6: Trade Policy Issues
Procedure: The PowerPoint Presentation
Duration: 60 minutes
Overview
 This lesson discusses different policy issues of
international trade: free trade vs. protectionism,
trade liberalization in the developing world, the
effects of international negations, and the role of
the World Trade Organization in globalization.
Lesson 6 (cont.)
Outline
 List of Class needs: the text, a computer, and a
notebook.
 Pre-class reading and preparation: Chapter 9 and 10 of
the text.
 Activities and timing: Go over the entire presentation
in 60 minutes and think about the main findings of the
lesson. Read any latest online discussion on global
trade. See the links as mentioned above for the latest
data and discussion.
 Identification of Learning Objectives: Objective #6
from Section I
Lesson 6 (cont.)

Identification of the Global Workforce Skills for the
lesson: Skill points 1, 2, and 4 in Section II

Lesson notes and suggestions for Instructors: Read
the relevant chapters in the recommended texts
and look for online data for the latest figures of
global trade.
Acknowledgment: The Course Developer took help of different sources
as referred while preparing the study materials. When a considerable
number of diagrams have been developed to enhance interest in the
subject, many diagrams come from the required text for the
convenience of the students.
Policy Issues of global trade

Global trade cannot be judged only on the basis of
theories and analyses. Government policies reflect
objectives that go beyond simple measures of cost
and benefit. Hence, we observe a number of
debates on the policies of global trade. The
following are the main topics:

Free trade vs. protectionism

Liberalization in the developing world

The role of the World Trade Organization (WTO)
Free trade
 Free trade means there will be no
restrictions on either exports or
imports in the form of
 Tariffs
 Subsidies
 Quotas
 Restrictions
Cases for free trade

The first case for free trade is the argument that
producers and consumers allocate resources most
efficiently when governments do not distort
market prices through trade policy.

National welfare of a small country is highest with
free trade. With restricted trade, consumers pay
higher prices.

With restricted trade, distorted prices cause
overproduction either by existing firms producing
more or by more firms entering the industry.
Cases for free trade (cont.)
The efficiency
argument for
free trade
suggests that
a trade
restriction,
such as a
tariff, leads to
production and
consumption
distortions.
Cases for free trade (cont.)

When quotas are used instead of tariffs, costs
can be magnified through rent seeking.

To seek quota licenses or the rights to sell a
restricted number of imports and the profit that
they will earn, individuals or institutions need
to spend time and other resources.

Thus, another reason why trade allocates
resources efficiently is that it avoids the loss of
resources through rent seeking.
Cases for free trade (cont.)

A second argument for free trade is that it
allows firms or industry to take advantage of
economies of scale.

A third argument for free trade is that it
provides competition and opportunities for
innovation.

These are dynamic benefits, unlike the static
benefits of eliminating the efficiency losses
caused by distorted prices and overproduction.
Cases for free trade (cont.)

A fourth argument, called the political
argument for free trade, says that free trade is
the best feasible political policy, even though
there may be better policies in principle.

Any policy that deviates from free trade would
be quickly manipulated by political groups,
leading to decreased national welfare.
Cases against free trade

For a “large” country, a tariff or quota lowers
the price of imports in world markets and
generates a terms of trade gain.

This benefit may exceed the losses caused by
distortions in production and consumption.

In fact, a small tariff will lead to an increase in
national welfare for a large country.

But at some tariff rate, the national welfare will
begin to decrease as the economic efficiency
loss exceeds the terms of trade gain.
Cases against free trade (cont.)
The Optimum Tariff

For a large country, there is an optimum tariff to at which
the marginal gain from improved terms of trade just
equals the marginal efficiency loss form production and
consumption distortions.
Cases against free trade (cont.)

A tariff rate that completely prohibits imports
leaves a country worse off, but tariff rate t0 may
exist that maximizes national welfare: an
optimum tariff.

An export tax (a negative export subsidy) that
completely prohibits exports leaves a country
worse off, but an export tax rate may exist that
maximizes national welfare through the terms
of trade.
Cases against free trade (cont.)

An export subsidy lowers the terms of trade for
a large country; an export tax raises the terms
of trade for a large country.

An export tax may raise the price of exports in
the world market, increasing the terms of trade.

A second argument against free trade is that
domestic market failures may exist that cause
free trade to be a suboptimal policy.
Cases against free trade (cont.)

Types of market failures include:

Persistently high under-employment of workers
◦ surpluses that are not eliminated in the market for
labor because wages do not adjust

Persistently high under-utilization of structures,
equipment and other forms of capital
◦ surpluses that are not eliminated in the market for
capital because prices do not adjust
Cases against free trade (cont.)

Types of market failures include (cont.):

Technological benefits for society discovered
through private production, but from which private
firms can not fully profit
Environmental costs for society caused by private
production, but for which private firms do not fully
pay. Property rights that are not well defined or well
enforced
 Sellers that are not well informed about the
(opportunity) cost of production or buyers that are
not well informed about value from consumption

Cases against free trade (cont.)
Economists calculate the marginal social
benefit to represent the additional benefit to
society from private production.
 With a market failure, marginal social benefit is
not accurately measured by the producer
surplus of private firms, so that economic
efficiency loss calculations are misleading.
 It is possible that when a tariff increases
domestic production, the benefit to domestic
society will increase due to a market failure.

Cases against free trade (cont.)
The Domestic Market
Failure Argument for
a Tariff suggests that
if production of a
good yields extra
social benefits
(measured in panel
(b) by area (c) not
captured as producer
surplus), a tariff can
increase welfare.
Cases against free trade (cont.)

The domestic market failure argument against
free trade is an example of a more general
argument called the theory of the second best.

This theory states that government intervention
which distorts market incentives in one market
may increase national welfare by offsetting the
consequences of market failures elsewhere.
Decision

Now it’s your turn to decide between free
trade and protectionism
Trade liberalization in developing
economies

There is some evidence that low and middle
income countries which had relatively free trade
had higher average economic growth than those
that followed import substituting
industrialization.

But this claim is a matter of debate.

Regardless, by the mid-1980s many governments
had lost faith in import substituting
industrialization and began to liberalize trade.
Trade liberalization (cont.)

Effective Rates of Protection for Manufacturing in
India and Brazil

Effective rates of protection for manufacturing in India
have decreased by 68 percent between the late 1980s and
1990s. They dropped by 75 percent in Brazil over the
same period of time.
Trade liberalization (cont.)
The Growth of Developing-Country Trade

Trade liberalization after 1985 led to a surge in both imports
and exports as a percentage of GDP in the developing world.
Trade liberalization (cont.)

As with import substituting industrialization,
economic development was the ultimate goal of
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 import
substituting industrialization,
Trade liberalization (cont.)

But unstable macroeconomic policies and
financial crises contributed to slower growth since
the 1980s.

Other countries like India have grown rapidly since
liberalizing trade in the 1980s, 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 Hechscher-Ohlin model predicts.
Trade liberalization (cont.)

Instead of import substituting industrialization,
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 are
countries that have experienced rapid growth in
various export sectors and rapid economic growth
in general.

These economies or a subset of them are
sometimes called “high performance Asian
economies.”
International negotiations of trade
policy

The average U.S. tariff rate on dutiable imports
has decreased substantially from 1920–1993.

Since 1944, much of the reduction in tariffs and
other trade restrictions came about through
international negotiations.

The General Agreement of Tariffs and Trade
(GATT) was begun in 1947 as a provisional
international agreement and was replaced by a
more formal international institution called the
World Trade Organization (WTO) in 1995.

http://www.wto.org/
Further discussion
on the WTO follows
International negotiations of trade
policy (cont.)
The U.S. Tariff Rate: An Example

After rising sharply at the beginning of the 1930s, the
average tariff rate of the U.S. has steadily declined.
International negotiations of trade
policy (cont.)

Multilateral negotiations mobilize exporters to
support free trade if they believe export
markets will expand.

This support would be lacking in a unilateral
push for free trade.

This support counteracts the support for
restricted trade by import-competing groups.

Multilateral negotiations also help avoid a trade
war between countries.
World Trade Organization

The WTO negotiations addresses trade
restrictions in at least 3 ways:
1.
Reduction of tariff rates through multilateral
negotiations.
2.
Binding: a tariff is “bound” by having the
imposing country agree not to raise it in the
future.
3.
Prevention of non-tariff barriers: quotas and
export subsidies are changed to tariffs because
the costs of tariff protection are more apparent.
World Trade Organization (cont.)

The World Trade Organization was founded in
1995 on a number of agreements:
◦ General Agreement on Tariffs and Trade:
covers trade in goods
◦ General Agreement on Tariffs and Services:
covers trade in services (ex., insurance,
consulting, legal services, banking).
◦ Agreement on Trade-Related Aspects of
Intellectual Property: covers international
property rights (ex., patents and copyrights).
World Trade Organization (cont.)

The World Trade Organization was founded in
1995 on a number of agreements (cont.):
◦ 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 cases are settled fairly quickly: even with
appeals the procedure is not supposed to last
more than 15 months.
World Trade Organization (cont.)

The World Trade Organization was founded in
1995 on a number of agreements (cont.):
◦ The panel uses previous agreements by
member countries to decide which ones are
breaking their agreements.
◦ A country that refuses to adhere to the
panel’s decision may be punished by allowing
other countries to impose trade restrictions
on its exports.
World Trade Organization (cont.)

The GATT/WTO multilateral negotiations,
ratified in 1994 (called the Uruguay Round),
◦ agreed that all quantitative restrictions (ex.,
quotas) on trade in textiles and clothing as
previously specified in the Multi-Fiber
Agreement were to be eliminated by 2005.

But as the restrictions were eliminated, China
had to re-impose quotas until 2011 due to
political pressure.
World Trade Organization (cont.)

In 2001, a new round of negotiations was
started in Doha, Qatar, but these negotiations
have failed to produce an agreement.

Most of the remaining forms of protection are
in agriculture, textiles and clothing—industries
that are politically active.
Summary points

Trade policy issues

Arguments favoring and opposing free
trade

Trade liberalization in the developing
world

Effects of international trade negotiations

World Trade Organization
Activity/Essay
1.
After examining the arguments for and
against free trade, it’s your turn to
decide. Write an essay on free trade
justifying your opinion.
Activity/Essay

Do you think whether developing countries
should liberalize. Explain your opinion.

Comment critically on the role of the World
Trade Organization (WTO).

Suggest what should the WTO do to improve
the trade balance of developing/developed
countries?