AAMP Training Materials
Module 4.4: Winners & Losers from
Regional Trade
Nicholas Minot (IFPRI)
n.minot@cgiar.org
Objectives
• Understand welfare impact of trade
– Identify types of gains from trade
– Learn how to measure welfare impact of trade
– Address myths about trade
• Examine effects of trade restrictions
– Who gains & who loses from trade restrictions
– Highlight politics of trade restrictions
• Explore policies to compensate for losses
Module Contents
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•
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Objectives
Types of gains from trade
Myths about trade
Measuring welfare impact of trade
Exercises
Conclusions
What are gains from trade?
• Gains from trade refer to the benefits gained by a group
of people from exchanging goods and services with
other groups of people
• Usually we think of gains from trade from countries
trading with each other, but there are also gains from
districts, villages, or even households trading with each
other
• The term “gains from trade” does not mean that
everyone in the group gains…
– It means that benefits > losses
Why are there gains from trade?
Four types of gains from trade:
1. Comparative advantage
2. Competition
3. Economies of scale
4. Dynamic gains from trade
1. Comparative Advantage
• Definition: Each country can produce some goods at
relatively lower cost than other goods
• A country will export goods it can produce at relatively
lower cost and import goods that cost relatively more to
produce
1. Comparative advantage (cont.)
Example
• Bolivia is a high-cost producer
• Argentina has an absolute advantage in everything
• What can Bolivia export?
Argentina
Bolivia
Cost in days of Labor
Potatoes
10
10
Beef
15
30
Soap
12
18
Beer
22
66
Shirts
18
45
Radios
25
75
1. Comparative advantage (cont.)
Example (continued)
• Argentina will export beer and radios (goods for which it
has the largest cost advantage)
• Bolivia will export potatoes and soap (goods which it
produces least inefficiently)
Argentina
Bolivia
Ratio
Cost in days of Labor
Potatoes
10
10
1.0
Beef
15
30
2.0
Soap
12
18
1.5
Beer
22
66
3.0
Shirts
18
45
2.5
Radios
25
75
3.0
2. Increased competition
• Without trade, some companies dominate their industry, so
they can act as monopolists and charge higher prices
• With trade, companies have to compete with imports and offer
prices close to costs
• Usually does not apply to crop production because many
small farmers keep prices competitive
• May apply to agricultural inputs (seeds, fertilizer, chemicals,
etc) and agricultural machinery
• Often applies to manufacturing, particularly in countries with a
small market
3. Economies of scale
• Many goods have “economies of scale” in production
– Definition: Economies of scale : the per-unit cost declines as the
volume of production increases
– Common among manufactured goods (e.g. cars)
– But less common among agricultural commodities
• If the domestic market is small and there is no trade, the
costs of production will be high
• In this case, trade allows a larger market, higher
production, and lower costs
3. Economies of scale - example
Without trade,
Paraguay produces
P1 radios,
Bolivia produces
B1 radios. Costs
are high.
With trade,
Paraguay produces
P2 radios for both
countries at lower
cost. Bolivia stops
producing radios,
importing instead
B2
B1 P1
P2
Cost
per
unit
Radios
Cost of producing radios
declines (red arrow)
3. Economies of scale - example
At the same time,
P2
Bolivia increases
Cost
production of
per
another good (say
unit
soap) while
Paraguay stops
producing soap and
imports.
The cost of soap
also goes down (red
arrow).
P1 B1
B2
Radios
Note that this is not the same as
comparative advantage because both
countries have the same cost of production.
4. Dynamic gains from trade
• Static gains mean that trade gives a one-time increase in
income (GDP)
• Dynamic gains means that trade increases the rate of
growth in income (GDP)
• Why does trade create dynamic gains?
– Competition spurs innovation and investment
– Trade introduces new technology and inputs
– Open trade policy increases investment, particularly foreign
investment
• Open trade policy is a signal of a good investment climate
• Allows foreign companies to invest while catering to home
consumers
4. Dynamic gains from trade - examples
• North Korea vs South Korea
– North Korea has followed extreme self-sufficiency policy but
economic growth is stagnant
– South Korea has followed more open trade policy and has been
one of the Asian Tigers, with rapid growth
• Studies of determinants of economic growth show:
– Landlocked countries have less trade and slower growth than
countries with coast
– Countries with open trade policies have higher growth rates on
average
Three common trade myths
1. “When two countries trade, one country wins and the
other loses.”
2. “Some countries are so inefficient, they don’t have a
comparative advantage in anything”
3. “The country should promote exports and reduce
imports”
Myth #1: “When two countries trade, one
country wins and the other loses”
• Trade is not a zero-sum game
• Both countries generally benefit from trade, though the
benefits may not be equal, and there are winners and
losers in each country
• Example: If Uganda exports maize to Kenya, both
countries gain overall, but:
– Some Ugandan maize producers and Kenyan maize consumers
gain
– Some Ugandan maize consumers and some Kenyan maize
producers lose
Myth #2: “Some countries are so
inefficient, they don’t have a comparative
advantage in anything”
• Some countries may not have an absolute advantage in
anything
– Like Bolivia the example earlier
• Every country has a comparative advantage in
something
– Although it may be difficult to predict ahead of time
Myth #3: “The country should promote
exports and reduce imports”
• Mercantilist philosophy (1500s): Maximize exports and
minimize imports
– This is a flawed philosophy
• The only reason to export is to be able to pay for
imports, either now or later
• Exports help the economy via job creation
• Imports help the economy by lowering cost and
increasing variety of inputs for producers and goods for
consumers
Measuring the static gains from trade
• Three scenarios
1. Exports vs. Autarky
2. Imports vs. Autarky
3. Removing import barriers
Autarky (definition): Self-sufficiency, or a situation in which
there is not international trade
Gains from trade: Exports vs. Autarky
Trade vs. Autarky in Exports
Price
Supply
World
Price
Autarky
Price
Demand
Quantity
• Export price is higher than
autarky price
• Producer benefit from the
higher price = blue +
green
• Consumer loss from
higher price = blue
• Net gain = green
Gains from trade: Imports vs. Autarky
Trade vs. Autarky for Imports
• Import price is lower than
autarky price
• Consumer benefit from
lower price = blue + green
• Producer loss from lower
price = blue
• Net gain = green
Price
Supply
Autarky
Price
Import
Price
Demand
Quantity
Gains from trade: Removing Import Barriers
Static gains from reducing
import barriers
• Domestic price with tariff
is higher than price
without tariff
• Removing import barrier
reduces price
• Consumer benefit from
lower price = blue + green
• Producer loss from lower
price = blue
• Net gain = green
Price
Supply
Price w/
tariff
Price w/o
Tariff
Demand
Quantity
Measuring static gains from trade
Information needed to
calculate static benefits of
eliminating an import tariff
(green area)
Price
Mt
Pt
• Current level of imports
with tariff (Mt)
• Current price with tariff
(Pt)
• What price would be
with no tariff (Pn)
• What imports would be
with no tariff (Mn)
Pn
Mn
Quantity
• Net benefit = green area =
0.5 x (Mt + Mn) x (Pt – Pn)
Example: Measuring Static Gains from Trade
Wheat import tariffs in Kenya
Price
293
360
960
1138
$430
$270
845 thousand tons
Quantity
Net benefit = Area = 0.5 x (Mt + Mn) x (Pt – Pn)
= 0.5 x (600 + 845) x (430 – 270)
= 725 thousand tons x $160/ton = $116 Million
How big are gains from trade?
• Static gains from trade
– Most studies of trade liberalization show gains of 1 – 6% of GDP,
depending on how restrictive trade policy was before
liberalization.
• Dynamic gains from trade
– Harder to measure, but generally much larger
– Wacziarg and Welch (2008)
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Econometric study of dozens of countries from 1950 – 1998
Trade liberalization increased trade/GDP ratio 5 – 10 pct points
Trade liberalization increases GDP growth rate 1.5 to 2 pct points
Over 10 years, this represents a GDP that is 22% higher
Why do governments impose trade restrictions?
• Political influence of producers
– Producers are usually larger, better informed and better
organized than consumers
• Infant industry argument
– Problem of infants who never grow up
• Concern about impact on poverty
– If producers are poorer than consumers
• Dependence on tariff revenue
• Cost of transition
Why do governments impose trade restrictions?
In most cases, political influence of producers:
Ameliorating negative effects of trade
• Who is hurt by removing trade barriers
– Removing export restrictions raises domestic price, benefiting
producers but hurting consumers
– Removing import restrictions lowers domestic price,
benefiting consumers but hurting producers
• Compensation - Some governments try to
compensate or assist those hurt by removing trade
barriers
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Tax relief
Retraining
Assistance to regions hard-hit by trade reform
Safety-net programs (for poor in general)
Exercises – How to use
• Open Excel Workbook “Module 4.4 gains_from_trade”
• Yellow areas can be changed by user
• Green areas give results and should not be changed by
user
• Graph shows results
– Solid lines are “before” change
– Dashed lines are “after” change
• Two worksheets
– First represents an imported good
– Second represents an exported good
Exercise 1 – Higher world prices & imports
• Open worksheet “Ex1 – Import gains”
• Simulate 10% increase in import price by inserting
“10” in yellow cell next to “Pct increase in import
price” (D16)
• What happens to production? Consumption? Imports?
• Why does the higher price cause these three effects?
• What is the impact on consumer welfare?
• What is the impact on producer welfare?
• What is the net impact on producers and consumers?
• Return import price to original value (10  0)
Exercise 2 – Import tariffs
• Simulate a 10% import tariff by inserting “10” in
yellow cell next to “New import tariff” (D19)
• What happens to production? Consumption? Imports?
• What is the net impact on producers and consumers?
• What is the tariff revenue generated by the tariff?
• How is this result different than a 10% increase in import
price?
• Return tariff to original value (10  0)
Exercise 3 - Self-sufficiency via tariffs
• Increase the tariff rate (D19) in intervals until you
reach self-sufficiency (no imports)
• How high does the tariff have to be in order to achieve
self-sufficiency?
• After reaching self-sufficiency, what is the net effect on
producers and consumers?
• After reaching self-sufficiency, what is the tariff revenue?
Why?
• Write down the tariff revenue for tariff rates of 10%, 15%,
20%, 30%, and 40%.
• Why does the tariff revenue rise and then fall as tariff
rate increases?
Exercise 4 – Self-sufficiency via productivity
• Increase productivity (D18) in intervals until you
reach self-sufficiency (no imports)
• How high much does productivity have to increase to
achieve self-sufficiency?
• What is the effect of productivity growth on prices?
• Why is this?
• [Note that in this spreadsheet, the welfare impact
measures do not work for changes in productivity]
Exercise 5 – Export taxes
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Open worksheet “Ex2 – Export Gains”
Increase the new export tax (D19) at 5% intervals
What export tax yields the highest tax revenue?
What is the effect of that tax on producers, consumers
and net effect?
• What export tax would result in stopping exports
completely?
Exercise 6 – Productivity and exports
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Increase productivity (D18) by 35%
What is the effect on domestic prices?
Why?
What is the effect on consumption?
Why?
What is the effect on exports?
Conclusions
• Every country can benefit from trade through
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–
–
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Comparative advantage
Increased competition
Economies of scale
Dynamic gains from trade
• Trade creates a net benefit over autarky
– Consumers win if imports reduce the price of goods
– Producers win if exports increase the price of their produce
Conclusions
• However, not everyone gains from trade
– Producers of import-competing goods lose from trade
– Consumers of exportable goods lose from trade
• Gains and losses can be estimated
– Requires information on production, consumption, trade, prices,
and price elasticities
• Potential negative effects of trade can be moderated by
– Training programs for displaced workers
– Safety net programs that help poor households
– Regional development programs that assist regions adversely
affected.