International Agreements: Trade, Labor, and the Environment

INTERNATIONAL

AGREEMENTS: TRADE,

LABOR, AND THE

ENVIRONMENT

11

1

International Trade

Agreements

2

International

Agreements on

Labor Issues

3

International

Agreements on the

Environment

4

Conclusions

Introduction

• 1999 WTO trade negotiations in Seattle, WA were the first to be heavily protested, with protests sometimes turning violent.

• Past trade negotiations had focused on lowering tariffs in most sectors of members’ economies.

• Remaining barriers to trade, however, dealt with regulatory barriers, such as environmental regulations.

• The Uruguay Round (1986 –1994) allowed for countries to bring disputes if they felt they were excluded from a market due to unreasonable environmental standards.

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 2 of 124

Introduction

• These new rules infuriated many groups who thought the WTO might threaten their environmental interests.

• Additionally, many felt it undesirable for a panel in

Geneva to make rulings affecting domestic regulations.

• All these groups gathered in Seattle to voice their dissatisfaction with the WTO.

• The goal of this chapter is to examine why international agreements are needed, and how these agreements affect labor and environmental issues.


International Trade Agreements

• Countries will often enter into a trade agreement to reduce trade barriers between themselves.

• The WTO is a multilateral trade agreement, involving many countries, all with the goal of reducing tariffs between member countries.

 WTO has negotiated many trade agreements.

 Under the most favored nation principle , the lower tariffs agreed to in these negotiations must be extended equally to all WTO members.

 New members get these benefits, but must also agree to lower their own tariffs.

• To demonstrate a multilateral trade agreement, we will assume there are only two countries.



• The Logic of Multilateral Trade Agreements

 Tariffs for a large Country

 Figure 11.1 shows the effects of a tariff on a large country

(Home).

 We found before that a tariff leads to a deadweight loss for

Home: (b+d).

 We also saw a terms-of-trade gain for Home, e , which equals the reduction in Foreign price due to the tariff times the Home imports with the tariff.

 If Home applied the optimal tariff, then the terms-of-trade gain exceeds DWL, and Home gains overall.

 For Foreign, a DWL, f , exists from inefficient production levels.

 The Home gain comes at the expense of an equal terms-oftrade loss for Foreign, e , plus the DWL, f.



Figure 11.1



• The Logic of Multilateral Trade Agreements

 We stated before that it is optimal for large countries to impose small tariffs, but that did not consider strategic interactions between multiple large countries.

 If every country imposes a small optimal tariff, is it still optimal behavior for these countries?

 Figure 11.2 shows the payoff matrix between Home and Foreign, both large countries deciding to impose a tariff.

 Assume the two countries are the same size so payoffs are symmetrical.



Figure 11.2



• Prisoner’s Dilemma

 The pattern of payoffs we just saw has a special structure called the “prisoner’s dilemma”.

 This is similar to our situation where each country acting on its own has an incentive to apply the tariff, but doing so makes both worse off.

 Nash Equilibrium

 The only Nash equilibrium in figure 11.2 is the lower right quadrant —both countries apply a tariff.

 To move from that point unilaterally would increase a country’s loss, (e+f) > (b+d+f), so the Nash equilibrium for both countries is to apply the tariff.

 Free trade agreements can help move us away from this equilibrium.



• Regional Trade Agreements

 In this case countries eliminate tariffs among themselves, but keep tariffs against other countries.

 Article XIV of the GATT states regional trade agreements are acceptable as long as the group does not jointly increase tariffs against outside countries.

 Sometimes they are called preferential trade agreements.

 Member countries are favored over other countries.

 This violates the MFN principle, but RTA’s are permitted because they are a positive move toward free trade with a larger group of countries.




 Free trade area

 A group of countries agreeing to eliminate tariffs (and other barriers to trade) between themselves, but keeping whatever tariffs they formerly had with the rest of the world.

 In 1989, Canada entered into a free trade agreement with the

U.S. known as the Canada-U.S. Free Trade Agreement

(CUSFTA).

 In 1994, Mexico was included to create the North American

Free Trade Agreement (NAFTA).

 Each of these countries have their own tariffs with all other countries of the world, but have worked to eliminate trade barriers with each other.




 Customs Union

 Similar to a free trade area, except that in addition to eliminating tariffs among countries in the union, the countries within a customs union also agree to a common schedule of tariffs with each country outside the union.

 Examples are the European Union (EU) and the signatory countries of Mercosur South America.

 All countries in the EU have identical tariffs with respect to each outside country, as does Mercosur.




 Rules of Origin

 If China is looking to export a good to Canada, it will want to do so at the lowest cost.

 If Canada has high tariffs on that good, but Mexico has low tariffs, why not export to Mexico and then trade it freely to

Canada?

 Free trade areas have complex rules of origin.

• content requirements

 The good from China to Mexico would not get duty-free access to Canada in this example.

 So what are the economic effects of regional trade agreements, in either case?



• Trade Creation and Trade Diversion

 When trade agreements are made, the increased trade can be of two types.

1.

Trade creation occurs when a member country imports a product from another member country that it made for itself before.

 Gain in consumer surplus for importing country due to lower prices.

 Gain in producer surplus for exporting country due to increased sales.

 Same as opening trade effect in Ricardian or HO models.

 No other country is affected because the good was not traded at all before —welfare gains for both countries.



• Trade Creation and Trade Diversion

2.

Trade diversion occurs when one member country imports a product from another member country that it was previously importing from an outside country.

 Trade is taken away from one country and moved to another country.

 This is not always the most efficient move since the former country might have been producing at lower costs, but due to changes in tariffs, it ends up cheaper to import from the member country.



• Numerical Example of Trade Creation and

Diversion

 Let’s consider an example from NAFTA where an auto part is now imported by the U.S. from Mexico instead of from China.

 We can keep track of the gains and losses for the countries involved.

 Asia loses export sales, loss in producer surplus.

 Mexico gains producer surplus from increased sales.

 Since Mexico is not the most efficient producer, there is potential social loss due to the trade diversion.

 We can see the potential cost amount in Table 11.1.



Table 11.1 Cost of Importing an Automobile Part



• Trade Creation

 Assume there is a 20% tariff.

 After NAFTA, the U.S. will import from Mexico for $20, since it costs more to import from Asia ($22.80) or to make it themselves

($22).

 The U.S. clearly gains from the lower cost of the part, Mexico gains through exports to the U.S., and Asia is unaffected since it was not exporting at that tariff level anyway.

• Trade Diversion

 Now suppose the tariff was 10% instead.

 Before NAFTA, the U.S. imported the part from Asia for $20.90.

 After NAFTA, it will import from Mexico at a price of $20.

 What about the U.S.? Although they gain $0.90 on each part, they lose $1.90 in tariff revenue from each import from Asia.



• Trade Diversion in a Graph

 Figure 11.3 shows the free-trade price of the part from

Asia, with the free-trade export supply curve for Asia.

 We assume the U.S. is a small country relative to the potential supply from Asia.

 Before NAFTA, both Mexico and Asia face the same tariff.

 Start with equilibrium at point A.

 Of total imports, Q

2 comes from Mexico at B, since under perfect competition these imports have the same tariff-inclusive price as those from Asia.

 With NAFTA, imports from Mexico rise to Q

3

.



Figure 11.3

Net Loss

Price

P asia

+t

P asia a

B b

The price faced by the

P asia

U.S.

with the tariff, before NAFTA, is imports from Mexico are now Q higher so price stays at S +t

3 will be from Mexico at B asia mex at C. MC for Mexico are

S mex

+t

•The U.S. loses tariff revenue of

(a+b+c)

•Mexico gains producer surplus of

(a+b)

S mex revenue of (a+b+c+d)

C A

S asia

+t c d

S asia

M

US

Import Quantity Q

2

Q

3

Q

1



• Interpretation of the Loss

 The combined loss c can be interpreted as the average difference between Mexico’s MC and Asia’s MC times the extra imports from Mexico.

 This is similar to the “production loss” or “efficiency loss” we saw with a tariff for a small country.

 What we have to remember is that even though we moved to free trade between Mexico and the U.S., the tariff with China remained.

 It is really only a partial step toward free trade, which can clearly be bad for countries involved.



• Not all trade diversion creates a loss.

 The previous loss is only a possible outcome, depending on Mexico’s MC’s.

 There could be a gain to the importing country.

 In figure 11.3, suppose that after joining NAFTA,

Mexico has significant investment into the auto parts industry, and its supply curve shifts to S’ mex

.

 Equilibrium is then at D at a price of P asia and Mexico will fully replace Asia as a supplier of parts.

 Clearly Mexico’s producer surplus still gains as well.



Figure 11.3

Net Gain

Price

If Mexico has significant investment in auto parts after

NAFTA, supply could shift to S’ mex imports to point D.

increasing equilibrium

U.S. still loses tariff revenue of (a+b+c+d).

S mex

+t

But gains consumer surplus of

(a+b+c+d+e) for a net U.S. gain of e.

S mex

S' mex

P asia

+t

B C A e

S asia

+t a b c d

P asia

S asia

D

M

US

Import Quantity Q

2

Q

3

Q

1



• Trade Diversion in a Graph

 It is very possible for any particular case to have elements of trade diversion and trade creation.

 NAFTA and other regional trade agreements have the potential to create net gains for members.

 However, this is only true if the amount of trade creation exceeds the amount of trade diversion.

 Now we can use this information to see the effect on

Canada and the U.S. of opening free trade.


Trade Creation and Diversion for Canada

APPLICATION

• Professor Daniel Trefler has analyzed the effects of

CAFTA and NAFTA on Canadian manufacturing industries.

 Estimates the amount of trade creation and diversion for Canada in its trade with the U.S.

• He finds the reduction in Canadian tariffs on U.S. goods increased imports of those goods by 54%.

 Trade Creation

• Purchasing those goods from the U.S. decreased their imports from other countries by 40%.

 Trade Diversion


Trade Creation and Diversion for Canada

APPLICATION

• 54% of the trade creation is multiplied by the 80% of

Canadian imports that come from the U.S.

• 40% of lost imports from the rest of the world is multiplied by the 20% that typically comes from the rest of the world.

• Taking the difference between trade created and diverted, we get:

80% x 54% - 20% x 40% = 35% > 0

Share of

US imports

Increase in US imports

Share of other imports

Decrease in other imports

Since this number is positive, trade creation is greater than trade diversion. Canada gained.


International Agreements on Labor Issues

• Regional issues often involve issues other than tariffs.

 The environment and labor are the two biggest.

• Labor standards refer to all issues that directly affect workers, including occupational health and safely, child labor, minimum wages, etc.



• Labor standards were included in NAFTA to satisfy two different groups.

 Consumers and policy makers worried about

“exploitation.”

 Unions in the developed countries are also concerned with these issues partly due to solidarity with foreign workers and partly due to increased competition for

“home” workers.

 Are these concerns really veiled protectionism?

 Need to be careful that enforcing labor standards in other countries does not create a worse condition for those workers.



• Labor Side Agreement under NAFTA

 NAFTA does not change the labor laws in countries, but is meant to improve enforcement.

 If one country believes another is not enforcing their own laws, the country can be brought before the North

American Agreement on Labor Cooperation (NAACL).

 Many cases have dealt with the maquiladora plants in

Mexico, but charges have been brought against the

U.S. as well.

 Migrant workers picking apples in Washington state.

 1998 case with resolution in 2000.



• Consumer Responsibility

 How much do consumers value the idea that clothing purchased is made under good working conditions?

 National Bureau of Economic Research (NBER) surveyed consumers on this question (see Table 11.2).

 Sample A asked if they cared “about the condition of the workers who make the clothing they buy.”

 Sample B was asked about the premium they would be willing to pay for workers in “good” conditions, and the discount needed to buy the Tshirt made under “bad” conditions.



Table 11.2 Survey Responses



• Consumer Responsibility

 One observation is that consumers have a downward-sloping demand curve for labor standards.

 Will pay a small amount to assume good standards.

 A second observation is that individuals need a higher discount to buy the shirt made under “bad” conditions than the premium they would pay for the one made under “good” conditions.

 Consumers are more worried about potential losses than potential gains.

• Corporate Responsibility

 Pressure from consumers and unions has forced many corporations to report on the working conditions of their overseas plants and those of sub-contractors.

 Nike publicized the names of their sub-contractors overseas.

 We see that other corporations are following suit.


Nike Reveals Overseas Supply Chain

HEADLINES

• Nike chose to disclose the names and locations of about

700 factories that produce their shoe and apparel goods.

• Nike’s audited 569 factories during 2004 and 2005 with some of the following results:

 Physical or verbal abuses in about ¼ of South Asian factories.

 25-50% of factories restrict access to water and/or bathroom facilities during the workday.

 More than half of South Asian and 25% of other factories have 60 or more hour workdays.

 In about 1 out of 10 factories, penalties existed for refusing to work overtime.


Nike Reveals Overseas Supply Chain

HEADLINES

• With all the demands from consumers and activist groups, companies are realizing the importance of their responsibility in their production processes.

• Many companies are hoping that revealing more of their production conditions will results in gains.

• According to a survey by London-based

AccountAbility, 72 of the world’s 100 highest grossing companies produced annual corporate responsibility reports in 2004.



• Country Responsibility

 Should national governments monitor and enforce labor regulations in foreign countries?

 Many U.S. trade laws allow the President to withhold trading privileges from countries that do not give basic rights to their workers.

 In only about half the cases in which this has been done, has it been considered effective at improving rights.

 Very blunt instrument; punish good firms along with the bad.

 Is it fair to impose our standards on much poorer countries?

 Studies show NGOs are more effective at raising wages than U.S. policies have been, and at much lower costs to the foreign country.



• Country Responsibility

 U.S. doubled a minimum wage in Indonesia at a cost of

10% increase in unemployment.

 An NGO increase in minimum wage from antisweatshop activism led to more closed plants, but with losses more than offset by employment gains at remaining firms.

 Governments can force increased wages on foreign workers, but it is a very blunt tool.

 NGOs are better at targeting particular plants, and not the country as a whole.


International Agreements on the Environment

• Environmental Issues in the GATT and WTO

 GATT has Article XX known as the “green provision.”

 This allows countries to adopt their own laws in relation to environmental issues, provided the laws are applied uniformly to domestic and foreign producers.

 Laws cannot discriminate against imports.

 If these provisions allow countries to apply their own environmental regulations, why were people protesting so heavily?

 Table 11.3 details some of the specific GATT and WTO cases.



• Tuna-Dolphin Case

 In 1991, Mexico brought a GATT case against the U.S.

 The U.S. had banned tuna imports from Mexico because Mexican fishermen did not use dolphin-safe nets as were required by U.S. fishermen.

 The U.S. reasoned the rule should be the same for both Mexican and U.S. fishermen.

 GATT concluded that the U.S. could not ban tuna imports for this reason because the U.S. had applied the import restriction to the production process method and not the product itself.

 The idea that the production process could not be a basis for trade restriction was a principle of the GATT that was upheld here.



• Tuna-Dolphin Case

 The GATT panel also wanted countries to know that

GATT rules were not set up so that trade could be used for one country to impose its own rules on another country —even to protect the environment.

 Although environmentalists were upset, the response by consumers did lead to the dolphins being protected, as the U.S. and Mexico worked out a system of labeling tuna as “dolphin safe.”

 Major companies then only sold this “dolphin friendly” tuna, so despite the initial ruling, the dolphins were protected.



• Asbestos from Canada

 In 1998, France blocked the imports of asbestos from Canada based on known health hazards.

 Canada appealed to the WTO, but lost the case in a 2001 ruling.

 The WTO ruled that Article XX(b) allowed for some exceptions to the equal treatment rule.

 Canada was prohibited from exporting products containing asbestos even though French firms were themselves using asbestos-based products.

 This ruling was considered a victory for environmentalists.



• Biotech food in Europe

 A final ongoing case concerns whether genetically modified food can be imported into Europe.

 In 2003, the U.S. appealed to the WTO that the EU was keeping out genetically modified food and crops.

 The EU claimed that there was no “moratorium” on these imports even though none had been approved since 1998.

 Europe said that it needed more time to study the effects of genetically modified products and was keeping them out for precautionary reasons until more information was collected.



• Biotech food in Europe

 In 2006, the WTO ruled that Europe’s actions violated the principle that restrictions must be based on

“scientific risk assessments.”

 They cannot keep out imports due to precautionary reasons only, but had to have evidence to back up the import restriction.

 Europe decided to use consumer labeling to let buyers decide whether to purchase genetically modified foods or not.



• Summary of GATT/ WTO Cases

 The outcomes of these cases have lead some observers to conclude that although some of the cases have been “lost” at the WTO, environmentalists have gained ground in making sure that environmental concerns are respected.

 This does not mean we can now drop environmental issues.

 The lobbying activity of environmental groups has been important in shifting public opinion and WTO rulings in support of the environment.



• Does Trade Help or Harm the Environment?

 After looking at some specific cases, can we now answer a more general question about whether trade helps or harms the environment?

 We have clearly seen examples on both sides.

 So what are some possible outcomes?

 We can look at some other examples.



• U.S. Sugar Quota

 As discussed, the U.S. maintains an import quota on sugar, leading to higher prices for U.S. buyers.

 One demand for imported sugar cane comes from firms producing ethanol.

 The import price for sugar cane is very high so farmers purchase American corn, which is federally subsidized.

 Therefore, more corn than sugar is used to produce ethanol due to the corn subsidies and the sugar quota.



• U.S. Sugar Quota

 Why do we care if more corn than sugar is used for ethanol production?

 Producing ethanol from corn is much less efficient than producing it from sugar cane.

 Additionally, corn depletes the soil and requires significant fertilizers to grow.

 If we could purchase sugar cane at the world prices, it would be much more efficient to use it to produce ethanol than to use corn.

 The U.S. quota, therefore, has an indirect and negative impact on the environment.




 U.S. Automobile VER

 The sugar quota is not the only case where U.S. trade restrictions have lead to environmental harm.

 The VER on Japanese cars in 1991 limited the number of cars

Japan could export to the U.S., but did not limit the value of the cars exported.

 This gave Japan an incentive to export larger and/or more luxurious models to gain greater profits.

 These luxurious models had larger engines and decreased fuel economy.

 Figure 11.4 shows the impact of the VER on gas mileage.



Figure 11.4




 U.S. Automobile VER

 The data show that the luxury models with the lowest gas mileage had the greatest increase in sales between the years of the VER.

 Prices on these did not rise as much as they did on the economy models, so sales went up.

 As consumers shifted toward the nicer, lower gas mileage cars, carbon dioxide emissions increased.

 A free trade policy would have kept Japan importing the smaller more fuel efficient cars during the 1980s.

 This would have been better for the environment.



• The Tragedy of the Commons

 Trade in fish

 Because of overharvesting, many species of fish are no longer commercially viable.

 According to one study, 29% of fish and seafood species have collapsed.

• The catch declined more than 90% between 1950 and 2003.

 This occurs when you have many individuals competing for the same fish stock, but there is no real ownership and/or enforcement of the stock.

 This is the tragedy of the commons —the fish are treated as common property that anyone can harvest.

 International trade can make the problem worse as global demand is directed toward resources of a particular country or region, so even more overharvesting takes place.




 The solution to the tragedy of the commons

 The cause of the tragedy is not the international trade, but the fact that the resource is treated as common property.

 Assigning property rights to the resource, which allows the owner to limit the use of the resource, is one way to alleviate the tragedy.

 But with a truly global resource, this is not enough.

 International agreements are typically needed to prevent overharvesting of the resource.

 One country acting on its own does not have enough control of the harvest.

 International agreements are arranged through the Convention on International Trade in Endangered Species (CITES).




 Trade in Buffalo

 There is a historic case from the U.S. with the slaughter of the

Great Plains buffalo, in a ten year period from 1870 –1880, to the point of near extinction.

 There have been many arguments put forth for why this occurred, but new research offers another reason that seems to dominate.

 An invention in London in 1871 allowed buffalo hides to be tanned for industrial use.

 This created a huge demand for buffalo hides in Europe increasing the price significantly in the U.S.

 Most of the hides from the U.S. were exported to Europe.




 Trade in Buffalo

 Figure 11.5 shows estimates of the imports of untanned hides to the UK and France from the U.S.

 It looks at the extra demand in the UK and France after the invention was made.

 Imports into these countries grew rapidly after 1871, peaking in

1875.

 In that year, the UK and France combined imported more than 1 million hides, and from 1871 –1878, imported about 5 million.

 This can plausibly explain the slaughter of the Great Plains buffalo.



Figure 11.5



• International Agreements on Pollution

 Pollution is a by-product of many manufacturing activities.

 The tragedy of the commons applies to pollution too, as countries can consider the air or water as a common resource when emitting pollutants.

 Pollution can be an international issue.

 Global pollutants are substances that cross boundaries and affect many different countries.

 Examples: CFCs —chlorofluorocarbons which deplete the ozone layer —and CO

2

—carbon dioxide which contributes to global warming.



• Global Pollutants

 A prisoner’s dilemma similar to figure 11.2 for tariffs can apply here as well.

 Since the pollution crosses countries, each country does not face the full cost of its own pollution.

 There is little incentive for one country to limit their pollution emissions.

 International agreements are needed.

• Payoff Matrix

 Figure 11.6 shows the payoff matrix for two countries deciding on whether to regulate emissions or not.

 Again, Home’s payoffs are in the lower-left corner and Foreign’s payoffs are in the upper-right corner.

 We start at regulation and measure the change in welfare when there are no regulations.



Figure 11.6





 We start in the upper-left quadrant, with both countries regulating.

 If either country deviates from this position, it will experience a gain for producers and a loss for consumers.

 If pollution is local, the country might realize that the costs outweigh the benefits.

 With global pollutants, however, the calculation changes.

 If the pollution crosses borders, then the gains from regulation may appear less than the costs to the producers.

 Neither country will want to regulate.





 Given that one country does not regulate, the other country will have a greater incentive not to regulate.

 If Home does not regulate in figure 11.6, then Foreign’s best decision will likely be to not regulate either.

 The payoffs in the matrix can lead us to a situation where neither country regulates its pollution.

 This is very similar to the prisoner’s dilemma we discussed before.

 Both countries end up with a bad outcome even though they are making the best decision individually.

 Multilateral agreements are needed to ensure that countries end up in the upper left quadrant with both regulating.


The Kyoto Protocol

APPLICATION

• In December 1997, representatives from many nations met in Kyoto, Japan, to discuss nonbinding targets for reducing greenhouse gas emissions.

• Carbon Dioxide (CO

2

) is emitted from fossil fuel combustion and becomes trapped in the atmosphere leading to increases in the earth’s temperature.

• Even small increases in the earth’s temperature can have drastic effects as weather patterns and ocean levels change, affecting many economic activities.



APPLICATION

• Building on the United Nation’s 1992 treaty on climate change, the Kyoto Protocol established specific targets for reduction in greenhouse gas emissions:

 Industrial countries should cut emissions collectively to

5.2% less than 1990 levels.

 Targets for individual countries range from 8% for the

EU, 7% for the U.S., and to 0% for Russia. Additional allowable increases exist for Australia and Iceland.

 Targets were also established, for example, so that

Russia could sell its credits if it ended up below its 1990 level.



APPLICATION

• Over 160 countries have ratified this agreement, however, the U.S. has yet to and is the only industrial country not to.

• The U.S. gives four reasons for this:

 Although evidence for global warning is strong, we do not know the effect of policy actions.

 As the largest emitter, meeting Kyoto targets would greatly affect the U.S. economy.

 Kyoto failed to include the developing countries, mainly

China and India.

 There are other ways to pursue reductions in greenhouse gas emissions.



APPLICATION

• The first point made by the U.S. has become less plausible over time.

 We have seen more evidence for global warming and its possible consequences.

• The second point is also true. The U.S. is the largest emitter of greenhouse gases and the reductions proposed in Kyoto will adversely affect the economy.

 Unlike many countries, the U.S. already had significant restrictions on plant emissions in 1990, making their baseline much lower to begin with.



APPLICATION

• The third point is probably the main point why the

U.S. has not joined.

 As we saw with the prisoner’s dilemma game, if one country does not regulate, it decreases the incentives for the other country.

 Any further discussions will have to include China and

India and other large developing countries.

• The fourth reason is also correct.There are other ways of reducing emissions.

 Many states and companies have taken it upon themselves to do things to reduce emissions, which can play a positive role.


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