The Political Economy Of International Trade

The Political Economy of International Trade Chapter 6

© McGraw Hill Companies, Inc., 2000 2007 2008 2009

Real Outcomes in Trade • Have looked at representative sample of theories seeking to describe trade and trade patterns. • In many cases though outcomes are determined or strongly influenced by other factors. • Illustrate first through examples...

EU-US and Beef 1989 - EU bars growth hormone treated beef. US exports decline from $231mm in ‘88 to $98mm in ‘94. With other countries, US files complaint to WTO. US wins (1998) - WTO Panel declares ban to be illegal. EU reluctant to comply and appeals, but loses the appeal. 1999 - US threatens to raise tariffs on hundreds of EU products. 5-1 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

2005: The Beef Case Still... WTO hearing on EU's US beef ban begins 12.09.2005 - 09:54 CET | By Meghan Sapp EUOBSERVER / BRUSSELS - International trade relations are set to make history on Monday (12 September) as the World Trade Organisation (WTO) opens its trade dispute process to the public for the first time. The EU banned the import of hormone-raised beef during the mid-1980s but in 1996 the US applied for a dispute settlement panel through the WTO. Canada did the same a year later. The US and Canada won both their cases on the grounds that EU scientific data used for the hormone ban were not sufficient and the EU was forced to rescind the ban. Though the EU says it amended its directives in 2003 and notified the WTO it had complied with the ruling, the US and Canada disagreed. In 1999, the WTO ruled the US and Canada could fine the EU (according to a 1997 ruling) for not abiding by world trade rules. The US and Canada have since imposed trade restrictions on the EU as retaliation for the hormone ban. http://euobserver.com/?aid=19844&rk=1 Acc 12/9/5

2008: The Beef Case Still... WTO rejects EU beef hormone ban but also raps US, Canada Mar 31, 2008 GENEVA (AFP) — The World Trade Organisation on Monday ruled that the European Union, United States and Canada all failed to respect global trade rules in a long-running row over beef treated with growth hormones.... The case goes back nearly 10 years to 1998 when the WTO ruled Washington and Ottawa could slap higher tariffs on a list of EU products after it condemned Brussels for banning beef producing with certain growth-promoting hormones ... Noting that the panel also said it did not consider the new EU hormones directive to be in line with WTO sanitary measures, Brussels said in a statement that it "disagrees with these findings." Both sides have the option of appealing the ruling, the EU noted. http://afp.google.com/article/ALeqM5hEqmznwYN5qTPQWtGq27IEPJkwDw 041108

US Targets EU Beef Pork Sausages Corned Beef Roquefort Cheese Chocolate Products Mustards Chewing Gum

Soups and Broths Truffles Mineral Water Cut Flowers Yarn Electric Hair Clippers Motorcycles and Mopeds 5-2

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EU-US and Beef What can we draw from this? Many arguments big country/little country: this one unusual but increasing. Was EU motivated by protectionism? What should the role of government be? To whom is it primarily responsible? Nature of response, nature of confrontation.

2002/3: The converse 2002: EU develops “hit list” of US exports to EU as reprisal for US steel, farm protection measures List recognises essentially political nature of actions: targets exports from those states which have sought to gain from barriers (orange juice…) 2003: WTO sanctions reprisals by EU for US steel tariffs: US takes off tariffs, must satisfy EU and others.

Another example: Airbus – 2004 to... Airbus-Boeing Culture War The United States has launched a major economic dispute with Europe, taking the biggest trade complaint ever to the World Trade Organization (WTO) for litigation http://www.csmonitor.com/2004/1021/p08s01-comv.html

On 14 December 2007, the Chairman of the Panel informed the DSB (Dispute Settlement Body) that due to the substantive and procedural complexities involved in this dispute, it now expected to complete its work in 2008. http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds316_e.htm 150708 The dispute between the United States and European Union over subsidies for the European Airbus is so complicated that the World Trade Organisation (WTO) will not be able to rule on it until next year, a WTO document shows. Published: October 23, 2008 13:07h

http://www.javno.com/en/economy/clanak.php?id=195449 050209

Trade Policy and Politics Pressures for government intervention: Protecting jobs and industries: emerging industries.

Social/political concerns Increasing exports. National security. Retaliation. International product domination: New trade theory and subsidies. 5-3 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

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How would you rate the relative importance of these factors?

Instruments of Trade Policy Tariffs Subsidies Quotas and VER’s Local content requirements Anti-dumping actions Administrative policies/procedures Must understand difference in the nature of instruments – particularly whether price or quantity

5-4

Instruments of Trade Policy Tariffs

-> Taxes

Tariffs - oldest form of trade policy Specific ad valorem (in proportion to the value)

Good for government Good for producers - but reduces efficiency

Bad for consumers 5-4 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Hypothetical Tariff Rate Quota

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Tariffs and Welfare Loss The use of tariffs (taxes) to advantage local producers does not come without cost. Distributional issues arise whereby consumers have to fund the benefits given producers As well, the mechanism itself involves losses overall to the economy, analogous to the deadweight loss of any tax. Most easily seen and measured by using surplus as measure of welfare.

Autarchy – No trade Local supply The closed economy CS pe

Local production = Local consumption

PS Local demand qe

Importing at World Price World price becomes both a demand and supply curve.......why? S

pe pw Note: small country case

SW DL qe

q

Importing at World Price S

pe pw

SW DL

Imports

qe Local production

q Local consumption

An Importing Country The gains from trade

S

pe pw

SW DL qe

q

Impact of a Tariff Imports after

pe

S

Tariff

Tariff p

pw

SW DL

Imports before

qe

q

Impact of a Tariff – Welfare Loss Total consumer surplus (benefit) lost through tariff S

pe pw

SW DL Imports after tariff

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Impact of a Tariff – Welfare Loss Surplus gained by producers at the expense of consumers

S Tariff revenue to government

pe pw

SW DL Imports after tariff

Nett Loss of a Tariff Welfare loss = deadweight loss S

pe

Welfare loss overall SW+ T

pw

DL Imports after tariff

SW

Tariffs overall Tariffs therefore involve Redistribution • Consumer to producer • Consumer to government An absolute loss in economic efficiency terms plus…the intangibles which arise from the manner of allocation of tariff protection and the distortions induced by that process

Instruments of Trade Policy Subsidies Like tariffs, a price instrument. A payment to a domestic producer. cash grants (eg US biodiesel) low-interest loans tax breaks government equity participation in the company • eg Airbus

Subsidy payments generated from taxes. © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Subsidies Must watch definitions – part of critical reading. 7 6 5 4 3

Percent

2

Ireland

Sweden

W. Ger.

UK

Japan

US

0

IDC

1

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Subsidies to EC Manufacturers

Greece

Italy

Portugal

Ireland

Belgium

Spain

France

Holland

Luxembourg

16 14 12 10 8 6 4 2 0

Germany

%

GB

(Percent of Value Added)

5-7 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Instruments of Trade Policy Import Quotas and Voluntary Export Restraints Both quantity instruments Import Quota: Restriction on the quantity of some good imported into a country.

Voluntary Export Restraint (VER): Quota on trade imposed by exporting country, typically at the “request” of the importing country. Reagan 1981. Simply quotas under another name 5-8 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Results of Japanese VERs Benefits producers by limiting import competition Japan - limited to 1.85 million vehicles/year Cost to consumers - $1B/year between ‘81 - 85. Money went to Japanese producers in the form of higher prices. 5-9 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

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So who were the ‘winners’ from VERs? If the gains overall might be negative, why would governments do it?

Annual Cost to American Consumers for Import Protection $ Millions 30 Textiles

shifted

25 20 Consumer Losses Producer Gains

15 10 5

Automobiles Dairy Meat

Sugar

0

5-13 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

So why accept the costs? shifted Peanuts: (US, 1982 – 87) Quotas , import restrictions and price supports transferred $US255M per year from 1982 – 1987 from consumers to producers, with $US34M deadweight loss. Cost to consumers: $1.23 each Benefit to peanut growers: $11,100 each Small group/large group interaction.

Peanuts? (Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. 1995. Economics of Regulation and Anti-trust. 2nd ed. Cambridge: MIT Press. in Keohane, Revesz & Stavins The Positive Political Economy of Instrument Choice in Environmental Policy, Resources for the Future 97-25, 1997)

Instruments of Trade Policy Local Content Requirements

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 (US) beginning to implement. For component part manufacturer, LCR acts the same as an import quota. Benefits producers, not consumers. 5-10 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Instruments of Trade Policy Antidumping Policies Defined variously as: Selling goods in a foreign market below production costs. Selling goods in a foreign market below fair market value (but who defines that?). Result of: Unloading excess production. Predatory behavior. Remedy: seek imposition of tariffs.

But --- often used as a means of protection? © McGraw Hill Companies, Inc., 2000 2007 2008 2009

5-11

Instruments of Trade Policy Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country. Examples in imposing rules. Japan - Tulip bulbs. France – videos

Sometimes quarantine or environmental measures argued to be of this type. 5-12 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Political Arguments for Intervention Protecting jobs and industries. VERs.

National security. Defense industries - semiconductors.

Retaliation. Protecting consumers. Furthering foreign policy objectives. No justification other than can do it. Helms-Burton Act.

Protecting human rights. MFN. 5-14 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

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How would you rate the relative importance of these factors for countries other than the US?

National Security World Semiconductor Production 60 50 40 Japan USA

30 20 10 0 1974

76

78

80

82

84

86

88

5-15 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Retaliation US Trade Sanctions Partial List 25 20 15 New Sanctions

10

98

97

95

0

1993

5

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Afghanistan Italy Burma Libya Canada Nigeria China N. Korea Cuba Pakistan India Saudi Arabia Iran Sudan Iraq Syria Yugoslavia 5-16

Retaliation - Helms-Burton Act 1996. Allows American to sue foreign firms that use property in Cuba confiscated from them after the 1959 revolution. Backlash Violates a state’s sovereignty.

Also passed the D’Amato Act - Libya and Iran. 5-17 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Economic Arguments for Intervention Infant industry. Oldest argument - Alexander Hamilton, 1792. Protected under the WTO. Only good if it makes the industry efficient. • Brazil auto-makers - 10th largest - wilted when protection eliminated. Requires government financial assistance. • Could argue that if a good investment, global capital markets would invest. 5-18 © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Economic Arguments for Intervention Strategic trade policy. Government helps raise national income if firstmover advantage successful. Government intervention may help domestic firms overcome first-mover advantage of foreign firms.

The role of Porter’s ‘diamond’ in forming views? © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Revised Case for Free Trade Paul Krugman, MIT economist, argues that strategic trade policies can lead to trade wars. The best way to handle disputes is to work to establish rules that minimize trade-distorting subsidies - a function of the World Trade Organization. He also argues that government intervention usually favors special interest groups that distort the subsidy to their own ends. Therefore, “a blanket policy of free trade, with exceptions granted only under extreme pressure … may be the best policy that the country is likely to get.” http://www.wws.princeton.edu/~pkrugman/ http://www.pkarchive.org/ © McGraw Hill Companies, Inc., 2000 2007 2008 2009

Summary: Arguments for Intervention Political Protecting jobs and industries. National security. Retaliation. Protecting consumers. Furthering foreign policy objectives. Protecting human rights.

Economic Infant Industry Strategic Trade Policy

The implications for business - I Impact of trade barriers on firms’ strategy, and on achievable production cost: • Tariffs raise cost of exporting products to a country • VER’s may limit ability to service country from outside • Local content laws may mean location of more capacity in a country than is economic • Even when barriers do not currently exist firms may need to retain local capacity as precautionary measure

All tend to reduce flexibility, raise cost

The implications for business - II These issues may limit firms’ ability to disperse production in economically efficient fashion. Also policy implications for firms: Firms are major policy influence on government Some support for intervention as per new trade theory but Likelihood of retaliation means protection gained from government can backfire Firms must have considered policy approach recognising likely negatives of barriers

Things you should know about.. The various forms of barriers to trade, and the principle underlying their operation. Tariffs: Distributional issues and welfare losses. Who pays?

Political arguments for protection Economic arguments for protection Problems for governments –internal and external pressures Implications for business Cost, location, policy