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Brian Butler: TBird int'l economics class 06


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Series of lectures from Brian Butler, given during fall 2008 session at Thunderbird Global MBA, Miami campus:

This lecture 06: continue learning the basics of trade economics, by looking at the negative impacts of trade barriers (tariffs, subsidies, etc) from an economics point of view

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Brian Butler: TBird int'l economics class 06

  1. 1. <ul><li>Brian David Butler </li></ul><ul><li>Miami Campus Facilitator </li></ul><ul><li>International Economics & Trade (Prof. Grosse) </li></ul><ul><li>Email: [email_address] </li></ul><ul><li>home: 305-396-6116 </li></ul><ul><li>Connect: </li></ul><ul><li>Facebook </li></ul><ul><li>Linkedin </li></ul><ul><li>GloboTrends blog </li></ul>Session #5
  2. 2. Class outline <ul><li>Last week today </li></ul><ul><li>Trade theory trade barriers </li></ul><ul><li>Why trade? Economics of tariffs </li></ul><ul><li>Comparative advantage </li></ul>
  3. 3. Question… <ul><li>Why is protectionism bad? </li></ul><ul><li>What should a nations trade policy be? </li></ul><ul><li>Should the USA use a Import tariff or an import quota to protect its auto industry from Japan or south Korea? Who will benefit and who will loose from an import quota? Do the benefits outweigh the costs? </li></ul>
  4. 4. Making the case for “free trade”… <ul><li>Comparative Advantage </li></ul><ul><ul><li>Benefits of specialization + free trade </li></ul></ul><ul><ul><li>Increased efficiency </li></ul></ul><ul><ul><li>Minimized opportunity costs </li></ul></ul><ul><ul><li>Last class </li></ul></ul><ul><li>Troubles with protectionism </li></ul><ul><ul><li>Prove the benefits of free trade by looking at harm caused by protectionism… </li></ul></ul><ul><ul><li>This class </li></ul></ul>
  5. 5. Many “wrong” reasons <ul><li>Protect firms </li></ul><ul><li>Save jobs </li></ul><ul><li>Become independent </li></ul><ul><li>Encourage FDI </li></ul><ul><li>Reduce Balance of Payments issues </li></ul><ul><li>Promote export growth </li></ul><ul><li>Political motivation </li></ul>
  6. 6. Only “good” reasons <ul><li>Promote infant industries </li></ul><ul><li>Health & safety standards </li></ul><ul><li>Stop foreign dumping </li></ul><ul><li>Political motivation (?) </li></ul>
  7. 7. US trade policy fundamentals <ul><li>Countervailing duties </li></ul><ul><ul><li>offset foreign subsidies </li></ul></ul><ul><li>Antidumping </li></ul><ul><ul><li>tariff to offset foreign firm’s selling into U.S. market at prices below cost </li></ul></ul><ul><li>Trade Adjustment Assistance </li></ul><ul><ul><li>Retrain, compensate for job loss from imports </li></ul></ul>
  8. 8. What caused the “Great Depression”? <ul><li>Not the stock market crash of 1929 </li></ul><ul><li>But, trade protectionism of 1930’s </li></ul><ul><ul><li>“ beggar thy neighbor” </li></ul></ul><ul><ul><li>Smoot Hawley </li></ul></ul><ul><ul><li>Between 1929 – 1933, trade declined by 54% </li></ul></ul>
  9. 9. Trade barrier: Definitions <ul><li>Import tariff - taxes levied on imports…raises the price of imported goods </li></ul><ul><li>Export subsidy - payments given to domestic producers who sell abroad…incentive to export…effect is to raise prices at home </li></ul><ul><li>Quota : restriction on the quantity of goods that can be imported. This type of import control is usually accomplished by issuing a license to a company </li></ul>
  10. 10. Trade barrier: definitions <ul><li>Dumping : selling for less than the cost. very difficult to prove. Most anti-dumping cases only look at price in one country vs price in other....which is not right....instead you need to look at cost...but how to you know what the actual cost to produce is?  you anti-dumping is very subjective. </li></ul><ul><li>Terms of trade : relative prices of a country's exports to imports </li></ul>
  11. 11. Tariffs <ul><li>Tariff = tax on imports, like cost of transport </li></ul><ul><li>With tariff, shippers not willing to move wheat from foreign to home unless home price exceeds foreign price by at least $t </li></ul><ul><li>But, if no wheat is being shipped, then </li></ul><ul><li>Home: demand > supply and price will rise </li></ul><ul><li>Foreign: supply > demand and price will fall </li></ul><ul><li>Result? </li></ul><ul><li>Home demand will fall, </li></ul><ul><li>Quantity of imports will fall </li></ul>
  12. 12. Tariff <ul><li>Does foreign export price really fall? </li></ul><ul><li>Only if home (importer that imposes tariff) is very large, and can change world price. </li></ul><ul><ul><li>“ When a small country imposes a tariff, its share of the world market for the goods it imports is usually minor to begin with, so that’s its import reduction has very little effect on the world price” </li></ul></ul><ul><ul><li>See figure 8-4 “effects of tariff” </li></ul></ul>K&O, 8 th ed. p.180
  13. 13. Tariffs <ul><li>Who benefits / who is hurt by tariffs? </li></ul><ul><ul><li>Benefit: consumers in exporting country + government in importing country </li></ul></ul><ul><ul><li>Hurt: consumers in importing country </li></ul></ul><ul><li>How to quantify benefit / pain? </li></ul><ul><ul><li>Consumer / producer surplus </li></ul></ul>
  14. 14. Consumer Surplus: Difference between what consumers would have paid & what they actually paid for last unit. Producer Surplus: A producer willing to sell a good for $2 but receiving a price of $5 gains a producer surplus of $3
  15. 15. Tariffs <ul><li>Import tariff </li></ul><ul><ul><li>Raises price in importing country & decreases price in exporting country </li></ul></ul><ul><li>PRICES </li></ul><ul><li>Tariff raises domestic price </li></ul><ul><li>But, lowers foreign export price (if large country can influence world price) </li></ul><ul><li>QUANTITY </li></ul><ul><li>Domestic Production increases </li></ul><ul><li>Domestic consumption falls </li></ul>
  16. 16. = consumer loss (a+b+c+d) = producer gain (a) = government revenue gain (c+ e) 2 D 1 D Price, P Quantity, Q P T P W P* T 1 S 2 S S D <ul><li>PRICES </li></ul><ul><li>Tariff raises domestic price from Pw to Pt </li></ul><ul><li>But, lowers foreign export price from Pw to Pt* </li></ul><ul><li>QUANTITY </li></ul><ul><li>Domestic Production increases from S1 to S2 </li></ul><ul><li>Domestic consumption falls from D1 to D2 </li></ul>} Q R d c b a e Costs and Benefits of a Tariff for The Importing Country K&O, 8 th ed. p.190 The costs and benefits to different groups can be represented as sums of the five area a, b, c, d, and e. The box e only exists if the country is large and can influence world prices.
  17. 17. = efficiency loss (b + d) = terms of trade gain (e) Price, P Quantity, Q P T P W P* T S D The colored triangles represent efficiency losses, while the rectangle represents a terms of trade gain. Since the US is a large country, it may be able to force the foreign suppliers to lower their prices to P* T . } d b e Imports Net Welfare Effects of a Tariff K&O, 8 th ed. p.192
  18. 18. Loss from Tariff <ul><li>The loss from the triangles = efficiency loss that arises because a tariff distorts incentives to consume and produce </li></ul><ul><li>The rectangle represents the (potential) terms of trade gain that arise if big country can lower world export price with tariff </li></ul><ul><li>How BAD is a tariff? </li></ul><ul><ul><li>Compare triangles vs rectangle </li></ul></ul><ul><ul><li>But, if small country can not drive down price …then clearly tariff is very BAD (reduces welfare) </li></ul></ul>
  19. 19. Export Subsidies <ul><li>Export Subsidies </li></ul><ul><ul><li>Payment to a firm or individual that ships a good abroad. </li></ul></ul><ul><ul><li>When a gov’t offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy. </li></ul></ul><ul><ul><li>Effects? Exactly the REVERSE of the tariff </li></ul></ul><ul><ul><ul><li>Importing country: price rises </li></ul></ul></ul><ul><ul><ul><li>Exporting country : price falls </li></ul></ul></ul>
  20. 20. Export Subsidy – who benefits? Who hurts? <ul><li>Exporting country: </li></ul><ul><ul><li>Consumers are hurt, producers gain, and government loses because it spends $ on subsidy </li></ul></ul><ul><li>In contrast to </li></ul>
  21. 21. Export Subsidies <ul><li>“ Above the Supply / Demand” curve </li></ul><ul><ul><li>Main difference = no revenue for government </li></ul></ul><ul><ul><li>Cost (tax break or subsidized loans) </li></ul></ul><ul><ul><li>But, politically difficult to pass in USA </li></ul></ul><ul><ul><li>Example: Europe Common Agriculture Policy </li></ul></ul>
  22. 22. Import Quotas <ul><li>qutotas </li></ul><ul><ul><li>Basically same as tariff </li></ul></ul><ul><ul><li>But with NO government revenue </li></ul></ul><ul><ul><li>Instead…benefit goes to foreigners - rents </li></ul></ul>
  23. 23. * Only if importer is large country that can influence world price and terms of trade ** quota benefit goes to foreigners who benefit from quota rents… excess profits from holding import quota licenses Price impact for importers Price Impact for exporters Impact on local consumers Impact on local producers Impact on local gov’t Net Impact country as whole Tariff Increases price Decreases* Large loss Small gain Large gain Depends on terms of trade Export subsidy Decreases price Increases Small loss Large gain Massive cost Negative always Import quota Increases price Decreases Large loss Small gain None** Depends on terms of trade
  24. 24. Review example: <ul><li>Chemicals wine </li></ul><ul><li>France FF 500 FF 50 </li></ul><ul><li>Germany DM 180 DM 20 </li></ul><ul><li>Cost producing one bottle wine or one ton chemicals, assume quality is same </li></ul><ul><li>Which country has: </li></ul><ul><ul><li>Absolute advantage? </li></ul></ul><ul><ul><li>Comparative advantage? </li></ul></ul><ul><li>What exchange rate will result in 2-way trade? </li></ul>
  25. 25. <ul><li>chem wine </li></ul><ul><li>France FF 500 FF 50 </li></ul><ul><li>Germany DM 180 DM 20 </li></ul><ul><ul><ul><li>Comparative: =50/18 = 50/20 </li></ul></ul></ul><ul><ul><ul><li>= 2.78 = 2.5 </li></ul></ul></ul><ul><li>Absolute advantage? Germany in both </li></ul><ul><li>Comparative? France in wine </li></ul><ul><li>2-way trade between FF2.78 / DM </li></ul><ul><ul><li>and FF 2.5 / DM </li></ul></ul>