Instruments of Trade Policy: Non-tariff Barriers and Applications

1. Learning Unit 14
Instruments of Trade Policy:
Non-tariff Barriers and Applications
ECON452
International Economics

2. Objectives
1. Describe how quotas affect trade
2. Explain how export subsidies and general subsidies affect trade
3. Relate the theory and evidence behind “political economy” views of
trade policy.
4. Explain how international negotiations and agreements have
promoted world trade.
5. Understand how transportation costs affect trade
6. Recognize effects of environmental regulations in the developed
countries on pattern of trade

3. Introduction
• In addition to tariff, the government may use various non-tariff barriers (NTBs) to
influence international trade.
• Like tariffs, NTBs will
– affect the relative supply and demand in the world market.
– affect the world relative prices.
– cause terms of trade effect to all the countries.
– affect national welfare.

4. Non-Tariff Barriers
• Non-Tariff Barriers (NTBs): Government instruments and regulations other than
tariff to affect flows of international trade.
• NTBs include
– (a) Import Quota, (b) Voluntary Export Restraint (VER), (c) Export Subsidies,
and (d) Export Credit Subsidies which directly affect imports of foreign goods
and services form other countries or export of domestic goods and services to
other countries
– (e) Local Content Requirement, (f) Government Procurement, (g) Bureaucratic
regulations, and (h) Subsidies which indirectly affect imports of foreign goods
and services by imposing disadvantages on foreign-made goods and services
over domestic goods and services
– Some non-tariff barriers are not intended to restrict imports, but indirectly
affect flow of trade through limiting access of market and
standard/requirement such health, safety, etc.

5. Export Subsidy
• Export subsidies: payments given to domestic producers that export.
• An export subsidy can also be specific or ad valorem:
– A specific subsidy is a payment per unit exported.
– An ad valorem subsidy is a payment as a proportion of the value exported.
• An export subsidy allows domestic producers to sell exporting goods in foreign
country less than the domestic price.
– It creates a price gap between the domestic price and the foreign price by the
amount of export subsidy (s).
• The government payment for the export subsidy reduces the total welfare of the
country.
– It must be paid by tax payers – either producers or consumers.

6. Demand and Supply of Exporting Country
• Under autarky, a country reaches its equilibrium
at EA and produces and consume QA units of
goods at Price PA.
• Under free trade, the country can sell or
purchase at the world price (PW) higher than
the domestic price (PA).
– The domestic price of exporting country will
increase from PA to PW.
– At PW, the producers will produce QS units and
consumers will purchase QD units of goods.
– The country will export QS - QD units.
Price, P
Quantity, Q
PW
PA
QAQD QS
EA
Exports

7. Welfare Effect of Free Trade on Exporting
Country
• Under free trade
– Consumer surplus
decreases.
– Producer surplus
increases.
– The country gains by an
area of triangle, BCEA.
Price, P
Quantity, Q
PW
PA
QAQD QS
EA
CS
PS
Price, P
Quantity, Q
PW
PA
QAQD QS
EA
CS
PS
B C

8. Effect of Export Subsidies – Small Country
Case
• The government gives amount of s of export
subsidies to domestic producers.
• The domestic price increases to PS, but the domestic
producers can sell to foreign country at PW.
PS – s = PW
• At PS, the domestic producers will produce QS
S, while
the domestic consumers will purchase QD
S, assuming
the government prohibits any imports from foreign
country at PW.
• The country will export QS
S – QD
S units.
Price, P
Quantity, Q
PW
QAQD QS
s (subsidy)
QS
S
PS
QD
S

9. Total Surplus of Export Subsidies – Small
Country Case
• Consumer surplus decreases.
• Producer surplus increases.
• The government payment of export subsidy
(SP) is an area of rectangle, FGHI.
SP = s x (QS
S – QD
S)
• Total surplus of the country is
TS = CS + PS – SP
• The export subsidy creases a deadweight loss
equal to a triangle area, GHJ.
DWL = (1/2) x (QS
S - QS) x s
Price, P
Quantity, Q
PW
QAQD QS
s (subsidy)
QS
S
PS
QD
S
F
I
G
H
PS
CS
J

10. Welfare Effect of Export Subsidy – Small
Country
• Domestic producers benefit from export subsidy because they can sell at higher
price (PS) than under free trade (PW) and their producer surplus increases.
• Domestic consumers hurt from export subsidy because they must pay a higher
price (PS) than under free trade (PW) and their consumer surplus decreases.
• The loss for consumers and the government subsidy payment outweigh the gains
for producers, the country as whole loses from export subsidy by the amount of
deadweight loss.

11. Effects of an Export Subsidy – Large Country
Case
• Export subsidy encourages more production. An
increase of production of goods by large country
will lower the world market price.
• An export subsidy raises prices in the exporting
country (PS) while lowering them in the importing
country (PS*).
PS – s = PS*
• The triangles b and d represent the efficiency loss.
• The area b + c + d + e + f + g represents the cost of
the subsidy paid by the government.
– The terms of trade decrease, because the
price of exports falls.

12. Welfare Effect of Export Subsidy – Large
Country
• Like small country case, the export subsidy raises the price in the exporting
country, decreasing its consumer surplus (consumers worse off) and increasing its
producer surplus (producers better off).
• In contrast to a tariff, an export subsidy worsens the terms of trade by lowering
the price of exports in world markets (from PW to PS*).
– Large country will have more damage from export subsidy that small country.
• An export subsidy always damages national welfare.

13. Export Subsidy in EU – Case of Agricultural
Policy
• The European Union’s Common Agricultural Policy sets high prices for
agricultural products and subsidizes exports to dispose of excess output.
– Subsidized exports reduce world prices of agricultural products.
• The cost of this policy for European taxpayers is almost $30 billion more than its
benefits (in 2007). Subsidy payments are about 22% of the value of farm output.
– The EU has proposed that farmers receive direct payments independent of
the amount of production to help lower EU prices and reduce production.

14. Import Quota
• Import quota: a restriction on the quantity of a good that may be imported.
• This restriction is usually enforced by issuing licenses or quota rights.
• A binding import quota will push up the price of the import because the quantity
demanded will exceed the quantity supplied by domestic producers and from
imports.
– Since a quota raises domestic price of imported goods, it will have same
distributional and welfare effect as tariff.
• When a quota instead of a tariff is used to restrict imports, the government
receives no revenue.
– Instead, the revenue from selling imports at high prices goes to quota license
holders.
– These extra revenues are called quota rents.

15. Effects of Import Quota
• Under free trade, a country trades
goods with foreign country at PW.
– Domestic consumers purchase QD units.
– Domestic producers produce QS units.
– The country imports QD – QS units.
• When the government sets an import
quota at q units.
– The country can import maximum of q
units from foreign country.
– The domestic price increases to PQ.
– Domestic consumers purchase QD
Q units.
– Domestic producers produce QS
Q units.
– The country imports QD
Q – QS
Q = q units.
Price, P
Quantity, Q
PW
PA
Quota
QS QDQS
Q QD
Q
PQ

16. Welfare Effects of Import Quota
• Consumer surplus decreases by the area of
a+b+c+d.
• Producer surplus increases by the area of a.
• The quota rent is created (an area of c) and
earned by foreign producers who sell to
domestic consumer at higher price.
• Total surplus of the country decreases by
the area of b+c+d.

17. Import Quota in the U.S. – Case of Sugar
• Imports of sugar into the United States limited
and quota rights passed out to foreign
governments.
• Price of sugar in the United States has remained
well above world prices.
• U.S. consumers are hurt by more than U.S.
producers benefit; foreigners earn quota rents.
• For 2014, the sugar quota is estimated to:
– cost consumers 3.5 billion ($11 per person or $30 for a
typical household),
– generate producer surplus losses for food producers
who use refined sugar as an ingredient) of $909 million
– benefit sugar producers $3.9 billion (mostly to
refiners)

18. Voluntary Export Restraint
• A voluntary export restraint works like an import quota, except that the quota is
imposed by the exporting country rather than the importing country.
• These restraints are usually requested by the importing country.
• The profits or rents from this policy are earned by foreign governments or foreign
producers.
– Foreigners sell a restricted quantity at an increased price.

19. Voluntary Export Restraint by Japan – Case
of Automobiles
• In 1979, sharp oil price increases caused the U.S. market to shift abruptly
toward smaller cars made in Japan.
– As the Japanese market share soared and U.S. output fell, strong political
forces in the United States demanded protection.
– Rather than act unilaterally and risk creating a trade war, the U.S. government
asked the Japanese government to limit its exports.
• The Japanese, fearing unilateral U.S. protectionist measures if they did not
do so, agreed to limit their sales. The first agreement, in 1981, limited
Japanese exports to the United States to 1.68 million automobiles.
– The price of Japanese cars in the United States rose, with the rent
captured by Japanese firms.
– The total costs to the United States are estimated to have been $3.2
billion in 1984.

20. Local Content Requirement
• A local content requirement is a regulation that requires a specified fraction of a
final good to be produced domestically.
• It may be specified in value terms, by requiring that some minimum share of the
value of a good represent home value added, or in physical units.
• From the viewpoint of domestic producers of inputs, a local content requirement
provides protection in the same way that an import quota would.
• Local content requirement provides neither government revenue (as a tariff
would) nor quota rents.
• Instead, the difference between the prices of home goods and imports is
averaged into the price of the final good and is passed on to consumers.

21. Local Content Requirement in the U.S. -
ARRA
• Any public work project funded by the American Recovery and Re-Investment Act
of 2009 (ARRA) must use U.S. iron, steel, and manufactured goods (unless foreign
bid more than 25% lower).
– The Bay Bridge linking San Francisco and Oakland did not use ARRA funding
because some key components would have been 23% ($400 million) more
expensive.
• Delays due to having to show that some items are unavailable from U.S. sources.
• Has triggered protectionist clauses that shut U.S. firms out of opportunities
abroad.

22. Other Trade Policies
• Export credit subsidies
– A subsidized loan to exporters
– U.S. Export-Import Bank subsidizes loans to U.S. exporters.
• Government procurement
– Government agencies are obligated to purchase from home suppliers, even
when they charge higher prices
(or have inferior quality) compared to foreign suppliers.
• Bureaucratic regulations (red tape)
– Safety, health, quality, or customs regulations can act as
a form of protection and trade restriction.

23. Summary: Effects of Alternative Trade Policies
• For each trade policy, the price rises in the country adopting the policy.
– Domestic producers supply more and gain.
– Domestic consumers demand less and lose.
– All these trade policies create production and consumption distortions.
Policy Tariff Export Subsidy Import Quota
Voluntary
Export Restraint
Producer
surplus
Increases Increases Increases Increases
Consumer
surplus
Falls Falls Falls Falls
Government
revenue
Increases Falls (government
spending rises)
No change (rents to
license holders)
No change (rents
to foreigners)
Overall
national
welfare
Ambiguous
(falls for small
country)
Falls Ambiguous (falls for
small country)
Falls

24. Case for Free Trade
• 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.
• Free trade allows firms or industry to take advantage of economies of scale.
– Protected markets limit gains from external economies of scale by inhibiting the
concentration of industries.
• Free trade provides competition and opportunities for innovation.
– By providing entrepreneurs with an incentive to seek new ways to export or compete
with imports, free trade offers more opportunities for learning and innovation.
• Free trade avoids the loss of resources through rent seeking.
• 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.

25. Case Against Free Trade
• For a “large” country, a tariff 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.
• Domestic market failures may exist that cause free trade to be a
suboptimal policy.
– Persistently high underemployment of workers
– Persistently high underutilization of structures, equipment, and other forms
of capital
– Property rights not well defined or well enforced

26. Transportation Costs
• Transportation and logistics costs: All the costs of transferring goods from one
nation to another including freight charges, warehousing costs, costs of loading
and unloading, insurance premium, and interest charges while goods are in
transit.
• When goods are shipped internationally, a buyer or a seller of goods must be
responsible for arrangement and payment of shipment. Two types of
arrangements are
– C.I.F. (Cost, Insurance, and Freight): A seller must pay the costs and freight
including insurance to ship the goods to the destination of buyer.
– F.O.B. (Free on Board): A seller loads the goods to ship that a buyer arranges,
and the buyer is responsible for liability of shipment including insurance.

27. Transportation Costs and Prices
• Without transportation costs, the domestic price is equal to the foreign price.
• With transportation costs, the price in the importing country is higher than the
price in the exporting country by the amount of transportation costs (t).
PH = PF + t
Where PH is a price of goods in the importing country (Home) and PF is a price of
goods in the exporting country (Foreign).
• Transportation cost acts like tariff (without tariff revenue) and affects an
economy of the importing country since it creases a price gap between the
importing country and the exporting country.

28. Transportation Costs – Small Country Case
• Since the world price is the price of the goods in other country, the importing
country’s price will be higher than the world price by the transportation cost
(regardless of who actually pays it).
• A small country cannot affect the world price.
• Home’s price must increase by t (an amount of transportation cost).
PH = PW + t

29. Transportation Costs – Diagram
• Without transportation cost, Home imports QD –
QS units at a price of PW.
• With transportation costs, Home will import QD
T –
QS
T units at a price of PW + t.
• Transportation costs reduce the imports.
• If the transportation cost is greater than PA-PW,
that is PW + t > PA, then there will be no trade.
QD
QS QS
T QD
T
PA

30. Non-traded Goods and Services
• Non-traded goods and services: Goods and services for which transportation
costs exceed price differences across nations.
– Examples: haircuts, auto repairs, and medical services
• Nontraded goods and services exist due to high transport costs.
– Countries tend to spend a large fraction of national income on nontraded
goods and services.
• The price of non-traded commodities is determined by domestic demand and
supply conditions, while the price of traded commodities is determined by world
demand and supply conditions.

31. Technological Progress and Non-traded Goods
• The great reduction in transport costs by technological progress converted many non-
traded into traded goods.
• Industrial revolution: Invention of steam engine and internal combustion engine allows
faster and cheaper shipment across ocean. Refrigerated cargo container allows to keep
food fresh over long period.
– Example: U.S. exports beef and pork to China. Columbia exports fresh flowers to the
U.S. by airplane.
• Internet revolution: Information can be sent instantaneously and free across countries.
– Example: Call center services located in India to assist customers in the U.S.
Software engineers in research lab in China develop software and ship to the U.S.
Radiologists in India read X-ray taken in the U.S. and feed back to doctors in the U.S.

32. Environmental Standard
• Environmental standards: the levels of air pollution, water pollution, thermal
pollution, and pollution resulting from garbage disposal that a country allows.
– The price of traded goods and services does not fully reflect social
environmental costs (externalities).
– The government regulation on the environmental standard internalizes some
of environmental costs.
 Example: Penalty on water pollution, Requirement for preventing water
pollution, Automobile emission standard
– Each country has different level of environmental standard.
 Polluting goods and industry have different costs and prices across
countries.

33. Environmental Standard and Prices
• With higher environmental standard, the cost of producing polluting goods in the
country with higher environmental standard is higher than the cost of producing
polluting goods in the country with lower environmental standard by the amount of cost
of complying higher environmental standard (e).
CostH = CostW + e
– When the government impose stricter environmental standard and demands
polluting firms to comply the standard with pollution-reduction devices or charges a
high penalty, then the cost of production increases.
– Alternatively, the government imposes a special tax on goods which causes pollution
and uses the tax revenue to compensate people who suffer from the pollution.
• Higher cost of production causes the price in the country with higher environmental
standard to become higher than the price in the country with lower environmental
standard.

34. Effects of Environmental Standard
• With equal environmental standard, Home’s cost of
production is same as other countries.
– The equilibrium price is same as the world price at PW.
– The country produces and consumes QW units.
– No trade at PW.
• With higher standard, the cost of production
increases by e (either pollution-reduction cost or a
special tax).
– The domestic supply curve shifts up by e.
– Without trade, the domestic price increases to PE.
– The production and consumption of polluting goods
decreases to QE.
Price, P
Quantity, Q
PW
PE
QWQE
D
S
SE
e
EW
EE

35. Effects of Environmental Standard on Trade
• Assume the case of small country, where the
country cannot affect the world price PW.
• With trade, the country can still purchase from
other country at PW.
• The consumers in Home continue to consume QW
units.
• The producers in Home produce QS units.
• The country imports QW – QS units from other
country.
• The production of polluting goods decreases in
Home and shifts to foreign country where the
environmental standard is low.
Price, P
Quantity, Q
PW
Import
QWQS
D
S
SE
e
E

36. Environmental Standard and Comparative
Advantage
• A nation with lower environmental standards can use the environment as a
resource endowment in attracting polluting firms from abroad and achieving a
comparative advantage in polluting goods and services.
• When the cost of production or price of good with tax is higher than the world
price, then the country may import the goods from other countries.
– Exporting polluting industry to the country with lower environmental
standard.
– Example: With lower environmental standard, China took many trash from
the U.S. for land-fill.

37. Government Regulations and Trade
• Beside the environmental standard, the government impose various
regulations on domestic producers and increases the cost of production.
– Occupational Safety standard
– Minimum wages
• These regulations have the same effects as the environmental standard
on the domestic economy, giving a comparative advantage to the
countries with lower standard.
– U.S. firms either moved to off-shoring production facilities or outsourced to
foreign companies, then import the products to the U.S. to avoid U.S. regulations.
– Example: Sweatshop in Indonesia where children are forced to work long hours
seven days a week. Child miners in hazardous mines.

38. Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University
Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University