5. Political Economy of Trade Policy Flashcards
Free Trade….
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- leads to competition and specialization
- allows to take advantage of economies of scale
- which leads to lower prices and
- avoids any efficiency losses of protectionist policies
- also avoids the follow up costs typically associated with protectionist trade policies
Free Trade avoids follow up costs of protectionist policies such as…
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- administrative costs
- costs created by perverse incentives
What are some arguments in favor of free trade?
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- allows for consumption of goods and services (or greater variety thereof) than can only be produced abroad
- leads to more innovation (and thus better quality or totally new products and services) due to exchange of ideas/ knowledge
- strong economic ties with other countries may reduce the likelihood of political / military conflict
When could a country get a gain from a tariff?
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- a large country can potentially get a net gain from a tariff via its terms of trade effect (terms of trade gains can outweigh the efficiency losses)
- does not work if country too small
- does not work if tariff too large (efficiency losses too large)
- does not work if other countries retaliate (since they pay for the terms of trade gain)
What are arguments in favor of protectionism?
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- country wants to retaliate, to ensure other country does not increase tariffs even more
- country wants to redistribute welfare (if relocation of workers from import-competing sectors or compensating them for their losses using the gains of trade does not seem feasible)
- country wants to protect its strategic industries (eg pharma production)
- country wants to ensure technological sovereignity (eg AI)
- without it we could result in market failure due to externalities
Market failure due to externalities | Protectionsim | What might happen if there is a positive externality from a companies activity?
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- positive externality might be cleam domestic production to avoid CO2-emissions
- this implies that domestic production will be - without any regulation - below the optimal level (from the viewpoint of the domestic society)
- a tariff on “non-clean” products from abroad could then increase domestic clean production, correct the market failure and thus imncrease domestic welfare
Definition Political Economy + its key assumption
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What are two of such ideas of political economy?
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- economics using economic models to analyze the outcome of political processes
- key assumption: politicians maximize electoral success (instead of national welfare)
- median voter model: politicians pick the policy of the median voter
- collective action model: special interests are more influential in politics than general interests
Definition
- median voter model?
- collective action model?
- politicians pick the policy of the median voter; predicts trade policias that benefit large massess of voters, i.e. are the general interest
- special interests are more influential in politics than general interests
In opposition to the Median Voter Model….
…. special interests may be better organized in politics and thus be very influential as well
Policies such as large tariffs (hurt/benefit) the consumers ie the massess, (hurt/ benefit) the producers in the import competing sectors, but overall have a net (positive/ negative) welfare effect.
- hurt consumers
- benefit producers
- negative welfare effect
Whats the “Problem of collective action” and what does it imply + What is the consequence of this problem?
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- states that the distribution of gains/losses of a tariff across people is not even
- consumers have very large costs from the tariff, but there are so many of them that the loss of every individual is rather small (incentive to get politically organized here is low)
- producers (OR unemployed in the import competing sector) have large benefits from tariff and are NOT so many (incentive to get politicall organized is very high)
- problem may lead to special interests prevailing over general interests
What do todays models of political economy incorporate?
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- they rely on both median voter theory and collective action theory
- they incorporate both incentives to
1. more to the political center to win elections (leading to general interest policies) and
2. to cater to special interests to get campaign funding or support in key electoral districts or form special groups (leading to special interests policies) - mixed models are largely supported, i.e. both are present in most countries
Protectionism may be the individually optimal trade policy for…
but…
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… large countries
,,, a trade war may be the consequence (remember prisoners dilemma)
What is something that has allowed ourselves to overcome protectionism? In which way?
Whats the name of one basic idea behind that?
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- international cooperation
- e.g. prisoners dilemma: we can actually stick to free trade when we do binding/credible contracts
- e.g. multilateral negotiations after world war II caused reduction on tariffs
- quid pro quo: i reduce tariff, you do too!
What are the main ways in which the WTO (wrold trade organization) negotiations adress trade restrictions?
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- reducing tariff rates: by doing multilateral negotiations
- binding tariff rates (when you have a bound tariff, the imposing country cannot simply increase it anymore in the future)
- eliminating nontariff barriers (quotas, export subsidies), but with exceptions (agricultural export subsidies are still allowed)
