6.2 Economics Behind Trade Agreements Flashcards
What is trade and distortions
Trade policies influence prices, resource allocation and income distribution
Some gain and some lose from free trade. Gains often exceed the losses, so free trade maximises national welfare (total surplus) yet most governments restrict trade
What is trade diversion and creation?
When an agreement is formed
- Trade between member countries of goods were produced in countries but not traded at all -> creates trade
- Trade betwween member countries of goods that were imported from countries outside the trade agreement -> trade diversion
Example on week 6 page 5,
Basically after an agreement if it is cheaper to buy from new country, then trade will be created
If after an agreement it is cheaper from a country within the agreement instead of previously being from a country outside the agreement, trade will be diverted to new country in agreement
How do you illustrated gains from trade?
COnsumer and producer surplus, hella simple you know this stuff g
Question as to whether countries benefit from trade at the expense of another
Illustrated on page 2
What is the import demand curve? What is the export supply curve?
Illustrated page 1
What are some negative impacts of trade?
Can decrease welffare of producers for imported countries
When both the exporter and importer, high productive firms remain in market, low productive firms exit - workers positively affected by free trade, others get lower salaries or lose jobs
Trade can be beneficial buy also raise inequality and unemployment:
- Increasing trade with LIC/MICs
- Increasing trade with China
- North/South trade implies skill transfer between countries -> some grousp of workes better off, some worse off
Inequality on the UK on slow rising positive pattern - 95th percentile much higher than the 20th/50th
Global inequaltiy:
- China and Emerging economies increasing shares of manufacturing exports, US and Gemrany falling
- Crucial for reallocation of labour across sectors and across firms
- Countries with low labour market frictions may benefit more from trade
What are the arguments for trade policy
Second best:
- In presence of domestic market failures trade policy can improve welfare - infant industry, difficulties for domestic taxation, national protection
Political economy - tariffs redistribute income between groups in a society
Optimal tariff argument - large country incentive to use tariffs to improve terms of trade
Infant industry argument:
-Emerging industries often do not have enough size (EofS) to compette with firms from other countries
These industries must be producted until reaching similar scales - industry needs time to learn and become competitive
- Usually through government intervention
Application of Infant industry argument
Question as to how firms know which industries to protect
Automobile industry in china:
- Tariffs induce firm’s learning until firms are competitive at world prices
- China had protected many industries until joined WTO
Tariffs on automobiles:
1980s - 260%
1996 - 80-100%
2006 - 25%
China went from 8th largest producer - about 2m whereas US was at about 12m in 2000
In 2009 - China produce about 13m, Japan second with about 7m and US fell to 5m
Today China is the largest maker of automobiles - an infant industry protection success?
Example of computers in Brazil
1977- program protect domestic computer firms. National autonomy in computer industry:
- Imports of computers banned
- Domestic firms buy from local suppliers
- Foreign producers of PCs not allowed to operate
Ban until 1990s
- Firms good at reverse engineering, never able to produce computers at competitive prices without tariff protection
- Increased producer surplus, however fall in CS - net loss of roughly $51m
- Industry never able to produce in absence of tariffs, meaning no future gains
What are some other traditional arguments for protection
National defence - argues that some industries are vital in times of war and emergency and so industries must be protected and self sufficient
- Problem is identifying vital industries
Alternative policy:
- Production subsidy
- Joint businesses government research and development companies
What is the terms of trade?
Relative price of export index over price of import index
Indicates amount of imports a country can buy per until exported (prices, not value)
If the TOT increases the country is better off - can buy more imports per unit exported
Application:
A large exporter, B small exporter
World price = 10 and country A imposes tariff of 5
Reduces import prices a lot, so what can foreign exporters of B do?
- Cut prices (absorb tariff) with the hope to keep imports
e.g. could sell product at price of 8 instead of 10
For country A, the increase in prices after tariff is equal to 3 in this case (8+5=13 - price before is 10) - which is less than the tariff (5)
- If all countries impose the optimal tariff, creates a problem as everyone is worse off
What are arugments for trade policy
Optimal tariff argument:
- TOT gain of one country is the TOT loss of another
- Large countries incentivised to impose optimal tariffs but if all countries do it, all countries are worse off
- Countries benefit from reciprocal trade negotiations
Purpose of trade agreements:
- Unilateral tariffs can improve welfare of countries
- However, if all countries increase tariffs, each country is worse off than under free trade, leading to inefficient equilibrium
- A trade agreement provides governments an escape from the inefficient equilibrium
How does game theory relate to tariffs? How does it show the purpose of trade agreements?
Country B
Tariff No Tariff
Country A Tariff -100,-100 100, -120
No Tariff -120, 100 -0, 0
Each government imposes import tariffs to host more of the worlds production.
More recently, emphasis on the role of production relocation externality
- If country A imposes tariff, domestic production increases in A
- If country B also imposes tariff: fall in production in A because exports of country A decrease
Reciprocity and non discrimination helps governments escape this other prisoners dilemma (tariff changes no production relocation)
Argument conssitent with GATT principles:
- Reciprocity: mutual change sin trade policy leave world prices unchanged
Non discrimination (with more than 2 countries tho)
FTAs and GATT/WTO negotiations help governments internalise the TOT externality
