Chapter 7: The Political Economy of Trade Policy Flashcards
Why should there be a need for free trade?
Producers and consumers allocate resources most efficiently when govt do not distort market prices
With restricted trade–> consumers pay higher prices and consume too little (consumption distortion) and firms produce too much (production distortion)
How does free trade bring dynamic benefits
Free trade provides competition and opportunities for innovation (dynamic benefits).
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.
Thereby, consumers can benefit from a faster rate of technological progress when trade is free.
Why do we still observe protection of industries
- Although free trade is better for every country, the losers in each country lobby for protection.
- There are exceptions to the result that free trade is better for every country.
As a result, trade policy can be dominated by special interests rather than national welfare considerations
What are some reasons for the cases against free trade
- Market failures due to labour and capital market frictions
- Market failure due to externalities
Explain market failures due to labour and capital market frictions
Domestic market failures may exist that cause free trade to be a suboptimal policy
The economic efficiency loss calculations that we studied earlier using consumer and
producer surplus assume that markets function well.
However in fact many markets do not function perfectly well
- include persistently high underemployment of workers (labour market frictions)
- high underutilization of structures, equipment and other forms of capital (capital market frictions)
What are the market failures due to externalities
Technological benefits for society discovered through private production, but from which private firms cannot fully profit.
Environmental costs for society caused by private production, but for which private firms do not fully pay.
The marginal social benefit represents the additional benefit to society from private production
WIth market failure, marginal social benefit not accurately measured by producer surplus of private firms
Firm problem does not take into account social benefit or social cost
What effects does the tariff create? When is it worth to introduce tariff
The tariff will have three effects: a: production distortion (-)
b: consumption distortion (-)
c: social benefit (+)
If c > a + b, the tariff improves national welfare. In that case, protectionism is better than free trade even though the country is small.
What is the First best and second best policies
When there is an externality, the best strategy is to solve the market failure without adding new distortions.This is the first best policy.
If the best policy of fixing the market failures directly is not feasible, government intervention may be second best way of fixing the problem
What is the environmental kuznets curve
Kuznets curve:
Y axis: Environmental damage
X axis: income per capita
As poor countries grow richer, possibly partly due to trade, they produce more and can consume more, leading to more environmental degradation.
But as countries grow richer, they often want to pay for more stringent environment protection (and can afford to do so).
Both of these ideas are represented as an environmental Kuznets curve:
an inverted “U-shaped” relationship between environmental degradation and income per person
What is a pollution haven
Place where economic activity is subject to strict environmental controls in some countries is moved to other counties with less strict regulation
Since rich countries usually have strict environemental regulations and poor countries do not, environmental hazardous activities may be moved to poor countries
What are the two ways to liberalize trade
Multilateral: through the GATT (General Agreement on Tariffs and Trade) and WTO (World Trade Organization), a negotiating forum which includes (almost) all countries of the globalized world.
Regional or bilateral: through trade agreements between a limited number of countries. Examples: EU, Mercosur, ASEAN, NAFTA, etc.
Pros and Cons of mulitlateral agreements
Pros of multilateral agreements: it allows better deals and to get closer to free trade.
Cons of multilateral agreement: even though the deal can be better, it’s more difficult to reach an agreement (too many parties).
Why is there a potential for a trade war
A trade war could result if each country has an incentive to adopt protection, regardless of what other countries do.
All countries could enact trade restrictions, even if it is in the interest of all countries to have free trade.
Countries need an agreement that prevents a trade war or eliminates the protection from one.
Using Nash Equilibrium,
Countries choose between free trade and protection. NE is for no coordinaion, both countries choose
Through establishing binding agreement (collaboration) can lead to avoiding trade war
How WTO negotiations address trade restrictions
1. Reducing tariff rates through multilateral negotiations.
2. Binding tariff rates: a tariff is “bound” by having the imposing country agree not to
raise it in the future.
3. Eliminating nontariff barriers: quotas are changed to tariffs because the costs of
tariff protection are more apparent and easier to negotiate, and export subsidies are eliminated.
What is the most favoured nation principle
A country that lowers the tariff on imports from one country must apply that tariff to all WTO member countries it imports from.
