Lecture 2 Flashcards
Puzzle of trade policy
Almost all economists agree that Free Trade is welfare
enhancing.
* We can make ourselves richer (on whole).
* All we have to do is eliminate barriers to trade.
* Then why does trade protection persist?
Types of trade protection tarrifs
Tariffs
A tax on imported goods
* Quotas
A limit on the amount of goods that can be imported by a
nation or globally (rare today because WTO doesn’t allow
quotas)
Why so many barriers to trade?
- Economically, free trade is a public good, and countries have economic
incentives to free-ride
All countries could be better off from coordinated liberalization - Other, non-economic concerns, especially for non-tariff barriers:
Consumer safety
Environmental protection
National Security Concerns
Not clear that liberalizing these would enhance welfare
Economic prisoners’ dilemma
- Gains from trade are only guaranteed if other states also
liberalize: - ‘If you liberalize and another state doesn’t, comparative
advantage might not be realized and one state may be worse off
Some states may be better off imposing a tariff if liberalization is not
reciprocated.
(Or at least politicians can be better off by catering to domestic interests.) - While trade is jointly beneficial, sometimes it is more
beneficial to exploit others’ open markets while you keep your
market closed.
Governments often want to protect important (non-competitive) industries
Where does an agreement fall?
An agreement will fall somewhere along the “contract
curve”, i.e. the set of “efficient” agreements acceptable to
all parties.
* A state’s bargaining power plays a role in where along the
curve it lands
* Not all about providing a public good
* States still want to maximize benefits (either economic or
political)
What is a determinant of bargaining power?
Determinants of bargaining power:
* Market size/trade volume:
* Patience:
* Attractiveness of Outside Options:
Bargaining can break down
What prevents successful bargaining?
* No mutually beneficial gains to be made:
status quo is already at one country’s policy ideal point
Preferences incompatible (can be the case for non-tariff barriers, think of
airbags and seatbelts!)
* Information problems:
Countries don’t know others’ ideal points, level of resolve or patience
Incentive to misrepresent
* Inability to credibly commit to the agreement
* Outside options
Facilitating cooperation
Several Factors make cooperation and bargaining easier:
* Small # of states, or one hegemon to back the system (more on that later)
* Information to monitor compliance
* Repeated interaction (tit for tat)
Ability to punish defectors
Reciprocity
Incorporate long-term gains into decision making
* Linkage of policies
Tie compliance to other issues like security
International institutions (WTO or RTAs) can help
International institutions in relation to trade
Provide mechanisms to aid trade cooperation
Set standards of behavior
Monitor and enforce compliance
Reduce transaction costs
* Often based upon the principle of reciprocity (iteration and tit for tat)
Concessions granted by one state are matched by others
* Can take many forms
Global Organisations (WTO)
Regional Organisations (NAFTA, CARICOM, MERCOSUR, EU CU)
Bilateral
GATT 1948-1994
General Agreement on Tariffs and Trade (GATT), 1948-1994
23 members by 1948
Created with other Bretton Woods institutions (IMF, World Bank)
Lasts until 1994, replaced by the WTO
WTO 1994-today
World Trade Organization (WTO), 1994 - today
Includes Updated General Agreement on Tariffs and Trade (GATT)
Uruguay Round Added Agreements on New Areas (Services, Non-Tariff
Barriers, Intellectual Property Rights…)
Both successful in reducing barriers to trade
Still, can’t agree on trade on agricultural and other goods protected by strong
interest groups in Western world.
3 important WTO elements
Established common principles and rules
2. Repeated intergovernmental bargaining process
3. Dispute settlement mechanism
Most favoured nation (MFN)
: All countries are treated as the closest
trading partner
Article 1: If you liberalize trade for one country, you have to
liberalize it for all WTO members (exceptions: RTAs and GSP…)
National treatment
Behind the border, foreign goods have to be
treated the same as domestic goods
Article 3: Prohibits regulations and other policies that give domestic
firms an unfair advantage
Exceptions to MFN
- Regional trade arrangements
Free-Trade Area (e.g., NAFTA)
or Customs Union (e.g., EU)
Condition: can’t raise trade barriers on others above prior
barriers - Generalized System of Preferences (from 1960s):
Developed countries can apply lower tariffs for developing
countries than for their peers
