Political Economy Flashcards
Question:
if trade policies tend to incur net losses, why do they get implemented?
What are the 4 cases FOR free trade
- efficiency
- EOS
- competition and innovation
- Best feasible politically
Outline the efficiency case for free trade
Restricted trade distorts prices = consumer and producer efficiency losses.
Why might the efficiency case for free trade not be that convincing nowadays?
Tariff rates already low for most countries and quotas rare so estimated gains of moving to free trade only small % GDP.
Protection costs are < X% go GDP for most countries
<1% GDP
EOS argument for free trade
Free trade allows firms to take advantage of EOS –>lower prices and increased choice.
Competition and innovation free trade argument
free trade provides more competition and incentives to differentiate. With heterogeneous firms, the least productive exit = average industry productivity rises.
What kind of benefits of free trade are competition and innovation cf efficiency losses?
DYNAMIC - accrued over time.
efficiency = static estimates.
Whats the political argument for free trade?
Any policy deviating from free trade would be quickly manipulated by special interests - like opening pandora box = decrease welfare. Also, deviating would increase trade policy uncertainty.
2 arguments against free trade
- TOT
2. domestic market failure
The TOT argument against free trade only exists for
LARGE countries who can affect world price.
What’s the optimum tariff rate?
-Between 0 an tp
where tp = prohibitive tariff rate i.e one that stops trade.
Where marginal gain from improved TOT = marginal efficiency cost.
Shape of optimum tariff graph
N shaped then flat line once tp passes.
What’s the optimum policy in export sectors? + real world example.
NOT a subsidy which lowers welfare.
Export TAX - this raises TOT, but not too large as to prohibit trade. EG Saudi Arabia and other oil producers.
Problems w trying to improve TOT =
Zero sum gain = foreigners lose = RETALIATION.
Prisoners dilemma: one country imposing tariff while other not NOT NE.
Bottom line on TOT argument against free trade.
Largely theoretical - not a useful justification in practice for restricting trade.
Whats the domestic failure argument against free trade>
Domestic market failures exist = trade restrictions as 2nd best policy where 1st best not feasible.
Example of market failure and how trade policy could help.
Persistently high underemployment. Tariff to raise production in import competiting sector.
What do CS and PS calculations implicitly assume?
EFFICIENT MARKETS: if inefficient, CS and PS do not accurately measure welfare.
What benefits do CS and PS capture? Why is this a problem when market failures exist?
Capture PRIVATE benefits.
Market failures, +VE externality MSB > MPB
So we need to look at social effects of policy, not just private effects. Social welfare gains could offset efficiency losses.
the domestic market failure argument is an example of what general argument?
Theory of second best = government intervention which distorts incentives in one market may increase national welfare by offsetting the consequences of market failure elsewhere.
First best vs second best policies
First best = directly intervening in the market that’s failed.
Second best = intervenes in another market to indirectly fix the problem.
2 problems with domestic market failure argument
- Second best: should rly tackle the source of the problem & always compare to an alternative domestic policy.
- Difficult to identify market failures and unclear when and to what degree to intervene.
Example of market failure an 2nd best policy US
US sugar quota. Argued labour market is too rigid to allow for wage cuts to create employment in other sectors.
Why is a domestic policy such as subsidy often less preferred to trade policy such as quota even if less welfare damaging?
Because its costs are more salient than that from trade. About perception and visibility.
Important insight about national welfare
In reality, no such thing as national welfare. Only desires of individuals who influence the political process.
Median voter theorem predicts
Democratic political parties will change their politicise to court the median voter i.e. the voter in the middle of the ideology spectrum on a certain issue.
2 assumptions of MVT
- Only 2 parties.
2. Only care about getting elected and winning majority - not about maintaining party ideology.
Equilibrium tariff rates in MVT and why
ta=tb=tm
One party always has an incentive to undercut to get closer to median voter –> drives both partied to tM.
Does trade policy follow MVT in reality? Give n example.
NO - removing US sugar quota should find a majority yet it remains.
Collective action problem
Consumers as a group have a large incentive to advocate for free trade, but individually have little incentive - the individual gains < cost and time of advocacy.
Political activity on behalf of a group is a … good
PUBLIC GOOD - an individual acting on behalf of the group doesn’t reap the full benefits themselves. Incentive to free ride –> underinvestment in advocacy.
Implication of collective action problem
Policies imposing large losses for society as a whole, but small losses individual may NOT face strong opposition.
2 conditions to overcome collective action problem
- small group: politically organised, precise well-defined goals.
- large incentives e.g. unemployment.
= large incentives per person.
Trade off between motives for politicians
- MVT: want to advocate popular policies to please majority.
- Collective action: want to please special interst groups who are more likely to donate to campaigns
2 industries that are well protected.
- agriculture
2. clothing: textiles and apparel.
Which theory is supported by the factor that farmers receive protection?
NOT MVT
collective action - farmers well organised and have their livelihoods at stake.
Why have workers in clothing overcome collective action problem?
Their work is labour intensive so could easily be shifted to low-wage countries = strong incentives t advocate.
Much of tariff reductions since WW2 have come abroad through…
INTERNATIONAL / MULTILATERAL negotiations.
GATT founded in…
1947
GATT replaced by WTO in…
1995
2 benefits of multilateral negotiations
- Mobilise exporters to support freer trade.
2. Avoid destructive trade wars.
How does multilateral collective action help mobilise exporters where unilateral does not?
Unilateral = consumers do not get their act together. Multilateral = foreign country exporters lose out, threaten retaliation = domestic exporters now incentivised to advocate.
Explain destructive trade war with prisoners dilemma
Each country acting individual has protection as dominant strategy so NE = both restrict trade. Pareto optimal outcome = free trade for both, which multilateral negotiations act as a coordination device.
3 ways WTO negotiates address trade restrictions.
- reduce tariff rates.
- binding - upper bound on tariff rates agree not to raise above in future.
- change nontariff barriers to tariffs since the costs of tariff are more transparent.
2 exceptions to WTO rules
- Agricultural subsidies.
2. When market disruption is caused by a surge in imports.
What’s the WTO dispute settlement procedure?
Formal procedure where countries in a trade dispute bring their cases to a panel of WTO experts. Quick decisions < 15 months. Countries not adhering to decisions are punished by allowing others to retaliate.
How many trade rounds since 1947?
8
Current WTO trade round + issues
Doha development round started in 2001 but come to nothing as disagreement between US and EU over agricultural protection.
Preferential trading agreements =
trade agreements between countries in which they have lower tariffs for each other but not for ROW.
PTAs are a form of…(2)
- Bilateral negotiations
- Trade policy discrimination
WTO most favoured national principle
Each country in the WTO promises that all countries will pay tariffs no higher than the nation that pays the lowest i.e. principle of non discrimination. If decrease t for one country, must decrease for all.
EXCEPTION to WTO’s MFN principle.
If lowest tariff rate = zero.
A PTA is made on what products?
ALL products - not just one.
2 types of PTA’s with t=0 (or near)
- free trade area
2. customs union
How do FTA and Customs union differ?
Both have free trade among members.
FTA = each member can have own policies towards non members.
CU = common external trade policy
FTA = … nightmare
administrative - have to make sure importers don’t arbitrage import tariff differences with non members.
No country should be a low tariff back door.
What kind of admin barriers can stop countries being a low tariff back door?
Rules of origin
Customs union = … nightmare
POLITICAL - time and effort to negotiate and the streamline external trade policy of all members.
When does PTA increase national welfare?
Trade creation: replace extension domestic production with cheap imports from FTA member.
When does PTA decrease national welfare?
Trade diversion: replace low cost imports from non members with higher cost imports from FTA member.
