Political economy of trade policy Flashcards
A policy should be pursued if…?
It increases net social welfare.
What is the main argument against active trade policy?
Loss of social welfare due to tariffs and quotas that lead to consumption and production distortions.
Why do countries not pursue more free trade?
Because the gains are very small.
How does trade protectionism affect EOS?
It makes markets smaller, so EOS cannot be pursued to full extent.
How does active trade policy affect innovation?
It hurts innovation, as firms do not have high incentives to pursue technology with higher efficiency.
What is rent-seeking behaviour?
That is when firms try to acquire economic rents and in doing so spend resources, but that does not affect welfare positively.
In practice, free trade is…?
The best policy to pursue due to imperfect information.
What are the arguments against free trade?
- terms of trade argument
2. domestic market failure argument
What is the terms of trade argument?
For large countries, there is an optimal positive tariff and optimal taxes on exports.
What is the weakness of optimal tariffs?
The retaliation of other countries if a tariff is imposed.
What is a market failure?
When welfare is not maximised in free trade.
How does domestic market failure occur?
When there are positive externalities (e.g. knowledge spillovers), but firms cannot appropriate them their production will be suboptimal.
It is worth pursuing an active trade policy if?
If the marginal social benefit is greater than the sum of production and consumption distortions.
What is the theory of second best?
If the markets in a country are not working properly, an intervention in one market is justified as long as it can fix the other markets.
How best to correct a market failure?
Adress it at the source and subsidies are better than tariffs.
