Transcript The Political Economy of International Trade Policy

Chapter 10
The Political Economy
of Trade Policy
Prepared by Iordanis Petsas
To Accompany
International Economics: Theory and Policy, Sixth Edition
by Paul R. Krugman and Maurice Obstfeld
Chapter Organization
 Introduction
 The Case for Free Trade
 Income Distribution and Trade Policy
 International Negotiations and Trade Policy
Copyright © 2003 Pearson Education, Inc.
Slide 9-2
Introduction
 What reasons are there for governments not
to interfere with trade?
• There are three arguments in favor of
free trade:
–Free trade and efficiency
–Economies of scale in production
–Political argument
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Slide 9-3
The Case for Free Trade
1) Free Trade and Efficiency
• The efficiency argument for free trade is
based on the result that in the case of a
small country, free trade is the best
policy.
–A tariff causes a net loss to the
economy (i.e. deadweight loss).
–A move from a tariff equilibrium to
free trade eliminates the efficiency loss
and increases national welfare.
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Slide 9-4
The Case for Free Trade
Figure 9-1: The Efficiency Case for Free Trade
Price, P
Production
distortion
World price
plus tariff
World price
S
Consumption
distortion
D
Quantity, Q
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Slide 9-5
The Case for Free Trade
2) Economies of scale in production
• Protected markets in small countries do not allow
firms to exploit economies of scale.
Example: In the auto industry, an efficient scale assembly
should make a minimum of 80,000 cars per year.
o In Argentina, 13 firms produce a total of 166,000 cars per
year.
• The presence of scale economies favors free trade that
•
generates more varieties and results in lower prices.
Free trade, as opposed to “managed” trade, provides a
wider range of opportunities and thus a wider scope
for innovation.
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Slide 9-6
The Case for Free Trade
3) Political Argument for Free Trade
• A political commitment to free trade may be
a good idea in practice.
• Trade policies in practice are dominated by
special-interest politics rather than
consideration of national costs and benefits.
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Slide 9-7
Income Distribution and Trade Policy
 Who Gets Protected?
Two sectors get protected in advanced countries:
Agriculture
Farmers are well organized and the structure of the U.S.
government enhances their political power.
Clothing
Both textiles and apparel have enjoyed substantial
protection. This sector employs less skilled workers and
it is unionized as well.
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Slide 9-8
International Negotiations and Trade Policy
 How was the removal of tariffs politically possible?
• The postwar liberalization of trade was achieved

through international negotiation.
• Governments agreed to engage in mutual tariff
reduction.
The Advantages of Negotiation
• It is easier to lower tariffs as part of a mutual
agreement than to do so as a unilateral policy
because:
– It helps mobilize exporters to support freer trade.
– It can help governments avoid getting caught in
destructive trade wars.
Copyright © 2003 Pearson Education, Inc.
Slide 9-9
International Negotiations and Trade Policy
Table 9-3: The Problem of Trade Warfare
Japan
U.S.
Free trade
Protection
10
20
Free trade
10
-10
-10
-5
Protection
20
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-5
Slide 9-10
International Negotiations and Trade Policy
 In Table 9-3, each country has a dominant
strategy: Protection.
 Even though each country acting individually
would be better off with protection, they
would both be better off if both chose free
trade.
• Japan and the U.S. can establish a binding
agreement to maintain free trade.
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Slide 9-11
International Negotiations and Trade Policy



International Trade Agreements: A Brief History
The multilateral tariff reductions since World War II
have taken place under the General Agreement on
Tariffs and Trade (GATT), established in 1947 and
located in Geneva.
It is now called the World Trade Organization
(WTO).
The WTO system is a legal organization that embodies
a set of rules of conduct for international trade policy.
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Slide 9-12
GATT Eight Rounds of Trade Negotiations
Year
Place/name
1947
Geneva
1949
Annecy
1951
Torquay
1956
Geneva
1960-1961 Dillon
Round
1964-1967 Kennedy
Round
1973-1979 Tokyo
Round
1986-1994 Uruguay
Round
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Subjects covered
Countries
Tariffs
Tariffs
Tariffs
Tariffs
Tariffs
23
13
38
26
26
Tariffs and anti-dumping measures
62
Tariffs, non-tariff measures, “framework”
agreements
Tariffs, non-tariff measures, rules, services,
intellectual property, dispute settlement,
textiles, agriculture, creation of WTO, etc
102
103
Slide 9-13
International Negotiations and Trade Policy

How different is the WTO from the GATT?
The GATT was a provisional agreement, while the
WTO is a full-fledged international organization.
 The GATT applied only to trade in goods, while the
WTO included rules on trade in services (the General
Agreement on Trade in Services (GATS)) and Trade
Related Aspect of Intellectual Property Rights (TRIPs).
 The WTO has a new “dispute settlement” procedure
which is designed to reach judgments in a much shorter
time.
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Slide 9-14
Principles of the WTO Trading System
1) Trade without discrimination
A. Most-favored-nation:
Under the WTO agreements, countries cannot
normally discriminate between their trading partners.
Cannot grant someone a special favor.
B. National treatment:
Imported and locally-produced goods should be
treated equally at domestic market. The same should
apply to foreign and domestic services, and to foreign
and local trademarks, copyrights and patents.
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Slide 9-15
2) Freer trade: gradually, through negotiation
Lowering trade barriers is one of the most obvious
means of encouraging trade. The barriers concerned
include tariffs and measures such as import quotas.
3) Predictability: through binding and
transparency
Sometimes, promising not to raise a trade barrier can
be as important as lowering one, because the promise
gives businesses a clearer view of their future
opportunities. With stability and predictability,
investment is encouraged, jobs are created and
consumers can fully enjoy the benefits of competition
choice and lower prices.
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Slide 9-16
Economic Integration
 A free trade area allows free-trade among members



(no tariffs), but each member can have its own trade
policy towards non-member countries.
A customs union allows free-trade among members
and requires a common external trade policy (common
tariff) towards non-member countries.
A common market is a customs union with free
mobility of factors of production (capital and labor)
among members.
A monetary union is a common market with
common currency and common monetary policy.
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Slide 9-17
Stages of Economic Integration
Common
Currency and
Monetary Policy
Free
Movement of
Factors
Unified
External Tariff
Elimination of
Tariffs
Preferential
Agreement
√
18
√
Free Trade
Area
√
√
Customs
Union
√
√
√
Common
Market
√
√
√
Monetary
Union
Main Regional Agreements
EU
EFTA
NAFTA
GAFTA
CAFTA
WAEMU
Mercosur
19
GCC
APEC
SAFTA ASEAN
COMESA