Transcript International Trade in Insurance

International Trade in Insurance
• Economic theory of trade
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absolute versus comparative advantage
static welfare analysis of trade
dynamic welfare analysis of trade
common trade restrictions
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tariffs
quotas
subsidies
government procurement
International Trade in Insurance
• Why restrict trade?
1. Foreign company will dominate the market
economies of scale and scope
greater financial resources
infant industry
2. Insurance is “strategic business”
national security
national economic diversification
International Trade in Insurance
• Need to preserve foreign exchange reserves
nature of insurance related trade flows
import substitution
the special case for insurance
• market development
• consumer protection concerns
why insurance is special
International Trade in Insurance
• Fair trade concepts
market access
nondiscrimination
transparency
national treatment
reciprocity
• some accounting issues in international
trade
Mercantilist versus Smith
• Mercantilist view: If one country wins from
trade the other country must lose
• Extending this view.. should Jalisco trade
with Veracruz? Should Tlalpan trade with
Copilco?
• Smith: Wealth of Nations is in the
productive capacity of labor and capital and
not in the gold reserves
Absolute versus comparative
advantage
The easiest way to see the notions of absolute and
comparative advantage is by means of an example
Suppose there are two countries each producing wine
and wheat with the following cost structure
Country
England
Portugal
Wheat
15
10
Wine
30
15
Comparative advantage
• opportunity cost of producing one unit of
wine in England is two units of wheat
• oc in Portugal of one unit of wine is…..
• relative costs are different
• Portugal is relatively better at producing
wine than England
• Portugal has a comparative advantage in
wine production (England in wheat)
Comparative advantage
• Assume only input is labor
• assume England has 270 man hours and
Portugal only has 180
• before trade England can produce and
consume 8 units of wheat and 5 units of
wine
• Portugal can consume 9 wheat 6 wine
• total production 17 wheat 11 wine
Comparative advantage
• Is it possible for England to be better off
and Portugal to be better off by not
producing both wine and wheat?
• YES
• If specialize, total output 18 wheat 12 wine
• trade! …not a zero sum game
• What should be the terms of trade?
Some observations
• one country may have absolute advantage in
producing everything but not a comparative
advantage in production in all goods
• comparative advantage may be in other
economic factors such as land, capital,…
• by how much each country gains depends
on the terms of trade
• why is London the largest reinsurance
market in the world?
Another example
• E and W produce two goods wine and
cheese
• W requires 3 hours of work to produce 1
bottle of wine and E requires 1
• W requires 7 hours of work to produce 1
kilo of cheese and E needs 5
• What are relative costs of production in
each country?
Terms of trade
• E can buy 1 kilo of cheese for five bottles of
wine if they produce all by themselves
• But W can buy 1 kilo of cheese for 2.33
bottles of wine (or five bottles buys 2.15
kilos of cheese [2.15=5/2.33])
• Thus, E can gain an extra 1.15 by selling in
W
• W cheese producers can get more by selling
in E
Common Misconceptions about
gains from international trade
• Mexico is inefficient in producing
everything, therefore, it will lose from trade
– In our example E has an absolute advantage in
producing both cheese and wine but they gain
from trade. Why? Gains are due to relative
efficiency and not absolute efficiency.
Common Misconceptions about
gains from international trade
• “Giant sucking sound” argument of Ross
Perrot
– American domestic workers have to be
protected against low wage Mexican workers.
If it is cheaper to produce in one country, it
should do so. For example, it does not make
sense for the Australian garment industry to
produce shirts at a cost twice that of China. We
need to compare relative costs and relative
productivities
Common Misconceptions about
gains from international trade
• Trade exploits Mexico and makes it worse
off (especially for goods that require lots of
labor)
– Value of production is not solely due to labor.
It is possible that the gain for the US economy
is larger than the gain for Mexico. However,
both gain from trade. Singapore example:
imports water, but exports refined petroleum!
Static welfare analysis of trade
• suppose a commodity has a domestic price
of 17.50 and a world price of 10
• Clearly a possibility of import
• government is considering a tariff of 5 on
import
• who will gain and who will lose?
• And by how much?
Gains and losses
• There is benefit to the producer called
producer surplus measured by ABCD and
the amount is $37.50
• Consumers suffer a loss an amount $87.50
measured by ABFG
• Government gains in the form of tax
revenue EHFD equals $25
Gains and losses
• Note that the total loss to the consumers is
not equal to what producers gain and what
the government gets as revenue
• There is an additional loss to the society as
a whole: CDE and FGH
• Since these losses are not gains of anybody
in the society, they are called deadweight
losses
Deadweight loss
• Clearly deadweight losses are bad for the
economy
• What does the deadweight loss depend on?
• It depends on the elasticity of demand and
the supply curves
• Consider demand elasticity: lower the
demand elasticity, higher the deadweight
loss
Deadweight loss
• What does the demand elasticity depend
on?
• Goods with few substitutes will have lower
elasticity of demand-necessities
• Goods with many substitutes will have
higher elasticity of demand-luxuries
• How large are the costs of trade
restrictions?
What do empirical studies show?
• Trade restriction has a cost of US$70b or
1.3% of GDP
• Is it worth it to have consumers pay more if
it saves jobs?
• Cost to society $168,000 per job saved!
• Study of Kodak Australia: tax concessions,
and other benefits given to stay in Australia
Then, why we see resistance?
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Job losses are concentrated in certain areas
They may bring in votes
They may have large political power
Benefits to consumers are diffused
Each consumer gains a little
They do not have political clout
It does not pay
S
price
20
DL
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F
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G
A
C
H
E
5
10
15
17.50
D
5
10
15
20
quantity
Dynamic welfare analysis
• Over time, there are further changes
• In Australia, tariff and quota on garment
import has been reduced (from 100% to
5%)
• It has killed the usual garment
manufacturing in Australia
• They are relocating factories to China, the
Philippines, Indonesia etc.
Rent seeking
• People spend resources to engineer
activities that lead to protectionism
• Lobbying for special interest groups
• Specific industries can get tax breaks,
import quota imposed and other benefits
• Example: Luxury boat builders in the US
Tax on insurers
• Makes insurance more expensive
• transfer consumer surplus to domestic
producers
• provides government with tax revenue
• create deadweight loss to society
• how about imposing a quota?
General equilibrium analysis
• There are spillover effects
• We have only studied the “partial
equilibrium” or own market effects
• Higher insurance costs leads to higher
product prices that needs insurance
• Effects are felt all over the economy
Common objections
• Foreign insurers will dominate the market
– economies of scale and scope: larger, more
efficient foreign companies will be able to drive
the local companies out of the market
– evidence shows that scale economies exist for
small and medium sized companies but not for
very large insurers (typically, they have
diseconomies of scale)
– dumping: who gains? Market share argument
Common objections
• For strategic reasons, insurance industry
should remain national
• There will be great foreign exchange
outflow
• Market development will be slowed down
• Consumers will not be protected
Dumping
• Goods sold abroad below the domestic price
• Japanese companies did that for many years
for diverse sets of goods: cars, electronics,
computers etc.
• What does that mean?
• Common argument: get into a foreign
country, wipe out the competition and enjoy
monopoly
Dumping
• To the country at the receiving end,
dumping costs domestic jobs
• What prevents domestic producers from
reentering the market?
• TVs, VCRs, etc. have become the biggest
success of Japan in the rest of the world,
and these industries were least helped by
MITI and now they are produced elsewhere
MITI knows how to pick…losers
• In the 1960s, MITI wanted auto companies
to produce just trucks
• Later it tried to keep the number of
producers low, in particular keep Honda out
of auto business
• MITI presumed that analog version of the
HDTV will be the industry standard, wrong
again!
Fair trade
• Market access
– no country allows free access to insurance
because of large potential for abuse
– localization of ownership: majority
shareholding local, subsidiary
– localization of insurance: certain or all lines
must be placed locally domiciled insurer
– benefits to economy: needs test
Fair trade
• Nondiscrimination or MFN treatment
– best possible market access
• Transparency
– regulatory requirements should be clearly set
and easily accessible
• National treatment
– foreign products are treated no differently from
domestic ones
Fair trade
• Reciprocity
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concessions by a country matched by other
matching need not be for the same industry
retaliation can lead to escalating trade war
increasing tariff to reduce foreign threat to local
export economy cannot last long because other
countries retaliate and can lead to reduced
welfare for both
Some implications of national
income accounting
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Y=C+I+G+(X-M) where Y is the GDP
Also, S=Y-C-G
Therefore, S=I+CA where CA=X-M
CA is called current account
By this mechanism, a country can invest
more than it saves
• Can it do that indefinitely?
Saving Rate (SR) and Investment Rate (IR) for Argentina
0.24
0.22
SR and IR
0.20
0.18
0.16
0.14
0.12
0.10
0.08
50
55
60
65
70
IR
75
SR
80
85
Year
90
0.5
Thailand’s saving and investment
SR and IR
0.4
0.3
0.2
0.1
0.0
50
55
60
65
70
SR
75
80
IR
85
90
Year
95