Transcript PPTch04

The European Union:
economics, policies and
history
1st edition
Chapter 4
Basic
Instruments:
The Theory of
Trade and the
EU
Susan Senior Nello
©The McGraw-Hill Companies, 2005
The main arguments in favour of
free trade: Absolute advantage
‘What is prudent in the conduct of every
private family can scarce be folly in that of a
great kingdom. A family will not make at
home what it costs less to buy from outside.
A taylor (sic) will not make his own shoes,
but will buy them from a shoemaker.’
Adam Smith
©The McGraw-Hill Companies, 2005
The main arguments in favour of
free trade: Absolute advantage
With two nations, if one country is more efficient
in the production of one good, and less efficient
in the production of the other, then each country
should specialise in the production of the good
where it has an absolute advantage.
In practice Smith’s concept of absolute
advantage explains only a small share of
international trade.
©The McGraw-Hill Companies, 2005
The main arguments in favour of
free trade: Comparative advantage
•
David Ricardo: even when one country is less
efficient in the production of both goods there
is a basis for mutually beneficial trade.
•
Even if one country has an absolute
disadvantage in the production of both goods,
it should specialise in the production and
export of the good where its absolute
disadvantage is smaller and import the
product where its absolute disadvantage is
greater.
©The McGraw-Hill Companies, 2005
The main arguments in favour of
free trade: Comparative advantage
•
The country with an absolute advantage in
the production in both goods should
specialize in the production and export of the
product where its absolute advantage is
greater, and import the good for which its
absolute advantage is smaller.
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The Heckscher-Ohlin Theorem
• Tries to explain the pattern of comparative
advantage between countries.
• Why does a country have a comparative
advantage in the production of a particular
good?
• According to this approach, trade can be
explained by the pattern of endowment of
countries with different factors of production.
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The Heckscher-Ohlin Theorem
Fig 4.1
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Intra-industry trade and product
differentiation
• Intra-industry trade consists of exports
and imports of the same product or group of
products.
• It is the result of product differentiation
as products are substitutes for each other, but
are slightly different.
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Intra-industry trade and product
differentiation
• The firm or plant can therefore specialise in a
few varieties of the products, so can make use
of longer production runs, more specialised
machinery and labour, and so on. Other varieties
of the product can be imported so consumers
may have a wider range of products available at
lower prices.
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Static economies of scale
• Occur when an increase in the use of inputs
results in a more than proportional increase
in output. In other words, the unit costs of
production fall as the scale of production
rises.
• A classic example is the assembly-line
production introduced by Henry Ford.
©The McGraw-Hill Companies, 2005
Static economies of scale
• A highly simplified model based on two
countries 1 and 2 and two products X and Y,
and two factors of production can be used to
illustrate Static economies of scale.
Fig 4.2
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Dynamic economies of scale
• Dynamic economies of scale are associated with
the learning process.
• The learning process refers to the unit cost
advantage that accrues to a firm because of the
experience it acquires through cumulative
production of goods and services.
• The fall in cost may be due to technological
improvements; better organisational structures
and/or performance of workers.
©The McGraw-Hill Companies, 2005
Dynamic economies of scale
• The firm which first moves down the ‘learning’
curve of a strategic industry will gain a cost
advantage over its competitors.
• Economic policy should therefore ensure that
markets are on an adequate scale to allow such
learning effects to be exploited.
• The existence of these experience economies
may render it difficult for new entrants to enter
the market.
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Dynamic economies of scale
Fig 4.3
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Tariffs
• Up until the WW1 it was widely accepted that if
trade barriers were introduced for protectionist
purposes they should be confined to tariffs.
• In the GATT/WTO context tariffs are considered
the ‘lesser evil’ compared with other trade
barriers because they are more transparent.
• The GATT/WTO favours the conversion of other
non-tariff barriers into tariffs.
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The economic effects of introducing
a tariff in a ‘small nation’
Fig 4.4
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The effect of introducing a tariff in a
‘large nation’
Fig 4.7
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The import demand of the home
country
Fig 4.8
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The import supply of the home
country, or the export supply of the
foreign country
Fig 4.9
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The effect of a tariff on the home
and foreign countries
Fig 4.10
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Non-tariff barriers and the ‘New
Protectionism’
• From the 1970s international trade became
increasingly subject to non-tariff barriers (NTBs)
• Main non-tariff barriers:
• quotas on imports;
• voluntary export restraint agreements (VERs);
• cartels;
• anti-dumping duties;
• export subsidies;
• differences
in
standards
and
technical
specifications, and administrative measures; and
• discrimination in public procurement.
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The main arguments presented in
favour of protection
• Protectionism may be advocated for noneconomic reasons, such as for defence,
national pride or to further foreign policy
objectives.
• The infant industry case protecting a new
industry until until it is large enough to compete
with foreign firms.
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The main arguments presented in
favour of protection
• According to the optimal tariff argument, if a
large nation introduces a tariff on a good widely
used, the world price would fall. As a result,
foreign producers would bear part of the cost of
the tariff.
• The senescent industry maintains that
protectionist measures may be necessary to
avoid unemployment.
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Second best
• Second best implies that if the conditions
of perfect competition are violated in some
part of the economy.
• It need not be optimal for the rest of the
economy to attain a perfectly competitive
equilibrium. In other words, it is not
possible to know whether the introduction
of an additional distortion will increase
(while still remaining in a suboptimal
situation) or reduce total welfare.
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Second best
• In the context of the debate on
protectionism this implies that it is
impossible to say a priori whether a
move towards free trade will improve
the situation, or that the introduction of
a protectionist measure will worsen it.
Under such conditions it is necessary to
examine the specific case in question to
decide on the most appropriate policy.
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More recent arguments in favour of
protection: Strategic Trade Theory
• According to Strategic Trade Theory, a
government may create a competitive
advantage for its firms in high-technology
industries through temporary protection,
subsidies and tax breaks.
• Strategies to promote investment in
infrastructure, people, and research and
development may also play an important
role.
©The McGraw-Hill Companies, 2005
More recent arguments in favour of
protection: Strategic Trade Theory
• This approach shares many of the
shortcomings of the infant industry
argument: choosing which sectors will be
future winners is difficult, and too much
government intervention may invite similar
measures by major competitors.
©The McGraw-Hill Companies, 2005
The political economy of
protectionism
• The expected benefits to producers from
protection are generally relatively high and may
be sufficient to induce them to take on the costs
of lobbying governments to introduce
protectionist measures.
• The costs of lobbying include the time, effort
and expense needed to obtain information,
organise a pressure group, signal preferences,
and carry out lobbying activities.
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The political economy of
protectionism
• The cost to consumers of the higher prices as a
result of protection may not be sufficient to
induce them to organise any kind of protest.
• The government may have an incentive to give
in to the requests of the producer lobby,
knowing that consumers will be unlikely to
organise any kind of effective resistance.
©The McGraw-Hill Companies, 2005