ECON 3601 Lecture Notes - Lecture 9: North American Free Trade Agreement, Median Voter Theorem, Economic Surplus

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The Cases for Free Trade

•The first case for free trade is the argument that producers and consumers allocate

resources most efficiently when governments do not distort market prices through

trade policy.

–National welfare of a small country is highest with free trade.

–With restricted trade, consumers pay higher prices and consume too little while

firms produce too much.

•However, because tariff rates are already low for most countries, the estimated benefits

of moving to free trade are only a small fraction of national income for most countries.

–For the world as a whole, protection costs less than 1 percent of GDP.

–The gains from free trade are somewhat smaller for advanced economies such as

the United States and Europe and somewhat larger for poorer developing

countries.

•Free trade allows firms or industry to take advantage of economies of scale.

•Protected markets limit gains from external economies of scale by inhibiting the

concentration of industries:

–Too many firms to enter the protected industry.

–The scale of production of each firm becomes inefficient.

•Free trade provides competition and opportunities for innovation (dynamic benefits).

•By providing entrepreneurs with an incentive to seek new ways to export or compete

with imports, free trade offers more opportunities for learning and innovation.

•Free trade avoids the loss of resources through rent seeking.

–Spend time and other resources seeking quota rights and the profit that they will

earn.

•The political argument for free trade says that free trade is the best feasible political

policy, even though there may be better policies in principle.

–Any policy that deviates from free trade would be quickly manipulated by

political groups, leading to decreased national welfare.

The Cases against Free Trade

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•For a “large” country, a tariff lowers the price of imports in world markets and generates

a terms of trade gain.

–This benefit may exceed the losses caused by distortions in production and

consumption.

•A small tariff will lead to an increase in national welfare for a large country.

–But at some tariff rate, the national welfare will begin to decrease as the

economic efficiency loss exceeds the terms of trade gain.

•A tariff rate that completely prohibits imports leaves a country worse off, but tariff rate

tO may exist that maximizes national welfare: an optimum tariff.

•An export tax (a negative export subsidy) that completely prohibits exports leaves a

country worse off, but an export tax rate may exist that maximizes national welfare

through the terms of trade.

•An export subsidy lowers the terms of trade for a large country; an export tax

raises the terms of trade for a large country.

•An export tax may raise the price of exports in the world market, increasing the

terms of trade.

Counter-Argument

•For some countries like the U.S., an import tariff and/or export tax could improve

national welfare at the expense of other countries.

•But this argument ignores the likelihood that other countries may retaliate against large

countries by enacting their own trade restrictions.

•A second argument against free trade is that domestic market failures may exist that

cause free trade to be a suboptimal policy.

•The economic efficiency loss calculations using consumer and producer surplus

assume that markets function well.

•Types of market failures include

•Persistently high underemployment of workers

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Document Summary

The first case for free trade is the argument that producers and consumers allocate resources most efficiently when governments do not distort market prices through trade policy. National welfare of a small country is highest with free trade. For the world as a whole, protection costs less than 1 percent of gdp. The gains from free trade are somewhat smaller for advanced economies such as the united states and europe and somewhat larger for poorer developing countries. Free trade allows firms or industry to take advantage of economies of scale. Protected markets limit gains from external economies of scale by inhibiting the concentration of industries: Too many firms to enter the protected industry. The scale of production of each firm becomes inefficient. Free trade provides competition and opportunities for innovation (dynamic benefits). By providing entrepreneurs with an incentive to seek new ways to export or compete with imports, free trade offers more opportunities for learning and innovation.

Related Questions

Question 6: Which of the following economic goals focuses on equal opportunities for education? (5 points)

-Equity

-Freedom

-Growth

-Security

Question 7: Marcel takes out student loans and works part-time to put himself through college. In time, he earns an advanced medical degree and goes to work in an understaffed city -hospital. Marcel's economic decisions benefit the goal of efficiency by (5 points)

-making his own job

-related decisions

-paying back loans to reduce the debt

-contributing to the nation's productivity

-taking advantage of equal opportunities

Question 8: Two countries produce milk and dairy products efficiently. Neither has an absolute advantage. However, Country A exports milk to Country B, and Country A imports cotton from Country B. Which of the following is inferred? (5 points)

-The opportunity cost of producing milk is lower for Country A.

-The opportunity cost of producing cotton is higher for Country B.

-Country A has a natural resource advantage in cotton.

-Country B has a natural resource advantage in milk.

Question 9: Worker hours to produce one unit of natural gas; Worker hours to produce one unit of oil; Brazil 4 9; Argentina 2 10; Mexico 3 7; United States 1 6. According to the chart, which country has the comparative advantage in oil production? (5 points)

-Brazil

-Mexico

-Argentina

-United States

Question 10: The United States can manufacture books at a much more rapid pace than manufacturers in Indonesia. Which of the following is a reason? (5 points)

-Indonesia, as a developed country, has a highly paid and experienced workforce

-Indonesia, as a developing country, has a less advanced manufacturing infrastructure

-The United States, as a developing country, has a high comparative advantage in manufacturing.

-The United States, as a developed country, has a lower cost of living than Indonesia

Question 11: A group of nations establishes a free-trade zone. What is the most likely effect? (5 points)

-Cost of trade increases

-Exports decrease

-Imports decrease

-Trade increases

Question 12: The United States may have a tariff on cotton products from China in order to (5 points)

-prevent Chinese manufacturers from losing profit because of low prices

-protect the business of the American cotton growers and manufacturers

-stop trade due to political disagreement on economic policy

-promote sales in the United States of cotton products from China

Question 13: A Chinese international salesperson hoping to increase exports to the U.S. may worry about the inflation of the U.S. dollar because the inflation may (5 points)

-increase the United States' supply of Chinese products

-decrease tariffs on Chinese products sold to the United States

-increase taxes on the United States' products sold to China

-reduce the United States' demand for Chinese products

Question 14: How would a strong U.S. dollar impact the trade of grain produced in the United States? (5 points)

-U.S. grain exports decrease

-U.S. grain exports increase

-U.S. grain imports decrease

-U.S. grain imports stagnate

Question 15: Which of these can be a result of inflation? (5 points)

-Businesses grow cautious about spending

-The government has to cut spending

-The price of household items increases

-Workers benefit from a lower cost of living

Question 16: If the inflation rate increases faster than their income, people will most likely (5 points)

-use a higher proportion of their incomes on basic needs

-spend a lower proportion of their incomes on basic needs

-get more goods and services for less money

-obtain fewer goods and services for less money

Question 17: To increase your standard of living, your wages must (5 points)

-rise faster than the inflation rate

-rise more slowly than the inflation rate

-keep pace with the inflation rate

-have a negative inflation rate

Question 18: Look at the map showing the European Union (EU) and its free-trade agreement (FTA) countries. Which is true about most current EU free-trade agreements? (5 points)

-The European Union's free-trade agreements are with all of the most developed nations in the world.

-The European Union's free-trade agreements include agreements with both developed and developing nations.

-The European Union's free-trade agreements focus on nations with access to overland trade routes

-The European Union's free-trade agreements focus on the Southern Hemisphere, as distant countries have access to goods not grown in Europe.

peachyellowjacket690

Too Late to Compensate Free Tradeâs Losers

CAMBRIDGE â It appears that a new consensus has taken hold these days among the worldâs business and policy elites about how to address the antiÂglobalization backlash that populists such as Donald Trump have so ably exploited. Gone are the confident assertions that globalization benefits everyone: we must, the elites now concede, accept that globalization produces both winners and losers. But the correct response is not to halt or reverse globalization; it is to ensure that the losers are compensated.

The new consensus is stated succinctly by Nouriel Roubini: the backlash against globalization âcan be contained and managed through policies that compensate workers for its collateral damage and costs,â he argues. âOnly by enacting such policies will globalizationâs losers begin to think that they may eventually join the ranks of its winners.â

This argument seems to make eminent sense, both economically and politically. Economists have long known that trade liberalization causes income redistribution

and absolute losses for some groups, even as it enlarges a countryâs overall economic pie. Therefore, trade deals unambiguously enhance national wellbeing only to the extent that winners compensate losers. Compensation also ensures support for trade openness from broader constituencies and should be good politics.

Prior to the welfare state, the tension between openness and redistribution was resolved either by largeÂscale emigration of workers or by reÂimposing trade protection, especially in agriculture. With the rise of the welfare state, the constraint became less binding, allowing for more trade liberalization. Today the advanced countries that are the most exposed to the international economy are also those where safety nets and social insurance programs â welfare states â are the most extensive. Research in Europe has shown that losers from globalization within countries tend to favor more active social programs and laborÂmarket interventions.

If opposition to trade has not become politically salient in Europe today, it is partly because such social protections remain strong there, despite having weakened in recent years. It is not an exaggeration to say that the welfare state and the open economy have been flip sides of the same coin during much of the twentieth century.

Compared to most European countries, the United States was a latecomer to globalization. Until recently, its large domestic market and relative geographical insulation provided considerable protection from imports, especially from lowÂwage countries. It also traditionally had a weak welfare state.

When the US began opening itself up to imports from Mexico, China, and other developing countries in the 1980s, one might have expected it to go the European route. Instead, under the sway of Reaganite and marketÂfundamentalist ideas, the US went in an opposite direction. As Larry Mishel, president of the Economic Policy Institute, puts it, âignoring the losers was deliberate.â In 1981, the âtrade adjustment assistance (TAA) program was one of the first things Reagan attacked, cutting its weekly compensation payments.â

The damage continued under subsequent, Democratic administrations. In Mishelâs words, âif freeÂtraders had actually cared about the working class, they could have supported a full range of policies to support robust wage growth: full employment,

collective bargaining, high labor standards, a robust minimum wage, and so on.â And all of this could have been done âbefore administering âshocksâ by expanding trade with lowÂwage countries.â

Could the US now reverse course, and follow the newly emergent conventional wisdom? Back in 2007, political scientist Ken Scheve and economist Matt Slaughter called for âa New Deal for globalizationâ in the US, one that would link âengagement with the world economy to a substantial redistribution of income.â In the US, they argued, this would mean adopting a much more progressive federal tax system.

Slaughter had served in a Republican administration, under President George W. Bush. It is an indication of how polarized the US political climate has become that it is impossible to imagine similar proposals coming out of Republican circles these days. The effort by Trump and his Congressional allies to emasculate former President Barack Obamaâs signature healthÂinsurance program reflected Republicansâ commitment to scaling back, not expanding, social protections.

Todayâs consensus concerning the need to compensate globalizationâs losers presumes that the winners are motivated by enlightened selfÂinterest â that they believe buyÂin from the losers is essential to maintain economic openness. Trumpâs presidency has revealed an alternative perspective: globalization, at least as currently construed, tilts the balance of political power toward those with the skills and assets to benefit from openness, undermining whatever organized influence the losers might have had in the first place. Inchoate discontent about globalization, Trump has shown, can easily be channeled to serve an altogether different agenda, more in line with elitesâ interests.

The politics of compensation is always subject to a problem that economists call âtime inconsistency.â Before a new policy â say, a trade agreement â is adopted, beneficiaries have an incentive to promise compensation. Once the policy is in place, they have little interest in following through, either because reversal is costly all around or because the underlying balance of power shifts toward them.

The time for compensation has come and gone. Even if compensation was a viable approach two decades ago, it no longer serves as a practical response to

globalizationâs adverse effects. To bring the losers along, we will need to consider changing the rules of globalization itself.

QUESTIONS:

a. According to Rodrik, why is it that "trade deals unambiguously enhance national wellbeing only to the extend that winners compensate losers?" Explain completely.

b. Rodrik draws a historical link between globalization and the "welfare state." Explain this link.

c. Rodrik mentions a previous proposal by Scheve and Slaughter called "A New Deal for Globalization." What was the essence of this proposal? What has become of it?

d. What is the "time inconsistency" problem and why is it relevant for Rodrik's argument?

e. In your opinion, what is one weakness in Rodrik's argument? Explain.

maroonporpoise564

We hear so much about the depletion of the ozone, the destruction of the rain forest, the pollution of the oceans and rivers, and the depletion of wildlife because

a. private individuals and businesses lack the time to take full account of these issues.

b. private individuals and businesses donï¿½t care about our environment.

c. scientists are looking to make names for themselves and thereby gain a lot of publicity.

d. the media focuses on negative stories.

e. private individuals and businesses lack incentives to take full account of the consequences of their actions.

4. An externality exists when

a. some of the costs of producing a product affect people unable, within a market system, to influence how much of a product should be produced.

b. only the buyers and sellers are affected by the production of a product or service.

c. every person in a market system has a chance to influence how much of a product should be produced.

d. the benefits from consuming the service affect only the purchasers of that service.

e. the costs of producing a service affect only the sellers of that service.

Why are chickens and cows not listed on the endangered species list?

a. People want to eat chickens and cows.

b. People cannot own a chicken or a cow.

c. Chickens and cows reproduce regularly.

d. Private property rights exist for chicken and cows.

e. People will pay to have chicken or beef.

10. Public radio raises its funding by staging telethons where no programs are aired for a period of time as the station solicits contributions. The stations have trouble raising money because

a. the government assigns private property rights to goods.

b. the consumption of a good cannot be limited to the person who purchased it.

c. the broadcasts are private.

d. people do not act in their own self-interest.

e. a monopoly produces a good.

The United States is a major trading partner for many nations because of the

a. size of the U.S. economy and its relatively high level of income.

b. free market benefits of capitalism.

c. commitment of the United States to help immigrants by both importing from and exporting to their countries of origin.

d. active participation of the United States in both the International Monetary Fund and the World Bank.

e. protection to shipping offered by the U.S. strategic presence in vital commercial areas, such as the Middle East.

18. Which of the following statements about international trade restrictions is true?

a. They typically benefit foreign producers at the expense of domestic consumers.

b. They ensure that countries will specialize in those products which they can produce most efficiently.

c. In the majority of cases they harm consumers.

d. They ensure that only efficient producers survive.

e. They ensure that higher-quality goods are provided at lower prices.

ECON 3601 Lecture Notes - Lecture 9: North American Free Trade Agreement, Median Voter Theorem, Economic Surplus

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