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Midterm Study Notes - Chapter 6-The Political Economy of International Trade

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University of Toronto Mississauga

MGT491 Midterm Notes Chapter 6: The Political Economy of International Trade N Classical trade theories in chapter 5 showed that in a world without trade barriers, trade patterns are determined by the relative productivity of different factors of production in different countries o Countries will specialize in products that they can make most efficiently, while importing products that they can produce less efficiently N Free trade refers to a situation in which a government does not attempt to restrict what its citizens can buy from or sell to another country N Although many nations are nominally committed to free trade, tend to intervene in international trade to protect the interests of politically important groups or promote interests of key domestic producers N US agricultural subsidies have helped protect the relatively inefficient cotton farmers from being exposed to the full forces of competition in the global marketplace o Subsidies remain in place due to the political influence that cotton farmers exert N When governments intervene, they often do so by restricting imports of goods and services into their nation, while adopting policies that promote domestic production and exports N Usually, motives are to protect domestic producers and jobs from foreign competition while increasing the foreign market for products of domestic producers N Social issues have recently become a part of the decision ex. movement in the US to ban imports of goods from countries that do not abide by the same labour, health and environmental regulations as the US INSTRUMENTS OF TRADE POLICY N 7 main instruments: tariffs, subsidies, import quotas, voluntary export restraints, local content requirements, administrative policies, and antidumping duties N Tariffs are oldest and simplest instrument of trade policy, a fall in tariff barriers recently has been accompanied by a rise in nontariff barriers such as subsidies, quotas, etc. Tariffs N Tariff a tax levied on imports (or exports) N 2 categories: o Specific tariffs levied as a fixed charge for each unit of a good imported (ex. 3$ per barrel of oil) o Ad Valorem tariffs levied as a proportion of the value of the imported good N In most cases, tariffs are placed on imports to protect domestic producers from foreign competition by raising the price of imported goods N Also produce revenue for the government until income tax was introduced, the US govt received most of its revenues from tariffs N Government gains increase government revenues N Domestic producers gain tariff affords them some protection against foreign competitors by increasing the cost of imported foreign goods N Consumers lose must pay more for certain imports N 2 conclusions can be derived from economic analysis of the effect of import tariffs: o Tariffs are unambiguously pro-producer and anti-consumer Protect producers from foreign competitors Raises domestic prices Almost all studies find that import tariffs impose significant costs on domestic consumers in the form of higher prices o Import tariffs reduce the overall efficiency of the world economy Protective tariff encourages domestic firms to produce products at home that, in theory, could be produced more efficiently abroad Consequence is inefficient utilization of resources N Sometimes tariffs are levied on exports of a product from a country o Far less common than import tariffs o Objectives: Raise revenue for the government Reduce exports from a sector, often for political reasons N Ex. China imposed a tariff on exports of textiles, primary objective was to moderate the growth in exports of textiles from China, thereby alleviating tensions with other trading partners www.notesolution.comSubsidies N Subsidy government payment to a domestic producer N Many forms, including cash grants, low-interest loans, tax breaks, government equity participation in domestic firms N Lowering production costs to help domestic producers: o Compete against foreign imports o Gain export markets N Agriculture is usually one of the largest beneficiaries of subsidies in most countries N Non-agricultural subsidies are much lower but still significant o Ex. subsidies given to Boeing and airbus to help them lower the cost of developing commercial jet aircraft o 40L3J88:-8LL08.,2017429,[.70L98147# 8503L3J475039,J4324309K,9Z,8:8094 develop military technology which was then transferred to civil aviation projects o L7-:88:-8LL08.,201742J4;0732039O4,38,9-0O4Z-market interest rates N Main gains from subsidies go to domestic producers, whose international competitiveness is increased as a result N Advocates of strategic trade policy (outgrowth of the new trade theory) favour subsidies to help domestic firms achieve a dominant position in industries where economies of scale are important, and the world market is not large enough to profitably support more than a few firms o Ex. aerospace, semiconductors o According to this argument, subsidies can help a firm achieve first-mover advantages in an emerging industry o If this is achieved, further gains to the domestic economy arise from the employment and tax revenues that a major global company can generate N Government subsidies must be paid for, typically by taxing individuals and corporations N Many subsidies are not that successful at increasing the international competitiveness of domestic producers, but rather they protect the inefficient and promote excess production N Ex: agricultural subsidies: o Allow inefficient farmers to stay in business o Encourage countries to overproduce heavily subsidized agricultural products o Encourage countries to produce products that could be grown more cheaply elsewhere and imported o Reduce international trade in agricultural products Import Quotas and Voluntary Export Restraints N Import quota direct restriction on the quantity of some good that may be imported into a country, usually enforced by issuing import licenses to a group of individuals or firms o Ex. cheese, only certain trading companies allowed to import cheese, only can import a certain quantity each year N Tariff rate quota common hybrid of a quota and a tariff a lower tariff rate is applied to imports within the quota than those over the quota (ex. an ad valorem tariff rate of 10% might be levied on rice imports of 1 million tons, after which an out-of-quota rate of 80% might be applied.) o Common in agriculture where their goal is to limit imports over quota N Voluntary export restraint (VER) variation the import quota, it is a quota on trade imposed by the exporting .4:39795L.,OO,99K0706:089419K0L25479L3J.4:3978J4;0732039 o Foreign producers agree to VERs because they fear more damaging punitive tariffs or import quotas might follow if they do not comply. o Agreeing to a VER is seen as a way to make the best of a bad situation by appeasing protectionist pressures in a country N Both import quotas and VERs benefit domestic producers by limiting import competition N Quotas do not benefit consumers always raises the domestic price of an imported good N The extra profit that producers make when supply is artificially limited by an import quota (and therefore the prices go up) is referred to as a quota rent. N If a domestic industry lacks the capacity to meet demand, an import quota can raise prices for both the domestically produced and the imported good Local Content Requirements N Local content requirement a requirement that some specific fraction of a good be produced domestically
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