‚Trade and Development‘
Table of Contents
3. Trade and Development
3.2 Trade protection – the arguments a) Effects of an import tariff
b) Effects of an export subsidy
c) Arguments for trade policy
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff
Assumption: small country (tariff has no effect on terms of trade)
Partial equilibrium analysis
Consider the effect of a specific tariff/ ad valorem tariff on the domestic market for
the imported good:
•
•
•
increase in domestic price
or
price
protected industry expands domestic production
decrease in domestic consumption
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above world market
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff Figure 11: Partial equilibrium analysis of an import tariff
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff
Welfare analysis:
•
∆Welfare= ∆Consumer surplus + ∆producer surplus + ∆government balance
•
•
•
•
∆Consumer surplus:
∆Producer surplus:
∆Government: tariff revenues:
Total Welfare effect:
‐(a+b+c+d)
+a
+c
‐(b+d)
 deadweight loss (production‐ and consumption bias)
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff
General equilibrium analysis
An import tariff leads to output expansion in the import‐competing industry which
needs a reallocation of resources (due to full employment condition) and, thus, affects
the output of the export industry.
A tariff leads to an increase in the domestic relative price:
1
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff General equilibrium analysis
Figure 12: General equilibrium analysis of an import tariff
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff
Effects of an import tariff in a small country
•
•
•
•
expansion in import‐competing industry (y1) at the expense of export‐oriented
industry (y2)
decrease in consumption: substitution‐ and income effect
decreasing trade flows, less specialization
decreasing welfare
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3. Trade and Development
3.2 Trade protection
a) Effects of an import tariff ‐ Differences between tariffs and quotas:
•
•
•
c represents tariff revenues (in case of import tariff), and quota rents (in case of
import quota), distribution of quota rents:
– Distribution of import licenses to domestic firms (quota rent as profits from
importing), welfare loss as in the case of a tariff.
– Auctioning of import licenses (c represents government revenues from
auction), welfare loss as in the case of a tariff.
– Rent‐seeking activities to obtain import licenses (MR equal MC of rent‐
seeking), welfare loss is higher than in the case of a tariff.
– Voluntary export restrains: quota rents obtained by foreign firms/government,
welfare loss higher than in the case of a tariff.
dynamic perspective on tariffs and quotas: efficiency enhancing effects of a tariff
vs. quality upgrading due to a quota
A quota is selective and discriminatory.
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
Assumption: small country (subsidy has no effect on terms of trade)
Partial equilibrium analysis
Consider the effects of an export subsidy on the domestic market for the exported
goods
•
•
•
increase in domestic price:
or
1
above world market
price creates incentives to produce export goods (for the domestic market)
export industry expands production
decrease in domestic consumption
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
Figure 13: Partial equilibrium analysis of an export subsidy
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
•
Welfare analysis:
•
∆Welfare= ∆Consumer surplus + ∆producer surplus + ∆government balance
•
•
•
•
∆Consumer surplus: ∆Producer surplus:
∆Government: tariff revenues:
Total Welfare effect: ‐ (a+b)
+(a+b+c)
‐ (b+c+d)
‐ (b+d)  deadweight loss (production‐ and consumption bias) Susanne Fricke ‐ Summer Term 2016
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
General equilibrium analysis An export subsidy leads to output expansion in the export industry (y2) which needs a reallocation of resources (full employment condition) and, thus, affect output of the import industry (y1).
An export subsidy leads to a decrease in the domestic relative price: 1
1
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
General equilibrium analysis Figure 14: General equilibrium analysis of an export subsidy
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3. Trade and Development
3.2 Trade protection
b) Effects of an export subsidy
Effects of an export subsidy in a small country
•
•
•
•
further expansion of output in export‐oriented industry (y2) at the expense of
import industry (y1)
decrease in consumption: substitution‐ and income effect
increasing trade flows, inefficient specialization
decreasing welfare
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy – 1. Infant industry argument
(import‐substitution and industrialization)
•
Protection of an industry would be desirable if firms in the industry will have a
potential comparative advantage in the future.
•
aim: industrialize and diversify export structure
•
Achieving comparative advantage is not possible without protection because costs
to produce the output are above world market price.
•
Protection of the infant industry allows to gain learning curve effects, realize
economies of scale (decreasing average costs), and spillover effects to other
industries.
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy – 1. Infant industry argument
(import‐substitution and industrialization)
Figure 15: Infant industry protection
p, AC
AC0
A
P1
B
ACforeign
ACdomestic
cumulated Output
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy – 1. Infant industry argument
(import‐substitution and industrialization)
Critical questions
•
•
•
•
•
Do we know today how the industry will perform in the future?
Will import protection make inefficient firms efficient? Or will inefficient firms
enter the market due to import protection?
Is there any incentive for the firms to lower average costs such that the protection
becomes needless? (gaining rents from protection)
Protection may not be a short‐term issue but become a long‐term payment
Alternative instruments to support industrialization? (subsidies, grants)
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 2. Strategic trade policy
(export promotion and rent‐shifting argument)
(Literature on strategic trade policy emerged in 1980s (i.e. Brander and Spencer
1982))
The rent‐shifting argument
•
Oligopolistic rents can be shifted from the foreign firm to the home firm. An export subsidy will lead to higher output and higher profits of the home firm and higher national welfare because the profit effect outbalances the costs of the subsidy (by assumption).  optimal level of subsidy maximizes national welfare
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 2. Strategic trade policy
(export promotion and rent‐shifting argument)
Assumptions of the models in general
•
imperfect competition (oligopoly: two countries each having a single firm)
•
firms produce homogenous good for a third market, no domestic sales
•
Cournot competition: quantities not prices
•
no consumers, welfare effect due to increase in firm profits
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 2. Strategic trade policy
(export promotion and rent‐shifting argument)
Critical questions:
•
retaliation measures (foreign country pays subsidy as well)  Prisoners Dilemma:
subsidy is the dominant strategy, but free trade better than subsidies
•
Bertrand competition on prices reverses the result: subsidy lead to decreasing
prices and, thus, profits and welfare loss. A tax would be optimal.
•
knowledge about the market?
•
cost of lobbying reduce welfare
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
Assumption: large country (tariff has an effect on world demand and world prices)
Partial equilibrium analysis
Consider the effect of an import tariff on the domestic market in a large country:
•
•
•
•
increase in domestic price:
or
1
above world market
price
protected industry expands domestic production
decrease in domestic consumption
Decrease in domestic demand for import goods lead to lower world market price
for imports.
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
Figure 16: Partial equilibrium analysis of an import tariff (ToT‐effect)
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
Welfare analysis:
• ∆Welfare= ∆Consumer surplus + ∆producer surplus + ∆government balance + ToT
•
•
•
•
•
∆Consumer surplus:
∆Producer surplus:
∆Government: tariff revenues:
∆ Terms‐of‐trade:
Total Welfare effect:
‐(a+b+c+d)
+a
+c
+e
‐(b+d) + e
 total effect depends on terms‐of‐trade effect relative to deadweight loss
 positive if terms‐of‐trade effect outbalances deadweight loss
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
General equilibrium analysis
•
•
An import tariff leads to output expansion in the import‐competing industry (y1)
which needs a reallocation of resources (full employment condition) and, thus,
affects output of the export industry (y2).
An import tariff leads to an increase in the domestic relative price.
1
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
General equilibrium analysis
•
On the world market: Decreasing domestic demand for imports and decreasing
domestic supply of exports lead to an improvement in the terms‐of‐trade:
↑
↓
↑
With respect to the following figure:
↓
↑
↓
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
General equilibrium analysis Figure 17: General equilibrium analysis of an import tariff (ToT‐effect)
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
(improvements of the terms‐of‐trade argument)
Effects of an import tariff in a large country
•
•
•
•
expansion in import‐competing industry (y1) at the expense of export‐oriented
industry (y2)
World market prices for imports decrease while world market prices for export
goods increase (terms‐of‐trade effect)
If terms‐of‐trade effect outbalances the production‐ and consumption bias, the
country gains from an import tariff
Export promotion instead of import substitution: What does the terms‐of‐trade
argument imply for an export subsidy?
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
Partial equilibrium analysis
Consider the effects of an export subsidy in a large country on the domestic market:
•
•
•
•
increase in domestic price:
or
1
above world market
price
export‐industry expands domestic production
decrease in domestic consumption
increase in domestic supply on world markets lead to lower world market price for
exports
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
Figure 18: Partial equilibrium analysis of an export subsidy (ToT‐effect)
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
Welfare analysis:
• ∆Welfare= ∆Consumer surplus + ∆producer surplus + ∆government balance + ToT
•
•
•
•
•
∆Consumer surplus:
∆Producer surplus:
∆Government: tariff revenues:
∆ Terms‐of‐trade:
Total Welfare effect:
‐ (a+b)
+(a+b+c)
‐(b+c+d)
‐ (e+f+g)
‐ (b+d) – (e+f+g)
 Total effect depends on terms‐of‐trade effect relative to deadweight loss.
 positive if terms‐of‐trade effect outbalances deadweight loss
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
General equilibrium analysis
•
•
An export subsidy leads to output expansion in the export industry (y2) which
needs a reallocation of resources (full employment condition) and, thus, negatively
affects output of import industry (y1).
An export subsidy leads to a decrease in the domestic relative price.
1
1
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
General equilibrium analysis
•
On the world market: Increasing domestic supply of export goods and increasing domestic demand for import goods lead to a negative terms‐of‐trade effect: •
↓
↑
↓
with respect to the following figure
↑
↓
↑
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3. Trade and Development
3.2 Trade protection
c) Arguments for trade policy ‐ 3. Optimal tariff
Export subsidy in the case of a large country
General equilibrium analysis
Figure 19: General equilibrium analysis of an export subsidy (ToT‐effect)
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