Master in Human Development and Food Security
2014-2015
International Economics
Lecture 3
Dr. Silvia Nenci
University of Roma Tre
[email protected]
Silvia Nenci
Outline
A brief summary of the H-O Model
• In class problems
The New Trade Theories
The New New Trade Theories: Firms in international trade
Trade Policies: Tariffs, Non-tariff barriers, New instruments for
Trade agreements
protection
Reading & discussion
Silvia Nenci
A brief summary of
the H-O Model
Silvia Nenci
Heckscher-Ohlin Model
The model was developed in 1919 by two Swedish economists,
Eli Heckscher and Bertil Ohlin
Basic assumptions:
• 2 countries: Home and Foreign
• 2 goods: computers and shoes
• 2 factors of production: labor and capital
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Heckscher-Ohlin Model
Assumptions of the Heckscher-Ohlin Theorem:
Assumption 1: Labor and capital flow freely between the
industries.
Assumption 2: The production of shoes is labor-intensive as
compared with computer production, which is capital-intensive.
Assumption 3: The amounts of labor and capital found in the
two countries differ, with Foreign abundant in labor and Home
abundant in capital.
Assumption 4: There is free international trade in goods.
Assumption 5: The technologies for producing shoes and
computers are the same across countries.
Assumption 6: Tastes are the same across countries.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (3 of 3)
A higher relative price of computers
Because Home is capital abundant and
computers are capital intensive, the Home
PPF is skewed toward computers.
The Home no-trade (or autarky) equilibrium
is at point A.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Foreign is labor-abundant and shoes
are labor- intensive, so the Foreign
PPF is skewed toward shoes.
The Foreign no-trade equilibrium is at
point A*, with a higher relative price
of computers, as indicated by the
A*.
steeper slope of (P*C /P*
Silvia
S) Nenci
Heckscher-Ohlin Model
Free-Trade Equilibrium
The Heckscher-Ohlin theorem states that:
• Home exports computers, the good that uses
intensively the factor of production (capital) found in
abundance at Home.
• Foreign exports shoes, the good that uses intensively
the factor of production (labor) found in abundance
there.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (1 of 2)
International Free-Trade Equilibrium at Home
At the free-trade world relative price of
computers, (PC /PS)W,
Home produces at point B in panel (a) and
consumes at point C,
exporting computers and importing shoes.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Point A is the no-trade equilibrium.
The “trade triangle” has a base equal to
the Home exports of computers (the
difference between the amount produced
and the amount consumed with trade,
(QC2 − QC3). The height of this triangle is
the Home imports ofSilvia
shoes
(QS3 − QS2).
Nenci
Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (1 of 2)
International Free-Trade Equilibrium in Foreign
At the free-trade world relative price of
computers, (PC /PS)W, Foreign produces at
point B* in panel (a) and consumes at point C*,
importing computers and exporting shoes.
Point A* is the no-trade equilibrium
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
The “trade triangle” has a base equal to
Foreign imports of computers (the
difference between the consumption of
computers and the amount produced with
trade, (Q*C3 − Q*C2). The height of this
triangle is Foreign exports of shoes
(Q*S2 – Q*S3).
Silvia Nenci
K
e y POINTS
T e r m of the Heckscher-Ohlin model
KEY
1. In the Heckscher-Ohlin model countries trade because the
available resources (labor, capital, and land) differ across
countries.
2. In the Heckscher-Ohlin model, we assume that the technologies
are the same across countries
3. The Heckscher-Ohlin model is a long-run framework, so labor,
capital, and other resources can move freely between the
industries
4. Patterns of trade: With two goods, two factors, and two
countries, the Heckscher-Ohlin model predicts that a country will
export the good that uses its abundant factor intensively and
import the other good.
Silvia Nenci
IN-CLASS PROBLEMS
Silvia Nenci
I N - C L A S S P R O B L E M S:
the H-O Model
1. Belgium is relatively well endowed with skilled workers compared
with China, which is relatively well endowed with unskilled workers.
Assume that the production of pharmaceutical products intensively
uses skilled workers and the production of toys intensively uses
unskilled workers.
Which country would you expect to have a higher relative wage in
skilled labor with no trade?
Answer: Belgium has a lower relative wage in skilled labor. This is
because skilled workers are in relative great supply in Belgium and so
their wages are relatively lower; vice versa for China: skilled workers
are in relatively low supply in China, so wages are relatively higher.
Silvia Nenci
I N - C L A S S P R O B L E M S:
the H-O Model
2. Compare the basis for trade between the Ricardian model and
Heckscher-Ohlin model.
How do the assumptions lead to differences in the pattern of trade
between countries in each of the models?
Answer: In the Ricardian model, comparative advantage determines
the pattern of trade. More specifically, the basis of trade is
determined by differences in technologies. The country with the
better technology (lower opportunity cost) will specialize and export
that product.
By contrast, factor endowments determine the pattern of trade in the
Heckscher-Ohlin model because technologies are assumed to be
identical across countries. In particular, a country will export the good
that uses intensively the factor of which it has an abundance.
Silvia Nenci
I N - C L A S S P R O B L E M S:
the H-O Model
3. Suppose Ireland and Canada produce two goods, Y and X. Assume
that good Y is labor intensive and good X is capital intensive.
Given these PPFs, which
country is relatively laborabundant? Capital-abundant?
Explain
Answer: Canada is capital-abundant whereas Ireland is laborabundant because Canada’s PPF is biased toward the capitalintensive good whereas Ireland’s PPF is biased toward the laborintensive good.
Silvia Nenci
The New Trade Theories
Silvia Nenci
Why countries trade
Silvia Nenci
USA's main exports to Germany
Unit : US Dollar thousand
P roduc t c ode
P roduc t la be l
Unite d S ta te s of Ame ric a 's e xports to G e rma ny
V a lue in 2 0 11
TOTAL
All produc ts
'87
V a lue in 2 0 12
V a lue in 2 0 13
48779200
48354852
47442249
Vehic les other than railway, tramway
6721872
7297720
6051037
'90
Optical, photo, tec hnical, medical, etc apparatus
5828342
5858626
5996439
'84
Mac hinery, nuclear reac tors, boilers, etc
6039220
5894851
5884932
'88
Aircraft, spac ec raft, and parts thereof
5674397
5656078
5809280
'85
Elec tric al, electronic equipment
4441704
4176456
4265620
'30
Pharmaceutic al products
2515682
2561810
2208824
'71
Pearls, precious stones, metals, coins, etc
1806466
1487383
1984524
'38
Miscellaneous chemic al produc ts
1503566
1458161
1580185
'99
Commodities not elsewhere spec ified
1448146
1389431
1360073
'29
Organic chemic als
1337973
1357339
1288524
'39
Plastic s and articles thereof
1308694
1196360
1188499
'27
Mineral fuels, oils, distillation produc ts, etc
1350587
1054978
863414
'12
Oil seed, oleagic fruits, grain, seed, fruit, etc , nes
352425
940514
812558
'08
Edible fruit, nuts, peel of c itrus fruit, melons
434239
466485
649739
'70
Glass and glassware
597946
540389
563711
'97
390647
363781
360520
'28
Works of art, collectors piec es and antiques
Inorganic c hemicals, prec ious metal compound,
isotopes
565399
440523
343005
'73
Articles of iron or steel
346606
343240
334642
'33
Essential oils, perfumes, cosmetics, toileteries
283269
314646
321851
'03
Fish, crustaceans, molluscs, aquatic invertebrates nes
289951
284451
314551
'74
Copper and articles thereof
274593
305286
301160
'47
Pulp of wood, fibrous cellulosic material, waste etc
292599
309415
270139
'40
332220
285797
270080
'48
Rubber and articles thereof
Paper and paperboard, articles of pulp, paper and
board
290031
269107
267940
'22
Beverages, spirits and vinegar
181023
184968
Silvia
Nenci
259122
USA's main imports from Germany
P roduc t c ode
P roduc t la be l
Unite d S ta te s of Ame ric a 's imports from G e rma ny
V a lue in 2 0 11
TOTAL
All products
'87
V a lue in 2 0 12
V a lue in 2 0 13
100392798
110602812
116924737
Vehicles other than railway, tramway
25005279
29992279
33168142
'84
Mac hinery, nuc lear reactors, boilers, etc
20696991
22469147
22374261
'30
Pharmaceutical produc ts
8509406
10185517
11174901
'90
Optical, photo, technic al, medical, etc apparatus
8865467
8926945
9036842
'85
Elec trical, electronic equipment
7657145
7849851
7808184
'99
Commodities not elsewhere spec ified
3212837
3492118
3717551
'29
Organic chemicals
2921629
3137577
3444239
'88
Airc raft, spacecraft, and parts thereof
1570659
1523341
2973561
'39
Plastic s and articles thereof
2306547
2504781
2643734
'73
Articles of iron or steel
1646913
2156193
1913667
'38
Miscellaneous chemical produc ts
1328337
1463370
1707361
'71
Pearls, prec ious stones, metals, c oins, etc
1414710
903251
1209582
'40
Rubber and artic les thereof
1128266
1202111
1200480
'28
Inorganic chemic als, precious metal compound,
isotopes
1340807
1293421
1097083
'72
Iron and steel
1300607
1265146
1078080
'48
Paper and paperboard, artic les of pulp, paper and
board
936960
915384
835700
'97
Works of art, collectors pieces and antiques
462857
853995
834437
'82
Tools, implements, cutlery, etc of base metal
649169
737781
815718
'94
Furniture, lighting, signs, prefabricated buildings
600225
599737
677175
'74
Copper and artic les thereof
675953
646996
626613
'76
Aluminium and artic les thereof
675225
663743
619956
'32
Tanning, dyeing extrac ts, tannins, derivs,pigments etc
517686
566919
598737
'70
Glass and glassware
537270
546710
542178
'22
Beverages, spirits and vinegar
555586
487750
468667
'83
Miscellaneous articles of base metal
391987
440838
466874
Silvia Nenci
Why do countries export and import the
same goods and/or services?
The Ricardian model and the H-O model explain why
countries trade but do not predict the simultaneous
import and export of a product
In those models, markets were perfectly competitive:
• many small producers of identical product not able to
influence the market price
To explain trade of the same product,
we need to
change those assumptions
Silvia Nenci
The New Trade Theory
“Thirty years have passed since a small group of theorists began applying concepts
and tools from industrial organization to the analysis of international
trade. The new models of trade that emerged from that work didn’t supplant
traditional trade theory so much as supplement it, creating an integrated
view that made sense of aspects of world trade that had previously posed
major puzzles. The “new trade theory” – an unfortunate phrase, now quite
often referred to as “the old new trade theory” – also helped build a bridge
between the analysis of trade between countries and the location of production
within countries”. THE INCREASING RETURNS REVOLUTION IN TRADE AND
GEOGRAPHY, Prize Lecture, December 8, 2008, Paul Krugman
New trade theory (NTT) is a collection of economic models in international trade developed in the late 1970s and early 1980s -which focuses on the role of increasing
returns to scale.
Silvia Nenci
The New Trade Theory
2 key hypotheses:
Imperfect competition (monopolistic competition, duopoly,
oligopoly)
Differentiated goods: in perfectly competitive markets, the
goods produced are homogeneous. Now we assume that
goods are differentiated.
Silvia Nenci
A model of monopolistic competition:
introduction
• Monopolistic competition has two key features:
• The goods produced by different firms are
differentiated (firms are able to exert some control
over the price).
• Firms enjoy increasing returns to scale, by which we
mean that the average costs for a firm fall as more
output is produced (by selling not only in the home
market but also in the foreign market firms can
increase their returns to scale)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
A model of monopolistic competition:
introduction - 2
• We now analyse a model of trade under monopolistic competition
with product differentiation and increasing returns to scale
• This model explains trade in the same type of product (very common
nowadays):
Intra-industry trade deals with imports and exports in the
same industry.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
K
e y Tofe monopolistic
rm
Model
competition: KEY POINTS
1.
The monopolistic competition model assumes differentiated products, many
firms, and increasing returns to scale. Firms enter whenever there are profits
to be earned, so profits are zero in the long-run equilibrium
2.
When trade opens between two countries, the demand curve becomes more
elastic, as consumers have more choices and become more price-sensitive.
Firms then lower their prices in an attempt to capture consumers from their
competitors and obtain profits. When all firms do so, however, some firms
incur losses and are forced to leave the market.
3.
Introducing international trade leads to additional gains from trade for two
reasons: (i) lower prices as firms expand their output and lower their average
costs and (ii) additional imported product varieties available to consumers.
There are also short-run adjustment costs, such as unemployment, as some
firms exit the market.
4.
Conclusion: The assumption of differentiated goods helps us to understand
why countries often import and export varieties of the same type of good.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Assumptions of the model of monopolistic competition:
Assumption 1: Each firm produces a good that is similar to
but slightly differentiated from the goods that other firms in
the industry produce.
•Each firm faces a downward-sloping demand curve for its
product and has some control over the price it charges.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Assumption 2: There are many firms in the industry
• If the number of firms is N, then D/N is the share of demand
that each firm faces when the firms are all charging the same
price.
• When only one firm lowers its price, however, it will face a
flatter demand curve.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Assumption 3: Firms produce using a technology with
increasing returns to scale.
FIGURE 6-3
Increasing Returns to
Scale This diagram
shows the average
cost, AC, and marginal
cost, MC, of a firm.
Increasing returns to
scale cause average
costs to fall as the
quantity produced
increases.
Marginal cost is below
average cost and is
drawn as constant for
simplicity.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Numerical Example of Increasing Returns to Scale
TABLE 6-2
Cost Information for the Firm This table illustrates increasing returns to
scale, in which average costs fall as quantity rises.
Whenever the price charged is above average costs, then a firm
earns monopoly profits.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Assumption 4: Because firms can enter and exit the industry
freely, monopoly profits are zero in the long run.
• Firms will enter as long as it is possible to make monopoly
profits, and the more firms that enter, the lower profits per
firm become.
• Profits for each firm end up as zero in the long run, just as
in perfect competition.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Next, we will examine monopolistic competition:
• in the short run
without trade
• in the long run
• in the short run
• in the long run
with free trade
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium without Trade
Short-Run Equilibrium
FIGURE 6-4
Short-Run Monopolistic
Competition Equilibrium
without Trade The shortrun equilibrium under
monopolistic competition
is the same as a monopoly
equilibrium.
The firm chooses to
produce the quantity Q0 at
which the firm’s marginal
revenue, mr0, equals its
marginal cost, MC.
The price charged is P0.
Because price exceeds
average cost, the firm
makes monopoly profits.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium without Trade
Long-Run Equilibrium
FIGURE 6-5 (1 of 2)
Long-Run Monopolistic Competition
Equilibrium without Trade
Drawn by the possibility of making
profits in the short-run equilibrium,
new firms enter the industry (drawing
demand away from existing firms and
producing more product varieties)
and the firm’s demand curve, d0,
shifts to the left and becomes more
elastic (i.e., flatter), shown by d1.
The long-run equilibrium under
monopolistic competition occurs at
the quantity Q1 where the marginal
revenue curve, mr1 (associated with
demand curve d1), equals marginal
cost.
At that quantity, the no-trade price,
PA, equals average costs at point A.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium without Trade
Long-Run Equilibrium
FIGURE 6-5 (2 of 2)
Long-Run Monopolistic
Competition Equilibrium without
Trade
In the long-run equilibrium, firms
earn zero monopoly profits and
there is no entry or exit. The
quantity produced by each firm is
less than in short-run equilibrium
(Figure 6-4). Q1 is less than Q0
because new firms have entered
the industry.
With a greater number of firms and
hence more varieties available to
consumers, the demand for each
variety d1 is less then d0. The
demand curve D/NA shows the notrade demand when all firms
Firm’s demand curve
charge the same price.
(quantity demanded depending on the price charged by that firm)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Short-Run Equilibrium with Trade
Assume Home and Foreign are exactly the same.
• Same number of consumers
• Same technology and cost curves
• Same number of firms in the no-trade equilibrium
Given the above conditions, if there are economies of scale, there
is reason for trade.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Short-Run Equilibrium with Trade
• The number of firms in the no-trade equilibrium in each
country is NA.
• When trade opens, the number of customers available to
each firm doubles.
• (Since there are twice as many consumers, but also twice as
many firms, the ratio stays the same (D/NA)).
• The product varieties also double.
• With the greater number of varieties available, the demand
for each individual variety will be more elastic.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Short-Run Equilibrium with Trade
FIGURE 6-6 (1 of 2)
Short-Run Monopolistic
Competition Equilibrium with
Trade
When trade is opened, the
larger market makes the firm’s
demand curve more elastic, as
shown by d2 (with
corresponding marginal
revenue curve, mr2).
The firm chooses to produce
the quantity Q2 at which
marginal revenue equals
marginal costs;
this quantity corresponds to a
price of P2 (point B). With sales
of Q2 at price P2, the firm will
make monopoly profits
because price is greater than
AC.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Short-Run Equilibrium with Trade
FIGURE 6-6 (2 of 2)
Short-Run Monopolistic
Competition Equilibrium with
Trade
When all firms lower their
prices to P2, however, the
relevant demand curve is D/NA,
which indicates that they can
sell only Q′2 at price P2.
At this short-run equilibrium
(point B′), price is less than
average cost and all firms incur
losses. As a result, some firms
are forced to exit the industry.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Long-Run Equilibrium with Trade
• Since firms are making losses, some of them will exit the
industry.
• Firm exit will increase demand for the remaining firms’
products and decrease the available product varieties to
consumers.
• We now have NT firms which is fewer than the NA firms we
had before.
• The new demand D/NT >D/NA (because the reduction of firms
increases the share of demand facing each one)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Long-Run Equilibrium with Trade
FIGURE 6-7 (1 of 2)
Long-Run Monopolistic
Competition Equilibrium with
Trade
The long-run equilibrium with
trade occurs at point C.
At this point, profits are
maximized for each firm
producing Q3 (which satisfies
mr3 = MC) and charging price PW
(which equals AC). Since
monopoly profits are zero when
price equals average cost, no
firms enter or exit the industry.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Long-Run Equilibrium with Trade
FIGURE 6-7 (2 of 2)
Long-Run Monopolistic
Competition Equilibrium with
Trade (continued)
Compared with the long-run
equilibrium without trade at
point A, the trade equilibrium at
point C has a lower price and
higher sales by all surviving
firms.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Gains from Trade
The long-run equilibrium at point C has two sources of gains
from trade for consumers:
1. A drop in price:
The lower price is a result of increased productivity of the
surviving firms coming from increasing returns to scale.
2. Gains from trade to consumers:
Although there are fewer product varieties made within
each country (by fewer firms), consumers have more
product variety because they can choose products of the
firms from both countries after trade.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Trade under Monopolistic Competition
Equilibrium with Free Trade
Adjustment Costs from Trade
• There are adjustment costs associated with monopolistic
competition, as some firms shut down or exit the industry.
• Workers in those firms experience a spell of unemployment.
• Over the long run, however, we could expect those workers
to find new jobs, so these costs are temporary.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Conclusions of the model
• When firms have differentiated products and increasing returns
to scale, there is a potential for gains from trade that did not
exist in earlier models.
• The model of monopolistic competition shows that trade will
occur between countries even if these countries are identical.
• There is trade within the same industries across countries
because there is a potential to sell in a larger market.
• This will induce firms to lower their prices below those charged
in the absence of trade.
• As firms exit, remaining firms increase their output and average
cost falls. Lower costs results in lower prices for consumers in
the importing country.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
Conclusions-2
• Lower prices and higher product variety are the gains from trade
under monopolistic competition.
• However, since some firms exit the market, there are short-run
adjustment costs due to worker displacement.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Silvia Nenci
A brief introduction to
the New New trade theory:
firms in international trade
(or heterogeneous firms)
Silvia Nenci
Firms in international trade
• Under Ricardian Model and H-O Model firms are black
boxes
• Under New trade theories:
firms' dimension counts with increasing return to
scale, but all domestic firms will export after
opening up to trade;
there is a firm-exit effect, but it is indeterminate
which firms exit the market
• Micro-level empirical evidence (see the many papers
by Bernard, et al. starting in the mid-90s) show stylized
facts unexplained under these theories
Silvia Nenci
Firms in international trade -2
• Firms are very different in terms of productivity
• Only a minority of firms are exporters
• Usually exporters are more productive
• Exporting is characterized by fixed costs
What effects on gains from trade?
• Opening up to trade kicks out the least productive
firms and enhances average productivity.
Hence, need a framework that could account for firms‘
heterogeneity
Silvia Nenci
The “New” new trade theory
This framework is called the “New” new trade theory (or the theory
of heterogeneous firms)
• Melitz (2003) constructed a model in which only a few highly
productive firms are engaged in export:
these firms are able to make sufficient profits to cover the
large fixed costs required for export operations.
• Helpman et al. (2004) expanded the Melitz (2003) model into
one in which the productivity of exporting firms is lower than
that of firms engaged in local production overseas (FDI).
only productive firms can cover the enormous fixed costs
(local factory construction, etc.) entailed in local production
overseas.
These "Melitz-type models" constituted the theoretical foundations
for empirical research based in particular on firm-level data.
Silvia Nenci
The “New” new trade theory -2
New source of trade gains:
• When lowered trade barriers stimulate competition on a
global scale, low-productivity firms that had been protected
are forced to withdraw from the market, replaced by the
increased production volume of high-productivity firms.
• As a consequence, the average productivity of a country on
the whole rises. This rise in average productivity means a rise
in people's real income; people become wealthier through
the natural selection of firms on a global scale.
Silvia Nenci
IN-CLASS PROBLEMS
Silvia Nenci
I N - C L A S S P R O B L E M S:
the New Trade Theory
1. Portland and Aleland are two identical countries. Beer
manufacturers in each country compete under monopolistic
competition.
a. Suppose the two countries engage in trade. Determine the impact
of free trade on consumers in Portland.
Answer: Consumers in Portland will gain from an increase in the
varieties of beer available through importing. Additionally, prices will
fall due to the increased competition.
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I N - C L A S S P R O B L E M S:
the New Trade Theory
2. How does trade affect the welfare of domestic producers in
Portland?
Answer:
- By selling abroad, the producers in Portland will be able to lower
their average costs through increasing returns to scale.
- However, they will face greater competition in their local market
due to new varieties available from the import of beer from
Aleland. As a result of the competition from Aleland, consumer
demand for their variety decreases, thus driving their prices down.
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I N - C L A S S P R O B L E M S:
the New Trade Theory
3. In the monopolistic competition model, would you expect prices to
be higher or lower as the number of firms increases? Briefly explain
why.
Answer: As the number of firms increases, there will be more product
varieties available to the consumers. Due to the increase in
competition, the demand curve for the existing firms become more
elastic and the demand for each variety decreases, leading to a fall in
prices.
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I N - C L A S S P R O B L E M S:
the New Trade Theory
4. Look at the table. At what level of output does the
firm experience increasing returns to scale?
Answer: The firm experiences increasing returns to scale
over the range of 5 to 270 units of output.
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Trade Policies
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Trade Policies
• Tariffs
• Non-tariff barriers
• New instruments for protection
Trade agreements
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Trade policy -2
The government of a country can use laws and regulations, called
“trade policies,” to affect international trade flows
The most commonly used trade policies are:
• Import Tariffs: A tax on a good coming into a country
• Import Quotas: Physical restriction on the number of goods
coming into a country
• Non-Tariff Barriers: Any methods not covered by a tariff (ex:
standards on fuel emissions from cars; documentation
required to sell drugs in different countries, ingredients in
products ; etc), most usually:
– Legislation
– Rules
– Exacting Standards or Specifications
– Regulations
– Voluntary Export Restraints (VERs)
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Arguments pro-protectionism
Common reasons in favour of protectionism:
• Protect domestic industries
• Protect domestic employment
• Strategic reasons
• Political pressures (lobbies)
From a theoretical standpoint, the traditional and modern approaches to the
trade theory substantially agreed on the fact that protection produce
distortive effects on the economy that introduces it.
But there are cases against free trade:
• Optimal tariff (terms of trade gains): for a “large” country, a small tariff or
quota lowers the price of imports in world markets leading to an increase in
national welfare that may exceed the losses caused by distortions (but risk of
retaliation!).
• Theory of the second best: if domestic market failures exist (persistently high
under-employment of workers, under-utilization of capital, environmental
costs for society , property rights not well defined ), free trade can be a
suboptimal policy (government intervention may increase national welfare by
offsetting the consequences of market failures)
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Types of Tariffs
A tariff is a tax levied when a good is imported.
A specific tariff is levied as a fixed charge for each
unit of imported goods.
• For example, $3 per barrel of oil.
An ad valorem tariff is levied as a fraction of the
value of imported goods.
• For example, 25% tariff on the value of imported
trucks.
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Costs and Benefits of Import tariffs:
the small country’s case
To examine the effect of an import tariff on Home’s welfare by assuming that
Home is a small country taking the world price as fixed (the world price is
unchanged by the tariff applied by the importing country).
0
•
•
•
Applying a tariff of t dollars will increase the import price from PW to PW + t.
The domestic price of that good also rises to PW + t. This price rise leads to an increase
in Home supply from S1 to S2, and a decrease in Home demand from D1 to D2.
Imports fall due to the tariff from S1D1 to S2D2.
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Import tariff: the small country’s case -2
Effects of Tariff :
Consumer Surplus (difference
between what the consumers
are willing to pay, represented
by the demand curve, minus
what they actually pay): it falls
by (a + b + c + d).
Producer Surplus (area between
the price received and the
marginal cost of production,
given by the supply curve): it
rises by area a
Government Revenue: it
increases by the area c
Overall Effect: the net loss in
welfare is (b + d)
• The area of triangle b can be interpreted as
the production loss (or the efficiency loss).
• The area of the triangle d can be
interpreted as the consumption loss due to
the higher price.
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Import tariff: the small country’s case -3
•
The use of a tariff by a small importing country always leads
to a net loss in welfare. We call that loss the “deadweight
loss.”
If a small country suffers a loss when it imposes a tariff, why
do so many have tariffs as part of their trade policies?
• One answer is that a developing country does not have any
other source of government revenue. Import tariffs are “easy to
collect.”
• A second reason is politics. The benefits to producers (and their
workers) are typically more concentrated on specific firms and
states than the costs to consumers, which are spread
nationwide.
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Import tariff: the large country’s case
If we consider a large country, we might expect that its tariff will
change the world price
PW+t
t
• Applying a tariff of t dollars will increase the import price from PW to P* + t . The
increase in the price due to the tariff is less than the amount of the tariff because the
burden of the tariff is incurred by consumers at Home but also by Foreign exporters
• The Foreign producers are absorbing a part of the tariff by lowering their price from
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PW to P*.
Import tariff: the large country’s case -2
Hence, in a large country, the decrease in imports demanded
due to the tariff causes foreign exporters to lower their
prices. Consumer and producer prices in the importing
country still go up, since these prices include the tariff, but
they rise by less than the full amount of the tariff (since the
exporter price falls).
The use of a tariff for a large country can lead to a net gain in
welfare because the price charged by the exporter has
fallen; this is a terms-of-trade gain for the importer.
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Import Quota
An import quota is a restriction on the quantity of a good that
may be imported.
This restriction is usually enforced by issuing licenses or quota
rights.
A binding import quota will push up the price of the import
because the quantity demanded will exceed the quantity
supplied by Home producers and from imports.
When a quota instead of a tariff is used to restrict imports,
the government receives no revenue.
• Instead, the revenue from selling imports at high prices goes to quota
license holders.
• These extra revenues are called quota rents.
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Import quotas: examples
2 Examples:
Banana Wars: The banana wars started in 1993 when the European Union set
quotas favoring banana imports from former colonies. These preferential
policies—whose aims were to assist the development of former colonies—
were challenged by American banana companies and the Latin American
countries where bananas were grown. The suit finally ended in late 2009.
American sugar: In an effort to protect American farmers from import
competition, the United States imposes import quotas on foreign sugar. As a
result of the restriction, the domestic sugar price has been two to three times
higher than the world price for the past 25 years. However, the sugar program
may need to change given that the world price of sugar has now risen to the
U.S. level and a shortage exists. Under the current condition, the U.S.
government could potentially remove the import quota, which would improve
domestic welfare. Not surprisingly, the U.S. sugar producers have a strong
incentive to maintain the status quo by lobbying for limits on trade expansion.
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Export Subsidy
An export subsidy is payment to firms for every unit . It can be
specific or ad valorem:
• A specific subsidy is a payment per unit exported.
• An ad valorem subsidy is a payment as a proportion of the value
exported.
Governments give subsidies to encourage domestic firms to
produce more in particular industries.
Examples:
• Europe maintains a system of agricultural subsidies known as
the Common Agricultural Policy (CAP).
• Other countries maintain similarly generous subsidies. For
example, the U.S. pays cotton farmers to grow more cotton and
subsidizes agribusiness and manufacturers to buy the American
cotton.
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Export Subsidy (2)
An export subsidy raises the price in the exporting country,
decreasing its consumer surplus (consumers worse off) and
increasing its producer surplus (producers better off).
Also, government revenue falls due to paying for the export
subsidy.
An export subsidy lowers the price paid in importing countries
PS* = PS – s.
In contrast to a tariff, an export subsidy worsens the terms of
trade by lowering the price of exports in world markets.
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The Effects of Trade Policy
For each trade policy, the price rises in the Home country
adopting the policy.
• Home producers supply more and gain.
• Home consumers demand less and lose.
The world price falls when Home is a “large” country that
affects world prices.
Tariffs generate government revenue; export subsidies drain
it; import quotas do not affect government revenue.
All these trade policies create production and consumption
distortions.
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Other Trade Policies:
Voluntary Export Restraint
A voluntary export restraint (VER) works like an import
quota, except that the VER is imposed by the exporting
country rather than the importing country.
These restraints are usually requested by the importing
country.
The profits or rents from this policy are earned by foreign
governments or foreign producers.
• Foreigners sell a restricted quantity at an increased price.
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Other Trade Policies:
Dumping
Dumping is the practice of a Foreign firm exporting goods at a
price that is below its own domestic price or below its average
cost of production (example of price discrimination and unfair
competition).
Countries respond to dumping by imposing antidumping duties
on imports.
Under the rules of the WTO, an importing country is entitled to
apply an antidumping tariff any time that a foreign firm is
dumping its product.
Examples of antidumping duty :
• the tariff that the European Union applies to imports of shoes
from China and Vietnam.
• the tariff applied by the US to the imports of solar panels from
China
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Trade Agreements
(multilateral & regional)
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International Trade Agreements
• When countries seek to reduce trade barriers between
themselves, they enter into a trade agreement—a pact to
reduce or eliminate trade restrictions.
• There are two primary types of free-trade agreements:
multilateral and regional. Multilateral agreements are
negotiated among large groups of countries to reduce trade
barriers among them
• The WTO is an example of a multilateral trade agreement
• Under the most favored nation principle of the WTO, the
lower tariffs agreed to in multilateral negotiations must
be extended equally to all WTO members.
•
A central exception to the MFN in the GATT/WTO is for customs
unions and free trade areas. Two reasons:
• 1. such agreements can contribute to the growth of world trade.
• 2. regional trade liberalization can serve as a building block to
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further liberalization at the multilateral level
International Trade Agreements -2
• Whereas regional agreements operate among a smaller
group of countries, often in the same region
• Regional trade agreements are also known as “preferential
trade agreements,” because they give preferential treatment
(i.e., free trade) to the countries included within the
agreement, but maintain tariffs against outside countries.
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Functions:
Its main function is to ensure
that trade flows as smoothly,
predictably and freely as
possible
• Administering WTO trade agreements
• Forum for trade negotiations
• Handling trade disputes
• Monitoring national trade policies
• Technical assistance and training for developing countries
• Cooperation with other international
organizations Switzerland
International Conferences
Singapore (1996); Geneva (1998); Seattle (1999); Doha (2001);
Cancùn (2003), Hong Kong (2005), Geneva (2009 and 2011), Bali
(2013)
Critical Issues:
Scheme
Location: Geneva,
Switzerland
Born: 1 January 1995
Agreement: Uruguay
Round (1986-1994)
Members: 160 countries
on 26 June 2014
Staff: 640
Head: Roberto Azevêdo
(Director-General)
About 80% of members countries are DCs
MFN Rule overhang preferential agreements btw ICs and DCs;
Regionalism
Failure of DDA
NTB
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Observer governments
Afghanistan
Algeria
Andorra
Azerbaijan
Bahamas
Belarus
Bhutan
Bosnia and Herzegovina
Comoros
Equatorial Guinea
Ethiopia
Holy See (Vatican)
Iran
Iraq
Kazakhstan
Lebanese Republic
Liberia, Republic of
Libya
Sao Tomé and Principe
Serbia
Seychelles
Sudan
Syrian Arab Republic
Uzbekistan
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EVOLUTION OF MULTILATERAL
TRADE NEGOTIATIONS: from GATT to WTO
• Rounds involve more and more Members
> 23 in 1947 Geneva Round; 160 in Doha Round
• Negotiations have encompassed more issues
> tariffs only in early Rounds; multiple border and nonborder
issues in later Rounds
• Negotiations have become more protracted
> months in early Rounds; many years in later Rounds
• Developing Countries have become more active
> no involvement in early Rounds; agenda setting now
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Regional integration:
RTAs classification
Regional economic integration can be classified into 4
stages (Machlup, 1977)
By increasing order of integration:
1. FREE TRADE AREA (FTA): eliminates protection among
members but each member keeps its own tariff structure
2. CUSTOMS UNION (CU): FTA + common external tariff (CET)
3. COMMON MARKET (CM): CU + free movement of factors
of production among member-countries
4. ECONOMIC UNION: CM + single currency and common
economic policies
Ex. Economic and Monetary Union of the EU
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Effects of trade agreements
The welfare gains and losses that arise from regional
trade agreements are more complex than those that
arise from multilateral trade agreements
2 main effects:
• Trade creation: occurs when high-cost domestic
production is replaced by low-cost imports from
other members.
• Trade diversion: occurs when low-cost imports from
nonmembers are diverted to high-cost imports from
member nations.
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Regional economic integration
During the last decades there has been a rapid growth in the number of regional
trade agreements. As of 15 January 2012, some 511 RTAs had been notified to
the GATT/WTO, 319 were in force
RIAs notified to the WTO
Source: WTO 2014
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The most famous example of RIA:
European Union
Common market heading toward economic union
Elements of economic union:
Yes: - common monetary policy
- common currency (euro)
No: - common fiscal policy
- harmonized taxation
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Examples of Regional Trade Agreements -1
Among the best known are:
- The European Union,
- The European Free Trade Association (EFTA): set up for the
promotion of free trade and economic integration to the benefit of Iceland,
Liechtenstein, Norway and Switzerland.
- The North American Free Trade Agreement (NAFTA): to remove most
barriers to trade and investment among the United States, Canada, and
Mexico.
- The Southern Common Market (MERCOSUR): economic and political
agreement among Argentina, Brazil, Paraguay and Uruguay to promote
free trade and the fluid movement of goods, people, and currency
among its members.
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Examples of Regional Trade Agreements -1
-The Association of Southeast Asian Nations (ASEAN) Free Trade
Area: Its aims include the acceleration of economic growth, social
progress, cultural development, the protection of regional peace and
stability among its members (Indonesia, Malaysia, the Philippines,
Singapore , Thailand ,Brunei, Burma (Myanmar), Cambodia, Laos, and
Vietnam)
- The Common Market of Eastern and Southern Africa (COMESA):
free trade area to promote regional economic integration through trade
and investment among 19 African countries (Burundi, Comoros, Congo,
Dem Rep.Djibouti, Egypt, Eritrea, Ethiopia, Kenya, Libya, Madagascar,
Malawi, Mauritius, Rwanda, Seychelles, Sudan, Swaziland, Uganda,
Zambia, Zimbabwe)
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PTA/RTA and WTO
Under the WTO, such discriminatory trade policies are
generally not allowed:
• Each country in the WTO promises that all countries will pay tariffs no
higher than the nation that pays the lowest: called the “most favored
nation” (MFN) principle.
BUT:
Article XXIV: allows members to form an RTA provided they:
1. eliminate within-union trade barriers on “substantially” all trade
2. do not raise trade barriers on goods produced outside the union
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Relation to Multilateralism
(are RIAs desirable ?)
Contrasting stances among economists:
1. Regionalism is an alternative to multilateralism (a
stumbling bloc) Bhagwati (1998)
2. Regionalism is a useful supplements to multilateralism (a
building bloc) Ethier (1998) e Baldwin (1999).
“Classical” answer:
• “It all depends”. Different degrees of preferences, depth of
integration, country coverage , country size etc.
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Mega-regionals
The Transatlantic Trade and Investment Partnership
TTIP(EU+US), the Trans-Pacific Partnership TPP (Trans-Pacific
among Australia, Brunei Darussalam, Canada, Chile, Japan,
Malaysia, Mexico, New Zealand, Peru, Singapore, US, Vietnam)
and the Regional Comprehensive Economic Partnership RCEP
(ASEAN+ Australia, China, India, japan, South Korea, New
Zealand) represent over three quarters of global GDP and two
thirds of world trade (Ash & Lejarraga, 2014)
The sheer size of the mega-regions means that there would be
effects on third parties
The outcomes of the mega-regionals for rules on trade and
investment, trade-related standards and regulation would likely
drive the international rules and standards
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The Trans-Atlantic Trade and
Investment Partnership (TTIP)
• The Transatlantic Trade and Investment Partnership (TTIP) is a
trade agreement that is presently being negotiated between the
European Union and the United States (talks started in July 2013)
• It aims at removing trade barriers in a wide range of economic
sectors to make it easier to buy and sell goods and services between
the EU and the US.
• On top of cutting tariffs across all sectors, the EU and the US want to
tackle non tariff barriers such as differences in technical regulations,
standards and approval procedures (es. now when a car is approved
as safe in the EU, it has to undergo a new approval procedure in the
US even though the safety standards are similar).
• The TTIP negotiations will also look at opening both markets for
services, investment, and public procurement. They could also
shape global rules on trade.
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TTIP
Free Trade Area (FTA)
• Zero tariffs on all goods and services trade between EU
and US
• No change in tariffs on imports from outside; thus mostly
unequal tariffs
Areas that TTIP is set to cover…
• market access for agricultural and industrial goods,
• government procurement,
• investment,
• energy and raw materials,
Most important
for EU & US
• regulatory issues,
• sanitary and phytosanitary measures,
• services,
88
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Trade Effects of TTIP
The main (expected) effects:
• Trade creation: Import from partner what was
previously produced at home
• Trade diversion: Import from partner what was
previously imported from 3rd country
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Effects of TTIP
TTIP is designed to drive growth and create jobs.
Independent research shows that TTIP could boost:
• the EU's economy by €120 billion;
• the US economy by €90 billion;
• the rest of the world by €100 billion
Trade diverting effects are mainly observed for Brazil
and China and negative welfare effects for LDCs
(Brockmeier & al, 2014)
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Reading article & discussion
«Transatlantic Trade Goes Global»
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