1、Prepared by Iordanis PetsasTo Accompany,Sixth Editionby Paul R.Krugman and Maurice ObstfeldSlide 9-2Copyright 2003 Pearson Education,Inc.IntroductionThe Case for Free TradeNational Welfare Arguments against Free TradeIncome Distribution and Trade PolicyInternational Negotiations and Trade PolicySumm
2、aryAppendix:Proving that the Optimum Tariff is PositiveChapter OrganizationSlide 9-3Copyright 2003 Pearson Education,Inc.IntroductionFree trade maximizes national welfare,but it is associated with income distributional effects.Most governments maintain some form of restrictive trade policies.This ch
3、apter examines some of the reasons governments either should not or do not base their policy on economists cost-benefit calculations.Slide 9-4Copyright 2003 Pearson Education,Inc.IntroductionWhat reasons are there for governments not to interfere with trade?There are three arguments in favor of free
4、 trade:Free trade and efficiency Economies of scale in production Political argumentSlide 9-5Copyright 2003 Pearson Education,Inc.Free Trade and EfficiencyThe efficiency argument for free trade is based on the result that in the case of a small country,free trade is the best policy.A tariff causes a
5、 net loss to the economy.A move from a tariff equilibrium to free trade eliminates the efficiency loss and increases national welfare.The Case for Free TradeSlide 9-6Copyright 2003 Pearson Education,Inc.World priceplus tariffWorld pricePrice,PQuantity,QSDConsumptiondistortionProductiondistortionFigu
6、re 9-1:The Efficiency Case for Free TradeThe Case for Free TradeSlide 9-7Copyright 2003 Pearson Education,Inc.The Case for Free TradeTable 9-1:Estimated Cost of Protection,as a Percentage of National IncomeSlide 9-8Copyright 2003 Pearson Education,Inc.Additional Gains from Free TradeProtected market
7、s in small countries do not allow firms to exploit scale economies.Example:In the auto industry,an efficient scale assembly should make a minimum of 80,000 cars per year.In Argentina,13 firms produced a total of 166,000 cars per year.The presence of scale economies favors free trade that generates m
8、ore varieties and results in lower prices.Free trade,as opposed to“managed”trade,provides a wider range of opportunities and thus a wider scope for innovation.The Case for Free TradeSlide 9-9Copyright 2003 Pearson Education,Inc.Political Argument for Free TradeA political commitment to free trade ma
9、y be a good idea in practice.Trade policies in practice are dominated by special-interest politics rather than consideration of national costs and benefits.The Case for Free TradeSlide 9-10Copyright 2003 Pearson Education,Inc.Activist trade policies can sometimes increase the welfare of the nation a
10、s a whole.There are two theoretical arguments against the policy of free trade:The terms of trade argument for a tariffThe domestic market failureNational Welfare Arguments Against Free TradeSlide 9-11Copyright 2003 Pearson Education,Inc.The Terms of Trade Argument for a TariffFor a large country(th
11、at is,a country that can affect the world price through trading),a tariff lowers the price of imports and generates a terms of trade benefit.This benefit must be compared to the costs of the tariff(production and consumption distortions).It is possible that the terms of trade benefits of a tariff ou
12、tweigh its costs.Therefore,free trade might not be the best policy for a large country.National Welfare Arguments Against Free TradeSlide 9-12Copyright 2003 Pearson Education,Inc.1National welfareTariff rateOptimumtariff,toProhibitivetariff rate,tpFigure 9-2:The Optimum TariffNational Welfare Argume
13、nts Against Free TradeSlide 9-13Copyright 2003 Pearson Education,Inc.Optimum tariff The tariff rate that maximizes national welfare It is always positive but less than the prohibitive rate that would eliminate all imports.It is zero for a small country because it cannot affect its terms of trade.Nat
14、ional Welfare Arguments Against Free TradeSlide 9-14Copyright 2003 Pearson Education,Inc.What policy would the terms of trade argument dictate for export sectors?An export subsidy worsens the terms of trade,and therefore unambiguously reduces national welfare.Therefore,the optimal policy in export s
15、ectors must be a negative subsidy,that is,a tax on exports.Like the optimum tariff,the optimum export tax is always positive but less than the prohibitive tax that would eliminate exports completely.National Welfare Arguments Against Free TradeSlide 9-15Copyright 2003 Pearson Education,Inc.The Domes
16、tic Market Failure Argument Against Free TradeProducer and consumer surplus do not properly measure social costs and benefits.Consumer and producer surplus ignore domestic market failures such as:Unemployment or underemployment of labor Technological spillovers from industries that are new or partic
17、ularly innovative Environmental externalitiesA tariff may raise welfare if there is a marginal social benefit to production of a good that is not captured by producer surplus measures.National Welfare Arguments Against Free TradeSlide 9-16Copyright 2003 Pearson Education,Inc.cabS1S1S2S2D2D1PW +tPWPr
18、ice,PQuantity,QDollarsQuantity,QSD(a)(b)Figure 9-3:The Domestic Market Failure Argument for a TariffNational Welfare Arguments Against Free TradeMarginal socialbenefitSlide 9-17Copyright 2003 Pearson Education,Inc.The domestic market failure argument against free trade is a particular case of the th
19、eory of the second best.The theory of the second best states that a hands-off policy is desirable in any one market only if all other markets are working properly.If one market fails to work properly,a government intervention may actually increase welfare.National Welfare Arguments Against Free Trad
20、eSlide 9-18Copyright 2003 Pearson Education,Inc.How Convincing Is the Market Failure Argument?The are two basic arguments in defense of free trade in the presence of domestic distortions:Domestic distortions should be corrected with domestic(as opposed to international trade)policies.Example:A domes
21、tic production subsidy is superior to a tariff in dealing with a production-related market failure.Market failures are hard to diagnose and measure.Example:A tariff to protect urban industrial sectors will generate social benefits,but it will also encourage migration to these sectors that will resul
22、t in higher unemployment.National Welfare Arguments Against Free TradeSlide 9-19Copyright 2003 Pearson Education,Inc.In practice,trade policy is dominated by income distribution considerations.The desires of individuals get more or less imperfectly reflected in the objectives of government.There exi
23、st models in which governments try to maximize political success.Electoral Competition Political scientists argue that policies are determined by competition among political parties that try to attract as many votes as possible.Income Distribution and Trade PolicySlide 9-20Copyright 2003 Pearson Edu
24、cation,Inc.Assumptions of the model:There are two competing political parties.The objective of each party is to get elected.Each party has to decide on the level of the tariff imposed(this is the only policy available).Voters differ in the tariff they prefer.What policies will the two parties promis
25、e to follow?Both parties will offer the same policy consisting of the tariff that the median voter(the voter who is exactly halfway up the lineup)prefers.Income Distribution and Trade PolicySlide 9-21Copyright 2003 Pearson Education,Inc.VotersPreferred tariff rateMedian votertMtBtAPolitical supportI
26、ncome Distribution and Trade PolicyFigure 9-4:Political CompetitionSlide 9-22Copyright 2003 Pearson Education,Inc.Collective ActionThis approach views political activity as a public good.For instance,the imposition of a tariff protects all firms in an industry,but the lobbying costs for imposing the
27、 tariff are covered by only a few firms.Trade policies that impose total large losses that are spread among many individual firms or consumers may not face opposition.Industries that are well organized(or have a small number of firms)get protection.Income Distribution and Trade PolicySlide 9-23Copyr
28、ight 2003 Pearson Education,Inc.Modeling the Political ProcessInterest groups“buy”policies by offering contributions contingent on the policies followed by the government.Income Distribution and Trade PolicySlide 9-24Copyright 2003 Pearson Education,Inc.Who Gets Protected?Two sectors seem to get pro
29、tected in advanced countries:Agriculture Farmers are well organized and the structure of the U.S.government enhances their political power.Clothing Both textiles and apparel have enjoyed substantial protection.This sector employs less skilled workers and it is unionized as well.Protection is very li
30、kely to diminish in the future in both sectors(due to international trade negotiations).Income Distribution and Trade PolicySlide 9-25Copyright 2003 Pearson Education,Inc.Income Distribution and Trade PolicyTable 9-2:Effects of Protection in the United States($billion)Slide 9-26Copyright 2003 Pearso
31、n Education,Inc.International Negotiations and Trade PolicyInternational integration has increased from the mid-1930s until about 1980 because the United States and other advanced countries gradually removed tariffs and nontariff barriers to trade.Slide 9-27Copyright 2003 Pearson Education,Inc.Figur
32、e 9-5:The U.S.Tariff RateInternational Negotiations and Trade PolicySlide 9-28Copyright 2003 Pearson Education,Inc.How was the removal of tariffs politically possible?The postwar liberalization of trade was achieved through international negotiation.Governments agreed to engage in mutual tariff redu
33、ction.The Advantages of NegotiationIt is easier to lower tariffs as part of a mutual agreement than to do so as a unilateral policy because:It helps mobilize exporters to support freer trade.It can help governments avoid getting caught in destructive trade wars.International Negotiations and Trade P
34、olicySlide 9-29Copyright 2003 Pearson Education,Inc.Table 9-3:The Problem of Trade WarfareInternational Negotiations and Trade PolicySlide 9-30Copyright 2003 Pearson Education,Inc.In Table 9-3,each country has a dominant strategy:Protection.Even though each country acting individually would be bette
35、r off with protection,they would both be better off if both chose free trade.In game theory,this situation is known as a Prisoners dilemma.Japan and the U.S.can establish a binding agreement to maintain free trade.International Negotiations and Trade PolicySlide 9-31Copyright 2003 Pearson Education,
36、Inc.International Trade Agreements:A Brief HistoryInternationally coordinated tariff reduction as a trade policy dates back to the 1930s(the Smoot-Hawley Act).The multilateral tariff reductions since World War II have taken place under the General Agreement on Tariffs and Trade(GATT),established in
37、1947 and located in Geneva.It is now called the World Trade Organization(WTO).The GATT-WTO system is a legal organization that embodies a set of rules of conduct for international trade policy.International Negotiations and Trade PolicySlide 9-32Copyright 2003 Pearson Education,Inc.The GATT-WTO syst
38、em prohibits the imposition of:Export Subsidies(except for agricultural products)Import quotas(except when imports threaten“market disruption”)Tariffs(any new tariff or increase in a tariff must be offset by reductions in other tariffs to compensate the affected exporting countries)Trade round A lar
39、ge group of countries get together to negotiate a set of tariff reductions and other measures to liberalize trade.International Negotiations and Trade PolicySlide 9-33Copyright 2003 Pearson Education,Inc.Eight trade rounds have occurred since 1947:The first five of these took the form of“parallel”bi
40、lateral negotiations(e.g.,Germany with France and Italy).The sixth multilateral trade agreement,known as the Kennedy Round,was completed in 1967:This agreement involved an across-the-board 50%reduction in tariffs by the major industrial countries,except for specified industries whose tariffs were le
41、ft unchanged.Overall,the Kennedy Round reduced average tariffs by about 35%.International Negotiations and Trade PolicySlide 9-34Copyright 2003 Pearson Education,Inc.The so-called Tokyo round of trade negotiations(completed in 1979)resulted in:Reduced tariffs New codes for controlling the proliferat
42、ion of nontariff barriers,such as VERs.An eighth round of negotiations,the so-called Uruguay Round,was competed in 1994.International Negotiations and Trade PolicySlide 9-35Copyright 2003 Pearson Education,Inc.The Uruguay RoundIts most important results are:Trade liberalization Administrative reform
43、sTrade LiberalizationThe average tariff imposed by advanced countries decreased by almost 40%.More important is the move to liberalize trade in two important sectors:agricultural and clothing.From the GATT to the WTOMuch of the publicity surrounding the Uruguay Round focused on its creation of the W
44、TO.International Negotiations and Trade PolicySlide 9-36Copyright 2003 Pearson Education,Inc.How different is the WTO from the GATT?The GATT was a provisional agreement,while the WTO is a full-fledged international organization.The GATT applied only to trade in goods,while the WTO included rules on
45、trade in services(the General Agreement on Trade in Services(GATS)and on international application of international property rights.The WTO has a new“dispute settlement”procedure which is designed to reach judgments in a much shorter time.International Negotiations and Trade PolicySlide 9-37Copyrigh
46、t 2003 Pearson Education,Inc.Benefits and CostsThe economic impact of the Uruguay Round is difficult to estimate.However,estimates of the GATT and of the Organization for Economic Cooperation and Development suggest a gain to the world economy as a whole of more than$200 billion annually once the ag
47、reement is fully in force.Most economists believe that these estimates are too low.The costs of the Uruguay Round will be felt by well-organized groups,while much of the benefit will accrue to diffuse populations.International Negotiations and Trade PolicySlide 9-38Copyright 2003 Pearson Education,I
48、nc.Preferential Trading AgreementsNations establish preferential trading agreements under which they lower tariffs with respect to each other but not the rest of the world.The GATT-WTO,through the principle of non-discrimination called the“most favored nation”(MFN)principle,prohibits such agreements
49、.The formation of preferential trading agreements is allowed if they lead to free trade between the agreeing countries.International Negotiations and Trade PolicySlide 9-39Copyright 2003 Pearson Education,Inc.Free trade can be established among several WTO members as follows:A free trade area allows
50、 free-trade among members,but each member can have its own trade policy towards non-member countries.Example:The North American Free Trade Agreement(NAFTA)creates a free trade area.A customs union allows free trade among members and requires a common external trade policy towards non-member countrie
