Chapter 9 The Political Economy of Trade Policy
Chapter 9 ▪ The Political Economy of Trade Policy
Chapter organization Introduction The Case for Free trade National Welfare Arguments against Free Trade Income Distribution and Trade Policy a International Negotiations and Trade Policy Summary Appendix: Proving that the Optimum Tariff is Positive Copyright C 2003 Pearson Education, Inc Slide 9-2
Copyright © 2003 Pearson Education, Inc. Slide 9-2 ▪ Introduction ▪ The Case for Free Trade ▪ National Welfare Arguments against Free Trade ▪ Income Distribution and Trade Policy ▪ International Negotiations and Trade Policy ▪ Summary ▪ Appendix: Proving that the Optimum Tariff is Positive Chapter Organization
Introduction Free trade maximizes national welfare. but it is associated with income distributional effects Most governments maintain some form of restrictive trade policies This chapter examines some of the reasons governments either should not or do not base their policy on economists cost-benefit calculations Copyright C 2003 Pearson Education, Inc Slide 9-3
Copyright © 2003 Pearson Education, Inc. Slide 9-3 Introduction ▪ Free trade maximizes national welfare, but it is associated with income distributional effects. • Most governments maintain some form of restrictive trade policies. • This chapter examines some of the reasons governments either should not or do not base their policy on economists’ cost-benefit calculations
Introduction What reasons are there for governments not to interfere with trade? There are three arguments in favor of free trade Free trade and efficiency Economies of scale in production Political argument Copyright C 2003 Pearson Education, Inc Slide 9-4
Copyright © 2003 Pearson Education, Inc. Slide 9-4 Introduction ▪ What reasons are there for governments not to interfere with trade? • There are three arguments in favor of free trade: – Free trade and efficiency – Economies of scale in production – Political argument
The Case for Free Trade Free Trade and efficiency The efficiency argument for free trade is based on the result that in the case of a small country free trade is the best polic y a tariff causes a net loss to the economy A move from a tariff equilibrium to free trade eliminates the efficiency loss and increases national welfare Copyright C 2003 Pearson Education, Inc Slide 9-5
Copyright © 2003 Pearson Education, Inc. Slide 9-5 ▪ Free Trade and Efficiency • The 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 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 Trade
The Case for Free Trade Figure 9-1: The Efficiency Case for Free Trade Price, P Production Consumption distortion W distortion orld price plus tariff World price Quantity, Q Copyright C 2003 Pearson Education, Inc Slide 9-6
Copyright © 2003 Pearson Education, Inc. Slide 9-6 World price plus tariff World price Price, P Quantity, Q S D Consumption distortion Production distortion Figure 9-1: The Efficiency Case for Free Trade The Case for Free Trade
The Case for Free Trade Table 9-1: Estimated cost of protection as a Percentage of National Income Brazil(1966) 9.5 Turkey(1978) 5.4 Philippines (1978) 5.4 United States(1983) 0.26 Sources: Brazil: Bela Balassa, The Structure of protection in Developing Countries Baltimore: The Johns Hopkins Press, 1971); Turkey and Philippines, World Bank, The World Development Report 1987(Washington: World Bank, 1987); United States David G. Tarr and Morris E. Morkre, Aggregate Costs to the United states of Tariffs and quotas on Imports(Washington D. C. Federal Trade Commission, 1984) Copyright C 2003 Pearson Education, Inc Slide 9-7
Copyright © 2003 Pearson Education, Inc. Slide 9-7 The Case for Free Trade Table 9-1: Estimated Cost of Protection, as a Percentage of National Income
The Case for Free Trade Additional gains from Free Trade Protected markets 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 more 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 nnovation Copyright C 2003 Pearson Education, Inc Slide 9-8
Copyright © 2003 Pearson Education, Inc. Slide 9-8 ▪ Additional Gains from Free Trade • Protected markets 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 more 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 Trade
The Case for Free Trade Political argument for Free Trade a political commitment to free trade may be a good Idea in practice Trade policies in practice are dominated by special interest politics rather than consideration of national costs and benefits Copyright C 2003 Pearson Education, Inc Slide 9-9
Copyright © 2003 Pearson Education, Inc. Slide 9-9 ▪ Political Argument for Free Trade • A political commitment to free trade may be a good idea in practice. • Trade policies in practice are dominated by specialinterest politics rather than consideration of national costs and benefits. The Case for Free Trade
National Welfare Arguments Against Free Trade Activist trade policies can sometimes increase the welfare of the nation as a whole There are two theoretical arguments against the policy of free trade The terms of trade argument for a tariff The domestic market failure Copyright C 2003 Pearson Education, Inc Slide 9-10
Copyright © 2003 Pearson Education, Inc. Slide 9-10 ▪ Activist trade policies can sometimes increase the welfare of the nation as a whole. ▪ There are two theoretical arguments against the policy of free trade: • The terms of trade argument for a tariff • The domestic market failure National Welfare Arguments Against Free Trade