Chapter 10
What are the requirements of the GATT-WTO system?
Export subsidies are not allowed.
Separate out and identify the arguments for free trade in this statement. "It would let consumers and producers make their choices based on the real costs of goods, not artificial prices determined by government policy."
Free trade and efficiency Free trade and efficiency would let consumers and producers make their choices based on the real costs of goods, not artificial prices determined by government policy.
Give an intuitive explanation for the optimal tariff argument.
In a large country, a tariff can favorably shift the terms of trade such that the tariff revenue exceeds the welfare loss.
If governments make trade policies based on national economic welfare, is the problem of trade warfare still represented by a "Prisoner's dilemma" game? What is the equilibrium solution to the game if governments formulate policy in this way? Would they ever choose the strategy of protectionism?
In this case, it would no longer be a Prisoner's dilemma game; each country's dominant strategy would be to engage in free trade and there would be no incentive to switch to protectionism.
e. "The real price of timber has fallen 40 percent, and thousands of timber workers have been forced to look for other jobs."
Not valid. Cheaper lumber has benefited consumers and builders. It would be more efficient for the winners from trade to compensate the losers.
b. "The growing exports of off-season fruit from Chile, which now accounts for 80 percent of the U.S. supply of such produce as winter grapes, are contributing to sharply falling prices of these former luxury goods."
Not valid. Since these are off-season fruits, domestic producers are not harmed by the imports.
c. "U.S. farm exports don't just mean higher incomes for farmers—they mean higher income for everyone who sells goods and services to the U.S. farm sector."
Not valid. Unless there is some domestic market failure, an export subsidy always produces more costs than benefits.
"It would help to clean up domestic politics."
Political argument for free trade
d. "Semiconductors are the crude oil of technology; if we don't produce our own chips, the flow of information that is crucial to every industry that uses microelectronics will be impaired."
Potentially valid. If one assumes there are external economies in this industry, the benefit of a tariff may outweigh the costs.
Which of the following are potentially valid arguments for tariffs or export subsidies, and which are not? a. "The more oil the United States imports, the higher the price of oil will go in the next world shortage."
Potentially valid. In addition to a terms of trade benefit, it would encourage the accumulation of inventories to minimize the potential for future adverse shocks. This is potentially a valid argument for a tariff, since it is based on an assumed ability of the United States to affect world prices—that is, it is a version of the optimal tariff argument. If the United States is concerned about higher world prices in the future, it could use policies which encourage the accumulation of oil inventories and minimize the potential for future adverse shocks.
What is the main reason explaining why agriculture enjoys protective tariffs in the U.S.?
Producers (who gain) are well organized, while consumers (who lose) are not.
Which of the trade rounds was the first to achieve across-the-board tariff reduction?
The Kennedy Round.
What is the essence of the "terms-of-trade" argument against free trade?
A large country can improve its terms-of-trade by imposing tariffs, and the optimal tariff is positive.
"It would allow escape from the confines of a narrow domestic market."
Additional gains from free trade
"It would open new horizons for entrepreneurship."
Additional gains from free trade
Why are international negotiations important in order to reduce tariff rates worldwide?
They help avoid trade wars. International negotiation helps the cause of tariff reduction in two ways: It helps broaden the constituency for freer trade by giving exporters a direct stake, and it helps governments avoid the mutually disadvantageous trade wars that internationally uncoordinated policies could bring.
X = 100% and Y = €18,000
Trade creation This would lead to trade creation because German cars that cost €30,000 to produce would be replaced by Polish cars that cost only €20,000.
X = 100% and Y = €12,000
Trade diversion
Suppose that upon Poland's entering the European Union, it is discovered that the cost of automobile production in Poland is €20,000, while it is €30,000 in Germany. Suppose that the EU, which has a customs union, has an X percent tariff on automobiles and that the costs of production are equal to Y (valued in euros) in Japan. Comment on whether the addition of Poland to the European Union would result in trade creation or trade diversion under the following scenarios:
Trade diversion This would lead to trade diversion because the lower cost Japanese cars with an import value of €27,000 (but real costs of €18,000) would be replaced by Polish cars with a real cost of production equal to €20,000.
When are preferential trade agreements welfare-improving?
When they lead to trade creation.
In the case of a free trade area, the members _____ tariff rates against the outside world.
act independently in setting
Because of its politically sensitive nature, the last economic sector to be liberalized via multilateral trade negotiations has been
agriculture.
Unlike the eight previous rounds of world trade negotiations since the creation of GATT in 1948, the Doha round appears to be the first to have
broken down with no agreement.
Production of high-technology products such as smartphones depends crucially on the use of "rare earths," a small group of exotic metals. As it happens, China dominates the production of these rare earths; given possible international tensions, there have been calls for special policies to encourage rare-earth production in the United States. Can such calls be justified in economic terms? Special policies to encourage rare-earth production in the United States
can be justified if China otherwise would have substantial market power. One possible justification for subsidizing the domestic production of rare earth metals is the terms of trade argument for protection. Since China dominates the production of these metals, they have enough market power that they could impose an export tax on these metals and raise the world price (much like Saudi Arabia does with oil exports). Another potential justification for subsidizing domestic production would be if doing so would generate some social benefit in excess of the private benefit to producers.
One important theme in the 2016 U.S. presidential election was a backlash against trade agreements in general; a significant number of voters were convinced that America's trade deals amounted to a giveaway of sovereignty, and that the United States should stop tying its own hands and pursue whatever trade policy serves its self-interest. How would you respond to that assertion? This view
fails to recognize that uncoordinated trade policies are likely inferior to those based on negotiations between governments.
The "theory of the second best" states that
in the presence of a market failure, government intervention may improve welfare.
Customs unions differ from free trade areas by the manner in which
member countries apply tariffs to nonmembers.
In 2004 the United States signed a free trade agreement with several Central American nations and the Dominican Republic, known as DR-CAFTA. The agreement was expected to boost clothing exports from these nations, which had until then been suffering from growing Asian competition. Assuming the agreement worked in this respect, what would this say about its overall economic impact? The overall economic impact of DR-CAFTA was
positive but small.
Customs unions and free trade areas are examples of _____ trading agreements.
preferential They are called preferential even though they do entail a certain amount of discrimination against nonmembers.
The world trading system can be characterized as a combination of "levers" and "ratchets." In this analogy the "ratchets" represent
the implementation of binding tariffs which prevent backsliding.
The notion that trade policy often imposes costs on large numbers of people, and benefits only a few is explained by
the problem of collective action.
Given the model of competition among political parties used by political scientists, the most likely tariff policy would be
the tariff rate favored by the median voter.
