Econ443

*Intra Industry (5)

*1) 2 way exchange of similar goods 2) steadily grown over the last 1/2 industry 3) accounts for 1/4th to 1/2 of all world trade flows 4) plays prominent role in the trade of manufactured goods among advanced industrial nations, which account for the majority of world trade 5) Important for the US- Tend to be ones that produce manufactured goods -chemicals, specialed machiner

Advantages of negotiation *What are 2 reasons why it is easier to lower tariffs as part of a mutual agreement than to do so as a unilateral policy? *Who tends to be more organized and effective in altering trade policy *What can international negotiation help avoid?

*1) A mutual agreement helps mobilize support for freer trade 2) Negotiated agreements on trade can help governments avoid getting caught in destructive trade wars *Import-competing producers *A trade war

*What are some static welfare effects results from the formation of customs unions? (3)

*1) Administration savings from the elimination of customs officers, border patrols, etc. for trade among member nations -this benefit happens whether it is trade creating or diverting 2) A trade-diverting customs union, by reducing its demand for imports from and its supply of exports to the rest of the world, is likely to lead to an improvement in the collective terms of trade of the customs union -the opposite is likely to be true for trade creating unions since part of the increase in real income resulting from formation of the customs union spills over into a greater demand for imports from the rest of the world 3) Any customs union, by acting as a single unit in international trade negotiations, is likely to have much more bargaining power than all of its members separately

*How do you solve the political economy arguments (2)

*1) Blanket policy of free trade 2) System of rules of the game -WTO important

4 main functions of the WTO *What were the administrative issues in the Uruguay Round

*1) Communication: Forum for exchange of information 2) Constraints: limits or constrains trade policy options of member governments 3) Exceptions: permits exceptions to constraints for specific reasons with prescribed means 4) Dispute mechanism *Issues with Intellectual property rights -and include trade in services

*What are some dynamic benefits of customs unions? (4) First 1

*1) Increased competition: -in the absence of a customs union producers are likely to grow sluggish and complacent behind trade barriers -when a customs union is formed and trade barriers are eliminated, producers in each nation must become more efficient to meet the competition of other producers within the union, merge, or go out of business -may stimulate the development or utilization of new technology; will cut costs of production to the benefit of consumers

*Anti global movement questions and answers

*1) Is globalization good for workers? -redistribution policies 2) Do we need international labor standards -to what extent should international trade agreements include provisions to raise wages and working conditions in developing countries 3) Is globalization bad for the environment -how much power should the WTO have -issue of WTO vs. national sovereignty -ex: U.S. imports of dolphin friendly tuna

*Issues of US trade policy today (6)

*1) Multilateral trade negotiations (WTO and the Doha Agenda) 2) What will substitute pending Free Trade Agreements? -TPP ; TTIP 3) Renegotiation of NAFTA 4) Changing relationship with leading trade partners 5) The role of trade vs. protectionism in the U.S. economic recovery 6) The role of multinational firms

*What are the 2 main principles of the WTO?

*1) National treatment: you can't discriminate between foreign and domestic goods once you let them in the market -requirement that foreign goods be treated similarly to domestic goods once they enter the domestic market 2) Most Favored Nation: all countries must treat all other trading partners like their "most favored" trading partner -exception: regional trade agreements

*Common fallacies about international economics (first 4)

*1) Now that the U.S. is a truly global economy we need a new economic paradigm -don't need new tools to examine a global economy, use same ones from micro and macro 2) Competition between different countries is like competition between different businesses (positive sum game) 3)When a high wage country trades with a low wage country, the wages of workers in the high wage country will be pulled down -low wage countries tend to have lower wages because they are less productive 4) Free trade destroys jobs, protectionism saves them

*What is a political argument for free trade?

*1) Optimal tariff may be OK but risk of retaliation and trade war 2)Gov. doesn't act to maximize social welfare: Reflects the fact that a political commitment to free trade may be a good idea in practice even though there may be better policies in principle -trade policies in practice are dominated by special interests politics -sometimes there may be tariffs and export subsidies that could increase national welfare but any gov. agency attempting to pursue a sophisticated program of intervention in trade will probably be captured by special interests groups and converted into a device for redistributing income to politically influential sectors -May want to argue free trade even if its not best conceivable policy

*3 main reasons a cluster of firms may be more efficient than an isolated firm? (1)

*1) Specialized supplier: In many industries the production of goods or development of new products requires the use of specialized equipment of support services -individual companies may not provide a large enough market for these services to keep the suppliers in business. A localized cluster of industries can solve this problem. -Many firms provide a large enough market to support a wide range of suppliers -Dense networks of specialized give clustered industries advantages -Prices may be lower because many firms are competing -Specialized firms can focus on what they do best and contract other work

*What happened in relation to trade liberalization in the Uruguay round (2) *What happened with the attempts to liberalize these industries (3)

*1) Tariff reduction -about 40% but tariffs were already low -most fell from like 6.3% to 3.9% -only a small increase in world trade 2) There was a move to liberalize trade in 2 important sectors -Agriculture and Clothing *1)Agreement required agricultural exporters to reduce the value of subsidies by 36% , and the volume of subsidized exports by 21% over a 6 year period -countries that protect their farmers were required to replace quotas with tariffs, which are bound 2) MFA was phased out over a 10 year period -clothing has been largely liberalized; we have seen increases in imports from China which received backlash from clothing producers in the U.S. 3) New set of rules concerning gov. procurement -purchases made not by private firms or consumers but by gov. agencies

*Reasons the world is more interconnected (2) *What are the most important international challenges facing the world today? (6)

*1) Technological progress -travel, communications, trade in "cultural goods" 2) and increase in standard of living *1) Financial and economic crises 2) Trade protectionism in developed countries 3) excessive fluctuations and misalignments in exchange rates 4) Structural problems in developed countries 5) deep poverty in many developing countries 6) unsustainable development (resource scarcity, environmental degradation, climate change)

What are the arguments for Protectionism (6)

*1) Terms of Trade Argument 2) Domestic Market Failure 3) Income distribution 4) Infant Industry Argument 5) Political Economy of Trade 6) Strategic Trade and Industrial Policy

*What 3 steps are involved in determining n and P

*1) derive a relationship btwn the number of firms and the Average cost of a typical firm -n goes up, AC goes up -more firms the lower the ouput of each firm and the higher each firms cost/unit 2) Look at the relationship between the number of firms and the price each firm charges -higher n means lower p -downward sloping -more competition leads to lower prices 3) Firm entry and exit decisions based on profits each firm earns -When price exceeds AC, firms earn and profits and more firms will enter the industry and vice versa

*What do we need to determine to analyze the industry?

*1) the number of firms 2) average price they charge

*What are the most important trade issues in the US today? (5)

*1)Renegotiation of current trade agreements 2) Potential increase in protectionism that can lead to 3) Trade wars 4) change in relationships with trade partners 5) disruption of international supply chains

*What are some dynamic benefits of customs unions? 2 and 3

*2) Economies of scale: -likely to result from the enlarged market -by reducing the range of differentiated products manufactured in each plant and increasing "production runs" 3) Stimulus to investment to take advantage of the enlarged market and to meet the increased competition -likely to spur outsiders to set up protection facilities within the customs union to avoid the (discriminatory) trade barriers imposed on nonunion products -called tariff factories

*3 main reasons a cluster of firms may be more efficient than an isolated firm? (2 and 3) *Example of external economies of scale

*2) Labor Market Pooling: A cluster of firms can create a pooled market for workers with highly specialized skills -Producers less likely to suffer from labor shortages and workers less likely to become unemployed 3) Knowledge Spillovers: An important source of technological know how comes from the informal exchange of info and ideas that takes place most effectively when an industry in concentrated in a fairly small area so that employees is different companies mix socially and talk freely about technical issues *Say originally: industry with 10 firms producing 100 widgets each (1000 widgets) -Industry doubles in size so it now consists of 20 firms, each still producing 100 widgets. -cost of each firms lowers as a result of bigger size

*What are some other trade policy instruments (last 2)

*2) National Procurement: Purchases by the gov. or strongly regulated firms can be directed toward domestically produced goods even when these goods are more expensive than imports 3) Red-tape barriers: Sometimes a gov. wants to restrict imports without doing so formally

*Explain the problem of insufficient information? Reason 2

*2) We can't consider industries in isolation -if one industry is subsidized, it will draw resources from other industries and lead to increases in their costs -Even a policy that succeeds in giving U.S. firms a strategic advantage in one industry will tend to cause strategic disadvantage elsewhere -To assess whether this policy is worth you have to weigh the offsetting effect, even if you have a precise understanding of one industry you need equally precise understanding of those industries with which that industry competes for resources

*What are arguments 3 and 4?

*3) Domestic problems best solved with domestic solutions 4) Problem of too much government intervention

*What are the conditions more likely to lead to increased welfare and trade creation in customs unions? ( 3 and 4)

*3) The greater is the number of countries forming the customs union and the larger their size -greater probability that low-cost producers fall within the union 4) The more competitive rather than complementary are the economies of member nations -greater opportunities for specialization in production and trade creation with the formation of the customs union -customs union is more likely to increase welfare if it is formed by 2 competitive industrial nations rather than an industrial nation and an agricultural (complementary) nation

*What are some dynamic benefits of customs unions? #4 *Which gains are more important? dynamic or static? *What is the best option for countries

*4) better utilization of the economic resources of the entire community *Dynamic *Unilaterally eliminating all trade barriers -joining a customs union is only a second-best solution

*What do estimates suggests were the benefits of the Uruguay round? *Costs *DOHA dissapointment

*A gain to the world economy as a whole of more than $200 billion annually, raising world income by 1% *The costs were felt by concentrated, often well-organized groups, while the benefits accrued to broad, diffuse populations *DOHA failed but the ratchets are stilli n place and world trade remains much freer -probably failed because tarifs are already so low

*Voluntary Export Restraint (VER) -aka? *example of VER *From an economic point of view what are VER's like? *VER Costs

*A quota on trade imposed from the exporting country's side instead of the importer's -voluntary restraint agreement (VRA) -usually requested by importer and agreed to by the exporter to forestall other trade restrictions *limitation on auto exports to the United States enforced by Japan after 1981 *Just like an import quota where the licenses are assigned to foreign governments and are therefore very costly to the importing country *Always more costly to the importing country than a tariff that limits imports by the same amount -what would have been revenue under a tariff becomes rents earned by foreigners under the VER -loss for importing country

*How can a government shift excess returns from foreign to domestic firms? *Counterarguments: What are some problems with the Brander-Spencer Analysis? (3)

*A subsidy to domestic firms -Deters investment and production by foreign competitors which can raise the profits of domestic firms by more than the amount of the subsidy -(example of this written in your paper notes) *1) How do we pick winners? -Making practical use of the theory would require more information than is likely to be available 2) Risks foreign retaliation 3) If everyone does this the effects are neutralized

*Explain Free Trade and Efficiency (Argument 1) *In the modern world tariff rates are generally low and import quotas are relatively rare. What is the result of this?

*A tariff causes a net loss to the economy measured by areas b and d on the graph which represent efficiency loss -distorts the economic incentives of both producers and consumers -A move to free trade eliminates these distortions -reverse of cost-benefit of analysis of a tariff *total costs of distortions due to tariffs and import quotas tend to be modest in size -for the world as a whole estimates say protection costs less than 1 percent of GDP -gains from free trade are somewhat smaller for advanced economies such as the United States and somewhat larger for poorer "developing countries"

*What has the WTO been accused of doing? *What are some major differences between GATT and WTO (3)

*Acting as a sort of world government, undermining national sovereignty *1) GATT did not include provisions in services -insurance, consulting, banking,etc. -The WTO includes rules for trades in goods and services 2) Advanced countries have experienced a shift from depending on physical capital to depending on "intellectual property" -protected by patents and copyrights -WTO tries to take on the issue of defining the international application of international property rights using its agreement on Trade-Related aspects of Intellectual Property (TRIPS) 3) "Dispute settlement procedure -problem arises when one country accuses another of violating the rules of the trading system

*What was GATT originally *When was the World Trade Org established? *did anything change with the GATT after establishment of the WTO?

*An agreement not an organization -they ended up governing world trade for the next 48 years after development in 1947 -countries participating were contracting parities, not members -held permanent secretariat in Geneva, known as the GATT *1995 -formal organization *GATT rules remain in force, and the basic logic of the system remains the same

*How does the biased effect of increases in resources on production possibilities explain international trade? *If the home country is more labor abundant and cloth production is more labor intensive what will be the difference in their PPFs

*An increase in the supply of labor expands production possibilities disproportionately in the direction of cloth production, and vice versa ; thus an economy with a high relative supply of labor to capital will be relatively better at producing cloth than an economy with lower labor -An economy will tend to be relatively effective at producing goods that are intensive in the factors with which the country is relatively well endowed *Home's will be shifted out more in the direction of cloth ; home will produce a higher ratio of cloth to food

*What is an example of how protection leads to an inefficient scale *What is another argument for free trade related to additional gains from free trade

*Argentine automobile industry -emerged because of import restrictions -An efficient scale assembly plant should make from 80,000 to 200,000 automobiles per year, yet in 1964 the Argentine industry produced only 166,000 and had no fewer than 13 firms -inefficient scale of production *By providing entrepreneurs with an incentive to seek new ways to export or compete with imports, free trade offers more opportunities for learning and innovation than are provided by a system of "managed" trade -a related form of gains from trade involves the tendency for more productive firms to engage in exports, while less productive firms stay with the domestic market -a move to free trade makes the econ. as a whole more efficient by shifting industrial mix towards firms with higher productivity

*What is the one time where import quotas may be allowed, though they are generally forbidden? *What is the lever in the ratchet lever system? *How many trade rounds have been completed since 1947? *Explain the Doha failure? *The first 5 rounds took place under what form

*As a temporary measure to deal with "market disruption" -an undefined phrase usually interpreted to mean surges of imports that threaten to put a domestic sector suddenly out of business *Trade Round - large group of countries get together to negotiate a set of tariff reductions and other measures to liberalize trade *8 *In 2001, a meeting in the Persian Gulf City of Doha inaugurated a 9th round but by the summer of 2010 they still have failed to reach an agreement *Parallel bilateral negotiations

*What is the relationship between the wage rental ratio (w/r) and labor capital ratio (L/K)? *What does the importance of a particular factor's price to the cost of producing the good depend on?

*As wages go down producers will use more labor and less capital and vice versa *how much of that factor the good's production involves -if a good's production makes little use of labor then a rise in wages won't have as much of an effect on the price of the good -there is a one to one relationship between w/r and Pc/Pf

*Does a trade-diverting customs union result in trade creation or diversion? *Theory of second best

*Both -can increase or reduce the welfare of union members, depending on the relative strength of these 2 opposing forces -welfare of nonmembers can be expected to decline because their economic resources can only be utilized less efficiently than before trade was diverted away from them *if all the conditions required to maximize welfare or reach Pareto optimum can't be satisfied, trying to satisfy as many of these conditions as possible does not necessarily or usually lead to the second-best position

*Kennedy Round *Tokyo Round *When was the 8th round (Uruguay Round) begin and end? *What were the 2 most important results of the Uruguay round?

*Completed in 1967 -agreement involved an across-the-board 50% reduction in tariffs by the major industrial countries, except for specified industries whose tariffs were left unchanged -Overall the round reduced average tariffs by about 35% *Reduced tariffs by a formula more complex than that of the Kennedy round -New codes were established in an effort to control the proliferation of nontariff battiers such as VERs and orderly marketing agreements *1986 and 1994 *Trade Liberalization and Administrative reforms

*Domestic Market Failure Argument Against Free Trade (Argument 2) *Domestic Market Failure *3 examples of domestic market failure

*Concepts of producer and consumer surplus do not properly measure costs and benefits (producer surplus in particular) -This can happen due to producer surplus measurements not considering domestic market failure *Market in the country is not doing its job right *1) Possibility that the labor used in a sector would otherwise be unemployed or underemployed 2) existence of defects in the capital or labor markets that prevent resources from being transferred as rapidly as they should be to sectors that yield high returns 3) possibility of technological spillovers from industries that are new and particularly innovative

*H-O Theorem *Stople Samuelson *Rybczynski Effect *Factor-Price Equalization

*Country that is abundant in a factor exports the good that is intensive in that factor (pattern of trade *An increase in the relative price of a good increases the purchasing power of the factor used intensively in the production of that good *At constant prices an increase in 1 factor will increase more than proportionately the production of the good intensive in that factor and decrease the output of the other good -based expansion of the PPF *Free trade causes factor price to be more equal -if free trade continues, factor prices will equalize

*Infant Industry Argument (Argument 4) *What are some problems with the infant industry argument (3) Reason 1 and 2

*Developing countries have a potential comparative advantage in manufacturing, but new manufacturing industries in developing countries can't initially compete with well-established manufacturing in developed countries -thus it makes sense to use tariffs or import quotas as temporary measures to get industrialization started *1) Not always a good idea to try to move today into the industries that will have a comparative advantage in the future 2) protecting manufacturing does no good unless the protection itself helps make the industry competitive -"pseudo-infant industry: an industry is initially protected then becomes competitive for reasons that have nothing to do with the protection -may look like a success but may not actually have been one and may have been a net cost to the economy

*What are some problems with the infant industry argument (3) Reason 3 *what are 2 market failures that supporters of the infant industry argument have identified as reasons why it may be a good idea? (Reason 1)

*Domestic policy may be better -There may be some domestic market failure that gov. intervention can help *1) Imperfect capital markets: If a developing country does not have a set of financial institutions (such as efficient stock markets banks) that would allow savings from traditional sectors to be used to finance investment in new sectors, then growth of new industries will be restricted by the ability of firms in these industries to earn current profits -low initial profits will be an obstacle to investment even if the long-term returns on the investment will be high -first best policy is to create a better capital market, but protection of new industries, which would raise profits and thus allow more rapid growth can be justified as a second best policy option

*What is the most famous example of a customs union *Common Market *Economic Union *Duty-free zones or free economic zones

*European Union *Like a customs union but allows the free movement of labor and capital among member nations *Everything, and also Harmonizes or even unifies the monetary and fiscal policies of member states -most advanced type of economic integration *Areas set up to attract foreign investments by allowing raw materials and intermediate products duty-free

*Agriculture Protection in the United States *What 2 parts does the clothing industry consist of? *How has the U.S. clothing industry historically been protected?

*Farmers make up about 2 million workers of 130 million in the U.S. -farmers tend to be well organized and politically powerful and often achieve very high rates of effective protection -the U.S. is a food exporter so tariffs or import quotas can't raise prices (sugar is an exception) -gov. reluctance to pay out directly has limited the size of these subsidies and much of the protection is concentrated in the clothing industry *1) Textiles: spinning and weaving of cloth 2) apparel (assembly of cloth into clothings) *Through both tariffs and import quotas

*What is the "Terms of Trade" Argument for Tariffs (Argument 1)? *In this case what happens when tariff increases?

*For a large country that is able to affect the prices of foreign exporters, a tariff lowers the price of imports and thus generates a terms of trade benefit (area e on the graph) -it is possible that when the costs are weighed against the benefits of the tariff that the benefits outweigh the costs and that there is a terms of trade benefit of the tariff -at small tariff rates, a large country's welfare is higher than with free trade *Costs begin to grow more rapidly -a tariff rate that completely prohibits trade leaves the country worse off than with free trade

*How does the theory of second best apply to trade agreements *What are the conditions more likely to lead to increased welfare and trade creation in customs unions? (6) 1 and 2

*Forming a customs union and removing trade barriers only among the members will not necessarily produce the 2nd best welfare position *1) Higher preunion trade barriers of member countries -greater probability that formation of the customs union will create trade among union members rather than divert trade from nonmembers to members 2) Lower custom union's barriers on trade with the rest of the world -makes it less likely that formation of the customs union will lead to costly trade diversion

*How did GATT deal with disputes *How does the WTO deal with disputes

*GATT was more informal -most countries still did what they were supposed to because they didn't want to be known as the country that didn't follow trade rules *Panels of experts are selected to hear cases -usually reach conclusion in less than 1 yr -Even though WTO has no enforcement powers, they can grant the country that filed the complaint the right to retaliate -country may be able to impose restrictions on the other countries exports to their country in response to something unfair that was done without being in violation of WTO rules

*Explain the problem of insufficient information? Reason 1 of 2

*Has two parts 1) Even when looking at an industry in isolation it may be difficult to know exact gains and losses of entering vs. not entering (payoff matrix) -if the gov. gets its wrong, a subsidy policy may turn out to be a costly misjudgment -Ex: suppose that Boeing has some underlying advantage like better technology so that even if Airbus enters, Boeing will still enter; so even with subsidy given to Airbus, Boeing has an underlying advantage and won't see the subside as a deterrent and the profits of Airbus will fall short of the subsidy's value; this would have been a costly mistake

*Assuming Home produces a higher ratio of cloth and Foreign produces a higher ratio of food what does this mean for the relative price of cloth in the two countries? *What good will a country export? *Hecksher-Ohlin Theorem (Basic explanation)

*Home will have a higher supply of cloth and a lower price for cloth ; the foreign country will have a higher price for cloth and when they trade the price will be in between H and F. *A country will export the good whose relative price increases when trade occurs -so Home will export cloth -home is labor abundant and cloth is labor intensive *The country that is abundant in a factor exports the good whose production is intensive in that factor

*Electoral competition - example of what voters want *What policies will the 2 parties promise to follow?

*Imagine that a country exports skill-intensive goods and imports labor intensive goods -voters with high skill levels will favor a lower tariff and voters with low skills will be better off if the country imposes a high tariff -think of lining up all the voters in the order of the tariff rate they prefer with the voters who favor the lowest rate on the left and those who favor the highest rate on the right *They will tend to try to find middle ground

*Explain the payoff countries face when deciding whether to protect or open their markets and why a trade war may begin

*Imagine there are 2 countries -the U.S. and Japan -The governments will choose protection because individually this is what is best for them -If the U.S. protects and Japan chooses free trade, the U.S. will have the largest gain in the payoff matrix and Japan will have negative gains -however, if the U.S. chooses not to protect and Japan chooses free trade the U.S. will end up with negative gains -It is risky to choose free trade because of the fact that the other country could choose to protect -Country's view their best bet as protecting -Also keep in mind that country's have to think not only of the country's welfare but also they often have to appeal to special interests groups -Free Trade is the best decision overall because both countries will gain -When they both decide to protect there will be and trade war and both will have negative gains

*Where have local content requirements widely been used? *What does a local content regulation do from the perspective of domestic producers of parts? " " firms that must buy locally *What do LCR's produce or not produce

*In developing countries trying to shift their manufacturing base from assembly back to intermediate goods *provides protection in the same way an import quota does *doesn't place a strict limit on imports -allows firms to import more, provided that they also buy domestically -the effective price of inputs to the firm is an average of the price of imported and domestically produced inputs *does not produce either government revenue or quota rents -instead the difference between the price of imports and domestic goods in effect gets averaged in the final price and is passed on to consumers

*What are the general problems with the market failure approach

*In practice it is difficult to evaluate which industries really warrant special treatment, and there are risks that a policy intended to promote development will end up being captured by special interests -many stories of infant industries that have never grown up and remain dependent on protection

*What is an example of domestic policy vs. trade policy for a market failure

*In the U.S. an import quota on automobiles has been supported on the grounds that it is necessary to save the jobs of autoworkers -argues that U.S. labor markets are too inflexible for autoworkers to remain employed either by cutting their wages or by finding jobs in other sectors -Domestic policy: a subsidy to firms that employ autoworkers would face opposition and would require tax increase -import quota would be even more expensive due to its distortion of consumer choice -only difference is that costs would be less visible, taking the form of higher automobile prices rather than direct gov. outlays

*What is a general principle when dealing with market failures? (goes with counterargument 1) *What is the important implication for trade policy makers?

*It is always preferable to deal with market failures as directly as possible, because indirect policy response leads to unintended distortions of incentives elsewhere in the economy -trade policies justified by domestic market failure are never the most efficient response, they are always "second best" rather than "first best" policies *any proposed trade policy should always be compared with a purely domestic policy aimed at correcting the same problem -if domestic policy seems too costly or has undesirable side effects, trade policy is almost surely even less desirable - even though costs are less apparent

Ch.12 (274-277) Strategic Trade and Industrial Policy (Argument 6) *What did Spencer and Brander identify as the market failure that justifies government intervention? *Explain this

*Lack of perfect competition *In some industries there are only a few firms that are in effective competition -because of the small # of firms, the assumptions of perfect competition do not apply -There will be excess returns: firms will make profits above what equally risky investments elsewhere in the economy can earn -It is possible in principle for a government to alter the rules of the game to shift these excess returns from foreign to domestic firms

*Explain GATT-WTO mechanical analogy? *What is the principle ratchet in the system? *Do countries operate with this ratchet? *Where is there some wiggle room for this?

*Like a device used to push a heavy object (the world economy) gradually up a slope -to get there requires both levers to push the object as well as ratchets to prevent backsliding *the process of binding: when a tariff rate is bound the country imposing the tariff agrees not to raise their rate in the future *Yes, at present almost all tariff rates in developed countries are bound -as are about 3/4ths of the rates in developing countries *A country can raise a tariff if it gets the agreement of other countries, which usually means providing compensation by reducing other tariffs -binding has been very effective

*Rent Seeking (Argument 5) *Example of this

*Manipulating public policy as a strategy to increase profits -To enforce an import quota, a gov. has to issue import licenses and economic rents accrue to whoever receives these licenses -In some cases individual's and companies incur substantial costs trying to get import licenses *Indian companies were allocated the right to buy imported inputs in proportion to their installed capacity in the 1950s and 60s -this created an incentive to over-invest, for ex: a steel company might build more blase furnaces than it expected to need simply because this would give it a larger # of import licenses -the resources used to build this idle capacity represented a cost of protection over and above efficiency losses

We live in a globalized world..examples *Trade in goods *Services *People *Finance

*Many goods we consume are imported, or have components that are imported *Many services are provided by foreigners *Workers can migrate around the world *Currencies easily exchanged; we can invest in companies anywhere in the world (one of the reasons financial crises are so big)

*What is better than a bilateral trade agreement? *When did these types of agreements begin? *What does GATT stand for? *Explain how is came about *Was the ITO ever established? Why?

*Multilateral negotiations involving a # number of countries *Soon after the end of WW2 *General Agreement on Tariffs and Trade *Diplomats from the victorious allies imagined that multilateral negotiations would take place under the auspices of a proposed body called the International Trade Organization -but in 1947, unwilling to wait until the ITO was in place, a group of 23 countries began trade negotiations under a provisional set of rules that became knows as the GATT *No, it ran into severe political opposition, especially in the U.S.

*What is something that the GATT-WTO generally tries to prevent? *Due to this, what is not allowed *What is the exception to this? *Most of the costs of protection in the U.S. comes from what? *What does the GATT-WTO do with existing import quotas

*Non-tariff interventions in trade *Export subsidies *When the GATT was first created the U.S. insisted on a loophole for agriculture exports, which has since been exploited on a large scale by the European Union *Import Quotas *Grandfathers them: allows them to continue to exist since they already did before the ban -there has been an ongoing and often successful effort to remove such quotas or convert them to tariffs

*Trade diversion -why does it result *What does trade diversion do to welfare

*Occurs when lower-cost imports from outside the customs union are replace by higher cost imports from a union member -because of the preferential trade treatment given to member nations *reduces welfare because it shifts production from more efficient producers outside the customs union to less efficient producers inside the union. -worsens the international allocation of resources and shifts production away from comparative advantage

*Trade Creation *What effect can a trade-creating customs union have

*Occurs when some domestic production in a nation that is a member of the customs union is replaced by lower-cost imports from another member nation -increases the welfare of member nations because it leads to greater specialization in production based on comparative advantage *Also increases the welfare of nonmembers because some of the increase in its real income (due to its greater specialization in production) spills over into increased imports from the rest of the world

*Internal econ. of scale example *Dynamic Increasing Return *AC = ? *Q = ?

*Output of widget is still 1000 but amount of firms is cut in 1/2 so now each firm produces more (200 widgets) -will have monopolistic competition (imperfect competition) *When cost fall with with cumulative production over time rather than with the current rate of production -external economy may arise from the accumulation of knowledge * TC/Q *S/n

*What is the general conclusion about the income distribution effects of the international trade in the long run?

*Owners of a country's abundant factor gain from trade, but owners of a country's scarce factors lose -in home abundant factor is labor *

*What does the public good character to politics mean? *Example of this *What does Olson describe as the problem of "collective action"

*Policies that impose large losses in total, but small losses on any individual may not face any effective opposition *Sugar quota - imposes a cost on a typical American family of about $30 per year but costs millions (or billions) to consumers overall -From the POV of individual self-interest this costs is not enough to cause people to lobby their congressperson to remove the quota *While it is in the interests of the group as a whole to press for favorable policies, it is not in any individual's interest to do so

*Example of marginal social benefit that may not be capture by producer surplus measure *Domestic market failure argument is a particular case of what general concept?

*Production of some good yields experience that will improve the technology of the econ. as a whole but the firms in the sector can't appropriate this benefit and therefore do not take it into account in deciding how much to produce -this marginal social benefit will not be captured by the producer surplus measure *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 they are not, gov. intervention may actually increase welfare by offsetting the consequences of market failures elsewhere -imperfections in the internal functioning of an economy justify interfering in its external econ. relations

*Preferential trade arrangements *Free trade area *Customs union

*Provide lower barriers on trade among participating nations than on trade with nonmember nations *form of economic integration wherein all barriers are removed on trade among members -each nation retains its own barriers to trade with nonmembers -all barriers removed, not just lowered barriers *allows no tariffs or other barriers on trade among members, and it also harmonizes trade policies toward the rest of the world -ex: setting common tariff rates

*Income Distribution Argument (Argument 3) *Counterarguments (2)

*Scarce factor loses from trade -trade or other trade policy instruments can redistribute income from abundant to scarce factor -remember H-O model *1) Gains from trade go down -income of country as a whole goes down 2) Domestic Problems should be solved with domestic solutions -should use distribution policies -transfers are better -tax winners, subsidize losers

*What model applies for the short run? *Leontief Paradox *What does the H-O model work best for?

*Specific factors *U.S. is capital abundant so you would expect it to export capital intensive goods; data shows that the U.S. is a net importer of capital intensive goods *Developed and developing countries

*Explain foreign retaliation *

*Strategic policies are Beggar-thy-neighbor policies that increase our welfare at other countries' expense -these policies therefore risk a trade war that leaves everyone worse off -most economists would not advocate that the U.s. be the initiator of such policies

*Electoral Competition -explain the model

*Suppose that there are 2 competing parties, each of which is willing to promise whatever will enable it to win the next election -Policy can be described along a single dimension, say, the level of the tariff rate -voters differ in the policies that they prefer

*Optimum tariff *What policy would the terms of trade argument dictate for export sectors?

*Tariff rate that maximizes national welfare -tariff justified by the terms of trade argument -optimum tariff rate always positive but less than the prohibitive rate (this rate would eliminate all imports) *A negative subsidy -a tax on exports that raises the price of exports to foreigners -optimum export tax is always positive but less than the prohibitive tax that would eliminate exports completely -ex: Saudi Arabia and oil

*What did Mancur Olson point out in his now famous book about political activity? *Example of this

*That it is a public good -benefits of such activity accrue to all members of the group, not just the individual who performs the activity *Suppose someone writes a letter to their congressperson demanding a lower tariff rate on their favorite imported good and this letter actually changes the congressperson's vote and the lower tariff is approved -all consumers who buy the good benefit from lower prices even if they did not bother to writer letters

Post Test 2 *What does the theory of economic integration refer to? *What does the degree of economic integration range from *What is the loosest form of economic integration

*The commercial policy of discriminatively reducing or eliminating trade barriers only among the nations joining together *preferential trade arrangements to free trade areas, customs unions, common markets, and economic unions *preferential trade arrangements

*Explain additional (dynamic) gains from free trade (Argument 2) *Explain the additional gain that involves economies of scale

*There is a widespread belief among economists that calculations that show substantial gains from free trade in some cases, do not represent the whole story -especially in small country cases *Protected markets limit gains from external economies of scale by inhibiting the concentration of industries -when the economies of scale are internal, they not only fragment production internationally, but by reducing competition and raising profits -they also lead too many firms to enter the protected industry -with a proliferation of firms in narrow domestic markets, the scale of production of each firm becomes inefficient

*What is the best policy to deal with this issue? *What happened in the 1930s?

*They should establish an agreement, such as a treaty, to refrain from protection -"tying of one's hands" -make the agreement legal so they don't have to worry about what the other country will do *the U.S. passed the Smoot-Hawley Act -an extremely irresponsible tariff law

*What do critics of the domestic failure argument argue? Political Economy of Trade (Argument 5) *What is the political economy *Trade policy is the result of interaction between..? *So far we have assumed that governments act as?

*This case is typical -most deviations from free trade are adopted not because their benefits exceed their costs but because the public fails to understand their true costs *Interaction between economic system and political system *Producers, consumers, government *benevolent dictators -maximizing national welfare

*Why do countries trade?

*To exploit their differences -can be different due to technologies, resource endowments (factors of production), tastes -some countries have more skilled labor, while others may have more unskilled labor 1) Because they're different 2) exploit economies of scale

*What is another more modern example of rent-seeking?

*Tuna is protected by a "tariff-rate quota" -a small quantity of tuna can be imported a low tariff rate (6%) but any imports beyond that face a (12.5%) tariff -There are no import licenses; each year the right to import tuna at the low tariff rate is assigned on a first come first served basis -result is a costly race to get tuna into the United States as quickly as possible -importers attempt to qualify for the largest share of the TRQ as possible by stockpiling large quantities of canned tuna in customs-bonded warehouses in late December and releasing the warehoused product as soon as the calendar year begins -the money importers spend on warehousing lots of tuna in December represents a loss to the U.S. economy over and above the standard costs of protection

*Smoot-Hawley Act *What was done to mitigate the negative effects of this act? *Why are bilateral negotiations not always the best? (2)

*Under this act tariff rates rose steeply and U.S. trade fell sharply -some economists believe that this helped deepen the Great Depression *Bilateral tariff negotiation -The U.S. would approach some country that was a major exporter of some good and offer to lower tariffs on that good if that country would lower its tariffs on some U.S. exports *Do not take full advantage of international coordination -benefits from a bilateral negotiation may spillover to parties that have not made any concessions -ex: If the U.S. reduces tariffs on coffee, Columbia may also gain from a higher world coffee price 2) Some advantageous deals may inherently involve more than 2 partners -U.S. sells more to Europe they sell more to Saudi Arabia and they sell more to Japan

*Explain dispute settlement with WTO *What was the DOHA round mainly for *What was the battle in Seattle?

*Usually just the complaint is enough to get countries to comply -or the WTO will rule and the country will comply with the ruling -If not the complaining country will be allowed to retaliate *objective was improving trading prospectives of developing countries -aka Doha development round -mrkt access in developing countries *protesters protested WTO ministerial meetings in Seattle in 1999

*Median voter *What will always be in the political interest of a party? *Does the median voter model work well for trade policy?

*Voter who is exactly halfway up the lineup -both parties will tend to converge on the tariff rate preferred by the median voter *To undercut any tariff proposal that is higher than what the median voter wants *NO -makes an almost precisely wrong prediction -the model predicts that the political winner should benefit the majority and inflict large losses on a few people -BUT protectionist policies are more likely to inflict widespread loss but help a small group

*When can the problem of collective action best be overcome? *Why also may it be in the interest of a politician to adopt positions that are against the interest of the typical voter

*When a group is small -so that each individual reaps a significant share of the benefits of favorable policies and/or well organized so that members of the group can be mobilized to act in their collective interest -the reason that a policy like the sugar quota can happen is that the sugar producers form a relatively small, well-organized group that is well aware of the size of the implicit subsidy members receive while sugar consumers are a huge pop. that does not even perceive itself as an interest group * Politicians need money to run successful campaigns for advertising, polling, and so on -if the politician is offered a sufficiently large financial contribution to do so that may be worth more than more votes

*What is an interesting innovation in local content regulations *What are some other trade policy instruments? (3) first 1

*allowing firms to satisfy their local content requirement by exporting instead of using parts domestically -ex: U.S. auto firms operating in Mexico have chosen to export some components from Mexico to the United States, even though those components could be produced in the United States more cheaply, because doing so allows them to use less Mexican content in producing cars in Mexico for Mexico's market *1) Export credit subsidies: This is like an export subsidy except that it takes the form of a subsidized loan to the buyer -U.S. has a gov. institution, the Export-Import Bank, that is devoted to providing at lead slightly subsidized loans to aid exports

*Multi-Fiber Arrangement *2 parts of the clothing industry *What is a result of these 2 factors *How does this sector tend to be in advanced countries? *What happened with the expiration of the MFA?

*clothing industry subject to import and export quotas for a large number of countries *1) Labor-intensive: need relatively little capital, and can do job without extensive formal education 2) Technology is relatively simple -no great difficulty in transferring the technology even to poor countries *Low wage nations have a strong comparative advantage and vice versa *well organized *costs of clothing protection and hence overall costs of U.S. protection fell sharply

*What is the most famous multilateral VER *Explain study on VERs in the 3 major industries in the U.S. *Local content requirement *how is this fraction specified?

*covers more than one country Multi-Fiber Arrangement: limited textile exports from 22 countries until the beginning of 2005 *3 major U.S. voluntary export restraints of the 1980s in textiles and apparel, steel, and automobiles -found that about 2/3rds of the cost to consumers of these restraints was accounted for by the rents earned by foreigners *A regulation that requires some specified fraction of a final good to be produced domestically *1) sometimes physical units -like U.S. oil import quota in the 1960's 2) sometimes in value terms -requiring that some minimum share of the price of a good represent domestic value added

*What determines what input choice producers will make?

*depends on the relative costs of capital and labor -if capital rental rates are high and wages are low producers will choose to produce using relatively little capital and a lot of labor -depends on the ratio of the two factor prices (w/r)

*What would happen if the economy's labor force grows (L/K goes up) *What happens to the PPF when the labor force grows?

*relative demands of labor in each sector (food and cloth) stays the same ; so the extra labor will go to the more labor intensive good (in this case cloth) ; more labor and capital will go towards making more cloth *the PPF will shift out ; after this increase the economy can produce more of both cloth and food than before ; the outward shift will be much larger in the direction of cloth than of food ; this is known as a biased expansion of the production possibilities -if the bias is strong enough, there could be an actual fall in the production of food

*What is globalization? -Stiglitz -Held and McGrew *4 dimensions of globalization

*the closer integration of the countries and peoples of the world -a widening, deepening, and speeding up of interconnectedness in all aspects of contemporary social life *1) Economic 2) Cultural 3) Environmental 4) Political

Chapter 5 *What does the bowed shape of the PPF tell us? *What determines where on the PPF the economy produces *" " On the graph

*the opportunity cost in terms of food of producing one more unit of cloth rises as the economy produces more cloth and less food (cloth on the x axis) *Prices -produces at the point that maximizes the value of production -Value of the economy's production -V = (PC x QC) + (PF x QF) *the point on the PPF that touches the highest possible isovalue (indifference curve) -at that point the slope of the PPF is equal to -PC/PF

*What is the opportunity cost in terms of food of producing another unit of cloth? *What is one of the main differences in having a two factor model?

*the relative price of cloth *Producers may have room for choice in the use of inputs -ex: a farmer can choose between using relatively more capital and fewer workers, or vice versa. -don't face a fixed input requirement

*What would happen if the relative price of cloth were to rise? (Pc/Pf goes up) *Changes in relative factors have a strong effect on what? *How does a cloth price increase lead to higher wages?

*w/r would rise ; because labor is now more expensive relative to capital the amount of labor used relative to capital will drop ; so Lc/Kc and Lf/Kf will both fall -purchasing power of workers goes up and purchasing power of capital owners goes down *income distribution *ratio of labor to capital falls ; factors of production are paid in their marginal product meaning that the real wage of workers in terms of cloth is equal to the marginal productivity of labor in cloth production; when the ratio of labor to capital falls the marginal product of labor in terms of that good rises so workers real wages are higher

What are 3 common misconceptions about trade?

1) Free trade is beneficial only if your country is strong enough to stand up to foreign competition -don't confuse absolute and comparative advantage 2) Sweatshop labor argument: Foreign competition is unfair and hurtful "causes material injury" if based on low wages -Lower wages reflect lower productivity 3) Exploitation argument aka Unequal exchange argument: trade exploits a nation and makes it worse off if its workers receive a lower wage than workers in another nation -workers could possibly be paid lower if they don't trade

What are the 3 arguments that represent the standard view of most international economists (at least in the U.S.)

1) The conventionally measured costs of deviating from free trade are large 2) There are other benefits from free trade that add to the costs of protectionist policies 3) Any attempt to pursue sophisticated deviations from free trade will be subverted by the political process

What are some limitations or counterarguments against the "Terms of Trade" Argument for a Tariff? (2)

1) This argument is of little practical importance to small countries because they can't affect world prices of imports or their exports 2) For big countries (like U.S.), the problem is that this argument amounts to argument for using national monopoly power to extract gains at other countries' expense -This can lead to retaliation from other large countries; Trade wars -beggar thy neighbor strategy

Post Test 1 What are the arguments in favor of free trade? (7)

1)Efficiency Case 2) Additional (dynamic) benefits of Free Trade 3) Domestic problems best solved with domestic solutions 4) Problem of too much government intervention 5) Rent Seeking Political Economy Arguments 6) Optimal tariff argument potentially OK, but their is a risk of retaliation and trade war 7) Government doesn't necessarily act to maximize social welfare

*what are 2 market failures that supporters of the infant industry argument have identified as reasons why it may be a good idea? (Reason 2) *What is the first and second best answer to this problem *The market failure arguments apply to?

2) Appropriability Argument - Firms in a new industry generate social benefits for which they are not compensated -pioneering firms may in addition to producing physical output create intangible benefits (such as knowledge of new markets) in which they are unable to establish property rights -in some cases the social benefits will outweigh the costs but because of the problem of appropriability, no private entrepreneurs will be willing to enter *1) Compensate firms for their intangible contributions 2) encourage entry into a new industry by using tariffs or other trade policies (if 1 is not possible) *specifically apply to new industries rather than any industry

What are the conditions more likely to lead to increased welfare and trade creation in customs unions? (5 and 6)

5) The closer geographically are the members of the customs unions. -transportation costs represent less of an obstacle to trade creation among members 6) The greater is the preunion trade and econ relationship among potential members of the customs union -leads to greater opportunities for significant welfare gains as a result of the formation of the customs union

*Common fallacies about international economics (last 4)

5) The gov. should help industries compete 6) A trade surplus is good, deficit is bad 7) A trade deficit is the result of bad economic policies. it means the economy is in trouble 8) A country that runs trade deficits loses jobs, a country that runs a trade surplus creates jobs (having a trade deficit isn't necessarily a bad thing

Counterarguments against the Market Failure Argument (2)

Can't really say that there are no domestic market failures, especially in developing countries, but... 1) Domestic market failures should be corrected by domestic policies aimed directly at the problem's sources -ex: production increase can be achieved via a production subsidy instead of a tariff; this way prices for consumers don't increase (loss of b is avoided) and social benefit would still be achieved 2) Economists can't diagnose market failure well enough to prescribe policy