Module 14.2: Trade Restrictions

Perhaps the best way to understand the roles of the organizations designed to facilitate trade is to examine their own statements.

According to the International Monetary Fund (IMF; more available at www.IMF.org): Article I of the Articles of Agreement sets out the IMF's main goals: promoting international monetary cooperation; facilitating the expansion and balanced growth of international trade; promoting exchange stability; assisting in the establishment of a multilateral system of payments; and making resources available (with adequate safeguards) to members experiencing balance of payments difficulties. According to the World Bank (more available at www.WorldBank.org): The World Bank is a vital source of financial and technical assistance to developing countries around the world. Our mission is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources, sharing knowledge, building capacity and forging partnerships in the public and private sectors. We are not a bank in the common sense; we are made up of two unique development institutions owned by 187 member countries: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Each institution plays a different but collaborative role in advancing the vision of inclusive and sustainable globalization. The IBRD aims to reduce poverty in middle-income and creditworthy poorer countries, while IDA focuses on the world's poorest countries. ...Together, we provide low-interest loans, interest-free credits and grants to developing countries for a wide array of purposes that include investments in education, health, public administration, infrastructure, financial and private sector development, agriculture and environmental and natural resource management. According to the World Trade Organization (WTO; more available at www.WTO.org): The World Trade Organization (WTO) is the only international organization dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible. ...Trade friction is channeled into the WTO's dispute settlement process where the focus is on interpreting agreements and commitments, and how to ensure that countries' trade policies

Some of the reasons for trade restrictions that have support from economists are: (2)

Infant industry. Protection from foreign competition is given to new industries to give them an opportunity to grow to an internationally competitive scale and get up the learning curve in terms of efficient production methods. National security. Even if imports are cheaper, it may be in the country's best interest to protect producers of goods crucial to the country's national defense so that those goods are available domestically in the event of conflict.

Other arguments for trade restrictions that have little support in theory are: (2)

Protecting domestic jobs. While some jobs are certainly lost, and some groups and regions are negatively affected by free trade, other jobs (in export industries or growing domestic goods and services industries) will be created, and prices for domestic consumers will be less without import restrictions. Protecting domestic industries. Industry firms often use political influence to get protection from foreign competition, usually to the detriment of consumers, who pay higher prices. Other arguments include retaliation for foreign trade restrictions; government collection of tariffs (like taxes on imported goods); countering the effects of government subsidies paid to foreign producers; and preventing foreign exports at less than their cost of production (dumping).

Most of the effects of all four of these protectionist policies are the same. With respect to the domestic (importing) country, import quotas, tariffs, and VERs all:

Reduce imports. Increase price. Decrease consumer surplus. Increase domestic quantity supplied. Increase producer surplus. With one exception, all will decrease national welfare. Quotas and tariffs in a large country could increase national welfare under a specific set of assumptions, primarily because for a country that imports a large amount of the good, setting a quota or tariff could reduce the world price for the good.

Types of trade restrictions include: (5)

Tariffs: Taxes on imported good collected by the government. Quotas: Limits on the amount of imports allowed over some period. Export subsidies: Government payments to firms that export goods. Minimum domestic content: Requirement that some percentage of product content must be from the domestic country. Voluntary export restraint: A country voluntarily restricts the amount of a good that can be exported, often in the hope of avoiding tariffs or quotas imposed by their trading partners.

Current Account

The current account comprises three sub-accounts: Merchandise and services. Merchandise consists of all raw materials and manufactured goods bought, sold, or given away. Services include tourism, transportation, and business and engineering services, as well as fees from patents and copyrights on new technology, software, books, and movies. Income receipts include foreign income from dividends on stock holdings and interest on debt securities. Unilateral transfers are one-way transfers of assets, such as money received from those working abroad and direct foreign aid. In the case of foreign aid and gifts, the capital account of the donor nation is debited.

We can write the relation between the trade deficit, saving, and domestic investment as:

X − M = private savings + government savings − investment

The North American Free Trade Agreement (NAFTA) is an example of the European Union (EU) is an example of the euro zone is an example of

a free trade area an economic union a monetary union.

or a country with a trade deficit, it must be balanced by a net surplus in the capital and financial accounts. As a result, investment analysts often think of all financing flows as

a single capital account that combines items in the capital and financial accounts. hinking in this way, any deficit in the current account must be made up by a surplus in the combined capital account. That is, the excess of imports over exports must be offset by sales of assets and debt incurred to foreign entities. A current account surplus is similarly offset by purchases of foreign physical or financial assets.

A voluntary export restraint (VER) is just as it sounds. It refers to

a voluntary agreement by a government to limit the quantity of a good that can be exported. VERs are another way of protecting the domestic producers in the importing country. They result in a welfare loss to the importing country equal to that of an equivalent quota with no government charge for the import licenses; that is, no capture of the quota rents.

We can make a distinction, however, between a trade deficit resulting from high government or private consumption and one resulting from high private investment in capital. In the first case: In the second case:

borrowing from foreign countries to finance high consumption (low savings) increases the domestic country's liabilities without any increase to its future productive power. In the second case, borrowing from foreign countries to finance a high level of private investment in domestic capital, the added liability is accompanied by an increase in future productive power because of the investment in capital.

Foreign borrowing results in a ______________________, which means there is a trade deficit.

capital account surplus

A country that has imports valued more than its exports is said to have a _________________________, while countries with more exports than imports are said to have a ______________________.

current account (trade) deficit current account surplus.

A tariff placed on an imported good increases the _____________ , decreases the _________________, and increases the ___________________. Domestic producers _______, foreign exporters _______, and the domestic government _______ by the amount of _____________.

domestic price quantity imported quantity supplied domestically gain lose gains the tariff revenues.

The primary influences referred to here are on the current account deficit or surplus. If a country's net savings (both government savings and private savings) are less than the amount of investment in domestic capital, this investment must be financed by

foreign borrowing.

There are various types of agreements among countries with respect to trade policy. The essence of all of them: The positive effects result from The negative effects result because

is to reduce trade barriers among the countries. increased trade according to comparative advantage, as well as increased competition among firms in member countries. some firms, some industries, and some groups of workers will see their wealth and incomes decrease. Workers in affected industries may need to learn new skills to get new jobs.

Some countries impose capital restrictions on the flow of financial capital across borders. Restrictions include:

outright prohibition of investment in the domestic country by foreigners, prohibition of or taxes on the income earned on foreign investments by domestic citizens, prohibition of foreign investment in certain domestic industries, and restrictions on repatriation of earnings of foreign entities operating in a country.

Overall, capital restrictions are thought to decrease economic welfare. However,

over the short term, they have helped developing countries avoid the impact of great inflows of foreign capital during periods of optimistic expansion and the impact of large outflows of foreign capital during periods of correction and market unease or outright panic. Even these short-term benefits may not offset longer-term costs if the country is excluded from international markets for financial capital flows.

Export subsidies are

payments by a government to its country's exporters. Export subsidies benefit producers (exporters) of the good but increase prices and reduce consumer surplus in the exporting country. In a small country, the price will increase by the amount of the subsidy to equal the world price plus the subsidy. In the case of a large exporter of the good, the world price decreases and some benefits from the subsidy accrue to foreign consumers, while foreign producers are negatively affected.

On balance, economic welfare is improved by

reducing or eliminating trade restrictions.

Lower levels of private saving, larger government deficits, and high rates of domestic investment all tend to

result in or increase a current account deficit. The intuition here is that low private or government savings in relation to private investment in domestic capital requires foreign investment in domestic capital.

In terms of overall economic gains from trade, the deadweight loss is From the viewpoint of the domestic country, the loss in consumer surplus is

the amount of lost welfare from the imposition of the quota or tariff. only partially offset by the gains in domestic producer surplus and the collection of tariff revenue.

According to the U.S. Federal Reserve, "The BOP [balance of payments] includes

the current account, which mainly measures the flows of goods and services; the capital account, which consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets; and the financial account, which records investment flows."

In the case of a quota, if the domestic government collects the full value of the import licenses, the result is: If the domestic government does not charge for the import licenses, this amount is a gain to those foreign exporters who receive the import licenses under the quota and are termed:

the same as for a tariff. quota rents.

We list these types of agreements, generally referred to as trading blocs or regional trading agreements (RTA), in order of their degrees of integration.

Free Trade Areas -All barriers to import and export of goods and services among member countries are removed. Customs Union -All barriers to import and export of goods and services among member countries are removed. -All countries adopt a common set of trade restrictions with non-members. Common Market -All barriers to import and export of goods and services among the countries are removed. -All countries adopt a common set of trade restrictions with non-members. -All barriers to the movement of labor and capital goods among member countries are removed. Economic Union -All barriers to import and export of goods and services among the countries are removed. -All countries adopt a common set of trade restrictions with non-members. -All barriers to the movement of labor and capital goods among member countries are removed. Member countries establish common institutions and economic policy for the union. Monetary Union -All barriers to import and export of goods and services among the countries are removed. -All countries adopt a common set of trade restrictions with non-members. -All barriers to the movement of labor and capital goods among member countries are removed. -Member countries establish common institutions and economic policy for the union. -Member countries adopt a single currency.

Governments sometimes place restrictions on the flow of investment capital into their country, out of their country, or both. Commonly cited objectives of capital flow restrictions include the following:

Reduce the volatility of domestic asset prices. In times of macroeconomic crisis, capital flows out of the country can drive down asset prices drastically, especially prices of liquid assets such as stocks and bonds. With no restrictions on inflows or outflows of foreign investment capital, the asset markets of countries with economies that are small relative to the amount of foreign investment can be quite volatile over a country's economic cycle. Maintain fixed exchange rates. For countries with fixed exchange rate targets, limiting flows of foreign investment capital makes it easier to meet the exchange rate target and, therefore, to be able to use monetary and fiscal policy to pursue only the economic goals for the domestic economy. Keep domestic interest rates low. By restricting the outflow of investment capital, countries can keep their domestic interest rates low and manage the domestic economy with monetary policy, as investors cannot pursue higher rates in foreign countries. China is an example of a country with a fixed exchange rate regime where restrictions on capital flows allow policymakers to maintain the target exchange rate as well as to pursue a monetary policy independent of concerns about its effect on currency exchange rates. Protect strategic industries. Governments sometimes prohibit investment by foreign entities in industries considered to be important for national security, such as the telecommunications and defense industries.

Capital Account .

The capital account comprises two sub-accounts: Capital transfers include debt forgiveness and goods and financial assets that migrants bring when they come to a country or take with them when they leave. Capital transfers also include the transfer of title to fixed assets and of funds linked to the purchase or sale of fixed assets, gift and inheritance taxes, death duties, and uninsured damage to fixed assets. Sales and purchases of non-financial assets that are not produced assets include rights to natural resources and intangible assets, such as patents, copyrights, trademarks, franchises, and leases

Financial Account

The financial account comprises two sub-accounts: Government-owned assets abroad include gold, foreign currencies, foreign securities, reserve position in the International Monetary Fund, credits and other long-term assets, direct foreign investment, and claims against foreign banks. Foreign-owned assets in the country are divided into foreign official assets and other foreign assets in the domestic country. These assets include domestic government and corporate securities, direct investment in the domestic country, domestic country currency, and domestic liabilities to foreigners reported by domestic banks.

A quota restricts the quantity of a good imported to ________________. Domestic producers ________, and domestic consumers ______ from ___________________. The right to export a specific quantity to the domestic country is granted by the domestic government, which may or may not _________________________. If the import licenses are sold, the domestic government _____________________.

the quota amount gain lose an increase in the domestic price charge for the import licenses to foreign countries gains the revenue.