Trade policy
◼ Apply the theories we learnt to craft TRADE POLICY and
TRADE POLICY INSTRUMENTS. Most if not all countries
have Trade Policies, and use trade policy instruments.
◼ POINT OF DEPARTURE: TRADE IS GOOD (But as we have
seen from our theories, TRADE can create
WINNERS/LOSSERS). So, countries come up with policies
and instruments of trade policies to minimize LOSSES or
increase GAINS from Trade.
◼ Instruments of Trade Policy include: • Tariffs • Export
subsidies • Import quotas • Voluntary export restraints •
Local content requirements
LEARNING OBJECTIVES
Effect of export subsidy and import tariff.
Specific, ad valorem subsidy and tariff
Welfare effects of export subsidy, import tariff
Other ways in which governments influence
trade.
Compare impact of import tariff and import
quota
Kenneth A. Reinert, Cambridge University
Press 2021
Trade Policy Measures
◼ A country can grant import protection to a
sector of its economy in form of either
❑ Tariffs: a tax on imports
◼ Specific tariff is a fixed tax per physical
unit of the import
◼ Ad valorem tariff is a percentage tax
applied to the value of the import
❑ Non-tariff measures (see Table 7.1)
❑ Employ both types of measures
Kenneth A. Reinert,
Cambridge University Press 2021
Table 7.1 Non-tariff measures:
Tax-like measures
Kenneth A. Reinert, Cambridge University
Press 2021
Table 7.1 Non-tariff measures:
Cost-increasing measures
Kenneth A. Reinert, Cambridge University
Press 2021
Table 7.1 Non-tariff measures: Quantitative measures
Kenneth A. Reinert, Cambridge University
Press 2021
Table 7.1 Non-tariff measures
Government procurement measures
Kenneth A. Reinert, Cambridge University
Press 2021
A Tariff
A tariff is a tax levied when a good is
imported.
◼ The purpose of a tariff is twofold : To
provide revenue for the government
◼ And to protect particular domestic sectors
from import competition
◼ Importance of tariffs have decline due to
nontariff barriers such as import quotas
Kenneth A. Reinert,
Cambridge University Press 2021
Kinds of tariffs
◼ A specific tariff is levied as a fixed
charge for each unit of imported
goods. For example, $3 per barrel of
oil.
◼ An ad valorem tariff is levied as a
fraction of the value of imported
goods. – For example, 25% tariff on
the value of imported trucks
Kenneth A. Reinert, Cambridge University
Press 2021
Effects of tariffs on a “small” country
◼ In trade theory, a country is said to be “small” if
events in that country can have no effect on
worldwide free trade prices
◼ A tariff is a tax on imported goods Tariffs raise the
price of imported goods above the world price by
the amount of the tariff.
◼ This Reduces consumption, …
❑ Increases production, and thereby …
❑ Reduces the amount imported
Effects of a Tariff on Prices and Quantities
Price
of Steel
Domestic
supply
Equilibrium
without trade
Price
after tariff Tariff
Price World
before tariff Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
under free trade
Welfare under free trade
Price
of Steel
Consumer surplus
before tariff Domestic
supply
Producer
surplus Equilibrium
before without trade
tariff
Price World
before tariff price
Domestic
demand
S D
0 Q Q Quantity
of Steel
Imports
under free trade
Consumer Surplus after Tariff
Price
of Steel
Consumer surplus
after tariff Domestic
supply
A
Equilibrium
without trade
B
Price
after tariff Tariff
Price World
before tariff Imports price
Domestic
with tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
under free trade
Producer Surplus after Tariff
Price
of Steel
Domestic
supply
Producer
surplus Equilibrium
after tariff without trade
Price
after tariff C Tariff
Price World
before tariff G Imports price
Domestic
after tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
under free trade
Government’s Revenue from Tariff
Price
of Steel
Domestic
supply
Tariff Revenue
Price
after tariff Tariff
E
Price World
before tariff Imports price
Domestic
after tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
under free trade
Effects of Tariff on Social Welfare
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
with tariff C Tariff
D E F
Price World
without tariff G Imports price
Domestic
after tariff
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without tariff
EFFECT OF TARIFF IN LARGE
COUNTRY
◼ For a “large” country, whose imports and
exports affect world prices, the welfare effect
of a tariff is ambiguous.
◼ The tariff lowers the Foreign price, allowing
Home to buy its imports cheaper
Kenneth A. Reinert, Cambridge University
Press 2021
Import quotas
◼ Restriction on quantity of a good that may be
imported. Usually enforced by issuing licenses or
quota rights.
◼ A binding import quota will push up the price of the
import because the quantity demanded will exceed
the quantity supplied by Home producers and from
imports. When a quota instead of a tariff is used to
restrict imports, the government receives no
revenue. Instead, the revenue from selling imports at
high prices goes to quota license holders. These
extra revenues are called quota rents
Kenneth A. Reinert, Cambridge University
Press 2021
The Effects of an Import Quota
◼ An import quota is a limit—imposed by the
domestic government—on the quantity of a
good that can be produced abroad and sold
domestically.
◼ Because the quota raises the domestic price
above the world price, domestic buyers of
the good are worse off, and
❑ domestic sellers of the good are better off.
◼ Import license holders are better off they
make a profit from buying at the world price
and selling at the higher domestic price.
The Effects of an Import Quota
Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
Quota
supply
A
+
Import supply
Isolandian
price with B
Equilibrium
quota
with quota
C D E'
Price E" F
World World
without =
price G Imports price
quota Domestic
with quota
demand
S S D D
0 Q Q Q Q Quantity
of Steel
Imports
without quota
The Effects of an Import Quota
◼ Consumer surplus decrease, producer
surplus increase, license holder surplus
increase
◼ Total surplus in the market decreases by an
amount referred to as a deadweight loss.
◼ The quota can potentially cause an even
larger deadweight loss, if a political
mechanism such as lobbying is employed to
allocate the import licenses.
EFFECT OF EXPORT SUBSIDY
◼ Raises the price in the exporting country (this is due
to undersupply in the local market)
◼ It decreases consumer surplus (consumers worse off)
and increases producer surplus (producers better off).
◼ Government revenue falls due to paying for the
export subsidy.
◼ Lowers the price paid in importing countries (due to
oversupply)
◼ Worsens the terms of trade by lowering the price of
exports in world markets.
Kenneth A. Reinert, Cambridge University
Press 2021
The Lessons for Trade Policy
◼ Both tariffs and import quotas . . .
❑ raise domestic prices.
❑ reduce the welfare of domestic consumers.
❑ increase the welfare of domestic producers.
❑ cause deadweight losses.
EXPORT SUBSIDIES IN EU
◼ There are no tariffs within the EU (customs
union)
◼ Massive agricultural export subsidy
program • The subsidy program began as
a guarantee for high prices for European
farmers. The EU used to buy agricultural
products whenever the prices fell below
certain level
Kenneth A. Reinert, Cambridge University
Press 2021
EU’s Common Agricultural Policy sets high prices for
agricultural products and subsidizes exports to
dispose of excess output. –
Subsidized exports reduce world prices of agricultural
products.
Cost for European taxpayers is almost $30 billion
more than its benefits (in 2007). Subsidy payments
are about 22% of the value of farm output.
EU has proposed that farmers receive direct
payments independent of the amount of production to
help lower EU prices and reduce production
Kenneth A. Reinert, Cambridge University
Press 2021
Voluntary export restraint
◼ Works like an import quota, but quota is
imposed by the exporting country rather
than importing country.
◼ Usually requested by the importing
country.
◼ Profits/ rents earned by foreign
governments or foreign producers.
◼ Foreigners sell a restricted quantity at an
increased price
Kenneth A. Reinert, Cambridge University
Press 2021
Local content requirement
◼ Requires a specified fraction of a final good to be
produced domestically.
◼ May be specified in value terms, by requiring that
some minimum share of the value of a good
represent home value added, or in physical units.
◼ For domestic producers of inputs, provides
protection in the same way that an import quota
would. For firms that must buy home inputs,
however, the requirement does not place a strict limit
on imports, but allows firms to import more if they
also use more home parts
Kenneth A. Reinert, Cambridge University
Press 2021
Local content requirement
◼ Provides neither government revenue
(as a tariff would) nor quota rents.
◼ Instead, the difference between the
prices of home goods and imports is
averaged into the price of the final
good and is passed on to consumers.
Kenneth A. Reinert, Cambridge University
Press 2021
OTHER TRADE POLICIES
◼ Export credit subsidies – subsidized loan to
exporters
◼ Government procurement – Government
agencies are obligated to purchase from
home suppliers, even when they charge
higher prices (or have inferior quality)
compared to foreign suppliers. •
◼ Bureaucratic regulations (red tape) –
Safety, health, quality, or customs regulations
can act as a form of protection and trade
restriction Kenneth A. Reinert, Cambridge University
Press 2021
Anti-Dumping and Countervailing Measures
◼ Anti-dumping: a product has been sold at
less than “normal” value
◼ Tariff can be applied against “dumped”
goods if the dumping causes “material
injury” to the domestic competing sector
producing a “like product.”
◼ Anti-dumping is consistent with obligations
under the WTO
Kenneth A. Reinert,
Cambridge University Press 2021
Anti-Dumping and Countervailing Measures
◼ Calculating the dumping margins can be
complicated
◼ importing country can choose from 3 policy
responses.
❑ (1) Impose anti-dumping duties equal to the found
dumping margin.
❑ (2) Impose anti-dumping duties sufficient to
remove “material injury” (“lesser-duty rule”).
❑ (3) Have foreign exporting firms increase their
prices (“price undertakings”)
Kenneth A. Reinert,
Cambridge University Press 2021
EFFECTS OF TRADE POLICY
◼ For each trade policy, price rises in the Home
country adopting the policy. Home producers
supply more and gain.
◼ Home consumers demand less and lose. • The
world price falls when Home is a “large” country
that affects world prices.
◼ Tariffs generate government revenue; export
subsidies drain it; import quotas do not affect
government revenue. All these trade policies
create production and consumption distortions.
Kenneth A. Reinert, Cambridge University
Press 2021
SUMMARY
◼ A tariff increases the home price and the
quantity supplied and reduces the quantity
demanded and the quantity traded; also
decreases the world price when the country
is “large.”
◼ A quota does the same; an export subsidy
does the same.
◼ Tariffs generate government revenue; export
subsidies drain it; import quotas are revenue
neutral
Kenneth A. Reinert, Cambridge University
Press 2021
SUMMARY
◼ The welfare effect of a tariff, quota, or export
subsidy can be measured by efficiency loss
from consumption and production distortions.
And terms of trade gain or loss.
◼ Import quotas, voluntary export restraints,
local content requirements: government of
importing country receives no revenue.
◼ Voluntary export restraints and occasionally
import quotas: quota rents go to foreigners
Kenneth A. Reinert, Cambridge University
Press 2021
