Trade Policies

1. Trade Policies Free trade vs protectionism

2. This part is simple: • Free trade makes the country as a whole better off, even though it may not make every individual in the country better off • Winners gain more than the losers lose • The tale of a great inventor • Trade allows us to obtain the goods at lower cost just as superior technology would allow us to obtain the goods at lower cost

3. “Valid” arguments for protection • Advantages of diversification • What if we have a war? • What if our staple industry becomes obsolete? • May be valid for small countries • Protection for specific groups • Skilled workers vs unskilled workers (with factor endowment induced comparative advantage) • Increase incomes of a group at expense of lower average income • Could be done by other means, better? • These arguments take sides in income vs other objectives tradeoff

4. “Valid” arguments for protection • Improving terms of trade • Recall, terms of trade = 100 (index of export prices) / (index of import prices) • If a tariff increases export prices more than import prices, terms of trade may improve • May be valid only for large countries • Protection of infant industries • Large economies of scale • Significant learning by doing • Seems to have worked historically • Or did it? • Strategic trade policies • Hoping to “break in” very profitable industries worldwide • These arguments suggest economic gains to a country as whole

5. Erroneous arguments for protection • Keeping money at home • But you don’t need to, the money always return anyway • Protection against low-wage foreign labour • But this is refusing to obtain goods at low cost • Exports are “better” than imports • Exports EX increase GDP, imports IM decrease GDP • NX = (EX – IM) • But this says income is more important than consumption • Protection creates domestic jobs • It may create jobs for some • But it destroys jobs for others

6. How does protectionism work? • Tariff (import duty) • The price increases above the world price • Domestic quantity supplied increases • Domestic quantity demanded (consumed) decreases • Total surplus decreases => net effect is negative • Producers gain less than consumers gain • Quota • Can import no more than set amount • Quota reduces our surplus more than “equivalent” tariff does • The difference is: • With tariff, government receives revenue • With quota, foreign producers receive that revenue • Voluntary export restriction VER • A country who sells may prefer self-imposed quota because • With tariff, foreign government receives revenue • With quota, Canadian producers receive that revenue

7. How does protectionism work? • Tariff (import duty) • The price increases above the world price • Domestic quantity supplied increases • Domestic quantity demanded (consumed) decreases • Total surplus decreases => net effect is negative • Producers gain less than consumers gain • Quota • Can import no more than set amount • Quota reduces our surplus more than “equivalent” tariff does • The difference is: • With tariff, government receives revenue • With quota, foreign producers receive that revenue • Voluntary export restriction VER • A country who sells may prefer self-imposed quota because • With tariff, foreign government receives revenue • With quota, Canadian producers receive that revenue

8. Current Trade Policies • Read. NOT tested.