Microeconomics 1

Lecturer: Adam Allanson Lecture 26

5 May 2011

Impact of Quota / VER

Equivalent Tariff

Is a 600,000 quota really equivalent to a 50% tariff? What will happen if domestic demand rises?

Is a 600,000 quota really equivalent to a 50% tariff? What will happen if domestic demand rises?

Is a 600,000 quota really equivalent to a 50% tariff? What will happen if the world price rises?

Assume specific tariff of $10,000 (rather than 50% ad valorem tariff).

Is a 600,000 quota really equivalent to a 50% tariff? What will happen if the world price rises?

Assume specific tariff of $10,000 (rather than 50% ad valorem tariff).

Quotas when domestic demand & world prices change In summary: where domestic demand is increasing, fixed quantitative quotas become more distortionary over time: under a quota the increase in demand is satisfied by local producers rather than (more efficient) foreign producers; where world prices are rising, fixed quotas become less distortionary and may become non-binding; quotas are less transparent than tariffs: their impact on domestic prices is not immediately obvious; and quotas are generally being phased out under World Trade Organisation (WTO) trade agreements.

Thinking about international trade issues

Micro 1 is not about giving you the answers, but giving you an analytical framework to enable you to ask the right questions.
Trade issues are often complex, involving many competing interests, and analysing them requires an understanding of the affected markets and institutions. An understanding of economic history will help understand the current situation and (hopefully) help us avoid repeating the same mistakes.

A brief (and very incomplete) history

1930s: Great Depression caused countries to place tariffs on goods in order to protect jobs.
Others retaliated with tariffs of their own and international trade collapsed, exacerbating the economic downturn. World War II 1939 to 1945. General Agreement on Tariffs and Trade (GATT) was established in 1948: multilateral negotiations aimed at reducing tariffs and reviving trade. The EU Common Agricultural Policy (1950s) EU tries to guarantee food supply (self sufficiency being a key goal). The US Food Security Act (1985) established the US Export Enhancement Program.

The EU Common Agricultural Policy (CAP)

CAP: A system of production, export and storage subsidies and price floors aimed at ensuring that the EU had a viable agricultural sector and that EU was self-sufficient in food production. The CAP was very successful in meeting its objective of moving the EU toward self-sufficiency from the 1980s onward. Suddenly, however, the EU had to contend with almost permanent surpluses of the major farm commodities, some of which were exported (with the help of subsidies), others of which had to be stored or disposed of within the EU. These measures had a high budgetary cost, distorted some world markets, did not always serve the best interests of farmers, to the extent that they quickly became unpopular with consumers and taxpayers. European Commission of Agriculture and Rural Development, The Common Agricultural Policy Explained

The US Export Enhancement Program (EEP)

The Export Enhancement Program (EEP) is designed to help U.S. farm products meet competition from subsidizing countries, especially the European Union. Under the program, the U.S. Department of Agriculture pays cash to exporters as bonuses, allowing them to sell U.S. agricultural products in targeted countries at prices below the exporters cost of acquiring them. The major objectives are to expand U.S. agricultural exports and to challenge unfair trading practices.
US Department of Agriculture Fact Sheet (March 2006)

Thinking about price floors and anti-dumping

Price floor: A government-guaranteed minimum price for producers which is usually above the free market equilibrium price. Price floors, domestic subsidy policies and export enhancement schemes (such as the EU CAP and US EEP) all serve to drive world prices lower than they would otherwise be. EU and US taxpayers pay for these schemes and producers in other countries suffer from the results of lower world prices and reduced market access.

Dumping: Selling a product for a price below its cost of production. The WTO will allow tariffs to be imposed to offset the effects of dumping. But is foreign dumping bad for the domestic (importing) economy?

Dumping and Anti-Dumping Tariffs

Dumping and Anti-Dumping Tariffs

Dumping and Anti-Dumping Tariffs

Dumping and Anti-Dumping Tariffs

Dumping and Anti-Dumping Tariffs

What concerns might you have about this analysis?
Only measures gains in current period What happens next month/year? Is this market perfectly competitive? Is there costless entry and exit in this market? Are there any spill-over benefits from having a local industry? What happens if dumping reduces the number of suppliers such that the market is less competitive? Many concerns about unfair trade relate to potential for abuse of market power (monopoly)

The World Trade Organization (WTO)?

(see www.wto.org)

The World Trade Organization (WTO): is an international organisation (based in Geneva) that enforces international trade agreements between member countries; currently has 153 member countries: member governments use the WTO as a negiating forum to sort out the trade problems they face with each other; was formed in 1995 following the Uruguay Round of the General Agreement on Tariffs and Trade (GATT); works towards reducing tariffs and other trade barriers in order to promote free trade and fair competition (see WTO website and article on Wattle).

The World Trade Organization (WTO)?

(see www.wto.org)

WTO Objective: the WTO works towards reducing tariffs and other trade barriers in order to promote free trade and fair competition (see WTO website and article on Wattle). WTO Trade Agreements: set rules and member governments agree to keep their trade policies within agreed limits and adhere to agreed principles. For example:
Under WTO Most-Favoured-Nation rules, countries cannot normally discriminate between their trading partners. Under National Treatment rules, imported and locally-produced goods should be treated equally. Importantly, WTO note that National Treatment only applies once a good or service has entered the market. Therefore, charging tariffs on an import is not a violation of National Treatment even if locally-produced products are not charged an equivalent tax.

Why do some people oppose the World Trade Organization?

Globalisation: The process of countries becoming more open to foreign trade and investment. Anti-globalisation: Some people believe that free trade and foreign investment destroy the distinctive cultures of many countries, create environmental and health problems, and can lead to the exploitation of workers.

The argument over trade policies and globalisation

Protectionism: The use of trade barriers to shield domestic companies from foreign competition. Protectionism is usually justified on the basis of the following arguments: 1. Saving jobs 2. Protecting high wages

3. Protecting infant industries

4. Protecting national security

The argument over trade policies and globalisation

Radical environmentalism (Hubbards term)
1. Argument that trade restrictions should be put in place against countries who lack environmental protection laws. Poorer countries tend to lack these laws, therefore the WTO does not support this approach. WTO recommends maintaining trade, and wealthier countries offering financial and practical assistance to help improve production techniques and enforce environmental standards. (The WTO may not always be right these are on balance issues that need careful consideration.)

The argument over trade policies and globalisation

Radical environmentalism (Hubbards term)
2. Argument that free trade increases carbon dioxide emissions due to the transportation of goods and services around the world. Transportation emissions are only part of total production emissions. Lower total emissions could occur if production occurred in efficient markets and trade took place. Key issue is whether transportation costs include the external costs to the environment (e.g. appropriate pricing of carbon here and abroad) irrespective of whether transportation is within Australia or from overseas.

The argument over trade policies and globalisation

Positive versus normative analysis
All interferences with free trade make some people worse off, some people better off, and reduces total income and consumption. Positive analysis: The reduction in economic efficiency from a tariff, quota or VER can be measured. This can usefully inform decision making.

Normative analysis: Whether a tariff or quota is bad public policy and should be eliminated is a normative decision.