The Economics of Globalisation Lecture 3: Trade Policy

Annina Kaltenbrunner A.Kaltenbrunnner@leeds.ac.uk G.19

Recap and Motivation

Traditional trade theories (Comparative Advantage Theories)
Trade increases welfare for all countries through static efficiency gains
Lower prices - Increased output and consumption Any restrictions on trade can only be distortionary and reduce welfare >> no role for trade policy

Trade Policy in the Comparative Advantage Framework

Trade Policy in the Comparative Advantage Framework

Net Effect of Tariff: (b+d)-e
b+d=efficiency loss
Production Distortion Loss (Home produces goods which could be produced more cheaply abroad) Consumption Distortion Loss

e=terms of trade gain

Assessment will depend on how we value gain/loss of each agent Redistribution? Net effect of tariff depends on the ability of tariffimposing country to drive down foreign export prices (large vs. small country assumption)

Recap and Motivation

Markets do not work efficiently >> Important role of government to intervene in trade relations
Trade policy crucial element of alternative economic paradigms (Dunkley, 2004)

New Trade Theories

Trade increases welfare (lower prices) through increased efficiency and falling average costs
Potential role for trade policy New trade theory but no new trade policy (Krugman, 1992) Political Economy arguments against trade policy /Rent seeking (e.g. Krueger, 1997)

Historical evidence shows that trade policy important instrument to promote growth, industrialisation, and development (Consumer Welfare vs. Development)

Outline
Main Instruments of Trade Policy The Case for Trade Protection and Trade Policy
The Market Failure Argument
Infant Industry

The Keynesian Case for Trade Protection: Thirlwalls Law The Terms of Trade Argument: The Prebisch-Singer Thesis Verdoorns Law and Global Value Chains Theories of Dependence and Unequal Exchange

Trade Policy in Practice: ISI vs. Export Promotion

Learning Outcomes
Know and Understand the case and effect of trade policy (trade protection) in different economic paradigms Evaluate the appropriateness of trade protection for different countries at different time frames in light of the theoretical and empirical (historical) evidence

Types of Trade Instruments

Tariffs
Oldest form of trade policy Government revenue and domestic protection Import vs. Export tariff Specific vs. Ad-valorem > Effective rate of protection Export subsidies (CAP) /Export credit subsidies Import quotas Voluntary export restraints (Multi Fibre Agreement) Local content requirements National procurement Technical, Administrative and other Regulations (Red-tape barriers)

Non-Tariff based Trade Policy Instruments

International Cartels Dumping (persistent; predatory; sporadic)

Trade restrictions to counteract dumping are justified

Types of Trade Instruments

Source: WTO, 2012

Global Trade Map

http://www.wto.org/english/res_e/statis_e/st atis_e.htm (Data on Tariffs for Country and Product Groups)

The Case for Trade Protection

The Market Failure Argument
Inefficient Markets Gains from Trade not clear
For example: Prices do not restore efficient market equilibrium; Frictions to factor mobility across sectors; transaction costs

Marginal social benefit beyond producer surplus

Private production would not take place without incentive need for government intervention

The Market Failure Argument Infant Industry

Governments should temporarily support new industries until they have grown strong enough to meet international competition and create comparative advantage Market failure arguments for new industries
(Dynamic) economies of scale (learning effects) Public Goods (e.g. large fixed costs) (Technological) Externalities The Appropriability argument Linkages Imperfect capital markets

Example: Bioplastic in Canada (Rudge et al. 2005)

The Market Failure Argument Infant Industry

Source: Ocampo and Taylor, 1998

The Market Failure Argument Critique

Traditional
Trade policies as second-best Difficulty to identify market failures Foreign Retaliation

Trade protection only as temporary measure? Trade protection only for developing countries to catch up with the developed world? First-Mover Advantage and Catch-Up

The Case for Trade Protection The Keynesian View

Demand Determination of Output Y=C+I+G+(X-M)
Trade Balance Crucial Determinant of Growth What are the implications of trade liberalisation on the trade balance?

The Keynesian View Thirlwalls Law

Developing Countries Balance of Payments Constrained The rate of growth of output of a country (g) can be approximated by the formula

g=x/y
where x is the growth of export volume (determined by the growth of world income and the income elasticity of demand for exports) and y is the income elasticity of demand for imports. (Thirlwall, 2006) Implications
Exports as main driver of growth Important Role of Income Elasticities Trade Balance not given
Income Elasticity of Exports (Prebisch-Singer Thesis) Income Elasticity of Imports (High in developing Countries)

Trade protection to support domestic demand

The Case for Trade Protection

The Terms of Trade Argument
Prebisch-Singer Hypothesis Developing countries experience a secular decline in their terms of trade (export /import prices)
Developing Countries export commodities and import manufacturing goods

Two reasons:
Supply Side:
Relation between income and productivity Factor prices in developing countries rise more slowly than productivity due to population pressure and surplus labor

Demand side:
Demand for primary products grows more slowly than that for industrial products as world income grows
1. 2. Low income elasticity of primary commodities (less than 1) Primary commodities substituted by synthetics (e.g. Rubber)

The Terms of Trade Argument

Trade leads to:
Balance of Payments Problems (balance of payments constrained growth (Thirwall, 2006) Decline in Welfare in Developing Countries Underdevelopment (commodity dependence vs. industrialisation)

Trade Protection (Import Substitution) to:

ration scarce foreign exchange - correct balance of payments disequilibria arrest the deterioration in the terms of trade by damping down the demand for imports start producing and exporting goods with a much higher income elasticity of demand in world markets (switch from commodity to manufacturing goods)

International Price Stabilisation Schemes

Source: Cashin and Dermott, 2002

Source: Cashin and Dermott, 2002

The Case for Trade Protection Global Value Chains

Heterogeneous Developing Countries
Commodity (Africa, Latin America) vs. manufacturing producer (Asia China, South-East Asia)

Deteriorating Terms of Trade of developing countries

Deteriorating prices of manufacturing goods exported from developing countries (high vs. low value added manufacturing)

Structure of Global Production (Global Value Chains) vertical FDI and intra-industry trade
>>> Production and Exports of low value added products based on low wages from developing countries >>> Innovation and Development in Developed Countries

Global Value Chains Dell Notebook

http://www.youtube.com/watch?v=owQzo82 ac_M&noredirect=1

Global Value Chains Textile Industry

Source: Staritz, 2012

Global Value Chains Problems

Strong Competition Lower Prices Deteriorating Terms of Trade
Low entry-barriers Labour-intensive nature

Slow growing markets/low income elasticities Vulnerability to international market conditions Resource Transfer through Profit and Remittances (Balance of Payments Problem) Very little dynamic productivity gains in low-value added technology (Verdoorns Law)

Global Value Chains Verdoorns Law and Cumulative Causation

Verdoorn Law (Nicholas Kaldor): In manufacturing sector higher output causes higher productivity through dynamic economies of scale (e.g. learning by doing)

Output Growth

Export Growth
Price Competitiveness and (Foreign Income Growth)

Productivity Growth and (Wage Growth)

Implications: Trade Policy to move from primary products and low value-added manufacturing to high-value added manufacturing (Taiwan, South Korea, China etc.)

The Case for Trade Protection Other Factors

Income Distribution (Heckscher-Ohlin Model) Food protection Security National Autonomy Political (both national and geopolitical)

Theories of Dependence and Unequal Exchange (Thirlwall, 2006; Palma 1978)

Attempt to explain the perpetuation and widening of the differences between centre and periphery For example: Dos Santos, Baran, Gunder Frank, Amin and Emmanuel Unequal development as integral part of the world capitalist system development of some parts of the system (centre) occurs at the expense of others (periphery) Trade as transfer of economic surplus from the centre to the periphery and from workers to capital Development in centre conditions development in periphery and maintains underdevelopment (The development of underdevelopment)
colonial dependence (resource exploitation) financial-industrial dependence (capital transfer) technological-industrial dependence (MNCs)

Domestic Elites Autonomous Development and Focus on Domestic Market

Trade Policy in Practice Import Substitution vs. Export Promotion (Lall, 1994; Liang, 1992; Chang, 2002)
Import substituting industrialization
Develop industries oriented toward the domestic market by using trade restrictions to encourage the replacement of imported manufactures Based on infant industry argument Main development strategy in 1950s and 1960s

Very successful in promoting manufacturing growth/Strong Growth BUT:

Complex and time-consuming regulations Firms might not become competitive Lack of imports and foreign exchange Small market/Production at inefficient scale Necessity of accompanying policy measures

Export Promotion vs. Import Substitution (Asia vs. Latin America)

Empirical evidence (Chang, 2002; Liang, 1992; Lall, 1994) Protected Export Promotion Trade Liberalization potentially negative effects on development (Lecture 8)

Core Readings
Krugman, Paul, Maurice Obstfeld and Marc Melitz (2011) International Economics: Theory and Policy, 9 th edition (Global edition), Pearson Education, Chapters 9-12 OR Salvatore, Dominic (2011) International Economics: Trade and Finance , 9 th edition, Wiley, Chapters 8,9,11 Dunkley, G. (2004): Free Trade: Myth, Reality and Alternatives. Zed Books, Chapter 3, 6, 8 Weiss, J. (2002): Industrialisation and Globalisation. Routledge, Chapter 4 Thirlwall, A.P (2006): Growth and Development. 8th Edition; Chapters 7 and 16 (8+15 in 9th Edt)

Additional Readings
Palma, G. (1978): Dependency: A Formal Theory of Underdevelopment or a Methodology for the Analysis of Concrete Situations of Underdevelopment? World Development 6, p. 881-924 Cashin, P.; Dermott, C.J. (2002): The long-run Behaviour of Commodity Prices: Small Trends and Big Variability. IMF Staff Papers, 49 (2). Ocampo, J. A. and L. Taylor (1998) Trade Liberalisation in Developing Economies: Modest Benefits but Problems with Productivity Growth, Macro Prices, and Income Distribution, The Economic Journal, 108(450), p. 1523-1546. Lall, S. (1994) The East Asia Miracle Study: Does the Bell Toll for Industrial Policy, World Development, 22(4), p. 645-654. Liang, N. (1992) Beyond Import Substitution and Export Promotion: A New Typology of Trade Strategies, Journal of Development Studies, 28(3), p. 447-472. Chang, H.-J. (2002): Kicking away the ladder? : Policies and Institutions for Economic Development in Historical Perspective. Anthem Press, London. Thirlwall, T. (2011): Balance of Payments Constrained Growth Models: History and Overview. PSL Quarterly Review, Vol. 64, Nr. 259, p. 307-351 Milberg, W. (2004): The Changing Structure of Trade linked to Global Production Systems: What are the Policy Implications? International Labour Review, Vol. 143, Nr. 1-2 Staritz, C. (2012): Apparel Exports. Still a Path for Industrial Development? Dynamics in Apparel Global Value Chains and Implications for Low-Income Developing Countries. OEFSE Working Paper. Available at: http://www.oefse.at/Downloads/publikationen/WP34_apparel_exports.pdf Thirwall, A.P. (1983): A plain man guide to Kaldors growth laws. Journal of Post Keynesian Economics, Vol. 5 (3), p. 345-358 Unctad (2013): World Investment Report, Chapter IV (Global Value Chains)

Background Readings
WTO (2012): World Trade Report ; available at: www.wto.org World Tariff Profiles, 2011. Online Source, Available at: http://www.wto.org/english/res_e/booksp_e/tari ff_profiles11_e.pdf Rutge et al. (2005): Infant Industries Accessing Global Markets: Strategic Risks and Potential Trade Barriers in Bioplastics. Innovative Marketing, Vol 1(2), p. 22-31