The Political Economy of International

Trade
Chapter 6

© McGraw Hill Companies, Inc., 2000 2007 2008 2009

 Real Outcomes in Trade
• Have looked at representative sample of
theories seeking to describe trade and trade
patterns.

• In many cases though outcomes are determined

or strongly influenced by other factors.

• Illustrate first through examples...

 EU-US and Beef
1989 - EU bars growth hormone treated beef.
US exports decline from $231mm in ‘88 to
$98mm in ‘94.
With other countries, US files complaint to WTO.
US wins (1998) - WTO Panel
declares ban to be illegal.
EU reluctant to comply and
appeals, but loses the appeal.
1999 - US threatens to raise
tariffs on hundreds of EU products.
5-1
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 2005: The Beef Case Still...
WTO hearing on EU's US beef ban begins
12.09.2005 - 09:54 CET | By Meghan Sapp
EUOBSERVER / BRUSSELS - International trade relations are set
to make history on Monday (12 September) as the World Trade
Organisation (WTO) opens its trade dispute process to the public
for the first time.
The EU banned the import of hormone-raised beef during the mid-1980s but in
1996 the US applied for a dispute settlement panel through the WTO. Canada did
the same a year later. The US and Canada won both their cases on the grounds that
EU scientific data used for the hormone ban were not sufficient and the EU was
forced to rescind the ban. Though the EU says it amended its directives in 2003
and notified the WTO it had complied with the ruling, the US and Canada
disagreed. In 1999, the WTO ruled the US and Canada could fine the EU
(according to a 1997 ruling) for not abiding by world trade rules. The US and
Canada have since imposed trade restrictions on the EU as retaliation for the
hormone ban.
http://euobserver.com/?aid=19844&rk=1 Acc 12/9/5
 2008: The Beef Case Still...
WTO rejects EU beef hormone ban but also raps US,
Canada Mar 31, 2008 GENEVA (AFP) — The World Trade
Organisation on Monday ruled that the European Union, United States and
Canada all failed to respect global trade rules in a long-running row over
beef treated with growth hormones....
The case goes back nearly 10 years to 1998 when the WTO ruled
Washington and Ottawa could slap higher tariffs on a list of EU products
after it condemned Brussels for banning beef producing with certain
growth-promoting hormones ...
Noting that the panel also said it did not consider the new EU hormones
directive to be in line with WTO sanitary measures, Brussels said in a
statement that it "disagrees with these findings."
Both sides have the option of appealing the ruling, the EU noted.
http://afp.google.com/article/ALeqM5hEqmznwYN5qTPQWtGq27IEPJkwDw 041108
 US Targets EU
Beef Soups and Broths
Pork Truffles
Sausages Mineral Water
Corned Beef Cut Flowers
Roquefort Cheese Yarn
Chocolate Products Electric Hair Clippers
Mustards Motorcycles and
Chewing Gum Mopeds
5-2
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 EU-US and Beef
What can we draw from this?

Many arguments big country/little country:

this one unusual but increasing.

Was EU motivated by protectionism?

What should the role of government be? To

whom is it primarily responsible?

Nature of response, nature of confrontation.

 2002/3: The converse
2002: EU develops “hit list” of US
exports to EU as reprisal for US steel,
farm protection measures

List recognises essentially political

nature of actions: targets exports from
those states which have sought to gain
from barriers (orange juice…)

2003: WTO sanctions reprisals by EU

for US steel tariffs: US takes off tariffs,
must satisfy EU and others.
Another example: Airbus – 2004 to...
Airbus-Boeing Culture War
The United States has launched a major economic dispute with
Europe, taking the biggest trade complaint ever to the World Trade
Organization (WTO) for litigation
http://www.csmonitor.com/2004/1021/p08s01-comv.html

On 14 December 2007, the Chairman of the Panel informed the DSB

(Dispute Settlement Body) that due to the substantive and procedural
complexities involved in this dispute, it now expected to complete its work in
2008. http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds316_e.htm 150708
The dispute between the United States and European Union over subsidies
for the European Airbus is so complicated that the World Trade
Organisation (WTO) will not be able to rule on it until next year, a WTO
document shows. Published: October 23, 2008 13:07h
http://www.javno.com/en/economy/clanak.php?id=195449 050209
 Trade Policy and Politics
Pressures for government intervention:
Protecting jobs and industries:
emerging industries.
Social/political concerns
Increasing exports.
National security.
Retaliation.
International product domination:
New trade theory and subsidies.
5-3
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 How would you rate the
relative importance of

? these factors?
 Instruments of Trade Policy
Tariffs
Subsidies
Quotas and VER’s
Local content requirements
Anti-dumping actions
Administrative policies/procedures

Must understand difference in the nature of

instruments – particularly whether price or
quantity
5-4
 Instruments of Trade Policy
Tariffs -> Taxes
Tariffs - oldest form of trade policy
Specific
ad valorem (in proportion to the value)
Good for government
Good for producers
- but reduces efficiency
Bad for consumers

5-4
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 Hypothetical Tariff Rate Quota

© McGraw Hill Companies, Inc., 2000 2007 2008 2009

 Tariffs and Welfare Loss
The use of tariffs (taxes) to advantage local
producers does not come without cost.
Distributional issues arise whereby
consumers have to fund the benefits given
producers
As well, the mechanism itself involves
losses overall to the economy, analogous to
the deadweight loss of any tax.
Most easily seen and measured by using
surplus as measure of welfare.
 Autarchy – No trade
Local supply
The closed economy

CS Local production
=
pe Local consumption
PS

Local demand

qe
 Importing at World Price
World price becomes both a demand
and supply curve.......why?

pe

pw SW
DL

Note: small country case qe q

 Importing at World Price

pe

pw SW
Imports
DL

qe q
Local Local
production consumption
 An Importing Country

The gains from trade S

pe

pw
SW
DL

qe q
 Impact of a Tariff

Imports after
S

pe Tariff
Tariff p

pw SW
Imports before
DL

qe q
Impact of a Tariff – Welfare Loss
Total consumer surplus
(benefit) lost through tariff

pe
pw
SW
DL

Imports after tariff

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Impact of a Tariff – Welfare Loss

Surplus gained by producers

at the expense of consumers
S

Tariff revenue to
government
pe
pw
SW
DL

Imports after tariff

 Nett Loss of a Tariff
Welfare loss = deadweight loss
S

Welfare loss overall

pe
pw SW+ T
SW
DL

Imports after tariff

 Tariffs overall
Tariffs therefore involve

Redistribution
• Consumer to producer
• Consumer to government

An absolute loss in economic efficiency terms

plus…the intangibles which arise from the

manner of allocation of tariff protection and the
distortions induced by that process
 Instruments of Trade Policy
Subsidies
Like tariffs, a price instrument.
A payment to a domestic producer.
cash grants (eg US biodiesel)
low-interest loans
tax breaks
government equity participation in the company
• eg Airbus
Subsidy payments generated from taxes.

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 Subsidies
Must watch definitions – part of critical reading.

7
6
5
4
3
Percent
2
1
0 Sweden

Ireland
Japan
US
IDC

W. Ger.
UK

5-6
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 Subsidies to EC Manufacturers
(Percent of Value Added)
% 16
14
12
10
8
6
4
2
0

Belgium
Holland

Spain

Ireland
GB
Germany
Luxembourg

Italy
France

Greece
Portugal

5-7
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 Instruments of Trade Policy
Import Quotas and Voluntary Export Restraints
Both quantity instruments
Import Quota:
Restriction on the quantity of some good imported
into a country.

Voluntary Export Restraint (VER):

Quota on trade imposed by exporting country,
typically at the “request” of the importing country.
Reagan 1981. Simply quotas under another name

5-8
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 Results of Japanese VERs
Benefits producers by limiting import
competition

Japan - limited to 1.85 million vehicles/year

Cost to consumers - $1B/year between ‘81 - 85.
Money went to Japanese producers in the form
of higher prices.

5-9
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 So who were the ‘winners’
from VERs?

? If the gains overall might

be negative, why would
governments do it?
 Annual Cost to American
Consumers for Import Protection
$ Millions
30
Textiles shifted
25

20
Consumer Losses
15 Producer Gains

10
Automobiles Dairy
5
Meat Sugar
0

5-13
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 So why accept the costs?
Peanuts: (US, 1982 – 87) shifted

Quotas , import restrictions and price supports

transferred $US255M per year from 1982 – 1987
from consumers to producers, with $US34M
deadweight loss.
Cost to consumers: $1.23 each
Benefit to peanut growers: $11,100 each
Small group/large group interaction.
Peanuts?
(Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. 1995. Economics of
Regulation and Anti-trust. 2nd ed. Cambridge: MIT Press. in
Keohane, Revesz & Stavins The Positive Political Economy of Instrument Choice in
Environmental Policy, Resources for the Future 97-25, 1997)
 Instruments of Trade Policy
Local Content Requirements
Requires some specific fraction of a good to be
produced domestically.
Percent of component parts.
Percent of the value of the good.
Initially used by developing countries to help shift
from assembly to production of goods.
Developed countries (US) beginning to implement.
For component part manufacturer, LCR acts the
same as an import quota.
Benefits producers, not consumers.
5-10
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 Instruments of Trade Policy
Antidumping Policies
Defined variously as:
Selling goods in a foreign market below production
costs.
Selling goods in a foreign market below fair market
value (but who defines that?).
Result of:
Unloading excess production.
Predatory behavior.
Remedy: seek imposition of tariffs.
But --- often used as a means of protection?
5-11
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 Instruments of Trade Policy
Administrative Policies
Bureaucratic rules designed to make it
difficult for imports to enter a country.

Examples in imposing rules.

Japan - Tulip bulbs.
France – videos

Sometimes quarantine or environmental

measures argued to be of this type.
5-12
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Political Arguments for Intervention
Protecting jobs and industries.
VERs.
National security.
Defense industries - semiconductors.
Retaliation.
Protecting consumers.
Furthering foreign policy objectives. No
justification other than can do it.
Helms-Burton Act.
Protecting human rights.
MFN.
5-14
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 How would you rate the
relative importance of these
factors for countries other
than the US?

?
 National Security
World Semiconductor Production
60

50

40
Japan
30
USA
20

10

0
1974 76 78 80 82 84 86 88

5-15
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 Retaliation
US Trade Sanctions
Partial List
Afghanistan Italy
25
Burma Libya
20
Canada Nigeria
15
China N. Korea
New
10 Sanctions Cuba Pakistan
5 India Saudi Arabia
0
Iran Sudan
98
1993

95

97

Iraq Syria
Yugoslavia
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 Retaliation - Helms-Burton Act

1996. Allows American to sue foreign

firms that use property in Cuba confiscated
from them after the 1959 revolution.
Backlash
Violates a state’s sovereignty.
Also passed the D’Amato Act - Libya and
Iran.

5-17
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 Economic Arguments for
Intervention
Infant industry.
Oldest argument - Alexander Hamilton, 1792.
Protected under the WTO.
Only good if it makes the industry efficient.
• Brazil auto-makers - 10th largest - wilted when
protection eliminated.
Requires government financial assistance.
• Could argue that if a good investment, global
capital markets would invest.

5-18
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Economic Arguments for Intervention
Strategic trade policy.
Government helps raise national income if first-
mover advantage successful.
Government intervention may help domestic
firms overcome first-mover advantage of
foreign firms.
The role of Porter’s ‘diamond’ in
forming views?
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 Revised Case for Free Trade
Paul Krugman, MIT economist, argues that strategic
trade policies can lead to trade wars. The best way to
handle disputes is to work to establish rules that minimize
trade-distorting subsidies - a function of the World
Trade Organization.

He also argues that government intervention usually favors

special interest groups that distort the subsidy to their
own ends.

Therefore, “a blanket policy of free trade, with exceptions

granted only under extreme pressure … may be the best
policy that the country is likely to get.”
http://www.wws.princeton.edu/~pkrugman/
http://www.pkarchive.org/
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Summary: Arguments for Intervention
Political
Protecting jobs and industries.
National security.
Retaliation.
Protecting consumers.
Furthering foreign policy objectives.
Protecting human rights.
Economic
Infant Industry
Strategic Trade Policy
The implications for business - I
Impact of trade barriers on firms’ strategy, and
on achievable production cost:
• Tariffs raise cost of exporting products to a country
• VER’s may limit ability to service country from
outside
• Local content laws may mean location of more
capacity in a country than is economic
• Even when barriers do not currently exist firms may
need to retain local capacity as precautionary
measure
All tend to reduce flexibility, raise cost
 The implications for business - II
These issues may limit firms’ ability to
disperse production in economically efficient
fashion. Also policy implications for firms:
Firms are major policy influence on government
Some support for intervention as per new trade
theory but
Likelihood of retaliation means protection gained
from government can backfire
Firms must have considered policy approach
recognising likely negatives of barriers
 Things you should know about..
The various forms of barriers to trade, and the
principle underlying their operation.
Tariffs:
Distributional issues and welfare losses. Who pays?
Political arguments for protection
Economic arguments for protection
Problems for governments –internal and external
pressures
Implications for business
Cost, location, policy