Chapter 9A crazy world of trade protection Examples1. US Sugar Quota2. Trade in Agriculture3. Multi-Fiber AgreementTrade protection in the U.S.The cases for FREE TRADEThe cases for PROTECTIONISMOptimum tariffDomestic market failureWorld Trade OrganizationPreferential Trading AgreementsTrade Creation & Trade DiversionSlide 14Slide 15Slide 16Regionalism vs. MultilateralismSlide 18Chapter 9Supplementary NotesA crazy world of trade protectionExamples 1. US Import Quota on Sugar2. Trade in Agriculture3. Multi-Fiber Agreement (MFA)1. US Sugar Quota2. Trade in Agriculture•EU’s Common Agricultural Policy (CAP): Due to export subsidies, a number of agricultural products sell at two or three times world prices.•Japan’s rice policy: Domestic price of rice higher than 5 times the world price due to banned imports. In 1998, Japan imposed a 1000-percent tariff on rice imports.•The clothing industry (Textiles and apparel) has been heavily protected by tariffs and import/export quotas•MFA sets both import and export quotas for a large number of countries.•The industry is labor intensive. •In advanced countries, it is well-organized.•In the US, it accounts more than ¾ of consumer costs of protection in 1990.3. Multi-Fiber AgreementTrade protection in the U.S.The cases for FREE TRADE•Efficiency•Economies of scale•Competition•Political economy argumentThe cases for PROTECTIONISM•Optimal tariff•Domestic market failure •Infant industry•How convincing are they?Optimum tariffDomestic market failureWorld Trade Organization•Created 1995, replaced GATT (General Agreements for Tariffs and Trade)•Set rules for goods and services trade, international investment, and protection of intellectual property rights.•Strengthen disputes settlement procedure •Home Page: http://www.wto.org/Preferential Trading Agreements•Free Trade Area: Eliminate internal trade barriers but maintain existing barriers to nonmembers NAFTA, LAFTA, EFTA •Customs Union: Eliminate internal trade barriers and erect common barriers to nonmembersEuropean Community (European Union now), Mercosur (the Southern Cone Common Market).Trade Creation & Trade DiversionInitial situation in Country A:•A levies100 % tariff on imports from B and C. Products from B and C are $2.00 and $1.50.•A imports from C of EF. •A’s consumers pay $3. •A’s gov’t collects $1.50 for each unit of imports.A forms an FTA with B and eliminates the tariff. The consumer price declines to $2. Imports increase to GH, all from B.Trade creation: As domestic price declines, consumption increases and production declines. Imports increase by GE and FH.Trade diversion: A now imports from B. The source of imports diverts from C (the world’s lowest-cost producer) to B (the lowest-cost member producer). As a result, A pays more for its imports.Regional trade liberalizationWelfare AnalysisConsumers gain from a lower price + (a+b+c+d)Producers lose due to a lower price - aGovernment loses tariff revenue (__________)Net gain ( )Gains from trade creation:Losses from trade diversion:Regionalism vs. MultilateralismWhy are regional trade blocs getting more popular? a. Willing to trade with countries sharing similar culture, geographical proximity, etc.b. Disillusioned by the slow pace and inability of GATT in dealing with trade disputesProblems with Regionalism•Discrimination against nonmembers•Cause trade diversionSome Justifications for Regionalism•Complementary to the process of multilateral liberalization under GATT, thus not inconsistent with GATT: the current official position of the US•Most trade blocs are natural. Trade diversion is small and the benefit of trade creation is much greater.