Review Session 2 - Essential Economics of Preferential Liberalisation

Transcription

1 Review Session 2 - Essential Economics of Preferential Liberalisation Lorenzo Rotunno 24/03/2010

2 Review Session 2 - Essential Economics of Preferential Liberalisation 2 1 Types of Trade Barriers Three types of trade barriers according to their effects on rents: Domestically Captured Rents (DCR): go to a domestic group (private or public); Foreign Captured Rents (FCR): go to a foreigner group (private or public); "Frictional" barriers: no rents. Rents arise whenever a trade policy drives a wedge between the domestic and the border price (also called "price decoupling"). They signal the presence of market distortions: someone is obtaining something without paying the corresponding costs.

3 Review Session 2 - Essential Economics of Preferential Liberalisation The Classic DCR barrier: Tariffs Figure 1 Open Economy Market Domestic MS C XS MS p FT A B D MD M M FT = X FT Imports The Home Government captures the trade rents (A+B). The Home net welfare effects of the tariff are ambiguous: B (terms of trade effect) - C (trade volume effect).

4 Review Session 2 - Essential Economics of Preferential Liberalisation Possible DCR barriers: Quota and Tariff Quota Home imposes a quantitative restriction (M 0 ) to the imports from Foreign. The price and quantity effects are analogous to those of the tariff T (referred to as the "tariff equivalent" of the quota M 0 ). Quotas are administered through import or export licences. If domestic agents (e.g., rms) are holders of import licences, they can buy at the (lower) border price p 0 T and resell at the (higher) domestic price p 0. In this case, the quota is a DCR barrier. Domestically administered quotas have the same effects of tariffs, yet they are forbidden by the WTO...why? They tend to favour corruption and smuggling (but not clear if more than tariffs); Dynamic efciency losses: the quota removes linkages between more efcient international rms and less efcient domestic rms. The tariff quota (or tariff-rate quota) has been used as a transition policy instrument from quotas to tariffs (e.g., cotton in the U.S.). It is currently the main (only?... index_en.htm) quantitative restriction in the EU. Imports enter duty free the market up to a certain ceiling (quota), after which they face a (often prohibitive) tariff.

5 Review Session 2 - Essential Economics of Preferential Liberalisation FCR Barriers: Export Licences and Undertakings If the quota is administered by Foreigners through export licenses, the trade rents (A+B) go to Foreign. A more interesting FCR barrier is the price undertaking: Home (e.g., the EU) asks Foreign to sell its goods in the Home market at a price no lower than a certain level (e.g. p 0 ). The rationale for this instrument is political economy: Home wants to protect inuential domestic industry from international competition without hurting Foreign.

6 Review Session 2 - Essential Economics of Preferential Liberalisation 6 Figure 2 Border p FT A Export Supply (Foreign) D= D1+D2 MS Domestic Open Economy Market XS MS C C=C1+C2 p FT p FT B B B A MS Domestic Import Demand (Home) A D MD X X FT Exports M M FT = X FT Imports M M FT Imports Home is unambiguously worse off from a FCR barrier (net welfare loss= -A-C). Foreign obtains the trade rents and can thus benet from the FCR barrier (net welfare impact= A-D; since B cancels out: it a loss for exporting rms that face a lower border price, but is a gain for export license holders).

7 Review Session 2 - Essential Economics of Preferential Liberalisation Frictional Barriers (TBTs) They are product standards and domestic regulations that increase to cost of exporting, providing a cost advantage to domestic rms. No rents are created. The key difference with other trade barriers is that the domestic price equals the border price, since the regulation or standard is applied to all rms, both domestic and foreign. Home loses -A-C, as in the FCR barrier case. Foreign does not receive any rents, so it is worse off with frictional barriers (-B-D). While these barriers are always detrimental to Home from an economic perspective, they might have an important role in ensuring "public goods" such as health or the environment. The EU has partly eliminated (at least theoretically) TBTs through the principle of mutual recognition.

8 Review Session 2 - Essential Economics of Preferential Liberalisation 8 2 Preferential Trade Liberalisation The analysis of Preferential Trade Arrangements (PTAs) or Discriminatory Trade Liberalisation requires at least three countries: Home, which decides unilaterally to remove tariffs to imports from Partner; while the Rest of the World (RoW) is the discriminated country, which has to pay the tariff T to export goods to Home. The three countries are assumed to be identical. In particular, Home is a net importer of the good while Partner and RoW are net exporters. Our benchmark case is a MFN tariff levied by Home towards both Partner and RoW. What happens if Home removes T only towards imports from Partner?

9 Review Session 2 - Essential Economics of Preferential Liberalisation and Quantity Effects Figure 3 Export Supply (RoW) Export Supply (Partner) Open Economy Market (Home) Border XS R Border XS P Domestic MSMFN MS PTA MS T MD X R X R Exports X P X P Exports X R M M Imports Quantity Effects Under a MFN tariff, RoW and Partner export the same quantity (XR 0 = X0 P ). The MS MF N curve is thus the horizontal sum of the two exporters' supply curves (XS R + XS P ). Following the PTA, Partner does not pay T and thus expands its exports from X 0 P to X00 P.

10 Review Session 2 - Essential Economics of Preferential Liberalisation 10 RoW is now discriminated and its exports fall from XR 0 to X00 R. The resulting MS P T A has two segments. In the rst one, RoW does not export since the border price (i.e., the domestic price at Home minus the tariff) is lower than its autarky price, while Partner can export since now its border price equals the domestic price at home p 00. When the domestic price is sufciently high, both RoW and Partners export and the MS curve has the usual slope (i.e., half of the slope of XS R and XS P ). The fact that Partners exports increase while RoW exports decrease creates supply switching (or trade diversion). However, Home imports increase with respect to the MFN equilibrium (trade creation): consumers can now purchase imports from Partner at a lower price p 00. This implies that the rise in exports of Partner is bigger than the fall in exports from RoW Effects The domestic price lowers following the PTA from p 0 to p 00, since part of imports does not pay tariffs. The discrimination creates two border prices: the one of Partner equals the domestic price at Home, while the border price for RoW is now the new domestic price minus the tariff (p 00 T ). Note that the border price has decreased for RoW: rms have to be more competitive to ll the "articial" gap created by the PTA.

11 Review Session 2 - Essential Economics of Preferential Liberalisation Welfare Effects Look at trade price (terms of trade - ToT) and trade volume effects On Partner and RoW Figure 4 Export Supply (RoW) Export Supply (Partner) Border XS R Border XS P D2 E1 D1 T E2 X R X R Exports X P X P Exports Partner gains from PTA: it expands export volumes (trade volume effect= +D1) and it receives an higher price (ToT effect= +D2). RoW loses from a PTA: its export volume shrinks (trade volume effect= -E2) and its export price goes down (ToT effect= -E1).

12 Review Session 2 - Essential Economics of Preferential Liberalisation On Home Figure 5 Import Demand (Home) Home Market Domestic B2 A1 A=A2+A3 Domestic D A2 A1 A3 T C B1 MD T B2 Supply C B1 Demand X R M M Imports Z C Quantity Looking at the Import Demand curve: Gains on the imports coming from RoW (area B1) since the border price for RoW has decreased (from p 0 T to p 00 T, positive ToT effect).

13 Review Session 2 - Essential Economics of Preferential Liberalisation 13 Losses on the imports coming from Partner (area C) since in this case the border price has increased (from p 0 T to p 00, negative ToT effect). Gains on the new imports (from M 0 to M 00, positive trade volume effect) thanks to the drop in the domestic price. Looking at the Home market (redistributive effects): As domestic price falls, consumers gain the area D+A2+A1+A3; The area D is transferred from producers, who will oppose the PTA; Under the MFN equilibrium, tariff revenues equal A1+C+B2. With the PTA, the government receives tariffs only from RoW exporters (the area B1+B2), but loses tariffs from Partner (-A1-C). Both procedure lead to a net welfare change that is ambiguous and equal to the area B1-C+A. 3 Customs Union A Customs Union (CU) is a reciprocal PTA (e.g., Home and Partner liberalise reciprocally their markets) where the parties agree on a Common External Tariff (CET).

14 Review Session 2 - Essential Economics of Preferential Liberalisation 14 A simplied trade structure: 3 countries (identical), 3 goods, each country exporting 2 goods and importing one (Home imports good 1 and Partner good 2). Partner and Home do not alter their tariff vis-à-vis RoW. The price and quantity effects are symmetric at Home and Partner. Repeat the same reasoning (see Figure 3) for the unilateral discriminatory liberalization of Home (market of good 1) and apply it to Partner (market of the good 2). Home exports more of the good 2 to Partner, while RoW exports less because of the lower border price (supply switching). Rather, Home faces now a higher border price that is equal to the domestic price of good 2 in Partner. As shown in Figure 3 for good 1 at Home, Partner imports more of the good 2 following the CU (trade creation).

15 Review Session 2 - Essential Economics of Preferential Liberalisation Welfare Effects of CU Welfare effects will be identical in Home and Partner. Focus on Home. Figure 6 Export Supply Good 1 (Partner) Import Demand Good 1 (Home) Border MS Domestic C2 A D2 D1 C1 T B1 MD X P X P Exports X R X P M M Imports

16 Review Session 2 - Essential Economics of Preferential Liberalisation 16 In the import market (good 1), the net welfare effect at Home is B1 C+A (see Figure 4). Partner gains D1+D2 because it sees an higher border price. The positive ToT effect for Partner (D1) equals part of the negative ToT effects suffered by Home (C1). This last area is given by the value of previous imports from Partner that are now purchased by Home at an higher border price (from p 0 T to p 00 ). However, reciprocal liberalisation between Home and Partner implies that in the market of good 2 Home is gaining D1, and this cancels out the loss of C1 in the market of good 1. Moreover, Home gains D2 in the market of good 2. Summing up, the net welfare change for Home (and for Foreign by symmetry) due to the formation of a CU (from a MFN equilibrium) is: A+B+D2-C2. The net effect is still ambiguous, but more likely to be positive than the welfare effect of a PTA. RoW loses more under a CU, since now it is discriminated in two markets (each country imports a different good). Moreover, it may end up losing even more in the long run because of the negative difference between its exports, which fall, and its imports, which do not change.

17 Review Session 2 - Essential Economics of Preferential Liberalisation CU with Frictional Barriers Starting point: a frictional barrier imposed by each country with tariff equivalent T. and quantity effects of a CU between Home and Partner: The cost of imports (Home's border price in the market of good 1) decreases, since the cost of importing and the domestic price do not differ with a frictional barrier. Partner (or Home in the market of good 2) receives an higher border price and thus increases exports of good 1 to Home RoW sees a lower border price and its exports decreases. The Welfare effects for Home (symmetric for Foreign) are (go back to Figure 5): Since the domestic price falls, the private surplus change is positive in the market of good 1 (A2+A1+A3) This gain is no longer offset by loss of tariff revenues, since these do no exist with frictional barriers. Moreover, Home gains D1+D2 (see Figure 6) in its export market (good 2). A trade liberalisation of frictional barriers is always welfare enhancing, even if discriminatory (RoW loses).