International_Economics_Tenth_Edition (1)

Japan negotiates export quota in U.S. market; United States imposes import quota on others.

Japan voluntarily limits exports to Britain and Benelux.

Japan enters into agreement with European Union to curb price competition.

Export and import quotas; annual growth rates.

Japan voluntarily restrains exports to the United States.

States, Japan, and Germany. Assume that Su,s, and Du.s. depict the supply and demand schedules of autos for the United States. SJ denotes the supply schedule of Japan, assumed to be the world's lowcost producer, and SG denotes the supply schedule of Germany.

Referring to Figure 5.4(a), the price of autos to the U.S. consumer is $20,000 under free trade. At that price, U.S. firms produce 1 auto, and U.S. consumers purchase 7 autos, with imports from Japan totaling 6 autos. Note that German autos are too costly to be exported to the United States at the free-trade price.

Suppose that Japan, responding to protectionist sentiment in the United States, decides to restrain auto shipments to the United States rather than face possible mandatory restrictions on its exports. Assume that the Japanese government imposesan export quota on its auto firms of 2 units, down from the free-trade level of 6 units. Above the free-trade price, the total U.S. supply of autos now equals U.S. production plus the export quota; the auto supply curve thus shifts from Su.s. to Su.s.+Q in Figure 5.4(a). The reduction in imports from 6 autos to 2 autos raises the equilibrium price to $30,000. This leads to an increase in the quanti-

ty supplied by u.s. firms from 1 auto to 3 autos and a decrease in the U.S. quantity demanded from 7 autos to 5 autos.

The export quota's price increase causes consumer surplus to fall by area a + b + c + d + e + f + g + h + i + j + k + I, an amount totaling $60,000. Area a + h ($20,000) represents the transfer to U.S. auto companies as profits. The export quota results in a deadweight welfare loss for the U.S. economy equal to the protective effect, denoted by area b + c + i ($10,000), and the consumption effect, denoted by area f + g + I ($10,000). The export quota's revenue effect equals area d + e + j + k ($20,000), found by multiplying the quotainduced increase in the Japanese price times the volume of autos shipped to the United States.

Remember that under an import quota, the disposition of the revenue effect is indeterminate: It will be shared between foreign exporters and domestic importers, depending on the relative concentration of bargaining power. But under an export quota, it is the foreign exporter who is able to capture the larger share of the quota revenue. In our example of the auto export quota, the Japanese exporters, in compliance with their government, self-regulate shipments to the United

States. This supply-side restriction, resulting from japanese firms' behaving like a monopoly, leads to a scarcity of autos in the United States. japanese auto makers then are able to raise the price of their exports, capturing the quota revenue. For this reason, it is not surprising that exporters might prefer to negotiate a voluntary restraint pact in lieu of facing other protectionist measures levied by the importing country. As for the export quota's impact on the U.S. economy, the expropriation of revenue by the japanese represents a welfare loss in addition to the deadweight losses of production and consumption.

Another characteristic of a voluntary export agreement is that it typically applies only to the most important exporting nation(s). This is in contrast to a tariff or import quota, which generally applies to imports from all sources. When volun-

tary limits are imposed on the chief exporter, the exports of the nonrestrained suppliers may be stimulated. Nonrestrained suppliers may seek to increase profits by making up part of the cutback in the restrained nation's shipments. They may also want to achieve the maximum level of shipments against which to base any export quotas that might be imposed on them in the future. For example, japan was singled out by the United States for restrictions in textiles during the 1950s and in color television sets during the 1970s. Other nations quickly increased shipments to the United States to fill in the gaps created by the japanese restraints. Hong Kong textiles replaced most japanese textiles, and TV sets from Taiwan and Korea supplanted japanese sets.

Referring to Figure 5.4(b), let us start again at the free-trade price of $20,000, with U.S. imports

from japan totaling 6 autos. Assume that japan agrees to reduce its shipments to 2 units. However, suppose Germany, a nonrestrained supplier, exports 2 autos to the United States in response to

the japanese cutback. Above the free-trade price, the total u.s. supply of autos now equals U.S. pro-

duction plus the Japanese export quota plus the nonrestrained exports coming from Germany. In Figure 5.4(b), this is illustrated by a shift in the supply curve from Su.s. to Su.S.+Q+N'The reduction in imports from 6 autos to 4 autos raises equilibrium price to $25,000. The resulting deadweight losses of production and consumption inefficiencies equal area b + g ($5,000), less than the deadweight losses under japan's export quota in the absence of nonrestrained supply. Assuming that japan administers the export restraint program, japanese companies would be able to raise the price of their auto exports from $20,000 to $25,000 and earn profits equal to area c + d ($10,000). Area e + (($10,000) represents a trade-diversion effect, which reflects inefficiency losses due to the shifting of 2 units from japan, the world's low-cost producer, to Germany, a higher-cost source. Such trade diversion results in a loss of welfare to the world because resources are not being used in their most productive manner. The overall welfare of the United States thus decreases by area b + c + d + e + ( + g under the export-quota policy.

When increases in the nonrestrained supply offset part of the cutback in shipments that occurs under an export quota, the overall inefficiency loss for the importing nation (deadweight losses plus revenue expropriated by foreign producers) is lessthan that which would have occurred in the absence of nonrestrained exports. In the preceding example, this reduction amounts to area i + j + k + I ($15,000). The next section will consider the effects of voluntary export quotas on the U.S. auto industry.

Japanese Auto Restraints Put Brakes on U.S. Motorists

In 1981, as domestic auto sales fell, protectionist sentiment gained momentum in the U.S. Congress, and legislation was introduced calling for import quotas. This momentum was a major factor in the

administration's desire to negotiate a voluntary restraint pact with the japanese. japan's acceptance of this agreement was apparently based on its view that voluntary limits on its auto shipments would derail any protectionist momentum in Congress for more stringent measures.

The restraint program called for self-imposed export quotas on japanese auto shipments to the United States for three years, beginning in 1981. First-year shipments were to be held to 1.68 million units, 7.7 percent below the 1.82 million units exported in 1980. In subsequent years, auto shipments were to be held to the same number plus 16.5 percent of any increase in domestic U.S. auto sales recorded in 1981. As it turned out, falling U.S. sales caused japanese auto exports to be limited to 1.68 million units in 1982 and 1983. Still facing a weak auto industry, the United States was able to negotiate an export restraint pact with japan for 1984, during which japanese firms would limit auto shipments to the United States to 1.85 million units. In 1984, the United States released japan from its formal commitment to the export agreement, but the japanese government thought it imprudent to permit its automakers to export freely to the United States. The japanese government has imposed its own export quotas on its auto manufacturers since the termination of the export agreement.

The purpose of the export agreement was to help u.s. automakers by diverting u.s. customers from japanese to u.s. showrooms. As domestic sales increased, so would jobs for American autoworkers. It was assumed that japan's export quota would assist the U.S. auto industry as it went through a transition period of reallocating production toward smaller, more fuel-efficient autos and adjusting production to become more cost-competitive. The restraint program would provide U.S. auto companies temporary relief from foreign competition so they could restore profitability and reduce unemployment.

Not all japanese auto manufacturers were equally affected by the export quota. By requiring japanese auto companies to form an export cartel against the U.S. consumer, the quota allowed the large, established firms (Toyota, Nissan, and Honda) to increase prices on autos

sold in the United States. To derive more revenues from a limited number of autos, Japanese firms shipped autos to the United States with fancier trim, bigger engines, and more amenities such as air-conditioners and deluxe stereos as standard equipment. Product enrichment also helped the Japanese broaden their hold on the U.S. market and enhance the image of their autos. As a result, the large Japanese manufacturers earned record profits in the United States.

The export quota was unpopular, however, with smaller japanese automakers, including Suzuki and Isuzu. Under the restraint program, as administered by the japanese government, each company's export quota was based on the number of autos sold in the United States three years prior to initiation of the quota. Smaller producers claimed that the quota forced them to freeze their U.S. dealer networks and abandon plans to introduce new models. Table 5.4 depicts the estimated welfare effectsfor the United States of the japanese export quota.

TABLE 5.4

Effects of Japanese Export Quota in Autos'

'These estimates apply to 1984, the fourth year of the export quota.

Source: U.s. International Trade Commission, A Review of Recent Developments in the U.S. AutomobileIndustry Including an Assessment of the Japanese Voluntary Restraint Agreements (Washington, DC: U.S. Government Printing Office, 1985).

Dom~stic Content S-xA'Y

Requirements

Today, many products, such as autos and aircraft, embody worldwide production. Domestic manufacturers of these products purchase resources or perform assembly functions outside the home country, a practice known as outsourcing or production sharing. For example, General Motors has obtained engines from its subsidiaries in Mexico, Chrysler has purchased ball joints from Japanese producers, and Ford has acquired cylinder heads from European companies. Firms have used outsourcing to take advantage of lower production costs overseas, including lower wage rates. Domestic workers often challenge this practice, maintaining that outsourcing means that cheap foreign labor takes away their jobs and imposes downward pressure on the wages of those workers who are able to keep their jobs.

To limit the practice of outsourcing, organized labor has lobbied for the use of domestic content requirements. These requirements stipulate the minimum percentage of a product's total value that must be produced domestically if the product is to quality for zero tariff rates. The effect of content requirements is to pressure both domestic and foreign firms who sell products in the home country to use domestic inputs (workers) in the production of those products. The demand for domestic inputs thus increases, contributing to higher input prices. Manufacturers generally lobby against domestic content requirements, because they prevent manufacturers from obtaining inputs at the lowest cost, thus contributing to higher product prices and loss of competitiveness.

Worldwide, local content requirements have received most attention in the automobile industry. Developing countries have often used content requirements to foster domestic automobile production, as shown in Table 5.5.

Figure 5.5 illustrates possible welfare effects of an Australian content requirement on automobiles. Assume that DA denotes the Australian demand schedule for Toyota automobiles while 5J depicts the supply price of Toyotas exported to Australia,

Did you know that U.S. buyers of cars and light trucks can learn how American or foreign their new vehicle is? On carsand trucks weighing 8,500 pounds or less, the law requires content labels telling buyers where the parts of the vehicle were made. Content is measured by the dollar value of components, not the labor cost of assembling vehicles. The percentages of North American (tl.S. and Canadian) and foreign parts must be listed as

an average for each car line. Manufacturers are free to design the label, which can be included on the price sticker or fuel economy sticker or can be separate. Below are some examples of the domestic and foreign content of vehicles sold in the United States for the 2004 model year. The data were collected from automobile stickers at dealers' lots.

a + c) minus the income paid to Japanese managers and the return to Toyota's capital investment (factory) in Australia.

However, the income gains of Australian resource owners inflict costs on Australian consumers. Because the content requirement causes the price of Toyotas to increase by $9,000, Australian consumer surplus decreases by area a + b ($3,600,000). Of this amount, area b ($900,000) is a deadweight welfare loss for Australia. Area a ($2,700,000) is the consumer cost of employing higher-priced Australian resources instead of lower-priced Japanese resources; this amount represents a redistribution of welfare from Australian consumers to Australian resource owners. Similar to other import restrictions, content requirements

lead to the subsidizing by domestic consumers of the domestic producer.

I Subsidies

National governments sometimes grant subsidies to their producers to help improve their trade position. By providing domestic firms a cost advantage, a subsidy allows them to market their products at prices lower than warranted by their actual cost or profit considerations. Governmental subsidies assume a variety of forms, including outright cash disbursements, tax concessions, insurance arrangements, and loans at below-market interest rates. Table 5.6 provides examples of governmental subsidies for several nations.

For purposes of our discussion, two types of subsidies can be distinguished: a domestic subsidy, which is sometimes granted to producers of importcompeting goods, and an export subsidy, which goes to producers of goods that are to be sold overseas. In both cases, the government adds an amount to the price the purchaser pays rather than subtracting from it. The net price actually received by the producer equals the price paid by the purchaser plus the subsidy. The subsidized producer is thus able to supply a greater quantity at each consumer's price. Let us use Figure 5.6 on page 156 to analyze the effects of these two types of subsidies.

Domestic Subsidy

Figure 5.6(a) illustrates the trade and welfare effects of a production subsidy granted to importcompeting manufacturers. Assume that the initial supply and demand schedules of the United States for steel are depicted by curves Su.s.oand Du.s.o' so that the market equilibrium price is $430 per ton. Assume also that, because the United States is a small buyer of steel, changes in its purchases do not affect the world price of $400 per ton. Given a free-trade price of $400 per ton, the United States consumes 14 tons of steel, produces 2 tons, and imports 12 tons.

To partially insulate domestic producers from foreign competition, suppose the U.S. government grants them a production subsidy of $25 per ton of steel. The cost advantage made possible by the subsidy results in a shift in the U.S. supply schedule from 5u.s.1) to 5u.s. 1• Domestic production expands from 2 to 7 million tons, and imports fall from 12 to 7 million tons. These changes represent the subsidy's trade effect.

The subsidy also affects the national welfare of the United States. According to Figure 5.6(a), the subsidy permits U.S. output to rise to 7 million tons. Note that, at this output, the net price to the steelmaker is $425-the sum of the price paid by the consumer ($400) plus the subsidy ($25). To the U.S. government, the total cost of protecting its steelmakers equals the amount of the subsidy ($25) times the amount of output to which it is applied (7 million tons), or $175 million.

Where does this subsidy revenue go? Part of it is redistributed to the more efficient U.S. producers in the form of producer surplus. This amount is denoted by area a ($112.5 million) in the figure. There is also a protective effect, whereby more costly domestic output is allowed to be sold in the market as a result of the subsidy. This is denoted by area b ($62.5 million) in the figure. To the

\evel d67S

litO\- C 0.01VI..¥)

;j:--

price paid by foreigners. Foreign consumers are favored over domestic consumers to the extent that the foreign price of a subsidized export is less than the product's domestic price.

The granting of an export subsidy yields two direct effects for the home economy: a terms-of- trade effect and an export-revenue effect. Because subsidies tend to reduce the foreign price of home-nation exports, the home nation's terms of trade is worsened. But lower foreign prices generally stimulate export volume. Should the foreign demand for exports be relatively elastic, so that a given percentage drop in foreign price is more than offset by the rise in export volume, the home nation's export revenues will increase.

Figure 5.6(b) illustrates the case of an export subsidy applied to television sets in trade between Japan and the United States. Under free trade, market equilibrium exists at point E, where Japan exports 1 million television sets to the United States at a price of $100 per unit. Suppose the Japanese government, to encourage export sales, grants to its exporters a subsidy of $50 per set. The Japanese supply schedule shifts from 510 to 511, and market equilibrium moves to point F. The terms of trade thus turns against Japan because its export price falls from $100 to $75 per television set exported. Whether Japan's export revenue rises depends on how U.S. buyers respond to the price decrease. If the percentage increase in the number of television sets sold to U.S. buyers more than offsets the percentage decrease in price, Japan's export revenue will rise. This is the case in Figure 5.6(b), which shows Japan's export revenue rising from $100 million to $112.5 million as the result of the decline in the price of its export good.

Although export subsidies may benefit industries and workers in a subsidized industry by increasing sales and employment, the benefits may be offset by certain costs that fall on the society as a whole. Consumers in the exporting nation suffer as the international terms of trade moves against them. This situation comes about because, given a fall in export prices, a greater number of exports must be exchanged for a given dollar amount in imports. Domestic consumers also find they must pay higher prices than foreigners for the goods they

help subsidize. Furthermore, to the extent that taxes are required to finance the export subsidy, domestic consumers find themselves poorer. In the previous example, the total cost of the subsidy to Japanese taxpayers is $75 million ($50 subsidy times 1.5 million television sets).

IDumping

The case for protecting import-competing producers from foreign competition is bolstered by the antidumping argument. Dumping is recognized as a form of international price discrimination. It occurs when foreign buyers are charged lower prices than domestic buyers for an identical product, after allowing for transportation costs and tariff duties. Selling in foreign markets at a price below the cost of production is also considered dumping.

Forms of Dumping

Commercial dumping is generally viewed as sporadic, predatory, or persistent in nature. Each type is practiced under different circumstances.

Sporadic dumping (distress dumping) occurs when a firm disposes of excess inventories on foreign markets by selling abroad at lower prices than at home. This form of dumping may be the result of misfortune or poor planning by foreign producers. Unforeseen changes in supply and demand conditions can result in excess inventories and thus in dumping. Although sporadic dumping may be beneficial to importing consumers, it can be quite disruptive to import-competing producers, who face falling sales and short-run losses. Temporary tariff duties can be levied to protect home producers, but because sporadic dumping has minor effects on international trade, governments are reluctant to grant tariff protection under these circumstances.

Predatory dumping occurs when a producer temporarily reduces the prices charged abroad to drive foreign competitors out of business. When the producer succeeds in acquiring a monopoly position, prices are then raised commensurate with its market power. The new price level must be sufficiently high to offset any losses that occurred during the period of cutthroat pricing. The firm would

158 Nontariff Trade Barriers

presumably be confident in its ability to prevent the entry of potential competitors long enough for it to enjoy economic profits. To be successful, predatory dumping would have to be practiced on a massive basis to provide consumers with sufficientopportunity for bargain shopping. Home governments are generally concerned about predatory pricing for monopolizing purposes and may retaliate with antidumping duties that eliminate the price differential. Although predatory dumping is a theoretical possibility, economists have not found empirical evidence that supports its existence.

Persistent dumping, as its name suggests, goes on indefinitely. In an effort to maximize economic profits, a producer may consistently sell abroad at lower prices than at home. The rationale underlying persistent dumping is explained in the next section.

International Price

Discrimination

Consider the case of a domestic seller that enjoys market power as a result of barriers that restrict

'IGURE 1.11

International Price Discrimination

competition at home. Suppose this firm sells in foreign markets that are highly competitive. This means that the domestic consumer response to a change in price is less than that abroad; the home demand is less elastic than the foreign demand. A profit-maximizing firm would benefit from international price discrimination, charging a higher price at home, where competition is weak and demand is less elastic, and a lower price for the same product in foreign markets to meet competition. The practice of identifying separate groups of buyers of a product and charging different prices to these groups results in increased revenues and profits for the firm as compared to what would occur in the absence of price discrimination.

Figure 5.7 illustrates the demand and cost conditions of South Korean Steel Inc. (SKS), which sells steel to buyers in South Korea (less elastic market) and in Canada (more elastic market); the total steel market consists of these two submarkets. Let DSK be the South Korean steel demand and Dc be the Canadian demand, with the corresponding marginal revenue schedules represented