International_Economics_Tenth_Edition (1)

9.Rather than generating tax revenue as do tariffs, subsidies require tax revenue. Therefore, they are not an effective protective device for the home economy. Do you agree?

10.In 1980, the u.s. auto industry proposed that import quotas be imposed on foreign-produced cars sold in the United States. What would be the likely benefits and costs of such a policy?

11.Why did the u.s. government in 1982 provide import quotas as an aid to domestic sugar producers?

12.Which tends to result in a greater welfare loss for the home economy: (a) an import quota levied by the home government or (b) a voluntary export quota imposed by the foreign government?

13.What would be the likely effects of export restraints imposed by Japan on its auto shipments to the United States?

14.Why might U.S. steel-using firms lobby against the imposition of quotas on foreign steel sold in the United States?

15.Concerning international dumping, distinguish between the price-based and cost-based definitions of foreign market value.

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Table 5.9 illustrates the demand and supply schedules for television sets in Venezuela, a "small" nation that is unable to affect world prices. On graph paper, sketch Venezuela's demand and supply schedules of television sets.

TABLE 5.9

Venezuelan Supply of and Demand for Television Sets

U I II I

a.Suppose Venezuela imports TV sets at a price of $150 each. Under free trade, how many sets does Venezuela produce, consume, and import? Determine Venezuela's consumer surplus and producer surplus.

b.Assume that Venezuela imposes a quota that limits imports to 300 TV sets. Determine the quota-induced price increase and the resulting decrease in consumer surplus. Calculate the quota's redistributive effect, consumption effect, protective effect, and revenue effect. Assuming that Venezuelan import companies organize as buyers and bargain favorably with competitive foreign exporters, what is the overall welfare loss to Venezuela as a result of the quota? Suppose that foreign exporters organize as a monopoly seller. What is the overall welfare loss to Venezuela as a result of the quota?

c.Suppose that, instead of a quota, Venezuela grants its import-competing producers a subsidy of $100 per TV set. In your diagram, draw the subsidy-adjusted supply schedule for Venezuelan producers. Does the subsidy result in a rise in the price of TV sets above the free-trade level? Determine Venezuela's production, consumption, and imports of TV sets under the subsidy. What is the total cost of the subsidy to the Venezuelan government? Of this amount, how much is transferred to Venezuelan producers in the form of producer surplus, and how much is absorbed by higher production costs due to inefficient domestic production? Determine the overall welfare loss to Venezuela under the subsidy.

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Table 5.10 on page 170 illustrates the demand and supply schedules for computers in Ecuador, a "small" nation that is unable to affect world prices. On graph paper, sketch Ecuador's demand and supply schedules of computers.

a.Assume that Hong Kong and Taiwan can supply computers to Ecuador at a per-unit price of $300 and $500, respectively. With

TABLE 5.10

Computer Supply and Demand: Ecuador

free trade, how many computers does Ecuador import? From which nation does it import?

b.Suppose Ecuador and Hong Kong negotiate a voluntary export agreement in which Hong Kong imposes on its exporters a quota that limits shipments to Ecuador to 40 computers. Assume Taiwan does not take advantage of the situation by exporting computers to Ecuador. Determine the quota-induced price increase and the reduction in consumer surplus for Ecuador. Determine the quota's redistributive effect, protective effect, consumption effect, and revenue effect. Because the export quota is administered by Hong Kong, its exporters will capture the quota's revenue effect. Determine the overall welfare loss to Ecuador as a result of the quota.

c.Again assume that Hong Kong imposes an export quota on its producers that restricts shipments to Ecuador to 40 computers, but now suppose that Taiwan, a nonrestrained exporter, ships an additional 20 computers to Ecuador. Ecuador thus imports 60 com-

puters. Determine the overall welfare loss to Ecuador as a result of the quota.

d.In general, when increases in nonrestrained supply offset part of the cutback in shipments that occur under an export quota, will the overall welfare loss for the importing country be greater or smaller than that which occurs in the absence of nonrestrained supply? Determine this amount in example of Ecuador.

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Figure 5.8 illustrates the practice of international dumping by British Toys, Inc. (BTl). Figure 5.8(a) shows the domestic demand and marginal revenue schedules faced by BTl in the United Kingdom, and Figure 5.8(b) shows the demand and marginal revenue schedules faced by BTl in Canada. Figure 5.8(c) shows the combined demand and marginal revenue schedules for the two markets as well as BTl's average total cost and mar~ ginal cost schedules.

a.In the absence of international dumping, BTl would charge a uniform price to UK. and Canadian customers (ignoring transportation costs). Determine the firm's profitmaximizing output and price, as well as total profit. How much profit accrues to BTl on its UK. sales and on its Canadian sales?

b.Suppose now that BTl engages in international dumping. Determine the price that BTl charges its UK. buyers and the profits that accrue on UK. sales. Also determine the price that BTl charges its Canadian buyers and the profits that accrue on Canadian sales. Does the practice of international dumping yield higher profits than the uniform pricing strategy? If so, by how much?

19.Why is a tariff-rate quota viewed as a compromise between the interests of the domestic consumer and those of the domestic producer? How does the revenue effect of a tariffrate quota differ from that of an import tariff?

5.1 The u.s. Department of State reports on the history, politics, and economic and trade policies of the regions and countries with which the United States regularly trades. Look at the background notes on regions after setting your browser to this URL:

http://www.state.gov/countries

and Trade Web page. Information about their foreign trade policy, bilateral and regional relationships, and trade and investment are available at this URL:

http://www.mft.govt.nz/for.html

5.3 The Canadian Trade Commissioner Service serving Canadian business abroad provides their market reports and services

accrues to the domestic government as tariff revenue, but the remainder is captured by business as windfall profits-a gain to business resulting from sudden or unexpected government policy.

In this example, after enactment of the tariff quota, imports total 15 tons of sugar. The U.s. government collects area a ($200), found by multiplying the within-quota duty of $40 times 5 tons. Area b + c ($800), found by multiplying the remaining 10 tons of imported sugar times the over-quota duty of $80, also accrues to the government.

Area d ($200) in the figure represents windfall profits. Under the tariff-rate quota, the domestic price of the first 5 tons of sugar imported is $440, reflecting the foreign supply price of $400 plus the import duty of $40. Suppose U.S. import companies can obtain foreign sugar at $440 per ton. By reselling the 5 tons to U.S. consumers at $480 per ton, the price of over-quota sugar, U.S. importers would capture area d as windfall profits. But this opportunity will not last long, because foreign sugar suppliers will want to capture the windfall gain. To the extent that they can restrict sugar exports to the United States, foreign producers could force up the price of sugar and expropriate profits from U.S. importing companies. Foreign producers conceivably could capture the entire area d by raising their supply price to $480 per ton. The portion of the windfall profit captured by foreign sugar producers represents a welfare lossto the U.S. economy.

U.S. Tariff History: Average Tariff Rates

1111111111

'Ratio of duties collected to FOB value on dutiable imports.

Source: U.S. Census Bureau, Statistical Abstract of the United States

(Washington, DC: U.S. Government Printing Office, various issues). See also World Trade Organization, Annual Report, various issues.

for a downsizing of the tariff protection afforded U.S. manufacturers. During the 1840s and 1850s, the u.s. government found that it faced an excess of tax receipts over expenditures. Therefore, the government passed the Walker Tariffs, which cut duties to an average level of 23 percent in order to eliminate the budget surplus. Further tariff cuts took place in 1857, bringing the average tariff levels to their lowest level since 1816, around 16 percent.

During the Civil War era, tariffs were again raised with the passage of the Morill Tariffs of 1861, 1862, and 1864. These measures were primarily intended as a means of paying for the Civil War. By 1970, protection climbed back to the heights of the 1840s; however, this time the tariff levels would not be reduced. During the latter part of the 1800s, U.s. policy makers were impressed by the arguments of American labor and business leaders who complained that cheap foreign labor was causing goods to flow into the United States. The enactment of the McKinley and Dingley Tariffs largely rested upon this argument. By 1897, tariffs on protected imports averaged 46 percent.

Although the Payne-Aldrich Tariff of 1909 marked the turning point against rising protection-

ism, it was the enactment of the Underwood Tariff of 1913 that reduced duties to 27 percent on average. Trade liberalization might have remained on a more permanent basis had it not been for the outbreak of World War I. Protectionist pressures built up during the war years and maintained momentum after the war's conclusion. During the early 1920s, the scientific tariff concept was influential, and in 1922 the Fordney-McCumber Tariff contained, among other provisions, one that allowed the president to increase tariff levels if foreign production costs were below those of the United States. Average tariff rates climbed to 38 percent under the Fordney-McCumber law.

I Sn100t-Hawley Act

The high point of u.s. protectionism occurred with the passage of the Smoot-Hawley Act in 1930, under which U.S. average tariffs were raised to 53 percent on protected imports. As the Smoot-Hawley bill moved through the U.S. Congress, formal protests from foreign nations flooded Washington, eventually adding up to a document of some 200 pages. Nevertheless, both the House of Representatives and the Senate approved the bill. Although about a thousand U.S. economists beseeched President Herbert Hoover to veto the legislation, he did not do so, and the tariff was signed into law on June 17, 1930. Simply put, the Smoot-Hawley Act tried to divert national demand away from imports and toward domestically produced goods.

The legislation provoked retaliation by 25 trading partners of the United States. Spain implemented the Wais tariff in reaction to U.S. tariffs on cork, oranges, and grapes. Switzerland boycotted U.S. exports to protest new tariffs on watches and shoes. Canada increased its tariffs threefold in reaction to U.S. tariffs on timber, logs, and many food products. Italy retaliated against tariffs on olive oil and hats with tariffs on U.S. automobiles. Mexico, Cuba, Australia, and New Zealand also participated in tariff wars. Other beggar-thy-neighbor policies, such as foreign-exchange controls and currency depreciations, were also implemented. The effort by several nations to run a trade surplus by reducing imports

176 Trade Regulations and Industrial Policies

led to a breakdown of the international trading system. Within two years after the Smoot-Hawley Act, U.S. exports decreased by nearly two-thirds. Figure 6.1 shows the decline of world trade as the global economy fell into the Great Depression.

How did President Hoover fall into such a protectionist trap? The president felt compelled to honor the 1928 Republican platform calling for tariffs to aid the weakening farm economy. The stock market crash of 1929 and the imminent Great Depression further led to a crisis atmosphere. Republicans had been sympathetic to protectionism for decades. Now they viewed import tariffs as a method of fulfilling demands that government should initiate positive steps to combat domestic unemployment.

President Hoover felt bound to tradition and to the platform of the Republican party. Henry

Smoot-Hawley Protectionism and World

Trade, 1929-1933 (Millions of Dollars)

April

September

November

October

The figure shows the pattern of world trade from 1929 to 1933. Following the SmootHawley Tariff Act of 1930, which raised u.s. tariffs to an average level of 53 percent,other nations retaliated by increasing their own import restrictions. and the volume of world trade decreased as the global economy fell into the Great Depression.

811.11111 !glll!!'m~l, f J lilli!.l

Source: Data taken from League of Nations. Monthly Bulletin of Statistics, February. 1934. See also Charles Kindleberger, The World in Depression (Berkeley. CA: University of California Press. 1973). p. 170.

Ford spent an evening with Hoover requesting a presidential veto of what he referred to as "economic stupidity." Other auto executives sided with Ford. However, tariff legislation had never before been vetoed by a president, and Hoover was not about to set a precedent. Hoover remarked that "with returning normal conditions, our foreign trade will continue to expand."

By 1932, U.S. trade with other nations had collapsed. Presidential challenger Franklin Roosevelt denounced the trade legislation as ruinous. Hoover responded that Roosevelt would have U.S. workers compete with peasant labor overseas. Following Hoover's defeat in the presidential election of 1932, the Democrats dismantled the Smoot-Hawley legislation. But they used caution, relying on reciprocal trade agreements instead of across-the-board tariff concessions by the United States. Sam Rayburn, the Speaker of the House of Representatives, insisted that any party member who wanted to be a member of the House Ways and Means Committee had to support trade reciprocity instead of protectionism. The Smoot-Hawley approach was discredited, and the United States pursued trade liberalization via reciprocal trade agreements.

IReciprocal Trade

Agreements Act

The combined impact on U.S. exports of the Great Depression and the foreign retaliatory tariffs imposed in reaction to the Smoot-Hawley Act resulted in a reversal of u.s. trade policy. In 1934, Congress passed the Reciprocal Trade Agreements Act, which set the stage for a wave of trade liberalization. Specifically aimed at tariff reduction, the act contained two features: (1) negotiating authority and (2) generalized reductions.

Under this law, the president was given the unprecedented authority to negotiate bilateral tariffreduction agreements with foreign governments (for example, between the United States and Sweden). Without congressional approval, the president could lower tariffs by up to 50 percent of the existing level. Enactment of any tariff reductions was dependent on the willingness of other nations to reciprocally lower their tariffs on U.S.

goods. From 1934 to 1947, the United States entered into 32 bilateral tariff agreements, and over this period the average level of tariffs on protected products fell to about half of the 1934 levels.

The Reciprocal Trade Agreements Act also provided for generalized tariff reductions through the most-favored-nation (MFN) clause. This clause is an agreement between two nations to apply tariffs to each other at rates as low as those applied to any other nation. For example, if the United States extends MFN treatment to Brazil and then grants a low tariff on imports of machinery from France, the United States is obligated to provide the identical low-tariff treatment on imports of machinery from Brazil. Brazil thus receives the same treatment as the initially mostfavored nation, France. The advantage to Brazil of MFN status is that it can investigate all of the tariff policies of the United States concerning imported machinery to see if treatment to some nation is more favorable than that granted to it; if any more favorable terms are found, Brazil can call for equal treatment. In 1998, the U.S. government replaced the term most-favored nation with normal trade relations, which will be used throughout the rest of this textbook.

According to the provisions of the World Trade Organization (see next section), there are two exceptions to the normal trade relations clause:

(1)Industrial nations can grant preferential tariffs to imports from developing nations that are not granted to imports from other industrial nations; and

(2)Nations belonging to a regional trading arrangement (for example, the North American Free Trade Agreement) can eliminate tariffs applied to imports of goods coming from other members while maintaining tariffs on imports from nonmembers.

Granting normal trade relation status or imposing differential tariffs has been used as an instrument of foreign policy. For example, a nation may punish unfriendly nations with high import tariffs on their goods and reward friendly nations with low tariffs. The United States has granted normal trade relation status to most of the nations with which it trades. As of 2002, the United States did not grant normal trade relation status to the following countries: Afghanistan, Cuba, Laos, North Korea, and Vietnam. U.S. tariffs on imports from these countries are often three or four (or more) times as high as those on comparable imports from nations receiving normal trade relation status, as seen in Table 6.2.

178 Trade Regulations and Industrial Policies

General Agreement on

Tariffs and Trade

Partly in response to trade disruptions during the Great Depression, the United States and some of its allies sought to impose order on trade flows after World War II. The first major postwar step toward liberalization of world trade was the General Agreement on Tariffs and Trade (GATT), signed in 1947. GATT was crafted as an agreement among contracting parties, the member nations, to decrease trade barriers and to place all nations on an equal footing in trading relationships. GATT was never intended to become an organization; instead, it was a set of bilateral agreements among countries around the world to reduce trade barriers.

In 1995, GATT was transformed into the World Trade Organization (WTO). The WTO embodies the main provisions of GATT, but its role was expanded to include a mechanism intended to improve GATT's process for resolving trade disputes among member nations. Let us first discuss the operation of the original GATT system.

The GATT System

GATT was based on several principles designed to foster more liberalized trade. One was nondiscrimination, embodying the principles of normal trade relations and national treatment. Under the normal trade relations principle, all member nations are bound to grant to each other treatment as favorable as they give to any nation with regard to trade matters. This allows comparative advantage to be the main determinant of trade patterns, which promotes global efficiency. There have been exceptions to the normal trade relations principle; for example, regional trade blocs (European Union, North American Free Trade Agreement) have been allowed. Under the nationaltreatment principle, member nations must treat other nations' industries no less favorably than they do their own domestic industries, once foreign goods have entered the domestic market:, thus, in principle, domestic regulations and taxes cannot be biased against foreign products.

The GATT principle of nondiscrimination made trade liberalization a publicgood: What was

produced by one nation in negotiation with another was available to all. This gave rise to the coordination problem shared by all public goods: that of getting each party to participate rather than sit back and let others do the liberalizing, thus freeriding on their efforts. A weakness of GATT trade negotiations from the 1940s to the 1970s was the limited number of nations that were actively negotiating participants; many nations--especially the developing nations-remained on the sidelines as free riders on others' liberalizations: They maintained protectionist policies to support domestic producers while realizing benefits from trade liberalization abroad.

Another aspect of GATT was its role in the settlement of trade disputes. Historically, trade disputes consisted of matters strictly between the disputants; no third party was available to which they might appeal for a favorable remedy. As a result, conflicts often remained unresolved for years, and when they were settled the stronger country generally won at the expense of the weaker country. GATT improved the dispute-resolution process by formulating complaint procedures and providing a conciliation panel to which a victimized country could express its grievance. GATT's dispute-settlement process, however, did not include the authority to enforce the conciliation panel's recommendations-a weakness that inspired the formation of the World Trade Organization.

GATT also obligated its members to use tariffs rather than quotas to protect their domestic industry. GATT's presumption was that quotas were inherently more trade distorting than tariffs because they allowed the user to discriminate between suppliers, were not predictable and transparent to the exporter, and imposed a maximum ceiling on imports. Here, too, there were exceptions to GATT's prohibition of quotas. Member nations could use quotas to safeguard their balance of payments, promote economic development, and allow the operation of domestic agricultural-support programs. Voluntary export-restraint agreements, which used quotas, also fell outside the quota restrictions of GATT because the agreements were voluntary.