Chapter 10 The Political Economy of Trade Policy Guido Baldi)

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Chapter 10

The Political Economy of Trade Policy

(adapted by Guido Baldi)

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.10-2

International Negotiations of Trade Policy

• Average tariff rates have decreased substantially from the mid-1930s to 2016.

• Since 1944, much of the reduction in tariffs and other trade restrictions has come about through international negotiations.

– The General Agreement of Tariffs and Trade was begun in 1947 as a provisional international agreement and was replaced by a more formal international institution called the World Trade Organization in 1995.


Figure: The U.S. Tariff Rate


International Negotiations of Trade Policy (cont.)

• Multilateral negotiations mobilize exporters to support free trade if they believe export markets will expand.

– This support would be lacking in a unilateral push for free trade. The multilateral approach counteracts the support for restricted trade by import-competing groups.



• Multilateral negotiations also help avoid a trade war between countries, where each country enacts trade restrictions.

• A trade war could result if each country has an incentive to adopt protection, regardless of what other countries do.

– All countries could enact trade restrictions, even if it is in the interest of all countries to have free trade.

– Countries need an agreement that prevents a trade war or eliminates the protection from one.


Table 10-3: The Problem of Trade Warfare



• In this example, each country acting individually would be better off with protection (20 > 10), but both would be better off if both chose free trade than if both choose protection (10 > –5).

• If Japan and the U.S. can establish a binding agreement to maintain free trade, both can avoid the temptation of protection and both can be made better off.

– Or if the damage has already been done, both countries can agree to return to free trade.


International Trade Agreements: A Brief History

• In 1930, the United States passed a remarkably irresponsible tariff law, the Smoot-Hawley Act.

– Tariff rates rose steeply and U.S. trade fell sharply.

• Initial attempts to reduce tariff rates were undertaken through bilateral trade negotiations:

– U.S. offered to lower tariffs on some imports if another country would lower its tariffs on some U.S. exports.

• Bilateral negotiations, however, do not take full advantage of international coordination.

– Benefits can “spill over” to countries that have not made any concessions.


World Trade Organization

• In 1947, a group of 23 countries began trade negotiations under a provisional set of rules that became known as the General Agreement on Tariffs and Trade, or GATT.

• In 1995, the World Trade Organization, or WTO, was established as a formal organization for implementing multilateral trade negotiations (and policing them).


World Trade Organization

• WTO negotiations address trade restrictions in at least 3 ways:

1. Reducing tariff rates through multilateral negotiations.

2. Binding tariff rates: a tariff is “bound” by having the imposing country agree not to raise it in the future.


World Trade Organization (cont.)

3. Eliminating nontariff barriers: quotas and export subsidies are changed to tariffs because the costs of tariff protection are more apparent and easier to negotiate.

– Subsidies for agricultural exports are an exception.

– Exceptions are also allowed for “market disruptions” caused by a surge in imports.



• The World Trade Organization is based on a number of agreements:

– General Agreement on Tariffs and Trade:covers trade in goods.

– General Agreement on Tariffs and Services:covers trade in services (ex., insurance, consulting, legal services, banking).

– Agreement on Trade-Related Aspects of Intellectual Property: covers international property rights (ex., patents and copyrights).



– The dispute settlement procedure: a formal procedure where countries in a trade dispute can bring their case to a panel of WTO experts to rule upon.

• The panel decides whether member counties are breaking their agreements.

• A country that refuses to adhere to the panel’s decision may be punished by the WTO allowing other countries to impose trade restrictions on its exports.



• The GATT multilateral negotiations in the Uruguay Round, ratified in 1994:

– agreed that all quantitative restrictions (ex., quotas) on trade in textiles and clothing as previously specified in the Multi-Fiber Agreement were to be eliminated by 2005.

• Quotas on imports from China were temporarily reimposed due to a surge in Chinese clothing exports when MFA expired.



• In 2001, a new round of negotiations was started in Doha, Qatar, but these negotiations have not produced a comprehensive agreement.

– Most of the remaining forms of protection are in agriculture, textiles, and clothing—industries that are politically well organized.


Table 10-4: Percentage Distribution of Potential Gains from Free Trade


Trade Facilitation Agreement (TFA)

• Negotiations were concluded in 2013 in Bali.

• Entered into force in 2017.

• Bureaucratic burdens lead to trade costs when moving goods across borders.

• The Trade Facilitation Agreement aims at simplifying export and import processes.

– For instance, reduced fees and formalities connected with the import/export of goods or faster clearance procedures.

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Agricultural Export Subsidies

• In 2015, WTO members adopted a historic decision to abolish agricultural export subsidies and to set rules for other forms of farm export support (has also implications for Switzerland).

• What are the effects of export subsidies?

– Subsidies lower the world price of products.

– Since importing countries benefit from cheaper food, why would poor countries want rich countries to remove their agricultural subsidies?

– Subsidies harm farmers in poor countries who compete with farmers in rich countries.


Preferential Trading Agreements

• Preferential trading agreements are trade agreements between countries in which they lower tariffs for each other but not for the rest of the world.

• Under the WTO, such discriminatory trade policies are generally not allowed:

– Each country in the WTO promises that all countries will pay tariffs no higher than the nation that pays the lowest: called the “most favored nation” (MFN) principle.

– An exception is allowed only if the lowest tariff rate is set at zero.


Preferential Trading Agreements (cont.)

• There are two types of preferential trading agreements in which tariff rates are set at or near zero:

1. A free trade area: an agreement that allows free trade among members, but each member can have its own trade policy towards non-member countries.

– An example is the North America Free Trade Agreement (NAFTA).



2. A customs union: an agreement that allows free trade among members and requires a common external trade policy towards non-member countries.

– An example is the European Union.



• Are preferential trading agreements necessarily good for national welfare?

• No, it is possible that national welfare decreases under a preferential trading agreement.

• How? Rather than gaining tariff revenue from inexpensive imports from world markets, a country may import expensive products from member countries but not gain any tariff revenue.



• Preferential trading agreements increase national welfare when new trade is created, but not when existing trade from the outside world is diverted to trade with member countries.

• Trade creation

– occurs when high-cost domestic production is replaced by low-cost imports from other members.

• Trade diversion

– occurs when low-cost imports from nonmembers are diverted to high-cost imports from member nations.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.24

Switzerland and Free Trade Agreements (FTA)

• Agreement between two or more countries

• Swiss FTA often between EFTA countries & a third party (exceptions, for example, China, Japan)

• Covered domains

– Goods & Services (reduction of tariffs and other trade restrictions)

– Foreign direct investment (preventing discrimination)

– Intellectual property (protection of IPR)

– Public procurement (market access)


Regional coverage of Swiss FTA

Source: SECONegotiations ongoing: Thailand, Indonesia, India, Vietnam, Malaysia, Customs Union Russia-Belarus-Kazakhstan, Algeria

Negotiations completed in the beginning 2016: Georgia, Philippines

Existing FTA

EFTA collaboration declarations

Negotiations ongoing / in preparation

Preliminary studies / exploratory contacts

Currently 28 Agreements with 38 Partner outside the EU


Notified Regional Trade Agreements 1948-2016

Quelle: WTO, Stand 1.2.2016

Global FTAs


Challenges regarding FTA• Limited benefits of FTA

– Limited coverage (agriculture!)

• Limited utilisation of FTA

– Costs of information and time, restrictiveness of rules of origin, logistics

• General criticism of free trade

– Collective action problem → FTA represent particular interests

– Protection of environment and labour standards (e.g. TTIP & genetics, meat products from cattle treated with certain hormones for growth, etc.)

– Unequal negotiation capacities

• FTA and 3rd countries (i.e. rules of origin affecting 3rd countries like CH)

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FTA – Spaghetti Bowl

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Regional Trade Agreements 1990

Source: Inter-American Development Bank


FTA – Spaghetti Bowl

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Regional Trade Agreements 2014

Source: Inter-American Development Bank


Free Trade Agreemnts, Bilateral Investment Treaties, and Foreign Direct Investment

• Growing number of Bilateral investmenttreaties (BTI) since the 1960s. Aim: protection of foreign direct investment(FDI).

• More recently, free trade agreements (FTA) also include chapters on FDI.

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Bilateral investment treaties

• Three topical areas

– Rules on investment protection

– Rules on market access

– Rules aimed at serving the economic and social development dimension

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• From the 1960s through the 1980s, a few advanced economies accounted for most of outward FDI. Developing economies received inward flows.

• BTIs were designed against this backdrop. Investment protection in developing economies was important for advanced economies.

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• Since the 1980s/1990s, a growing number of emerging or developing economies have become the source of outward investment.

• In addition, emerging economies have become important markets for foreign firms.

• These developments made rules concerning market access important.

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• At the same time, social and environmental concerns have become more important. What kind of social and environmental guidelines/rules should multinational corporations follow in their host countries?

• As a result, rules concerning social and environmental sustainability have become more important.

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The current trade conflicts• Currently, the U.S. government is following a more protectionist

trade policy than in the past.

– The trade deficit of the United States against other countries is perceived by the US government as being a problem. (not really based on sound economic analysis)

– «China trade shock»: the offshoring of (mostly manufacturing) production from the U.S. to China and other countries is seen as being the reason for high jobless rates and economic stagnation in some states in the mid-east of the US.

– In some industries (especially some fields in Information and Communication Technology), China is at the technological frontier, which seems to worry policy-makers in the United States (and elsewhere)

– The trade dispute between the U.S. and China is not just a pure trade dispute. It is also a rivaly at the political and military level.

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Has there been a „China trade shock“?: Autor, Dorn and Hanson (2016): The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade, NBER Working Paper No. 21906.

Some of their main findings:

• Labour markets in the U.S. whose industry composition exposes them to rising Chinese import competition experience significant falls in employment, particularly in manufacturing and among non-college workers.

• Trade impacts rise in the 2000s as imports accelerate, while the effect of technology appears to shift from automation of production activities in manufacturing towards computerisation of information-processing tasks in non-manufacturing.

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Main findings (cont.):• China’s emergence as a great economic power has induced a

shift in patterns of world trade.• Simultaneously, it has challenged much of the received

empirical wisdom about how labor markets adjust to trade shocks. Alongside consumer benefits of expanded trade are adjustment costs and distributional consequences. These impacts are most visible in the local labor markets in which the industries exposed to foreign competition are concentrated.

• Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock started.

• Exposed workers experience reduced lifetime income.

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• Better understanding when and where trade is costly are key items on the research agenda for trade and labor economists. How can one improvethe compensation and re-training of the losers?

• At the same time, one should not forget the big gains possible from free trade. How can the economic benefits of less tariffs and barriers to trade be better explained to the people?

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«Trump’s trade war» (the following slides draw from: Peterson Institute for International Economics: Trump’s trade war: timeline)

• President Donald Trump’s trade war with the world involves multiple battles.

• Each battle uses a particular US legal rationale, such as calling foreign imports a “national security threat,” followed by Trump imposing tariffs and/or quotas on imports. Subsequent retaliation by trading partners followed.

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Steel and Aluminium as a «national security threat»

• On June 1, 2018, the U.S. imposes tariffs on all trading partners of 25 percent on steel and 10 percent on aluminum under national security grounds.

• Targeted mainly imports from Canada, the European Union, and Mexico. Only 6 percent of the imports covered derive from China, due to prior US imposition of antidumping and countervailing duties.

• Other countries like Australia, Brazil and Argentina get exceptions.

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Retaliation

• The European Union (June 22, 2018) and Canada retaliate and increase tariffs on a number of goods (EU: steel and aluminiumprodcuts; in addition, other items includingmotor boats, motorcycles (Harley-Davidson), blue jeans).

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Cars as a «national security threat»

• The United States might impose higherimport tariffs on cars and car parts by May 2019 because of a perceived «national security threat».

• This might affect EU countries (notablyGermany).

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Tariffs between the EU and the US: the current situation (Source: Francois et al. 2012)


Non-tariff barriers index by business (index between 0-100) (Source: Francois et al. 2012)


Trade conflict in North America (1)• Renegotiation of NAFTA (North American Free Trade

Agreement) in 2018 demanded by U.S. government

• Main points:

– Rules of origin: These rules set minimum amounts of local production such that a product qualifies for zero tariffs within the free trade region. They are designed to prevent “bazaar trade”: for instance, Chinese imports might enter the U.S. via Mexico because Mexico has lower tariffs on Chinese imports than the U.S.

– Rules of origin were made stricter in the renegotiations in 2018 (from 62.5% to 75%).

– In addition, new rules were imposed. Around 40 percent of the value of a car will have to be produced by workers earning at least $16 per hour (this rule mainly targets Mexican production. US hopes that production will be shifted back to the US.

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Trade conflict in North America (2)

• The new agreement United States–Mexico–Canada Agreement (USMCA) might come into effect thisyear.

• Potential side effects?

• Companies may rework their supply chains and face new costs.

• The new regulations could be so costly that companies decide to source even less content from North America and, for instance, pay the tariff of 2.5 percent on cars and car parts from other countries in the world.

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Trade conflict United States-China (1)

• On March 22, 2018, the Trump administration releases a report finding China is conducting unfair trade practices related to technology transfer, intellectual property, and innovation.

• On July 6, 2018, the first phase of US tariffs on Chinese imports go into effect (mostly intermediate inputs or capital equipment). In parallel with US tariffs, China’s tariffs on US imports also go into effect (mainly agricultural products including soybeans and vehicles.

• On July 24, 2018, the US administration announces it will subsidize American farmers for up to $12 billion for their lost export sales resulting from all of the president’s tariffs.

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Trade conflict United States-China (2)

• September 24, 2018, additional tariff increases are imposed. Imports from China are subject to a 10 percent tariff (50 percent are intermediate goods, like computer and auto parts, but 24 percent are consumer goods, up from the 1 percent of consumer goods targeted in the previous tariff phase). Trump also announced the rate will increase to 25 percent if no agreement is found with China.

• China retaliates. Higher Chinese tariffs are mainly on intermediate inputs and capital equipment.

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What are the effects of the US-China trade conflict?

• Difficult to assess, probably too early now.

• According to Zoller-Rydzek and Felbermayr (2018), Chinese exporters bear most of the tariffs. Their profits are reduced, while US consumers only pay slightly higher prices. However, this could just be a short-term effect. In the medium- to long-term, prices might increase in the U.S..

• Will production shift from China to other countries (e.g. Vietnam)? Would such a shift take place even without tariffs because wages in China have increased?

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What are the effects of the US-China trade conflict?

• Example: Trade of soybean (and related products) is affected.

– Farmers (especially soybean producers) in the United States are hit. International soybean trade was redirected. China now mostly buys soybeans (and related products) from Argentina and Brazil (Argentina, Brazil, and the United States are the most important producers of soybean).

– The price for US soybean has decreased and is lower than the price of South American producers.

– The European Union and other countries have somewhat increased soybean imports from the U.S. and buy less from South America.

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Trade conflict United States-China

• The United States and China are currently negotiating (March 2019). The U.S. mainly asks for better market access of US companies in China and better protection of intellectual property.

• Even if an agreement is reached in the coming weeks or months, it is likely that the trade conflict will continue. The conflict is not only about trade, but also about the leadership in future technologies and the current and future role of China/United States in world politics.

• Also difficult to predict whether the US will impose higher tariffs on cars from other countries (including EU).

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Chapter 10 The Political Economy of Trade Policy Guido Baldi)