Chapter 11

Autumn 2021
 International Agreements

Logic of international agreements

Recall effects of import tariffs for a large country
Large country may gain individually from a tariff
World welfare is reduced
This is one rationale for international agreements
Similar situations might exist in other areas such as environment

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 International Agreements

Logic of multilateral trade agreements

Home and Foreign decide whether to apply tariffs

Assume following payoff matrix:

Free trade is in upper left corner

Other payoffs are expressed relative to free trade situation
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 International Agreements

Logic of multilateral trade agreements

Payoff pattern is an example of the prisoner’s dilemma

Only Nash equilibrium is the lower right corner with tariffs

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 International Agreements

Logic of multilateral trade agreements

Outcome is undesirable for both countries when compared to free
trade
How could free trade be achieved?
By communicating, i.e. making an agreement
Even with an agreement there remains an incentive for a country to
deviate
WTO provision for retaliation

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 International Agreements

Regional trade agreements

Allowed by WTO though they imply unequal treatment of countries

Free-trade areas
No tariffs within a group of countries
E.g. NAFTA
Customs Unions
No tariffs within a group of countries
In addition common tariffs with countries outside the union
E.g. EU

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 International Agreements

Regional trade agreements

Trade creation
A member country imports a product from another member country
that it produced self before
Trade diversion
A member country imports a product from another member country
that it imported from outside the trade region before

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 International Agreements

Regional trade agreements

Forming regional trade agreements may harm the member countries
due to trade diversion
Tariff is lifted for Mexico ⇒ Its share of US imports increases
Price received by Mexicans is still Pasia + t

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 International Agreements

Regional trade agreements

Loss in US tariff revenue: −(a + b + c)
Gain in Mexico’s producer surplus: +(a + b)
Net effect due to NAFTA: −c

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 International Agreements

International agreements on labor issues

International trade agreements may include other issues besides trade

Labor standards: safety, child labor, minimum wages etc.
Environment
Reasons for inclusion:
Genuine concern from people and policy-makers
Protecting from competition
Many economists see attempts to enforce minimum labor standards
mainly as disguised protectionism
What is the net effect of labor standards for people in developing
countries?

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 International Agreements

International agreements on labor issues

International trade agreements may include other issues besides trade

Labor standards: safety, child labor, minimum wages etc.
Environment
Reasons for inclusion:
Genuine concern from people and policy-makers
Protecting from competition
Many economists see attempts to enforce minimum labor standards
mainly as disguised protectionism
What is the net effect of labor standards for people in developing
countries?

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 International Agreements

International agreements on labor issues

Labor standards are commonly seen as a domestic issue

⇒ Labor agreements not necessarily as easy to implement as trade
agreements
Consumer activism and NGOs form an alternative channel

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 International Agreements

International agreements on labor issues

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 International Agreements

Environment and trade

Does free trade harm the environment?

Both cases exist
More efficient allocation may help the environment
US sugar quota implies that more corn than sugar is used for producing
ethanol despite the fact that corn is less energy-efficient
US quotas for Japanese cars implied that more gasoline-hungry US cars
were used

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 International Agreements

Environment and trade

Tragedy of the commons
Common property is overharvested
e.g. fish, buffalo
International trade may exacerbate the problem by opening up higher
demand for each harvester

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 International Agreements

Environment and trade

The fundamental cause of the problem is lack of property rights

⇒ Negative externalities
With a global resource solution requires international agreements

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 International Agreements

Environment and trade

Tragedy of the commons applies to pollution as well

Clean air and water can be seen as common property
Some pollutants are more global than others
A country does not face the full cost of its global pollutants

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 International Agreements

Environment and trade

Assume following payoff matrix

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 International Agreements

Environment and trade

Likely outcome depends on whether consumer or producer surplus is

more important to government
With global pollutants lower right corner with no regulation is likely

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