Lecture 8: Measuring the impact of trade policy

Previous lecture showed how government intervention eg. via taxes, or quotas/permits drives a wedge between the consumers marginal willingness to pay and producers MC. The consequence is a decline in net welfare though note certain sectors within society may gain. i.e. policy is also likely to have distributional consequences. This was applied to protection of an industry eg. via tariffs. Analysis indicated a net welfare loss arising from the use of such trade policy.

Figure 9.11 Effect of a Tariff

Free trade: CS = A+B+C+D+E PS =D TR =0 Tariff: CS PS TR =A = B+F =D

Welfare CS = -(B+C+D+E) PS = B TR =D W = -(C+E)

Trade policy instruments:

Tariffs = a tax on imports. Can either be a specific tax per unit imported, or an ad valorem tax based on the value of the good imported. Quotas: where the amount of imports is limited to a certain quantity. Eg. trade in textiles and clothing. VERS (Voluntary Export Restraints): signatories to GATT and the WTO are prohibited from introducing / raising tariffs and quotas. One way round this was where countries agreed to voluntarily restrain their exports (eg. Japanese cars in the 1980s) Export subsidies: where specific export industries are offered subsidies if they export Non-tariff barriers to trade: customs formalities, technical standards, labelling requirements

How is the impact of policies measured

Partial Equilibrium Modelling:
Requires information/assumptions about slopes of supply and demand schedules, as well as base data on trade flow, production, and tariffs. Can be implemented at a high degree of product disaggregation. Welfare measures based on CS, profits and tariff revenue

General Equilibrium modelling

Also requires information on supply and demand, as well as on intermediate input markets, factor markets, consumer behaviour + on the interrelationships between these ( Social Accounting Matrix (SAM)). Level of information required typically means these are implemented at a much higher degree of aggregation. Welfare measure based on CV or EV, profits and tariff revenue

Both of these techniques are very widely used to measure the impact of changes in trade policy or tax policy.

Methodology
1. Choice of model: The model is composed of a system of simultaneous equations. When these are solved the equilibrium quantities replicate the real world ie they give you the same quantities of goods, factors etc that the data tell you really exist 2. The procedure that is employed to ensure that this happens is known as calibration 3. Simulation: you can then change one of the parameters eg. tariffs, run the model again and compare the new values with the initial values. The difference gives you the impact of the policy. 4. Output:
Changes in production Changes in trade flows Changes in welfare + disaggregation of this

Partial Eq. Example - Egypt

1. Choice of model:
Single importer Egypt Domestic supply Three exporters EU, US, Rest of the World (ROW) 28 manufacturing industries

2. Choice of experiment/simulation:

Regional integration ie. simulating the Barcelona process Multilateral experiment: reduction of tariffs with regard to all sources Sensitivity analysis over key parameters, eg the elasticitity of substitution of a good across countries. See Excel file with simulations.

Regional Integration: Theory & Empirics

Regional integration is where a sub-set of countries choose to liberalise trade between themselves, but not vis-vis the rest of the world. Moving from restricted to free trade is welfare increasing, natural to assume that a move from restricted trade to regional integration will also be welfare increasing. However, this is not necessarily the case. Restricted trade is a distorted equilibrium, and so is regional integration: Trade creation: a shift from high cost domestic producers to lower cost partner country producers Trade diversion: a shift in source of imports from lower cost rest of world sources to higher cost partner country sources.

Trade Creation and Trade Diversion

Initially no regional integration and the same import tariffs on world and on country b.

imports of S1-D1 from world which is the cheaper supplier. Pw(1+ t) Now regionally integrate with b pb ie no tariffs on imports b. The price at home to Pb CS PS GR W =a+b+c+d = -a = -(c + e) = (b + d) - e

pw

b c d e D

where b + d = trade creation and e = trade diversion

Q S1 D 1 Classical theory does not offer us an a priori reason why countries integrate. If you consider integration as 1) unilateral tariff reduction (leading to TC) 2) then switching import from world to b therefore why do step 2?

CGE results: perfect competition, CRS

Welfare gains (US$ Billion) Authors Lippoldt & Kowalski (Base = 1998) Scenario Global 100% in manufacturing tariffs 100% in manufacturing + agricultural tariffs World Bank, 2004 (Base = 1997) Manuf cut to 5% in DCs, 10% in LDCs 63.3 97.2 98 254.3 82 LDCs 51.4 68.4 58 108.1 18*

Andersen, Francois et.al 100% M liberalisation (Base = 1995) Dessus, et.al (Base = 1995)
* = non OECD countries

100% in manuf and ag. Tariffs

Source: Trade and the Global Economy, HM Treasury and DTI, May 2005

CGE results: imp. comp, dynamic models

Welfare gains (US$ Billion) Authors Nagarajan (base = 1995, IC, IRS) World Bank, 2004 (1997 base, dynamic) Scenario Global 50% in protection on M, A & S + trade facilitation 100% liberalisation in A + M aby all 385 LDCs

832

539

Dessus, et.al 100% A +M tariffs (Base = 1995, dynamic)

1212

455

Source: Trade and the Global Economy, HM Treasury and DTI, May 2005 Note, that in contrast, the Edinburgh G8 summit agreed to boost aid to $50 billion! Total support to agriculture in the OECD countries, in 2001 was $311 billion

Hufbauer & Elliot on the US

1. Tariffs and quantitative restrictions in 1990 cost American consumers about $70 billion = more than 1% of GDP 2. Net change in welfare for the economy was of the order of $11 billion. 70% of this was captured by foreign producers as quota rents 3. Nearly 50% of the consumer costs are accounted for by 21 industries 4. More than a third ($24 billion) are from protection in textiles and clothing. 5. In terms of net national welfare, the cost per protected job is about $54,000.

Messerlin on the EU
1. EC protection (tariff and NTB) highly concentrated in certain sectors agriculture, process foodstuffs, textiles & clothing, steel and chemicals. 2. Many highly protected goods are intermediate goods in which LDCs have a comparative advantage 3. The costs to EU consumers add up to approximately 7% of EU GDP. 4. The estimated rents from protection correspond to about 30-40% of the total costs of protection 5. In terms of net national welfare the cost per job saved is of the order of 220,000

And for the LDCs

Similarly Robinon et. al. show that protectionism and subsidies by developed countries, cost LDCs $24 billion annually.
Latin America & the Caribbean: $8.3 billion LDCs in Asia: $6.6 billion Sub-saharan africa ~ $2 billion

However, note that successful development policy is not simply about having a liberal trade regime.
Requires appropriate domestic policies, regulations and structures, macro-economic stability, appropriate investment, lack of corruption

Also simply liberalising (agricultural) trade may not be the answer see eg. article by D. Rodrik

Summary
Wide variety of protectionist measures that can be used, though note the constraints of GATT and the WTO Estimating the costs of these policies typically involves either partial or general equilibrium models. The underlying welfare measures are then consumer surplus, and CV/EV. Cost of these policies can be very high for both DCs and LDCs Note however that models are sensitive to assumptions therefore have to be very careful in interpreting results

Additional Readings
1. 2. Feenstra, R. (1992), How Costly is Protectionism, Journal of Economic Perspectives, 6(3), 159-78. Hufbauer,G. C and Elliott K A (1994) Measuring the Costs of Protection In the US. Institute for International Economics, Washington, DC. (Read pp. 1-42, plus a couple of case studies.) Hufbauer, G.C. Surveying the cost of protection: A partial equilibrium approach, http://www.iie.com/publications/chapters_preview/66/2iie2350.pdf Messerlin, P, The real cost of European Protectionism, http://www.which.net/campaigns/other/freetrade/messerline.pdf Diao, X, Diaz-Bonila,E and Robinson, S, How much does it hurt: The impact of agricultural trade policies on developing countries. Dani Rodrik, How to Make the Trade Regime Work for Development, February 2004. A few thoughts on the Doha and post-Doha trade agenda

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