© 2007 pearson addison-wesley. all rights reserved chapter 11 diagram analysis for ipe
TRANSCRIPT
11-2Copyright © 2007 Pearson Addison-Wesley. All rights reserved.
Commercial Policy as a second-best device
• Trade policy is the second best policy instrument.
• If the distortion comes from the production side, then the production policy itself (production subsidy) would be better.
• If the distortion comes from the consumption side, then the consumption policy itself would be better.
• The tariff can be used to help implement some social objective, but it proves frequently the second to best to some alternative policy instruments.
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Production Goals
• Suppose free-trade level of production is thought to be low.
• Two different strategies: tariffs on importable; or production subsidy on importable like food.
• Free-trade production is at A and consumption at B.
• If OJ level of food production must be undertaken, a tariff that raises food’s relative price at home to line 2 is sufficient.
• What is consumption behind this tariff wall?
• It should satisfy: (1) the consumption bundle must lie on an indifference curve whose slope reflects relative domestic prices; (2) it must have the same value as production point C at world price, that is point E.
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Figure 11.3 Tariffs vs. Production Subsidies to Achieve a Production Goal
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Production Goals
• The restricted imports are EK, matched at world prices by clothing exports KC.
• Using production subsidy, production point is still at point C.
• World food prices are reflected in line HEC, parallel to line 1.
• Food producers receive the higher (subsidized) price shown by line 2.
• But now home consumers are free to buy at world price, and the best such point for them is H on curve y2.
• Y2 is higher that y1 in the case of tariffs.
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Evidence on U.S. Tariff Structure
• Next table shows the results of a simple test on the levels of protection that prevailed in the 1970s.
• Industries are ranked from the most protected to the least.
• The ranked list was divided into quarters.
• What is effective protection rate?
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Effective Rate of Protection
• The effective rate of protection measures how much protection a tariff or other trade policy provides domestic producers.
– It represents the change in value that an industry adds to the production process when trade policy changes.
– The change in value that an industry provides depends on the change in prices when trade policies change.
– Effective rates of protection often differ from tariff rates because tariffs affect sectors other than the protected sector, a fact which affects the prices and value added for the protected sector.
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Effective Rate of Protection (cont.)
• For example, suppose that an automobile sells on the world market for $8000, and the parts that made it are worth $6000.– The value added of the auto production is
$8000-$6000
• Suppose that a country puts a 25% tariff on imported autos so that domestic auto assembly firms can now charge up to $10000 instead of $8000.
• Now auto assembly will occur if the value added is up to $10000-$6000.
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Effective Rate of Protection (cont.)
• The effective rate of protection for domestic auto assembly firms is the change in value added:
($4000 - $2000)/$2000 = 100%
• In this case, the effective rate of protection is greater than the tariff rate.
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Table 11.1 Characteristics of Industries in Relation to Levels of Protection Given by U.S. Tariffs
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Does the tariff protect labor-intensive industries?
• The least-protected industries are indeed the least labor intensive.
• However, the most heavily protected industries are not very labor intensive.
• It does not confirm the prediction of the majority of voters that tariffs favor labor-intensive industries.
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Does the tariff protect low-skilled ?
• If the politicians aim in part to redistribute income to those poor, high tariffs should protect industries that employ low-skill and low-wage labor.
• Evidence: Low-wage industries do get the highest protection.
• However, their real income as consumers suffer seriously.
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Does the tariff protect small or big business?
• Theory conflicts.
• The lobbying model suggests that small industries can influence political decision at low cost, thus securing high protection.
• The collective decision suggest that high protection should go to large sellers.
• Evidence suggests that protection favors small establishments.
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Table 11.1 Characteristics of Industries in Relation to Levels of Protection Given by U.S. Tariffs
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Growth, Protection, and Welfare
• If a country devotes newly resources to its exportable sectors, the country’s terms of trade will tend to worsen.
• Immiserizing Growth
• But this is not true if the country is too small to affect world price of its export commodity.
• Why?
• Suppose a small country imposes tariff on its importable (food) like Figure 10.4.
• Such a diversion of resources entails real income losses.
• Tariff in a small country cause dead-weight-loss.
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Figure 10.4 The Effect of a Tariff on Imports
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Growth, Protection, and Welfare
• As this country grows, the more resources it devotes to the protected import-competing sector, the more its potential real income gains from growth are cut back.
• In the extreme case, growth at home could even result in a loss of welfare.
• Figure 11.4 illustrates these possibilities.
• Line 2 indicates world prices whereas line 1 shows domestic prices behind the tariff wall.
• With a tariff on food imports, line 1 showing domestic prices is flatter than line 2 which shows world prices.
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Growth, Protection, and Welfare
• A’ is the initial consumption point corresponding to production along TT’ at A.
• Now suppose tariff and world prices are unchanged, but the value of produced income at domestic prices rises by 25%.
• Consider difference cases for industries’ expansion.
• Point D: only the exportable sector expands 25%.
• The representative consumption point is at D’ which is the highest.
• Point B: fairly balanced expansion relative to point A.
• The consumption is at B’ which means real income increases.
• Growth has increased real income.
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Figure 11.4 Growth with Protection
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Growth, Protection, and Welfare
• Point C and C’ is for expansion of pure import-competing industrial expansion.
• In the extreme case, if growth has been so biased in favor of importable (food), it would lower the real income.
• Therefore, growth to any of points B, C,D, and E shows a 25% increase in produced income at domestic price.
• But corresponding consumption points B’, C’, D’ and E’ are not equivalent.