I bet you wonder how I knewabout your plans to make me bluewith some other guy you knew before.Between the two of us guysyou I love you more.It took me by surprise(drive me crazy),when I found out yesterday.Don’t you know that ...

I heard it through the grapevine.How much longer would you be mine?Oh I heard it through the grapevine,and I’m just about to lose my mind. Honey, Honey, Yea.Heard it through the grapevine, how much longer would you be mine, baby oooo oooo oo oo

I know a man ain’t supposed to cry,but these tears I can’t hold inside.Losing you would end my life you see,‘cause you mean that much to me.You could have told me yourself that you love someone else.Instead...

I heard it through the grapevine.How much longer would you be mine?Oh I heard it through the grapevine,and I’m just about to lose my mind. Honey, Honey, Yea.Heard it through the grapevine, how much longer would you be mine, baby oooo oooo oo oo

People say beware of what you see, supply and demand are what you hear.I can’t hide being confused.If it is true please tell me dear.Do you plan to let me go for that other guy you loved before?Don’t you know...

A Trade Policy Puzzle

• Gains from trade arguments (such as comparative advantage) suggest removing trade barriers, a policy of free trade– wide agreement among economists

• Yet, we see many trade barriers--tariffs, quotas, and less visible barriers

• Let’s look at the – effects

– reasons

– remedies

Effect of a tariff18_01

New export supply curve

Export supply curve

Import demand curve

QUANTITY

PRICETotal shaded area equals tariff revenue to the government.

Price without tariff

Tariff shifts up the export supply curve by this amount.

Price paid by consumers (with tariff)

Price received by foreign sellers (with tariff)

Effect of a Quota18_02

Export supply curve

Import demand curve

QUANTITY

PRICE

Shaded area equals profits from quota that go to quota holder.

Price received by foreign producers

Price paid by U.S. consumers

Price without quota

Quota: Imports cannot exceed this amount.

Effect of a Voluntary Restraint Agreement (VRA)

18_03

VRA: The foreign government agrees to keep its firms' exports below this amount.

Export supply curve

Import demand curve

QUANTITY

PRICE

Price paid by U.S. consumers

Price at which foreign producers would sell VRA amount

Profits of foreign producers increase by this amount.

Equivalence of Tariff, Quota, VRA

• All reduce quantity imported

• All raise the price consumers pay by the same amount

• Differences– for tariff, revenue goes to government– for quota, that revenue goes to quota holder– for VRA, that revenue goes to foreign firms as

profit

Mini History of U.S. Trade Policy

• Before the income tax, tariffs were the major source of revenue to the U.S. government

• Tariffs have fluctuated greatly reflecting internal political conflicts (abominations), trade wars (Smoot-Hawley), and new techniques to remove trade barriers (GATT)

18_05

TARIFFS AS A SHARE OFTOTAL FEDERAL RECEIPTS(PERCENT)

100

75

50

25

01800 1900 2000

(est.)

18_06

Uruguay Round completed (1993)

General Agreement on Tariffs and Trade created (1947)

Reciprocal Trade Agreement Act (1934)

Smoot-Hawley tariff (1930)

Civil War tariffs

“Tariff of abominations” (1828)

Underwood Tariff Act (1913)Compromise

tariff (1833) and subsequent tariff reductions

DUTIES CALCULATED AS A PERCENTAGE OF DUTIABLE IMPORTS

70

60

50

40

30

20

10

01820 19701830 19601840 19501850 19401860 1930 1980 19901870 19201880 19101890 1900

18_07

April

1930

2,739

1931

1932

1933

May

June

JulyJanuary

February

March

August

SeptemberNovember

December

October

1,839 992

1,206

Contracting Spiral of World Trade

Economic and other arguments against free trade

• Infant industry argument– due to Alexander Hamilton– industry needs protection until it gets big

enough to keep costs low– but

• protection usually lasts well beyond infancy

• not clear which industry to protect

national security argument

• certain goods or services are needed in time of war– shipping: Jones Act (shipping between U.S. ports

must be on U.S. ships)– VRA on machine tools– rice!!!!!– textiles needed for military uniforms!!!!!

• Alternatives– stockpile crucial materials

retaliation argument

• use threat of a trade barrier as a bargaining instrument

• but– can cause trade war– is usually used as a specious argument for

protection

monopoly power argument

• hold back exports to exploit other countries– OPEC cartel

• beggar thy neighbor

Argument against reducing trade barriers because of costs during

transition to free trade• True, we do not instantly move to the

benefits of free trade and some people can be harmed during the transition

• But better to– phase out barriers slowly (10 years) – give assistance (unemployment compensation,

welfare)

• Analogy with new technological innovation

Argument that other countries are subsidizing their industries

• But they are giving U.S. consumers a good deal; why complain?

• Most difficult to deal with in practice because it does not seem fair

Policies to Remove Trade Barriers (Traditional)

• Unilateral Disarmament– Smith, Ricardo, Repeal of corn laws in England– rarely works, example of textile quota (Poland)

• Multilateral-- Reciprocal Tariff Reduction (GATT, WTO)– Most Favored Nation (MFN) approach– has worked very well--tariffs way down since

WWII

Policies to remove trade barriers (newer)

• Regional--NAFTA, fast track for Chile– trade creation versus trade distortion– free trade area versus common market

• rules of origin (15 pound agreement)

• Bilateral dealings– U.S. - Japan– U.S.- China– quiet now because of Asian financial crisis, (let’s get

on to macro to find out why).