Archive for the 'Barriers to trade' Category

Oct 04 2010

The high cost of tariffs

CBC News – Money – Shipping industry gets tariff break

A tariff is a tax on imported goods or services aimed at raising the price of foreign products to make domestically produced substitutes more attractive to consumers. A tariff is a form of protectionism, which we study in unit 4.1 of the IB Economics course.

Tariffs are appealing to policymakers as a tool for protecting domestic firms from foreign competition. Used wisely, a barrier to trade such as a tariff can promote the development of certain vital industries in the domestic economy that might otherwise not exist due to the existent of more efficient, lower cost foreign competition. Tariffs benefit domestic producers but harm domestic consumers, who must pay a higher price for the imported good than they would have to under purely free trade.

The Canadian government has, until recently, charged a 25% tariff on cargo ships, tankers and large ferries built in foreign countries. As of this month, however, this tariff is being removed.

Imported cargo ships, tankers and large ferries will no longer be subject to a 25 per cent tariff, Finance Minister Jim Flaherty announced Friday.

The measure is aimed at making it cheaper for Canadian shipowners to replace aging fleets with more modern and more efficient vessels.

Waiving the tariff will save the industry $25 million a year for the next 10 years, the government estimates.

“These were tariffs that don’t serve any purpose because … the ships to which they apply are not capable of being made competitively in Canada,” Flaherty told reporters…

The effects of a tariff in the Canadian ship market can be illustrated using a simple supply and demand diagram. The diagram below shows the Canadian ship market before the removal of the 25% tariff and after its removal.

The domestic supply and demand curves for ships in Canada are shown above. Notice that the domestic equilibrium price for ships in Canada without trade is very high. This is because Canadian ship builders have high costs of production and therefore would require a very high price in order to be able to build ships domestically.

So where do Canadian ship buyers get their ships from? The article mentions that one Canadian company bought ships from a Turkish ship builder. Besides Turkey, some of the other countries that specialize in ship production include Denmark, South Korea, China and Japan. The world supply of ships is represented by the blue line. In a purely free trade environment, the price of ships in Canada is determined by the intersection of domestic demand and world supply, at a price of Pw.

The world price of ships is completely unresponsive to changes in demand from Canadian ship buyers. This explains why world supply is horizontal. Since the Canadian market makes up such a small proportion of the total market for ships, an increase in demand in Canada will have no impact on the world price of ships. Therefore, the world supply curve as seen by Canada ship buyers is perfectly elastic. Canadian ship buyers can buy as few ships or as many ships as they like without affecting world price.

A tariff is a tax, and a tax is a determinant of supply. A tariff of 25% increases the costs of imported ships, and shifts the world supply curve upwards. This raises the price of imported ships, and decreases the quantity demanded of ships in Canada from Q3 to Q2 ships. Notice that at the higher world price of Pwt, there are a few domestic ship builders in Canada willing and able to produce and sell ships, so domestic quantity supplied increases from 0 to Q1.

The existence of a tariff reduces the number of imported ships in Canada from 0Q3 to Q1Q2. Domestic producers of ships, who without protection would not be able to compete and therefore produce zero ships, instead produce Q1 and enjoy producer surplus represented by the triangle X. The Canadian government collects taxes on the imported ships represented by the area Z, found by multiplying the number of imported ships (Q1Q2) by the amount of the tariff (Pwt-Pw).

The tariff on imported ships did little good for the Canadian ship market. Canadian ship builders were already uncompetitive and benefited little if at all. While the government did earn revenues from the tax, the net effect on the market was a loss of welfare represented by the triangles labelled Y in the graph above. These gray areas represent the net welfare loss (or dead weight loss) of the ship tariff.

The consumers of ships, which are in fact Canadian companies that produce other goods and services, such as the ferry companies that provide access to Canada’s several remote coastal and island communities, were clearly harmed by the 25% tariff, since the price of ships is a resource cost and the tariff translated into lower supply and higher prices for consumers of ferry services. The tariff’s effect on ship buyers in Canada is visible in the graph above. At a price of Pw, the total consumer surplus in the ship market is the area of VXYZ. With the higher price resulting from the tariff, however, consumer surplus is only the are V, while producer surplus increased only to the area X and government surplus (the tax revenue from the tariff) is area Z. The net effect, however, is a loss of total welfare of the triangles labelled Y.

The tariff’s removal, on the other hand, increases the welfare of ship consumers back to VXYZ, eliminating the dead weight loss and increasing total welfare and efficiency in the ship market. This also benefits the customers of the companies that buy ships, including ferry passengers, as evidenced in the article

“The duty remission to BC Ferries will allow it to implement a two per cent rate reduction for its users later this month, the Finance Department said.”

A tariff on imports is a protectionist measure aimed at increasing domestic producer surplus in a market in which domestic firms face competition from lower cost foreign producers. However, it should be observed that a tariff generally creates a net loss of welfare for society as a whole, as the consumers of the taxed good face a higher price and demand a lower quantity of output. While a tariff reduces imports may increase domestic production, the benefit to producers comes at the cost of lost consumer surplus and a net loss of welfare in the market as a whole. The tariff also leads to allocative inefficiency in a market, as domestic resources are over-allocated towards the production of a good on which imports are subject to tariffs.

Removing tariffs on ships increases the benefit to ship buyers, who in turn pass that benefit on to their own customers, lowering the prices of important services such as shipping and ferry service to Canadian consumers. In addition, foreign producers of ships increase their sales in Canada and experience greater demand, benefiting foreign producers and workers. The increase in foreign income may mean more demand for Canada’s exports in turn, increasing employment in other sectors of the Canadian economy in which they do have a comparative advantage over their trading partners. Overall the elimination of tariffs increases total welfare, eliminates dead weight loss, and leads to a more efficient allocation of a nation’s resources towards the goods it is able to competitively produce in the global economy.

Discussion Questions:

  1. What was the intended purpose of the 25% tariff on imported ships? Was this a valid reason to tax foreign built ships?
  2. Who are the various “stakeholders” affected by a tariff on imported ships. Try to identify five different stakeholders who are affected by the tariff and its removal.
  3. Why does the removal of a tariff improve allocative efficiency in a country? Does it also improve productive efficiency?

15 responses so far

Sep 30 2010

Free Trade Debate: to what extent has globalization based on free trade contributed to global economic growth and development?

Today in class, my IB year 2 students undertook a debate on the extent to which free trade has contributed to or hurt the well-being of the world’s people. In preparation for this debate, students were asked to research and bookmark to our class’s Diigo group one article offering evidence in support of their argument.

The debate was framed around a quote from Paul Krugman from chapter 11 of the excellent book, Naked Economics.

“You could say that globalization, driven not by human goodness but by the profit motive, has done far more good for more people than all the foreign aid and soft loans provided by well-intentioned governments and aid agencies.”
I was very impressed with their well thought out viewpoints, considering we have only just started our Unit 4: International Trade section of the IB course. Below are the summaries of my student’s arguments for and against free trade. Next to their names are links to the articles they found to support their argument.
Anti-trade arguments
Ika:
  • 80% of the toys sold in America are made in China.
  • Foreign companies make toys in factories operated and owned by Chinese.
  • Working conditions in China are horrible with a minimum wages that is far too low.
  • In addition to low wages, standards of worker safety are lower than the United States, leading to exploitation of labor to produce cheap toys for Americans.
  • To make matters worse, the prices of a certain toy may vary greatly from rich country to rich country. For example, a doll that sells for $29 in the USA sells for $64 in Holland. How is this fair?
  • The cost of labor makes up less than 5% of the price of the toy.
  • Free trade only increases the profits of the capitalists, but does not help the workers in the poor countries where products are manufactured.
Koen: The Negative Impact of Free Trade | eHow.com
  • Due to free trade, demand for labor in more developed countries decreases since production occurs in other countries where it’s cheaper to produce.
  • This means jobs lost in rich countries, so less economic growth, less consumption, lower incomes.
  • Growth in some countries comes at the expense of growth in other countries. There are winners and LOSERS in free trade.
Sarah: Doha trade deal ‘will hurt Africa’ | Environment | The Guardian
  • Under free trade as we call it today, subsidies to farmers in Europe make it difficult for African farmers to compete.
  • Africa accounts for less of the total trade in the world today than it did in 1990, mostly because of its inability to export produce due to subsidies to farmers in Europe.
  • With less access to advanced capital and the lack of government  subsidies, African farmers find it difficult to compete on the global produce market.
  • Free trade hurts poor countries’ farmers and therefore increases the gap between rich and poor.
Silvia:
  • Trade liberalization creates some losers as it increases the gap between those with skills to work in the global market and those who don’t have those skills.
  • Trade leads to an increase in inequality and more relative poverty.
  • Trade creates severe tensions between big and small firms and workers who succeed and those who lag behind.
  • Export growth can exacerbate the exploitation of natural resources. Without environmental protection, trade may make us richer but at the price of future development.
Pro-trade arguments
Duy Anh: allAfrica.com: Africa: Free Trade Area for East, Southern Africa Making Progress
  • Africa is establishing Free Trade Areas to improve the flow of goods and services across country. If trade were not beneficial, then why would so many countries be clamoring to enter a free trade area?
  • When workers can move freely in a region it can lead to better, more efficient resource allocation. The same is true of capital, goods and services. Larger markets lead to more efficiency and greater opportunities for employment and for business operators.
  • Reducing tariffs, quotas and other barriers to trade increases efficiency and allows for more opportunities for all those who live within a free trade areal.

Christopher: Foreign Trade, Not Foreign Aid « John Stossel

  • If we help developing countries improve and increase their trade with each other and the rest of the world, it will create jobs, allow entrepreneurs to start companies and therefore reduce unemployment.
  • Greater opportunities and less unemployment leads to more social stability, reduction in poverty, and less likelihood that the poor people of the world will become “extremists” or result to violence and terrorism to express their dissatisfaction with the world.
  • More trade and international relationships reduces likelihood of conflict between and within poor countries.
  • We should expect to see social and political stability arising from increased economic opportunity.
  • Free trade WILL increase economic opportunities in poor countries.
General comments from the class after both sides have presented their arguments
  • Unlike aid, free trade cannot be “used up”. Aid is a one-off, when it’s gone it’s over, but trade can be self-perpetuating.
  • On the other hand, Sarah says,  “but it all depends on the kind of aid and how it is used!”
  • Aid can be invested responsibly, but often times it is not.
  • So maybe there is room for BOTH aid AND trade.
  • Lara says,  “In extreme circumstances, aid is necessary. In other, trade is better as a long-run means of achieving growth and development”

The exercise of debating the pros and cons of free trade for rich and poor countries was rewarding and provided an interesting and engaging way to introduce Unit 4 of the IB Economics course. The final two units, on International Trade and Economic Development, are closely tied, as one of the main strategies for achieving improvements in people’s standards of living is to improve the unfettered access to resource, good and service markets across national boundaries. We will be revisiting the debate on the effectiveness of trade versus aid at promoting the objectives of economic development repeatedly throughout the rest of the second year of IB economics.

For now, some questions went unresolved in today’s debate, and I will ask my student and any other interested reader to respond to those questions in the comments below.

Discussion questions:

  1. Is it possible that free trade has increased not only the relative poverty in the world, but also the number of people living in absolute poverty? In other words, trade makes the rich get richer, but does it make the poor get poorer? Or do the poor just feel poorer due to increased wealth and income of the rich?
  2. In 1970, the economies of China and Africa were roughly the same size, and the average income of a Chinese person was around the same as an African’s. Today, China’s economy is more than three time’s the size of Africa’s. What has China done differently than Africa to lead to such a huge income gap between the two regions?
  3. Why should people in Europe, America and other high income regions of the world care about the economic development of the world’s poorest countries? Does improving the lives of Africans require that we in Europe and the rich West make sacrifices in our own standards of living?
  4. African countries want Europe to stop subsidizing its farmers to make it easier for African farmers to compete. But doing so would mean the loss of an important part of European history and culture. Why would less subsidies to farmers in Europe help Africa, and should Europe listen to Africa on this issue or not?

11 responses so far

Feb 05 2010

US Exports: the key to job creation? Obama thinks so…

Obamas Efforts To Boost Exports Face Hurdles : NPR

President Obama thinks the key to recovering the millions of American jobs lost during the recession lies in boosting exports to the rest of the world:

The plan sounds great. As we learn in AP and IB Economics, free trade leads to benefits for nations that choose to participate in it. Of course, promoting free trade will harm some industries and workers whose jobs end up being “off-shored” or “out-sourced” to countries with cheaper or more qualified labor; but Obama’s hope is that promoting free trade will result in a net gain of 2 million American jobs.

The goal of doubling US exports in 5 years, however, may be overly ambitious. According to the CIA World Factbook, the US is currently the fourth largest exporter in the world, sending just around $1 trillion worth of goods and services abroad in 2009, behind the EU with $1.9 trillion, China with $1.2 trillion and Germany with $1.18 trillion of exports. Obama’s goal to double US exports would propel the US to the single largest exporting nation in the world, putting it right around where the 27 nations of the European Union are today.

To achieve his goal, Obama proposals include three strategies for boosting demand and supply of US exports.

  • On the supply side he suggests continuing recent guarantees for payment by foreign buyers. Essentially such a scheme reduces the risks that often accompany international commerce, reducing the “costs” of exporting firms, which in essence increases the supply of exports from the US.
  • On the demand side the US must pressure China to revalue its currency. A stronger RMB (and a weaker dollar) will increase China’s demand for US goods and services.
  • Also on the demand side, the US should push through free trade agreements with South Korea, Panama and Columbia, which have encountered obstacles among US lawmakers who fear that more free trade may actually mean a loss of US jobs.

Free trade agreements, export payment guarantees and a weaker US dollar in China will help Obama reach his goal. Chances are, however, that it will ultimately be unattainable. Doubling US exports would propel the US to the top of the list of exporting countries, surpassing even China, today’s current leader, by $700 billion more than the country exported last year. The impact on US GDP would undoubtedly be enormous, adding upwards of  $1 trillion to the US economy.

Creating jobs through trade is controversial, as many Americans still believe trade is partially to blame for the loss of American jobs in recent years.

“The average voter in the U.S. has been pretty on the fence about whether they want more trade coming into the United States,” Slaughter says. “The income pressures that a lot of households have faced in recent years have sort of shifted that balance where more voters now are a lot more wary of globalization than they used to be.”

While his goal is lofty, Obama is on the right track towards growing the US economy and promoting job creation. Trade benefits Americans not just because it will increase demand for our goods and services abroad, but because it will lead to lower prices for many of the things we enjoy consuming at home, ultimately increasing real incomes in America while also creating jobs.

The graph below presents a simple explanation of how the above strategies can result in more jobs in US export industries.

Discussion Questions:

  1. How does China manipulate the value of its currency? Why is such manipulation harmful to US exporters?
  2. How does a government payment guarantee for exporters actually reduce the costs of doing business for US exporting firms?
  3. Do you believe that more free trade agreements with countries like South Korea and Panama will create jobs or destroy jobs in the United States? Explain.

3 responses so far

Oct 26 2009

Exchange rates, currency manipulations, and the balance of trade

FT.com | The Economists’ Forum | Imbalances and undervalued exchange rates: Rehabilitating Keynes

In our year 2 IB Economics class, we are beginning the part of our International Trade unit on exchange rates and the balance of trade . While the market for a particular currency reflects many of the same characteristics as a product market (i.e. upward sloping supply curve, downward sloping demand curve), the consequences of a change the price of a currency (the exchange rate) is far more powerful than a change in the price of a particular good or service in a product market.

How does the value of a country’s currency affect that country’s balance of trade with other countries? To understand this important concept, we first need to know something about the process by which currencies are exchanged when two countries trade. Let’s look at an example:

When an American consumer wants to buy an iPod that was made in China she will have to pay for it in US dollars, since that’s what she earns her wages in from selling her labor in the resource market. Apple now has the consumer’s $300, which gets split up to cover all the costs the company faced in the manufacture, distribution, marketing and sale of the iPod. Part of that $300 (say $100) will go to the manager of the factory in China where it was made.

The factory manager in Shanghai faces his own costs he must cover. He must pay rent on his factory space, interest on the loans he took out to acquire capital, and wages to the workers assembling iPods on his factory floor. The problem is, these costs are all in Chinese yuan, but he’s holding the US dollars that Apple paid him for his iPod. In order to cover his costs, the Chinese factory owner must take the $100 to a Chinese bank and swap it for RMB. The local bank that changes his money now hands the $100 over to China’s central bank (the PBOC) which prints and exchanges RMB to the bank at whatever the prevailing exchange rate is at the time.

Ultimately, China’s central bank will decide what to do with its holding of US dollars. Most of the dollars are loaned back to the United States through China’s purchase of US Treasury securities (the IOUs the US government sells to finance its deficits). China’s voracious demand for US dollar denominated assets keeps the demand for (and the the value of) dollars high on foreign exchange markets, meaning the RMB remains relatively cheap for Americans and therefore Chinese manufactured goods attractive.

China’s policy of exchange rate manipulation has upset many American politicians over the years, who often blame China for America’s shrinking manufacturing sector. A weak RMB means the cost of producing things like iPods in China is far lower than it would be in the US. By keeping demand for dollars high on the foreign exchange markets through its incessant demand for US treasury securities and other financial and real assets, while simultaneously hoarding vast reserves of US dollars in its central bank, thus keeping supply of dollars on foreign exchange markets low (see graph), China has prevented the RMB from appreciating, fueling the growth of the country’s export-manufacturing sector.

China’s currency manipulations may soon ilicit a response from the United States as president-elect Barack Obama takes office next year. Facing a recession and rising unemployment, combined with the recent appreciation of the US dollar, the pressure is on Obama to take immediate action to restore America’s manufacturing sector. According to the Financial Times blog “the Economists’ Forum”:

If the US economy takes a downturn and the dollar continues to strengthen, a resurgence of protectionist pressures is likely. This time around, these pressures could well take the form of unilateral action against competitive currencies. It is noteworthy that President-elect Obama has actively and repeatedly supported action against “currency manipulation.”

The “competitive currency” perceived to pose the greatest threat to America’s inustrial sector is certainly the Chinese RMB. Currency manipulation is a form of protectionism, which in a time of global economic slowdowns poses a larger threat than ever to both developed and developing nations’ economies alike. For this reason, the World Trade Organization may need to employ carrot and stick methods to create incentives for China to liberalize its currency controls and allow the RMB to strengthan against the dollar and other major currencies:

How would this new rule against undervalued exchange rates be incorporated in the WTO? Through negotiation. The (WTO) should place rules on undervalued exchange rates…. The US and EU have been the principal demandeurs for action by China in the past. But it is important to remember that until very recently, a number of developing countries—Brazil, Mexico, Korea, Turkey and South Africa—were affected by the competitive pressure from the undervalued (RMB). Indeed, some months ago, the Indian Prime Minister urged China to follow a more market-based exchange rate policy. For obvious reasons, more emerging market countries have not voiced their concerns, but it is possible that a coalition of affected countries could unite on this issue.

Clearly, Chinese concerns have to be addressed for any new rules to be crafted and commonly agreed… First, China’s major trading partners could pledge granting China the status of a “market economy” in the WTO contingent on it eliminating currency undervaluation and moving to a market-based system. This status would have significant value for China by shielding it against unilateral trade actions such as anti-dumping and countervailing duties by trading partners. Second, as part of radical governance reform of the IMF, which is desirable in itself, China should be offered a substantially larger voting share in the IMF commensurate with its economic status.

Discussion Questions:

  1. How does China continuing to undervalue its currency threaten the industrial economies of its largest trading partners?
  2. What is China’s purpose for maintaining the low value of the RMB relative to the currencies of other nations?
  3. What would be a unilateral protectionist measure an Obama administration may advocate if the WTO refuses to take action against China’s currency manipulations? How would you advise president-elect Obama on the issue of whether to take protectionist action against China in the context of the current economic crisis in America?

103 responses so far

Sep 23 2009

Tit, tat, tariff… China and America’s latest shoving match is underway

America, a champion of free trade between the world’s nations… right?

Actually, the United States places tariffs (taxes on import) on virtully every item it trades for with the rest of the world. Below is just one tiny section of the 75 page table of contents (!!) of the “Harmonized Tariff Schedule of the United States”.

JOGGING SUITS knitted or crocheted . . . . . . . . .. . . . . 6112.11-19
JOINERY of wood, for builders . . . . . . . . . . . . . . . . . . . . . . . . . 4418
JOINTS artificial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 9021.11
JOJOBA OIL . . . . . . . .  . . . . . . . . . . . . . . . . . . 1515.90, 1516-1518
JOKE ARTICLES . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 9505.90
JONGKONG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . . . . Ch. 44
JOURNALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . 49-3, 4902
JUDO UNIFORMS of cotton . . . .  . . . . . . . . . . . . 6203.22, 6204.22
JUICES fruit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20-US1-3
fruit and vegetable . . . . . . . . . . . . . . . . . . . . . . . . 20-5, 2009.11-90
meat, fish, or aquatic invertebrates . . . . . . . . . . . . . . . . . .1603.00
JUMPSUITS men’s or boys’ . . .  . . . . . . . . . . . . . . . . . . .  6211.32-33
women’s or girls’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6211.42-43
JUNIPER seeds of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …0909.50

Yes, folks. Even “Joke Articles” made overseas are taxed before ending up in the hands of American consumers (by 70% as it turns out!). But tariffs are no joke. The podcast below offers an excellent evaluation of the effects of America’s tariffs on various stakeholders, including American consumers, producers, and workers and on foreign producers, consumers and workers.

[podcast]http://welkerswikinomics.com/blog/wp-content/uploads/Tariffs.mp3[/podcast]

After listening to the whole podcast, respond the the following questions in a comment.

Discussion Questions:

  1. How does a tariff on Chinese tires affect American tire manufacturers? Why are American firms that make tires actually opposed to the tariff on Chinese imports?
  2. Which group is the main proponent of higher tariffs on Chinese tires? Why does this group favor higher tariffs?
  3. How have the Chinese responded to the American tire tariff? Why are American chicken farmers upset about the tax on Chinese tires?
  4. Why do “97% of economists say tariffs are a bad idea?” The commentator says economists hate them because “they are so inefficient”. Discuss the economic reasoning behind this statement.
  5. Do you think it is likely that the 35% tariff on Chinese tires will save or create jobs for Americans? Why or why not? What are your conclusions regarding the economic wisdom of tariffs?

10 responses so far

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