“This post was originally published in April, 2008. It has been re-published today for the benefit of my year 2 IB Econ students, who are currently studying barriers to free trade.

Bloomberg.com: Economy - Korea Beef Deal Won’t Yield Trade Vote

Free trade: everyone either loves it or loves to hate it. South Korea and the US have been in negotiations for a landmark free trade agreement for years. Korea, however, has had a “beef” with US beef imports since 2003, when a case of Mad Cow Disease gave Korean officials the jitters and all imports were halted.

Even though Mad Cow has disappeared from American beef, the ban has remained, making it difficult for negotiators to come to any major agreements on the reduction of tariffs and other barriers to trade in other markets in which the US and Korea trade. Just last week, South Korea removed the beef ban, giving some analysts hope that a free trade deal may soon be agreed upon.

President Bush signed the agreement last year but has hesitated to pass it on to Congress; where certain Democratic politicians have refused to approve the agreement until S Korea removed the beef ban. Now that the ban has been lifted, however, it appears that the issues keeping an agreement from being reached may run deeper than the simple beef ban:

In addition, Ford Motor Co., unions and Democrats, including both Hillary Clinton and Barack Obama, all say the accord must be reworked to address what they call South Korea’s barriers to U.S. manufactured goods.

“I understand there are foreign policy considerations, but this is too important for us,” Stephen Biegun, vice president for government affairs at Ford said in an interview earlier this month. “We don’t see any sign that they are ready to change.”

Levin, who represents autoworkers in suburban Detroit, said the accord will need to be changed to address what he calls South Korea’s non-tariff barriers to U.S. manufactured goods, especially autos.

Clinton, in a response to questions from the Pennsylvania Fair Trade Coalition, said the agreement with South Korea “will cost America jobs.”

The S Korea / US Free Trade Agreement should bring a boost in trade between the two countries:

The U.S. is South Korea’s second-largest export market behind China, with shipments totaling $45.8 billion in 2007. Imports from the U.S. last year reached $37.2 billion. The trade agreement would eliminate or reduce tariffs on a wide range of goods including automobiles, vegetables and electronics.

Through free trade there are winners and losers. This is a theme we’ve explored in some depth already during our International Economics unit. The winners, in the case of the S Korea/US FTA will likely be manufacturers in S Korea and service industries in the US. Judging by Ford Motor Company’s response to the FTA, we can assume that American manufacturers will be losers from the accord.

Does this make it bad, however? According to macroeconomic theory, no. The removal of tariffs on imports from S Korea will force American manufacturers to become more competitive and achieve greater efficiency, both which will result in a more efficient allocation of resources in both S Korea and the US. If Ford, for example, sells fewer cars because of in influx of high quality, affordable Korean automobiles, then Ford may be forced to shut down some of its plants in the US. This will lead to the loss of American jobs, just as Hillary Clinton claims it will.

But in the long-run, America as a whole should be better off for it. Manufacturers in the US will focus more on capital intensive goods such as industrial equipment, the manufacture of which requires highly skilled labor, which America has in abundance. In addition to industrial equipment and other high skilled manufactured goods, the US service sector should benefit from freer trade with S Korea.

With beef being resolved, the U.S. banks, insurance companies and other services companies that stand to gain the most from this accord are gearing up their lobbying efforts.

Beef “has been our biggest obstacle in having a meaningful dialogue on the benefits of this agreement,” said Matt Niemeyer, vice president for the business insurer ACE Ltd. and a former U.S. trade official. “It’s now time to work with Congress to find a way to move this important agreement this year.”

As any student of economics knows by now, politics and economics don’t always mix well. The opposition to the S Korea/US FTA among Congressional Democrats is more political than it is economic. Jobs will be lost, that’s true, but overall trade between two technologically advanced, developed countries like the US and S Korea should do more for improvements in efficiency and in resource allocation than it will in harm for a handful of American workers who may find themselves out of work due to greater demand for imported automobiles.

*A tariff on Korean automobiles results in the following outcomes:

• The quantity demanded of automobiles is less than it would be without a tariff (Q4 rather than Q3)
• The quantity supplied by American auto manufacturers is greater than it would be without the tariff (Q2 rather than Q1)
• The difference between Q2 and Q1 represents an overallocation of resources in America towards automobile manufacturing.
• The domestic quantity demanded exceeds the domestic quantity supplied. The difference (Q4 - Q2) is made up for by imports from S Korea.
  
• The government earns revenue equal to the area of the yellow rectangle (amount of tariff x number of cars imported)
• Society experiences a loss of efficiency (deadweight loss) equal to the combined areas of the green triangles Y and X. This is consumer surplus lost, accounted for by the higher price paid by American consumers imposed by the tariff.

In the model above, the removal of a tariff on Korean automobiles will result in a decrease in output by American firms from Q2 to Q1, an increase in imports from Q4 - Q2 to Q3 - Q1, and an increase in consumer surplus, efficiency, and better overall allocation of resources in America.

Discussion questions:

1. How does the graph illustrate the concept of “winners and losers from free trade”?
2. Who gains and who loses from free trade with the US within Korea?
3. Is it possible that a free trade agreement with Korea would actually create jobs in America? Explain…
4. Why do politicians oppose free trade deals that would result in such improvements in efficiency, allocation of resources, and even in the employment opportunities for American workers?

Beyond the Noise on Free Trade - New York Times

Ever wondered which presidential candidate had the most “economistic” views on economic issues? In other words, which candidate supports economic policies most in line with the mainstream economic theories of our day: Obama, Clinton or McCain?

First question is what, exactly, are the mainstream economic views at issue? In Harvard Professor Gregory Mankiw’s article above, he talks about the issue of free trade:

Economists are, overwhelmingly, free traders. A 2006 poll of Ph.D. members of the American Economic Association found that 87.5 percent agreed that “the U.S. should eliminate remaining tariffs and other barriers to trade.”

The benefits from an open world trading system are standard fare in introductory economics courses. In my freshman course at Harvard, we start studying the topic in the second week, and we return to issues of globalization throughout the year. The basic lessons can be traced back to Adam Smith of the 18th century and David Ricardo of the 19th century: Trade between two countries creates winners and losers, but it leaves both nations with greater overall prosperity.

Indeed, all principles of economics courses (including our AP and IB courses here at SAS) teach in the first units the concepts of comparative advantage and trade based on specialization by nations in the production of the goods for which they have a lower opportunity cost than others. This basic tenet, illustrated so clearly with a simple productions possiblity curve, has proven to be the source of endless political turmoil in America, a country whose market economy is built on the principles of free trade, but whose citizens seem to increasingly oppose it today:

In December, an NBC News/Wall Street Journal poll asked Americans, “Do you think the fact that the American economy has become increasingly global is good because it has opened up new markets for American products and resulted in more jobs, or bad because it has subjected American companies and employees to unfair competition and cheap labor?”

When this question was asked a decade ago, the public was almost evenly split. In the recent poll, however, only 28 percent endorsed globalization, while 58 percent opposed it.

The protectionist tide seems to be rising in America in the face of rising unemployment, falling output, inflation and all-around insecurity among households and firms. So the question arises, where do the leading candidates fall on issues of free trade? Is it a threat to Americans’ well-being or the source of our vast wealth and power? Mankiw examines the candidates’ stances on a few major trade issues in the last few years. 

Here’s what he finds: Overwhelmingly, John McCain has shown support for policies aimed at expanding free trade, while Clinton and Obama have taken stances oposing open markets. From opposing tariffs on Chinese imports to advocating a reduction of subsidies to American farmers to supporting the Central American Free Trade Agreement (FTA) and the US/South Korea FTA, McCain has consistently fallen on the side of the mainstream economists on the issue of globalization, while his Democratic counterparts have taken stances opposing trade liberalization and the opening of new markets to competition between American and foreign producers.

What conclusions can be drawn from Mankiw’s observation? Are Democrats economically illitereate? Do Obama and Clinton need to sit through Econ 101 to learn that trade and specialization benefit society through expansion of output and lower prices? Probably not. Mankiw suggests that the rhetoric coming from the “Hillbama” campaigns is probably just populism aimed at gaining support of voters who fear the threat they perceive trade to pose to their livelihoods.

Maybe the candidates’ records as legislators are not good indicators of what their policies might be as president. Maybe campaign rhetoric… is nothing more than that. But counting on it requires, one might say, the audacity of hope.

Personally, I hope Mankiw is right, and that the Democrats prove to be a bit more ”economistic” in their policies should one of them end up in office. What do you think? Should American voters believe everything candidates say in their campaigns? If Hillary and Barack appear to be anti-trade and protectionist now does that mean America will be put on a path of isolation should one of them win the White House? Should we, as economists, be afraid, or hopeful, in this time of “change” and “hope” in America?

Powered by ScribeFire.

Foreign Policy: Why We Trade

Professor Russ Roberts, host of the EconTalk podcast, has an essay in the latest issues of Foreign Policy journal titled “Why We Trade”. In this piece, Roberts defends the benefits of trade from a broad perspective, beyond the popular political view of trade, usually along the lines of “exports, good - imports, bad”. Roberts compares this line of thinking (characteristic of presidential candidates of both the Republican and Democratic parties), to the 14th century, pre-Adam Smith view of world trade, known as mercantilism.

Mercantilism was a view of global economic interaction that placed emphasis on the accumulation of gold and other precious metals from abroad in exchange for your country’s exports. The doctrine failed to recognize the importance of imports from abroad, as this was viewed as a loss of wealth to foreigners. Mercantilists viewed wealth in terms of bullion or the amount of precious metals a country owned. Today, of course, our understanding of wealth has evolved to account for the amount of output, or products (goods and services), we are able to consume. Herein lies the flaw in the rhetoric of modern politicians who, “are always talking about the necessity of other countries’ opening their markets to American products. They never mention the virtues of opening U.S. markets to foreign products.”

Continue Reading »

Understanding the World Trade Organization

Below is an audio introduction to the World Trade Organization, courtesy of my year 2 IB Econ students here at SAS. Our current unit (IB Unit 4) examines free trade, global economic integration, and the WTO among other topics. As an introduction to the WTO, student were asked to record a two-minute podcast of the main ideas from a specific page on the WTO’s website. Below are their summaries of the basic functions and agreements of the organization, summarized and podcasted for your listening pleasure!

 

 Marco Garafolo: "What is the WTO?": Play Now | Play in Popup | Download

 

 Enno Zhang: "Principles of the Trading System" [2:40m]: Play Now | Play in Popup | Download

 

 Manon Van Thorenburg: "Tariffs": Play Now | Play in Popup | Download

 

 Dennis Melzer: "Textiles": Play Now | Play in Popup | Download

 

 James Hannam: "Standards and Safety" [2:36m]: Play Now | Play in Popup | Download

 

 Kaj Nieman: "Anti-dumping, subsidies, etc.": Play Now | Play in Popup | Download

Introduction to the WTO, continued…

 

 Carlos Siu: "Intellectual Property": Play Now | Play in Popup | Download

 

 Lucas Topham: "Non-tariff Barriers": Play Now | Play in Popup | Download

 

 Wan Jin Park: "Services": Play Now | Play in Popup | Download

 

 Danny Witters: "Agriculture" [1:20m]: Play Now | Play in Popup | Download

 

 Daniel Yeung: "Plurilaterals" and "Trade Policy Reviews" [1:57m]: Play Now | Play in Popup | Download

Seeing Sugar’s Future in Fuel - New York Times

“The sugar producers say whatever its costs, the new farm bill is needed to save their industry.”

We’ve all heard the news about this amazing new fuel that just might save the world from the perils of global warming… ethanol, food fuel, alternative energy, replacement for oil, the panacea to all of America’s energy, climate, and geo-political woes! Corn farmers in America’s grain belt have benefited hugely of late due to large subsidies bundled with America’s latest farm bill.

The new version of this bill, being debated in Congress now, contains a proposal to prop up the country’s 12,000 sugar farmers by promising to buy any surplus sugar resulting from cheap sugar imports from Mexico (themselves the result of market liberalizations accompanying the North Atlantic Free Trade Agreement) at a profitable price. The sugar lobby insists that sugar should play a larger part in the production of ethanol, currently which is made mostly from corn.

To effect that policy, the government would buy excess sugar and sell it at a loss to ethanol producers. They ferment corn starch to ethanol, but adding a little sugar can speed the reaction…

Mr. Keenum suggested that the Agriculture Department would end up buying sugar for 22 cents a pound and selling it to ethanol producers for 4 to 7 cents a pound. “You can easily do the math and look at the loss potential,” he said.

Continue Reading »

Here’s an online special for my IB students. We’ve recently started our unit on International economics, and one of the first topics is free trade, protectionism, barriers to trade, and the arguments in support of and against such protection. Below are the graphs we discussed in our Smartboard lesson during today’s class.

If you click on each image it will take you to a full size version.

What to notice about the impact of a tariff: Domestic producers benefit at the expense of domestic consumers and foreign producers. The green triangles represent efficiency or welfare loss because that is consumer surplus that is forgone after the tariff. The yellow rectangle is not DWL because it is tariff revenue for the government.

Be sure to understand the indirect effects of such policies also. For example, any of the three forms of protection shown here will lead to a decrease in net exports for America’s trading partners, which means a decrease in Aggregate Demand and the possibility of higher unemployment, recession, lower income, thus less demand for American products abroad. So, not only does the tariff hurt American consumers through higher prices and lower quantity, but it could harm other American businesses whose products are no longer in demand from foreigners whose incomes have declined thanks to the American tariffs.

Note also the regressive nature of tariffs. Much like a VAT or an excise tax, tariffs place a greater burden on low income earners than high income earners, as a particular tax on imports represents a larger percentage of a poor person’s income. Continue Reading »