Archive for the 'Protection' Category

Feb 21 2013

Obama’s proposed trade deal – Good for America, Good for Europe – so who are the losers?

In his state of the Union address last week, US president Obama shared his plan for a “transatlantic trade and investment partnership”. The proposed agreement would eliminate tariffs and take other steps to promote free trade of goods and services traded between the United States and the 27 European Union nations.

While tariffs on most goods are already very low (rarely higher than 3% according to the Economist)there still exist several non-tariff barriers to trade between world’s two largest economies.  These barriers to trade include policies such as:

  • The “buy American” provision that many US congressmen support for government spending
  • Subsidies to farmers in both the US and the EU
  • Subsidies to the world’s two largest airplane manufacturers, Boeing and Airbuss
  • Protection of “geographically unique brands” such as Champagne and Roquefort cheese (which reduces competition in the US market for these European products)
  • Different standards and regulations in the two economies over health and safety requirements for foreign produced products such as pharmaceuticals and food, vehicles, information flows, and so on.

Truly free trade between nations requires not only the removal of protective tariffs, but also the dismantling of subsidies for domestic producers as well as non-tariff barriers to trade such as strict rules and regulations of imported products.

If the US and Europe succeed in forming a new free trade agreement, the benefits could be substantial for both economies:

Trade in goods and services between the two economic giants amounts to nearly $1 trillion each year, and total bilateral investment between them to nearly $4 trillion. Getting rid of remaining tariffs could raise Europe’s GDP by around 0.4% and America’s by a percentage point. Ditching even half of today’s non-tariff barriers could boost GDP in both places by 3%.

A single TTIP test for new drugs would be a massive boon for pharmaceutical firms. Agreed standards for electric cars would create a vast market, as well as huge demand for accompanying infrastructure. Think how Amazon and Google could gain from looser rules on cross-border flows of information in Europe. And think how Europe’s austerity-blighted economies could gain from more demand from abroad.

The gains from trade are many. However, the arguments against free trade often prevent these benefits for many from being enjoyed to protect the interests of a few. One question to consider when looking at the likely outcome of any new free trade agreement is whether it will lead to trade creation or trade diversion. One nation that may have reason to be concerned about a new trade agreement between the US and the EU is Switzerland, which is not part of the EU. If a new agreement creates new trade and increases the flow of goods and services between the US and the EU, it may be the case that this comes at the cost of of reduced trade between the US, the EU and Switzerland.

The Swiss, not being part of either major economy, would maintain its own rules, regulations tariffs and subsidies that affect trade with the other two economies. It may, therefore, be the victim of increased trade between the other two economies, while trade is diverted away from the Swiss economy as Americans buy more EU-produced goods and Europe buys more American produced goods. If this results, it may put pressure on the Swiss to reduce or remove many of their own trade barriers so as to prevent losing demand from the US and EU.

Discussion Questions:

  1. How do non-tariff barriers to trade such as subsidies and health and safety regulations reduce the flow of goods between nations?
  2. The article mentions that “Europe’s austerity-blighted economies could gain from more demand from abroad.” Interpret this statement. Do you think free trade could provide relief to the debt-ridden countries in the Eurozone?
  3. Why should Switzerland be worried about a new free trade agreement between the US and the Eurozone.

 

No responses yet

Sep 29 2011

Protectionism’s many weaknesses

After our lesson on tariffs and protectionism the other day, one of my year 2 IB Econ students emailed me with a few questions she had not had the chance to ask in class. I thought I’d post my responses here, since they were such good questions!

Question: Hi Mr Welker, I asked this on Monday’s blog about self-sufficiency, but no one answered my question and I have been meaning to ask this in class but I always get distracted and I forget. And perhaps you have already answered this, pardon me if you have.

Since Exports and Investment have a great effect on economic growth, why would a government want to protect its nation by imposing barriers to trade? Because by doing so, foreign firms cannot invest in that nation and potentially create job opportunities and also contribute to that nations GDP since, even though it’s a foreign investment, the revenue is collected by that government.

Answer: Protectionism is not typically aimed at reducing the amount of exports from the nation engaging in it, rather reducing the amount of imports or promoting increased exports. You’re exactly right that exports and investment contribute to aggregate demand (and therefore economic growth and employment) in a nation. But imports are a ‘leakage’ from the nation’s economy, and the greater the level of import spending, the lower a nation’s net exports. A nation with a trade deficit actually experiences negative net exports. The purpose of protectionism is to reduce import spending, or increase export revenues, and thereby increase net exports and aggregate demand and employment in the nation.

As for foreign investment, one of the consequences of a large trade deficit is increased foreign ownership of domestic resources or factors of production. Since a country that imports more than it exports spends more on foreign goods than it earns from the sale of its own goods to foreigners, foreign governments and firms end up with large amounts of that country’s money that is NOT being spent on that country’s goods. Much of this ends up back in the deficit country as foreign investment. Sometimes foreigners will buy government bonds (invest in the deficit country’s debt, in other words), but sometimes the money comes back home as foreigners buying up factories and real estate. Foreign investment may indeed help create jobs at home, but so does domestic investment, and when foreigners invest it means the country’s resources are now owned by interests abroad, which many countries view as a threat to their national and economic security. This can also serve as a justification for protectionism: to prevent foreign ownership of domestic assets.

Question: Also if the country is not exporting, it’s not enjoying the benefits of revenue from exported goods that could boost their economic growth. And anyway, isn’t the point of making money to spend it? Otherwise what is the incentive of being employed and earning an income? Unless of course, one can argue that income earned can then be spent on domestically produced goods.

Again, the purpose of protectionism is not to reduce a country’s exports, rather to reduce its imports and to increase its exports. But you have made a very important observation here that points to a major flaw in the argument for protectionism. The purpose of exporting goods it to make money to spend on imported goods, otherwise, WHY TRADE? A country gains from trade not only because it has a wider market for its own goods, but because the people of the nation have a wider market from which to choose the goods they themselves can consume. When a nation erects barriers to trade, it will ultimately have the effect of reducing not only imports, but possibly the nation’s own exports. Since foreigners earn less money from selling goods to the protected nation, they have less money to spend on that nation’s goods!

All protectionism can hope to do is increase the welfare of particular industries while reducing the welfare of the rest of society. It is rarely justifiable on the grounds that it will increase the total welfare of society as a whole, unless of course the protected industry is one vital to national security, such as the defense sectors or the energy sector (even this one is debatable!)

Question: Or do government spending (through subsidies, and creating job opportunities) and increased consumption due to income gains caused by government intervention overcome these factors and compensate for the lost opportunity of exports and investments.

Increasing government spending to off-set the fall in social welfare resulting from protectionism will only lead to greater inefficiency in society. Government may have to spend more on unemployment benefits for workers whose jobs are lost due to protectionism, which may require higher taxes on those workers whose jobs are being protected. As explained above, one industry’s gain leads to a loss of welfare for society as a whole. This is the problem with protectionism. It favors certain industries but imposes higher prices on consumers and higher costs of production on other industries. It should not be the government’s job to “pick winners and losers” in the global economy. By protecting certain industries, however, government attempts to do just that, but society as a whole loses.

I hope you understand what I am asking for here. Whenever you have time, I would love to hear your perspective.

Maphrida

Great questions, Maphrida!

Discussion Questions:

  1. How might protectionism lead to an increase in aggregate demand and domestic employment?
  2. Why does a large trade deficit lead to a build-up of foreign ownership of domestic factors of production?
  3. Discuss the view that protectionism in the form of tariffs on particular goods helps certain industries but harms the rest of society. Can you imagine an example of a protectionist policy that could increase the welfare of society as a whole?
  4. Explain how a protectionist policy that makes imports more expensive and thus reduces demand for imported goods can ultimately lead to a reduction in demand for the protected country’s exports abroad.

5 responses so far

Oct 07 2010

US / China Trade War – Could this be the beginning?

This post was originally published on September 15, 2009. It is being reposted today for my year 2 IB Econ students, who are studying free trade and protectionism as part of Unit 4 of the IB Econ course.

US president Barack Obama made a speech directly to Wall Street today. In his speech, Obama reflected on the many lessons America has learned in the last year since the financial crisis began. He urged his audience of investors, bankers and brokers that

“Normalcy cannot lead to complacency,” Obama said. “Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we are still recovering, they are choosing to ignore them.”

“They do so not just at their own peril, but at our nation’s,” the president added.

In addition to his warnings about the threat posed by overly risky financial markets to the US economy, President Obama expressed his commitment to free trade and “the fight against protectionism”.

Obama says:

…enforcing trade agreements is part and parcel of maintaining an open and free trading system.

The enforcement of existing trade agreements Obama refers to is his way of justifying a decision his administration made over the weekend that actually limits free trade between America and one of its largest trading partners, China.

Trade relations between two of the world’s biggest economies deteriorated after Barack Obama, US president, signed an order late on Friday to impose a new duty of 35 per cent on Chinese tyre imports on top of an existing 4 per cent tariff.

In his first big test on world trade since taking office in January, Mr Obama sided with America’s trade unions, which have complained that a “surge” in imports of Chinese-made tyres had caused 7,000 job losses among US factory workers.

So, in his speech today, Obama decries protectionism and calls for expanded trade and free trade agreements which are “absolutely essential to our economic future”. But only three days ago, he supported a blatantly protectionist measure aimed at keeping foreign produced goods out of America in order to save a few thousand American jobs.

Obama’s decision is a bad one for several reasons. As an economics teacher, I will turn firstly to a diagram for an illustration of the net loss to the American people of higher tariffs on imported tires:
Tire protection

The key point to notice in the above graph is that a tariff on imported tires results in a net loss of welfare in America. The blue area represents the increase in the welfare of tire manufactures (this could be interpreted as the jobs saved in the tire industry and the profits earned due to higher prices); the black areas, on the other hand, are welfare loss. Since all tire consumers in America pay more for their tires due to the 35% tariff, real income is affected negatively for the nation as a whole.

One effect of the protectionist policy the graph does not illustrate, and perhaps the most serious negative impact of the tariff on America, is the response the Chinese are likely to take to what they interpret as a violation of existing free trade agreements between the US and China.

“This is a grave act of trade protectionism,” Mr Chen said in a statement. “Not only does it violate WTO rules, it contravenes commitments the US government made at the [April] G20 financial summit.”

Beijing said it had requested WTO-sanctioned consultations with the US over Washington’s new duties on tyres. Yao Jian, a commerce ministry spokesman, said the duties were in ”violation of WTO rules”.

China said it would now investigate imports of US poultry and vehicles, responding to complaints from domestic companies.

The problems with protectionism are myriad. Clearly American consumers suffer through higher tire prices. In addition, Chinese manufacturers will see sales fall as their product becomes less competitive in the US market. According to the CCTV report below, as many as 9,000 workers in the Chinese tire industry will lose their livelihoods due to declining demand from the US. But the unforseen effects of the US tariff on Chinese tires is the retaliatory measures China will almost certainly take. If China imposes new tariffs on American automobiles and poultry, the scenario in the graph above will be reversed, and Chinese consumers will face higher prices, Chinese car and poultry producers will experience rising sales, while the American auto worker and chicken farmer will suffer.

Free trade tends to result in net benefits for economies that choose to participate in it. American tire manufacturers are certainly harmed by cheap Chinese imports; however, America as a whole benefits through cheaper goods, more consumer surplus, higher incomes in China and therefore greater demand for imports of products made in America. The road to protectionism is a dangerous path to take for the Obama administration. Justifying these new tariffs by claiming that they “enforce existing free trade agreements” is a political maneuver aimed at covering up the truth, which is that the Obama administration has sided with a special interest group to save a few thousand jobs and garner political favor at a time when 700,000 American jobs are being lost each month. By doing so, he is calling into question his own commitment to free trade, and harming America’s image as a global proponent of global economic integration.

Discussion Questions:

  1. Why is the Chinese government so upset about a new tax on such an insignificant product as automobile tires?
  2. “Self-sufficiency is the road to poverty”: Do you agree?
  3. Some would say that it is a small price to pay for Americans to face higher prices for one product like tires in order to “save” 7,000 Americans’ jobs. Would you agree? Why or why not?
  4. If 7,000 Americans were to lose their jobs due to free trade with China, what would we call the type of unemployment experienced by these workers? Is this the same type of unemployment experienced by the 700,000 workers who have lost their jobs each month during the last year of recession in the United States?

33 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?

9 responses so far

May 12 2009

Deteriorating terms of trade and the current account balance

U.S. Trade Gap Widens on Oil Imports – WSJ.com

Terms of trade is a term that is often misunderstood by IB Economics students. Simply put, a nation’s terms of trade refers to the relative price of a country’s exports to its imports.

When a country’s imports increase in price, while the value of its exports stays the same, the country’s terms of trade are said to deteriorate. As a nation experiences deteriorating terms of trade, it finds itself moving towards a deficit in its current account, meaning that expenditures on imports are growing more than income from exports, also called a trade deficit.

The United States has run trade deficits for most years since 1970. Since 2004 the US has annually spent over $600 billion MORE on imports than it earned from the sale of its exports. (Balance of trade data going back to 1960 can be found here).

Usually, when a country enters a recession, it would be expected that its balance of trade would improve, since households demand fewer imports and domestic inflation decreases making the country’s products more attractive to foreign households. In fact, in 2008, when the US entered its current recession, its trade deficit actually decreased. Recently, however, due to the weakness of many of its trading partners and a deterioration in terms of trade, America’s recession is accompanied by a deepening trade deficit:

The U.S. trade deficit widened for the first time in eight months during March, as the price and use of imported oil both climbed.

The U.S. deficit in international trade of goods and services increased to $27.58 billion from February’s revised $26.13 billion, the Commerce Department said Tuesday. Originally, the February deficit was estimated at $25.97 billion.

U.S. exports in March slipped by 2.4% to $123.62 billion from $126.63 billion as trading partners bought less consumer goods and cars from the U.S. U.S. imports fell at a lower rate, dropping 1.0% to $151.20 billion from February’s $152.76 billion

Discussion Questions:

  1. How did rising oil prices lead to an increase in America’s trade deficit?
  2. What determines demand for American exports in the rest of the world? Why is demand for American goods and services falling even as their prices decline due to deflation in the US?
  3. Where does America get the money to buy hundreds of dollars more in imports than it sells in exports? What do foreigners do with all the US dollars they earn from their enormous trade surplus with the US?
  4. Why doesn’t the US government simply place tariffs or quotas on imports to try and achieve more balanced trade with the rest of the world? Is this an appropriate response to a trade deficit?

5 responses so far

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