International Economics - Midterm #2

U.S. Tariff Policy - Early Years (1789 - 1800s) 

First tariff law (1789): uniform tariffs from 5-15%. Tariffs made up over 90% of federal revenue 

U.S. Tariff Policy - Shift in 1900s

Income tax (1913) reduced reliance on tariffs as a source of government revenue as tariffs were seen as regressive. The later introduction of corporate income tax and payroll tax, reliance on tariffs was reduced even further.

U.S. Tariff Policy - Protectionism

Infant-Industry argument: young industries should be granted import protection until they could grow and prosper (supported by Northern manufacturers and opposed by Southerners) 

Late 1800s tariff rates

High tariffs as they were swayed by complaints of cheap foreign labor that caused goods to flow into the U.S. 

Smoot-Hawley Act

The Great Depression spurred the government to implement tariffs to reduce America’s imports and protect its firms and workers. This policy pushed costs onto America’s trade partners by decreasing their sales and the price they got for the goods they exported. U.S. average tariffs were 53% on protected imports, prompting retaliation from 25 nations and leading U.S. exports to fall 66%. 

Reciprocal Trade Agreements Act

Tipped the balance of power in favor of lower tariffs and set the stage for a wave of trade liberalization. President was given unprecedented authority to negotiate bilateral tariff reduction agreements with foreign governments. Most favored nation clause stated that countries can’t discriminate between trading partners participating in a trade agreement. 

Bilateral Trade Agreement

Two countries which agree to reduce trade restrictions to increase business opportunities between them. 

Multilateral Trade Agreement

Includes 3+ countries and is the most complex and dificult to negotiate

Pros and Cons of Free Trade Agreements

Pros: keep trade wars in check, help consumers by lowering prices of imports, domestic producers find new markets for their products

Cons: domestic producers may not be able to compete and go out of business

Trade Agreements Negotiated by the President and Not Authorized by Congress

Mini-Trade Agreements: short, targeted agreement with a foreign government that focuses on liberalization of nontariff trade barriers applied to particular goods and services

Trade Executive Agreements: international agreement between the U.S. negotiated by the President without Senate approval 

General Agreement on Tariffs and Trade

Post WW2 aimed to liberalize trade multilaterally by decreasing trade barriers and placing al nations on equal footing.

Most Favored Nation Principle

Lower tariffs apply to all GATT members

National Treatment Principle

Treat imported and domestically produced goods equally once goods enter the market.

GATT dispute resolution

Formalized complaint procedures and created a panel. Didn’t have the authority to enforce panel recommendations and obligated members to use tariffs instead of quotas to protect domestic industries.

GATT Transparency Tactics

Ceilings on imported tariff rates, changes on tariff rates required compensation, public trade rules

Kennedy Round

Cut tariffs on manufactured goods

Tokyo Round

Tariff reductions and agreement to remove or lessen many nontariff barriers

Uruguay Round

Tariff cuts for industrial countries

WTO

International organization where members bind their commitments and adhere to GATT rules and trade pacts negotiated under GATT. Strengthened GATT mechanism for settling trade disputes. However, small countries are disadvantaged by retaliation

WTO Pros and Cons

Pros: U.S. retains control over laws and benefits from rules, growth drives demand for cleaner environments 

Cons: Critics argue that sovereignty is undermined, trade liberalization may lower environmental standards, BRICs vs rich nations, rise of regional deals, Doha failure

Trade Promotion Authority (Fast-Track Authority)

Congress has 60 days to permit or deny fast-track authority. If approved, president has limited time to complete trade negotiations which Congress has to up/down the agreement. 

Safeguards (the Escape Clause)

Temporary relief from import surges by allowing the President to modify trade concessions granted to foreign nations (tariff increases, tariff rate quotas, etc.)

Countervailing Duties

Offset foreign subsidies harming U.S. producers

Pros and Cons of Dumping and Subsidized Imports

Pros: Benefits consumers if imports are finished goods and consuming industries if imports are intermediate inputs 

Cons: Costs on import-competing industry and its workers

Section 301 of Trade Act

empowers U.S. Trade Representatives to respond to unfair trading practices by foreign nations through tariffs/import restrictions on products and services 

Trade Adjustment Assistance

Mitigate negative effects of increased imports on domestic industries. Winners from trade can compensate losers while retaining benefits.

Industrial Policies of the U.S.

Government intervention to structure economy in national interest through subsidies, R&D, and tariffs. Government must intervene because free market may fail to invest in vital sectors. However, government is less effective at identifying promising firms and industries. 

Export-Import Bank

Export subsidies to American manufactures to encourage international sales and providing jobs for Americans

Strategic Trade Policy

Government can alter terms of competition to favor domestic companies, assist firms in capturing economic profits from foreign competitors. However, this can lead to retaliation and government may lack information to intervene well. 

Comprehensive Sanctions

Broad-based trade restrictions that limit commercial activity with an entire country

Targeted Sanctions

Restrict transactions with specific persons or entities of a target country

Trade Sanctions 

Reduce target’s output with boycotts and quotas

Financial Sanctions

Asset freezes and loan bans, thus damaging target economy by reducing supply of loanable funds or capital and results in an increase in interest rates leading to adverse effects on the real economy 

Tensions Between Developing Nations and Advanced Nations

Economic Ladder: developing nations at the bottom must displace advanced producers in order to climb

Protectionism: Shields low-income workers in advanced nations, complicating global equity

Unstable Export Markets

Instability of primary-product prices and producer revenues is the low price elasticity of the demand and supply schedules for such products. Essentially, changes in supply or demand will lead to wide variations in price. 

Worsening Terms of Trade

Export prices fall relative to imports, favoring advanced nations. Additionally, there is monopoly power of manufacturers in advanced nations leading to higher prices and gains in productivity lead to higher earnings for manufacturers rather than price reductions. Export prices are determined by very competitive markets. 

Limited Market Access

Global protectionism have been hindering developing nations’ market access in agriculture and labor-intensive manufactured goods. Tariff escalation also decreases demands for processed imports from developing nations, restricting diversification. Advanced nations argue that developing nations also need to lower their own tariffs. 

Agricultural Export Subsidies of Advanced Nations

Subsidies discourage agricultural imports, displacing developing country shipments to advanced country markets. Unwanted surpluses of agricultural commodities from government support are dumped into world markets, decreasing prices. 

International Commodity Agreements

Between leading producing and consuming nations of commodities. Evolved into study group agreements to collect and release market information and conduct R&D

Production and Export Controls

Quotas set to maintain target prices. This influences world supply which then impacts prices. However, there are allocation disputes, threat of new entrants, and it incentivizes cheating.

Buffer Stocks 

During periods of rising demand, the buffer stock manager must sell to prevent price from rising above the ceiling level. During periods of abundant supply, the manager purchases tin to prevent the price from falling below the floor. This promotes economic efficiency because primary producers can plan if they know prices won’t move drastically and it moderates price inflation. However, there is difficulty when determining target price, high cost of holding stocks, and high potential for making poor decisions

Multilateral Contracts

Stabilize commodity prices by having a minimum price at which importers will purchase guaranteed quantities from the producing nations and a maximum price at which producing nations will sell guaranteed amounts to importers. This will hold prices within a target range. With this method, there is less distortion of market mechanism and allocation of resources. However, there is limited stability due to easy exit/entry. 

Cartels

Create higher prices by restricting output to where marginal revenue equals marginal cost. Cartel output is divided among its members by setting up production quotas for each supplier

Obstacles to cartel profit maximization

Many sellers, cost/demand differences, potential competition, economic downturn, substitute goods

Countermeasures to OPEC

Raising fuel economy standards, increase federal excise tax on gasoline, boosting domestic supply, diversifying imports, explore energy alternatives 

World Bank

International organization that provides loans to developing nations (governments and private firms) to reduce poverty. Has problem with fraud and corruption and other nations are starting to fund infrastructure in developing nations to get access raw materials and export markets.

IMF

IMF channels funds from countries that have surpluses to those that have deficits. Funds come from quotas (pooled funds from member nations) and loans. Risks include moral-hazard and the recession risk from contractionary policies that come as a stipulation with the loan. 

Generalized System of Preferences

Major advanced nations temporarily reduce tariffs on designated manufactured imports from developing nations below levels applied to imports from other advanced nations

Pros and Cons of Aid for Developing Nations

Pros: boosts growth 

Cons: fosters corruption, favors the wealthy in poor nations, squandered 

Import Substitution

Extensive use of trade barriers to protect domestic industries from import competition.

Pros: low risk, easier to implement, local jobs

Cons: no incentive to increase efficiency, no economies of scale, small markets, corruption

Export-Led Growth

Promote comparative advantage exports

Pros: economies of scale, increased efficiency, developing nations have an advantage in labor-intensive manufactured goods 

Flying Geese Pattern of Growth

Nations gradually move up in technological development by following the pattern of nations ahead of them in the development process 

India: Breaking Out of the Low-Income Classification

Deregulation, eliminating preferences for small-scale/inefficient producers, reform agriculture to generate jobs in rural areas

Regional Trading Arrangements

Nations reduce trade barriers for only a small group of partner nations, discriminating against the rest of the world. Once regional benefits are received, there is little incentive to sign multilateral WTO agreement that would negate these benefits. This can also lead to more economic interdependence and it is a self-reinforcing process. It also encourages workers to move from import competing industries to export competing industries. 

Free Trade Area

Members agree to remove all tariff and nontariff barriers 

Customs Union

Agreement among two or more trading partners to remove all tariff and nontariff trade barriers and each member nation has identical trade restrictions against nonparticipants. 

Common Market

Free movement of goods and services among member nations, initiation of common external trade restrictions against nonmembers and free movement of factors of productions across national borders

Economic Union

National, social, taxation, and fiscal policies harmonized and administered by supranational institution 

Monetary union

Unification of national monetary policies and use of common currency administered by supranational monetary authority

Reasons for Regionalism

Economies of large-scale production, increased specialization, increased foreign investment, managing immigration flows, promote regional security

Static Effects of Economic Integration

Domestic production of one member in the union is replaced by another member’s lower-cost imports. Imports from low-cost supplier outside of the union is replaced by higher-cost supplier within the union.

Dynamic Effects of Economic Integration

Creation of broader markets, economies of scale, greater competition, increased investment, greater productivity 

Treaty of Rome

European Community became European Union

Convergence Criteria

Price stability, low long-tern interest rates, stable exchange rates, sound public finances

Common Agricultural Policy

Abolished restrictions in agricultural products traded internally

Variable Levies: applies tariffs to agricultural imports entering the EU, difference between lowest prices on world market and support price and more restrictive than fixed tariffs. Effectively discouraging foreign producers from absorbing part of the tariff or cutting prices

Export Subsidies: exports of surplus quantities have been assured, encouraging more production

Brexit

Pro: U.K contributes more to EU than it gets in return

Cons: Weaker economy and security for Europe in general and U.K. could lose foreign investment

Optimal Currency Area

EMU led to single currency which lowered the costs of goods and services, facilitated price comparison, and promoted uniform prices. The European Central Bank controls the euro supply, sets short term interest rates, and has fixed exchange rates for member countries.

Pros: Unfirm prices, lower transaction costs, more certainty for investors, price stability

Cons: loss of independent monetary policy, no flexible exchange rate

Eurozone as a Suboptimal Currency Area

Problems: Some countries didn’t meet economic entry criteria, integration of differing economies without adjustment, difficulties in reducing budget deficits 

Challenges: ability of EU Central bank to focus on price stability over long term, operation of monetary policy, difficulty in reducing budget deficits and debts, need for structural reform

USMCA Pros and Cons for Mexico and Canada

Pros: better access to others’ markets, Mexico would benefit from U.S. investment and expertise

Cons: Integration with U.S. would threaten Canada’s social welfare model 

Mexico as Nearshoring

Proximity to U.S., free trade area, low cost and available labor, political stability

Foreign Direct Investment

Acquisition of a controlling interest in an overseas company or facility through buying stake, building plants, expanding subsidiaries, and reinvesting in profits

Motives for Foreign Direct Investment

New markets, cheaper production, fewer trade barriers, fewer transportation costs

MNE Demand Factors 

Seek new demand when exports falter for better distribution 

MNE Cost Factors

Seek to increase profit levels through reductions in production costs. Pursuit of essential raw materials: extractive industries, agricultural commodities, cheaper labor, reduction in production cost, government subsidies

Direct Exporting Versus Foreign Direct Investment/Licensing

If there is a small demand, exporting wins. However, if there is a large demand, foreign direct investment/licensing evens out due to economies of scale. Transport/tariffs can impact this. 

Foreign Direct Investment Versus Licensing

In a small market, license. In a large market foreign direct investment. Risks include currency fluctuations and subsidiary expropriations 

Country Risk Analysis

Political: stability, corruption, domestic conflict

Financial: debt as a percentage of GDP, loan default, exchange rate stability

Economic: rate of growth of GDP, per capita GDP, inflation

Foreign Plans in the U.S.

Pros: avoid import barriers, gain access to new markets, hedge against changes to exchange rates, jobs, technology transfer 

Cons: union fears job loss, imported parts limit gains 

International Joint Ventures

2+ firms combine skills/assets

Pros: functions are too costly for one company to absorb, governments place restrictions on foreign ownership of local businesses, forestalling protectionism against imports, competition, new markets, cost cuts 

Cons: coordination of activities limits competition, reinforces upward pressure on prices, and lowers level of domestic welfare 

Employment and MNEs

For the host country, if purchasing already existing businesses, no effect, but if establishing new businesses, employment increases 

For the source country, there are concerns with runaway jobs and cheap foreign labor. MNEs also can escape collective-bargaining and influence of domestic unions, employment declines in the short term

National Soveriegnty

Can impact economic and other policies of host and source governments. Can shift profit overseas and evade taxes of host country

Transfer Pricing

MNEs set internal prices to shift profits and influence tax burden. For instance, overpaying for an internally produced component to decrease profits made by final product and cut final tax. 

Immigration as an Issue 

Domestic labor groups prefer restrictions on immigration. Domestic manufacturers favor unrestricted immigration as a source of cheap labor. In the long term, immigrants make a net positive contribution to public coffers.