Chapter 10: Political Economy of Trade Policy

Why do economists generally support free trade?

Because it increases efficiency, avoids welfare losses, and enhances national welfare, especially for small countries.

What are the extra benefits of free trade?

Exploiting scale economies, stimulating innovation and learning, reducing rent-seeking, and promoting competition

How does free trade affect rent-seeking?

It reduces rent-seeking behavior by removing incentives to gain profits through quotas or protection.

What is the infant industry argument for tariffs?

Protecting emerging industries until they become competitive.

What is the terms of trade argument?

A large country may improve its terms of trade by imposing tariffs that lower the price of imports.

When might a tariff be beneficial for a large country?

When the terms of trade gains outweigh production and consumption distortions.

What does the optimal tariff depend on?

 It is zero for small countries and positive but below prohibitive levels for large countries.

What is the domestic market failure argument against free trade?

Market prices may not reflect true social costs/benefits due to externalities like unemployment, innovation spillovers, or environmental harm

What economic theory supports intervention in the presence of market failure?

The theory of the second best.

What are the two criticisms of using trade policy to correct domestic distortions?

1) Domestic problems should be solved with domestic policies.

2) Market failures are difficult to identify and measure.

Why don’t governments always follow economists’ advice?

Trade policy is influenced by special interest groups, lobbying, and political constraints rather than national welfare

How did post-WWII trade liberalization happen?

Through international negotiations like GATT and later WTO.

Why are trade agreements more effective than unilateral liberalization?

They create exporter support and reduce risk of trade wars.

What are the main WTO rules?

Prohibition of new tariffs and quotas, elimination of export subsidies (except in agriculture), and enforcement through dispute settlement.

Why did the Doha round fail?

Remaining trade barriers are politically sensitive; potential economic gains were limited.

What is the MFN principle under GATT/WTO?

It requires countries to treat all WTO members equally in trade matters.

When are PTAs allowed?

If they result in free trade between member countries

What are the effects of PTAs?

Trade creation (positive) and trade diversion (negative); they can be stepping stones or stumbling blocks to global free trade