Chapter 1-7: Notes on Tariffs and Free Trade

Tariffs and Trade Deficits

• Trump's new tariffs:
  • 10% baseline on everyone, including remote islands.
  • Additional "reciprocal tariffs" based on trade deficits (imports vs. exports).
  • This isn't truly reciprocal; based on trade deficit, not matching other countries' rates.
• Impact of Tariffs (Recap from last week):
  • Burden on the American consumer (a tax).
  • Negative impact on trading partners (magnified for large countries).
  • Potential benefit for domestic producers (dependent on international price decreases).
  • Government tariff revenue depends on trade changes; net benefit for US is unlikely.
• Optimal Tariff Rate
  • The current tariffs aren't based on economic models to maximize US benefit, unlike the ideal optimal tariff rate.
  • Retaliation from other countries is expected.

Reasons for Trade Intervention

• Potential Reasons for countries to Intervene in Trade:
  • The speaker does not believe Trump is unintelligent.
  • No economic reason was identified for initial tariffs on Canada and Mexico.
  • Republicans are defending the tariffs, claiming a new dawn for America.
  • Politically, there seems to be no negative impact on them yet.
  • The 10% tariff, plus 25% tariffs on aluminum and steel (inputs), is not ideal.
• Preferable Solution
  • Not intervening in trade is the preferable solution, assuming markets work well (no slavery, environmental impact, etc.).
  • Most trade is between countries in the global north, where these conditions are generally met.
• Economic Arguments:
  • Protecting employment by supporting import-competing sectors.
  • Infant industry protection arguments for jump-starting economic growth.
• Non-Economic Arguments:
  • Preserving cultural identity (e.g., minimum percentage of Flemish music on Belgian radio).
  • National security (limitations on trade of medical goods, weapons, rare earths, nuclear materials).

Case for Free Trade

• Dynamic Long-Term Effects:
  • Economies of scale: access to bigger markets increases production size, pushing down prices.
  • Specialization, learning effects, and innovation further improve production processes.
  • GDP growth: small changes to innovation and learning growth have big impacts, compounded over time.
  • Melitz's model: benefits of international trade are concentrated for the most efficient firms, amplifying effects.
• Political Economy: Rent Seeking Behavior
  • Rent-seeking behavior (bribery, political lobbying) is incentivized when trade intervention is possible.
  • Free trade eliminates the incentive for industries to lobby for protection.
  • Arduous tariffs on aluminum and steel were a political quid pro quo in Pennsylvania.

Arguments Against Free Trade

• Tariffs for Revenue
  • Developing countries may use tariffs as an easy way to implement taxes due to weak state apparatuses.
  • Historically, tariffs were the biggest source of income for the US government until the 20th century.
• Counterargument
  • Consumer cost is very high relative to government revenue.
  • Taxes on income can collect the same amount of revenue from consumers while drastically reducing the cost of that revenue.
  • Tax revenue: red square
  • Consumer Cost: gigantic area above consumer demand curve
• Large Country Case:
  • A Large country can implement tariffs to improve it's economic standing.
  • Optimal tariff rate.
• Retaliation
  • Net welfare impact occurs when you implement a tariff against trading partners.
  • Those partners will institute tariffs on you as a response.
  • Beggar-thy-neighbor policy.

Retaliation

• How to Retaliate:
  • The point of retaliating is to get the other party to remove tariffs.
  • Canada proposed tariffs targeted at specific goods like alcohol from Republican districts, hurting those with larger political sway.
  • Goal is minimal consumer harm + maximum political impact.
• Examples of Retaliation
  • South Korea is considering an all-out response.
  • China may increase tariffs, potentially matching the US rate.
  • Actions China could do, the first 2 directly impacting their market, while the last strategy can be considered more strategic:
    • Devalue its currency: lowers export costs by printing extra money and purchasing foreign currency.
      • Increase in the supply of currency ->, lowers it's value.
    • Exporting rare earths: Limit rare earth exports, needed for batteries.

Devaluing currency

• Devaluing Currency
  • Demand for Currency (normal downward sloping curve)
  • The supply of the currency is fixed.
  • In order to decrease the value of the currency, print more money.
• Downsides of Devaluing Currency
  • Impoverishes Citizens:
    • Savings are no longer worth as much.
    • Reduces the amount of dollars you can get (imports become more expensive).
• Interconnectedness
  • US is trading partner, can not be replaced easily due to supply chains.

European Bazooka

• More a framework for EU to take retaliatory measures, not just tariffs.
• Can impact foreign direct investment.
• EU members must sign off on measures.

Protect Employment

• Tariffs protect employment and increase sector production.
• From 19th century.
• Global North has more Education, infrastructure for efficient production.

Theories in practice: Cost per job saved in EU, from book of internt'l economics.

• Monetary policy (expansionary), Interest rates.
• Fiscal stimulation, Lower taxes.
• Distributional impacts of trade help people find new jobs, and get assistance.

Market Failures

• Market failures can be a valid argument for interventions in trade.

  • Labor markets aren't working well.
  • Implementing tariffs still have costs.
  • Small benefit, high cost.

• Subsidies

  • Implementing trade creates incentive to alter things, and will cause larger problem.

  • Tariffs always a costly way of intervening in trade.

  • Government policies create incentive structure where politically powerful groups can exploit policies.

Infant Industry Protection

• Government can support their industries in a number of ways.
• Could borrow money to get to the point where they are profitable.
• Government can also give support to industries, allowing them to Mature.
• For developing nations.
• Used to give support to specific sectors, and grow the country.

Arguments against Infant Industry Protection

• Cannot grow infant quickly enough.

• Sector becomes to dependent on protection.

• Politically the industry could use surplus money to lobby government to never take away protection.

• Needs to have form of market failure.

• Strong property rights make it impossible to keep that industry from intervention.

• This is a beneficial intervention because it helps industries, it provides protection.

The main argument to it is:

• It is hard to identity which industry would be the right one to develop.
  • Require a lot of information.

China

What the Korean government did was start high involve subsidies: carrots.

Then industrial policy in order to promote sectors

• From an Agricultural society.

Korea (carrots = industries)

• Textiles and wigs.
• Shipbuilding, heavy metal Industry Industry Industry.
  • Government pushed electric sector.
• Strategy export exportation building, and they go for rest of the market that has large scale.

A better explanation is, import Substitution route.

Trump is trying to make to, makes it easier for American firms to grow. Make American firms sell domestic markets.

Might be potential for spill overs if we stop foreign good.

• Brazil tried, computer manufacturing Industry from Brazil, where the reason why we're not working on the British, the import sector has not been the one.
  Other countries, Argentina's has not been, the main reason is.

• Because career intervened, you stop government intervention a natural experiment. That has been going on after the long term of assassination.

  National security is pretty for the Sector, So what should you do during war? Weapon food

Cultural Protection

• French have massive subsidies to small villages