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Arguments for Trade Protection Lecture 8
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Externalities |
1. Distortions - causes a gap between private and social benefits (or costs)
Causes
Government policies such as taxes, subsidies, price controls, quotas, etc.
Market failure
2. Externalities – failure to include all costs and/or benefits
Negative externality - an individual's or firm's action harms others without their consent
Property rights are not defined well
Not all costs are registered, therefore supply function understates the true cost of production
Example: A polluting firm
A firm supplies Q* which sell for P* and freely pollutes
Pollution is a social cost to society, Social Marginal Costs (SMC)
Government can force the firm to include pollution costs, causing the supply function to shift left
Gov. imposes taxes, regulations, pollution permits, etc.
Taxes are efficient in this case
Equilibrium price increases while quantity supplied decreases
This is efficient because firm pays all costs including pollution
Firms still pollute, but less
Note – Countries impose a tariff against countries that have lax environmental laws
Example - leakages - U.S. relocate manufacturing to China, because China has little environmental regulations
A Polluting Firm Pollutes the Environment |
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Positive externality (or spillover effects) - an individual's actions generate benefits for nonparticipating parties
Demand functions understates the true value of output
Called Social Marginal Benefits (SMB)
From the viewpoint of efficiency, too few units may be produced
Example: Inoculations - people getting inoculated help prevent the spread of diseases
People who are not inoculated also benefit
Government can subsidize inoculations, bringing the market price down
Gov. imposes trade barriers that generate Social Marginal Benefits (SMB)
Note – author says a production subsidy is more effective than a tariff
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Infant Industry Argument |
American Alexander Hamilton (1755-1804)
U.S. came into existence in 1791
Hamilton stated we need to protect U.S. industries
U.S. industries were young and needed to thrive and grow
Imposed tariffs on imports
Gives U.S. gov. revenue
German Friedrich List (1789-1846) – exiled from Germany for his views
State action was needed to promote education, technology, and industry
Promotes heavy industry
Industries require more mental abilities than in agricultural
Import substitution - a country helps develop a domestic industry that substitutes for imported products
Mercantilistic policy – restrict imports and keep exports the same
Worked for the U.S.
Failure for Brazil, Mexico, Turkey, and other Latin American countries
Benefits
Low risk to establish business, because market is already there
Could encourage foreigners to invest in country to avoid trade barriers
Problems
Government has problems picking winners and losers
Fosters monopolies; restricts competition
A smaller market means firms cannot gain economies of scale in production
Difficult to remove protection; protected industry will resist
Gov. may own or control industry; could foster corruption
No focus on exports
Exports are a source foreign revenue
Many governments borrowed to finance current spending
Many governments could not control their spending
Mexico and Latin American countries had a crisis in late 1980s and early 1990s
Economics
Similar to the economics of a tariff
Over time, a country’s supply function would increase and shift right, if the theory is valid
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Dying Industry Argument |
Free trade causes one or more industries to go in decline
The country does not have a comparative advantage in these industries
Regional effects – industries tend to be located in specific regions
Regions go into economic decline
Labor, capital, and land have trouble moving to new industries
People complain loudly to politicians in their region
Politicians help pass tariffs to protect region and garner votes
Product Life Cycle - country produces a high-tech good and then loses its comparative advantage
Country starts producing a high-tech product
Country exports this product
A foreign country begins producing product
Country loses its comparative advantage
Foreign country begins exporting product
The United States lost its electronics, radios, computers, cars, TV sets, etc.
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Government Revenue |
Government Revenue
Government needs the revenue from tariffs and export taxes
Country may be low income with high tax evasion
Government (i.e. customs) can easily monitor border crossings and ports, and collects tax revenue
Note – export taxes hinder exports, because taxes cause a higher price
Government needs the money
National Defense and National Security
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Politics |
1. Tariff escalation – tariffs become greater with products that have more manufacturing
Example
Raw materials tend to have no or little tariffs
Intermediate goods tend to have higher tariffs
Finished products like clothes, cars, etc. have the highest tariff
Government is protecting a manufacturing industry
Company can circumvent a tariff by producing product within country using imported parts; reduces impact of a tariff
Strengthens the North-South Dilemma
Countries
2. Politics - trade protection are tied to politics
Large companies may produce the finished products
Russia and other corrupt countries
Manufacturing adds significant value to products
The squeaky wheel gets the grease
People harmed by free trade complain to politicians
Book - democratic governments are more likely to pass trade protection
Not true – dictatorships can move faster
The dictator wants a new law; thus, the law quickly comes into existence
Many dictators do not use free markets
Dictators expand their military and increase their power base
Democracies – laws can be challenged by courts, etc.
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