DEVELOPMENT ECONOMICS
Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,
Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest
Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest
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Author: Katalin Szilágyi Supervised by Katalin Szilágyi
January 2011
Week 10 Trade policy
Gains from international trade
• Heckscher–Ohlin:
• International trade involves transformation of goods
• If the marginal rate of transformation is different between countries, both can gain from trade
• Result doesn’t depend on
• behavior of other countries (free trade vs. protectionism)
• determinants of world market prices
Income distribution
• No distribution effects in the Ricardian model (only 1 input)
• Can play a role if more inputs (Hecksher–Ohlin)
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• Illustration: 2 countries (N, S)
• 2 inputs: L – labor, K – capital
• N is relatively better endowed with capital
• 2 goods: computer (capital-intensive), rice (labor-intensive)
• N exports computers and imports rice
• The export sector can make use of labor laid off in the rice sector (because rice imported)
• Inputs made available will not be ideal for computer production, labor will be in excess supply. Capital will be relatively scarce
• Excess labor will push wages down. Price of capital will increase
• Owners of capital will gain from trade, owners of labor will lose
• The overall effect of free trade is positive, but there will be losers
• Import competition may trigger lobbying for trade restrictions
Problems with comparative advantage
• Trade in food / primary commodities increase, but their share in total exports decreases
• Countries specialized in these products will probably see slower growth in the future
• Could be compensated with large-scale savings today
• Government can change industry/exports structure → paternalistic attitude toward
”time-inconsistent market agents”
• Market failures may block change
• Lack of credit opportunities
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• Barriers to entry (economies of scale)
• Co-ordination problems
• Market-based allocations are efficient IF we accept the initial allocation
Trade policy instruments 1. Import substitution
Import substitution
• Aim: to bolster competitiveness of domestic producers
• Domestic market can be a good field for domestic producers to experiment
• Domestic and foreign producers will be treated differently
Tariff
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Quota
Tariff and quota
• Tariffs generate revenues for governments
• Quotas are also implicit subsidies to domestic producers
• In principle, effects are equivalent.
• If the government doesn’t exactly know supply and demand
• Tariff: effect on quantities will be unsure
• Quota: effect on prices will be unsure
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Tariff, quota and uncertainty
Welfare effects
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• Dynamic effects from import substitution
• Learning by doing
• Lower costs, gain in competitiveness
• Spillover effects
• Effects on other industries
• Infrastructure
• Economies of scale
Problems with implementation
• Infant industries argument
• Aim: to create advantages until the industry becomes competitive in the international markets
• Transitory subsidies
• Credible threat?
• Increasing industry → increasing lobby power
• Institutional persistence
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Trade policy instruments 2. Export subsidy
Export subsidy
• Argument: if the internal market is small, the industry can catch up in foreign markets
• ”Outward orientation” is more accepted than ”inward orientation”
• Why?
• Closer relationship with the rest of the world
• Cheaper products for developed countries (vs. constraints on developed countries exporters)
• Targets manufacture goods
• Forms of the subsidy
• Direct (cash)
• Import regulation: making required imports cheaper for a given industry
• Preferential credit opportunities
• Appreciation of the exchange rate
• Also in the case of import substitution (less of a problem there)
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• World market price can fall (if the country is big enough)
• Effective if world demand is highly elastic (and prices do not fall much)
• Welfare effects
– consumer surplus + producer surplus
– cost of export subsidy (implicit deadweight loss)
• Dynamic effects are as in the case of import substitution
