International Trade in Insurance

1
International Trade in Insurance

• Economic theory of trade
• absolute versus comparative advantage
• static welfare analysis of trade
• dynamic welfare analysis of trade
• common trade restrictions
• tariffs
• quotas
• subsidies
• government procurement

2
International Trade in Insurance

• Why restrict trade?
• 1. Foreign company will dominate the market
• economies of scale and scope
• greater financial resources
• infant industry
• 2. Insurance is strategic business
• national security
• national economic diversification

3
International Trade in Insurance

• Need to preserve foreign exchange reserves
• nature of insurance related trade flows
• import substitution
• the special case for insurance
• market development
• consumer protection concerns
• why insurance is special

4
International Trade in Insurance

• Fair trade concepts
• market access
• nondiscrimination
• transparency
• national treatment
• reciprocity
• some accounting issues in international trade

5
Mercantilist versus Smith

• Mercantilist view If one country wins from trade
  the other country must lose
• Extending this view.. should Jalisco trade with
  Veracruz? Should Tlalpan trade with Copilco?
• Smith Wealth of Nations is in the productive
  capacity of labor and capital and not in the gold
  reserves

6
Absolute versus comparative advantage

• The easiest way to see the notions of absolute
  and comparative advantage is by means of an
  example
• Suppose there are two countries each producing
  wine and wheat with the following cost structure
• Country Wheat Wine
• England 15 30
• Portugal 10 15

7
Comparative advantage

• opportunity cost of producing one unit of wine in
  England is two units of wheat
• oc in Portugal of one unit of wine is..
• relative costs are different
• Portugal is relatively better at producing wine
  than England
• Portugal has a comparative advantage in wine
  production (England in wheat)

8
Comparative advantage

• Assume only input is labor
• assume England has 270 man hours and Portugal
  only has 180
• before trade England can produce and consume 8
  units of wheat and 5 units of wine
• Portugal can consume 9 wheat 6 wine
• total production 17 wheat 11 wine

9
Comparative advantage

• Is it possible for England to be better off and
  Portugal to be better off by not producing both
  wine and wheat?
• YES
• If specialize, total output 18 wheat 12 wine
• trade! not a zero sum game
• What should be the terms of trade?

10
Some observations

• one country may have absolute advantage in
  producing everything but not a comparative
  advantage in production in all goods
• comparative advantage may be in other economic
  factors such as land, capital,
• by how much each country gains depends on the
  terms of trade
• why is London the largest reinsurance market in
  the world?

11
Another example

• E and W produce two goods wine and cheese
• W requires 3 hours of work to produce 1 bottle of
  wine and E requires 1
• W requires 7 hours of work to produce 1 kilo of
  cheese and E needs 5
• What are relative costs of production in each
  country?

12
Terms of trade

• E can buy 1 kilo of cheese for five bottles of
  wine if they produce all by themselves
• But W can buy 1 kilo of cheese for 2.33 bottles
  of wine (or five bottles buys 2.15 kilos of
  cheese 2.155/2.33)
• Thus, E can gain an extra 1.15 by selling in W
• W cheese producers can get more by selling in E

13
Common Misconceptions about gains from
international trade

• Mexico is inefficient in producing everything,
  therefore, it will lose from trade
• In our example E has an absolute advantage in
  producing both cheese and wine but they gain from
  trade. Why? Gains are due to relative
  efficiency and not absolute efficiency.

14
Common Misconceptions about gains from
international trade

• Giant sucking sound argument of Ross Perrot
• American domestic workers have to be protected
  against low wage Mexican workers. If it is
  cheaper to produce in one country, it should do
  so. For example, it does not make sense for the
  Australian garment industry to produce shirts at
  a cost twice that of China. We need to compare
  relative costs and relative productivities

15
Common Misconceptions about gains from
international trade

• Trade exploits Mexico and makes it worse off
  (especially for goods that require lots of labor)
• Value of production is not solely due to labor.
  It is possible that the gain for the US economy
  is larger than the gain for Mexico. However,
  both gain from trade. Singapore example imports
  water, but exports refined petroleum!

16
Static welfare analysis of trade

• suppose a commodity has a domestic price of 17.50
  and a world price of 10
• Clearly a possibility of import
• government is considering a tariff of 5 on import
• who will gain and who will lose?
• And by how much?

17
Gains and losses

• There is benefit to the producer called producer
  surplus measured by ABCD and the amount is 37.50
• Consumers suffer a loss an amount 87.50 measured
  by ABFG
• Government gains in the form of tax revenue EHFD
  equals 25

18
Gains and losses

• Note that the total loss to the consumers is not
  equal to what producers gain and what the
  government gets as revenue
• There is an additional loss to the society as a
  whole CDE and FGH
• Since these losses are not gains of anybody in
  the society, they are called deadweight losses

19
Deadweight loss

• Clearly deadweight losses are bad for the economy
• What does the deadweight loss depend on?
• It depends on the elasticity of demand and the
  supply curves
• Consider demand elasticity lower the demand
  elasticity, higher the deadweight loss

20
Deadweight loss

• What does the demand elasticity depend on?
• Goods with few substitutes will have lower
  elasticity of demand-necessities
• Goods with many substitutes will have higher
  elasticity of demand-luxuries
• How large are the costs of trade restrictions?

21
What do empirical studies show?

• Trade restriction has a cost of US70b or 1.3 of
  GDP
• Is it worth it to have consumers pay more if it
  saves jobs?
• Cost to society 168,000 per job saved!
• Study of Kodak Australia tax concessions, and
  other benefits given to stay in Australia

22
Then, why we see resistance?

• Job losses are concentrated in certain areas
• They may bring in votes
• They may have large political power
• Benefits to consumers are diffused
• Each consumer gains a little
• They do not have political clout
• It does not pay

23
S
price
DL
17.50
D
F
B
5 10 15 20
G
A
H
C
E
D
5 10 15 20
quantity
24
Dynamic welfare analysis

• Over time, there are further changes
• In Australia, tariff and quota on garment import
  has been reduced (from 100 to 5)
• It has killed the usual garment manufacturing in
  Australia
• They are relocating factories to China, the
  Philippines, Indonesia etc.

25
Rent seeking

• People spend resources to engineer activities
  that lead to protectionism
• Lobbying for special interest groups
• Specific industries can get tax breaks, import
  quota imposed and other benefits
• Example Luxury boat builders in the US

26
Tax on insurers

• Makes insurance more expensive
• transfer consumer surplus to domestic producers
• provides government with tax revenue
• create deadweight loss to society
• how about imposing a quota?

27
General equilibrium analysis

• There are spillover effects
• We have only studied the partial equilibrium or
  own market effects
• Higher insurance costs leads to higher product
  prices that needs insurance
• Effects are felt all over the economy

28
Common objections

• Foreign insurers will dominate the market
• economies of scale and scope larger, more
  efficient foreign companies will be able to drive
  the local companies out of the market
• evidence shows that scale economies exist for
  small and medium sized companies but not for very
  large insurers (typically, they have diseconomies
  of scale)
• dumping who gains? Market share argument

29
Common objections

• For strategic reasons, insurance industry should
  remain national
• There will be great foreign exchange outflow
• Market development will be slowed down
• Consumers will not be protected

30
Dumping

• Goods sold abroad below the domestic price
• Japanese companies did that for many years for
  diverse sets of goods cars, electronics,
  computers etc.
• What does that mean?
• Common argument get into a foreign country, wipe
  out the competition and enjoy monopoly

31
Dumping

• To the country at the receiving end, dumping
  costs domestic jobs
• What prevents domestic producers from reentering
  the market?
• TVs, VCRs, etc. have become the biggest success
  of Japan in the rest of the world, and these
  industries were least helped by MITI and now they
  are produced elsewhere

32
MITI knows how to picklosers

• In the 1960s, MITI wanted auto companies to
  produce just trucks
• Later it tried to keep the number of producers
  low, in particular keep Honda out of auto
  business
• MITI presumed that analog version of the HDTV
  will be the industry standard, wrong again!

33
Fair trade

• Market access
• no country allows free access to insurance
  because of large potential for abuse
• localization of ownership majority shareholding
  local, subsidiary
• localization of insurance certain or all lines
  must be placed locally domiciled insurer
• benefits to economy needs test

34
Fair trade

• Nondiscrimination or MFN treatment
• best possible market access
• Transparency
• regulatory requirements should be clearly set and
  easily accessible
• National treatment
• foreign products are treated no differently from
  domestic ones

35
Fair trade

• Reciprocity
• concessions by a country matched by other
• matching need not be for the same industry
• retaliation can lead to escalating trade war
• increasing tariff to reduce foreign threat to
  local export economy cannot last long because
  other countries retaliate and can lead to reduced
  welfare for both

36
Some implications of national income accounting

• YCIG(X-M) where Y is the GDP
• Also, SY-C-G
• Therefore, SICA where CAX-M
• CA is called current account
• By this mechanism, a country can invest more than
  it saves
• Can it do that indefinitely?

37
(No Transcript)
38
Thailands saving and investment