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Economics of Trade Liberalization and Integration

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MD-MS diagram permits tracking domestic & international consequences of trade policy changes. ... Colonial preferences conflicted with the Common External Tariff. ... – PowerPoint PPT presentation

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Title: Economics of Trade Liberalization and Integration


1
Economics of Trade Liberalization and Integration
  • Jan Fidrmuc
  • Brunel University

2
Import demand curve (MD)
Home Supply
price
price
1
P
2
P
P
3
P
P
Home import demand curve, MDH
Home Demand
quantity
imports
Z
C
Z
C
M
M
3
Import supply curve (MS)
4
MD-MS Diagram
  • MD-MS diagram permits tracking domestic
    international consequences of trade policy
    changes.

5
Non-discriminatory (MFN) Tariff
  • Consider tariff of T euros per unit
  • MFN non-discriminatory tariffs
  • WTO rules lowest tariff (most-favored nation)
    must apply equally to all trading partners
  • Exception FTAs
  • Tariff shifts MS curve up by T.
  • Exporters earn domestic price minus T
  • They would need domestic price of PT to continue
    to offer the same exports.

6
MFN Tariff Analysis
  • New equilibrium in Home (MDMS) is at P and M.
  • Domestic price P now differs from border price
    (price exporters receive) P-T.
  • Domestic price rises.
  • Border price falls.
  • Imports fall.

Border price
Domestic price
MS with T
MS
XSMS
P
PFT
PFT
T
P-T
MD
Foreign exports
Home imports
M
MFT
XM
XFT MFT
7
Welfare effects
  • Foreign loss due to drop in exports equal to area
    D (trade volume effect).
  • Foreign loss due to drop in border price equal to
    area B (border price effect, a.k.a., ToT effect).
  • Net effect on Foreign -D-B.
  • Home loss equal to area -A-C (trade volume drops
    and price rises).
  • Home gain due to drop in border price and tariff
    revenue equal to area AB.
  • Net effect on Home -CB.
  • World welfare change is -D-C.
  • If Home gains (-CBgt0) it is because it exploits
    foreigners by making them pay part of the
    tariff (i.e. area B).

8
Distributional consequences
  • Home consumers lose area EC2AC1
  • Home producers gain E
  • Home tariff revenue AB.
  • Net change B-C2-C1 (this equals B-C in left
    panel).
  • Net effect can be positive or negative.
  • Tariffs imposed because they benefit domestic
    producers who are often organized and politically
    influential
  • This comes at a cost to domestic consumers and to
    foreigners
  • If Foreign retaliates and also imposes a tariff,
    everyone loses
  • With reciprocity, protectionism is not a zero-sum
    game

9
Distributional consequences
10
Preferential Trade Liberalization
  • Previous analysis used 2 countries only Home and
    Foreign
  • European integration is discriminatory (or
    preferential) and its analysis requires at least
    three countries
  • At least two integrating nations.
  • At least one excluded nation.
  • MD-MS diagram must to allow for two sources of
    imports.

11
The PTA Diagram Free trade
Partner
Home
RoW
Border price
Border price
Domestic price
MS
XSP
XSR
1
2
PFT
MD
XP
RoW Exports
Partner Exports
Home imports
XR
MXPXR
12
The PTA Diagram MFN tariff
13
Discriminatory unilateral liberalization
  • Assume Home removes T on imports only from
    Partner.
  • This liberalization shifts up MS (as with MFN
    tariff) but not as far since it applies only to
    one half of imports.
  • Shifts up MS to half way between MS (free trade)
    and MS (MFN tariff)
  • More complex, kinked MS curve with PTA.
  • If price falls below Pa, RoW will export zero.

14
Discriminatory, unilateral liberalization
Border price
Border price
Domestic price
MSMFN
Partner
RoW
Home
MSPTA
XSP
MS
XSR
P
P
P
T
P-T
P-T
Pa
1
T
MD
p
RoW Exports
Partner Exports
Home imports
M
XP
XP
M
XR
XR
15
Domestic price border price changes
  • Domestic price falls to P from P.
  • Partner-based firms see border price rise, P-T
    to P.
  • RoW firms see border price fall from P-T to
    P-T.

Domestic price
Border price
Border price
MSMFN
XSP
XSR
MSPTA
MS
P
P
P
T
P-T
P-T
P-T
MD
Home imports
M
XR
XR
XP
XP
M
Partner Exports
RoW Exports
16
Quantity changes supply switching
  • RoW exports fall and Partner exports rise supply
    switching trade diversion
  • Domestic imports rise trade creation.
  • Partner exports rise more than RoW exports fall.

17
Impact of customs union formation
18
Welfare effects
  • Homes net change AB-C ? ambiguous
  • Partners net change D.
  • RoWs net change -E.

19
Analysis of a Customs Union
  • European integration involved a sequence of
    preferential liberalisations, all of them
    reciprocal
  • Both Home Partner drop T on each others
    exports.
  • Need to address the 3-nation trade pattern.
  • Example each country produces 3 goods, exports 2
    and imports 1

20
Analysis of a Customs Union
  • Home and Partner eliminate T on their mutual
    trade
  • Both impose T on trade with RoW
  • Home-Partner CU has Common External Tariff (CET)
    equal to T
  • Analysis is simply a matter of recombining
    results from the unilateral preferential case.
  • In market for good 1, analysis is identical.
  • In market for good 2, Home plays the role of
    Partner and Partner plays role of Home.

21
Welfare effects of a customs union
  • In market for good 1
  • Home change AB-C1-C2.
  • In market for good 2
  • Home change D1D2.
  • NB D1C1.
  • Net Home impact AB-C2D2 .
  • Partner impact identical.
  • RoW loses in both markets.
  • RoW exports fall but imports stay the same trade
    deficit

22
EU Trade Policy
23
Geographical Structure of Trade
24
Differences among Member States
25
Composition of trade
26
What with whom?
27
EUs MFN tariff structure (the CET)
28
Institutions
  • Trade policy is an exclusive prerogative of the
    EU.
  • Customs Union requires agreement.
  • Commission has responsibility for negotiating
  • Trade Commissioner.
  • Council of Ministers sets Directives for
    Negotiation, accepts/rejects final deal.
  • Commission in charge of surveillance and
    enforcement of 3rd nation commitments.
  • Trade disputes with US, China, etc.

29
EU External Trade Policy
  • EU has special arrangements with 139 nations
    often more than one per partner. Each can be very
    complex.

30
Non-preferential trade
  • Only about 1/3 EU imports are not granted some
    sort of preferential treatment
  • Only 9 nations (US, Japan, etc.).
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