Trade Policy

Introduction

Trade policy refers to the set of government actions that influence international trade flows. These policies can promote free trade or impose restrictions to protect domestic industries. Understanding trade policy is essential for analyzing the effects of globalization, market efficiency, and national welfare.

20.1 Free Trade or Protection?

Key Concepts

• Free Trade: The unrestricted exchange of goods and services between countries.

• Protectionism: Government policies that restrict imports to protect domestic producers from foreign competition.

• Tariff: A tax applied on imports, raising the price of foreign goods.

• Non-tariff Barriers (NTBs): Restrictions other than tariffs, such as import quotas or complex customs procedures, designed to reduce imports.

The Case for Free Trade

• Encourages countries to specialize in products where they have a comparative advantage.

• Maximizes world production and average living standards.

• Benefits the country as a whole, though not necessarily every individual.

• Comparative Advantage: The ability of a country to produce a good at a lower opportunity cost than others.

• Example: If Canada is more efficient at producing wheat and the US at producing cars, free trade allows each to specialize and trade, increasing total output.

The Case for Protection

• Promoting Diversification: Small countries may avoid specializing in a few products to reduce risks from technological change or price swings.

• Protecting Specific Groups: Social and distributional concerns may justify protection, but this often reduces average living standards.

• Improving the Terms of Trade: Large countries may use tariffs to improve their terms of trade and national income; small countries cannot.

• Infant Industry Argument: New industries may need temporary protection to achieve economies of scale or learning by doing.

• Earning Economic Profits in Foreign Markets: Protectionist policies may help domestic firms gain advantages and profits in foreign markets.

Invalid Arguments for Protection

• "Keep the money at home"

• "Protect against low-wage foreign labour"

• "Exports are good; imports are bad" (mercantilism)

• "Create domestic jobs"

• Note: These arguments are not supported by economic theory and often lead to inefficiency.

Lessons from History: The Great Depression

• In 1929, protectionist policies (tariff increases) were widely adopted.

• Retaliatory tariffs led to a sharp decline in global trade.

• These actions worsened the economic situation during the Great Depression.

20.2 Methods of Protection

Tariffs

Tariffs are taxes on imported goods, raising their price and reducing imports. The effects can be analyzed using supply and demand diagrams.

• Under free trade: Domestic production = , Domestic consumption = , Imports = .

• With a per-unit tariff , domestic price rises to .

• Domestic production increases to , consumption falls to , imports fall to .

• Producer surplus increases, government revenue increases, but consumer surplus decreases.

• Overall economic wellbeing decreases by the deadweight loss (areas 2 + 4 in the diagram).

Deadweight Loss Equation:

• Tariffs:

  • Impose costs on consumers

  • Benefit domestic producers

  • Generate government revenue

  • Net effect is negative due to deadweight loss

Import Quotas

• Direct quantity restrictions on imports.

• Raise the price foreign suppliers receive.

• Unlike tariffs, quotas do not generate government revenue.

• Quotas are generally worse than tariffs for the importing country.

Tariffs Versus Quotas: Application

• Exporting countries prefer quotas; importing countries prefer tariffs.

• Example: US-Canada softwood lumber dispute involved both tariffs and quotas.

• Canada preferred quotas over equivalent tariffs for its lumber exports.

Trade-Remedy Laws and Non-Tariff Barriers (NTBs)

• Some NTBs address legitimate trade problems.

• Dumping: Selling goods in a foreign market at below cost or below domestic price. Can benefit consumers but may harm domestic producers.

• Antidumping Laws: Designed to counter predatory pricing, now often used to protect domestic firms from foreign competition.

• Countervailing Duties: Tariffs imposed to offset foreign government subsidies, often a form of disguised protectionism.

Climate Policy and Trade Policy

• Climate policies (e.g., reducing GHG emissions) raise costs for domestic firms.

• Imports from countries without similar policies may have unfair cost advantages.

• Carbon Tariffs: Tariffs on imports to adjust for differences in climate policy costs.

• Border Carbon Adjustments (BCAs): Used to protect domestic firms' competitiveness.

• Uncertainty remains about WTO rules regarding BCAs.

Applying Economic Concepts: Supply Management and Freer Trade

• Canada's supply management in dairy, poultry, and eggs involves:

  • Restricting output below free-market levels

  • Imposing high tariffs to prevent competing imports

• This system irritates trade partners and complicates trade negotiations.

20.3 Current Trade Policy

The GATT and the WTO

• GATT (General Agreement on Tariffs and Trade): Established in 1947 to prevent unilateral tariff increases.

• WTO (World Trade Organization): Replaced GATT in 1995, oversees global trade rules.

• Successive negotiation rounds have reduced average tariffs since 1947.

Regional Trade Agreements

• Regional agreements liberalize trade among a subset of countries.

• Three main forms:

  • Free Trade Area (FTA): Abolishes tariffs among members, each sets own tariffs for non-members.

  • Customs Union: Free trade among members plus a common external tariff.

  • Common Market: Customs union plus free movement of labor and capital.

Trade Creation and Trade Diversion

• Trade Creation: Increased trade within the group due to reduced barriers, efficient specialization according to comparative advantage.

• Trade Diversion: Trade within the group replaces trade with outside countries, potentially inefficient from a global perspective.

• Main argument against regional agreements: Costs of trade diversion may outweigh benefits of trade creation.

US-Mexico-Canada Agreement (USMCA, formerly NAFTA)

• NAFTA began in 1994, replaced by USMCA in 2020.

• Guided by national treatment: Laws must not discriminate based on nationality.

• Includes a dispute-settlement mechanism for resolving trade conflicts.

Other Major Provisions

• All internal tariffs eliminated as of 2010.

• National treatment applies to foreign investment after entry.

• Some restrictions remain (e.g., supply management, cultural industries).

• Trade in most non-agricultural services liberalized.

• Government procurement open to cross-border bidding.

Results of NAFTA/USMCA

• Industry shifted toward greater export orientation.

• Trade flows increased, especially between Canada and the US.

• Inter-industry trade volume increased.

• Potential for trade diversion with Mexico, which competes with other low-wage countries.

Applying Economic Concepts: Canadian Wine and Free Trade

• Before CUFTA (1989), Canadian wine industry was protected by tariffs and could only use domestic grapes.

• Produced mainly low-quality wines.

• After tariffs were eliminated, Canadian wines competed with imports and quality improved.

• Now Canadian wineries produce high-quality wines.

Summary Table: Methods of Protection

Additional info: These notes expand on the original slides and text by providing definitions, examples, and context for key concepts, as well as a summary table for comparison.