Vilém Semerák Spring 2018 TRADE POLICY II

Transcription

1 Vilém Semerák Spring 2018 TRADE POLICY II

2 Outline of the Lecture Trade policy in GE models Optimum tariff debate Effective protection Trade policy and imperfect competition Auctions of quota permits Quotas v. tariffs under imperfect competition Strategic trade policy models Basic logic Original Brander-Spencer model Bertrand case

3 Optimum Tariff Debate

4 Small Country and Optimum Tariff In this simple model small country will never profit from tariff The optimum tariff = 0 National welfare Prohibitive tariff Tariff rate

5 Large Country and Optimum Tariff TOT effect large country may even profit from imposition of tariffs The optimum tariff Bickerdike (1906) National welfare Optimum tariff Prohibitive tariff Tariff rate

6 Optimum vs. Scientific Tariff Optimum tariff maximizes welfare of the large country that imposed the tariff Scientific tariff equalizes production costs among countries so that no country can undercut

7 Calculating the Optimum Tariff? Market of the RoW P P ES RoW ES RoW ED H ED H ED H T ED H T Q Q

8 Optimum Tariff Monopsony Power p X Free Trade domestic price = average costs of imports Monopsony behaviour dom. price = marg. costs of import 1 MC X px 1 ROW ex C X p X I X I X p X H p T p FT ROW p T ROW ES X H ED X e ROW X MC p H T p X p I p ROW T X X p I p X ROW T X X 1 e 1 t 1 e 1 1 ROW X ROW X I M I FT Imports

9 Measuring Consumer Utility How to deal with heterogeneous consumers if we want to be sure whether a policy change led to a Pareto-improvement or not? Complicated option: Mathematical model with heterogeneous households Simple options: Representative consumer assumption Assume additive quasilinear utility functions and analyze the resulting social welfare function

10 Effective Allocation: Contract Curve C A 2 0 A Contract curve B C T 1 C C T 2 0 C A 1

11 Adding Utilities? Social Welfare Function (1) Assume that every individual has a quasi-linear utility function: U c h 0 U h ( c h ) With U h increasing and strictly concave in c Budget constraint: c h 0 p' c h I h Let c h = d h (p) be optimal vector of consumption for each individual, remaining income is spent on numeraire commodity h h h c I p' c ( p) 0

12 Social Welfare Function (2) SWF as sum of individual utilities: Using the envelope theorem: Result: we can use the social welfare function just like an indirect utility function for the economy as a whole H h h h h h p d U p c p I I p W 1 ) ( ' ), ( H h h p d p d p I p W 1 ), ( Negative of total consumption

13 Simple Application of the Social Welfare Function Further assumptions (and their implications): Only one import good is subject to a tariff Holding prices of all other goods fixed, we will treat p as a scalar Domestic price depends on the world price (and the specific tariff): p = p * + t Numeraire good is also traded, at a fixed world price = 1 Labour is the only factor of production, each unit of numeraire requires one unit of labour Then wages = 1, and total income equals labour supply L This basically means partial equilibrium setting (fixed wage, balancing through flows of numeraire commodity) Output of the analyzed good = y, y may be produced by competitive or imperfectly competitive firms Costs of production = C(y), marginal costs = C (y) Imports: m = d(p) y, where d (p) < 0 (implied by concavity of U h ) Revenue from the tariff (t.m) is redistributed back to consumers Consumers also receive the profits of the import competing industry (p.y C(y))

14 Social Welfare Analysis (3) General expression: W( p, I) W, p L t m p y Cy Wt Holds regardless of the type of competition in the sector

15 Social Welfare Analysis (4) Total differential of W(.) dw d p dp m t dm dp y dp p C' y dy dw dp dm dp m1 t p dp C' y dy dw t dm dp dp Efficiency costs of the tariff m dp * Terms of trade effects p C' y dy Change in industry output times price-cost margin

16 Perfect Competition, Small Country Now let s focus on a small open economy with perfect competition Perfect competition: p = C (y) World prices p * are fixed (dp * / = 0, dp/ = 1) dw t dm dp dp m dp * p C' y dy dw t dm dp

17 Analysis of Implications (1) Evaluating at a zero tariff: dw t0 Implications: there is critical point at t = 0 Maximum or minimum? t dm dp 0 d 2 W 2 t0 dm dp 0 dm/dp = d (p) (1/C ) where d (p)<0 and C >0 Optimal tariff for a small economy is zero

18 Analysis of Implications (2) We can use Taylor series approximation of welfare, around the free trade point W t W 0 t dw 1 2 t0 t 2 d 2 W 2 t0 W t 2 1 d W 1 dm 1 W 0 t 2 t 2 pm dp 2 t0

19 Large Country Upward sloping excess supply or downward sloping excess demand of the rest of the world

20 Social Welfare Analysis Reminder Total differential of W(.) dw t dm dp dp m dp * p C' y dy Efficiency costs of the tariff Terms of trade effects Change in industry output times price-cost margin We still assume perfect competition: p = C (y) And domestic prices still equal world prices + the tariff: p = p * + t But the world prices are no longer fixed! dp * / 0 and therefore dp/ 1

21 Perfect Competition, Large Country (1) Perfect competition: p = C (y) Domestic prices: p = p * + t World prices p * are fixed (dp * / 0, dp/ 1) dw t dm dp dp m dp * p C' y dy dw t dm dp dp Marginal dead-weight loss from the tariff m dp * Terms of trade effect of the tariff

22 Perfect Competition, Large Country (2) dw t dm dp dp m dp * Using dp * / < 0, we get: dw t0 m dp * 0 Meaning: increasing the tariff from zero (by a little) will necessarily raise the welfare!

23 Optimum Tariff: Another Perspective As previously derived for a large country with perfect competition: dw t dm dp dp m dp * FOC for maximum: dw 0 t p * * dp * m p * dm dp dp

24 Optimum Tariff: Another Perspective (2) As domestic imports = foreign exports: m x dm dp dp dx Substituting into the FOC, we get: t p * * dp * x p * dx 1 dx dp * p x * Optimum tariff = inverse of the elasticity of foreign export supply

25 Optimum Tariff - Conclusion Optimum tariff: t ROW e X Optimum tariff > 0 for large countries See Feenstra on alternative maths formula and the discussion of pricing strategies of the exporting firms (and the pass-through of the tariff) What about small countries? Application in the real world: 1. Problem do we have enough information to estimate excess demand and excess supply curve Note: elasticity of foreign supply curve is not sufficient 2. Problem what about retaliation? 1

26 Effects of Higher Tariff Rates in the U.S. and Japan Billions of 1980 US dollars Effects of 10 percentage point increase in tariffs: - bilaterally by the United States - multilaterally by the United States Effects on U.S. Real Income $ 2.5 (0.10%) $ 15.7 (0.60%) - bilaterally by Japan $ multilaterally by Japan (-0.04%) $ 0.5 (0.02%) Effects on Japan s Real Income $ (-0.43%) $ 0.7 (0.07%) $ 1.0 (0.10%) $ 8.7 (0.84%) Source: P.A. Petri: Modeling Japanese-American Trade: A Study of Asymmetric Interdependence. cited from Appleyard & Field

27 Effective Protection

28 ERP: Logic and Use When intermediate inputs exist (and they are traded), we may need a bit more comprehensive indicator of effects of trade barriers on individual economic sectors Definitions: Corden-Anderson-Naya: The proportionate increment in value-added per unit output over the freetrade value-added per unit output Corden-Leith The proportionate change in the price of value-added Meaningful for separable production function only. Predictive power of ERP indexes: severely limited predictive power for primary factor reallocation and gross output changes See Bhagwati (1998) for more details on underlying theoretical concepts

29 CR Consumers Autarky Free Trade Rest of the World Consumers Price: USD Car market Price: USD Car producer Car producers Price: 5000 USD Steel market Price: 5000 USD Steel producer Steel producers Value added: 5000 USD

30 Effective Protection How does existence of traded intermediate inputs influence impacts of tariffs? If some of the intermediate inputs are not traded freely, it is the tariff structure that matters Effective protection measures impact of changes in structure of tariffs on value added t e v v v v.. value added (price of output price of intermediate inputs)

31 CR Protection Rest of the World Consumers Tariff on cars: 20% Consumers Price: USD Car market Price: USD Car producer Price: 5000 USD Tariff on steel: 0% Steel market Car producers Price: 5000 USD Steel producer Steel producers Value added: 7000 USD Effective protection: 40%

32 CR Protection Rest of the World Consumers Tariff on cars: 20% Consumers Price: USD Car market Price: USD Car producer Price: 6000 USD Tariff on steel: 20% Steel market Car producers Price: 5000 USD Steel producer Steel producers Value added: 6000 USD Effective protection: 20%

33 CR Protection Rest of the World Consumers Tariff on cars: 0% Consumers Price: USD Car market Price: USD Car producer Car producers Price: 6000 USD Tariff on steel: 20% Steel market Price: 5000 USD Steel producer Steel producers Value added: 4000 USD Effective protection: -20%

34 Effective Rate of Protection Tariff on output > tariff on inputs effective rate of protection > nominal tariff Tariff on output = tariff on inputs effective rate of protection = nominal tariff Tariff on output < tariff on inputs effective rate of protection < nominal tariff But: non-tariff instruments also matter Assumptions: CRS No substitution in production Small country case Production and trade exist

35 Empirical Evidence Escalating tariffs, higher protection of final goods, lower protection in case of intermediate inputs and esp. raw materials Effective protection higher than nominal protection (approx. twice) Some developing countries import-substituting industrialization = high rates of effective protection + overvaluation Example: Argentina (1969), nominal tariff on finished textiles 63%, effective 832%!

36 Empirical Evidence - USA Sector Nominal Rate (%) Effective Rate (%) Wearing apparel Textiles Glass and glass products Nonmetal. miner. products Footwear Metal products Food, beverages, tobacco industry average Source: Deardorff and Stern: The Michigan Model of World Production and Trade

37 Empirical Evidence - Japan Sector Nominal Rate (%) Effective Rate (%) Food, beverages, tobacco Agriculture, forestry, fisheries Footwear Wearing apparel Nonelectrical machinery Furniture and fixtures industry average Source: Deardorff and Stern: The Michigan Model of World Production and Trade

38 All products Agricuture Mining Food, beverages and tobacco Textiles, apparel Wood products Paper, printing Chemicals, plastics Non-metallic mineral products Basic metal products Fabricated metal products Other manufacturing NOT APPLICABLE NOT APPLICABLE Chart III.3 Tariff escalation by ISIC 2-digit industry, 2006 EU 2006 Per cent 25,0 Raw materials Semi-processed Fully processed 20,0 15,0 10,0 5,0 0,0 Source : WTO Secretariat calculations, based on EC Official Journal L286, 28 October 2005; and WTO estimates.

39 Market Protection and Imperfect Competition

40 Perfect vs. Imperfect Competition Our GE/PE models were too perfect Perfect competition, information, etc. Implications: Economies are in optimum, there is no opportunity for Pareto welfare improvement (think of the first welfare theorem) Trade policy is necessarily mainly about redistribution among different interest groups Imperfect competition (information) Economies may not work so well Perhaps there may be some space for rational welfare improving trade policy Example: market with monopoly where welfare is being lost because of the dead weight costs

41 Quotas, Tariffs and Monopoly Generally: free trade = anti-monopoly policy Contestable market hypothesis market is relatively small (i.e. at best handful of producers), but it is open to entry monopolist cannot restrict output and increase price If monopolistic producer faces foreign competition, then: Tariffs leave domestic markets contestable Quota destroys the contestability

42 Free Trade Makes Monopoly Behave Competitively P MC P M P w MR D Q M FT Q M Q D FT Q

43 A Monopolist Protected by Tariff P MC P M P w +t P w MR D Q M FT Q M T Q M Q D T Q D FT Q

44 A Monopolist Protected by a Quota P MC P Q Import quota P w MRQ MR D Q D Q M FT Q Q Q D FT Q

45 Monopoly Interesting Issues Auction for import quota permits motivation of monopolistic producers vs. non-producing importers Double distortion what if the monopolist reduces output that would have been too high because of other distortions/imperfections? Effects of tariffication on volume of trade if quotas are replaced by equivalent tariffs, monopolistic firms may increase output and thus reduce imports

46 Quota and Auctions P MC P M P Q P w AC Import quota MR Q MR D Q D Q Q Q D FT Q

47 Quota and Tariffication P MC P Q,T Import quota P w MR Q MR D Q D Q Q Q FT M Q T M Q D FT Q

48 Exercise: Quota and Monopoly We are going to analyze impacts of trade on an industry with a single domestic producer (monopoly). You are given the following information about the producer and her market: Demand in the market: Q D = 1005 P Total cost function: TC = 15 Q + ½ Q 2 Derive the marginal revenue function, marginal cost function, and average cost function of the producer. Draw a diagram describing the autarky equilibrium of the market. Calculate the equilibrium price and monopoly rent of the producer (still for the autarky case). Assume that world price equals 300 and trade is completely liberalized. Explain what happens with the monopoly position and calculate the volume of production of the producer and imports. Assume that trade is possible, but it has not been liberalized completely. Instead an import quota was introduced, the import quota equals 99. Explain and show in a diagram how the producer will behave under the quota. Assume that the government obeys its advisors and decide to sells the right the import (within the quota) in an auction. Describe possible motivation of the producer to participate in this auction. Calculate the quota rent and possible benefits from obtaining the quota and describe the likely result of such an auction.

49 Strategic Trade Policy

50 Increasing Returns, Imperfect Competition and Trade Policy There can be virtually no positive effects of trade policy in the world of neoclassical trade models so what about increasing returns and imperfect competition? Oligopolistic market structures mean also existence of rents and we may try to design trade policy that would maximize the share of rent that will be gained by our firms Economic analysis of oligopoly game theory, industrial organization models

51 Strategic Trade Policy Original version: Brander & Spencer (1985) Gist: government can influence the size and share of economic rents that its domestic firms earn from a foreign market Understood as an argument for active trade policy (subsidization of exporters) Simplest version: Third market isolated from the home market Duopoly of home and foreign firm in the third market Cournot type of competition in the third market

52 Strategic Trade Policy Trade policy based on interference into strategic relationships between firms Original model: James Brander, Barbara Spencer Problems several modifications with different implications and high sensitivity to assumptions The simplest case the third country approach we simplify analysis by assuming away impacts of trade policy on domestic consumers

53 STP and Rents Home Government Domestic Firm Foreign Firm Third Market

54 Cournot Competition Duopoly - 2 firms that choose the optimal volume of production (output) Important assumption: when optimizing, the firms regard output of their competitor as given Reaction curves - show the optimum output of a firm for every output of its competitor (curves derived from standard optimization) Iso-profit curves - the lower is the curve, the higher profit is being achieved

55 Trade Policy in Game Theory Government Decides about appropriate subsidy, tax, tariff Home Firm Chooses volume of output Foreign firm Foreign firm Foreign firm Chooses its volume of output Profit of domestic firm Profit of foreign firm

56 General Solution Define some Welfare function of the country (it includes profits of our firm, possibly costs/revenues of the measure, effects if assumed on our consumers) Define profit functions of the two firms which will include the trade measure as a parameter Solve backwards!!! Find equilibrium strategies of the two firms in the Cournot market Their optimum behavior as a function of trade policy measure Substitute into the Welfare function Maximize the Welfare function with respect to the trade policy measure

57 Third Market - Cournot Duopoly Q F RF H Non-cooperative equilibrium Isoprofit functions of H RF F Q H

58 Suboptimal Subsidy in Cournot Market Q F Non-cooperative equilibrium RF H New equilibrium with subsidy RF F Q H

59 Optimal Subsidy in Cournot Market Q F Non-cooperative equilibrium RF H New equilibrium with subsidy RF F Q H

60 Impacts of Subsidy Government can push its firm into previously instable point that maximizes the firm s profit Optimal solution: we force our company to behave like a Stackelberg leader Firm H produces more, firm F has got to decrease its market share Increase in profit is higher than subsidy! Increase in profit is at the expense of the foreign firm, foreign consumers also profit from lower price!

61 Demonstration: simplest version of the traditional model with Cournot mode of competition

62 Cournot s Duopoly Model Two firms (H and F) that optimize profit by choosing Q Inv. demand function: PQ Q 5000 Q Q Cost function of H: Cost function of F: H C C F 1000 H Q H F 1200Q F H F Profit of H: Q P Q Q C Q H H H F H H H 1 Q 2 H Q H Q H Q F

63 Profit Function of Firm H

64 Contours of Profit Function of H

65 Contours of Profit Function of F

66 Reaction Functions of H and F

67 H F H F F F H F F F F Q Q Q Q Q Q Q Q Q F H F H H H Q Q Q Q Q Assumption: 0 H F Q Q Assumption: 0 F H Q Q Reaction Functions Mathematical Derivation

68 Impact of Decrease in Costs of H (or Subsidy) Reaction function of H and F

69 Impacts of Subsidy Government can push its firm into previously instable point that maximizes the firm s profit Firm H produces more, firm F has got to decrease its market share Increase in profit is higher than subsidy! Increase in profit is at the expense of the foreign firm, foreign consumers also profit from lower price! In this case optimum subsidy = 1050 per unit, profit of H (with subsidy) increases to 441 mil., increase in profit is 245 mil. (total subsidy mil.)

70 Prisoner s Dilemma (Cournot Market) The situation is symmetric, i.e. the foreign government has got absolutely the same motivation to interfere as ours! Government H FT S Government F FT S P Q, Q A B Q Q CQ H FCH MCH QH H F H B=1/100, A=5000, MC H = 1000, MC F = 1200, FC H =FC F = 0 F

71 Stackelberg Model We assume that H knows reaction function of F uses this knowledge during optimization In this situation: H Q Q 2 H H 200 Profit of H: mil., production units, Profit of F: mil., production units

72 STP and Bertrand Competition Difference: firms choose optimum prices Again - when optimizing firms view price of their competitor as given Again - reaction curves and isoprofit curves (but in a slightly different form) Higher total output than in the Cournot case Different implications: state can improve its welfare by taxing the firm We will increase the total rent and we will this despite lower share gain more

73 Third Market Bertrand Case P F RF H Isoprofit curves of F RF F Isoprofit curves of H P H

74 Suboptimal Tax in Bertrand Market P F Isoprofit curves of F RF F Isoprofit curves of H RF H P H

75 Optimal Tax in Bertrand Market P F Isoprofit curves of F RF F Isoprofit curves of H RF H P H

76 Governments and Information Government can use the optimal STP: When it knows the type of the oligopoly market When it has reliable information about demand and about cost functions of the firms But even in this case, two other policies dominate STP Collusion at the level of governments Provision of information services to domestic firms Leads to the same result as STP (Stackelberg equil.) And in principle should be cheaper to administer

77 Imperfectly Informed Policymaker How can government get the information? Do the firms have motivation to provide the correct information? Can governments apply suboptimal STP based on simple rules instead of perfect information? Two stages of the information game About the nature of competition in the market A bit naive there may be other ways how to test it (and problems with time consistency) About the size of (marginal) costs more realistic Wong (1990) has shown that if policymakers do not have complete information about the home firm's costs, some export policies could be welfare worsening Qiu (1994), Brainard and Martimort (1992)

78 References Markusen et al. chapters 15 and 16 Feenstra chapter 7 Krugman and Obstfeld: International Economics Theory and Policy Brander, Krugman: A Reciprocal Dumping Model of International Trade. NBER working paper No. 1194, August 1983

79 Sources of data World Integrated Trade Solution: WTO main website: WTO Trade Profiles Database: