Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world

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2 Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: Pearson Education Limited 2014 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6 10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. ISBN 10: ISBN 13: British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Printed in the United States of America

3 the United States and the EU have a long-running disagreement over the EU s prohibition of imports of beef and pork from livestock that is fed growth hormones. The EU claims that this is to protect the health of its consumers, while the United States argues that there is no scientific evidence to support the ban. The WTO agrees with the United States, but the EU insists that the meat has long-run health effects. Does the EU continue to ban imports in order to protect its beef and pork producers, or is it simply exercising a reasonable level of caution? While there is no consensus about the dollar value of economic losses due to nontariff measures, there is a consensus among economists that the world economy would be better off if they were reduced. Research indicates that benefits would accrue through the lowering of prices for many goods, increases in export and import volumes, increases in production levels, and overall economic welfare. In this respect, they are not much different from tariffs or quotas. They are generally much more difficult to eliminate, however, as they are embedded more deeply in national economic policies. C a s e s t u d y Intellectual Property Rights and Trade Intellectual property is usually divided into copyrights and related rights for literary and artistic work, and industrial property rights for trademarks, patents, industrial designs, geographical indications, and the layout of integrated circuits. The rules for respecting intellectual property rights as they relate to trade were negotiated during the Uruguay Round ( ), and culminated in the Trade-Related Aspects Intellectual Property Rights (TRIPS) agreement. The growth of world trade over the last half of the twentieth century led to a greater awareness of the importance of intellectual property. More and more, traded goods and services incorporated specialized knowledge and unique ideas. Pharmaceuticals, computer hardware, telecommunications equipment, and other high technology products are valuable because of the innovation and research they incorporate, while software, movies, music, and other artistic expressions are valued for their creativity. The protection given to creators and innovators varied greatly until standardization began with the signing of the TRIPS agreement. The lack of intellectual property protection is viewed as a nontariff measure since the failure or inability to protect intellectual property restricts trade flows. Exporters are reluctant to sell products into a market if they know that their ideas or brands will be stolen and copied by local producers. Hence, there were strong pressures by developed countries to reach an agreement on 143

4 enforcement of protections for intellectual property. Since the implementation of the Uruguay Round in 1995, there have been thirty-one intellectual property complaints brought to the WTO, most having to do with patents, and a large share of those related to pharmaceuticals. It is probably impossible to prevent copyright infringements that happen through informal networks of families and friends. For example, friends copying each other s music on their ipods or sharing their copy of Microsoft Office cannot easily be stopped when it is done outside a formal market. On the other hand, many countries have very large and very visible markets where fake goods with counterfeit trademarks and illegal copies of DVDs and software are sold. Beijing s famous Silk Market is an example that attracted a lot of attention. In 2005, as part of its commitment to fulfill its WTO obligations, Chinese courts imposed fines on the landlord of the market and began the process of eliminating fake goods, many of which had counterfeit labels from European luxury brands. Furthermore, intellectual property violations in the industrial arena (for example, through copying patented technologies) involve billions of dollars in losses. The fundamental economic rationale for the TRIPS agreement is that by protecting innovation it gives a financial incentive to firms and individuals to do research and to continue to innovate. Nevertheless, the TRIPS agreement is not uniformly seen as a positive step for world prosperity. Among others, Nobel Laureate Joseph Stiglitz has criticized it for the costs it has imposed on China, Mexico, and other developing countries that must devote scarce resources to its implementation. Mexico, he argues, has spent over $50 million in its implementation. Also, it is not empirically well established that the benefits of innovation outweigh the costs of access, particularly for developing countries. This is particularly true for developing countries that find their access to new technologies curtailed when they must pay royalties and other fees. Pharmaceuticals are a case in point. With the AIDS crisis in full force in many countries, access to anti-aids drugs is critical. If patent enforcement under the TRIPS agreement prevents the production of inexpensive copies, then it is harmful to world prosperity. Although a number of exceptions were written into the agreement to allow access to life-saving medicines and other critical technologies, it is difficult for many developing countries to take advantage of the exceptions because they lack the technical know-how to make generic varieties of expensive and sophisticated drugs. In addition, the United States and other governments have put pressure on developing countries governments to respect patent rights, even in cases where the rules permit a developing country to break a patent. In the end, many countries simply lack the resources to fully implement the TRIPS agreement. Nevertheless, it remains an area of active interest, particularly for rich developed country markets with large numbers of patents, copyrights, and trademarks to protect. 144

5 Summary Tariffs increase domestic production and employment at the cost of greater inefficiency and higher prices. Production and distribution effects are measured by estimating the changes in producer surplus and consumer surplus. In addition to short-run welfare and efficiency effects, tariffs have long-run costs of increased rent seeking, slower innovation, and the loss of export markets through the retaliation of trading partners. In theory, a large country can improve its welfare with tariffs. In general, welfare-improving tariffs tend to be small, and they improve welfare only if there is no retaliation by supplying nations and no external costs such as increased rent seeking. Economists distinguish between nominal and effective rates of protection. The effective rate is the difference in domestic value added with and without tariffs, expressed in percentage terms. Quotas have similar effects as tariffs, although the overall national losses are greater due to the transfer of quota rents to foreign producers. Auction markets, in which governments auction the right to import an item under a quota, can reduce the amount of quota rents and, in the limit, provide the same revenue as an equivalent tariff. Administratively, quotas take many forms. They can be well-specified quantitative restrictions on imports, negotiated limits on a trading partner s exports, or requirements to obtain a license to import. Nontariff measures include a wide variety of regulations and policies that effectively reduce the volume of international trade. They often act as hidden forms of protection and are commonly embedded deeply in a country s rules and institutions. Together with quotas, they make up nontariff barriers to trade. Vocabulary consumer surplus deadweight loss effective rate of protection efficiency loss intellectual property rights large country case nominal rate of protection nontariff barrier (NTB) nontariff measure nontransparent producer surplus quota rents transparent voluntary export restraint (VER) 145

6 Study Questions All problems are assignable in MyEconLab. 1. Graph the supply and demand of a good that is produced domestically and imported. Assume that the country is not large enough to affect the world price. Illustrate the effects that a tariff on imports has. Discuss the following: a. Income distribution effects b. Resource allocation effects c. Domestic production and consumption effects d. Government revenue effects e. Price of the good effects 2. Suppose that the world price for a good is 40 and the domestic demand-andsupply curves are given by the following equations: Demand: P Q Supply: P Q a. How much is consumed? b. How much is produced at home? c. What are the values of consumer and producer surplus? d. If a tariff of 10 percent is imposed, by how much do consumption and domestic production change? e. What is the change in consumer and producer surplus? f. How much revenue does the government earn from the tariff? g. What is the net national cost of the tariff? 3. Under what conditions may a tariff actually make a country better off? 4. In addition to the production and consumption side deadweight losses, what are some of the other potential costs of tariffs? 5. The Uruguay Round of the GATT began a process of phasing out the use of voluntary export restraints. Why did they come into widespread use in the 1980s? For example, given that VERs are a form of quotas, and that they create quota rents and a larger reduction in national welfare than tariffs, why did nations use them instead of tariffs? 6. The GATT strongly favors tariffs as a protective measure over quotas or other nontariff measures. It encourages new members to convert quotas to their tariff equivalents. One of the main reasons that tariffs are preferred is because they are more transparent, particularly by comparison to nontariff measures. Explain the idea of transparency, and how nontariff measures may be nontransparent. 146

7 7. Suppose that in the United States bikes are built from a combination of domestic and foreign parts. a. If a bike sells for $500 but requires $300 of imported parts, what is the domestic value added? b. If a 20 percent tariff is levied on bikes of the same quality and with the same features, how do the price and the domestic value added change? (Assume that the United States cannot cause the world price to change.) c. What is the effective rate of protection? d. If, in addition to the 20 percent tariff on the final good, a 20 percent tariff on imported parts is levied, what is the effective rate of protection for U.S. bike manufacturers? Glossary Consumer surplus. The difference between the value of a good to consumers and the price they have to pay. Graphically it is the area under the demand curve and above the price line. See also Producer surplus. Deadweight loss. A pure economic loss with no corresponding gains elsewhere in the economy. See also Efficiency loss. Effective rate of protection. Effective rates of protection consider levels of protection on intermediate inputs as well as the nominal tariff levied on the protected good. Effective rates are measured as the percentage change in the domestic value added after tariffs on the intermediate and final goods are levied. See also Nominal rates of protection. Efficiency loss. A form of deadweight loss that refers to the loss of income or output that occurs when a nation produces a good at a cost higher than the world price. Intellectual property rights. Intellectual property is divided into copyrights and related rights for literary and artistic work, and industrial property rights for trademarks, patents, industrial designs, geographical indications, and the layout of integrated circuits. Large country case. A country that purchases a significant share of the world s output of a particular good may improve its welfare by imposing a tariff that causes import prices to fall. Nominal rate of protection. The amount of a tariff (or the tariff equivalent of a quota) expressed as a percentage of the good s price. See also Effective rate of protection. Nontariff barrier (NTB). Any trade barrier that is not a tariff. Most important are quotas, which are physical limits on the quantity of permitted imports. Nontariff 147