REQUIRED ECON expert only

vzan0903

feenstra_3e_ch09_essentials.pptx

Home >Business & Finance homework help >Economics homework help >REQUIRED ECON expert only

International Agreements: Trade, Labor, and the Environment

International Trade Agreements

International Agreements on Labor Issues

International Agreements on the Environment

In protests at the 1999 meeting of the World Trade Organization in Seattle, Washington, environmentalists dressed as turtles and other endangered species that had been affected by recent WTO rulings.

Discussions about trade reform had been occurring since the formation of General Agreement on Tariffs and Trade (GATT) in 1947:

However, never before had there been such an organized protest against it.

What explains this grassroots movement against the WTO?

Introduction

The new WTO rules governing environmental regulations infuriated grassroots groups in the United States.

The goal of this chapter is to examine why international agreements like those negotiated under the WTO for trade, and those negotiated for environmental reasons like the Copenhagen Summit, are needed.

The reduction in the price received by exporters is a terms-of-trade gain for the importing country.

We show in this chapter that when two or more countries apply tariffs against each other in an attempt to capture this terms-of-trade gain, they both end up losing.

Introduction

Import tariff increases the import price for consumers in the large country but lowers the price received by foreign exporting firms.

To avoid such losses, international agreements to reduce tariffs and move toward free trade are needed. These international agreements take several forms.

Introduction

The WTO is a multilateral agreement, involving many countries, with agreement to lower tariffs between all the members.

There are also smaller regional trade agreements, involving several countries, often located near each other.

1 International Trade Agreements

When countries seek to reduce trade barriers between themselves, they enter into a trade agreement—a pact to reduce or eliminate trade restrictions.

Under the most favored nation principle of the WTO, the lower tariffs agreed to in multilateral negotiations must be extended equally to all WTO members.

The WTO is an example of a multilateral trade agreement, which we analyze first in this section.

The Logic of Multilateral Trade Agreements

1 International Trade Agreements

Tariffs for a Large Country

FIGURE 9-1 (1 of 2)

The tariff shifts up the export supply curve from X* to X* + t.

As a result, the Home price increases from PW to P* + t,

and the Foreign price falls from PW to P*.

Tariff for a Large Country

The Logic of Multilateral Trade Agreements

1 International Trade Agreements

Tariffs for a Large Country

FIGURE 9-1 (2 of 2)

The deadweight loss at Home is the area of the triangle (b + d), and Home also has a terms-of-trade gain of area e.

Foreign loses the area (e + f), so the net loss in world welfare is the triangle (b + d + f).

Tariff for a Large Country (continued)

The Logic of Multilateral Trade Agreements

1 International Trade Agreements

Payoff Matrix

FIGURE 9-2

Payoffs in a Tariff Game This payoff matrix shows the welfare of the Home and Foreign countries as compared with free trade (upper-left quadrant in which neither country applies a tariff). Welfare depends on whether one or both countries apply a tariff. The structure of payoffs is similar to the “prisoner’s dilemma” because both countries suffer a loss when they both apply tariffs, and yet this is the unique Nash equilibrium.

The Logic of Multilateral Trade Agreements

1 International Trade Agreements

Prisoner’s Dilemma The pattern of payoffs in Figure 9-2 has a special structure called the prisoner’s dilemma. Each country acting on its own has an incentive to apply a tariff, but if they both apply tariffs, they will both be worse off.

Nash Equilibrium The only Nash equilibrium in Figure 9-2 is for both countries to apply a tariff (lower-right quadrant). The Nash equilibrium in this case leads to an outcome that is undesirable for both countries even though it is the best outcome for each country given that the other country is imposing a tariff.

FIGURE 9-2 (revisited)

The Logic of Multilateral Trade Agreements

1 International Trade Agreements

Trade Agreement

This bad outcome can be avoided if the countries enter into some kind of trade agreement.

The WTO mechanism eliminated the prisoner’s dilemma by providing an incentive to remove tariffs; the outcome was in the preferred upper-left quadrant of the payoff matrix in Figure 9-2, rather than the original Nash equilibrium in the lower-right quadrant.

FIGURE 9-2 (revisited)

Regional Trade Agreements

1 International Trade Agreements

Under regional trade agreements, several countries eliminate tariffs among themselves but maintain tariffs against countries outside the region.

Regional trade agreements are sometimes called preferential trade agreements, to emphasize that the member countries are favored over other countries.

Free-Trade Area

A free-trade area is a group of countries agreeing to eliminate tariffs (and other barriers to trade) among themselves but keeping whatever tariffs they formerly had with the rest of the world.

Regional Trade Agreements

1 International Trade Agreements

Customs Union

A customs union is similar to a free-trade area, except that in addition to eliminating tariffs among countries in the union, the countries within a customs union also agree to a common schedule of tariffs with each country outside the union.

Rules of Origin

Free-trade areas have complex rules of origin, which specify what type of goods can be shipped duty-free within the free-trade area. These rules are not needed in a customs union.

1 International Trade Agreements

Trade Creation and Trade Diversion

When a regional trade agreement is formed and trade increases between member countries, the increase in trade can be of two types.

The first type of trade increase, trade creation, occurs when a member country imports a product from another member country that it formerly produced for itself.

The second reason for trade to increase within a regional agreement is due to trade diversion, which occurs when a member country imports a product from another member country that it formerly imported from a country outside of the new trade region.

HEADLINES

China-ASEAN Treaty Threatens Indian Exporters

The free trade agreement between China and members of the Association of Southeast Asian Nations (ASEAN) will mean nearly zero duty trade between several Asian nations making it difficult for Indian businesses.

The successful implementation of the FTA is bound to force New Delhi to expatiate similar trade agreements with countries in the ASEAN region besides China.

India has been trying to widen the trade basket to include manufactured goods, fruits, and vegetables. This effort might be severely hit because goods from ASEAN nations will now cost much less to the Chinese consumer.

Numerical Example of Trade Creation and Diversion

1 International Trade Agreements

TABLE 9-1

This table shows the cost to the United States of purchasing an automobile part from various source countries, with and without tariffs. If there is a 20% tariff on all countries, then it would be cheapest for the United States to buy the auto part from itself (for $22). But when the tariff is eliminated on Mexico after NAFTA, then the U.S. would instead buy from that country (for $20), which illustrates the idea of trade creation. If instead we start with a 10% tariff on all countries, then it would be cheapest for the U.S. to buy from Asia (for $20.90). When the tariff on Mexico is eliminated under NAFTA, then the U.S. would instead buy there (for $20), illustrating the idea of trade diversion.

Cost of Importing an Automobile Part

Trade Diversion in a Graph

1 International Trade Agreements

FIGURE 9-3 (1 of 2)

With Mexico and Asia facing the same tariff of t for sales into the United States, the equilibrium is at A with the quantity Q2 exported by Mexico and the remainder exported by Asia at a price of PAsia + t.

Trade Diversion

Trade Diversion in a Graph

1 International Trade Agreements

FIGURE 9-3 (2 of 2)

U.S. tariff revenue is the area (a + b + c + d).

Eliminating the tariff with Mexico under NAFTA leads to an expansion of Mexican exports to Q3.

The United States loses the tariff revenue (a + b + c), which is the U.S. loss as a result of trade diversion from Asia to Mexico.

Loss in U.S. tariff revenue: − (a + b + c)

Gain in Mexico’s producer surplus: + (a + b)

Combined effect due to NAFTA: − c

Trade Diversion (continued)

Trade Diversion in a Graph

1 International Trade Agreements

FIGURE 9-3 (revisited)

Not All Trade Diversion Creates a Loss

Suppose that after joining NAFTA, Mexico has considerable investment in the auto parts industry, and its supply curve shifts to SMex rather than SMex.

Then equilibrium imports to the United States will occur at point D, at the price PAsia, and Mexico will fully replace Asia as a supplier of auto parts.

Gain in consumer surplus: + (a + b + c + d + e)

Loss in tariff revenue: − (a + b + c + d)

Net effect on U.S. welfare: + e

APPLICATION

Trade Creation and Diversion for Canada

The effect of free-trade agreements on Canadian manufacturing industries can be measured by the difference between trade created and trade diverted:

Because this calculation is positive we conclude that trade creation exceeded trade diversion. Therefore, Canada definitely gained from the free-trade agreement with the United States

80% x 54% - 20% x 40% = 35% > 0.

Share of U.S. imports

Increase in U.S. imports

Share of other imports

Decrease in other imports

{

2 International Agreements on Labor Issues

We use the term labor standards to refer to all issues that directly affect workers, including occupational health and safety, child labor, minimum wages, and so on. Labor standards were included in NAFTA to satisfy several groups.

First, consumers and policy makers are often concerned with the working conditions in factories abroad and want to avoid “sweat shop” conditions that exploit workers.

Second, unions in the industrial countries are also concerned with these conditions, partly in solidarity with foreign workers and partly because poor labor standards abroad will create more competition for U.S. workers.

2 International Agreements on Labor Issues

Labor Side Agreement Under NAFTA

The labor side agreement negotiated under NAFTA does not change the existing labor laws in these countries but is meant to improve the enforcement of such laws.

Other Labor Agreements

Besides the labor side agreement in NAFTA, there are many other examples of international agreements that monitor the conditions of workers in foreign countries.

Unions and other organizations are concerned with issues such as job safety, the right of workers to unionize, workers’ entitlement to breaks and not being forced to work overtime, and so on.

TABLE 9-2

This table summarizes the responses from a survey conducted by the National Bureau of Economic Research that asked individuals about attitudes toward an item made under good working conditions and under poor working conditions.

2 International Agreements on Labor Issues

Survey Responses

Other Labor Agreements

Corporate Responsibility

Because of the pressure from consumers and unions, corporations have started to monitor and improve the conditions in their overseas plants and the plants of their overseas subcontractors.

Country Responsibility

Several U.S. trade laws give the president the power to withhold trade privileges from countries that do not give their workers basic rights, including the right to organize.

Living Wage

Is it fair to expect foreign firms to pay a living wage to their workers, that is, a wage above the norm in the developing country? Economists have a ready answer: the wages should be as high as the market will allow, and not any higher.

2 International Agreements on Labor Issues

HEADLINES

Wal-Mart Orders Chinese Suppliers to Lift Standards

Wal-Mart, the world’s biggest retailer, told its Chinese suppliers to meet strict environmental and social standards or risk losing its business.

This was likely in response to growing criticism in the U.S. over issues that include labor conditions in its supplier factories

The requirements include:

a clear demonstration of compliance with Chinese environmental laws,

an improvement of 20% in energy efficiency at the company’s 200 largest China suppliers, and

disclosure of the names and addresses of every factory involved in the production process.

HEADLINES

American Tariffs, Bangladeshi Deaths

The collapse of garment factories in Bangladesh in 2013 killed more than 1,000 workers. As a response, Sanchita Saxena of the University of California, Berkeley, proposes that the United States should reduce the tariff on garment imports from Bangladesh and other Asian countries.

Instead of reducing tariffs on imports from Bangladesh, President Obama increased the tariff on certain products by suspending the “preferential” trade treatment given to Bangladesh and other developing countries. The change in tariffs does not apply to garments, however, which already face high U.S. tariffs.

U.S. Suspends Bangladesh’s Preferential Trade Status

Environmental Issues in the GATT and WTO

3 International Agreements on the Environment

The WTO does not directly address environmental issues; other international agreements, called multilateral environmental agreements, deal specifically with the environment.

Environmental Issues in the GATT and WTO

TABLE 9-3 (1 of 2)

This table shows the outcome of environmental cases ruled upon by the GATT and WTO.

3 International Agreements on the Environment

Environmental Cases at the GATT and WTO

Environmental Issues in the GATT and WTO

TABLE 9-3 (2 of 2)

3 International Agreements on the Environment

This table shows the outcome of environmental cases ruled upon by the GATT and WTO.

Environmental Cases at the GATT and WTO (continued)

Does Trade Help or Harm the Environment?

Externalities

An externality occurs when one person’s production or consumption of a good affects another person.

Externalities can be positive, such as when one firm’s discoveries from research and development (R&D) are used by other firms, or negative, such as when the production of a good leads to pollution.

Closely related to the concept of externalities is the idea of market failure, which means that the positive or negative effects of the externality on other people are not paid for.

3 International Agreements on the Environment

Does Trade Help or Harm the Environment?

Externalities and Trade

3 International Agreements on the Environment

FIGURE 9-4 (1 of 2)

Panel (a) illustrates a negative production externality, which means that the social marginal cost curve, SMC, lies above the private marginal cost (supply) curve S. With free trade, the price falls from PA to PW and Home supply falls from Q0 to S1. As a result, the social cost of the externality is reduced by area c, which measures a social gain that is additional to the private gains from trade, area b.

Externalities and the Gains from Trade

Does Trade Help or Harm the Environment?

Externalities and Trade

3 International Agreements on the Environment

FIGURE 9-4 (2 of 2)

Panel (b) illustrates a negative consumption externality, meaning that the social marginal benefits, SMB, lie below the private marginal benefit (demand) curve D. The vertical distance between the SMB and D curve, times the quantity consumed, reflects the social cost of the externality. With free trade Home demand increases from Q0 to D1. As a result, the social cost of the externality increases by area d. That area is a social cost that offsets the private gains from trade, area b.

Externalities and the Gains from Trade (continued)

Examples of the Environmental Impact of Trade

U.S. Trade Restrictions in Sugar and Ethanol

The United States maintains an import quota on sugar, increasing the price of imported sugar. As a result firms purchase corn from American farmers to produce ethanol, which can be produced from sugar or corn.

Producing ethanol from corn is much less energy efficient. Corn depletes the soil and needs fertilizers in order to grow, which themselves use energy in their production.

In 2012 the U.S. eliminated a 54 cents per gallon tariff on ethanol. As a result, imports from Brazil rose dramatically, to 9.6 million barrels of ethanol in 2012.

Free trade in ethanol should in theory help alleviate the negative production externality of U.S. ethanol production from corn.

3 International Agreements on the Environment

Examples of the Environmental Impact of Trade

U.S. Automobile VER

The “voluntary” export restraint (VER) on exports of Japanese cars to the United States, which began in 1981, limited the number of cars that Japanese firms could export each year, but not their value.

As a result, there was an incentive for the Japanese firms to export larger and/or more luxurious models.

As the quality of the Japanese cars rose, so did the engine size and weight of the vehicles; as a result, the average gas mileage of the imported cars fell.

3 International Agreements on the Environment

Examples of the Environmental Impact of Trade

U.S. Automobile VER

FIGURE 9-5

U.S. Imports of Japanese Autos This figure uses data on Japanese imported cars from 1979 to 1982, before and after the “voluntary” export restraint with Japan began. The horizontal axis shows the change in the quantity sold (in percent) between these years, and the vertical axis shows the gas mileage of each model. The models with the lowest mileage—such as the Maxima, Cressida, and Mazda 626—had the greatest increase in sales between these years.

3 International Agreements on the Environment

The Tragedy of the Commons

Free trade can harm the environment when a resource is treated as common property that anyone can harvest. The resource may be subject to overuse, a phenomenon referred to as the tragedy of the commons.

Trade in Fish

When a resource such as fish is treated as common property that anyone can harvest, it will be subject to overfishing and its stocks will diminish rapidly over time as each producer seeks to maximize its own share of the resource.

According to one scientific study, 29% of fish and seafood species have collapsed; that is, their catch declined by 90% or more between 1950 and 2003.

3 International Agreements on the Environment

The Tragedy of the Commons

Trade in Buffalo

FIGURE 9-6

Buffalo Hide Imports This figure shows estimates of the imports to the United Kingdom and France of buffalo hides from the United States. The amount of imports into these countries was small or negative before 1871 but then grew rapidly and peaked in 1875. In that year, the United Kingdom and France combined imported more than 1 million hides and over the entire period from 1871 to 1878 imported some 3.5 million hides. Much of this trade volume can be attributed to an invention in London in 1871 that allowed buffalo hides to be tanned for industrial use.

3 International Agreements on the Environment

The Tragedy of the Commons

Trade in Solar Panels

When consumers install solar panels there is a positive consumption externality, because this source of electricity does not rely on the burning of fossils fuels, which contributes to climate change.

The extra social gains that come from free trade are even larger when one country subsidizes the production of solar panels and exports more panels at lower prices.

That is what the United States and the European Union believe that China has done. But rather than accept the low-priced solar panels, with the positive consumption externality, these countries have threatened to apply tariffs against China.

3 International Agreements on the Environment

International Agreements on Pollution

FIGURE 9-7

Payoffs in an Environmental Game

This payoff matrix shows the gains and losses for Home and Foreign countries, depending on whether they adopt environmental regulations. If governments weight producer surplus more than consumer surplus, then the structure of payoffs is similar to the prisoner’s dilemma because the Nash equilibrium is to have both countries not adopt regulations. That outcome can occur with “global” pollutants.

Multilateral Agreements

One example of an international agreement is the Montreal Protocol on Substances that Deplete the Ozone Layer, which has successfully eliminated the use of chlorofluorocarbons (CFCs).

Global Pollutants, Payoff Matrix, Nash Equilibrium

3 International Agreements on the Environment

APPLICATION

The Kyoto Protocol and the Copenhagen Accord

The Kyoto Protocol built on the United Nations’ 1992 treaty on climate change, established specific targets for reduction in greenhouse gas emissions: the industrial countries should cut their emissions of greenhouse gases by a collective 5.2% less than their 1990 levels.

APPLICATION

The Kyoto Protocol and the Copenhagen Accord

There are four reasons often given to explain why the United States did not join the Kyoto Protocol:

although the evidence toward global warming is strong, we still do not understand all the consequences of policy actions;

while the United States is the largest emitter of greenhouse gases, meeting the Kyoto targets would negatively affect its economy;

Kyoto failed to include the developing countries, especially China and India;

there are other ways to pursue reductions in greenhouse gas emissions.

APPLICATION

The Kyoto Protocol and the Copenhagen Accord

The Copenhagen Accord is a recognition that further increases in global average temperature should be kept below 2 degrees centigrade.

Under this accord, an agreement was made that industrialized countries will submit goals for greenhouse gas emissions reductions, while developing countries will communicate their efforts in this regard.

There is also the establishment of a fund to finance the needs of developing countries in fighting the effect of climate change.

In March 2010, China and India agreed to join the Copenhagen Accord, as has the United States and more than 100 other countries.

HEADLINES

Dismal Outcome at Copenhagen Fiasco

The Copenhagen Accord agreement recognizes the scientific case for keeping the rise in global temperatures to 2°C calling on developed countries to provide $100 billion a year in support of poor nations' efforts by 2020.

However, without additional specifications, there is ambivalence about who is paying what and to whom and how the regulation of emissions caps will be monitored.

Both the U.S. and China should lead by example, with unilateral low-cost carbon-abatement policies already announced or under consideration.

Aid to developing countries for greenhouse gas abatement is warranted, but should be negotiated separately.

1. There are two primary types of free-trade agreements: multilateral and regional. Multilateral agreements are negotiated among large groups of countries (such as all countries in the WTO) to reduce trade barriers among them, whereas regional agreements operate among a smaller group of countries, often in the same region.

K e y T e r m

KEY POINTS

2. Under perfect competition, we can analyze the benefits of multilateral agreements by considering the Nash equilibrium of a two-country game in which the countries are deciding whether to apply a tariff. The unique Nash equilibrium for two large countries is to apply tariffs against each other, which is an example of a “prisoner’s dilemma.” By using an agreement to remove tariffs, both countries become better off by eliminating the deadweight losses of the tariffs.

K e y T e r m

KEY POINTS

3. Regional trade agreements are also known as “preferential trade agreements,” because they give preferential treatment (i.e., free trade) to the countries included within the agreement, but maintain tariffs against outside countries. There are two types of regional trade agreements: free-trade areas (such as NAFTA) and customs unions (such as the European Union).

K e y T e r m

KEY POINTS

4. The welfare gains and losses that arise from regional trade agreements are more complex than those that arise from multilateral trade agreements because only the countries included within the agreement have zero tariffs, while tariffs are maintained against the countries outside the agreement. Under a free-trade area, the countries within the regional trade agreement each have their own tariffs against outside countries; whereas under a customs union, the countries within the regional trade agreement have the same tariffs against outside countries.

K e y T e r m

KEY POINTS

5. Trade creation occurs when a country within a regional agreement imports a product from another member country that formerly it produced for itself. In this case, there is a welfare gain for both the buying and the selling country.

K e y T e r m

KEY POINTS

6. Trade diversion occurs when a member country imports a product from another member country that it formerly imported from a country outside of the new trade region. Trade diversion leads to losses for the former exporting country and possibly for the importing country and the new trading region as a whole.

K e y T e r m

KEY POINTS

JNB (J.Baker) - In the text for this chapter there are 7 key points, only 6 are listed in the PPTs.

terms-of-trade gain

multilateral agreement

regional trade agreement

trade agreement

most favored nation principle

prisoner’s dilemma

K e y T e r m

KEY TERMS

preferential trade agreements

free-trade area

customs union

rules of origin

trade creation

trade diversion

externality

market failure

labor standards

living wage

multilateral environmental agreements

tragedy of the commons

common property

Kyoto Protocol

Copenhagen Accord