Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
10 EXPORT SUBSIDIES IN AGRICULTURE AND HIGH-TECHNOLOGY INDUSTRIES 1 WTO Goals 2 Agricultural Export Subsidies in Small Country 3 Agricultural Export Subsidies in Large Country 4 Agricultural Production Subsidies 5 High-Tech Export Subsidies 6 Conclusions Chapter Outline • Agricultural Export Subsidies in a Small Home country Impact of an Export Subsidy Impact of the Subsidy on Home Welfare • Agricultural Export Subsidies in a Large Home Country Effect of the Subsidy Home Welfare Foreign and World Welfare © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 2 of 118 Chapter Outline • Agricultural Production Subsidies Effect of a Production Subsidy in a Small Home Country Home Welfare Targeting Principle Effect of the Production Subsidy in a Large Home Country • High-Technology Export Subsidies “Strategic” use of High-Tech Export Subsidies Payoff Matrix Nash Equilibrium Best Strategy for Boeing Best Strategy for Airbus Multiple Equilibria © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 3 of 118 Chapter Outline Effect of a Subsidy to Airbus Best Strategy for Airbus Best Strategy for Boeing Nash Equilibrium European Welfare Subsidy with Cost Advantage for Boeing Best Strategy for Airbus Best Strategy for Boeing European Welfare Once Again Summary • Conclusions © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 4 of 118 Learning Objectives • Understand what an export subsidy is. • Understand agricultural subsidy policies. • Understand subsidies in the high-technology industry. • Understand how export subsidies can be used strategically by governments. • Understand the effects of export subsidies on prices, the amount of trade, and welfare. • Know how to use game theory to model strategic interactions between firms. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 5 of 118 Learning Objectives • Understand what a production subsidy is. • Understand the difference between an export subsidy and a production subsidy. • Understand the effect of a production subsidy on prices, the amount of trade, and welfare. • Understand why the WTO is focused more on eliminating export subsidies and less on production subsidies. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 6 of 118 Introduction • In December 2005, representatives of the 149 countries belonging to the WTO met in Hong Kong to discuss reforms of the world trading system. • The main focus of these meetings was the trade policy (tariffs and subsidies) on agricultural products. Lower world prices hurt farmers in land-rich developing countries like Brazil, India, and China. But lower world prices benefit land-poor developing countries that import agricultural products. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 7 of 118 Introduction • The first goal of this chapter is to explain agricultural subsidy policies. • The primary reason for agricultural export subsidies is political. • However, the fact that these subsidies are costly to those governments, and to exporters of land-rich developing countries, has led to pressures in the Doha round of WTO negotiations to remove them. • We will describe the tentative agreements to reduce agricultural subsidies made at the 2005 Hong Kong meeting, as part of the Doha round. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 8 of 118 Introduction • The second goal of this chapter is to examine how export subsidies can be used strategically by governments to bolster domestic companies and industries E.g. high-tech industries • Legislators often believe that subsidies to hightech industries might raise their profits and benefit the exporting countries. • Using the tools we have developed up to now, we examine the effects of export subsidies on prices, the amount of trade, and welfare. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 9 of 118 WTO Goals on Agricultural Export Subsidies • Table 10.1 describes the agreements made at the Hong Kong meeting of the WTO. • These have not been ratified by the legislatures in the countries involved so they are goals rather than outcomes. • Agricultural Export Subsidies An export subsidy is a payment to a firm for every unit exported. A fixed amount or a fraction of the sales price. Governments give subsidies to encourage domestic firms to increase production in particular industries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 10 of 118 WTO Goals on Agricultural Export Subsidies Table 10.1 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 11 of 118 WTO Goals on Agricultural Export Subsidies Table 10.1 cont. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 12 of 118 WTO Goals on Agricultural Export Subsidies • Agricultural Export Subsidies Member countries of the WTO agreed to abolish all export subsidies by the end of 2013. Europe maintains a system of agricultural subsides known as the Common Agricultural Policy (CAP). As a result, the sugar beet subsidy makes Europe a leading supplier of sugar, even though other countries have a natural comparative advantage over Europe. Other countries maintain similarly generous subsidies. U.S. pays cotton farmers to grow more cotton and subsidizes agribusiness and manufacturers to buy the American cotton. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 13 of 118 WTO Goals on Agricultural Export Subsidies • Agricultural Export Subsidies In Geneva, in July 2004, member countries agreed in principle to cut their export subsidies in agriculture, but slow progress has been made. At about the same time, several agricultural exporters, led by Brazil, brought a WTO case against sugar subsidies in Europe and cotton subsidies in the U.S. The WTO ruled in favor of Brazil in 2004, which also won appeals brought by Europe and the U.S. The favorable ruling created additional pressure for the Hong Kong talks. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 14 of 118 WTO Goals on Agricultural Export Subsidies • Indirect Subsidies Included in the Hong Kong agreements is the parallel elimination of indirect subsidies to agriculture, including food aid from developed countries to poor countries. Europe has already eliminated direct food subsidies and argues that cash aid to poor countries is much more effective. The U.S. continues to export agricultural commodities as aid. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 15 of 118 WTO Goals on Agricultural Export Subsidies • Domestic Farm Supports These include any assistance given to farmers, even if it is not directly tied to exports. These programs can still have an indirect effect on exports by lowering production costs, and therefore the competitiveness, of domestic products. • Cotton Subsidies Export subsidies in cotton received special attention because that crop is exported by many low-income African countries and is highly subsidized in the U.S. Although the U.S. agreed to eliminate them, it still leaves open other domestic supports to cotton not directly tied to exports. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 16 of 118 Brazil Wins Rulings on Two Trade Issues HEADLINES • The WTO ruled that the European Union’s sugar subsides and the U.S.’s cotton subsidies are illegal and violate the organization's rules. • This was a big victory for Brazil in their fight against farm aid in developing nations. • These disputes are part of efforts by developing and food exporting nations to influence wealthy governments to cut spending on farmers. • Both the U.S. and the EU plan on appealing the decision. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 17 of 118 Brazil Wins Rulings on Two Trade Issues HEADLINES • If the decision is upheld on appeal, it would force the U.S. to change its farm-payment legislation. • This could also cause a number of other countries to follow Brazil in submitting cases to the WTO. • If the decision is implemented by the U.S., cotton farmers will be hurt and may have to find other crops to plant. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 18 of 118 WTO Goals on Agricultural Export Subsidies • Other Matters From the Hong Kong WTO Meeting Another issue discussed is the use of tariffs as a response to another country’s subsidies. As we know, tariffs depress world prices, as do subsidies, so eliminating both is desirable. Subsidies also relate to other items on the WTO agenda, such as protectionist policies in the services sector. This becomes part of the negotiation trade off that occurs in WTO negotiations. Richer countries will trade off reductions in subsidies for access to service markets in poorer countries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 19 of 118 WTO Goals on Agricultural Export Subsidies • Countervailing Tariffs in Agriculture Whenever subsidies are used, exporting countries expect countervailing duties to be applied. Agriculture exporting developing countries tried to get these reduced, but were not successful in Hong Kong. • Issues Involving Trade in Industrial Goods and Services. Although there was agreement to achieve further cuts in the tariffs on industrial goods, the exact nature of the formula to be used has yet to be decided. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 20 of 118 WTO Goals on Agricultural Export Subsidies • Issues Involving Trade in Industrial Goods and Services There was also an agreement to discuss opening trade in the services sectors, which would benefit industrialized countries. The developing countries are expected to make some offer to open their market to trade in services. However, this is likely to lead to an expectation that wealthy countries accept more temporary immigrant workers in their service sectors. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 21 of 118 WTO Goals on Agricultural Export Subsidies • Issues Involving Trade in Industrial Goods and Services Finally, there was an agreement to allow tariff-free access to WTO member markets for 97% of imported products from the world’s 50 least-developed countries (LDCs). The U.S. already has this for 83% of products. Omitted from this, however, are textile imports into the U.S. from LDCs. U.S. wants to protect its domestic textile producers. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 22 of 118 Agricultural Export Subsidies in a Small Home Country • We now want to look at the effects of export subsidies on a country. • We start with a small Home country. Faces a fixed world price for its export. • Country will export sugar. • No trade equilibrium is shown in figure 10.1 at point A. World price of PW, Home quantity supplied at S1, quantity demanded at D1, and exports X1=S1-D1. • Quantity of exports is point B in panel b at free trade price of PW and export supply curve, X. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 23 of 118 Agricultural Export Subsidies in a Small Home Country Figure 10.1 The free trade equilibrium at world price PW, gives (without subsidy) exports of X1 and a horizontal Foreign import demand. Equilibrium is at B. Home Price World Price S D Home export supply X B PW Foreign import demand A D1 X1 S1 Quantity X1 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 24 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of an Export Subsidy Suppose the government wants to boost domestic exports of sugar. Each ton of sugar exported receives a subsidy, s. Exporters will receive PW+s for each ton exported. They are allowed to export all they want at the subsidized price and Home firms will not accept a price less than PW+s. If domestic price was lower than PW+s, the firms would just export their goods instead. Therefore, the domestic price must rise to PW+s. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 25 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of an Export Subsidy Home consumers could just import sugar at the world price, PW. Therefore, Home will impose a tariff equal to or higher than the amount of the export subsidy. This typically happens and, is therefore, realistic. The combined effect of the subsidy and the tariff is to raise the price at Home. Price is PW+s, Home supply increases to S2, Home demand falls to D2, Home exports increase to X2=S2D2. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 26 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of an Export Subsidy The change in the quantity of exports can be thought of in two ways reflected by points C and C’ in panel b. If we measure Home price PW on the vertical axis, C is on the original Home export supply curve, showing a movement along the curve. As the Home price has increased, the quantity of Home exports has increased from B to C. If we use the vertical axis as world price, which is fixed in our small country, the increase in exports due to the subsidy can be interpreted as a shift of the domestic export supply curve – point C′. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 27 of 118 Agricultural Export Subsidies in a Small Home Country Figure 10.1 (with subsidy) ThisHome decreases to D2, shifts increases to S2the , and The exportdemand supply curve downsupply by exactly increases exports to Xthe . Equilibrium atfalls C.to by amount ofthe the subsidy. of production s. With subsidy, Home priceisrises PWexactly +s 2MC Home Price World Price X S D X–s C PW+s B s PW C' s A D2 D1 X1 X2 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 28 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of an Export Subsidy Export subsidies increase both the price and quantity of exports. A movement along the domestic export supply curve. For the world perspective, the export subsidy results in an increase in export supply. Given the fixed world price, this means the export supply curve shifts down by the amount of the subsidy, s. As with a tariff, the subsidy has driven a wedge between what domestic exporters receive (PW+s), and what importers abroad pay (PW). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 29 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of the Subsidy on Home Welfare The rise in price lowers consumer surplus by (a+b). The rise in price raises producer surplus by (a+b+c). The export subsidy costs the government the amount of the subsidy, s, times the amount of exports, X2 shown by (b+c+d). Adding up this impact, we are left with a net effect on Home welfare of –(b+d). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 30 of 118 Agricultural Export Subsidies in a Small Home Country Figure 10.1 The increased price decreases consumer surplus by (a+b) (with welfare effects) Producer surplus increases by (a+b+c) The subsidy costs the government the amount –(b+c+d) This leaves us with a deadweight loss of (b+d) as before. Home Price World Price S D b Total deadweight loss, b+d d a X–s C PW+s s X B c PW C' s A D2 D1 X2 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 31 of 118 Agricultural Export Subsidies in a Small Home Country • Impact of the Subsidy on Home Welfare The deadweight loss due to the subsidy in a small country is similar to the effects of a tariff. Areas b and d have particular meanings. Triangle d equals the increase in marginal costs for the extra unit produced due to the subsidy. This is the production loss or efficiency loss for the economy. Triangle b is the drop in consumer surplus for those who no longer get to the consumer. This is the consumer loss for the economy. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 32 of 118 Agricultural Export Subsidies in a Large Home Country • Now suppose Home is large enough that its subsidy affects the world price of sugar. • Figure 10.2 shows the effects of the subsidy. • The Foreign export demand curve, M*, is downward sloping since changes in the amount exported will affect world price. • As before, in free trade, Home and world price is PW, Home exports X1=D1-S1. • The world export market is in equilibrium where Home export supply, X, and foreign import demand curve, M*, cross. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 33 of 118 Agricultural Export Subsidies in a Large Home Country • Effect of the Subsidy Home applies a subsidy, s. The Home export supply curve shifts right by the amount of the subsidy, X-s. The new intersection with the Foreign import demand gives a new equilibrium at P* and X2. Price is lower and exports are higher. Note that the new world price, P*, is less than PW although the new Home price is PW+s. Since Foreign consumers pay a lower price for Home exports, Home terms of trade fall but foreign terms of trade rise. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 34 of 118 Agricultural Export Subsidies in a Large Home Country • Effect of the Subsidy Since Home terms of trade fall, the Home country will suffer overall losses. Foreign consumers will gain. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 35 of 118 Agricultural Export Subsidies in a Large Home Country Figure 10.2 We begin in free trade equilibrium (with subsidy) Home demand applies adecreases subsidy, shifting and home the export supplysupply increases curve leading right by to the amountexports, increased of the subsidy, X2 s The new world price is at new equilibrium, P*. New Home price is P*+s (a) Home Market (b) World Market Home Price World Price D Home exports supply, X S X2 P*+s s X1 s X–s PW P* Foreign import demand, M* D2 D1 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 36 of 118 Agricultural Export Subsidies in a Large Home Country • Home Welfare We can see the welfare effects of the subsidy in figure 10.2. The higher Home price reduces consumer surplus by (a+b). Additionally, the higher price increases producer surplus by (a+b+c). We also need to consider the cost of the subsidy—the amount of the subsidy times the exports after the subsidy, area (b+c+d+e). This gives a net welfare loss of (b+d+e). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 37 of 118 Agricultural Export Subsidies in a Large Home Country Figure 10.2 Consumer surplus falls by -(a+b). (with subsidy) Producer surplus increases by +(a+b+c). Home Welfare The subsidy costs the government (b+c+d+e): subsidy times exports. Home Price D b d S This leaves a net deadweight loss of (b+d+e), greater than in a small country. P*+s c a s PW e P* D2 D1 S1 S2 Quantity © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 38 of 118 Agricultural Export Subsidies in a Large Home Country • Home Welfare In a small country, the deadweight loss associated with the subsidy is only (b+d). In a large country, there is an additional deadweight loss, (e), which is from the terms of trade loss to Home: e = e’ + f in panel b. From Home’s perspective, the terms of trade loss is just (e), but when we move to foreign welfare next, it will be useful to break up (e) into the two parts e’ and f. Due to a reduction in the world price of its exported good, a large country loses even more from a subsidy than a small country. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 39 of 118 Agricultural Export Subsidies in a Large Home Country • Foreign and World Welfare While Home definitely loses, Foreign definitely gains. Figure 10.2 panel b shows the welfare effects from the subsidy. The price of Foreign imports decreases leading to an increase in Foreign consumer surplus by (e′). The fall in the price of Foreign imports also improves Foreign’s terms of trade. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 40 of 118 Agricultural Export Subsidies in a Large Home Country • Foreign and World Welfare Combining Home welfare loss of (b+d+e) and subtracting Foreign terms-of-trade gain (e′), there is an overall deadweight loss for the world, (b+d+f) in panel b. The area (f) is the additional world deadweight loss due to the subsidy. This arises from the terms-of-trade loss in Home which is not completely offset by the terms-of-trade gain in Foreign. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 41 of 118 Agricultural Export Subsidies in a Large Home Country Figure 10.2 World Consumer surplus rises by -(e’) which is a terms of trade gain With Home welfare loss of (b+d+e) and Foreign terms-of-trade gain (e’), there is World an overall loss for the world of of f is an additional lossdeadweight due to decrease in Home’s terms (b+d+f) in completely panel b trade not offset by increases in World’s terms of trade (without subsidy) (a) Home Market (b) World Market Home Price World Price D b d S Home exports supply, X b+d P*+s c a s s PW e X–s f e' P* Foreign import demand, M* D2 D1 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 42 of 118 Agricultural Export Subsidies in a Large Home Country • Foreign and World Welfare This transfer of terms of trade is what countries sometimes use to make subsides sound like good ideas to “aid” poorer countries. However, the deadweight loss (f) means using the export subsidy to increase exports is an inefficient way to transfer gains from trade among countries. It would be more efficient to just give cash aid to the poorer countries. Cash does not change trade levels so would not have deadweight loss of (b+d+f). This is why the European countries eliminated transfers of food as a form of aid several years ago. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 43 of 118 Who Gains and Who Loses? APPLICATION • Let’s return to the Hong Kong meeting of the WTO in December 2005 to see which countries will gain and which will lose when the export subsidies are eliminated by 2013. • Gains Obvious winners will be current agricultural exporters in developing countries such as Brazil, Argentina, Indonesia, and Thailand, along with potential exporters such as India and China. These countries will gain even more when and if an agreement is reached on eliminating agricultural tariffs in the industrial countries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 44 of 118 Who Gains and Who Loses? APPLICATION • Gains These actions will also benefit industrial countries, suffering from deadweight losses and terms-of-trade losses from the combination of subsidies and tariffs. Clearly the farmers in industrial countries who lose the subsidies will be worse off. Given that it is usually the largest farmers who gain the most from subsidy programs, they may be better able to adjust to the elimination of subsidies than smaller farmers. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 45 of 118 Who Gains and Who Loses? APPLICATION • Losses Given that eliminating subsidies will typically lead to increased world prices, food-importing countries, typically the poorer non-food producing countries, will lose. One study finds that the existing pattern of agricultural supports raises the per-capita income of two-thirds of 77 developing nations, including most of the poorest countries such as Burundi and Zambia. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 46 of 118 Who Gains and Who Loses? APPLICATION • Losses Figure 10.3 shows some of these results. Poor countries are net importers of essential food items such as corn, rise, and wheat, and would be harmed by an increase in their world price. Many of the world’s poorest individuals depend on cereal crops for much of their diet and would be especially hard hit by any increase in those prices. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 47 of 118 Who Gains and Who Loses? APPLICATION Figure 10.3 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 48 of 118 Who Gains and Who Loses? APPLICATION Figure 10.3 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 49 of 118 Who Gains and Who Loses? APPLICATION • Food Aid What about indirect subsidies like food aid? The U.S. is still a principle supplier of food aid. This is for humanitarian purposes and to eliminate surplus commodities at Home. There is clearly a need for donations of food in cases of true food shortages. However, the U.S. also provides food aid shipments to areas without shortages. This can decrease local prices and harm local producers. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 50 of 118 Who Gains and Who Loses? APPLICATION • Food Aid European countries argue that it is better to have United Nations relief agencies buy food from local farmers in poor regions and then distribute it as needed. This boosts production in the poor country and helps feed its poorest citizens. The EU insisted on the elimination of indirect subsidies to regions without shortages by 2013, along with direct export subsidies. The goal has not yet been implemented. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 51 of 118 Who Gains and Who Loses? APPLICATION • While this was being discussed in Hong Kong, several U.S. agencies placed an advertisement in the Financial Times. • A response from Peter Mandelson, the European Commissioner for Trade, and Marian Fisher Boel, the European Commissioner for Agricultural and Rural Development, was also published in the Financial Times. • That letter was followed a week later by a letter response from the United Nations World Food Programme. • These exchanges make it clear the complexity of negotiations, where emotions run high, in the Doha Round. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 52 of 118 Agricultural Production Subsidies • The agreements reached in Hong Kong distinguish between export subsidies in agriculture and all other forms of domestic support that increase production. Tax incentives and other types of subsidies • This is because it is expected that these other forms have less impact on exports than do direct subsidies. • In this section, therefore, we will examine the impact of a production subsidy in agriculture for both a small and a large country. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 53 of 118 Agricultural Production Subsidies • A production subsidy is when the government provides a subsidy of s dollars for every unit (for example, tons of sugar) that a Home firm produces. It is a subsidy to every unit produced, not just to units exported. • The subsidy can be implemented by the government: guaranteeing a minimum price to the farmer. providing subsidies to the users of the crop to purchase it, thereby increasing demand for the crop and the price. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 54 of 118 Agricultural Production Subsidies • These policies all fall under Article XVI of the GATT. • This states that partner countries should be notified of the extent of such subsidies, and where possible, these subsidies should be limited. • In Hong Kong, the WTO members further agreed to classify countries according to the extent of such subsidies. • Table 10.1, described earlier, shows level of production subsidies for different countries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 55 of 118 Agricultural Production Subsidies • Effect of a Production Subsidy in a Small Home Country We have a small country with a fixed world price of PW. There is a subsidy of s increasing Home price to producers to PW+s. Home quantity supplied increases from S1 to S2. Quantity demanded at home does not change since producers still charge the world price at Home. This happens because Home producers receive the subsidy no matter who they sell to. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 56 of 118 Agricultural Production Subsidies • Effect of a Production Subsidy in a Small Home Country This contrasts with an export subsidy where Home firms only receive the subsidy for export sales and must sell to Home at the higher export price. You can see these effects in figure 10.4. The production subsidy increases exports to X2 = S2 – D1. The production subsidy increases exports by less than an export subsidy. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 57 of 118 Agricultural Production Subsidies Figure 10.4 (with production subsidy) Subsidy to producers increasing supply to We can increases see in (b) price that Home export supply increases, S-s producing S2. Home quantity demanded showing that exports increase from X1 to X2. does This not is a change. smaller increase than with an export subsidy since Home demand does not change. (a) Home Market (b) World Market Home Price World Price X D S S-s X’ C PW+s s B PW C' D1 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 58 of 118 Agricultural Production Subsidies • Home Welfare Producer surplus rises by (a+b) in panel a. Government cost of the subsidy is (a+b+c) – the amount of subsidy s times total production S2. Consumer surplus is unaffected since quantity demanded is unaffected. This leaves a new effect on Home welfare of (–c). The deadweight loss caused by the production subsidy, (c), is less than that caused by the export subsidy, (b+d). The only deadweight loss is in production inefficiency— producers produce at higher than marginal cost. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 59 of 118 Agricultural Production Subsidies Figure 10.4 (with welfare effects) Home producer surplus rises by (a+b) Subsidy costs government (a+b+c) Deadweight loss from production subsidy is c, which is less than with export subsidy of (b+d) in figure 10.1. (a) Home Market (b) World Market Home Price World Price X D S S-s C PW+s a s X’ b PW B c C' D1 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 60 of 118 Agricultural Production Subsidies • Targeting Principle Since the deadweight loss is lower for this subsidy than for the export subsidy, it makes a better policy instrument for the purpose of increasing Home supply. This is an example of the targeting principle. To achieve some objective, it is best to use the policy instrument that achieves the objective most directly. There are many examples of using a targeting principle in economics: Taxes on cigarettes and gasoline. To use an example from this book, it is better to provide trade adjustment assistance directly to those affected, than to impost a tariff or quota. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 61 of 118 Agricultural Production Subsidies • Effect of Production Subsidy in a Large Home Country We will not draw this case in detail but will use figure 10.4 to briefly explain. Price rises from PW to PW+s, and Home production increases to S2. Since demand has not changed, exports increase by the same amount as the change in Home supply. This is shown by the outward shift in the export supply curve from X to X′ in Panel b. The rise in exports from B to C′ is less than the increase in exports with an export subsidy, from B to C. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 62 of 118 Agricultural Production Subsidies Production Subsidy for a Small Country Large Home Country W +san export This increase exports (B to less than we curve saw with Thesee production subsidy leads to is increase in price to P We this asinan increase inC′) the export supply from X to X’ subsidy (B to C). and increased productionfrom to SB2 increasing exports by S1-S2 changing the equilibrium to C’ (a) Home Market (b) World Market Home Price World Price X D S S-s X’ C PW+s s B PW C' ΔX D1 S1 S2 Quantity X1 X2 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Exports 63 of 118 Agricultural Production Subsidies • Effect of Production Subsidy in a Large Home Country In the export supply subsidy, the increase in exports occurred due to the increase in supply and the decrease in demand. The export supply curve shifted down by the exact amount of the subsidy, s, (as in figure 10.1). With a production subsidy, the exports increased only due to the increase in Home production. The export supply curve then shifted down by an amount less than s, (as in figure 10.4). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 64 of 118 Agricultural Production Subsidies • Effect of Production Subsidy in a Large Home Country If we draw a downward-sloping foreign import demand curve in panel b, then the increase in supply due to the production subsidy would lower the world price. But the drop in world price would be less than the drop that occurred with the export subsidy, since the increase in exports is less. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 65 of 118 Agricultural Production Subsidies • Production subsidies in agriculture still lower world prices, but by less than export subsidies. • Therefore, the WTO is less concerned about eliminating production subsidies and other forms of domestic support for agriculture. • These other policies have a smaller impact on world prices and a smaller deadweight loss as compared to export subsidies. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 66 of 118 High-Technology Export Subsidies • We now change focus from agriculture to hightechnology products. • The high-tech sector also receives substantial subsides from the government. An example being subsidies to the aircraft industries in both the U.S. and Europe. • In the U.S., subsidies take the form of low-interest loans provided by the Export-Import Bank. The Export-Import Bank is a U.S. government agency that finances export related projects. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 67 of 118 High-Technology Export Subsidies • On the European side, support for R&D and other subsidies are given to Airbus directly by the government. Airbus produces parts and assembles its finished product in a number of European countries. • Japan and South Korea give direct subsidies to high-tech manufacturing firms and reach certain targets for export sales. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 68 of 118 High-Technology Export Subsidies • Another reason that some governments support high-tech industries is because of the possible spillover benefits to other areas of the economy. • Governments believe there is a positive externality that exists from the production of hightech products, so subsidizing them increases production and minimizes the externality. • This is similar to the infant industry argument for tariffs, but is applied to an export instead of an import. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 69 of 118 High-Technology Export Subsidies • “Strategic” Use of High-Tech Export Subsidies Governments argue subsidies might give a strategic advantage to export firms competing with a small number of rivals in international markets. If high-tech subsidies allow firms to compete more effectively and earn more profits in the international market, and if extra profits are greater than the subsidy, then the exporting country has an overall gain. This is similar to the benefit a large country can get from a tariff. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 70 of 118 High-Technology Export Subsidies • “Strategic” Use of High-Tech Export Subsidies We will use an assumption of imperfect competition to examine this issue. We allow for 2 firms in the market—a duopoly. Each firm can set the price and quantity of its output based on the price and quantity decisions of the other firm. We then examine the effects of strategic export subsidies in determining whether the profits of the exporting firm will rise enough to offset the cost of the subsidy to the government. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 71 of 118 High-Technology Export Subsidies • “Strategic” Use of High-Tech Export Subsidies To capture strategic decision making of two firms, we will use game theory. The modeling of strategic interactions (games) between firms as they choose actions that will maximize their returns. The goal is to model the strategic interactions of high-tech firms in Home and Foreign, and then see the impact of export subsidies on their respective decisions and payoffs. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 72 of 118 High-Technology Export Subsidies • “Strategic” Use of High-Tech Export Subsidies We begin with free trade. Two firms are competing for sales of a new type of aircraft. We will focus on the decision of each firm to develop the new aircraft, that competes with the aircraft of the other firm for sales to the rest of the world. We will ignore sales in their own countries, so we do not have to keep track of consumer surplus. Welfare is only dependent on the profits earned by Boeing or Airbus from sales to the rest of the world. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 73 of 118 “Strategic” Use of High-Tech Export Subsidies • Payoff Matrix Figure 10.5 shows a payoff matrix for Boeing and Airbus. Each producer must decide whether or not to produce the new aircraft. Each quadrant of the matrix shows the profit earned by Boeing in the lower-left corner. The profits of Airbus are in the upper-right corner. When both firms produce (upper left quadrant), their prices are reduced through competition, and both end up making negative profits of $5 million. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 74 of 118 “Strategic” Use of High-Tech Export Subsidies • In the top right quadrant Airbus is not producing: profits $0. Boeing is producing: profits $100 million. • In the bottom left quadrant Airbus is producing: profits $100 million. Boeing is not producing: profits $0. • In the bottom right quadrant Neither firm is producing. Profits for both are $0. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 75 of 118 “Strategic” Use of High-Tech Export Subsidies Figure 10.5 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 76 of 118 “Strategic” Use of High-Tech Export Subsidies • Nash Equilibrium We want to determine the outcome of this game between the two firms. We use the concept of the Nash Equilibrium. Each firm must make its own best decision, taking as a given each possible action taken by the rival firm. That is, the action of each player is the best possible response to the action of the other player. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 77 of 118 “Strategic” Use of High-Tech Export Subsidies • Best Strategy for Boeing What are Boeing’s possible strategies if Airbus chooses to produce? To find this, we look only at the column where Airbus is producing and see where Boeing is better off. In this case, Boeing is clearly better off not producing. This gives a profit of $0, rather than a profit of -$5 million This tells us that BOTH firms NOT producing is NOT a Nash Equilibrium. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 78 of 118 “Strategic” Use of High-Tech Export Subsidies • Best Strategy for Airbus What if Boeing does not produce? What is the best strategy for Airbus? We now look only at the bottom row of the matrix where Boeing is not producing. In this case, it is clear that Airbus is better off producing with a profit of $100 million versus $0. Therefore, we have a Nash Equilibrium when Airbus produces and Boeing does not. Each firm is making its best decision given what the other firm is doing. The bottom left square is a Nash Equilibrium. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 79 of 118 “Strategic” Use of High-Tech Export Subsidies • Multiple Equilibria Is it possible to have more than one Nash Equilibrium? What if Boeing decides to produce first. We can then look at the top row and see that Airbus’ best strategy is to not produce. If Airbus does not produce, looking at the last column of the matrix, Boeing’s best strategy is to produce. Therefore, the top right-hand box, with Boeing producing and Airbus not producing, is also a Nash Equilibrium. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 80 of 118 “Strategic” Use of High-Tech Export Subsidies • Multiple Equilibria When there are two Nash equilibria, then there must be some force that determines which one we are in. One of these is the first mover advantage. One firm is able to decide whether or not to produce before the other firm. Suppose we start at the Nash equilibrium in the upperright quadrant. Because Airbus is not producing and making $0 profits, the government in Europe might want to try to change the equilibrium so that Airbus would earn positive profits. The government might want Airbus to produce. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 81 of 118 “Strategic” Use of High-Tech Export Subsidies • Multiple Equilibria The European government might decide to provide subsidies to Airbus to achieve this. What happens to the payoff matrix, if anything, in such a case? The type of subsidy we will consider is a cash payment to Airbus. But in practice we know that subsidies can take on many forms. We will present a subsidy example in the “Headlines” section next. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 82 of 118 Airbus, China and Quid Pro Quo HEADLINES • Airbus was negotiating to build an assembly line for a new passenger plane in China. • The deal would have a significant effect on its business dealings there. • Producing European planes in China would give Airbus an advantage in the battle with Boeing for the world’s next great aviation market. • Airbus has 344 planes in service in China, Hong Kong, and Macao, but Boeing still dominates with nearly 2/3 of the market. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 83 of 118 Airbus, China and Quid Pro Quo HEADLINES • Airbus’ move shows the lengths it is willing to go to break into China’s market, despite being active there since 1985 without success. • Boeing has no plans to build a production line in China, but has still won orders to supply many of its 737s to Chinese carriers. • Airbus could greatly aid Europe in cultivating commercial ties with China. • Chinese and French leaders celebrate visits to each other with the signing of aircraft deals. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 84 of 118 “Strategic” Use of High-Tech Export Subsidies • Effect of a Subsidy to Airbus Suppose the European governments provide a subsidy of $25 million to Airbus to produce. This increases Airbus’ profits by $25 million when it produces. Figure 10.6 shows the new payoff matrix. Remember that under free trade the Nash equilibrium existed when one firm produced and the other did not. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 85 of 118 “Strategic” Use of High-Tech Export Subsidies • Best Strategy for Airbus Let’s begin at the Nash Equilibrium where Boeing produces and Airbus does not. After the subsidy, this is no longer a Nash equilibrium. If Boeing is producing then Airbus is now better off by also producing because of the $25 million subsidy. With the subsidy it now earns $20 million even when Boeing produces ($25 subsidy - $5 losses). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 86 of 118 “Strategic” Use of High-Tech Export Subsidies Figure 10.6 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 87 of 118 “Strategic” Use of High-Tech Export Subsidies • Best Strategy for Boeing If Airbus is now producing, is Boeing still making the best decision? When Airbus produces, Boeing loses $5 million when it produces, but loses nothing when it does not produce. Boeing will therefore find it best to drop out of the market and not produce. Once Boeing decides not to produce, Airbus’ decision does not change. The payoff to Airbus, however, now increases from $20 to $125 million. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 88 of 118 “Strategic” Use of High-Tech Export Subsidies • Nash Equilibrium It is easy to check that this result - the lower-left quadrant is a Nash equilibrium. Each firm is making its best decision, given the action of the other. It is also the only Nash equilibrium in this game. The effect of the government subsidy has been to shift the equilibrium from having Boeing as the only producer, to Airbus as the only producer. This is the only equilibrium possible now. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 89 of 118 “Strategic” Use of High-Tech Export Subsidies • European Welfare The subsidy has a big impact on the equilibrium of the game, but is Europe better off? We can add up the welfare of various parties involved. Since Europe is producing for the rest of the world, there is no consumer surplus in Europe. Airbus’ profits have increased from $0 to $125 million. The revenue cost of the subsidy is $25 million. The net gain in European welfare is +$100 million. The increase in profits are greater than the cost of the subsidy. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 90 of 118 Subsidy with Cost Advantage for Boeing • What about cost differences? Let us now consider another case in which Boeing has a cost advantage over Airbus. Assume the advantage is not from a subsidy, but due to U.S. comparative advantage in aircraft production. This gives another payoff matrix in figure 10.7. Boeing earns profits of $5 million when both firms produce, and profits of $125 million when Airbus does not produce. The only Nash equilibrium—the upper right quadrant— is where Boeing produces and Airbus does not. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 91 of 118 Subsidy with Cost Advantage for Boeing Figure 10.7 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 92 of 118 Subsidy with Cost Advantage for Boeing • Can we have both? Now suppose the European government provides the $25 million subsidy to Airbus but Boeing still has the cost advantage. Best Strategy for Airbus With the subsidy in place, and Boeing producing, the best decision for Airbus is to produce and earn profits of $20 million. Best Strategy for Boeing Given that Airbus produces, Boeing earns profits of $5 million when it produces and $0 when it does not. Therefore, Boeing will stay in the market. Both firms producing is now the new Nash equilibrium. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 93 of 118 Subsidy with Cost Advantage for Boeing Figure 10.8 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 94 of 118 Subsidy with Cost Advantage for Boeing • European Welfare Once Again When Boeing has the cost advantage, the European subsidy allows Airbus to enter the market. This has not resulted in the exit of Boeing as it did in the earlier no-cost-advantage scenario. Airbus’ profits have increased from $0 to $20 million. The revenue cost of the subsidy to Europe is still $25 million. The net gain in European welfare is now -$5 million. When Boeing has the cost advantage, the subsidy leads to a net loss in European welfare. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 95 of 118 Subsidy with Cost Advantage for Boeing • Summary Under conditions of imperfect competition, a subsidy by one government to its exporting firm might increase welfare for its nation or it might not. There is an increase in welfare only if profits rise by more than the cost of the subsidy. This is more likely satisfied if the subsidy leads to the exit of the other firm. However, if both firms remain in the market, it is unlikely that the increase in profits for the subsidized firm will exceed the subsidy cost. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 96 of 118 Subsidies to Commercial Aircraft APPLICATION • In the large passenger aircraft market, there are now two large firms. Boeing in the U.S. (who merged with McDonnellDouglas in 1997) Airbus in Europe. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 97 of 118 Subsidies to Commercial Aircraft APPLICATION • The U.S. and Europe have used various types of subsidies to support their respective firms: 1. Indirect subsidies that arise because the R&D for military versions effectively subsidize R&D for civilian aircraft. 2. The government might directly subsidize the R&D costs of a new aircraft, as Europe subsidizes R&D at Airbus. 3. The government can subsidize the interest rates that aircraft buyers pay when they borrow money to purchase aircrafts. Europe and the U.S. both provide low interest loans to aircraft purchasers. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 98 of 118 Subsidies to Commercial Aircraft APPLICATION • 1992 Agreement Realizing the subsidies are costly, the U.S. and Europe reached an agreement in 1992 to limit them. The main feature of the agreement is in Table 10.2. Development subsidies are now limited to 33% of the total development costs of a new aircraft. It is expected that these subsidies will be paid back at the government interest rate. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 99 of 118 Subsidies to Commercial Aircraft APPLICATION • 1992 Agreement: Limits indirect (military) subsidies to not more than 4% of any firm’s annual sales. Prohibits production subsidies. Limits the ability of government agencies to subsidize the interest rate on purchases of aircrafts. • Reducing subsidies led to a rise in prices for aircraft by 3.1% and 8.8%. • Governments benefited from no longer paying the subsidy. • Higher prices helped the firms, but led to welfare losses for purchasing countries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 100 of 118 Subsidies to Commercial Aircraft APPLICATION • Major Provisions of the 1992 Agreement Aircraft Covered Direct Support Levels Interest Rates Indirect Supports Escape Clause on Emergency Aid Production Supports Dispute Settlement Mechanisms © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 101 of 118 Subsidies to Commercial Aircraft APPLICATION • The Super Jumbo There are claims that the terms of the agreement are being violated by Airbus. It is selling a new aircraft, the double-decker A380, which is larger than the Boeing 747 and competes directly with it. The expenditures to develop the A380 are estimated at $12 billion. The European governments provided about $3.5 billion in low-interest loans to cover development costs. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 102 of 118 Subsidies to Commercial Aircraft APPLICATION • The Super Jumbo In 2005, both the U.S. and the EU filed countercomplaints at the WTO regarding illegal subsidies by the other party to their respective aircraft producers. Europe was accused of “illegally” subsidizing the A380, while the U.S. was accused of subsidizing the development of Boeing’s 787 commercial jet. The complaints charged that these subsidies violate the 1992 agreement. The U.S. is calling for termination of the agreement. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 103 of 118 Subsidies to Commercial Aircraft APPLICATION • National Welfare Will the subsidies to Airbus increase national welfare? From the previous information, it is more likely to happen if Airbus is the only firm producing in that market. Boeing has announced it will not produce a doubledecker like the A380. It will instead modify its current 747 and focus R&D on its new 787 “Dreamliner” aircraft. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 104 of 118 Subsidies to Commercial Aircraft APPLICATION • National Welfare Since Boeing will not enter the double-decker market, it is possible the profits earned by Airbus will cover the subsidy. Of course that assumes the Boeing plane is not more of a direct competitor to the Airbus. The profits earned will depend on how many are sold and at what price. Airbus says it needs to produce at least 250 planes to cover development costs, but expects to sell 1,500 over the next 20 years. As of April 2006, it has orders for only 159 and many of those has been discounted at least 10%. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 105 of 118 Subsidies to Commercial Aircraft APPLICATION • National Welfare In mid-June 2006, Airbus told its buyers it could not deliver as promised—delays of 6 months or more. Several of the largest customers entered into discussions to seek compensations for the delay. Singapore Airlines announced it would order the Boeing 787 “Dreamliner” instead. The stock price of Airbus’ parent company, EADS, fell by more than one-quarter of its value in a single day. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 106 of 118 Subsidies to Commercial Aircraft APPLICATION • These events do not mean the Airbus A380 will fail; delays happen often in this industry. • These events do, however, illustrate the intensity of the competition in the airline industry. • This competition benefits consumers who will be traveling on the new aircraft. • However, competition makes it more difficult for government subsidies to be recovered in profits © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 107 of 118 Airbus in a spin as investors punish delays HEADLINES • Due to the production delays, Airbus’ parent company, EADS, lost value on the market. • Recently Airbus has struggled with many problems on the production of their A380. • Boeing on the other hand has been successful in orders on its new 787 “Dreamliner” ramping up the competition for Airbus. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 108 of 118 Airbus in a spin as investors punish delays HEADLINES • Problems in new aircraft development is not unique to Airbus. • In 1990, Boeing had to shut down assembly lines and lost an assembly system due to issues with keeping suppliers and deliveries on time. • It also appears that Boeing may be having early problems and delays in development of the 787, but still claims they will have on time deliveries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 109 of 118 Airbus in a spin as investors punish delays HEADLINES • Last year the industry had a significant number of orders, higher than the previous industry peak. • EADS’ profits rose 17% in 2005 and were forecasted to rise 19% in 2006. • It was stated that delays from the A380 would not show in profit forecasts until 2007. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 110 of 118 Conclusion • Countries use export subsidies in a wide range of industries, including agriculture and hightechnology. • In agriculture, there is an underlying motivation for the subsidies to raise food prices and therefore incomes to farmers. • We found that export subsidies raise prices for producers, increasing their real income and their producer surplus. • This costs consumers due to higher food prices in the exporting country. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 111 of 118 Conclusion • We obtained the net loss due to the subsidy for the exporting country, which is a deadweight loss similar to a tariff in a small country. • For a large country, an import tariff and an export subsidy have different welfare implications. • Both export subsidies and import tariffs lead to a rise in domestic prices and a fall in world prices. • The fall in world prices from an export subsidy is a terms-of-trade loss for the exporting country. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 112 of 118 Conclusion • Applying an export subsidy in a large exporting country leads to even greater losses than applying it to a small country. There is no possibility of gain, as we found for a largecountry import tariff. • The losses due to an export subsidy, for either a small or large country, are less severe when we instead consider production subsidies. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 113 of 118 Conclusion • A production subsidy provides a farmer with an extra payment for every unit produced, regardless of whether it is sold at home or abroad. • Consumer prices do not change from their world level and exports increase only because domestic supply increases. • The excess supply due to the subsidies will indirectly spillover into international markets. • Losses due to production subsidies in an exporting country are less severe than the losses due to export subsidies. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 114 of 118 Conclusion • At the Hong Kong meetings of the WTO, countries agreed to eliminate export subsidies in agriculture by 2013. • The losses experienced by an export country due to subsidies potentially changes when we consider high-technology industries. • We showed that it is possible for an export subsidy to lead to gains for the exporting country, if increased profits outweigh the cost of the subsidy. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 115 of 118 Conclusion • This, however, usually requires forcing the other firm out of business, which does not always occur. • If both firms do stay in the market, and are both subsidized, it is unlikely that the subsidies are in the national interest of the countries • The countries that buy the goods, however, gain from lower prices. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 116 of 118 Key Points 1. An export subsidy leads to a fall in welfare for a small exporting country, similar to losses due to import tariffs. 2. In the large country case, an export subsidy lowers the price of that product in the rest of the world. 3. Export subsidies applied by a large country create a benefit for importing countries in the rest of the world, by lowering their import prices. 4. Production subsidies to domestic producers also have the effect of increasing domestic production. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 117 of 118 Key Points 5. It is common for countries to provide subsidies to their high-technology industries because governments believe that these subsidies can create a strategic advantage to their firms in international markets. 6. A Nash equilibrium is a situation where each player in a game is making their best response to the action of the other player. 7. Export subsidies can affect the Nash equilibrium of a game by altering the profits of the firms. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 118 of 118