Download Macroeconomics, foreign trade and the European Union. Basics.

Macroeconomics, foreign trade and the
European Union. Basics and Examples.
Lecture 2.
November 30th
Macroeconomics, foreign trade and European Union. Basics.
Today‘s topics
• Tariffs. What they are, what they cause.
• free trade zones: a better world? A theoretical approach
• comparative static analysis of free trade
• dynamic effects of free trade
• Is EU a useful free trade zone?
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Tariffs – a fact in international trade
International trade is always accompanied with tariffs
Tariffs can have different itentions:
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willingness to protect home industries
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income for the state
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to control imports
 Tariffs lead to an economical suboptimal situation
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
What are the impacts of tariffs?
In the following argumentation we assume tariffs, that lead to a substitution
of imports by domestic products.
• losses in production efficiency; suboptimal allocation of recourses
• losses in consumer welfare (as more expensive domestic goods have
to be consumed)
• change in terms of trades towards the tariff implementing state
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Are there situations when tariffs are positive?
The negative effects described above will be persistent. However, one could
make up situations in which tariffs are useful to a state in some extend.
• infant industry protection
• protection of strategical production (can be substituted by subsidies)
• optimal tariffs (more theoretical option, partners would act the
same way with leaving no positive effect)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Effects of free trade
As we learnt in the last lecture, EU implemented a common market.That means, it is a free
trade zone without any tariffs inside. So we should take a closer look to the effects of free
trade
in general we have to distinguish between two types of effects of free trade:
1.
2.
comparative statical effects (traditional welfare theory)
dynamical effects of integration
In the following we will have a short look at these effects
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Comparative statical analysis - assumptions
There are a number of assumptions in traditional free trade theory:
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competitive market ( no oligopolies or monopolies)
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homogenous goods
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no economies of scale
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no market access barriers
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no technological advance , no advance in products
we clearly see, that these assumptions are not too realistic, but let’s see what
theory brings to us though…
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Comparative statical analysis – trade impact of free trade
Creating a free trade zone erases the discrimination against the
partner states. However, the free trade zone itself now discriminates
all other states. Again there are two main effects in foreign trade by a
free trade zone:
1. trade creation (creating new trade - efficient)
2. trade diversion (changing existing trade relations - inefficient)
let’s have a look at a very simple example to explain:
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Trade structure impact of free trade – example (1)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Trade structure impact of free trade – example (2)
3) – 5) trade creation. As the tariff was set that way, that it hindered
any trade, the free trade area now allows trade again and
brings the factor allocation to a more efficient level
2) – 4) trade diversion. The – in terms of factor allocation efficient
– import from Japan is substituted by a less efficient import
from France, as through the free trade area Japan is
discriminated against France. However the situation is better
than a non trade situation.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Three scenarios of a free trade area
As we saw above there are positive and negative effects of free
trade zones. In the following we will have a look at 3 scenarios:
Free trade area, in a situation with non prohibitive tariffs before
2. Free trade after prohibitive tariffs. Small partner country
3. Free trade after prohibitive tariffs. Big partner country
1.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 1

Trade structure impact of free trade – example (2)
12
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
What do these curves show us?
To describe the curves:
• To the left we see domestic demand and supply for good X at
different price levels
• To the right we see the domestic excess demand for good X =
demand for imports of X, as well as the supply curves of the
countries A1 and A2, where A1 is a small country (import
demand effects A1s prices) and A2 a big country, which can
produce any demanded X for price G
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 0 – what would happen without any tariffs?
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The price of X is set by the world market = G. As domestic firms
rarely can compete at that price import demand FE exists. The import
can substitute inefficient local production and increase over all
efficiency.
Country A1 produces export goods of X the cheapest, but through
demand, prices are rising. Import from A1 takes place until price in A1
reaches G: 0M1
The rest of the domestic import demand is bought from A2 at G:
M0M3
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 1 – non prohibitive tariff is implemented
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Generally the situation is similar to above
As the prices for consumers in the domestic market rose to pt now,
the import demand decreases to AB
Import structure is the same as above. First the cheaper A1 (0M0)
then from A2 (M0M2 = less than before)
The efficiency structure of import is not disturbed, however more of the less
efficient domestic production is used and the overall consummation decreased.
The received tariff payments are lower than this loss negative welfare effect
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 1 – tariff union with the small country
What are now the effects of a free trade area with A1?
• A1 can export goods without tariff burden, so there is a price
advantage of T towards A2
• Although the local prices in A1 are higher between M0M1 the
price for domestic consumers is lower. The less effective
production from A1 is bought.
• Structure: 0M1 from A1, M1M2 from A2 (which is
discriminated)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 1 – tariff union and worse off…
Let’s evaluate the effects of the tariff and the tariff union.The curves help:
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By implementing a tariff the consumers’ wealth is decreasing by ABEF.
However, the state gets income from the tariffs, which increases the
income again: ABCD. We clearly see the income is smaller than the
loss. The loss is ACF + BDE, so called dead weight loss
•
The tariff union now does not increase the consummation, the price to
pay abroad for imports increased, the terms of trade decreased, the
income of the state decreased; c.p. the free trade zone with A1 has
only negative effects
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 2

Trade structure impact of free trade – example (2)
18
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 2 – some light, but still more shadow… (1)
In this scenario there is a quite high tariff set, a free trade agreement
then is agreed with the smaller country.
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implementing a high tariff has the same consequences as in
scenario 1. Income ABCD for the state, deadweight loss of
ACF+BDE
•
Import structure with tariffs: OM0 from A1 and M0M1
from A2 (efficient structure)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 2 – some light, but still more shadow… (2)
Free trade area with A1. Again Imports from A2 are discriminated.
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through the tariff union A1 products get that cheap on the
domestic market, that more can be consumed than before
(0M2) (trade creation)
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No goods from A2 are imported anymore (trade diversion)
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The price paid for the import goods got higher
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No income from tariffs
In total we see again a negative effect of free trade area as the trade diversion effect
is bigger than the trade creation effect
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 3

Trade structure impact of free trade – example (2)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Scenario 3 – positive effects of free trade zone
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Again the same situation as in (1) and (2) occurs for the
tariff situation
Having a free trade zone with the big country now brings us
almost to the price level for our imports we would have in
world wide free trade. The trade creation is much bigger
than trade diversion
The allocation of recourses improved overall
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
When is free trade useful? (1)
It is more likely, that a free trade zone brings positive effects, if…
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the tariffs between the future partners are relatively high
(big trade creating effect)
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the tariffs towards third parties are low (small diversion
effects)
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the area of the tariff union is big (small diversion, big creating
effect)
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the product structure of the partner countries is similar to each
other but different from third parties (small diversion effect)
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
When is free trade useful? (2)
It is more likely, that a free trade zone brings positive effects, if…
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transport costs between the member states are low (they are
geographically close)
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the number of efficient suppliers in the union is bigger than
outside
However these positive effects are if they exist usually not really big, if we
follow the classical theory.Therefore let’s have a look at the dynamical effects
of free trade in the following
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Dynamical effects of free trade
in contrast to the comparative static effects, the dynamical effects of
a tariff union are not that easy to present analytically. However there
is hardly any doubt that they exist. We will have a closer look at three
of them:
1.
economies of scale
2.
competition effects
3.
growth impulses through integration
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Economies of scale
the most competitive firms of each sector get a bigger
market to sell their goods on
to some point it gets more and more efficient to produce
more units of the same product:
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positive effects of mass production
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lowering share of fixed costs
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better efficiency of organizational structures
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Competition effects
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in some fields of national economies exist oligopolies and
monopolies which set prices at a sub optimal level in order
to
maximize the national wealth
Through a common market competitors from other countries
occur forcing the monopolists now to act as a firm
in
competition. Prices decrease, wealth increases
Danger of monopolies of the whole integration zone : necessary
to observe. (EU has competition observing institutions)
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Growth impulses through integration
Companies get access to bigger markets and might see the
possibility of expansion
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To use these new markets an impulse on technology
development is set
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By entering markets with high technology spill over effects
can occur
These effects will be bigger, the bigger the common market and the
number of industries is
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Conclusions (1)
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we saw from a theoretical view, that regional free trade
integration is not necessarily useful but can be positive
as we saw in the first lecture, EU is a huge market with many
differently structured states. That’s a good basis.
the big market allows to assume potential dynamic effects
are big
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
Conclusions (2)
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through common currency transaction costs are quite low.
To conclude we can say that European could be a good free trade
zone, however to which extent positive effects occur is difficult to
say. As conditions for positive effects under comparative static
analysis exist, we can conclude, that in addition a even bigger effect
as of dynamic effects should be existing.
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Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2
Macroeconomics, foreign trade and European Union. Basics.
What will be next
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What are the consequences of common market in Europe?
Some evidence from European reality.
Prime Minister’s Putin’s proposal: of November 25th: free
trade from Lisbon to Vladivostok?
The Euro. One market one currency? Chances and dangers.
Dollar vs.Yuan currency as economical weapon?
Dipl.- Kfm. Thomas Stiegler, University of Göttingen.
Lecture 2