Download Chapter 11 - Pearson Higher Education

Chapter 11
THE POLITICAL ECONOMY OF PROTECTION
Whatever the effect of trade policy on the country as a whole, trade policy tends to have
disparate effects on individual groups or sectors within the economy. Groups that stand
to lose (or gain) often resort to political action to protect their own interests, and actual
trade policy is often the outcome of a political process. Groups that find it hard to
coordinate their actions (because their members are numerous or widely dispersed, for
example) and groups whose stake in the outcome is small are less likely to defend their
interests. This may explain why industries seem to exercise more clout than consumers.
Different theoretical models of trade lead to different conclusions about how various
groups within the economy are affected by trade and trade policy. Theories of political
choice suggest that how a country makes trade policy (whether by putting it into political
party platforms and submitting it to a vote, or by making it the responsibility of
bureaucrats) may say something about which model of trade best describes the real
economy.
In some cases, a tariff's main purpose may be to raise revenue. Governments rely more
heavily on tariffs for revenue in countries where it is relatively more difficult to monitor
and tax domestic transactions or assets. The tariff that maximizes revenue always exceeds
the tariff that maximizes national income (the optimal tariff-- zero for a small country). In
other words, there is a cost to raising revenue through a tariff. That cost should be
measured against the costs of other types of tax.
Many of the arguments put forward to justify protection are incomplete or partly wrong.
Tariffs can be used to correct distortions (market failures) or achieve other social
objectives. Unless the distortion is an external one, a tariff is "second-best" -- wasteful
compared with a remedy that addresses the distortion directly, such as a production
subsidy to an industry whose bottom line doesn't capture all of its benefits to society, or a
consumption tax on a socially harmful product.
Protection is not an effective or an efficient means of maintaining overall employment.
The popular view that trade threatens jobs is owed partly to the fact that the identities of
the beneficiaries of future job creation in the export sector are unknown, but the victims of
layoffs in the import-competing industries are easily identified, and their losses visible.
Thus far, growth has been presented as beneficial, except perhaps when it severely
worsens a country's terms of trade. When growth is distorted by a tariff, however, even a
country too small to influence world prices may suffer.
SHORT-ANSWER QUESTIONS
1.
True or false:
If Malaysia wants to maximize tariff revenue, it should quote a higher export tax
on tin than if it wants to optimally exercise its large-country position in the world
market.
2.
True or false:
The large developing country incurs cost by using the maximum revenue tariff and
it should not, therefore, under any circumstances set such a high tariff.
3.
Recent arguments for protection of "strategic industries," i.e. industries with
positive spillover effects on other industries, share much with the infant industry
argument. They do differ in one important respect, however. How do they differ?
4.
In the United States, the proposed import restrictions on cars and steel were
supported by labor and capital in both industries. Which trade model provides an
explanation for this behavior?
5.
True or false:
The size of the revenue-maximizing tariff does not depend upon whether the
country is large or small.
6.
True or false:
The tariff is often a "second-best" policy instrument because it distorts both the
consumption decision and the production decision.
True or false (Questions 7 to 12):
7.
Workers will oppose a tariff on the labor-intensive good because a higher price
attracts more workers into that industry which in turn drives down the wage rate.
8.
The lobbying model of policy choice says that because consumers are numerous,
they are likely to form a majority of voters and consequently dominate special
interests.
9.
The U.S. tariff structure provides empirical support for the idea that tariffs tend to
protect small plants and low-wage workers.
10.
Economists who argue against protection typically are thinking only about
commodity markets. If they were to add the maintenance of full employment to
their policy goals, they would then favor tariffs.
11.
It is not trade policy but a country's size on world markets that determines how
growth will affect it. A country too small to influence its terms of trade can only
benefit from growth, regardless of its commercial policy.
12.
Spending resources in order to gain access to a protected income stream is known
as rent seeking.
PROBLEMS
1.
Reasons for Tariffs:
The tariff was historically an important source of government revenue for both
Europe and the United States and remains so today for many developing nations.
(a)
(b)
(c)
List some reasons why the tariff may be a particularly useful way to raise
revenue.
Why have the industrialized nations reduced their use of tariffs to raise
revenue?
What are some reasons for using tariffs in addition to the revenue
argument?
2.
The Prohibitive Tariff:
Point E is the endowment point and point A the free trade consumption point of a
small open economy.
(a)
(b)
3.
Indicate the prohibitive tariff.
Will an extremely large tariff on food, for example one that is larger than
the prohibitive rate, eliminate trade?
The Revenue-Maximizing Tariff when Production is Flexible:
For the small open economy illustrated above, 1-1 corresponds to the domestic
price when the revenue-maximizing tariff has been levied if the country is an
endowment economy.
(a)
(b)
Is the revenue-maximizing tariff larger or smaller than this rate if it has a
flexible technology?
Is the optimal tariff larger than the revenue-maximizing rate in either of
these cases?
4.
Ranking Policies:
In the following diagram, points A and B correspond to free trade production and
consumption.
Which production and consumption points would be realized if:
(a)
(b)
(c)
(d)
an import tax were levied?
an export tax were levied?
a tax on the consumption of the import good were levied?
a subsidy to the domestic production of the import good were granted?
Rank these four policies from best to worst from the perspective of domestic
consumers.
5.
Which theory or theories of policy choice might be consistent with trade policy
decisions that favor a minority at the expense of the majority?
6.
Some analysts see the domestic production of computer chips as vital for U.S.
national security. To achieve this goal some have called for a tariff on imported
chips, while others have called for a subsidy for American producers. A House
Committee has asked you to testify on this issue.
7.
(a)
Which position will you take? (Use the following diagram to support your
reasoning.)
(b)
How does the argument for protection in this scenario differ from
the infant industry argument as originally formulated?
Reducing Oil Consumption:
In the 1970s there was concern that oil consumption by the industrialized nations
was too high. It was specifically argued that the world's oil resources were being
depleted at too rapid a rate, leaving little for future generations. Many who took
this position spoke in favor of a tariff on oil, which they claimed had the additional
feature of retaliating against the price hikes of OPEC.
Which policy would you recommend to solve the "overconsumption" problem?
The OPEC problem?
8.
The Infant Industry Argument and the Second-Best Nature of Tariffs:
The IMF has hired you into their Economists Program to assess the performance
of a number of developing nations. One of these countries has a large tariff on the
imports of tractors. In a letter to their Minister of Finance you point out that the
tariff raises very little revenue and you advise that it be removed. You receive a
short note from the Minister's economic advisor stating that they would like to be
able to oblige, but that they consider domestic production of tractors of utmost
importance. The note reads, "The tractor industry is currently in its infancy, but
one day it will become an important source of foreign exchange earnings."
(a)
What will you reply to this argument?
(b)
(c)
9.
In response to the point you made in part (a), the Minister's advisor informs
you that the tractor industry receives protection because it provides useful
training for many young workers who later return to their villages as skilled
mechanics. The owner of the tractor factory claims that if trade were
unrestricted he would have to close the plant and an important educational
activity would be lost. How do you respond to this letter?
The Minister's advisor does not give up. He calls your office and explains
that unless the returns to domestic investors in the tractor factory remain
high no further investments will flow its way. This factory is considered an
important model for future factories in this country, so the social return
from its operation exceeds the private return earned by the investors. You
have sympathy for their desire to keep the factory open, but you do not
surrender. What is your counterargument?
"Second Best" Policies:
(a)
(b)
What does "second best" mean?
When is a tariff "first best"?