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Chapter 5 - Trade & Macro 5.1 Macroeconomic Factors – exchange rates – interest rates – government fiscal balance 5.2 International Agricultural Trade –Trade agreements 5.3 Trade Theory –Gains from trade –Distortions (tariffs & subsidies) –Farm programs 1) Exchange Rates Affects the competitiveness of agr. Products Early 1970’s – floating exchange rates Policy – over or under value exchange rate What is the impact of a ER distortion? Example 1: Argentina: Overvalued Exchange Rate (exporter) Shift of excess demand function Lower producer price Lower quantity exported Loss of producer surplus Source: International Monetary Fund -IFS Increase in Exchange Rate P S ED Q Interest Rates: Why interest rates are important: 1) Value of currency – prices received and paid Most commodities are US$ denominated 2) Cost of borrowing: Agriculture is capital intensive (borrowing) Inputs: seed, fertilizer, machinery 1980’s - high interest rates – low grain prices - debt crisis Cost of borrowing: How is it determined ? Role of central bank (Bank of Canada) Role of the market Government intervention (interest subsidies) Canadian Prime Rate % (1960-2004) 20 18 16 14 12 10 8 6 4 2 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 100 Basis points = 1% Src. Globe & Mail - March 8, 2008 Government Fiscal Balance Consequences for Agricultural Policy 1 – interest rate - more borrowing = higher rates "crowding out effect" - higher cost for farm borrowing 2001 Average capital/farm Total farm capital = $800,000 = $ 200 Billion 1% change in interest rates => $ 2 Billion (1971 - 2002) - Net market income - 1.8 $B (2002) 3.3 $B (1975) 2 – capacity to fund interventions - deficits = limited marge de manouvre - reduced scope for intervention Debt/GDP Canada (61-2003) 80 70 60 50 40 30 20 10 0 1961-62 1969-70 1977-78 1985-86 1993-94 2001-02 Deficit/GDP Canada (1961-03) 4 2 0 1961-62 -2 -4 -6 -8 -10 1966-67 1971-72 1976-77 1981-82 1986-87 1991-92 1996-97 2001-02 Fiscal Deficit - Debt Service (1961-2003) ($Millions) 60000 50000 40000 30000 20000 10000 0 1961-62 -10000 -20000 -30000 -40000 1966-67 1971-72 1976-77 1981-82 1986-87 1991-92 1996-97 2001-02 5.2 International TRADE Gains from trade: > increase in output due to specialization based on comparative advantage • each country – concentrates on producing goods and that it produces relatively efficiently – trading to obtain goods that it does not Trade Distortions • • • many forms of distortion (welfare reducing) tariffs, taxes, subsidies, quantitative measures non-tariff barriers (health, safety reg’s) Trade Agreements • • institutional arrangement – restraint on behaviour multi-lateral (regional), bilateral • Levels of cooperation – Range of goods (agr vs industrial) – Scope of instruments included – Customs union – full economic integration (EU) Reasons for Protection • new industry (infant industry argument) • national health + phyto-sanitary • unfair foreign trade policy • Defend domestic programs • improve balance of payments • improve “Terms of Trade” • generate revenue • slow down painful economic adjustment • Political economy benefits of additional trade are spread thinly among many individuals but the cost is high for only a few firms or groups Trade Theory • Why do nations trade? • What are the benefits? • Implications of trade distortions Theory • comparative advantage (Ricardo) • absolute advantage PA PM US PA PM CA • Ohlin (1933) • comparative advantage – due to resource endowments – Canada land rich, capital poor – => export agr & import manufactures Gains from trade • Trade allows for specialization – increased welfare Gains from Trade P1 . Agr. W1 W2 P2 Manufactures ES/ED Framework • Excess Demand (ED) • Excess Supply (ES) Gains from trade (versus no trade) • depend on the impact of a country on world prices • Small country – no price impact • Large country – prices adjust, impacts smaller 2 Country Model – 1 good • e.g. US/Canada cattle market • Assume: Canada - low cost producer • How are consumers and farmers affected by trade between the two countries? • Winners and losers – distribution effects – US – consumers gains, farmers lose – CA – consumers lose, farmers gain Gains from Trade . Canada Trade Sector ES US PUS WUS PW WCA PCA ED Trade Analysis: Trade Distortions 1 ) Import Tariff • Fixed-tariff rate vs ad valorem • Small country (fixed tariff) – domestic price increases – Supply increases, demand decreases – imports reduced – Net dead weight loss • Large country – domestic price increases – world price decreases – Imports decrease; domestic output increases – Consumers lose; producers gain – Government gains tariff revenue – Net welfare gain – Potential to compensate consumers Import Quota • Binding quota – if it restricts imports below free trade imports • Similar price effects to a tariff – – – – Imports lower Domestic price higher World price lower Rents to importers • Quota value: right to import – Based on difference between new world price and domestic price Large Country – Import Quota . Domestic Market World Market S D ES ED0 PQ Pw PWQ Q IQ Large Country - Tariff . Domestic Market World Market S D ES ED0 Pw TR ED1 Import tariff – Small Country S PT Pw b G income a D Government income – few transactions Export Subsidy • Used extensively – – – – – • Purpose: support domestic income (price) support Subsidy to export the excess supply US (EEP) starting in 1985 EU (ERP) – export restitutions – 1970’s not unique to agriculture – e.g. Bombardier price support program – increases ES • Subsidy Impacts – – – – world price falls (large country) Domestic price falls Exports expand Government payments = (Ps-PWs)*exports • value of exports increase relative to free trade • Deadweight loss – – – – Consumers gain Producers gain Foreign importers gain Taxpayer loses Export Subsidy – Large Country S Ps DWL Pw Pws DT Dd Exports Before Exports After Dd – domestic demand DT – total demand – including world demand Export Tax • Tax exporters • Exporting government gain revenue from export taxes • Producers in exporting country lose Export Cartel Assumptions: • • • • • 2 countries Cartel: importer + domestic supplier Suppliers maximize joint profits Price according to joint supply function MR = MC (joint MC) Results: • • • • Domestic price increases Imports and domestic production decrease Foreign surplus increases Deadweight loss Export Cartel . Exporter Importer Sd S ST PC a c Pw b D MR QE Qd Sd – domestic supply ST – domestic + foreign supply Exporter gain = (a-b) Deadweight loss = c Q Decoupled Subsidies • Programs that do not distort trade – within the green box category under GATT • policies that lead to a per-unit payment to producers are not decoupled • trade distorting => affects trade and prices • Is any farm program completely decoupled ?