Tag: gains from trade

Posted on

‘Tariff is the most beautiful word.’ Not for economists!

In an interview with Joe Rogan for his podcast, The Joe Rogan Experience, just before the US election, Donald Trump stated that, “To me, the most beautiful word – and I’ve said this for the last couple of weeks – in the dictionary today and any is the word ‘tariff’. It’s more beautiful than love; it’s more beautiful than anything. It’s the most beautiful word. This country can become rich with the use, the proper use of tariffs.”

President-elect Trump has stated that he will impose tariffs on imports of 10% or 20%, with 60% and 100% tariffs on imports from China and Mexico, respectively. This protection for US industries, combined with lighter regulation, will, he claims, provide a stimulus to the economy and help create jobs. The revenues will also help to reduce America’s budget deficit.

But it is not that straightforward.

Problems with tariffs for the USA

Imposing tariffs is likely to reduce international trade. But international trade brings net benefits, which are distributed between the participants according to the terms of trade. This is the law of comparative advantage.

In the simple two-country case, the law states that, provided the opportunity costs of producing various goods differ between the two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. The total production and consumption of the two countries will be higher.

So if the USA has a comparative advantage in various manufactured products and a trading partner has a comparative advantage in tropical food products, such as coffee or bananas, both can gain by specialisation and trade.

If tariffs are imposed and trade is thereby reduced between the USA and its trading partners, there will be a net loss, as production will switch from lower-cost production to higher-cost production. The higher costs of less efficient production in the USA will lead to higher prices for those goods than if they were imported.

At the same time, goods that are still imported will be more expensive as the price will include the tariff. Some of this may be borne by the importer, meaning that only part of the tariff is passed on to the consumer. The incidence of the tariff between consumer and importer will depend on price elasticities of demand and supply. Nevertheless, imports will still be more expensive, allowing the domestically-produced substitutes to rise in price too, albeit probably by not so much. According to work by Kimberly Clausing and Mary E Lovely for the Peterson Institute (see link in Articles below), Trump’s proposals to raise tariffs would cost the typical American household over $2600 a year.

The net effect will be a rise in inflation – at least temporarily. Yet one of Donald Trump’s pledges is to reduce inflation. Higher inflation will, in turn, encourage the Fed to raise interest rates, which will dampen investment and economic growth.

Donald Trump tends to behave transactionally rather than ideologically. He is probably hoping that a rapid introduction of tariffs will then give the USA a strong bargaining position with foreign countries to trade more fairly. He is also hoping that protecting US industries by the use of tariffs, especially when coupled with deregulation, will encourage greater investment and thereby faster growth.

Much will depend on how other countries respond. If they respond by raising tariffs on US exports, any gain to industries from protection from imports will be offset by a loss to exporters.

A trade war, with higher tariffs, will lead to a net loss in global GDP. It is a negative sum game. In such a ‘game’, it is possible for one ‘player’ (country) to gain, but the loss to the other players (countries) will be greater than that gain.

Donald Trump is hoping that by ‘winning’ such a game, the USA could still come out better off. But the gain from higher investment, output and employment in the protected industries would have to outweigh the losses to exporting industries and from higher import prices.

The first Trump administration (2017–21), as part of its ‘America First’ programme, imposed large-scale tariffs on Chinese imports and on steel and aluminium from across the world. There was wide-scale retaliation by other countries with tariffs imposed on a range of US exports. There was a net loss to world income, including US GDP.

Problems with US tariffs for the rest of the world

The imposition of tariffs by the USA will have considerable effects on other countries. The higher the tariffs and the more that countries rely on exports to the USA, the bigger will the effect be. China and Mexico are likely to be the biggest losers as they face the highest tariffs and the USA is a major customer. In 2023, US imports from China were worth $427bn, while US exports to China were worth just $148bn – only 34.6% of the value of imports. The percentage is estimated to be even lower for 2024 at around 32%. In 2023, China’s exports to the USA accounted for 12.6% of its total exports; Mexico’s exports to the USA accounted for 82.7% of its total exports.

It is possible that higher tariffs could be extended beyond China to other Asian countries, such as Vietnam, South Korea, Taiwan, India and Indonesia. These countries typically run trade surpluses with the USA. Also, many of the products from these countries include Chinese components.

As far as the UK is concerned, the proposed tariffs would cause significant falls in trade. According to research by Nicolò Tamberi at the University of Sussex (see link below in Articles):

The UK’s exports to the world could fall by £22 billion (–2.6%) and imports by £1.4 (–0.16%), with significant variations across sectors. Some sectors, like fishing and petroleum, are particularly hard-hit due to their high sensitivity to tariff changes, while others, such as textiles, benefit from trade diversion as the US shifts demand away from China.

Other badly affected sectors would include mining, pharmaceuticals, finance and insurance, and business services. The overall effect, according to the research, would be to reduce UK output by just under 1%.

Countries are likely to respond to US tariffs by imposing their own tariffs on US imports. World Trade Organization rules permit the use of retaliatory tariffs equivalent to those imposed by the USA. The more aggressive the resulting trade war, the bigger would be the fall in world trade and GDP.

The EU is planning to negotiate with Trump to avoid a trade war, but officials are preparing the details of retaliatory measures should the future Trump administration impose the threatened tariffs. The EU response is likely to be strong.

Articles

Questions

  1. Explain why, according to the law of comparative advantage, all countries can gain from trade.
  2. In what ways may the imposition of tariffs benefit particular sections of an economy?
  3. Is it in countries’ interests to retaliate if the USA imposes tariffs on their exports to the USA?
  4. Why is a trade war a ‘negative sum game’?
  5. Should the UK align with the EU in resisting President-elect Trump’s trade policy or should it seek independently to make a free-trade deal with the USA? is it possible to do both?
  6. What should China do in response to US threats to impose tariffs of 60% or more on Chinese imports to the USA?
Posted on

EU strikes major trade deals

The EU has recently signed two trade deals after many years of negotiations. The first is with Mercosur, the South American trading and economic co-operation organisation, currently consisting of Brazil, Argentina, Uruguay and Paraguay – a region of over 260m people. The second is with Vietnam, which should result in tariff reductions of 99% of traded goods. This is the first deal of its kind with a developing country in Asia. These deals follow a recent landmark deal with Japan.

At a time when protectionism is on the rise, with the USA involved in trade disputes with a number of countries, such as China and the EU, deals to cut tariffs and other trade restrictions are seen as a positive development by those arguing that freer trade results in a net gain to the participants. The law of comparative advantage suggests that trade allows countries to consume beyond their production possibility curves. What is more, the competition experienced through increased trade can lead to greater efficiency and product development.

It is estimated that the deal with Mercosur could result in a saving of some €4bn per annum in tariffs on EU exports.

But although there is a net economic gain from greater trade, some sectors will lose as consumers switch to cheaper imports. Thus the agricultural sector in many parts of the EU is worried about cheaper food imports from South America. What is more, increased trade could have detrimental environmental impacts. For example, greater imports of beef from Brazil into the EU could result in more Amazonian forest being cut down to graze cattle.

But provided environmental externalities are internalised within trade deals and provided economies are given time to adjust to changing demand patterns, such large-scale trade deals can be of significant benefit to the participants. In the case of the EU–Mercosur agreement, according to the EU Reporter article, it:

…upholds the highest standards of food safety and consumer protection, as well as the precautionary principle for food safety and environmental rules and contains specific commitments on labour rights and environmental protection, including the implementation of the Paris climate agreement and related enforcement rules.

The size of the EU market and its economic power puts it in a strong position to get the best trade deals for its member states. As EU Trade Commissioner, Cecilia Malmström stated:

Over the past few years the EU has consolidated its position as the global leader in open and sustainable trade. Agreements with 15 countries have entered into force since 2014, notably with Canada and Japan. This agreement adds four more countries to our impressive roster of trade allies.

Outside the EU, the UK will have less power to negotiate similar deals.

Articles

Questions

  1. Draw a diagram to illustrate the gains for a previously closed economy from engaging in trade by specialising in products in which it has a comparative advantage.
  2. Distinguish between trade creation and trade diversion from a trade deal with another country or group of countries.
  3. Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to benefit the most from the respective trade deals?
  4. Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to lose from the respective trade deals?
  5. Are the EU–Mercosur and the EU–Vietnam trade deals likely to lead to net trade creation or net trade diversion?
  6. What are the potential environmental dangers from a trade deal between the EU and Mercosur? To what extent have these dangers been addressed in the recent draft agreement?
  7. Will the UK benefit from the EU’s trade deals with Mercosur and Vietnam?
Posted on

USMCA or NAFTA 2.0?

An agreement in principle was reached on September 30 between the USA, Canada and Mexico over a new trade deal to replace the North American Free Trade Agreement (NAFTA). President Trump had described NAFTA as ‘the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country.’ The new deal, named the United States-Mexico-Canada Agreement, or USMCA, is the result of 14 months of negotiations, which have often been fractious. A provisional bilateral agreement was made between the USA and Mexico in August. At the same time, President Trump threatened a trade war with Canada if it did not reach a trade agreement with the USA (and Mexico). The new USMCA must be ratified by lawmakers in all three countries before it can come into force. This could take a few months.

So is USMCA a radical departure from NAFTA? Does the USA stand to gain substantially, as President Trump claims? In fact, USMCA is little different from NAFTA. It could best be described as a relatively modest reworking of NAFTA. So what are the changes?

The first change affects the car industry. From 2020, 75% of the components of any vehicle crossing between the USA and Canada or Mexico must be made within one or more of the three countries to qualify for tariff-free treatment. The aim is to boost production within the region. But the main change here is merely an increase in the proportion from the current 62.5%.

A more significant change affecting the car industry concerns wages. Between 40% and 45% of a vehicle’s components must be made by workers earning at least US$16 per hour. This is some three times more than the average wage currently earned by Mexican car workers. Although it will benefit such workers, it will reduce Mexico’s competitive advantage and could hence lead to some diversion of production away from Mexico. Also, it could push up the price of cars.

The agreement has also strengthened various standards inadequately covered in NAFTA. According to The Conversation article:

The new agreement includes stronger protections for patents and trademarks in areas such as biotech, financial services and domain names – all of which have advanced considerably over the past quarter century. It also contains new provisions governing the expansion of digital trade and investment in innovative products and services.
 
Separately, negotiators agreed to update labor and environmental standards, which were not central to the 1994 accord and are now typical in modern trade agreements. Examples include enforcing a minimum wage for autoworkers, stricter environmental standards for Mexican trucks and lots of new rules on fishing to protect marine life.

Another area where the USMCA agreement has made changes concerns trade in dairy products. This particularly affects Canada, which has agreed to allow more US dairy products tariff-free into Canada (see the CNN article at the end of the list of articles below). New higher quotas will give US dairy farmers access to 3.6% of Canada’s dairy market. They will still pay tariffs on dairy exports to Canada that exceed the quotas, ranging from 200% to 300%.

The other significant change for consumers in Mexico and Canada is a rise in the value of duty-free imports they can bring in from the USA, including online transactions. As the first BBC article listed below states:

The new agreement raises duty-free shopping limits to $100 to enter Mexico and C$150 ($115) to enter Canada without facing import duties – well above the $50 previously allowed in Mexico and C$20 permitted by Canada. That’s good news for online shoppers in Mexico and Canada – as well as shipping firms and e-commerce companies, especially giants like Amazon.

Despite these changes, USMCA is very similar to NAFTA. It is still a preferential trade deal between the three countries, but certainly not a completely free trade deal – but nor was NAFTA.

And for the time being, US tariffs on Mexican and Canadian steel and aluminium imports remain in place. Perhaps, with the conclusion of the USMCA agreement, the Trump administration will now, as promised, consider lifting these tariffs.

Video

Articles

Questions

  1. What have been the chief gains and losses for the USA from USMCA?
  2. What have been the chief gains and losses for Mexico from USMCA?
  3. What have been the chief gains and losses for Canada from USMCA?
  4. What are the economic gains from free trade?
  5. Why might a group of countries prefer a preferential trade deal with various restrictions on trade rather than a completely free trade deal between them?
  6. Distinguish between trade creation and trade diversion.
  7. In what areas, if any, might USMCA result in trade diversion?
  8. If the imposition of tariffs results in a net loss from a decline in trade, why might it be in the interests of a country such as the USA to impose tariffs?
Posted on

Are steel tariffs putting America first?

TATA steelworks, Ijmuiden, Netherlands: photo JS

Since running for election, Donald Trump has vowed to ‘put America first’. One of the economic policies he has advocated for achieving this objective is the imposition of tariffs on imports which, according to him, unfairly threaten American jobs. On March 8 2018, he signed orders to impose new tariffs on metal imports. These would be 25% on steel and 10% on aluminium.

His hope is that, by cutting back on imports of steel and aluminium, the tariffs could protect the domestic industries which are facing stiff competition from the EU, South Korea, Brazil, Japan and China. They are also facing competition from Canada and Mexico, but these would probably be exempt provided negotiations on the revision of NAFTA rules goes favourably for the USA.

TATA steel works IJmuiden Netherlands (photo JS)Assuming there were no retaliation from other countries, jobs would be gained in the steel and aluminium industries. According to a report by The Trade Partnership (see link below), the tariffs would increase employment in these industries by around 33 000. However, the higher price of these metals would cause job losses in the industries using them. In fact, according to the report, more than five jobs would be lost for every one gained. The CNN Money article linked below gives example of the US industries that will be hit.

But the costs are likely to be much greater than this. Accorinding to the law of comparative advantage, trade is a positive-sum game, with a net gain to all parties engaged in trade. Unless trade restrictions are used to address a specific market distortion in the trade process itself, restricting trade will lead to a net loss in overall benefit to the parties involved.

Clearly there will be loss to steel and aluminium exporters outside the USA. There will also be a net loss to their countries unless these metals had a higher cost of production than in the USA, but were subsidised by governments so that they could be exported profitably.

Valancia port: photo JSBut perhaps the biggest cost will arise from possible retaliation by other countries. A trade war would compound the net losses as the world moves further from trade based on comparative advantage.

Already, many countries are talking about retaliation. For example, the EU is considering a ‘reciprocal’ tariff of 25% on cranberries, bourbon and Harley-Davidsons, all produced in politically sensitive US states (see the first The Economist article below). ‘As Jean-Claude Juncker, president of the European Commission, puts it, “We can also do stupid”.’ In fact, this is quite a politically astute move to put pressure on Mr Trump.

But cannot countries appeal to the WTO? Possibly, but this route might take some time. What is more, the USA has attempted to get around WTO rules by justifying the tariffs on ‘national security’ grounds – something allowed under Article XXI of WTO rules, provided it can be justified. This could possibly deter countries from retaliating, but it is probably unlikely. In the current climate, there seems to be a growing mood for flouting, or at least loosely interpreting, WTO rules.

Articles

Report

Questions

  1. Explain how, by countries specialising in goods in which they have a comparative advantage, all countries can gain.
  2. Can tariffs or other trade restrictions ever be justified? Explain.
  3. Is there any economic justification for the US tariffs of 25% on steel and 10% on aluminium?
  4. Can putting tariffs on US imports be justified by countries whose steel and/or aluminium industires are faced with US tariffs?
  5. Can trade wars be won? Explain.
Posted on

Free trade from Cairo to Cape Town

A deal has just been signed between 26 African nations to form a new free trade area, the Tripartite Free Trade Area (TFTA). The countries have a population of 625 million (56% of Africa’s total) and a GDP of $1.6 trillion (63% of Africa’s total). The deal effectively combines three existing free trade areas: the Common Market for Eastern and Southern Africa, the Southern African Development Community and the East African Community.

Although the deal has been signed by the nations’ leaders, it still needs parliamentary approval from each of the countries. It is hoped that this will be achieved by 2017. If it is, it will mark a major step forward in encouraging intra-African trade.

The deal will involve the removal of trade barriers on most goods and lead to a reduction in overall tariffs by more than 50%. The expectation of the leaders is that this will generate $1 trillion worth of economic activity across the 26 countries through a process of trade creation, investment, increased competition and the encouragement of infrastructure development. But given the current poor state of infrastructure and the lack of manufacturing capacity in many of the countries, the agreement will also encourage co-operation to promote co-ordinated industrial and infrastructure development.

Up to now, the development of intra-African trade has been relatively slow because of poor road and rail networks and a high average protection rate – 8.7% on exports to other African countries compared with 2.5% on exports to non-African countries. As a result, intra-African trade currently accounts for just 12% of total African trade. It is hoped that the development of TFTA will result in this rising to over 30%.

Much of the gains will come from economies of scale. As Kenyan academic Calestous Juma says:

“By having larger markets, it signals the possibility of being able to manufacture products at a scale that is cost-effective. For example, where you need large-scale investments like $200m to create a pharmaceutical factory, you couldn’t do that if you were only selling the products in one country.”

The question is whether the agreement signed on the 10 June will lead to the member countries fully taking advantage of the opportunities for trade creation. Agreeing on a deal is one thing; having genuinely free trade and investing in infrastructure and new efficient industries is another.

Videos and audio
African leaders ink trade deal Deutsche Welle (11/6/15)
African leaders sign pact to create ‘Cape to Cairo’ free trade bloc euronews (10/6/15)
Africa Free Trade Analysis BBC Africa, Calestous Juma (9/6/15)

Articles

African Leaders To Sign Free Trade Agreement To Create Common Market International Business Times, Aditya Tejas (10.6.15)
EAC, COMESA and SADC Blocs Ink ‘Historic’ Trade Deal allAfrica, James Karuhanga (11/6/15)
Tripartite Free Trade Area an Opportunity Not a Threat allAfrica, Sindiso Ngwenya (9/6/15)
Africa a step closer to free trade area Business Report (South Africa), Rob Davies (11/6/15)
The Cape to Cairo trade ‘super bloc’ is here; 15 surprising – and shocking – facts on trade within Africa Mail & Guardian (Kenya), Christine Mungai (8/6/15)
The tripartite free trade area agreement in Africa is bound to disappoint Quartz Africa, Hilary Matfess (10/6/15)
Africa creates TFTA – Cape to Cairo free-trade zone BBC News Africa (10/6/15)
Will the Cape to Cairo free-trade zone work? BBC News Africa, Lerato Mbele (10/6/15)
African free trade still some way off BBC News, Matthew Davies (10/6/15)
Zambia not to benefit from Africa’s TFTA Medafrica, Geraldine Boechat (10/6/15)

Questions

  1. Distinguish between a free trade area, a customs union and a common market.
  2. What does the law of comparative advantage imply about the gains from forming a free trade area?
  3. Distinguish between trade creation and trade diversion.
  4. Why is it likely that there will be considerable trade creation from TFTA? Would there be any trade diversion?
  5. Why are small countries with a relatively low level of economic development likely to experience more trade creation than larger, richer ones?
  6. What barriers might remain in trade between the TFTA countries?
  7. Why might smaller, less developed members of TFTA be worried about the removal of trade barriers?
  8. Why might concentrating on developing local capacity, rather than just lowering tariffs, be a more effective way of developing intra-African trade
  9. What ‘informal’ barriers to trade exist in many African countries?
  10. Why is it that ‘Ordinary Africans are most probably not holding their breath’ about the gains from TFTA?