Flashcards in Political Economy Deck (61)
if trade policies tend to incur net losses, why do they get implemented?
What are the 4 cases FOR free trade
3. competition and innovation
4. Best feasible politically
Outline the efficiency case for free trade
Restricted trade distorts prices = consumer and producer efficiency losses.
Why might the efficiency case for free trade not be that convincing nowadays?
Tariff rates already low for most countries and quotas rare so estimated gains of moving to free trade only small % GDP.
Protection costs are < X% go GDP for most countries
EOS argument for free trade
Free trade allows firms to take advantage of EOS -->lower prices and increased choice.
Competition and innovation free trade argument
free trade provides more competition and incentives to differentiate. With heterogeneous firms, the least productive exit = average industry productivity rises.
What kind of benefits of free trade are competition and innovation cf efficiency losses?
DYNAMIC - accrued over time.
efficiency = static estimates.
Whats the political argument for free trade?
Any policy deviating from free trade would be quickly manipulated by special interests - like opening pandora box = decrease welfare. Also, deviating would increase trade policy uncertainty.
2 arguments against free trade
2. domestic market failure
The TOT argument against free trade only exists for
LARGE countries who can affect world price.
What's the optimum tariff rate?
-Between 0 an tp
where tp = prohibitive tariff rate i.e one that stops trade.
Where marginal gain from improved TOT = marginal efficiency cost.
Shape of optimum tariff graph
N shaped then flat line once tp passes.
What's the optimum policy in export sectors? + real world example.
NOT a subsidy which lowers welfare.
Export TAX - this raises TOT, but not too large as to prohibit trade. EG Saudi Arabia and other oil producers.
Problems w trying to improve TOT =
Zero sum gain = foreigners lose = RETALIATION.
Prisoners dilemma: one country imposing tariff while other not NOT NE.
Bottom line on TOT argument against free trade.
Largely theoretical - not a useful justification in practice for restricting trade.
Whats the domestic failure argument against free trade>
Domestic market failures exist = trade restrictions as 2nd best policy where 1st best not feasible.
Example of market failure and how trade policy could help.
Persistently high underemployment. Tariff to raise production in import competiting sector.
What do CS and PS calculations implicitly assume?
EFFICIENT MARKETS: if inefficient, CS and PS do not accurately measure welfare.
What benefits do CS and PS capture? Why is this a problem when market failures exist?
Capture PRIVATE benefits.
Market failures, +VE externality MSB > MPB
So we need to look at social effects of policy, not just private effects. Social welfare gains could offset efficiency losses.
the domestic market failure argument is an example of what general argument?
Theory of second best = government intervention which distorts incentives in one market may increase national welfare by offsetting the consequences of market failure elsewhere.
First best vs second best policies
First best = directly intervening in the market that's failed.
Second best = intervenes in another market to indirectly fix the problem.
2 problems with domestic market failure argument
1. Second best: should rly tackle the source of the problem & always compare to an alternative domestic policy.
2. Difficult to identify market failures and unclear when and to what degree to intervene.
Example of market failure an 2nd best policy US
US sugar quota. Argued labour market is too rigid to allow for wage cuts to create employment in other sectors.
Why is a domestic policy such as subsidy often less preferred to trade policy such as quota even if less welfare damaging?
Because its costs are more salient than that from trade. About perception and visibility.
Important insight about national welfare
In reality, no such thing as national welfare. Only desires of individuals who influence the political process.
Median voter theorem predicts
Democratic political parties will change their politicise to court the median voter i.e. the voter in the middle of the ideology spectrum on a certain issue.
2 assumptions of MVT
1. Only 2 parties.
2. Only care about getting elected and winning majority - not about maintaining party ideology.
Equilibrium tariff rates in MVT and why
One party always has an incentive to undercut to get closer to median voter --> drives both partied to tM.