SLIDE 1 Trade Policy
Import Substitution
, → erect barriers to foreign imports , → satisfy demand with domestic (less efÞciently–produced) substitutes , → allow domestic producers to become more efÞcient , → eventually remove the trade barriers
, → Tariffs , → Quotas (often combined with tariff beyond quota) , → Non–tariff barriers
SLIDE 2
The Impact of Import Barriers (Small Open Economy)
² Implicit assumptions: , ! competitive markets , ! all the parties get equal weight in the welfare analysis , ! world price, P ¤, is independent of domestic policy ² Static Welfare Consequences
Domestic consumers’ loss = P¤BDPt Domestic producers’ loss = P ¤ACP t Government revenue gain = CDEF Net deadweight loss = ACE + BDF
SLIDE 3
Domestic Supply Domestic Demand Price P* Autarky Price A B Imports Quantity 2.Import Sector with no Policy Intervention
SLIDE 4 Domestic Supply Domestic Demand Price P* A B Imports Quantity P
t
C D 3.Impact of Tariff
SLIDE 5 Potential Dynamic BeneÞts
, → from protecting domestic “infant” industry
- “Learning–by–doing” effects
, → cost reductions that can only be achieved through on–going production
(see Ray p. 670–672).
- Spillovers to other industries
, → e.g. through effects on public education system
- Increasing returns to scale
, → DC producers often have a ÞrstÐmover advantage , → LDC producers must achieve an efÞcient scale to compete
SLIDE 6
p* pt Price Quantity A B Domestic Demand Domestic Supply 7.Short Term Increase in Domestic Production due to Tariff
SLIDE 7
p* pt Price Quantity Domestic Demand
Internationally Competitive
8.Long Term – after cost reductions due to learning
SLIDE 8 Average Cost, Price Quantity
p* Average Cost Curve Q
f
Qd a b 9.Increasing Returns and Protection
SLIDE 9
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SLIDE 10
² Detrimental impact on primary exports due to exchange rate
distortions
, ! widespread IS reduces demand for foreign currency , ! domestic currency becomes overvalued , ! foreign prices of domestic exports rise and demand for them contracts , ! tends to hurt primary goods producing sectors (e.g. agriculture),
SLIDE 11
Example: Import Substitution in Brazil (Ray, pp. 674–6)
, ! large internal market ² 1949–1964: IS responsible for 25% of growth in demand for domestic
manufacturing
, ! imports fell from 14% to 6% of total supply ² 1965–74: shift towards export promotion , ! rapid export growth ² 1975–1982: return to IS, but for capital goods , ! “... created powerful domestic groups with enormous vested interests
in continuation of inward–looking policies...”
SLIDE 12
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SLIDE 13
Export Promotion
² Basic idea , ! provide preferential treatment to exporters of manufactured goods , ! once they are established, remove this aid. ² Main policy tools used in export promotion are: , ! export subsidies , ! reduced import duties on material inputs , ! preferential credit access and terms of that credit.
SLIDE 14
Example: Industrial and Export Policy in South Korea Period Export GNP Growth Growth 1960–71 40% 9% 1972–79 28% 10%
² export promotion–oriented industrial policies included: , ! targeted infant industry protection prior to launching export drive , ! currency undervaluation , ! tariff exemptions on and preferential access to imported inputs , ! tax breaks to suppliers of exporters , ! preferential credit access and subsidized interest rates for exporters , ! direct subsidies , ! reduced taxes faced by successful exporters , ! creation of public enterprises to “lead the way” in new industries , ! setting of export targets
SLIDE 15
The Impact of Export Subsidies
, ! effective world price for producers increased to P s = (1 + s)P ¤
Static Welfare Consequences Domestic producers’ gain = P ¤BDP s. Domestic consumers’ loss = P¤ACP s. Cost of government subsidy = CDFE. Net deadweight loss = ACE + BDF.
SLIDE 16
Domestic Supply Domestic Demand Price P* Autarky Price A B Exports Quantity 10.Export Sector with no Policy Intervention
SLIDE 17
Domestic Supply Domestic Demand Price P* A B Exports Quantity Ps C D E F 11.Impact of Export Subsidy
SLIDE 18 Dynamic Benefits
- Allows producers to overcome credit market failures
- Learning–by–doing / positive externalities
- Allows producers to overcome first mover advantage
Exchange Rate Effects
, → increase in demand for domestic currency (from foreign consumers) , → domestic currency becomes overvalued , → real export prices rise , → hurts other exporters (primary and manufacturing)
