Trade Policy Import Substitution Basic idea erect barriers to - PowerPoint PPT Presentation

Trade Policy Import Substitution • Basic idea → erect barriers to foreign imports , → satisfy demand with domestic (less ef Þ ciently–produced) substitutes , → allow domestic producers to become more ef Þ cient , → eventually remove the trade barriers , • Main policy tools: → Tariffs , → Quotas (often combined with tariff beyond quota) , → Non–tariff barriers ,

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 ¤ BDP t Domestic producers’ loss = P ¤ ACP t Government revenue gain = CDEF Net deadweight loss = ACE + BDF

Price Domestic Supply Autarky Price P* B A Domestic Demand Quantity Imports 2.Import Sector with no Policy Intervention

Price Domestic Supply D C t P P* B A Domestic Demand Quantity Imports 3.Impact of Tariff

Potential Dynamic Bene Þ ts → 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 ,

Price Domestic Supply p t p* Domestic Demand B A Quantity 7.Short Term Increase in Domestic Production due to Tariff

Price Internationally Competitive p t p* Domestic Demand Quantity 8.Long Term – after cost reductions due to learning

Average Cost, Price b p* Average Cost a Curve Quantity f Q d Q 9.Increasing Returns and Protection

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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), ,

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...”

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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. ,

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

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 .

Price Domestic Supply P* A B Autarky Price Domestic Demand Quantity Exports 10.Export Sector with no Policy Intervention

Domestic Price Supply C D P s P* B F E A Domestic Demand Quantity Exports 11.Impact of Export Subsidy

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) ,