Question

question 1 through 5

1. Using a demand and supply of a good, discuss the effect of tariff on domestic consumer, producers, and the net national loss from tariff. 2. What are the different types of economic integration or economic block? By using example, explain the differences between them. 3. What are the major provisions of GATT? In what respects the WTO different from GATT. 4. What are the arguments for trade restriction? Discuss the various types of nontariff barriers. s. Is free trade good for America? Explain what are the arguments made by politician for trade restriction?

Answer 1

Q 3) What are the major provisions of GATT? In what respects the WTO is different from GATT.

Ans)

Provision # 1. The ‘Most Favoured Nation’ Clause:

The most significant provision of the GATT agreement was that of the Most Favoured Nation (MFN) clause. The essence of this clause was that each contracting party of the agreement would treat all other contracting parties as the most favoured nation. It meant that the whole arrangement under the GATT agreement was based upon twin principles of non­discrimination and reciprocity.

Article I of the GATT agreement provided that “any advantage, or favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be-accorded immediately and unconditionally to the like product originating in or destined for the territories of all contracting parties.

The MFN clause implied that the tariff preferences resulting from bilateral trade negotiations between two member countries had to be extended on a non-discriminatory and reciprocal basis to all the other member countries. In essence, this clause discouraged the member countries from granting any new trade concessions unless those were multilaterally agreed.

The GATT agreement also made provision of Escape Clauses. The LDC’s, under certain circumstances, were assured the right to discriminate. For instance, they could adopt appropriate measures to counter dumping and export subsidies but only against the offending countries. The developed Western countries were allowed to extend special concessions in trade to their former colonies.

Provision # 2. Quantitative Restrictions on Imports:

The contracting parties were prohibited from imposing the quantitative restrictions on imports such as import quotas and import licences, under Article XI of the GATT agreement.

The exceptions were, however allowed in certain defined circumstances:

(i) The countries could take recourse to them, if otherwise the balance of payments adjustments were difficult. In this connection, it was specified that the import quota fixation should be limited to the extent necessary to check a serious fall in the foreign exchange reserves. Even in such a situation, the import quota fixation should be done after due consultation with the IMF.

(ii) The LDC’s could take resort to import quota restriction for protecting domestic industries when the use of tariff was not possible or applicable. But even that could be attempted only under the procedure laid down by the GATT.

(iii) In the case of agriculture and fisheries, quota restriction could be applied provided the domestic production were subject to equally restrictive controls.

(iv) When a foreign country was exporting products at artificially low (dumped) prices or at the subsidised prices, the affected country was allowed by the GATT to take suitable protective action including the restriction of imports through quota.

(v) In the event of a sudden increase in imports, a member country was allowed to take resort to temporary safeguard of import quota restriction for protecting domestic industry.

(vi) The import quota restrictions could be adopted by a country, if the imports were likely to harm the domestic production control and price support programmes.

(vii) The countries were allowed to form customs union or free trade areas under Article XXIV of the GATT agreement provided their aim was to promote trade among the constituent countries and not to raise trade barriers against other contracting parties.

In any case if there were a resort to quantitative restrictions on imports, it should be non­discriminatory. The GATT had emphasized upon the need of continuous consultation among the contracting parties on the nature of the BOP problems, alternative corrective measures and the possible effects of quantitative restrictions upon the economies of other contracting parties.

Those countries which continued to apply the quantitative restrictions were required to notify the GATT. If those restrictions caused harm to the interests of another country, the latter could ask for consultation with the country imposing restrictions under the GATT. If the consultations failed to bear results, the complaining country could invoke the provisions of Article XVIII of the GATT, under which the latter was authorised to suspend concessions or other obligations towards the offending country.

Provision # 3. Tariff Negotiations and Tariff Reduction:

Since the GATT prohibited all non-tariff restrictions on trade, the countries were permitted to resort to import tariffs as a means of protecting the domestic industries. But at the same time the GATT recognised that tariffs were the major impediments in the smooth and orderly growth of world trade.

The GATT contained an entrenched clause that sought to stabilise member countries’ tariffs. The Article II of the GATT specified that all concessions granted by contracting parties, as a consequence of negotiations under the GATT, must be entered in a ‘Schedule of Concessions’.

A concession might assume the form of a reduction in the rate of import tariff or an agreement to bind, i.e., not to hike the existing rate of duty. Once a concession was included in the schedule of concession, it could not be withdrawn except under certain specified circumstances, it meant that provisions of schedule of concessions, binding clause and tariff negotiations created a strong in-built bias towards the lowering down of rates of import tariff in the GATT.

It encouraged frequent negotiations among the contracting parties to reduce in a substantial measure the rates of import tariffs. The negotiations for tariff reduction were to be conducted on a reciprocal and mutually advantageous basis, keeping in consideration the varying needs of the contracting parties. The GATT allowed the use of some measure of tariff protection to the LDC’s in view of their special needs of industrial development and also for obtaining revenues.

The negotiation procedure concerning tariff reduction under the GATT was bilateral-multilateral. It was bilateral as two contracting parties entered into negotiations for tariff reduction on a selective commodity-to-commodity basis. The tariff reductions agreed between any two negotiating parties were to be made applicable to all the contracting parties under the ‘Most Favoured Nation’ clause. This was the multilateral aspect of tariff negotiations.

The bilateral-multilateral technique of negotiations had some drawbacks. First, the principle of reciprocity was injurious to the interests of the LDC’s. These countries producing mainly primary products had a weak bargaining power relative to the developed countries in bilateral negotiations. As a consequence, the terms of trade turned unfavourable for them. Second, that negotiations technique created uncertainty and instability in the tariff structures of many a country.

Third, that negotiations procedure was not equitable for those countries which already had a low-tariff structure. They had very little to offer in exchange of concessions offered by the other contracting party. Thus the former was likely to have a low bargaining power compared with the latter.

Fourth, this technique of tariff-reduction negotiations was very slow. The achievement in tariff reduction had remained very small and not encouraging since the enactment of the GATT. That resulted in the abandonment of bilateral commodity by commodity negotiations and emphasis shifted to only multilateral tariff reduction.

Provision # 4. Subsidies and Counter-Veiling Duties:

It was recognised by the GATT that the subsidies were alternative to tariffs. The Tokyo Round of the GATT in 1970’s considered it necessary to specify the code of conduct related to subsidies. The industrial countries agreed to a complete ban on export subsidies in the case of manufactured products.

The LDC’s were, however, exempted from this stipulation. The member countries were required to avoid subsidies on the export of primary products in principle. In case they provided subsidies on such products, that should be done in such a manner that the country employing them did not acquire a more than equitable share in the world export of the concerned products.

In case the subsidies resulted in harm to the interests of importing countries, the agreement authorized them to take resort to counter-veiling duties. As regards other subsidies such as the production subsidies, the members were allowed to use them provided they notify other parties of any subsidy that is likely to cause the exports of the latter to fall and imports to rise.

The former should also be prepared, on request to enter into consultation with the latter about the possibility of reduction or limiting such subsidies. In case any country was found to take recourse to dumping, i.e., the export price of a product was lower than its domestic price, the affected country was allowed to impose the counter-veiling or anti­dumping duties to the extent that the dumping got neutralised.

However, the country resorting to counter-veiling or anti-dumping duties should not impose duties at a higher rate than was required to offset the margin of dumping and the affected industry in the importing country should not acquire thereby a net additional protection.

Provision # 5. Complaints and Waivers:

Article XXII of the GATT made provision for dealing with any complaints from a contracting party related to the operation of the Agreement. The complainant party could request for consultation with the other contracting party, when the former felt that an action of the latter nullified or impaired the benefits accruing to that country under the Agreement. If no satisfactory solution was found, the matter could be referred to a group of experts to assist the two contracting parties.

The complaints had been concerning the discriminatory incidence of internal taxes, anti-dumping duties and special restrictions on imports. In this regard it had been noted with satisfaction that the number of complaints had fallen during the recent years.

Article XXV of the GATT laid down the procedure for granting waiver to some contracting parties from the application of the provisions of the GATT. Ordinarily the waivers were not granted unless those were approved by two-thirds of the voting contracting parties.

Some instances of the grant of waivers included the waivers to the European Coal and Steel Company (ECSC) at the eleventh session of the GATT in 1952 about the trade in products under ECSC treaty, to Britain in respect of Commonwealth Trade Preferences and, to the United States in respect of her Agricultural Adjustment Act.

Provision # 6. Settlement of Disputes:

The GATT had provided for the machinery for the settlement of any disputes among the contracting parties. Initially the contracting parties were involved into bilateral negotiations for resolving the matter. In case of failure, the matter could be referred to a panel of experts drawn from countries having no direct interest in the matter. This panel or committee, after a careful study, used to make a recommendation or ruling to be observed by the offending party.

In case the offending member either did not comply with the ruling or did not act upon the recommendation of the panel, the aggrieved party was authorized to retaliate by withdrawing some or all concessions offered to the offending country. Thus dispute settlement procedure of the GATT rested upon direct consultations, conciliation and third party adjudication. GATT had generally proved successful in resolving disputes among the contracting parties.

Difference between GATT and WTO -

BASIS FOR COMPARISON GATT WTO Meaning GATT can be described as a set of WTO is an rules, multilateral trade international agreement, that came into force, organization, that to encourage international trade came into existence to and remove cross-country trade oversee and liberalize barriers. trade between countries. Institution It does not have any institutional existence, but have a small secretariat. It has permanent institution along with a secretariat. Contracting parties Members Participant nations Commitments Provisional Full and Permanent Application The rules of GATT are only for trade in goods. The rules of WTO includes services and aspects of intellectual property along with the goods. Agreement Its agreement are originally multilateral, but plurilateral agreement are added to it later. Its agreements are purely multilateral. Allowed to continue Domestic Legislation Not allowed to continue Slow and ineffective Fast and effective Dispute Settlement System

Q 4) ARGUMENTS FOR TRADE RESTRICTIONS

Infant Industries

One argument for trade barriers is that they serve as a kind of buffer to protect fledgling domestic industries. Initially, firms in a new industry may be too small to achieve significant economies of scale and could be clobbered by established firms in other countries. A new domestic industry with potential economies of scale is called an infant industry.

Consider the situation in which firms in a country are attempting to enter a new industry in which many large firms already exist in the international arena. The foreign firms have taken advantage of economies of scale and have therefore achieved relatively low levels of production costs. New firms, facing low levels of output and higher average costs, may find it difficult to compete. The infant industry argument suggests that by offering protection during an industry’s formative years, a tariff or quota may allow the new industry to develop and prosper.

The infant industry argument played a major role in tariff policy in the early years of U.S. development. The high tariffs of the early nineteenth century were typically justified as being necessary to allow U.S. firms to gain a competitive foothold in the world economy. As domestic industries became established, tariff rates fell. Subsequent increases in tariffs were a response in part to internal crises: the Civil War and the Great Depression. Tariff rates have fallen dramatically since 1930.

Critics of the infant industry argument say that once protection is in place, it may be very difficult to remove. Inefficient firms, they contend, may be able to survive for long periods under the umbrella of infant industry protection.

Strategic Trade Policy

A new version of the infant industry argument has been used in the past few years as technological developments have spawned whole new industries and transformed existing ones. The new version of the infant industry argument assumes an imperfectly competitive market.

Suppose technological change has given rise to a new industry. Given the economies of scale in this industry, only a few firms are likely to dominate it worldwide—it will likely emerge as an oligopoly. The firms that dominate the industry are likely to earn economic profits that will persist. Furthermore, because there will be only a few firms, they will be located in only a few countries. Their governments could conceivably impose taxes on these firms’ profits that would enhance economic well-being within the country. The potential for such gains may justify government efforts to assist firms seeking to acquire a dominant position in the new industry.

Government aid could take the form of protectionist trade policies aimed at allowing these firms to expand in the face of foreign competition, assistance with research and development efforts, programs to provide workers with special skills needed by the industry, or subsidies in the form of direct payments or special tax treatment. Any such policy aimed at promoting the development of key industries that may increase a country’s domestic well-being through trade with the rest of the world is known as a strategic trade policy.

Although strategic trade policy suggests a conceptually positive role for government in international trade, proponents of the approach note that it has dangers. Firms might use the strategic trade argument even if their development were unlikely to offer the gains specified in the theory. The successful application of the approach requires that the government correctly identify industries in which a country can, in fact, gain dominance—something that may not be possible. Various European governments provided subsidies to firms that were involved in the production of Airbus, which is now a major competitor in the airplane industry. On the other hand, Britain and France subsidized the development of the supersonic plane called the Concorde. After only a few Concordes had been produced, it became obvious that the aircraft was a financially losing proposition and production was halted. The airline has now gone out of business.

Finally, those firms whose success strategic trade policy promotes might have sufficient political clout to block the taxes that would redistribute the gains of the policies to the population in general. Thus, the promise of strategic trade policy is unlikely to be fulfilled.

National Security And the National Interest Argument

Some argue that a nation should not depend too heavily on other countries for supplies of certain key products, such as oil, or for special materials or technologies that might have national security applications. On closer consideration, this argument for protectionism proves rather weak.

As an example, in the United States, oil provides about 40% of all the energy and about 40% of the oil used in the United States economy is imported. Several times in the last few decades, when disruptions in the Middle East have shifted the supply curve of oil back to the left and sharply raised the price, the effects have been felt across the United States economy. This is not, however, a very convincing argument for restricting imports of oil. If the United States needs to be protected from a possible cutoff of foreign oil, then a more reasonable strategy would be to import 100% of the petroleum supply now, and save U.S. domestic oil resources for when or if the foreign supply is cut off. It might also be useful to import extra oil and put it into a stockpile for use in an emergency, as the United States government did by starting a Strategic Petroleum Reserve in 1977. Moreover, it may be necessary to discourage people from using oil, and to start a high-powered program to seek out alternatives to oil. A straightforward way to do this would be to raise taxes on oil. What’s more, it makes no sense to argue that because oil is highly important to the United States economy, then the United States should shut out oil imports and use up its domestic supplies of oil more quickly.

Whether or not to limit certain kinds of imports of key technologies or materials that might be important to national security and weapons systems is a slightly different issue. If weapons’ builders are not confident that they can continue to obtain a key product in wartime, they might decide to avoid designing weapons that use this key product, or they can go ahead and design the weapons and stockpile enough of the key high-tech components or materials to last through an armed conflict. Indeed, there is a U.S. Defense National Stockpile Center that has built up reserves of many materials, from aluminum oxides, antimony, and bauxite to tungsten, vegetable tannin extracts, and zinc (although many of these stockpiles have been reduced and sold in recent years).

One final reason why economists often treat the national interest argument skeptically is that almost any product can be touted by lobbyists and politicians as vital to national security. In 1954, the United States became worried that it was importing half of the wool required for military uniforms, so it declared wool and mohair to be “strategic materials” and began to give subsidies to wool and mohair farmers. Although wool was removed from the official list of “strategic” materials in 1960, the subsidies for mohair continued for almost 40 years until they were repealed in 1993, and then were reinstated in 2002. All too often, the national interest argument has become an excuse for handing out the indirect subsidy of protectionism to certain industries or companies. After all, decisions about what constitutes a key strategic material are made by politicians, not nonpartisan analysts.

Job Protection

The desire to maintain existing jobs threatened by foreign competition is probably the single most important source of today’s protectionist policies. Some industries that at one time had a comparative advantage are no longer among the world’s lowest-cost producers; they struggle to stay afloat. Cost cutting leads to layoffs, and layoffs lead to demands for protection.

The model of international trade in perfect competition suggests that trade will threaten some industries. As countries specialize in activities in which they have a comparative advantage, sectors in which they do not have this advantage will shrink. Maintaining those sectors through trade barriers blocks a nation from enjoying the gains possible from free trade.

A further difficulty with the use of trade barriers to shore up employment in a particular sector is that it can be an enormously expensive strategy. Suppose enough of a foreign good is kept out of the United States to save one U.S. job. That shifts the supply curve slightly to the left, raising prices for U.S. consumers and reducing their consumer surplus. The loss to consumers is the cost per job saved. Estimates of the cost of saving one job in the steel industry through restrictions on steel imports, for example, go as high as $800,000 per year.

Cheap Foreign Labor and Outsourcing

One reason often given for the perceived need to protect American workers against free international trade is that workers must be protected against cheap foreign labor. This is an extension of the job protection argument in the previous section. From a theoretical point of view, of course, if foreign countries can produce a good at lower cost than we can, it is in our collective interest to obtain it from them. But workers counter by saying that the low wages of foreign workers means that foreign workers are exploited. To compete with foreign workers, American workers would have to submit themselves to similar exploitation. This objection, however, fails to recognize that differences in wage rates generally reflect differences in worker productivity.

Consider the following example: Suppose U.S. workers in the tool industry earn $20 per hour while Indonesian workers in the tool industry earn only $2 per hour. If we assume that the tool industry is competitive, then the wages in both countries are based on the marginal revenue product of the workers. The higher wage of U.S. workers must mean that they have a higher marginal product—they are more productive. The higher wage of U.S. workers need not mean that labor costs are higher in the United States than in Indonesia.

Further, we have seen that what matters for trade is comparative advantage, not comparative labor costs. When each nation specializes in goods and services in which it has a comparative advantage—measured in the amounts of other goods and services given up to produce them—then world production, and therefore world consumption, rises. By definition, each nation will have a comparative advantage in something.

A particularly controversial issue in industrialized economies is outsourcing, in which firms in a developed country transfer some of their activities abroad in order to take advantage of lower labor costs in other countries. Generally speaking, the practice of outsourcing tends to reduce costs for the firms that do it. These firms often expand production and increase domestic employment, as is discussed in the accompanying Case in Point essay.

Differences in Environmental Standards

Another justification for protectionist measures is that free trade is unfair if it pits domestic firms against foreign rivals who do not have to adhere to the same regulatory standards. In the debate over NAFTA, for example, critics warned that Mexican firms, facing relatively lax pollution control standards, would have an unfair advantage over U.S. firms if restraints on trade between the two countries were removed.

Economic theory suggests, however, that differences in pollution-control policies can be an important source of comparative advantage. In general, the demand for environmental quality is positively related to income. People in higher-income countries demand higher environmental quality than do people in lower-income countries. That means that pollution has a lower cost in poorer than in richer countries. If an industry generates a great deal of pollution, it may be more efficient to locate it in a poor country than in a rich country. In effect, a poor country’s lower demand for environmental quality gives it a comparative advantage in production of goods that generate a great deal of pollution.

Provided the benefits of pollution exceed the costs in the poor country, with the costs computed based on the preferences and incomes of people in that country, it makes sense for more of the good to be produced in the poor country and less in the rich country. Such an allocation leaves people in both countries better off than they would be otherwise. Then, as freer trade leads to higher incomes in the poorer countries, people there will also demand improvements in environmental quality.

Do economists support any restriction on free international trade? Nearly all economists would say no. The gains from trade are so large, and the cost of restraining it so high, that it is hard to find any satisfactory reason to limit trade.

Examples of Non-Tariff Barriers

Non-Tariff Barriers to trade can arise from:

• Import bans
• General or product-specific quotas
• Complex/discriminatory Rules of Origin
• Quality conditions imposed by the importing country on the exporting countries
• Unjustified Sanitary and Phyto-sanitary conditions
• Unreasonable/unjustified packaging, labelling, product standards
• Complex regulatory environment
• Determination of eligibility of an exporting country by the importing country
• Determination of eligibility of an exporting establishment (firm, company) by the importing country.
• Additional trade documents like Certificate of Origin, Certificate of Authenticity etc