Lecture-10-01122024-092448pm.pptx lecture

Lection 10

1. Lecture 9 Controversies in Trade Policy from " Chapter 12, International Economics: Theory and Policy" Instructor: Mehnaz Khan

2. Introduction to Trade Policy Controversies Three significant controversies have emerged in recent decades: The rise of sophisticated arguments for government intervention in trade, especially focusing on high-technology industries. The impact of globalization on labor standards and wages, particularly in developing countries. Environmental and cultural concerns tied to globalization, including the role of carbon tariffs and cultural homogenization.

3. Sophisticated Arguments for Activist Trade Policy Technology and Externalities : High-tech industries may generate spillover benefits (externalities) that individual firms cannot fully capture, leading to underinvestment. Some economists argue this justifies government intervention in high-tech sectors​. Strategic Trade Policy : Developed in the 1980s, this theory suggests that in industries with imperfect competition, government intervention can potentially shift profits from foreign to domestic firms. The classic Brander-Spencer model highlights how subsidies can deter foreign competition​. Imperfect Competition : In industries with few dominant firms, subsidies might raise national income by capturing "excess returns." However, strategic trade policies require precise information, and missteps can lead to economic inefficiency or retaliation​

4. The Brander-Spencer analysis The Brander-Spencer analysis provides a theoretical framework for understanding how government intervention can influence competition in imperfectly competitive markets. Here's a detailed explanation using the example of two firms, Boeing and Airbus: 1. Basic Premise of the Analysis The Brander-Spencer analysis explores a situation where there are only two firms, each from a different country, competing in the same market. In this simplified scenario, let’s assume: The firms are Boeing (from the U.S.) and Airbus (from Europe). They both have the capability to produce a new product, a superjumbo aircraft . Each firm can make a binary decision: produce or not produce the superjumbo aircraft. 2. Payoff Matrix Without Government Intervention In the initial setup without any government subsidies, the possible outcomes depend on the choices made by Boeing and Airbus: If only one firm (Boeing or Airbus) decides to produce, it will capture the entire market and earn high profits. If both firms produce, competition will drive prices down, and both firms may incur losses. If neither firm produces, profits are zero .

5. Government Intervention - European Subsidy to Airbus The European government decides to intervene by offering Airbus a subsidy of 25 if it chooses to enter the market. This subsidy changes the dynamics of competition: Now, even if Boeing chooses to produce, Airbus will have an incentive to produce due to the financial support. The subsidy effectively alters the payoffs and the competition landscape. The revised matrix with the subsidy looks like this:

6. Outcome with the Subsidy With the subsidy in place, the equilibrium shifts: Airbus will produce regardless of Boeing's decision because the subsidy makes production profitable. Boeing, foreseeing that Airbus will produce (and thus incurring losses if it competes), opts not to enter the market. New Outcome : Airbus produces, earns profits of 125 (due to the subsidy), and Boeing does not enter.

7. Implications of the Brander-Spencer Analysis Strategic Advantage : The subsidy enables Airbus to deter Boeing from entering the market, capturing the entire market share. Excess Returns : The profit gain for Airbus (125) exceeds the subsidy value (25), highlighting how a relatively small government intervention can lead to disproportionately large benefits by deterring competition. Welfare Impact : This raises European welfare at the expense of U.S. welfare. It shifts the advantage from Boeing (assumed to have a head start) to Airbus. Criticisms of the Analysis Information Requirement : Accurately implementing such a policy requires precise knowledge of industry dynamics, something difficult to obtain. Risk of Retaliation : Such interventions can provoke trade disputes and retaliatory measures from other countries. Potential for Misjudgment : If the government misestimates market conditions (e.g., Boeing has an unaccounted advantage), the subsidy could become a costly error, leading to economic inefficiency​

8. Globalization and Labor Issues The Anti-Globalization Movement : The 1990s saw a rise in opposition to globalization, especially regarding low wages and poor working conditions in developing countries. Critics argue that free trade benefits multinational corporations at the expense of workers​​. Trade and Wages : There is a debate over whether trade agreements should include labor standards to improve working conditions. Developing countries often view these standards as disguised protectionism, potentially limiting their competitiveness​​.

9. The Core Debate: Globalization's Impact on Workers Free Trade Advocates : Proponents of free trade argue that globalization enhances economic growth, provides access to cheaper goods, and opens up opportunities for developing countries to integrate into the global economy. They emphasize that trade leads to job creation in export sectors, which can lead to overall economic development. Anti-Globalization Activists : Critics contend that globalization can exploit workers in developing countries, leading to poor working conditions, low wages, and limited labor rights. They argue that multinational corporations often seek out countries with lower labor standards to reduce costs, which can contribute to a “race to the bottom” in wages and working conditions .

10. Proposals for Labor Standards in Trade Monitoring System for Wages and Conditions : Proposal : One modest suggestion from some economists is to establish a monitoring system that tracks wages and working conditions in export factories. This data would be made available to consumers in advanced countries, enabling them to make informed choices. Market Failure Argument : This proposal is based on the idea that consumers in wealthier nations care about the ethical aspects of their purchases but face significant challenges in gathering information. By providing accessible and reliable data, consumers can make decisions aligned with their values, creating a mutually beneficial scenario where workers in developing countries benefit from better wages and conditions*Consumer Perspective**: A quote from a teenager, cited by Kimberly Ann Elliott, illustrates the consumer mindset: “Look, I don’t have time to be some kind of major political activist every time I go to the mall. Just tell me what kinds of shoes are okay to buy, okay?” This highlights a desire for simplicity in ethical consumption . Proponents acknowledge that such a system would only impact a small portion of the workforce—those in export-oriented industries. However, they argue it’s a low-risk strategy that could still improve conditions for a segment of workers.

11. Opposition from Developing Countries Protectionism Concerns : Developing nations are often against the inclusion of labor standards in trade agreements. They fear that such standards will be leveraged as a form of protectionism, disadvantaging their products in international markets. Unattainable Standards : There is a concern that standards set by advanced countries could be so stringent that they become unattainable for developing nations, effectively pricing their goods out of the global marketplace. This fear was a major factor behind the collapse of trade talks in Seattle, where developing countries resisted the pressure to include stringent labor standards. Legal Risks : Developing nations are also wary of the potential for labor standards to serve as grounds for private lawsuits against foreign companies, similar to how anti-dumping laws are sometimes used. They fear that this could lead to harassment of foreign competitors, impacting their ability to participate in international trade effectively . The Broader Implication - Consumer Impact: Making labor standards transparent can empower consumers to make ethical choices, potentially leading to improved conditions in certified factories. However, critics argue that such standards are unlikely to significantly affect the broader population in developing countries. Trade Negotiations : The inclusion of labor standards in trade negotiations remains a contentious topic, balancing the desire to improve working conditions globally with concerns about fairness and economic impacts on developing nations. Political Dynamics : The debate over labor standards illustrates the political tensions between protecting domestic industries in developed nations and fostering competitive opportunities for developing countries.

12. The case study on global manufacturing, specifically the working conditions in Indian metal foundries, provides a stark illustration of the contrast between developing and developed countries' labor standards. It focuses on Shakti Industries, a foundry in West Bengal, India, which produces manhole covers for New York's power company, Con Edison. Here are the details: Working Conditions at Shakti Industries Primitive Labor Conditions : Workers at Shakti Industries handle molten iron without shoes and often wear minimal protective clothing. Images captured showed men, barefoot and bare-chested, dealing with glowing, molten metal, a practice far from the safety norms found in Western countries​. Safety Concerns : Despite the director's claim of no accidents, incidents are common. Sparks frequently ignite the workers' clothing, and in one instance, a worker's traditional lungi (a skirt-like garment) caught fire. He swiftly extinguished it using the garment itself before continuing his work​. Economic Disparities Wages : Workers at these foundries earn only a few dollars per day, significantly lower than their counterparts in the U.S., who earn about $25 an hour. This wage disparity underlines the economic differences between developing and developed countries​.

13. Public Reactions and Ethical Concerns Public Outrage : After the story was published, many called for ensuring humane working conditions for overseas manufacturing, pushing companies like Con Edison to reconsider their sourcing practices. This led to calls for contractual changes to improve workplace safety in international supply chains​. Contrasting Views : Some argue that imposing Western safety standards would increase costs to the point of closing local factories, potentially harming the livelihoods of workers who depend on these jobs. Others emphasize that, by Indian standards, these wages are relatively favorable, and the workers take pride in their roles​

14. Environmental and Cultural Issues Trade and the Environment : Environmental concerns have become central in trade debates. Critics claim that globalization can lead to environmental degradation, while proponents argue that economic growth can eventually lead to better environmental outcomes (Environmental Kuznets Curve)​​. Carbon Tariffs : A proposed tool to level the playing field between domestic producers and foreign competitors with different environmental standards, carbon tariffs are both supported and criticized. They are seen as a way to enforce global environmental standards but also face accusations of protectionism​. Cultural Homogenization : The chapter discusses how global trade can erode local cultures, leading to a more homogeneous global culture. There are arguments for protecting national culture through trade restrictions, though these clash with the principle of consumer choice and freedom​

15. The Role of the World Trade Organization (WTO) WTO and National Sovereignty : The WTO plays a crucial role in resolving trade disputes, yet it has been criticized for encroaching on national sovereignty. Instances where WTO rulings impacted domestic policies, like the U.S. Clean Air Act, illustrate this tension​ The case study involving the WTO's decision regarding U.S. gasoline standards centers around a dispute between the United States and Venezuela over the U.S. Clean Air Act's amendments in the 1990s. Here's a detailed breakdown of the situation and its implications: 1. Background of the Dispute In the early 1990s, the United States implemented new air pollution standards under amendments to the Clean Air Act. These standards regulated the chemical composition of gasoline sold within the U.S. to control pollution and improve air quality. However, the regulations contained specific provisions: Domestic refineries were allowed to calculate a "baseline" level of pollutants based on 1990 emission levels. This effectively resulted in more lenient standards for U.S. refineries compared to imported gasoline, creating a discrepancy between domestic and foreign suppliers​

16. The WTO Dispute Venezuelan Complaint : Venezuela, a significant exporter of gasoline to the U.S., argued that the American regulations violated the principle of "national treatment." This principle requires imported and domestic goods to be treated equally to prevent disguised protectionism. WTO's Decision : In 1995, a WTO panel ruled in favor of Venezuela, concluding that the U.S. standards indeed discriminated against imported gasoline. The U.S. appealed the decision, but the WTO upheld the initial ruling

17. Aftermath and Negotiations Regulatory Adjustments : Following the WTO's ruling, the United States was compelled to revise its gasoline standards to ensure that both domestic and imported gasoline faced equal treatment. This change aimed to align U.S. policies with its international trade obligations​. Environmental Impact : Environmental advocates were disappointed with the WTO's decision because they believed the original standards were genuinely aimed at reducing pollution, not protecting domestic industries. The ruling was seen as a setback to environmental policy, as it seemingly prioritized trade consistency over stringent environmental standards​

18. Broader Implications Trade and Sovereignty : The case became emblematic in discussions around the tension between national sovereignty and international trade rules. Critics of the WTO argued that such decisions limited a country's ability to enforce robust environmental protections. This concern remains a focal point in the anti-globalization movement. Economic vs. Environmental Goals : Supporters of the WTO ruling argued that the U.S. could have implemented a "clean" air rule that did not discriminate between domestic and foreign gasoline. They viewed the discriminatory baseline allowances as a subtle form of protectionism, favoring U.S. refineries under the guise of environmental regulation​ Lessons from the Case The WTO’s decision highlighted the delicate balance between upholding free trade principles and allowing countries the flexibility to enforce environmental regulations. It demonstrated that while the WTO aims to prevent protectionism, it can also complicate national efforts to set higher standards for environmental protection. For policymakers, this case underscores the importance of crafting non-discriminatory environmental policies that do not inadvertently favor domestic industries over international competitors​

19. Summary of Key Lessons Strategic Trade Policy : Governments must carefully evaluate the potential gains of interventionist policies against risks of retaliation and information limitations​. Globalization’s Impact on Workers : Free trade tends to benefit economies overall, but its distributional impacts require careful management to ensure workers in both developed and developing countries are not adversely affected​. Balancing Trade with Environmental Goals : The intersection of trade and environmental policies is increasingly important. Decisions like implementing carbon tariffs require international cooperation and careful design to avoid unintended consequences​