My report is focused on examining the concept of trade agreements and how they are evolving from being purely preferential toward being less restrictive and discussing the different trade barriers which are used by countries to protect specific domestic sectors.
A number of trade barriers have been employed in order to protect industries, to raise revenue, and to counter the barriers erected by other foreign countries. These barriers create a distortion of relative prices across countries and, consequently, distort individual consumption patterns and lower individual welfare. A general discussion of these barriers and their consequences is provided below.
A means of protecting domestic industries and creating revenue for centuries are tariffs. A tariff is really nothing more than a tax placed on goods imported into a country. In the early years of the U.S. , tariffs were the main source of revenue for the Federal government and continued to be an important source of revenue up until the 1930’s. Today, the average tariff rates across goods and across countries are between 10 and 15 percent and are not a significant source of revenue for most countries. However, tariffs still present a significant barrier to trade among nations. By placing a tax on imported goods, a tariff raises the price of goods and allows certain domestic producers to produce at higher levels. In doing so, resources may be diverted away from industries for which a country has a competitive advantage to industries for which the country does not have a competitive advantage. Diversion of resources creates higher prices and lower quality for goods that are produced domestically. Therefore, a tradeoff exists between saving jobs in specific industries versus the welfare of consumers.
A quota, also referred to as a quantitative restriction, is a policy tool to restrict trade by placing a ceiling on the amount of a product that can be imported during a given period.
As a result, the restriction will create artificially high prices on goods and reduce the amount of competition within that industry. A variation of the quota system is a voluntary export restrictions (VER). Under VER, an exporting country is asked to restrict their exports under the threat of explicit restrictions and trade barriers. In general, the goods that have quotas placed against them are goods that the country does not have a competitive advantage in and yet they produce them. Because the country does not have a competitive advantage in the goods, the cost of producing the goods will be higher than the cost of other countries, and therefore, the selling price will be higher than the world price of the goods. In the end, consumers are the ones who suffer the consequences by paying higher prices for the goods that have restrictions placed on it.
A tax imposed on imported goods by the customs authority is a duty, which has a similar effect as a tariff in that it raises the price of imports and distorts the relative price of goods and consumption patterns.
Therefore, duties create a consumer welfare loss. Many third world countries try to be protective of their unstable and struggling economies. Therefore, they want to be self-reliant as much as possible to encourage their domestic industries. In an attempt to protect their domestic industries, third world countries will often create exchange rate barriers to reduce the influx of foreign currency, which reduces the ability of a country to purchase imports. Consequently, residents will be forced to purchase goods from domestic producers which creates an artificially diversified domestic economy that produces a number of goods for which the country does not have a competitive advantage. As a result, consumers will have to pay a higher price on goods and services and resources will be diverted away from industries for which they have a competitive advantage (Gwartney and Stroup, 1995).
When a producer sells a product in a foreign market at prices below that of their own domestic market, occurs Dumping. Dumping could be just a strategy of a producer (predatory dumping practices), or it could be the result of foreign government subsidies. This will not only enable a domestic producer to crack the foreign market, it may, eventually, drive out competition in that foreign market.
Subsidies come in the form of grants, concessionary loans, loan guarantees, and tax credits that are provided by a government to provide financial benefits on the production, manufacturing, and distribution of goods or services to foreign markets. These subsidies distort the relative price of goods and distort individual consumption patterns. Furthermore, it is an anticompetitive practice that restricts the ability of foreign producers to compete in a worldwide market. Subsidies have been widely used in the agriculture industry.
Policies that are recognized as countervailing polices of trade can become protectionary policies as well. Trade policies such as anti-dumping, safeguards, and countervailing duties can be used to restrict trade and actually hurt free trade when these techniques are abused. When one country tries to retaliate against another country by using these policies, they can also create an escalating trading war that hurts consumers and producers of each country.
Many countries use what is referred to as “price bands” to restrict the importation of agriculture products. Price band is a policy instituted by the government that calculates the price range of a product from a time series analysis of international prices for that product. For example, a government may examine the prices of a product for a 60 month time period. Out of these prices, a portion of the highest and lowest prices will be eliminated. The remaining highs and lows establishes the price band. Imports entering within the price rage are assessed a standard tariff rate. Imports entering above that price range are assessed a lower tariff rate, while imports entering below that market rate are assessed a very high tariff rate. Therefore, if a particular country has low prices for a good because of excessive supply, their goods will have a higher tariff rate assessed to the product.
While there has been a decline in tariff rates across countries, a number of other barriers have often taken the place of the tariff. These barriers include licensing requirements,1 government procurement practices,2 technical standards, and domestic-content rules. In addition, a government can also make the custom system complex and burdensome to hinder imports. Like any other barrier, these requirements reduce the level of competition within a market and artificially create higher prices that reduces the welfare of the consumers.
MOTIVATION FOR THE FREE TRADE MOVEMENT
This review does not argue either for or against free trade. Instead, the review attempts to identify whether the “free trade wheel” is indeed in motion, driven fundamentally by decades of trade negotiations and agreements which as a whole tend towards being freer and more open.
Supporters of freer trade argue that it allows individuals the liberty to buy and sell goods and services from a worldwide market, and that (most) all countries will improve their quality of life when participating in trade that is without restrictions. Free trade allows people to make consumption decisions that maximize their welfare: restricted trade does not allow that freedom. In other words, when there is free trade, individuals are free to choose the least cost alternative, and hence, improve individual welfare.
Free trade also enhances production efficiency by allowing countries, or sectors within, to specialize in the production of goods in which they have a comparative advantage. A comparative advantage results from different countries having different endowments in factors of production. For example, if a country has abundant supply of coal, while another country has a highly technical labor force, each country should specialize in the production of goods which matches their resource pool. So in this case, the first country
ideally should specialize in the production of coal and energy, while the second country should specialize in goods that require a technical labor force.
By specializing in goods in which the country has a particularly competitive advantage, those goods can be produced at a lower cost than when the goods are produced by all countries. In doing so, all participants in trade can enjoy goods at a lower cost, higher quality, and increased quantity than if they were produced by all countries. This is in line with the tendency for industries to increasingly rely on globally integrated supply chains, whereby the production and distribution of goods is done through a chain of suppliers located across several international borders.
To remain competitive, parts and components are produced by suppliers which specialize in certain production factors. Moreover, these specialists tend to be located where their process receives the greatest comparative advantage. For example, labor-intensive processes (like simple assembly, or sewing) gravitate to areas where labor is relatively cost effective. On the other hand, capital-intensive processes tend to gravitate to areas where labor costs are relatively higher.
IMPACT OF TRADE AGREEMENTS ON GLOBAL TRADE
Trade agreements have created an ever-shrinking world that has progressively been moving towards a global market. On a daily basis, U.S. consumers buy goods that are produced in places like China , Germany , and Brazil , while U.S. companies produce goods that are consumed by people in places like Australia , Mexico , and Russia . This increase in trade can be attributed to a number of factors including the reduction in the
cost of communication and transportation, as well as other socioeconomic factors which have lead to higher worldwide disposable income. Another key factor is an almost century long series of continuously evolving international negotiations that have led to numerous agreements to reduce barriers to trade.
These trade agreements include both global and regional agreements. Examples of global agreements include the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO). Examples of regional agreements include the Latin American Free Trade Agreement (LAFTA), the Andean Pact, the Central American Common Market (CACM), the European Economic Community (EC), the Association of South East Asia (ASEAN), and the North American Free Trade Agreement (NAFTA). These agreements have reduced trade barriers among member nations and directly led to an increase in volume of trade.
PRINCIPLES AND EVOLUTION OF TRADE AGREEMENTS
Over time, countries have realized the importance of trade and have pursued international agreements that have reduced the barriers to trade.4 The pursuit of freer trade is often referred to as trade liberalization. Trade liberalization is the act of reducing trade barriers by reducing tariff rates, reducing quantitative restrictions, reducing the variance in protection across industries, and increasing the transparency of trade policy. These agreements have generally fallen into one of two categories:
1. Equal Treatment
2. Preferential Treatment
The classification is based upon a principle referred to as the most favored nation (MFN) principle whereby any access to a domestic market given to one trading partner has to be
extended to all countries. Under equal treatment, all countries are given access, while under preferential treatment, only certain countries are given access to a domestic market, while other countries are not. The principle is also applied in terms of the number of sectors involved. At the preferential extreme, a single sector or commodity is protected through agreement, while at the other extreme all goods are traded freely.
REFERENCES
Barro, Robert. May 1991. Economic Growth in a Cross Section of Countries. Quarterly Journal of Economics pp 407-443.
Coes, Don V. 1991 Trade Agreements in the Americas : Brazil University of New Mexico
ECLA. 1991. Latin American and Caribbean Trade and Investment Relations with the U.S. in the 1980s Santigo: U.N. Economic Commission for Latin America and the Caribbean .
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Edwards, Sebastion. September 1993. Openness, Trade Liberalization and Growth in Developing Countries. Journal of Economic Literature, vol. 31, pp. 1358-1393.
Gould, David M, Ruffin Roy J., and Woodbridge , Graeme L. Fourth Quarter 1993. The Theory and Practice of Free Trade. Economic Review—Federal Reserve Bank of Dallas pp 1-16
General Accounting Office. 1994. The General Agreement on Tariffs and Trade: Uruguay Round Final Act Should Produce Overall U.S. Economic Gains GAO/GGD-94-83b.
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Hufbauer, Gary and Elliot, Kimberly. January 1993. Measuring the Costs of Protection in the United States Washington , D.C.
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Michaely, Michael, Papageorgiou, Demetris, and Choski, Armeane M. 1991. Liberalizing Foreign Trade: Lesson of Experience in the Developing World Cambridge , MA
Nogueira, Uziel. November 1997. Mercosur: What comes next? IDB America Vol. 34, No. 11 p. 3.
Parkin, Michael. 1997. Microeconomics, 3rd ed. New York : Addision-Wesley.
Rajaptirana, Sarath. 1993. Latin American Trading Arrangements and GATT. Working Paper. Washington , D.C.
Rajaptirana, Sarath. 1994. The Evolution of Treaties and Trade Creation: Lessons for Latin America . Working Paper.Washington , D.C.
Schumacher, Edward. April 16, 1998. A Meeting of Minds, From Peoria to Patagonia . Wall Street Journal.
Tbilisi. 2009
Tbilisi. 2009
Ketevan Krialashvili
CEO
CEO
EPEC
1 Often, a country can require a license, which is a property right to export to a country. The country will only issue so many licenses and they are then bought and sold among producers who want to export to the country.
2 For government contracts, domestic producers are often given preferential treatment.
3 This could include pollution standards, safety standards, measurement standards, and health standards.
4 For additional evidence on how trade barriers can affect economic growth, refer to Barro (1991), Gould, Ruffin, andWoodbridge
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