For the project, Students should read Chapter 19 and then write a short Chapter Summary,

T he world is a giant shopping mall, and Americans are big spenders. For example, the U.S. population is less than 5 percent of the world's population, but Americans buy 38 percent of the diamond jewelry sold around the world. Americans also buy Japanese cars, French wine, European vacations, Chinese products galore, and millions of other goods and services from around the globe. Foreigners buy U.S. products too-grain, aircraft, movies, software, higher education, trips to New York City, and millions of other goods and services. For example, California grows 80 percent of the world's almond supply. In this chapter, we examine the gains from international trade and the effects of trade restrictions on the allocation of resources. The analysis is based on the familiar tools of demand and supply. Topics discussed in this chapter include: . Gains from trade . Free trade agreements . Absolute and comparative advantage . World Trade Organization, or WTO revisited . Common market . Tariffs and quotas . Arguments for trade restrictions . Cost of trade restrictions 19-1 The Gains From Trade A Virginia family that sits down to a dinner of Kansas prime rib, Idaho potatoes, and California string beans, with Georgia peach cobbler for dessert, is benefiting from inter- state trade. You already understand why the residents of one state trade with those of another. Back in Chapter 2, you learned about the gains arising from specialization and trade. You may recall how you and your roommate could maximize output when you each specialized. The law of comparative advantage says that the individual with the lowest opportunity cost of producing a particular good should specialize in that good. Just as individuals benefit from specialization and trade, so do states and, indeed, na- tions. To reap the gains that arise from specialization, countries engage in international trade. Each country specializes in making goods with the lowest opportunity cost.U.S. Exports U.S. exports of goods and services amounted to $2.3 trillion in 2014, or 13 per- cent of GDP. The left panel of Exhibit 1 shows the composition by major category in 2014. The largest category is services, which accounted for 31 percent of U.S. exports. U.S. service exports include transportation, insurance, banking, education, consulting, and tourism. Capital goods ranked second, at 24 percent of the total, with aircraft the largest export industry (Boeing is the top U.S. exporter). Industrial supplies ranked third, at 22 percent of exports, with chemicals and plastics topping that list. Capital goods and industrial supplies help foreign producers make stuff and together accounted for nearly half of U.S. exports. Consumer goods (except food and autos, which appear separately) accounted for only 11 percent of exports (phar- maceuticals tops this group). Consumer goods also include entertainment products, such as movies and recorded music. U.S. Imports U.S. imports of goods and services totaled $2.8 trillion in 2014, or 16 percent rela- tive to GDP. The right panel of Exhibit 1 shows the composition of U.S. imports. The biggest category, at 24 percent, is industrial supplies, with petroleum products accounting for most of that. Whereas consumer goods accounted for only 11 per- cent of U.S. exports, they were 22 percent of U.S. imports, with pharmaceuticals the largest item. Ranked third is capital goods, at 21 percent, with computers the largest item. Note that services, which accounted for 31 percent of U.S. exports, were only 17 percent of U.S. imports. EXHIBIT Composition of U.S. Exports and Imports in 2014 (a) U.S. Exports (b) U.S. Imports Food 6% Food 4% Services 17% Services 31% Industrial Industrial Consumer supplies supplies goods 24% 22% Consumer 22% goods 11% Capital goods Autos Capital goods Autos 21%Trading Partners 1\"World trade totaled about $21 trillion in 2014, or 2i] percent relative to world output of SIDS trillion that year. To give you some feel for America's trading partners, here were the top ID destinations for U.S. exports of goods and services for 2014 in order of importance: Canada, Mexico, China, the United Kingdom, Japan, lGermany, Brazil, South Korea, France, and India. The top Ii] sources of U.S. imports in order of im- portance were China, Canada, Mexico, japan, Germany, the United Kingdom, South Korea, France, India, and Saudi Arabia. 19-\": Production Possibilities without 'Itade The rationale behind most international trade is obvious. For example, the United States produces little coffee because, aside from Hawaii, our climate is not suited to growing coffee beans. More revealing, however, are the gains from trade where the comparative advantage is not so obvious. Suppose that just two goodsfood and clothingare produced and consumed and that there are only two countries in the worldthe United States, with a labor force of tilt] million workers, and the mythical country of Icodia, with Ill-[l million workers. The conclusions derived from this simple model have general relevance for international trade. Exhibit 2 presents production possibilities tables for each country, based on the size of the labor force and the productivity of workers in each country. The exhibit assumes that each country has a given technology and that labor is efficiently employed. If no trade occurs between countries, Exhibit 2 also represents each country's consumption possibilities table. The production numbers imply that each worker in the United States can produce either 6 units of food or 3 units of clothing per day. If all Iilil million U.S. workers produce food, their.r make till-[l million units per day, as shown in column U1 in panel {a}. If all U.S. workers make clothing, they produce Sill?! million units per day, as shown in column Ur The columns in between show some workers making food and some making clothing. Because a U.S. worker can produce either 6 units of food or 3 units of clothing, tire opportunity cost of I more unit of ciotbing is 2 units of food. Production Possibilities Schedules for the United States and Ixodle {I} The United States Production Possibilities with too trillion Workers {millions of units E d_ez} U U. U. U U. U. Suppose Isodian workers are less educated, work with less capital, and farm less fertile soil than U.5. workers, so each Izodian worker can produce only 1 unit of food or 2 units of clothing per day. If all EI'J million Iaodian workers specialise in food, they can make 200 million units per day, as shown in column 1', in panel {b} of Exhibit 2. If they all make clothing, total output is li-D million units per day, as shown in column fr Some intermediate production possibilities are also listed in the exhibit. Because an Iaodian worker can produce either I unit of food or 1 units of clothing, tire opportunity cost of I more unit ofciotfring is in unit offood. We can convert the data in Exhibit 2 to a production possibilities frontier for each country, as shown in Exhibit 3. In each diagram, the amount of food produced is mea- sured on the 1lirertical axis and the amount of clothing on the horizontal axis. U.5. com- binations are shown in the left panel by U1, U1, and so on. Iaodian combinations are shown in the right panel by 1,, 1,, and so on. Because we assume for simplicity that resources are perfoctly adaptable to the production of either good, each production possibilities curve is a straight line. The slope of this line differs between countries because the opportunity cost of production differs between countries. The slope equals the opportunity cost of clothingthe amount of food a country must give up to pro- duce another unit of clothing. The U.5. slope is 2, and the Isodian slope is 4'5. The 1.1.5. slope is steeper because its opportunity cost of producing clothing is greater. Exhibit 3 illustrates possible combinations of food and clothing that residents of each country can produce and consume if all resources are efficiently employed and there is no trade between the two countries. Autsrky is the situation of national self-sufficiency, in which there is no economic interaction with foreign producers or consumers. Suppose that LLS. producers maximise profit and 1.1.5. consumers maximise utility with the combination of 14C! million units of food and 130 million units of clothingcombination \"r This is called the sorority equilibrium. Suppose also that Production Possibilities Frontiers for the United States and Ito-dis Without Trade {millions of units per day! I'll;l The Unitas! States fill We Izodians are in autarky equilibrium, identied as combination l,, with 120 million units of food and 160 million units of clothing. 19-1c Consumption Possibilities Based on Comparative Advantage In our example, each U.S. worker can produce more clothing and more food per day than can each Izodian worker, so Americans have an ahsolute advantage in the prod uc- tion of both goods. Recall from Chapter 2 that having an absolute advantage means being able to produce something using fewer resources than other producers require. Should the U.S. economy remain in autarkythat is, self-sufficient in both food and clothingor could there be gains from specialization and trade!I As long as the opportunityr cost of production differs between the two countries, there are gains from specialization and trade. According to the law of comparative advantage, each country should specialize in producing the good with the lower oppor- tunity cost. The opportunity cost of producing 1 more unit of clothing is 1 units of food in the United States compared with it unit of food in Iaodia. Because the opportunity cost of producing clothing is lower in Izodia, both countries will gain if Iaodia special- izes in clothing and exports some to the United States, and the United States specialises in food and exports some to Iaodia. Before countries can trade, however, they must agree on how much of one good exchanges for anotherthat is, they must agree on the terms nitride. As long as Americans can get more than a a unit of clothing for each unit of food produced, and as long as laodians can get more than to a unit of food for each unit of cloth- ing produced, both countries will be better off specializing. After all, without trade Americans give up In unit of clothing to produce another unit of food, and Iaodians give up id unit of food to produce another unit of clothing, so there would be no trade unless each country gets a better deal. Suppose that market forces shape the terms of trade so that 1 unit of clothing ex- changes for 1 unit of food. To produce another unit of clothing themselves, Americans would have to sacrice 1'. units of food. Likewise, to produce another unit of food them- selves, Izodians would have to sacrifice 2 units of clothing. Exhibit 4 shows that with 1 unit of food trading for I unit of clothing,An1ericans and Isodians can consume anywhere along their blue consumption possibilities frontiers. The consumption possibilities |frontier shows a nation's possible com- binations of goods available as a result of specialization and trade. [Note that the U.S. consumption possibilities curve does not extend to the right of 400 million units of clothing, because Izodia could produce no more than that.] The amount each country actually consumes depends on the relative preferences for food and clothing. Suppose Americans select combination U in panel {a} and Iaodians select point l in panel [b]. Without trade, the United States produces and consumes 211i} million units of food and lSil million units of clothing. With trade, Americans specialize to produce SUD million units of food; they eat lltill] million units and exchange the rest for 2I'Jll million units of Izodian clothing.This consumption combination is reected by point U. Through EXHIBIT 4 Production (and Consumption) Possibilities Frontiers With Trade (millions of units per day) (a) The United States (b) Izodia 600- 600 - 500- 500- 400 - U 400- Food Food 300- 300 - 200 - UA I 200- 100 - 100- 0 100 200 300 400 Clothing 0 100 200 300 400 Clothing If Izodia and the United States can specialize and trade at the rate of 1 unit of clothing for 1 unit of food, both can benefit as shown by the blue lines. By trading with Izodia, the U.S. can produce only food and still consume combination U, which has more food and more clothing than U . Likewise, Izodia can attain preferred combination / by producing only clothing, then trading some clothing for U.S. food. Because Americans are more efficient in the production of food and Izodians more efficient in the production of clothing, total output increases when each spe- cializes. Without specialization and trade, world production is 360 million units of food and 340 million units of clothing. With specialization and trade, food increases to 600 million units and clothing to 400 million units. Thus, both countries increase consumption with trade. Although the United States has an absolute advantage in both goods, differences in the opportunity cost of production between the two na- tions ensure that specialization and trade result in mutual gains. Remember that comparative advantage, not absolute advantage, creates gains from specialization and trade. The only constraint on trade is that, for each good, world production must equal world consumption. We simplified trade relations in our example to highlight the gains from special- ization and trade. We assumed that each country would completely specialize in pro- ducing a particular good, that resources were equally adaptable to the production of either good, that the costs of transporting goods from one country to another were inconsequential, and that there were no problems in arriving at the terms of trade. The world is not that simple. For example, we don't expect a country to produce just one good. Regardless, there is broad evidence that specialization based on the law of19-1el Reasons for international Specialization Countries trade with one anotheror, more precisely, people, firms, and govern- ments in one country trade with those in anotherbecause each side expects to gain from trade. How do we know what each country should produce and what each should trade? Differences In Resource Endowments Differences in resource endowments often create differences in the opportunity cost of production across countries. Some countries are blessed with an abundance of fertile land and favorable growing seasons. The United States, for example, has been called the \"breadbasket of the world" because of its rich farmland ideal for growing wheat and corn. Coffee grows best in the climate and elevation of Colombia, Brazil, and 1"viietnan'l. Honduras has the ideal climate for bananas. Thus, the United States exports wheat and corn and imports coffee and bananas. Seasonal differences across countries also encourage trade. For example, in the winter, Americans import fruit from Chile, and Canadians travel to Florida for sun and fun. In the summer, Americans export fruit to Chile, and Americans travel to Canada for camping and hiking. Resources are often concentrated in particular countries: crude oil in Saudi Arabia, fertile soil in the United States, copper ore in Chile, rough diamonds in South Africa. The United States grows abundant supplies of oil seeds such as soybeans and sunflowers, but does not yet extract enough crude oil to satisfy domestic demand. Thus, the United States exports oil seeds and imports crude oil. More generally, countries export products they can produce more cheaply in return for products that are unavailable domesticaffy or are cheaper efsewfrere. Exhibit 5 shows, for 12 key resources, U.S. production as a percentage of U.S. consumption. If production falls short of consumption, this means the United States imports the difference. For example, because America grows coffee only in Hawaii, U.S. production is only 1 percent of U.S. consumption, so nearly all coffee is imported. The exhibit also shows that U.S. production falls short of U.S. consumption for crude oil and natural gas, and for metals such as zinc, copper, and aluminum. If U.S. production exceeds U.S. consumption, the United States exports the difference. For example, U.S. grown cotton amounts to SI'JZ percent of U.S. cotton consumption, so most U.S. grown cotton is exported. U.S. production also exceeds U.S. consumption for other crops, including wheat, oil seeds (soybeans, sunower seeds, cottonseeds}, and coarse grains (corn, barley, oats]. In short, when it comes to basic resources, the United States is a net importer of crude oil and metals and a net exporter of coal and farm crops. Economies of Scale If production is subject to economies of scalethat is, if the long-run average cost of production falls as a firm expands its scale of operationcountries can gain from trade if each nation specializes. Such specialization allows firms in each nation to produce more of a particular good, which reduces average costs. For example, one country can make computer chips that are sold in many countries, and another country can make cars that are sold in manv countries. The orimarv reason for establishina the sinale Coffee Aluminum Crude oil Copper Sugar Zinc Natural gas Coarse grains Coal Oil seeds Wheat Cotton 20 40 60 80 100 120 140 160 180 200 220 240 260 500 Percent If U.S. production is less than 100 percent of U.S. consumption, then imports make up the difference. If U.S. production exceeds U.S. consumption, then the amount by which production exceeds 100 percent of consumption is exported. Source: Based on annual figures selected from The Economist Pocket World in Figures: 2015 Edition (Profile Books, 2014). Differences in Tastes Even if all countries had identical resource endowments and combined those resources with equal efficiency, each country would still gain from trade as long as tastes differed across countries. Consumption patterns differ across countries and some of this results from differences in tastes. For example, the Czechs and Irish drink three times as much beer per capita as do the Swiss and Swedes. The French drink three times as much wine as do Australians. The Danes eat twice as much pork as do Americans. Americans eat twice as much chicken as do Hungarians. Americans like chicken, but not all of it. The United States is the world's leading exporter of chicken feet, and China is the world's leading importer (Tyson Foods alone ships about three billion chicken feet to China each year). Residents of West Africa prefer the dark bony meat of a chicken, such as backs and necks, so chicken farmers there sell these parts locally and ship chicken breasts abroad, where they are valued more. Soft drinks are four times more popular in the United States than in Europe. The English like tea; Americans, coffee. Algeria has an ideal climate for growing grapes (vineyards there date back to Roman times). ButMore Variety 't'et another reason for trade is to increase the snrlety of goods and services available. People prefer having a choice of products, and international trade helps broaden that choice.J International trade expands your selection of automobiles, computers, movies, clothing, drugs, wine, cheese, ethnic foods, and hundreds of other items. @CHECKPDIHT What are the gains from international trade, and why might countries still decide to trade even if no country has a comparative advantage? 19-2 Trade Restrictions and Welfare Loss Despite the benets of international trade, nearly all countries at one time or another erect trade barriers, which benefit some domestic producers but harm other domestic producers and all domestic consumers. In this section, we consider the effects of trade barriers and why they are imposed. 19-2: Consumer Surplus and Producer Surplus From Market Exchange Before we explore the net effects of world trade on social welfare, let's develop a frame- work showing the benefits that consumers and producers get from market exchange. Consider the hypothetical market for apples shown in Exhibit ii. The height of the demand curve shows what consumers are willing and able to pay for each additional pound of apples. In effect, the height of the demand curve shows the marginal benefit consumers expect from each pound of apples. For example, the demand curve indicates that some consumers in this market are willing to pay $311K! or more per pound for the first few pounds of apples. But every consumer gets to buy apples at the ma titer-clearing price, which here is $1.00 per pound. Most consumers thus get a bonus, or a surplus, from market exchange. The blueshaded triangle below the demand curve and above the market price reects the consumer surplus in this market, which is the difference between the most that consumers would pay for 50 pounds of apples per day and the actual amount they do pay. We all enjoy a consumer surplus from most products we buy. Producers usually derive a similar surplus. The height of the supply curve shows what producers are willing and able to accept for each additional pound of apples. That is, the height of the supply curve shows the expected marginal cost from producing each additional pound. For example, the supply curve indicates that some producers face a marginal cost of $0.50 or less per pound for supplying the rst few pounds. But $3.00 2.00 Dollars per pound Consumer S surplus 1.00 Producer surplus 0.50 D 0 60 Apples (pounds per day) Consumer surplus, shown by the blue triangle, indicates the net benefits consumers reap from buying 60 pounds of apples at $1.00 per pound. Some consumers would have been willing to pay $3.00 or more per pound for the first few pounds. Consumer surplus measures the difference between the maximum sum of money consumers would pay for 60 pounds of apples and the actual sum they pay. Producer surplus, shown by the gold triangle, indicates the net benefits producers reap from selling 60 pounds at $1.00 per pound. Some producers would have supplied apples for $0.50 per pound or less. Producer surplus measures the difference between the actual sum of money producers receive for 60 pounds of apples and the minimum amount they would accept for this amount. The point is that market exchange usually generates a surplus, or a bonus, for both consumers and producers. In the balance of this chapter, we look at the gains from international trade and how trade restrictions affect consumer and producer surplus. 19-2b Tariffs A tariff, a term first introduced in Chapter 3, is a tax on imports. (Tariffs can apply to exports, too, but we will focus on import tariffs.) A tariff can be either specific, such as a tariff of $5 per barrel of oil, or ad valorem, such as 10 percent on the import price of jeans. Consider the effects of a specific tariff on a particular good. In Exhibit 7, D is the U.S. demand for sugar and S is the supply of sugar from U.S. growers (there are about 10,000 U.S. sugarcane growers). Suppose that the world price of sugar is $0. 10 per pound. The world price is determined by the world supply and demand for a product. It is the price at which any supplier can sell output on the world market and at which any demander can purchase output on the world market. With free trade, any U.S. consumers could buy any amount desired at the worldEXHIBIT 7 Effect of a Tariff Price per pound $0.15 C d 0.10 D 0 20 30 60 70 Sugar (millions of pounds per month) At a world price of so.10 per pound, U.S. consumers demand 70 million pounds of sugar per month, and U.S. producers supply 20 million pounds per month; the difference is imported. After the imposition of a $0.05 per pound tariff, the U.S. price rises to $0.15 per pound. U.S. producers supply 30 million pounds, and U.S. consumers cut back to 60 million pounds. At the higher U.S. price, consumers are worse off; their loss of consumer surplus is the sum of areas a, b, c, and d. The net welfare loss to the U.S. economy consists of areas b and d. charge more than that. Now suppose that a specific tariff of $0.05 is imposed on each pound of imported sugar, raising the U.S. price from $0.10 to $0.15 per pound. U.S. producers can therefore raise their own price to $0.15 per pound without losing busi- ness to imports. At the higher price, the quantity supplied by U.S. producers increases to 30 million pounds, but the quantity demanded by U.S. consumers declines to 60 million pounds. Because quantity demanded has declined and quantity supplied by U.S. pro- ducers has increased, U.S. imports fall from 50 million to 30 million pounds per month. Because the U.S. price is higher after the tariff, U.S. consumers are worse off. Their loss in consumer surplus is identified in Exhibit 7 by the combination of the blue- and pink-shaded areas. Because both the U.S. price and the quantity supplied by U.S. produc- ers have increased, their total revenue increases by the areas a plus b plus f. But only area a represents an increase in producer surplus. Revenue represented by the areas b plus f merely offsets the higher marginal cost U.S. producers face in expanding sugar outputit's not a loss to the US. economy. Area d shows a loss in consumer surplus because less sugar is consumed at the higher price. This loss is not redistributed to anyone else, so area if reects part of the net welfare loss of the tariff. Therefore, areas it and d show the domestic economy's net welfare loss of the tariff; the two triangles measure a loss in consumer surplus that is not offset by a gain to anyone in the domestic economy. In summary: Of the total loss in U.5. consumer surplus (areas a, b, c, and d]: result- ing from the tariff, area a goes to LLS producers, area at becomes government revenue, but areas I; and d are net losses in domestic social welfare. 19-2: Import Quotas An import quote is a legal limit on the amount of a commodity that can be imported. Quotas usually target imports from certain countries. For example, a quota may limit furniture from China or shoes from Brazil. To have an impact on the domestic market, a quota must be less than what would be imported with free trade. Consider a quota on the LLS. market for sugar. In panel {a} of Exhibit E, D is the U.5. demand curve and S is the supply curve ofU.5. sugar producers. Suppose again that the world price of sugar is 50.10 per pound. 1With free trade, that price would prevail in the [1.5. market as well, and a total of 70' million pounds would be demanded per month. U.5. producers would supply 20 million pounds and importers, $0 million pounds. Effect of I Quota fl! a an an to Sugar 0 man 80 10 {millions of pounds per month} [millions of pounds per month! Super With a quota of 50 million pounds or more per month, the U.S. price would remain the same as the world price of $0.10 per pound, and the U.S. quantity would be 70 million pounds per month. In short, a quota of at least 50 million pounds would not raise the U.S. price above the world price because 50 million pounds were imported without a quota. A more stringent quota, however, would cut imports, which, as we'll see, would raise the U.S. price. Suppose U.S. trade officials impose an import quota of 30 million pounds per month. As long as the U.S. price is at or above the world price of $0.10 per pound, foreign producers will supply 30 million pounds. So at prices at or above $0.10 per pound, the total supply of sugar to the U.S. market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S. producers. U.S. and foreign producers would never sell in the U.S. market for less than $0.10 per pound because they can always get that price on the world market. Thus, the supply curve that sums domestic production and imports is horizontal at the world price of $0.10 per pound and remains so until the quantity supplied reaches 50 million pounds. Again, for prices above $0.10 per pound, the new supply curve, S', adds horizontally the 30-million-pound quota to S, the supply curve of U.S. producers. The U.S. price is found where this new supply curve, S', intersects the domestic demand curve, which in Exhibit 8 occurs at point e. By limiting imports, the quota raises the domestic price of sugar above the world price and reduces quantity below the free trade level. (Note that to compare more easily the effects of tariffs and quotas, this quota is designed to yield the same equilibrium price and quantity as the tariff examined earlier.) Panel (b) of Exhibit 8 shows the distribution and efficiency effects of the quota. As a result of the quota, U.S. consumer surplus declines by the combined blue and pink areas. Area a becomes U.S. producer surplus and thus involves no loss of U.S. welfare. Area c shows the increased economic profit to those permitted by the quota to sell Americans 30 million pounds for $0.15 per pound, or $0.05 above the world price. If foreign exporters rather than U.S. importers reap this profit, area c reflects a net loss in U.S. welfare. Area b shows a welfare loss to the U.S. economy, because sugar could have been purchased abroad for $0.10 per pound, and the U.S. resources employed to increase sugar production could instead have been used more efficiently producing other goods. Area d is also a welfare loss because it reflects a reduction in consumer surplus with no offsetting gain to anyone. Thus, areas 6 and d in panel (b) of Exhibit 8 measure the minimum U.S. welfare loss from the quota. If the profit from quota rights (area c) accrues to foreign producers, this increases the U.S. welfare loss. 19-2d Quotas in Practice The United States has granted quotas to specific countries. These countries, in turn, dis- tribute these quota rights to their exporters through a variety of means. By rewarding domestic and foreign producers with higher prices, the quota system creates two groups intent on securing and perpetuating these quotas. Lobbyists for foreign producers work the halls of Congress, seeking the right to export to the United States. This strong sup- port from producers, coupled with a lack of opposition from consumers (who remainof LLS. farm sales, accounted for 1? percent of political contributions from agriculture.\" Sugar growers even reversed a North American Free Trade Agreement provision that would have allowed tariff-free sugar from Mexico. Some economists have argued that if quotas are to be used, the United States should auction them off to foreign producers, thereby capturing at least some of the differ- ence between the world price and the LLS. price. huctioning off quotas would not only increase federal revenue at a time when it's desperately needed, but an auction would reduce the profitability of getting quota rights, which would reduce pressure on Washington to perpetuate them. American consumers are not the only victims of sugar quotas. Thousands of poor farmers around the world miss out on an opportunity to earn a living by growing sugar cane for export to America. 19-21: Tariffs and Quotas Compared Consider the similarities and differences between a tariff and a quota. Because both have identical effects on the price in our example, they both lead to the same change in quan- tity demanded. In both cases, LLB. consumers suffer the same loss of consumer surplus, and US. producers reap the same gain of producer surplus. The primary difference is that the revenue from the tariff goes to the LLS. government, whereas the revenue from the quota goes to whoever secures the right to sell foreign goods in the LLS. market. if quota rights accrue to foreigners, then the domestic economy is worse off with a quota than with a tari'. But even if quota rights go to domestic importers, quotas, like tariffs, still increase the domestic price, restrict quantity, and thereby reduce consumer surplus and economic welfare. Quotas and tariffs can also raise production costs. For example, LLS. candy manufacturers face higher production costs because of sugar quotas, mak- ing them less competitive on world markets. Finally, and most importantly, quotas and tariffs encourage foreign governments to retaiiate with quotas and tariffs of their own, thus shrinking U.5. export markets, so the weifare toss is greater than shown in Exhihits 3" anti 3. 19-21' Other 'Irade Restrictions Besides tariffs and quotas, a variety of other measures limit free trade. it country may provide export subsidies to encourage exports and tow-interest foans to foreign buyers. Some countries impose domestic content requirements specifying that a certain portion of a nal good must be produced domestically. C'ther requirements masquerading as health, safety, or technical standards often discriminate against foreign goods. For example, Nigeria protects chicken growers by banning chicken imports [which is why KFCs there added fish to the menu}. To gain access to Chinese markets, foreign produc- ers must transfer their technological know-how to a Chinese partner, so it can be made available throughout China.' European countries once prohibited beef from hormone- fed cattle, a measure aimed at U.5. beef. Purity laws in Germs ny bar many non-German beers. Until the European Community adopted uniform standards, differing technical requirements forced manufacturers to offer as many as seven different versions of the same TV for that market. Sometimes exporters will voluntarily limit exports, as when 19-3 Efforts to Reduce Trade Barriers Although some groups in the economy have a special interest in restricting trade, the trend has been toward freer trade. In this section, we examine international efforts to lower trade barriers. A nation sometimes negotiates a trade agreement with another nation, in what is known as a bilateral agreement. For example, the United States has negotiated bilateral open-skies agreements to deregulate airline competition on interna- tional routes, agreements that have generated at least $4 billion a year in gains to travel- ers. And travelers would gain another $4 billion a year if agreements were reached with other countries where Americans travel frequently.T 19-3: Freer Trade by Multilateral Agreement Mindful of how high tariffs cut world trade during the Great Depression. the United States, after 1"li'i'orld War II, invited its trading partners to negotiate lower tariffs and other trade barriers. A nrritlataral agreement is one reached among more than two countries. The result was the ltiarraral "mt anTarll'l's anrl Trade (lm, an inter- national trade treaty adopted in 194? by 2.3 countries, including the United States. Each GATT member agreed to {I} reduce tariffs through multinational negotiations, {2] reduoe import quotas, and {3] treat all members equally with respect to trade. Trade barriers have been reduced through trade negotiations, or \"trade rounds,\" under the auspices of GATT. Trade rounds offer a package approach rather than an issue-by-issue approach to trade negotiations. Concessions that are necessary but otherwise difficult to defend in domestic political terms can be made more acceptable in the context of a larger package that also contains politically and economically attractive benefits. Most early GATT trade rounds were aimed at reducing tariffs. The Kennedy Round in the mid-1950s included new provisions against shunning, which is selling a commodity abroad for less than is charged in the home market or less than the cost of production. The Tokyo Round of the 19?0s was a more sweeping attempt to extend and improve the system. The most recently completed round was launched in Uruguay in September 1935 and ratified by 12.3 participating countries in 1994. The number of signing coun- tries now exceeds 15D. This so-called Uruguay Iteratrl, the most comprehensive of the eight postwar multilateral trade negotiations, included 550 pages of tariff re- ductions on 35 percent of world trade. As a result of the Uruguay Round, average tariffs fell from 5 percent to 4 percent of the value of imports [when GATT began in 19-3b World Trade Organization The \"nuclear-[Ination {m1 now provides the legal and institutional founda- tion for world trade. 1Whereas GATT was a multilateral agreement with no institu- tional foundation, the WT!) is a permanent institution in lGeneva, Switzerland. A staff of about G economists and lawyers helps shape policy and resolves trade disputes among member countries. Whereas GATT involved only merchandise trade, the WTG also covers services and trade-related aspects of intellectual property, such as books, movies, and computer programs. The mo will eventually phase out quotas, but tariffs will remain legal. 1Whereas GATT relied on voluntary cooperation, the WTD settles disputes in a way that is faster, more automatic, and less susceptible to blockage than the GJ'LTT system was. The WT!) resolved more trade disputes in its first decade than GATT did in nearly SCI years. Since Z-D, developing countries have filed 6|] percent of the disputes. But the WT!) has also become a lighming rod for globalization tensions, as discussed in the following case study. 19-4: National Defense Argument Some industries claim they need protection from import competition because their out- put is vital for national defense. Products such as strategic metals and military hard- ware are often insulated from foreign competition by trade restrictions. Thus.I national defense considerations outweigh concerns about efficiency and equity. How valid is this argument? Trade restrictions may shelter the defense industry, but other means, such as government subsidies, might be more efficient. Ctr the government could stockpile basic military hardware so that maintaining an ongoing productive capacity would become less critical. Still, technological change could make certain weapons obsolete. Because most industries can play some role in national defense, instituting trade restrictions on this basis can get out of hand. For example, many decades ago Ll.5. wool producers se- cured trade protection at a time when some military uniforms were still made of wool. The national defense argument has also been used to discourage foreign ownership of LLS. companies in some industries. For example, in Z a Chinese state-owned company was prevented from buying Unocal Oil. And in 2011:}, the Congressional Steel Caucus tried to block a Chinese attempt to buy a Mississippi steel plant, saying that such a deal \"threatens American iobs and our national security."I 19-4b Infant Industry Argument The infant industry argument was formulated as a rationale for protecting emerging domestic industries from foreign competition. In industries where a firm's average cost of production falls as output expands, new firms may need protection from imports until these firms grow enough to become competitive. Trade restrictions let new firms achieve the economies of scale necessary to compete with mature foreign producers. But how do we identify industries that merit protection, and when do they become old enough to look after themselves? Protection often fosters inefficiencies. The imme- diate cost of such restrictions is the net welfare loss from higher domestic prices. These costs may become permanent if the industry never realises the expected economies of scale and thus never becomes competitive. As with the national defense argument, policy makers should be careful in adopting trade restrictions based on the infant in- dustry argument. Here again, temporary production subsidies may he more efficient than import restrictions. 19-4: Antidurnping Argument As we have noted already, dumping is selling a product abroad for less than in the home market or less than the cost of production. Exporters may be able to sell the good for less overseas because of export subsidies, or rms may simply find it profitable to sell for less in foreign markets where consumers are more sensitive to prices. But why shouldn't U.5. consumers pay as little as possible? If dumping is persistent, the increase in consumer surplus would more than offset losses to domestic producers. There is no good reason why consumers should not be affirmed to buy imports |fer a persistently fowsr price. .- .a- u of their monopoly position by sharply increasing the price, then other fintts, either domestic or foreign,could enter the market and sell for less.There are few documented cases of predatory dumping. Sometimes dumping may be sporadic, as firms occasionally try to unload excess inventories. Retailers hold periodic \"sales" for the same reason. Sporadic dumping can be unsettling for domestic producers, but the economic impact is not a matter of great public concern. Regardless, all dumping is prohibited in the United States by the Trade Agreements Act of 193, which calls for the imposition of tariffs when a good is sold for less in the United States than in its home market or less than the cost of produc- tion. In addition, WTG rules allow for offsetting tariffs when products are sold for \"less than fair value" and when there is \"material iniury\" to domestic producers. For example, U.S. producers of lumber and beer frequently accuse their Canadian counter- parts of dumping. 19-4d Jobs and Income Argument Dne rationale for trade restrictions that is commonly heard in the United States, and is voiced by W protesters, is that they protect U.S. jobs and wage levels. Using trade re- strictions to protect domestic iohs is a strategy that dates back centuries. One problem with such a policy is that other countries usually retaliate by restricting their imports to save their jobs, so international trade is reduced, jobs are lost in export industries, and potential gains from trade fail to materialixe. That happened big time during the Great Depression, as high tariffs choked trade and jobs. 1|Wages in other countries, especially developing countries, are often a fraction of wages in the United States. For example, including benefits, General Motors {GM} workers in Michigan earn about SSH per hour versus 5? for GM workers in Mexico, 54.50 in I.".'.Ihina, and SI in India. {The minimum wage in China is less than $2 an hour and in Mexico and India is less than $1 an houn] Looking simply at differences in wages, however, narrows the focus too much. Wages represent just one component of the total production cost and may not necessarily be the most important. Employers are interested in the labor cost per unit of output, which depends on both the wage and labor productivity. Wages are high in the United States partly because U.S. labor productivity remains the highest in the world. High productivity can be traced to better education and training and to the abundant computers, machines, and other physical capital that make workers more productive. U.S. workers also benet greatly from better management and a relatively stable business climate. But what about the lower wages in many developing coun- triesi| Low wages are often linked to workers' lack of education and training, to the meager physical capital available to each worker, and to a business climate that is less stable and hence less attractive for producers. For example, the total value of manufacturing output is about the same in the United States as in China, but Americans produce that output with only about If] percent of the manufacturing workforce that's employed in China.' What's more, advances in technology are making differ- I{Since multinational rms build plants and provide technological know-how in de- veloping countries, U.S. workers lose some of their competitive edge, and their relatively high wages could price some U.S. products out of the world market. This has already happened in the consumer electronics and toy industries. China makes Si) percent of the toys sold in the United States. Some U.S. toy sellers, such as the makers of Etch A Sketch, would no longer exist had they not outsourced manufacturing to China. Dverall, competition from Chinese imports between 1999 and 2.1111 cost the U.S. econ- omy about 2 million jobs, according to one estimate."1 Domestic producers do not like to compete with foreign producers whose costs are lower, so they often push for trade restrictions. Labor unions protested the Trans- Pacic Partnership on those grounds. According to one report, \"Unions see the pact as one of the biggest threats to organized labor and the U.S. middle class since the North American Free Trade Agreement took effect in 199Ii."1'1 But if restrictions negate any cost advantage a foreign producer might have, the law of comparative advantage becomes inoperative and domestic consumers are denied aocess to the lower-priced goods. I{Silver time, as labor productivity in developing countries increases, wage differ- entials among countries will narrow, much as they narrowed between the northern and southern United States during the last century. As technology and capital spread, U.S. workers, particularly unskilled workers, cannot expect to maintain wage lev- els that are far above comparable workers in other countries. So far, research and development has kept U.S. producers on the caning edge of technological develop- ments, but staying ahead in the technological race is a constant battle. As a sign of the times about how competition could so ueeae down the wage gap across countries, the Volkswagen factory in Tennessee pays workers only about half of what GM pays in Michigan, yet many thousands applied for the 2,1191] iob openings. 19-44: Declining Industries Argument Where an established domestic industry is in jeopardy of closing because of lower- priced imports, could there be a rationale for temporury import restrictions? After all, domestic producers employ many industry-specific resourcesboth specialised labor and specialized machines. This human and physical capital is worth less in its best alternative use. If the extinction of the domestic industry is forestalled through trade restrictions, specialized workers can retire voluntarily or can gradually pursue more promising careers. Specialized machines can be allowed to wear out naturally. Thus, in the case of declining domestic industries, trade protection can help lessen shocks to the economy and can allow for an orderly transition to a new industrial mix. But the protection offered should not be so generous as to encourage continued invest- ment in the industry. Protection should be of specific duration and should be phased out over that period. The clothing industry is an example of a declining U.S. industry. The 12,012\") U.S. jobs saved as a result of one trade restriction paid an average of less than 5311,111211} per year. But a Congressional Budget foice study estimated that the higher domestic clothing prices resulting from trade restrictions meant that U.S. consumers paid two to three times more