Ch10_For & Against Protection

Ch10_For & Against Protection - ARGUMENTS FOR AND...

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Unformatted text preview: ARGUMENTS FOR AND AGAINST PROTECTION 1 Overview Questions • What is a market failure? • What is the Coase Theorem? • What are the consequences of trade “protection”? • What are the implications for trade when markets fail? • What is an industrial policy? 5 Economists’ “Ideal” World Private Marginal Benefit Private Marginal Cost Social Marginal Benefit Social Marginal Cost = = = = Price It would be boring! 6 •1 In An “Ideal” World Ideal” • If the above conditions are satisfied, we call it a “first best” and there is no government intervention that will improve the “efficiency” of the outcome Assuming sufficient information in the marketplace It doesn’t mean that everyone would like the results! • Prescription: Leave well enough alone! There is still scope for income redistribution but it should be done directly and not through market intervention! 7 In An “Ideal” World • The Coase theorem says that if property rights are assigned, then the market will solve the “externalities” problem Overfishing? Assign to someone the property rights for the fish Overlogging of leased lands? Assign someone the property rights to the land & trees Polluting industries? Same as above! 8 The Coase Theorem • Steam railroad passes through fields Sparks and cinders cause fires Crops are destroyed • Clearly there is an externality • Does the allocation of property rights matter to the efficient allocation of resources? The answer seems to be obvious, except it isn’t! 9 •2 The Coase Theorem Efficient Outcomes Farmers Own Land; rights RR Owns Land Don’t plant Efficient: crops internalized Farmers Own Land; no rights Eff: RR pays farmers Eff: farmers lose Efficient Ineff: courts disagree Public land; Public land; unprotected enforcemnt Install spark arrestors Efficient: internalized Eff: RR does it Eff: farmers pay Ineff: Won’t happen Efficient Stop the RR; move line Efficient: internalized Eff: RR does it Eff: farmers pay Ineff: Won’t happen Efficient 10 Distortions • Social Marginal Cost > Price Most environmental issues are like that! Firms or individuals that deal in that activity don’t pay the full cost of the activity We grow rice in California! • Social Marginal Benefit > Price Violation of copyright protections Anything that creates a positive externality Education 11 Distortions (cnt) cnt) • Price > Social Marginal Cost Monopoly power. Not enough is produced because the monopoly sets the price too high • Price with tax > Social Marginal Cost Not enough is supplied because the tax creates a “wedge” between revenue and cost All proportional taxes are that way • Price with subsidy < Social Marginal Cost Too much is supplied Agriculture in advanced countries 12 12 •3 Distortions (cnt) cnt) Distortions Market Failure • The identification of distortions is a reason (or an invitation) for possible government intervention If you want government to intervene in your behalf, cry “market failure”! Different political outlooks have different “propensities” to find and identify distortions Different political outlooks have different opinions on how likely it is for intervention to be beneficial 13 Distortions (concl.) concl.) • Government is neither an impartial bystander nor an objective judge of need • For this reason, many economists are very very skeptical of the nearly constant demands to “fix market failures” Generally, real motives are well disguised! 14 Simple Distortion: Sales Tax Tax P Supply Cons: -(a + b) Prod: -(c + d) Pnew a Peq= MC c Gov: +(a + c) b d MCnew Demand Q Qeq 15 •4 Simple Distortion: Sales Subsidy Subsidy P Supply Cons: +(c + h + i) Prod: +(a + e + f) MCnew e c Pnew Gov: -(a + e + f + g + c + h + i + j) f a hi g Peq= MC j Demand Q Qeq 16 Theory of the 2nd Best • The best solution to the distortion is to best eliminate the distortion itself! • If that is not possible or feasible, we are in a “2nd best” world 2nd best world rules are murky and it is hard to know if you are doing as well as possible There are many different vantage points, paths, “max height” points, if you can’t get all the way up to the summit! 17 Specificity Rule • If there is an externality, government policy should target the specific source of the externality as directly as possible Most likely to enhance national economic efficiency Avoid calling in the “law of unintended consequences” 21 •5 Specificity Rule (concl.) • Government policy should intervene as directly as possible to achieve the specific objective, To minimize the national economic cost of achieving the objective i.e., to minimize the amount of economic damage (inefficiency) created • Key: Identify the specific problem clearly, then use a policy to attack the problem directly But is this always politically feasible? 22 Promoting Import-Competing Production Import- 23 23 Free Trade Arguments • • • • Efficiency Scale economies Transfer of technology Reduction of social costs (e.g. rent-seeking cost) 24 •6 Generic Protection Arguments -1 • Promote domestic production of the product Increase labor employment in this domestic production Sometimes to decrease domestic consumption of product • • • • Eliminate distortions and externalities Protect an “infant” or a “dying” industry Increase government revenue Alter the distribution of income in the country If any of these is a good thing, let’s do it with let’ protection! 25 Generic Protection Arguments -2 • National “pride” • National defense 26 Protection Arguments • To promote domestic production Really to protect jobs The same result is obtained with subsidies to production 27 •7 Protection Arguments • To eliminate distortions and externalities They create a wedge between social costs and social benefits with sub-optimal production and consumption BUT this problem can be solved with more specific interventions Less damaging 28 Protection Arguments • To protect an infant industry It protects the new industry in the initial learning stage. Without initial protection the industry may not survive the comparative advantage of competitors There are better and more specific policies than trade restrictions 29 The Infant Industry Argument 30 •8 Protection Arguments • To protect an infant industry How does the government know which industry deserves such protection? Why is government better at picking champion industries than the private sector? If there is the potential for net gain in the future why isn’t the private sector financing it? 31 Protection Arguments • To protect an infant industry What are the incentives for the industry to stop being an “infant industry”? How and when will protection be lifted? How to avoid a constituency for indefinite protection? 32 Protection Arguments • Dying Industry It may be costly to re-allocate resources. Again, there are preferable alternatives GM & Chrysler? • Tariff as a source of revenues for the government It is difficult for government, specially in developing countries, to raise taxes. Import tariffs may provide needed revenue 33 •9 Protection Arguments • National pride Society may find pride in knowing that products are produced domestically • Income redistribution Trade may affect certain groups negatively There are more specific redistribution policies that would be economically better 34 Protection Arguments • National defense Self-sufficiency would be extremely valuable in wartimes A country must have access to products necessary for national defense, specially because imports may not be readily available during times of hostilities 35 National Defense Apply the specificity rule: • Some products can be kept in stockpiles Imports during peacetime can be used to build the stockpiles • National production capabilities are needed for other products Best to use a subsidy to build or maintain national production capabilities • Political feasibility? 36 •10 Estimated Cost of Protection Huffbauer and Eliott (1994) study shows costs per worker protected for various industries in the U.S. In the protected industries ~ 10% of workers are protected ~ 0.2% of the labor force (net total cost ~ $10.3 billion) Messerlin (2001) study shows costs per worker protected for various industries in the E.U. In the protected industries ~ 3% of the workers are protected <0.2% of the labor force (net total cost ~ $31.1 billion) 37 An Additional Gain From Open Trade • The Economist article, “ The Future of Globalization…” summarizes an additional important argument for trade This is pretty common argument but worth exploring with the apparatus we have • It say that trade also improves efficiency in the domestic industry 39 An Additional Gain From Open Trade • The argument is that Protection makes domestic producers inefficient and high cost Trade forces the local producers to modernize and innovate This efficiency gain is an additional gain from trade It does not necessarily result in more jobs! 40 •11 An Additional Gain From Trade Consumers: +(a+b+c+d+e+f) P Producers: -a SDom Government: -(c+d+e) New SDom PTariff c a b d e Net: +(b+f) f PW D g Q Including efficiency gains Consumers: +(a+b+c+d+e+f) Producers: -(a+b+c) Government: -e Net: +(d+f) +g 41 Summary: Protection • Lots of arguments for protection Arise out of actual and claimed “market failures” • Specificity argument suggests that it is highly unlikely protection is the most efficient way to fix any distortion • Estimated costs of protection are high 43 THE END 44 •12 ...
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This note was uploaded on 02/15/2011 for the course FBE 462 at USC.

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