UnderstandingTrade… and a debateon perceptionsTrade is good for you… under certain conditions

Bad and good farming and public perception

Jorge NunezCEU

Master course Economics

Issues covered Why should trade be good? The limitations of the comparative advantage

theory: A banana is not a car… WTO Uruguay round agreements… Measures of support used and … their limits Tariffs, types and consequences Non tariff barriers Debate on food safety, GMOs, public perception

of risk

David Ricardo and comparative advantage

Trade economics is founded on the theory of comparative advantage

The origins of Trade economics are from David Ricardo and his theory of comparative advantage in Trade

The logic is simple. Each country has different endowments, thus some countries are better in some things than others.

By trading what you are good at (low opportunity cost), you can de facto get what you are not good at (high opportunity cost) cheaper price. Specialisation benefits you.

The opportunity costs are different.

A very simple model (absolute advantage)

Apples

Bananas

60

20

Apples

Bananas

70

A 30

B

If they trade they can SpecialiseGlobal output would be higherNow 45 apples40 bananas

Now they tradeIf each do only one:60 apples70 bananas C1 gives 30 apples for 25 bananas

Country 1 Country 2

Both are better offA’ B’

UA

UB

U’A

U’B30

10

15

30 4525

Relative advantageApples

Bananas20

Apples

Bananas

70

AB

With diminishing returns,Trade still beneficiary due to relative advantage

Comparative advantageapplesApples become more expensive Wp, it exports apples andbuys bananas

Country 1 Country 2

A’

B’

UA

UB

U’A

U’B

Dom ex rate,isorevenue

International,Ex. rate

Bananas become more Expensive (Wp) it exports and buys apples, until domestic production price same

Bananas become more Expensive (Wp) it exports and buys apples, until domestic production price same

We are all happy… but… Products are not equivalent, if we put bananas and

cars and both have absolute advantage, trade expands but the value added of products is very different. Bananas are also land dependant, imagine islands.

Most countries are trapped in poverty because of low value added.

Study of 154 countries (Felipe et al.): There are only 34 countries in the world that export

mostly sophisticated and well-connected products – high tech + services

28 countries in the world that are in a “middle product trap,”

17 countries that are in a “middle-low” product trap, and 75 countries that are in a difficult and

precarious “low product trap.” One day read Reinhard

RICARDO VS REAL WORLD

PROFIT MARGINa few %

PROFIT MARGINover 60%

VALUE ADDED

What does development require… Human capital: Solow growth model fallacy ‘A’

technical change is NOT exogenous, now well recognised

Infrastructure and administrative capacity Protection or high capital for investment as entry

costs high (barriers for infant industry argument?) Contradicts drive for free trade, free trade increases

barriers to new entrants, increases opportunity costs. Indirect support in richer countries makes it

harder => WTO conundrum. Free trade is fine, but not ‘per se’ in all

circumstances. It is specially AFTER you have the structures in place

Trade liberalisation in agriculture slowing down . Why? History of GATT and WTO EU and US were affecting strongly world price of

agriculture Rich countries liberalised manufacturing before

developing countries had a say. OECD measured consumer and producer support

equivalents CSE – PSE, which measure the subsidy or tax of policies on producers and consumers.

The GATT (WTO) agrees on methodology to calculate the AMS (Aggregate Measure of Support)

GATT: 1946-1995 from 1995: WTO Seven Rounds of Negotiations Most famous Uruguay Round 1986-1991, first

agriculture agreement Tariffication of barriers Tariff reductions Distorting subsidy estimation, limitation and

phasing out Doha Development Round… the never ending

Round since 2001 – maybe it does not tackle real issues?

Free trade is double sided Are green box policies not curtailing markets for

developing countries? LDCs got free trade access (e.g. EU – EBA), but

more trade liberalisation also cuts their relative advantage, in particular ACP (African, Caribbean and Pacific) countries had special agreements.

Getting rid of tariff barriers is nice, but NTBs (Non tariff barriers) are growing.

SPS (Sanitary and Phytosanitary) rules are creating new barriers

Rules of origin agreed hamper trade. Developing countries want more fairness.

Treatment of developing countries

GATT rules of MFN (Most favoured Nation) mean that all countries have to be treated same

Exception for DCs: GSP (Generalised System of Preferences) for preferential access since 1971

EU’s EBA has limited effect This is why in BALI meeting (Dec 2013) the real

deal was on technical assistance to facilitate trade from LDCs

Further trade liberalisation could actually harm LDCs

Increase in non trade barriers SPS rules expand EU makes unscientific anti GM policy (with

unintended results?) Due to SPS changes rejections of imported

goods to EU multiply over the years. EU introduces fork to farm – traceability

creating a costly process and impossible to comply for developing country smallholders – fosters large producers specialised in exports

SPS rules not based on scientific standards and subjective.

EU approach to safety based on flawed precautionary principle – minimax approach

Unrealistic worse case scenario is weighted against maximum benefits, regardless of probability of worse case scenario. As 100% food safety is impossible, rules become draconian.

Aflatoxins standards of EU for example. Rare disease. EU imposes standards far above international CODEX (FAO). Death risk 1,4 per billion people avoided, but killed 64% OF AFRICAN IMPORTS of cereals fruits and nuts, causing devastating economic misery and most probably death due to poverty.

Back to tariffs Tariffs have fallen since the Uruguay Round, but

the methodology used limited effective tariff reductions, because cuts were on average tariffs (36%), so countries can chose what to cut.

We look at: Tariff peaks (over 15%) In 33 over 200% in some even 1000% mainly

agriculture Tariff escalation, higher tariffs products in

increased level of processing

Doha’s attempt to move against tariff peaks and escalation has not yet worked

Effects of tariff peaks and escalation

They both reduce trade in key commodities Tariff escalation directs exports of developing

countries to products or markets with lower tariffs (lower value added normally), limiting the opportunities of diversification

Tariff escalation reduces the capacity of developing countries to expand their exports beyond raw material products to processed higher value-added goods

Tariff peaks, if combined with escalation and/or tariff quotas, limit imports de facto to levels controlled by the country offering the quotas.

Importance of Agriculture in trade

Eliminating 6 LDC outliers in trade composition

OECD

Non OECD

Tariff escalation helps to realise value added, keeping low value added on exporting countries

For LDCs it improved

Some other facts about trade… help us from China…? OECD DATABASE