Chapter 5 - Trade & Macro

5.1 Macroeconomic Factors

– exchange rates– interest rates– government fiscal balance

5.2 International Agricultural Trade

–Trade agreements

5.3 Trade Theory

–Gains from trade–Distortions (tariffs & subsidies)–Farm programs

1) Exchange Rates

Affects the competitiveness of agr. Products

Early 1970’s – floating exchange rates

Policy – over or under value exchange rate

What is the impact of a ER distortion?

Example 1:

Argentina: Overvalued Exchange Rate (exporter)

Shift of excess demand functionLower producer priceLower quantity exportedLoss of producer surplus

Canadian $ and Euro per $US (IMF/IFS)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Source: International Monetary Fund -IFS

P

Q

S

ED

Increase in Exchange Rate

Interest Rates:

Why interest rates are important:

1) Value of currency – prices received and paid

Most commodities are US$ denominated

2) Cost of borrowing:

Agriculture is capital intensive (borrowing)

Inputs: seed, fertilizer, machinery

1980’s - high interest rates – low grain prices- debt crisis

Cost of borrowing: How is it determined ?

Role of central bank (Bank of Canada)Role of the marketGovernment intervention (interest subsidies)

100 Basis points = 1%

Src. Globe & Mail - March 8, 2008

Government Fiscal Balance

Consequences for Agricultural Policy

1 – interest rate

- more borrowing = higher rates

"crowding out effect"

- higher cost for farm borrowing

2001 Average capital/farm = $800,000

Total farm capital = $ 200 Billion

1% change in interest rates => $ 2 Billion

(1971 - 2002) - Net market income

- 1.8 $B (2002) 3.3 $B (1975)

2 – capacity to fund interventions

- deficits = limited marge de manouvre- reduced scope for intervention

5.2 International TRADE

Gains from trade:

> increase in output due to specialization based on comparative advantage

• each country – concentrates on producing goods and that it produces

relatively efficiently– trading to obtain goods that it does not

Trade Distortions

• many forms of distortion (welfare reducing)• tariffs, taxes, subsidies, quantitative measures• non-tariff barriers (health, safety reg’s)

Trade Agreements

• institutional arrangement – restraint on behaviour• multi-lateral (regional), bilateral

• Levels of cooperation– Range of goods (agr vs industrial)– Scope of instruments included– Customs union – full economic integration (EU)

Reasons for Protection

• new industry (infant industry argument)

• national health + phyto-sanitary

• unfair foreign trade policy

• Defend domestic programs

• improve balance of payments

• improve “Terms of Trade”

• generate revenue

• slow down painful economic adjustment

• Political economy

benefits of additional trade are spread thinly among many individuals but the cost is high for only a few firms or groups

Trade Theory

• Why do nations trade? • What are the benefits?• Implications of trade distortions

Theory

• comparative advantage (Ricardo)• absolute advantage

• Ohlin (1933) • comparative advantage

– due to resource endowments– Canada land rich, capital poor

– => export agr & import manufactures

Gains from trade

• Trade allows for specialization – increased welfare

CA

M

A

US

M

A

P

P

P

P√√↵

>√√

↵

Gains from Trade

.

Agr.

Manufactures

P1

P2

W1 W2

ES/ED Framework

• Excess Demand (ED)• Excess Supply (ES)

Gains from trade (versus no trade)

• depend on the impact of a country on world prices

• Small country – no price impact• Large country – prices adjust, impacts smaller

2 Country Model – 1 good

• e.g. US/Canada cattle market

• Assume: Canada - low cost producer

• How are consumers and farmers affected by trade between the two countries?

• Winners and losers – distribution effects

– US – consumers gains, farmers lose– CA – consumers lose, farmers gain

Gains from Trade

.Canada USTrade Sector

ED

ES

PW

PUS

PCA

Trade

WUS

WCA

Analysis: Trade Distortions

1 ) Import Tariff• Fixed-tariff rate vs ad valorem

• Small country (fixed tariff)

– domestic price increases

– Supply increases, demand decreases

– imports reduced

– Net dead weight loss

• Large country

– domestic price increases

– world price decreases

– Imports decrease; domestic output increases

– Consumers lose; producers gain

– Government gains tariff revenue

– Net welfare gain

– Potential to compensate consumers

Import Quota

• Binding quota

– if it restricts imports below free trade imports

• Similar price effects to a tariff

– Imports lower

– Domestic price higher

– World price lower

– Rents to importers

• Quota value: right to import– Based on difference between new world price and

domestic price

Large Country – Import Quota

World MarketDomestic Market

ED0

ES

S

D

Pw

.

Q

PQ

IQ

PWQ

Large Country - Tariff

.

World MarketDomestic Market

ED0

ED1

ES

S

D

PwTR

Import tariff – Small Country

Pw

PT

S

D

ab G income

Government income – few transactions

Export Subsidy

• Used extensively

– Purpose: support domestic income (price) support– Subsidy to export the excess supply– US (EEP) starting in 1985– EU (ERP) – export restitutions – 1970’s– not unique to agriculture – e.g. Bombardier

• price support program – increases ES

• Subsidy Impacts– world price falls (large country)– Domestic price falls– Exports expand– Government payments = (Ps-PWs)*exports

• value of exports increase relative to free trade

• Deadweight loss– Consumers gain– Producers gain– Foreign importers gain– Taxpayer loses

Export Subsidy – Large Country

Dd – domestic demandDT – total demand – including world demand

Pw

Pws

S

DT

Dd

Ps

Exports BeforeExports After

DWL

Export Tax

• Tax exporters

• Exporting government gain revenue from export taxes

• Producers in exporting country lose

Export Cartel

Assumptions:• 2 countries• Cartel: importer + domestic supplier• Suppliers maximize joint profits• Price according to joint supply function• MR = MC (joint MC)

Results:

• Domestic price increases• Imports and domestic production decrease• Foreign surplus increases• Deadweight loss

Export Cartel

.

ImporterExporter

S

Pw

MR

D

Sd

ST

Sd – domestic supplyST – domestic + foreign supplyExporter gain = (a-b)Deadweight loss = c

PC

QE Qd

a

b

c

Q

Decoupled Subsidies

• Programs that do not distort trade– within the green box category under GATT

• policies that lead to a per-unit payment to producers are not decoupled

• trade distorting => affects trade and prices

• Is any farm program completely decoupled ?