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CHAPTER 8 ARGUMENTS AGIANST
FREE TRADE
Traditional Arguments against Free Trade
New Protectionism
The Political Economy of Trade Policy
1. Infant industry argument (幼稚产业保护论)
Promote home backward industries through government protection.
Main motive: create a level playing field.
Home industry: “late start”, no economies of scale
(crux of the argument)
§1 Traditional Arguments against Free Trade
The argument was first explicated
by Alexander Hamilton in his 1790
Report on Manufactures.
The first U.S. Secretary of the Treasury.
Later, it was picked up (referred and
developed) by Friedrich List in his
1884 work The National System
of Political Economy.
A leading German Economist in the
19th century
1755–1804
1789-1846
1755–1804
Many countries have successfully industrialized behind tariff barriers. For example, from 1816 through 1945, tariffs in the USA were among the highest in the world.
"Almost all NDCs [Newly Developed Countries] had adopted some forms of infant industry promotion strategy when they were in catching-up positions.”
But it is controversial as a policy recommendation:
Even when infant industry protection is well– intentioned,
"infant" industries may never "grow up”.
For example, during the 1980s Brazil enforced strict controls on
the import of foreign computers in an effort to nurture its own
"infant“ computer industry. This industry never matured.
Two problems that come up with this argument:
The identification of infant industry. The industries that are likely to become low-cost producers should be indentified.
Costs > amount of foreign exchange saved
(2) The form of protection. Tariff or subsidy？
A subsidy has a lower welfare cost to the country than a tariff.
Why not let the industry proceed on its own
(as Entrepreneurs in a market economy would undertake expansion
on their own )
Build efficient system in allocating funds through deregulation or
government guarantees for the loans.
2. Terms of trade argument
(1) Argument
A large country imposes a tariff
World price of the imported goods fall
PX/PM of the importing country improves
(2) Problems:
Fail to consider reduced level of home country’s welfare because of the country’s reduced consumption of low-cost imports.
This additional consideration of forgone （失去的）quantities is brought into the analysis through the concept of the optimum tariff rate (最优关税)——the rate that maximizes the country’s welfare.
Conceptually, it is the tariff rate at which the positive difference
between the gain from better prices and the loss from reduced
quantity of imports is at a maximum.
r
Optimum tariff, to Prohibitive tariff, tp Tariff rate
Figure 8-1 The optimum tariff
National welfare
1
National welfare
At point 1, corresponding to
the optimum tariff t0, national
welfare is maximized.
r
r
The optimum tariff rate is always positive but less than the prohibitive rate (tp) that would eliminate all imports.

(ii) Beggar-my-neighbor argument 以邻为壑 (损人利己)
（gain at the expense of foreign countries）
Harm the trading partner;
Trading partner will retaliate with a tariff of its own;
End up with reduced welfare;
Neither country may end up with better terms-of-trade.
3. Balance of trade （BOT） argument
BOT= E – M
Problems:
(1) Retaliation by trading partners；
(2) The reduced ability of foreign countries to buy the home
country’s products；
The improvement of BOT is not guaranteed.
Any other approaches to improve BOT
If the deficit is a macroeconomic problem, then increase Y, reduce spending (C+I+G)
Y = C + I + G + (X - M) Y - (C + I + G) = (X - M)
4. Tariff to Reduce Aggregate Unemployment Argument
Tariff demand for home-produced goods rises
more labor hired spendable income
other industries expand add new jobs
Several points raised:
1. Multiplier effects come about in a beggar-my-neighbor
manner because jobs lost abroad, retaliation.
2. National income of foreign countries reduced, thus cut
import.
Why not other policies: monetary and fiscal policy
4. Tariff to reduce aggregate unemployment argument
Several points raised:
1. Multiplier effects come about in a beggar-my-neighbor
manner because jobs lost abroad, retaliation.
2. National income of foreign countries reduced, thus cut
import.
Why not other policies: monetary and fiscal policy
demand for home-produced goods rises
Tariff
more labors hired
more spendable income
other industries expand
add new jobs
5. Fair competition argument
creating a level playing field
To offset foreign dumping
Dumping by foreign firms into the home country is in some sense
unfair and constitutes a threat to domestic producers because of
the low import price.
Therefore, this unfair behavior should be prevented through the
imposition of a tariff, that is, an antidumping duty.
(2) To offset a foreign subsidy
Unfair trade and disturbs the “level playing field”
Generates a distortion from the free-trade allocation of resources when the foreign country does not have a comparative advantage in this good.
An imposition of tariff can offset the distortion and aid the restoration of the trade pattern to a more efficient one.
6. National security argument
To assure continued domestic production in the event of a war.
Imports may capture the lion's share of the market if no restriction on them
during normal times.
A cutoff may occur if normal trade patterns are disrupted.
To prevent this happen, the industry must be protected.
Problems:
How to identify the industry Agriculture.
Steel Ships Planes (at one time or another) watch industry
Policies other than tariffs
e.g. Goods could be stockpiled, like the U.S. oil with the
Strategic Petroleum Reserve
§2 New Protectionism
Also called strategic trade policy theories, emerged in the 1970s.
Two distinguished features: It acknowledges:
The industrial product market is imperfect. The varieties of products make it possible for any firms in any countries to obtain monopoly forces to some extent;
The production of many industrial products enmies of scale.
Thus, the protection policy has two new bases:
To impose tariffs to extract the foreign monopoly profits;
(2) To help home firms to acquire more market shares so that they can realize economies of scale in production and thus obtain competition advantages in the market.
1. Tariff to extract foreign monopoly profit
0 Q
Price
Cost
D（=AR）
MR
C1
MC
F
Q1
P1
MC+t
C2
t
Q2
P2
T
Consumer surplus
loss
T: tariff revenue, monopolist’s profit transferred to the country
If T>Consumer suplus loss, then successful
R
Rectangle a : monopolist’s profit
S
Rectangle b: monopolist’s profit
a
b
H
G
●
2. Export subsidy in duopoly
(market share is important)
Table 8-1 Hypothetical payoff matrix for Boeing and Airbus
Unit: million dollars
Boeing Airbus
Produces Does not
produce
Produces (-5, -5) (100, 0)
Does not
produce
(0, 100)
(0, 0)
If Boeing takes the
lead in entering
China’s market,
Airbus only has two
choices: produce but
suffer loss and not
produce and no loss.
The rational choice is
surely not produce
(the upper-right
portion);
The outcome: (0, 100), (100, 0)
The one who takes the lead wins.
If Airbus enters the
market first, there are
also two choices for
Boeing and the
outcome is to give
up the market
(the lower-left portion).
Table 8-2 Hypothetical payoff matrix for Boeing and Airbus when Airbus receives $10 million subsidies
Unit: million dollars
Boeing Airbus
Produces Does not
produce
Produces (-5, 5) (100, 0)
Does not
produce (0, 110) (0, 0)
Airbus is sure
to make profit
if it produces.
Boeing gives up.
Outcome: (0, 110)
Table 8-3 Hypothetical payoff matrix for Boeing and Airbus when each company receives $10 million subsidies
Unit: million dollars
Boeing Airbus
Produces Does not
produce
Produces (5, 5) (110, 0)
Does not
produce (0, 110) (0, 0)
Both companies
will produce.
Outcome: (5, 5).
But government
expenditures
outweigh the
profits earned.
Case 2: Collision Course in Commercial Aircraft: Boeing-Airbus-
Mcdonnell Douglas—1991(A)
§3 The Political Economy of Trade Policy
Policies are set in political contexts, not by those who seek to
maximize economic efficiency.
1. Median voter model (Median voter theory)
A voting model positing that in a majority election:
(1) There are two competing political parties;
(2) The objective of each party is to get elected by majority vote.
Both parties will commit to the policy position preferred by the
median voter, the voter in the middle of distribution on the single
dimension.
Median voter Voters
Figure 8-3 An example of median voter model
Political
support
9
8
7
6
5
4
3
2
1
Preferred
Tariff
Rate
The Republic: 6%
(6 supporters )
The Democratic: 7%
(3 supporters)
The Republic
The Democratic
The Progressive party
If Progressive Party:
5%
Then No.1-5 will support
the progressive party
and the Republic will
only have one supporter,
No. 6.
A two-party
democracy should
enact trade policy
based on how many
voters it pleases.
2. Collective action theory
In many cases, the minority is protected.
Mancur Olson (曼瑟·奥尔森) developed
the theory.
The theory challenged wisdom (说法) in his day that:
(1) If anyone in a group has interests in common, then they
will act collectively to achieve them; and
(2) In a democracy, the greatest concern is that the majority
will tyrannize (‘tir naiz; 欺凌 exercise power) and
exploit the minority.
1932-1998
The collective action theory argues that
Individuals in any group attempting collective action will have incentives to “free ride” on the efforts of others if the group is working to provide public goods.
Individuals will not “free ride” in groups which provide benefits only to active participants.
Hence, without selective incentives to motivate participation, collective action is unlikely to occur even when large groups of people with common interests exist.
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Public goods: Consumption of it by one individual does not actually or potentially reduce the amount available to be consumed by another individual.
Large groups will face relatively high costs when attempting to organize for collective action while small groups will face relatively low costs.
Individuals in large groups will gain relatively less per capita of successful collective action。
Conclusion:
Collective action by large groups is difficult to achieve even when they have interests in common;
2. The minority can dominate the majority.
3. Contribution in political campaigns
Politicians also require funds to run campaigns.
These funds may especially come from groups who
do not have a collective action problem and are
willing to advocate a special interest policy.
Trade policy making is often influenced by
supporters of each political party since the ultimate
objective of the policy is to safeguard its political
power.

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