1. Protectionism, GATT, and world trade
In 1932, U.S. manufacturers, which used to enjoy steady relationships with their foreign distributors and export nearly 60% of their output, realized that their exports had fallen to only 20% of total output. Which of the following is the most likely reason for this decrease in exports?
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Explanation:
Relatively high import tariffs had existed in the United States for several decades. However, the Smoot-Hawley Act, signed into law in 1930, increased the tariffs to an unprecedented level of 53%.
This provoked retaliation by virtually all trading partners, and within just two years, U.S. exports fell by nearly two-thirds.
The signing of the General Agreement on Tariffs and Trade (GATT) in 1947 resulted in the adoption of several new trade policies.
In the following table, indicate if each of the policies listed was a result of GATT. Then, complete the last column by identifying the means by which each GATT policy was implemented.
|
Policy
|
GATT Policy
|
Implementation
|
|---|---|---|
| Promotion of trade transparency |  |
|
| Promotion of discriminatory taxes | |
|
| Promotion of lower trade barriers | |
|
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Explanation:
Signed in 1947, GATT was the first major postwar step toward the liberalization of trade on a multilateral basis. Crafted as an agreement among the member nations to decrease trade barriers and level the playing field for all nations, GATT was never intended to become an organization. Still, it managed to implement major policies to reduce trade barriers.
The promotion of trade transparency was implemented through making countries’ trade rules clear and public. By doing so, GATT tried to improve the predictability and stability of international trade. Countries were required to disclose their trade policies and practices publicly within the country or by notifying the GATT secretariat.
The promotion of lower trade barriers was implemented through settling trade disputes. An important goal of GATT was to provide third-party assistance in trade disputes. Historically, trade conflicts either remained unresolved or were settled in favor of a stronger country at the expense of a weaker country. GATT improved the process by formulating complaint procedures and providing a conciliation panel to which a wronged country could express its grievance. However, GATT’s dispute-settlement process lacked the authority to enforce its recommendations—a weakness that inspired the formation of the World Trade Organization.
GATT’s goal was to promote free trade and remove discriminatory taxes imposing a higher burden on a foreign product than on a domestic product, which violated the national treatment rules established in GATT, so promotion of discriminatory taxes was not a GATT policy.
In the 1960s, multilateral negotiations called the![]()
Kennedy Round resulted in![]()
lower tariffs on manufactured goods and caused![]()
an increase in U.S. exports.
resulted in and caused in U.S. exports.Points:
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Explanation:
From 1964 to 1967, GATT members participated in the so-called Kennedy Round of trade negotiations, at which negotiations shifted from a product-by-product format to an across-the-board format.
Tariff cuts on manufactured goods by an average of 35% was an important achievement of the Kennedy Round. As average tariff rates in industrial nations decreased during the postwar period, the importance of nontariff barriers increased.
The lower tariffs on manufactured goods in the 1960s—combined with an increasing number of countries willing to participate in multilateral trade—allowed the United States to increase its exports.
2. Basic facts about the WTO
The World Trade Organization (WTO) was built on the basis of the General Agreement on Tariffs and Trade (GATT) and, thus, inherited many of its features. Still, the WTO proved to be a very distinct institution.
Indicate whether each property in the following table is a unique property of the WTO compared to GATT.
|
Property
|
Unique Property of WTO
|
|
|---|---|---|
|
Yes
|
No
|
|
| Enforces dispute settlements | ||
| Encourages retaliatory tariffs | ||
| Oversees tariff cuts and reduction of nontariff measures | ||
| Reduces national sovereignty | ||
| Acts as a membership organization | ||
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Explanation:
The WTO is a membership organization responsible for governing the conduct of trade relations among its members. The WTO oversees the implementation of the tariff cuts and reduction of nontariff measures agreed to in the negotiations.
A major achievement of the WTO is a stronger mechanism for settling trade disputes. The old GATT dispute mechanism suffered from long delays, the ability of accused parties to block decisions of GATT panels that went against them, and inadequate enforcement. The dispute-settlement mechanism of the WTO addresses each of these weaknesses. It guarantees the formation of a dispute panel once a case is brought and sets time limits for each stage of the process. The decision of the panel may be taken to a newly created appellate body, but the accused party can no longer block the final decision.
WTO dispute-settlement panels cannot force any country to change its laws. Individual nations determine exactly how to respond to the recommendations of a WTO panel, if at all. If a country’s measure is found to be in violation of a WTO provision, that country may on its own decide to change the law; compensate a foreign country by lowering its trade barriers an equivalent amount in another sector; or do nothing and possibly suffer retaliation by the affected country. At the same time, however, the WTO does not allow a nation to use trade restrictions to enforce its own environmental, labor, health, and safety standards when they have selective and discriminatory effects against foreign producers.
The WTO does not encourage retaliatory tariffs, although retaliation is sometimes used. Most trade-dispute rulings of the WTO are resolved amicably, without resorting to retaliatory trade barriers.
According to the most favored nation clause (Article I of GATT), which of the following is true?
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Explanation:
Article I of GATT, the most favored nation clause, states that every country belonging to the WTO must be treated the same: If a country imposes low tariffs on one trading partner, then those low tariffs must be extended to every trading partner belonging to the WTO.
3. Issues in trade liberalization and WTO policies
Indicate whether each scenario in the following table represents a retaliatory tariff, a safeguard, or an environmental issue.
|
Scenario
|
Retaliatory Tariff
|
Safeguard
|
Environmental Issue
|
|---|---|---|---|
| The United States bans imports of shrimp from countries using nets that trap turtles. | |||
| A small country, like Ecuador, applies a higher tariff to imports from a large country that has been conducting unfair trade practices. | |||
| The United States imposes higher tariffs on the import of footwear for four years to give domestic producers time to adjust to import competition. |
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Explanation:
If Ecuador, a small country, decides to retaliate against unfair trade practices of a large country by applying a higher tariff to imports from that country, its national welfare will most likely decrease due to unfavorable terms of trade (the ratio of export prices to import prices). Therefore, small countries find retaliation relatively more costly to initiate than their larger trading partners. For a large country, terms of trade may actually improve due to retaliatory tariffs and, thus, offset at least some of the welfare loss due to increasing tariffs.
The four years of higher tariffs on the import of footwear is an example of a temporary safeguard. To help domestic producers who face fierce competition from imports, the president can use temporary safeguards to modify existing terms of trade by levying trade restrictions, such as higher tariffs or even quotas. Usually, safeguards decline during the period in which they are imposed to gradually wean the domestic industry from protectionism.
Although the goal of the U.S. ban on imports of shrimp from countries using nets that trap turtles in the 1990s was intended to correct for an environmental issue, it was found to be in violation of WTO free-trade rules. Environmentalists argued that the free-trade policies of the WTO contradicted the goal of environmental quality.
Which of the following arguments can be used to correctly defend the WTO’s position on the environment? Check all that apply.
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Explanation:
Trade and growth can encourage the development and dissemination of environmentally friendly production techniques as the demand for cleaner products grows. International companies may also contribute to a cleaner environment by using the most modern and environmentally clean technology in all their operations. This is less costly than using differentiated technology based on the location of production and helps companies maintain a good reputation. Trade can increase the cost of the wrong environmental policies if, for example, farmers freely pollute rivers. However, imposing tougher environmental laws will make polluters pay without shutting off exports.
4. Strategic trade policy
Suppose there are only two producers of aircraft in the world, AirCraft in the United States and AirEurope in the European Union. The following hypothetical payoff matrices show the profits (in millions of dollars) for each company. In the absence of subsidies, if only one company makes aircraft, it receives a profit of $90 million. If both companies decide to produce, they each lose $3 million. When a company decides not to produce, it earns zero profit.
| AirEurope | |||
| Produce | Not Produce | ||
| AirCraft | Produce | -3, -3 | 90, 0 |
| Not Produce | 0, 90 | 0, 0 | |
Suppose that the European Union considers aircraft a strategic industry and gives AirEurope a $9 million subsidy if it produces.
Fill in the cells of the following payoff matrix to reflect the $9 million subsidy.
| AirEurope | |||
| Produce | Not Produce | ||
| AirCraft | Produce |
-3
, 6
|
90
, 0
|
| Not Produce |
0
, 99
|
0
, 0
|
|
Points:
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Explanation:
When AirEurope is subsidized, and both firms choose to produce, AirEurope’s payoff is now −$3 million+$9 million=$6 million−$3 million+$9 million=$6 million, and AirCraft still loses $3 million. When AirEurope produces, but AirCraft does not, AirEurope’s payoff is now $90 million+$9 million=$99 million$90 million+$9 million=$99 million, and AirCraft still receives zero profit.
If after being offered a subsidy, AirEurope chooses not to produce while AirCraft produces, their payoffs are the same as they were without the subsidy. Finally, if both decide not to produce, both receive zero profit.
With a $9 million subsidy, regardless of whether AirCraft produces or not, AirEurope![]()
should produce if it wants to maximize its profit.
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True or False: Because AirEurope will enter the market if given a $9 million subsidy, AirCraft should not produce in this industry.
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Explanation:
With AirEurope receiving a $9 million subsidy, if AirCraft enters the market with its new aircraft, AirEurope will also choose to enter because the profit from producing ($6 million) is larger from the profit of not producing ($0 million). Moreover, if AirCraft does not enter the market, AirEurope will again choose to enter because the profit from producing ($99 million) is larger than the profit of not producing ($0 million). Therefore, AirEurope should always produce to maximize its profit.
Knowing that AirEurope will enter the market with certainty, AirCraft will choose to not produce because the profit from not producing ($0 million) is larger than the profit from producing (loss of $3 million). The European subsidy, therefore, ensures not only that AirEurope will continue to produce aircraft, but also that AirCraft will suffer a loss if it enters the market. Therefore, the statement is true.
5. Economic sanctions
Indicate whether each outcome in the following table is or is not an objective of economic sanctions.
|
Outcome
|
Objective
|
Not an Objective
|
|---|---|---|
| Reduction of nuclear proliferation | ||
| Preservation of national security | ||
| Promote imperfect competition | ||
| Export promotion |
Points:
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Explanation:
Economic sanctions are government-mandated limitations placed on customary trade or financial relations among nations. Among other objectives, economic sanctions seek to preserve national security and reduce nuclear proliferation.
In 1990, Western countries imposed economic sanctions on Iraq with the goal of terminating Iraq’s military takeover of Kuwait. Prior to the sanctions, oil and equipment were exported internationally by Iraq. The following graph shows Iraq’s production possibilities frontier (PPF) before the sanctions were imposed.
Drag the PPF curve on the following graph to show the effects of the imposed economic sanctions on Iraq’s production possibilities frontier.
Note: Select either end of the curve on the graph to make the endpoints appear. Then drag one or both endpoints to the desired position. Points will snap into position, so if you try to move a point and it snaps back to its original position, just drag it a little farther.
Points:
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Explanation:
The sanctions had a particularly devastating effect on Iraq’s economy. Declining export of oil led to idle wells, unused equipment, and unemployed workers in Iraq. As a result, the country’s output potential decreased. Thus, the PPF shifts inward.
Which of the following would impact the effectiveness of economic sanctions? Check all that apply.
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Explanation:
Among the most important determinants of the success of economic sanctions are the number of nations imposing sanctions and cultural factors in the target nation. Although unilateral sanctions may have some success in achieving intended results, such as the termination of Iraq’s military takeover of Kuwait, multilateral sanctions result in greater economic pressure on the target nation by demonstrating that more than one nation disagrees with the target nation’s behavior, which enhances the political legitimacy of the effort. Also, when the people of the target nation have strong cultural ties to the imposing nation, they are more likely to identify with the imposing nation’s objectives, which enhances the effectiveness of sanctions.
