Some Relevant International Trade Theory

Wednesday I will offer comparisons of international trade policies in the Reagan and Trump Administrations.  The purpose of this post is to provide some relevant background from international economics: quotas versus tariffs, the Lerner symmetry theorem, zero-revenue tariffs, and the magnitude of the economic costs of tariffs.

Quotas versus tariffs

When domestic producers seek protection from international competition, two policy tools have proven to be of interest: tariffs and quotas.  In theory, tariffs are straightforward: the foreign producers have to pay a tax on sales in the U.S. while domestic producers do not, which (hopefully) permits the domestic producers to either raise prices or make more domestic sales or both.  Domestic consumers pay more, domestic producers earn more profit, and foreign producers potentially earn less profit.

When protection is provided by quota (called an import quota from the U.S. perspective or an “export restraint” from the foreign perspective), the extra sales for domestic producers come from the fact that the foreign producers have a low cap (a.k.a., quota) on their sales in the domestic market.  Consumers lose by paying more and/or losing access to their preferred foreign brands, but otherwise the winners and losers from quotas depend very much on how the quota is administered.  That is, which foreign producers are allowed to make domestic sales, and how much?  If the rights to sell into the U.S. market were auctioned off by the Federal government, we would essentially have a tariff system.  But many times the foreign government allocates the rights to sell into the U.S. market under the quota.  In effect, the foreign government leads a cartel of its producers to restrain U.S. sales and thereby elevate what they charge in the U.S. market.

To the extent that the various foreign producers compete with each other more than they compete with domestic producers, the quota elevates the price of foreign-produced goods more than the price of the domestic-produced ones, and the quota amounts to redistribution from U.S. consumers to foreign producers.  As Professor Irwin described for the automobile export restraints of the 1980’s,

“In 1981, for example, Japan was persuaded to adopt a VER on automobile export to the United States, a trade restraint that dramatically increased the price of Japanese (and European) cars to U.S. consumers … the main beneficiaries of higher automobile prices were the Japanese (and European) automakers who captured scarcity rents: Japanese automakers reaped more than $2 billion in 1982 alone, while their European counterparts also raised their prices, to capture $1.5 billion that year” (Irwin 1994 p. 6)

Note that Irwin and others comparing tariffs favorably to quotas are comparing hypothetical tariffs to actual quotas.  In reality, tariffs may generate retaliation.  Moreover, especially since the advent of the WTO, actual tariffs often have quota elements to them (alternatively, quotas have been “tarifficated”).  In these cases, countries are provided with a quota of tariff exemptions that may allow at least some of the foreign businesses to profit from the tariff action.  These all make the incidence of tariffs more similar to quotas, although I accept the qualitative result that tariffs bring more revenue to the treasury and less profit to foreign producers than quotas do.

The Lerner Symmetry Theorem

“The Lerner symmetry theorem holds that a tax on imports is functionally equivalent to a tax on exports” (Irwin 2009, p. 72) even without tariff retaliation by the exporting country.  Similarly, a non-tariff restriction on imports imposes a cost on exports.

As I like to explain it, raising the Manhattan bridge and tunnel tolls on inbound vehicles, with no change in outbound tolls, will reduce both the number of inbound vehicles as well as reduce the number of outbound vehicles.  I have found that people from New York, of which there are a number in the current White House, readily understand the Lerner symmetry theorem this way.  At least one White House staff from Irvine, CA does not think that the Lerner symmetry theorem is relevant for international trade policy evaluation and is eager to have others share that opinion.

Zero-revenue Tariffs

At least one important tariff -- the longstanding 25 percent tariff on imported light trucks and cargo vans (almost half of the current auto market; hereafter "light trucks") -- collects essentially zero revenue because the tariff moved practically all production for domestic consumers to the U.S.  As shown in the chart below, such a tariff increases the price of light trucks even consumers pay no tariff and the treasury receives no tariff revenue.  The elevated price goes to domestic manufacturers, including those who are less efficient that international suppliers.

Quantifying Economic Costs of Tariffs

The attention that Federal international trade policy receives from the economics profession seems disproportionate to Federal intranational trade policy (namely, taxes and economic regulation).  The vast majority of trade involving Americans is from American-to-American.  At various times, the Federal government has introduced extraordinary barriers to this trade and hardly any economist notices.  As Professor Krugman put it in 2015,

“comparative advantage says “yay free trade”, but also suggests that once trade is already fairly open, the gains from opening it further are small. But because economists want to keep shouting yay free trade, they look for reasons why those gains might be larger….One particular misuse of the yay-free-trade sentiment is the persistent effort to make protectionism a cause of economic slumps, and trade liberalization a route to recovery.”

(Since President Trump took office, Professor Krugman is more cryptic about this point because “yay free trade” is one of the most common critiques of current Federal economic policy).

With that said, as an economist in the WhiteHouse I welcomed and appreciated the effort put by “outside economists” toward trade analysis.  That effort facilitated leveraging my comparative advantage on various intranational trade topics.