51 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
Actual trade policy often cannot be reconciled with the prescriptions of basic welfare analysis. One reason
for this is that the social accounting framework of policy makers does not match that implied by cost-benefit
analysis. For example, policy makers may apply a “weighted social welfare analysis” which weighs gains
or losses differently depending upon which groups are affected. Of course, in this instance there is the issue
of who sets the weights and on the basis of what criteria. Also, trade policy may end up being used as a
tool of income redistribution. Inefficient existing industries may be protected to preserve the status quo.
Indeed, tariffs theoretically can be set at levels high enough to restrict trade in a product.
Divergence between optimal theoretical and actual trade policy may also arise because of the manner in
which policy is made. The benefits of a tariff are concentrated while its costs are diffused. Well-organized
groups whose individuals each stand to gain a lot by trade restrictions have a better opportunity to influence
trade policy than larger, less well-organized groups which have more to lose in the aggregate but whose
members individually have little to lose.
Drawing upon these arguments, one would expect that you could generalize that countries with strong
comparative advantage in manufacturing would tend to protect agriculture, while countries with comparative
advantage in agriculture would tend to protect manufacturing. For the United States, however, this argument
is not validated by the pattern of protection. It is concentrated in four disparate industries: autos, steel, sugar,
International negotiations have led to mutual tariff reductions from the mid-1930s through the present.
Negotiations which link mutually reduced protection have the political advantage of playing well-organized
groups against each other rather than against poorly organized consumers. Trade negotiations also help avoid
trade wars. This is illustrated by an example of the Prisoner’s dilemma as it relates to trade. The pursuit of
self-interest may not lead to the best social outcome when each agent takes into account the other agent’s
decision. Indeed, in the example in the text, uncoordinated policy leads to the worst outcome since
protectionism is the best policy for each country to undertake unilaterally. Negotiations result in the
coordinated policy of free trade and the best outcome for each country.
The chapter concludes with a brief history of international trade agreements. The rules governing GATT are
discussed, as are the real threats to its future performance as an active and effective instrument for moving
toward freer trade. Also, the developments of the Uruguay Round are reviewed, including the creation of the
WTO and the economic impact of the Round. The chapter also notes that more recent multilateral negotiations
(the Doha Round) have stalled, largely over disagreements regarding agricultural subsidies and trade. This
has been a disappointment to free trade proponents as it marks the first time a major multilateral trade round
has failed to produce a substantial agreement. However, the failure of the Doha Round can be partially
attributed to the success of previous rounds of trade negotiations. As the world moves closer and closer to
free trade, the marginal gains from further reductions in trade barriers become smaller. This is highlighted
by Table 10-5 in the text, which shows that even under the most ambitious proposals in the Doha Round,
the gains from freer trade would only be about 0.18% of global income.
There is also a discussion of preferential trading agreements. Free Trade Areas and Customs Unions
are compared, and trade diverting and trade creating effects of customs unions are demonstrated in an
example. Finally, a case study discusses recent evidence on trade diversion in South America. There are
numerous examples of groups of countries moving toward regional economic integration; any of which
can be used as an example to illustrate the ideas of this section. An Appendix proves that there is always
an optimal positive tariff if a country’s protectionist actions affect world prices.
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