Book Title
International Economics: Theory and Policy 9th Edition

978-0132146654 Chapter 12 Lecture Notes

December 18, 2019
Chapter 12 Controversies in Trade Policy    57
Chapter 12
Controversies in Trade Policy
.1 Chapter Organization
Sophisticated Arguments for Activist Trade Policy
  Technology and Externalities
  Imperfect Competition and Strategic Trade Policy
Box: A Warning from Intel’s Founder
  Case Study: When the Chips Were Up
Globalization and Low-Wage Labor
  The Anti-Globalization Movement
  Trade and Wages Revisited
  Labor Standards and Trade Negotiations
  Environmental and Cultural Issues
  The WTO and National Independence
  Case Study: Bare Feet, Hot Metal, and Globalization
Globalization and the Environment
Globalization, Growth, and Pollution
The Problem of “Pollution Havens”
The Carbon Tariff Dispute
.2 Chapter Overview
While the text has shown why, in general, free trade is a good policy, this chapter considers two controversies
in trade policy that challenge free trade. The first regards strategic trade policy. Proponents of activist
government trade intervention argue that certain industries are desirable and may be underfunded by markets
or dominated by imperfect competition and warrant some government intervention. The second controversy
regards the recent debate over the effects of globalization on workers, the environment, and sovereignty.
While the anti-globalization arguments often lack sound structure, their visceral nature demonstrates that
the spread of trade is extremely troubling to some groups.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
58  Krugman/Obstfeld/Melitz •   International Economics: Theory & Policy, Ninth Edition
As seen in the previous chapters, activist trade policy may be justified if there are market failures. One
important type of market failure involves externalities present in high-technology industries due to their
knowledge creation. Existence of externalities associated with research and development and high
technology make the private return to investing in these activities less than their social return. This means
that the private sector will tend to invest less in high-technology sectors than is socially optimal. While
there may be some case for intervention, the difficulties in targeting the correct industry and understanding
the quantitative size of the externality make effective intervention complicated. To address this market
failure of insufficient knowledge creation, the first best policy may be to directly support research and
development in all industries. Still, while it is a judgment call, the technology spillover case for industrial
policy probably has better footing in solid economics than any other argument.
Another set of market failures arises when imperfect competition exists. Strategic trade policy by a government
can work to deter investment and production by foreign firms and raise the profits of domestic firms.
An example is provided in the text that illustrates the case where the increase in profits following the
imposition of a subsidy can actually exceed the cost of a subsidy to an imperfectly competitive industry
if domestic firms can capture profits from foreign firms. While this is a valid theoretical argument for
strategic policy, it is nonetheless open to criticism in choosing the industries which should be subsidized
and the levels of subsidies to these industries. These criticisms are associated with the practical aspects of
insufficient information and the threat of foreign retaliation. The case study on the attempts to promote
the semiconductor chips industry shows that neither excess returns nor knowledge spillovers necessarily
materialize even in industries that seem perfect for activist trade policy.
The next section of the chapter examines the anti-globalization movement. In particular, it examines the
concerns over low wages in poor countries. Standard analysis suggests trade should help poor countries,
and, in particular, help the abundant factor (labor) in those countries. Protests in Seattle, which shut down
WTO negotiations, and subsequent demonstrations at other meetings showed, though, that protestors either
did not understand or did not agree with this analysis.
The concern over low wages in poor countries is a revision of arguments in Chapter 2. Analysis in the
current chapter shows again that trade should help the purchasing power of all workers and that if anyone
is hurt, it is the workers in labor-scarce countries. The low wages in export sectors of poor countries
are higher than they would be without the export-oriented manufacturing, and while the situation of these
workers may be more visible than before, that does not make it worse. Practically, the policy issue is whether
or not labor standards should be part of trade pacts. While such standards may act in ways similar to a
domestic minimum wage, developing countries fear they would be used as a protectionist tool.
Anti-globalization protestors were by no means united in their cause. There were also strong concerns that
export manufacturing in developing countries was bad for the environment. Again, the issue is whether these
concerns should be addressed by tying environmental standards into trade negotiations, and the open
question is whether this can be done without destroying the export industries in developing countries.
Globalization raises questions of cultural independence and national sovereignty. Specifically, many are
disturbed by the WTO’s ability to overturn laws which do not seem to be trade restrictions, but which
nonetheless have trade impacts. This point highlights the difficulty of advancing trade liberalization when
the clear impediments to trade—tariffs or quotas—have been removed, yet national policies regarding
industry promotion or labor and environmental standards still need to be reformed.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
Chapter 12 Controversies in Trade Policy    59
The final section of the chapter examines the link between trade and the environment. In general,
production and consumption can cause environmental damage. Yet, as a country’s GDP per capita grows,
the environmental damage done first grows and then eventually declines as the country gets rich enough to
begin to protect the environment. As trade has lifted incomes of some countries, it may have been bad for
the environment—but largely by making poor countries richer, an otherwise good thing. In theory, there
could be a concern of “pollution havens” where countries with low environmental standards attract “dirty”
industries. There is relatively little evidence of this phenomenon thus far. Furthermore, the pollution in
these locations tends to be localized and is therefore better left to national rather than international policy.
The chapter concludes with a discussion of the cap and trade system for greenhouse gases (an example of
transboundary pollution) currently being debated in the U.S. Congress. Part of this policy aimed at reducing
carbon emissions is an imposition of a “carbon tariff ” on imports from countries that do not have their
own carbon taxes. Proponents argue that such tariffs are necessary to prevent production from shifting to
pollution havens and to reduce the overall level of carbon emissions, while opponents argue that these
tariffs are simply more protectionism masquerading as environmental regulation.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley