Sorry US tomato growers, consumers will be worse off from of the anti-dumping duty on Mexican tomatoes

The Financial Times reported last week (paywalled):

In July, President Donald Trump sided with Florida farmers, imposing a 17 per cent anti-dumping duty on Mexican tomatoes and accusing producers of selling at less than the cost of production. US growers see the levy, which took effect in July and is separate from broader trade tariff negotiations, as a lifeline for their declining industry...

Mexico supplies more than 60 per cent of the fresh tomatoes consumed in the US, a stark example of how the country has won market share across sectors to become the US’s top trading partner since the North American Free Trade Agreement came into effect in 1994.

That has also made it a prime target for Trump since his first presidential campaign. The duty is part of a glut of allegations of trade violations he has thrown at Mexico, alongside broader pressure on security and migration.

The tomato duty, which uses a different legal instrument to regular tariffs, is the first Trump trade levy to directly target a fresh food staple...

Price data has not been released for the period after the new duties were imposed. US growers say farm-level prices could rise, which would eat into retailers’ and distributors’ profits but would not necessarily affect regular Americans. But Mexico’s National Agricultural Council said the consumer would pay, predicting prices would go up 11.5 per cent.

Gándara said if US companies want to produce more, it would require large investments in expensive land and technology, which inevitably would lead to higher prices.

The US growers are not correct here. Regular Americans will be paying more as a result of this anti-dumping duty (which has the same effect as a tariff). This is shown in the diagram below, which shows the American market for tomatoes. With no international trade in tomatoes at all, the market would operate at equilibrium, with a price of P0, and Q0 tomatoes would be traded. However, the domestic price of tomatoes (P0) is higher than the world price (PW). This means that the US has a comparative disadvantage in producing tomatoes. In other words, other countries can produce tomatoes at lower cost (specifically, lower opportunity cost) than the US. One of those countries with a comparative advantage in producing tomatoes is Mexico. If the US allows international trade in tomatoes, US consumers will realise that they can buy tomatoes much cheaper from Mexico than from domestic US tomato growers. The price for tomatoes in the US market will drop to be equal to the world price PW. At this lower price, US consumers will buy more tomatoes (QD0). However, US tomato growers will only be willing to supply QS0 tomatoes at this lower price. The difference between QD0 and QS0 is satisfied by imports of tomatoes.

Now consider what happens if an anti-dumping duty (or a tariff) is imposed. If consumers want to buy tomatoes from the international market, they must now pay the world price PW plus the tariff. The price for tomatoes in the US market will increase to PW+T (where T is the per-unit size of the anti-dumping duty). At this higher price, US consumers will buy less tomatoes than without the tariff (QD1), but US tomato growers will be willing to supply more (QS1). The quantity of tomato imports decreases to the difference between QD1 and QS1. This was the purpose of the anti-dumping duty, of course - to keep a lot of Mexican tomatoes out of the US market.

However, who pays the cost of the tariff? We can work this out by thinking about the areas of economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity (without trade), consumer surplus is the area AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, consumer surplus is the area P0ED. Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the area AED.

With international trade (but no import tariff), the consumer surplus increases to the area AFPW. Producer surplus decreases to the area PWGD. Total welfare is the combined area AFGD. Notice that US tomato consumers are better off with trade, but US tomato growers are worse off. As a whole, US society is better off, because total welfare is larger (by the area EFG - this is a measure of the gains from trade).

Now consider what happens when the anti-dumping duty is applied. Consumer surplus decreases to the area ABK. Producer surplus increases to the area KCD. The government gains tariff revenue equal to the area CBJH (this is the per-unit amount of the anti-dumping duty, multiplied by the quantity of imports subject to the duty). Total welfare is all three of these areas added together, which is the area ABCD+CBJH. In other words, the anti-dumping duty makes US tomato growers better off (higher producer surplus), and makes the government better off (due to the duty revenue). However, the import tariff makes US tomato consumers worse off (lower consumer surplus), and US society as a whole worse off (lower total welfare). The loss of total welfare is equal to the areas BFJ+CHG - this is the deadweight loss of the import tariff.

So, it turns out that US consumers do end up paying part of the anti-dumping duty. They pay a higher price (PW+T instead of PW), and they lose some consumer surplus (their consumer surplus is smaller by the area KBFPW). US tomato growers may want to claim that tomato consumers will not be made worse off by the anti-dumping duty, but the growers are clearly not right about that.

International trade and the domestic price of butter in New Zealand

If you're in New Zealand, you probably couldn't avoid the news over the last six months about the price of butter. In case you missed it though, this New Zealand Herald article from January explains:

The price of butter has topped $9 for a 500g block in some shops and one analyst is warning prices could stay high for months due to global butter supply shortages...

A spokesperson for New World and Pak’nSave operator Foodstuffs said any change in supplier pricing had a direct impact on the price for customers.

“The price of butter on our shelves is primarily influenced by the broader dairy market and the wholesale costs set by our suppliers,” the spokesperson said.

“Over the past 18 months, global butter commodity costs have risen by around 43%...

ANZ agricultural economist Susan Kilsby said butter prices had lifted by 24% over the past year in the global markets.

“Demand for cream [which is used to make butter] does tend to peak over the Christmas holiday period which tightens supply available for butter,” Kilsby said.

“Butter has been in short supply in some parts of the world, as dairy production is relatively stagnant in many markets, whilst demand continues to lift.”

Unfortunately for Kiwi consumers, Kilsby expected butter prices to stay relatively high for the next three to six months.

Let's unpack what's going on with the price of butter. First, let's consider the impact of international trade. This is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing butter (and other dairy products). That means that New Zealand can produce butter at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of butter (PD) would be below the price of butter on the world market (PW0). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy butter in the domestic market (at the price PD), and sell it on the world market (at the price PW0) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW0). In other words, there are incentives to export butter. The rest of the world is willing to buy as much butter as we are willing to supply. [*] So, the demand curve in the domestic market for butter becomes D+exports (the red line in the diagram). The price in the domestic market is determined by the intersection of that demand curve and the supply curve, which is the price PW0. The domestic consumers end up having to pay the price PW0 for butter, since they are competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW0 instead?). At this higher price, the domestic consumers choose to purchase Qd0 butter, while the domestic dairy farmers sell Qs0 butter (assuming that the world market could absorb any quantity of butter that was produced). The difference (Qs0 - Qd0) is the quantity of butter that is exported.

In terms of economic welfare, if there was no international trade in butter, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic timber consumers) would be the area AEPD, the producer surplus (the gains to domestic dairy farmers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade. So to summarise, exporting butter makes domestic butter consumers worse off (lower consumer surplus), domestic dairy farmers better off (higher producer surplus), and society overall better off (higher total welfare).

Now consider how the increase in worldwide demand for butter (as noted in the article) affects the world market for butter, as shown in the diagram below. World demand has increased from DW0 to DW1, and that increases the equilibrium world price from PW to PW1.

Now, let's go back to the New Zealand domestic market for butter. The world price has increased from PW to PW1, as shown in the diagram below, and demand including trade has moved up from D+exports to D+exports1. Now, the domestic consumers have to pay the higher price PW1 for butter, since they are still competing with the world price (and the world price is now higher). At this higher world price, the domestic consumers now choose to purchase Qd1 butter, while the domestic dairy farmers now sell Qs1 butter (still assuming that the world market could absorb any quantity of butter that was produced). The quantity of exports is now (Qs1 - Qd1). That means that more butter is now being exported.

What does that mean for economic welfare? With the higher world price, the consumer surplus decreases further to AGPW1, the producer surplus increases further to PW1HF, and total welfare increases further to AGHF. In other words, the increase in the world price of butter makes domestic consumers worse off, but it makes domestic dairy farmers better off, and society overall better off.

While we might like dairy farmers to sell us butter at a lower price than they can receive from the world market, there is little incentive for them to do so. New Zealand butter consumers must pay the world price of butter. The world price has increased, so the domestic price of butter must increase as well. That higher butter price makes dairy farmers (and society overall) much better off. However, that will come as cold comfort to households that must pay a small fortune to butter their toast.

*****

[*] This assumes that the domestic market for butter in New Zealand is a small proportion of the total world market, such that domestic supply and demand do not affect the world price. For butter, that is unlikely to be true, as New Zealand exports a substantial proportion of global butter supply. However, for the purposes of this analysis, it doesn't have a big impact since we are not considering changes in domestic market conditions.

China's export restrictions on resources for semiconductors

The Financial Times reported last week (paywalled):

Chinese export controls on crucial semiconductor materials are hitting supply chains and stoking fears of shortfalls in western production of advanced chips and military optical hardware.

Beijing’s curbs on shipments of germanium and gallium, which are used for semiconductor applications and military and communications equipment components, have led to an almost twofold increase in the minerals’ prices in Europe over the past year.

China introduced the restrictions, which it says safeguard its “national security and interests”, last year in response to US-led controls on sales of advanced chips and chipmaking equipment.

The FT article focuses on the effect of the export controls on Europe. However, I want to look at the effect of the export controls (an export quota) on the prices of the resources (gallium and germanium) in China. However, let's start by considering why China is an exporter, and the gains from trade for China. This is demonstrated in the diagram below. China has a comparative advantage producing these resources. That means that China can produce gallium (or germanium) at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of gallium (PD) would be below the price of gallium on the world market (PW). Because the domestic price is lower than the world price, if China is open to trade there are opportunities for traders to buy gallium in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export gallium. The domestic consumers would end up having to pay the price PW for gallium as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 gallium, while the domestic suppliers sell Qs0 gallium (assuming that the world market could absorb any quantity of gallium that was produced). The difference (Qs0 - Qd0) is the quantity of gallium that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in gallium, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic gallium consumers) would be the area AEPD, the producer surplus (the gains to domestic gallium producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade.

Now consider what would happen if there is an export quota limiting the quantity of gallium exports below (Qs0 - Qd0). This is shown in the diagram below. Let's say that the quantity of exports is reduced to the amount between B and G on the diagram (about half the amount of exports that were previously occurring). Now consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for gallium. Then there is a limited quantity of exports that are allowed under the export quota, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce gallium). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). The domestic consumers choose to purchase Qd1 gallium at the price P1, while the domestic suppliers sell Qs1 gallium at that price. The difference (Qs1 - Qd1) is the quantity of exports of gallium.

Now consider the areas of economic welfare. The consumer surplus is larger than it was without the restricted exports (it is now the area AJP1), the producer surplus is smaller than it was without the restricted exports (it is now the area P1HF). There is a new area of welfare KLHJ, which is the profit that exporters of gallium would receive from exporting, because they can purchase the gallium at the price P1 domestically, and then sell it to the world market at the price PW. This area KLHJ is the licence-holder surplus. Total welfare is smaller than without the restricted exports (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the restricted exports) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no restricted exports, but have now been lost. The reduction in exports makes domestic gallium suppliers worse off, as well as society overall (in terms of economic welfare in total). However, domestic gallium consumers benefit in terms of higher consumer surplus, and the export licence holders are a new group that gains from these restrictions.

Now, the model we used above relies on an assumption that Chinese decisions about gallium (or germanium) exports do not affect the world price. In fact, because China produces 98 percent of the world's gallium, and 60 percent of the world's germanium (according to the FT article), this is unlikely to be true. When China restricts exports through the quota, the world price will increase. That has the effect of increasing the surplus for the export licence holders, but otherwise doesn't affect domestic consumers or producers. However, it will make international consumers worse off, since they would now have to pay a higher price for gallium. And that's what the FT article shows. However, now we know that it isn't just the global consumers of these resources who are worse off, but Chinese mining companies, and Chinese society generally, as well.

How a good growing season in Australia made New Zealand avocado growers worse off

RNZ reported earlier this week:

It had been tough going, New Zealand Avocado chief executive Brad Siebert said, but the new season which is just getting started looks good...

The glut of avocados last season was in part because Australia, a key market for NZ exports, had grown more of its own.

"Over the last decade Australia has taken around 85 percent of our exports but in the last three years that's dropped below 50 percent."...

Many growers have had two seasons in a row without any profit, he said.

"It's been really tough so there is a bit riding on this season."

According to New Zealand Avocado, Australia is New Zealand's largest export market for avocados, taking about 80 percent of our exports. A good growing season for avocados in Australia will therefore make life difficult for New Zealand avocado growers.

To see why, first consider the Australian avocado market, as shown in the diagram below. The domestic supply of avocados in Australia is S0, and demand is D. If there was no trade, the market would operate in equilibrium, where supply meets demand. The equilibrium quantity would be Q0, and the equilibrium price would be PD. However, Australia is an importer of avocados, which means that the domestic equilibrium price in Australia is higher than the world price (PW) - Australia is less efficient at producing avocados than the rest of the world, because they do so at a higher price than the world market. Since Australia can trade for avocados on the world market, and Australian consumers have the choice, they would not pay more than PW for avocados. At the world price PW, the domestic suppliers of avocados are willing to supply just QS avocados. However, domestic consumers demand Q1 avocados. The difference between QD and QS is the quantity of avocados imported (equal to M0). So, the effective supply of avocados to the Australian market is shown by the red line, where the domestic sellers sell up to QS avocados, and then the rest of the supply comes from the world market at the price of PW. 

Now consider what happens when there is a good growing season in Australia. This increases the domestic supply of avocados from S0 to S1. Now, at the price PW, Australian avocado growers are willing to supply Q0 avocados [*], while domestic consumers still demand QD avocados. The difference between QD and Q0 is the quantity of avocados imported now (equal to M1, and smaller than M0). The quantity of avocados imported into Australia declines.

Obviously, since New Zealand is a major contributor to Australian imports of avocados, this will make New Zealand avocado growers worse off, at least initially. To see why, consumer the New Zealand avocado market, shown in the diagram below. In this case, New Zealand is an exporting country, so the world price (PW) is higher than the domestic price (PA) - New Zealand is more efficient at producing avocados than the rest of the world, because they can do so at a lower price than the world market. Avocado growers in New Zealand would prefer to sell avocados to the world market for PW rather than locally at the price of PA. So, New Zealand consumers must also pay the world price for avocados. At that price, the domestic suppliers of avocados are willing to supply QSA avocados, but domestic consumers are only willing to buy QDA avocados. The difference between QSA and QDA is the quantity of avocados exported (equal to XA). The effective demand for New Zealand avocados, including exports, is shown by the blue line, where the domestic consumers buy up to QDA, and then the rest of the demand comes from the world market at the price of PW.

Now consider what happens when Australia reduces imports of avocados. In the short run, New Zealand can't easily divert those exports to other destinations in the world market. So, those avocados would now be supplied to the domestic market instead. So, instead of XA exports, there can only be XB exports. [**] If domestic consumers only bought QDA avocados, and growers could only export XB avocados, then not all of the growers' avocados are being sold. The growers produced QSA avocados, but are only able to sell QA (which is QDA plus XB). To sell those leftover avocados, the growers must go back to the New Zealand market. This is shown by the dotted blue line DC (incl. exports). Equilibrium in this market now occurs where that new demand curve meets the supply curve, which is at the quantity QC. The domestic price of avocados would increase to PC.

Now, to show that the domestic producers are made worse off, we need to consider the areas of economic welfare. Before the decrease in exports, the consumer surplus (the gains to domestic avocado consumers) is the area ABPW, the producer surplus (the gains to domestic avocado growers) is the area PWCE), and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area ABCE. After the decrease in exports, the consumer surplus increases to the area AFPC. Domestic consumers are made better off. The producer surplus decreases to the areas PCGE and HJGF combined [***]. Domestic growers are made worse off. Total welfare decreases to the areas AFGE and HJGF combined. Society as a whole is worse off. However, the key point of relevance to this post is that the growers are worse off.

Now, in the long run, New Zealand growers might be able to find other export markets, so that when Australian demand for imported avocados decreases, New Zealand isn't as badly affected. As the RNZ article notes:

Siebert said the industry had worked hard to diversify markets and is exporting to more countries this season than ever before.

"We're going back into Canada and North America, we haven't exported there in a number of years, we're also going into Asia.

That way at least, less avocados would need to be dumped on the domestic market in future, making the avocado growers better off (but, sadly, New Zealand avocado consumers would be made worse off). 

*****

[*] For simplicity in the diagram, I've assumed that the quantity supplied at the world price after the supply increase is exactly equal to Q0. It wouldn't be exactly that, but it makes the diagram a bit simpler.

[**] Again, I've assumed that the quantity of New Zealand exports is reduced by half. This just makes the diagram a bit simpler.

[***] This requires a bit of explanation. The sales of QE avocados to the domestic market generates producer surplus equal to the area PCFKE. Where does QE come from? It is the initial sales to domestic consumers of QDA, plus the extra sales from QA to QC (shifted over to the left so that the domestic sales are merged together - notice this just moves the two parts of the domestic demand curve, D and DC, together). Then the sales of export avocados (form QE to QC) generates additional producer surplus equal to the area HJGK. Combining those two areas gives PCGE + HJGF.

Jibbitz trading bans offer a missed opportunity to introduce some basic economics to children

I read this article from the New Zealand Herald from earlier this week with some interest:

Jibbitz - accessories that clip on to Crocs - are being banned in schools in Northland due to escalating arguments between youngsters over the sought-after items.

Kamo Primary School principal Sally Wilson was forced to take action after students became upset over Jibbitz trades and some resorted to stealing...

Wilson said attempts to create a safe environment for trades were a learning curve for tamariki and sometimes “ended in tears”.

Often, tamariki trade an item in the hopes of getting it back, and when they realise that isn’t going to happen, they “emotionally can’t cope”, she said.

Eventually, Wilson banned Jibbitz from the school because they had become “disruptive”.

“They were getting stashes and holding on to them, and there was an uneven trade for a certain one that they were after.”

While some kids have their “eye on the prize” and trade cheap Jibbitz for more expensive ones, Wilson said there have also been cases of stealing.

“It’s a learning curve about possessions.”

My children are well beyond the age of adding accessories to Crocs (or going to school, for that matter), but I can remember past crazes for trading Pokemon or Yu-Gi-Oh cards, where trading for sought-after cards got a bit out of hand. So, I can understand the attractiveness of a ban, to protect vulnerable, younger traders from being taken advantage of by older, more savvy traders, who understand that trades are 'for keeps' and better recognise the real value of what is being traded.

However, I can't help but feel that there is a missed opportunity here. The gains from trade is a cornerstone of economic principles, and can be taught very easily. And Jibbitz offer the opportunity to teach the gains from trade in a way that young children can readily understand. Jibbitz trading also offers an opportunity for young children to understand that there are two sides to every trade, and that trading is a voluntary activity. So, thinking about Jibbitz trading, whenever there is a trade of Jibbitz from one child to another (there are two traders), the trade will only happen if both children agree to the trade (either trader can say "no" to a trade), and each child will only agree to the trade if they think that what they are receiving is better than what they are giving away (there are gains from trade for both traders).

Instead of a ban, putting some simple rules for trading Jibbitz in place could really help. Here's a few. First. all trades are voluntary. Both children have to agree. Forced trades can be cancelled by a teacher. Second, all trades are 'for keeps'. There are no take-backs. As an extra rule perhaps a 'current price list' could be maintained, where the number of common Jibbitz expected to be traded for particularly rare or valuable Jibbitz are recorded. This may help avoid problems of a thin market for rare Jibbitz.

There are also opportunities for young children to better understand demand (some Jibbitz are more sought after than others), relative prices (the most sought-after Jibbitz may be traded for several less-sought-after Jibbitz), and scarcity (the rarest Jibbitz are likely to be the most valuable). All of these economic principles can be taught simply, and without recourse to economic jargon, and would help children to better understand some simple economics.

Of course, then there is this objection to Jibbitz trading:

Dargaville mother Taiāwhio Wati-Kaipo was first annoyed when Jibbitz were recently banned at Dargaville Primary School, worrying for her children’s ability to express their “individuality”.

But Wati-Kaipo soon considered the issue and realised the ban had a “deeper meaning”.

She believed the ownership of Jibbitz is a “social indication” of where someone is “sitting on the financial bracket”.

Wati-Kaipo said the price hike in Crocs themselves has created a “has and has not” situation among students.

“Without the Jibbitz, the Crocs were already speaking volumes about someone’s identity,” she said.

Wilson said the craze created a social comparison, as it was about who had the coolest ones and who had the most.

I know that at least some people really believe that inequality can be addressed by banning markets, but it's not correct. In this case, banning Jibbitz will simply shift the outward expression and indicators of social status to some other margin. There are many ways that social status is conveyed. Why stop at banning Jibbitz? Why not ban Crocs altogether? Or premium school bags? Or premium stationery? Or phone games or apps where players can buy special skins or other in-game virtual merchandise? Or phones entirely? Anyway, I'm getting off topic. The Jibbitz ban is a missed opportunity to help young children to better understand some key economic concepts that will be helpful in their development as economic citizens. A ban isn't necessary, and there are better responses to protect children from exploiting each other in the Jibbitz market.

Who pays for Europe's tariffs on Indonesian biodiesel?

My ECONS102 class covered international trade last week, so it was interesting to see import tariffs in the news. As Reuters reported:

Asked about this situation, a European Commission spokesperson told reporters that the EU was confident its duties on Indonesia were in full compliance with WTO rules and that the EU was ready to discuss the matter with Indonesia.

Trade relations between the EU and Indonesia have been strained by the bloc's move to limit imports of commodities linked to deforestation, which is expected to curb EU imports of palm oil from top suppliers Indonesia and Malaysia.

As well as biodiesel, palm oil is used widely in food and cosmetics.

Welcoming the European Commission's investigation, the European Biodiesel Board said it estimated that imports circumventing duties may have cost the EU around 221 million euros ($240.34 million) last year.

The association was also working with EU authorities to address allegations of fraudulent biodiesel imports from China, it added in a statement.

Let's put aside the issue of avoiding the import tariffs (or duties) - we'll come back to those later in the post. Instead, let's focus on the effect of an import tariff on the market for biodiesel in Europe. This is shown in the diagram below. [*] With no international trade in biodiesel at all, the market would operate at equilibrium, with a price of P0, and Q0 biodiesel would be traded. However, the domestic price of biodiesel (P0) is higher than the world price (PW). This means that Europe has a comparative disadvantage in producing biodiesel. In other words, other countries can produce biodiesel at lower cost (specifically, lower opportunity cost) than Europe. One of those countries with a comparative advantage in producing biodiesel is Indonesia. If Europe allows international trade in biodiesel, European consumers will realise that they can buy biodiesel much cheaper from international sources. The price for biodiesel in the European market will drop to be equal to the world price PW. At this lower price, European consumers will buy more biodiesel (QD0). However, European biodiesel producers will only be willing to supply QS0 biodiesel at this lower price. The difference between QD0 and QS0 is satisfied by imports of biodiesel.

Now consider what happens if an import tariff (or import duty) is imposed. If consumers want to buy biodiesel from the international market, they must now pay the world price PW plus the tariff. The price for biodiesel in the European market will increase to PW+T (where T is the per-unit size of the import tariff). At this higher price, European consumers will buy less biodiesel than without the tariff (QD1), but European producers will be willing to supply more (QS1). The quantity of biodiesel imports decreases to the difference between QD1 and QS1. This was the purpose of the tariff, of course - to keep a lot of Indonesian biodiesel out of the European market.

However, who pays the cost of the tariff? We can work this out by thinking about the areas of economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity (without trade), consumer surplus is the area AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, consumer surplus is the area P0ED. Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the area AED.

With international trade (but no import tariff), the consumer surplus increases to the area AFPW. Producer surplus decreases to the area PWGD. Total welfare is the combined area AFGD. Notice that European biodiesel consumers are better off with trade, but producers are worse off. As a whole, European society is better off, because total welfare is larger (by the area EFG - this is a measure of the gains from trade).

Now consider what happens when the import tariff is applied. Consumer surplus decreases to the area ABK. Producer surplus increases to the area KCD. The government gains tariff revenue equal to the area CBJH (this is the per-unit amount of the tariff, multiplied by the quantity of imports subject to the tariff). Total welfare is all three of these areas added together, which is the area ABCD+CBJH. In other words, the import tariff makes European biodiesel producers better off (higher producer surplus), and makes the government better off (due to the tariff revenue). However, the import tariff makes European biodiesel consumers worse off (lower consumer surplus), and European society as a whole worse off (lower total welfare). The loss of total welfare is equal to the areas BFJ+CHG - this is the deadweight loss of the import tariff.

So, the import tariff policy has a cost to society (equal to BFJ+CHG). Ideally, you would want there to be an offsetting benefit worth at least as much. The benefits of the tariff are (hopefully) less deforestation in Indonesia, and associated pollution (from burning forests), environmental and public health impacts.

Of course, the import tariff also makes Indonesian producers of biodiesel worse off, because they cannot sell as much into the European market (because their biodiesel is now more expensive due to the tariff. [**] That creates incentives for the Indonesian producers to try to avoid the tariffs. The European Union is alleging that this is what the Indonesian producers have done, by selling their biodiesel to entities in China and Britain (which apply low or no tariffs to imported biodiesel), and then re-exporting the biodiesel from those countries into the European Union (and the EU applies low or no tariffs to biodiesel imported from those countries). This sort of activity is extraordinarily difficult to police, because commodities like biodiesel can be difficult to trace. It will be interesting to see how this case plays out over the coming months.

*****

[*] I'll discuss this diagram as if it is the whole European market for biodiesel. However, you can easily interpret it instead as the European market for Indonesian biodiesel.

[**] The gains or losses to international producers and consumers are not shown in the market diagram above, which only demonstrates impacts within the European market.

Chinese and world demand, and the price of beef in New Zealand

When a country is open to international trade, the prices in the domestic economy don't only reflect domestic factors, but are also affected by changes in the international market as well. Consider this recent story from the New Zealand Herald:

If you feel like red meat is more expensive than it used to be, you're right.

Around 95 percent of New Zealand's sheep meat and 87 percent of beef is exported, and what's left behind for locals is being sold at a premium.

In January 2007, 1kg of beef mince would have cost $9 according to Stats NZ's food price index. If you put a pack in your shopping trolley in January this year, it would have cost $16.39...

Beef + Lamb NZ chief executive Rod Slater said the cost of meat in New Zealand reflected what markets overseas were willing to pay...

One of the emerging buyers for our red meat is China.

African swine flu decimated the country's pig numbers in 2018 and former trade negotiator and founder of consultancy Sanders Unsworth Charles Finny said this was why China had been importing more beef and lamb.

Consider the domestic market for beef, as shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing beef. That means that New Zealand can produce beef at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of beef (PD) would be below the price of beef on the world market (PW). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy beef in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export beef. The domestic consumers would end up having to pay the price PW for beef as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 beef, while the domestic beef farmers sell Qs0 beef (assuming that the world market could absorb any quantity of beef that was produced). The difference (Qs0 - Qd0) is the quantity of beef that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in beef, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic timber consumers) would be the area AEPD, the producer surplus (the gains to domestic beef farmers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade. So to summarise, exporting beef makes domestic beef consumers worse off (lower consumer surplus), domestic beef farmers better off (higher producer surplus), and society overall better off (higher total welfare).

Now consider how the change in demand from China affects the world market for beef, as shown in the diagram below. World demand has increased from DW0 to DW1, and that increases the equilibrium world price from PW to PW1.

Now, let's go back to the New Zealand domestic market for beef. The world price has increased from PW to PW1, as shown in the diagram below. Now, the domestic consumers have to pay the higher price PW1 for beef, since they are still competing with the world price (and the world price is now higher). At this higher world price, the domestic consumers now choose to purchase Qd1 beef, while the domestic beef farmers now sell Qs1 beef (still assuming that the world market could absorb any quantity of beef that was produced). The quantity of exports is now (Qs1 - Qd1). That means that more beef is now being exported.

What does that mean for economic welfare? With the higher world price, the consumer surplus decreases further to AGPW1, the producer surplus increases further to PW1HF, and total welfare increases further to AGHF. In other words, the increase in the world price of beef makes domestic consumers worse off (which is what the article notes), but it makes domestic beef farmers better off, and society overall better off.

Domestic consumers are affected by events on the world market, when the domestic market is open to international trade. However, openness to international trade is not all bad news for consumers. If international demand falls, the domestic price will fall and consumer surplus will increase (essentially, the opposite of the example above). And, New Zealand is not an exporter in all markets. In markets where New Zealand is a net importer, prices are lower, and consumer surplus is higher, than they would be without trade.

The effect of timber export restrictions on the domestic market for timber

The housing crisis is causing the government to search frantically for solutions. As the New Zealand Herald reported last week:

The Government was warned its efforts to tackle New Zealand's housing affordability issues could be hampered by wood shortages.

The issue has become so significant, Building and Construction Minister Poto Williams is considering limiting timber exports to ensure there is enough in the country.

What happens if the government limits timber exports, by implementing an export quota? Before we can answer that question, we need to consider the effect of exports on the domestic market, without any restrictions on exports. That situation is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing timber. That means that New Zealand can produce timber at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of timber (PD) would be below the price of timber on the world market (PW). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy timber in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export timber. The domestic consumers would end up having to pay the price PW for timber as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 timber, while the domestic suppliers sell Qs0 timber (assuming that the world market could absorb any quantity of timber that was produced). The difference (Qs0 - Qd0) is the quantity of timber that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in timber, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic timber consumers) would be the area AEPD, the producer surplus (the gains to domestic timber producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade.

Now consider what would happen if there is an export quota limiting the quantity of timber exports below (Qs0 - Qd0). This is shown in the diagram below. Let's say that the quantity of exports is reduced to the amount between B and G on the diagram (about half the amount of exports that were previously occurring). Now consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for timber. Then there is a limited quantity of exports that are allowed under the export quota, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce timber). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). The domestic consumers choose to purchase Qd1 timber at the price P1, while the domestic suppliers sell Qs1 timber at that price. The difference (Qs1 - Qd1) is the quantity of exports. Notice that the price of timber that timber consumers pay has fallen, and more timber is purchased domestically - we'll come back to those points shortly.

Now consider the areas of economic welfare. The consumer surplus is larger than it was without the restricted exports (it is now the area AJP1), the producer surplus is smaller than it was without the restricted exports (it is now the area P1HF plus the area KLHJ. The first area (P1HF) is producer surplus as if the farmers sold all of their products to the domestic market, while the second area (KLHJ) is the extra profits the suppliers get from selling the quota of exports. Total welfare is smaller than without the restricted exports (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the restricted exports) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no restricted exports, but have now been lost. The reduction in exports makes timber suppliers worse off, as well as society overall (in terms of economic welfare in total). However, timber consumers benefit in terms of higher consumer surplus.

Now consider the goals of the export quota. If the government is worried that domestic timber prices are too high, the export quota will lower the price (from PW to P1). If the government is worried that not enough timber is available and sold locally, the export quota will increase that quantity (from Qd0 to Qd1). It sounds like the export quota will have all the effects that the government might want. However, there is no free lunch here. Domestic timber producers are made worse off, and by more than the amount that domestic timber consumers gain (we know this because total welfare overall declines).

The negative impact on domestic timber producers is going to create a couple of negative incentives. First, at the margin it will dissuade timber growers from planting forests, because the return on investment will be lower (as timber prices are lower). Of course, that's not going to impact the market until 20-25 years into the future, so the current government might not care. Second, timber growers might prefer to leave their forests uncut, hoping that the export quota is lifted after the next change in government. If prices are low now, but there is an anticipated higher price in the future, then holding back supply might be a good strategy for some timber growers. That will have the opposite effect from what the government intends, because a reduced domestic supply of timber raises the domestic price, and decreases the quantity of domestic timber sold. This effect seems very likely to me.

The government needs to tread carefully, lest they create incentives that actually make the problem worse in the long run. Policy alternatives that encourage timber supply, rather than discouraging it, are likely to be more effective overall.

Reduced exports due to border restrictions and the domestic market for strawberries

Last week, my ECONS102 class covered international trade, including the effects of trade restrictions on economic welfare. Usually, the examples I use involve the government interfering in the market, through the use of quotas or tariffs, and those trade policies invariably lead to a loss of economic welfare (a deadweight loss). However, sometimes other things get in the way of international trade, such as this recent example from HortNews:

Strawberry prices fell 43% in November 2020 as Covid-19 border restrictions reduced exports, Stats NZ said.

Consumer prices manager Katrina Dewbery says that fewer exports have meant there is more supply available for domestic consumption.

Prices averaged $3.45/250g punnet in November, down from $6.04 in October.

“Prices are lower than we typically see for a November month with December generally being when they are cheapest. Some people may be seeing even cheaper prices during the first half of December,” Dewbery said.

There was no government intervention here, but a lack of capacity to export strawberries due to the COVID-19 border restrictions reduced the quantity that could be exported. We could interpret that as being similar to an export quota on strawberries (where the quantity of exports was restricted to less than it would have been with open borders), so let's look at the effect on the market for strawberries.

First, consider the case without any border restrictions. This is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing strawberries. That means that New Zealand can produce strawberries at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of strawberries (PD) would be below the price of strawberries on the world market (PW). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy strawberries in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export strawberries. The domestic consumers would end up having to pay the price PW for strawberries as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 strawberries, while the domestic suppliers sell Qs0 strawberries (assuming that the world market could absorb any quantity of strawberries that was produced). The difference (Qs0 - Qd0) is the quantity of strawberries that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in strawberries, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic strawberry consumers) would be the area AEPD, the producer surplus (the gains to domestic strawberry producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade.

Now consider what would happen if the quantity of strawberry exports was restricted below (Qs0 - Qd0). This is shown in the diagram below as an export quota. Let's say that the quantity of exports is reduced to the amount between B and G on the diagram (about half the amount of unrestricted exports). Now consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for strawberries. Then there is a limited quantity of exports that can get through the border restrictions, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce strawberries). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). The domestic consumers choose to purchase Qd1 strawberries at the price P1, while the domestic suppliers sell Qs1 strawberries at that price. The difference (Qs1 - Qd1) is the quantity of exports. Notice that the price of strawberries that consumers pay has fallen, just as the article linked above noted.

Now consider the areas of economic welfare. The consumer surplus is larger than it was without the restricted exports (it is now the area AJP1), the producer surplus is smaller than it was without the restricted exports (it is now the area P1HF plus the area KLHJ. The first area (P1HF) is producer surplus as if the farmers sold all of their products to the domestic market, while the second area (KLHJ) is the extra profits the farmers get from selling the limited amount of exports that are able to get through the border restrictions. Total welfare is smaller than without the restricted exports (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the restricted exports) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no restricted exports, but have now been lost.

The lost exports make strawberry farmers worse off, as well as society overall (in terms of economic welfare in total). However, strawberry consumers are the unwitting recipients of a gain. The interesting thing here is that the government is not responsible for the deadweight loss - this is a deadweight loss caused by a more general disruption in international trade. And it was not just strawberries that were affected - domestic consumers will have been made better off in all exported commodities that cannot be stored for long periods of time.

Jim Rose on free trade agreements

When teaching my students about the gains from trade, one of the points I like to make is to draw the distinction between free trade and free trade agreements. The takeaway from that distinction is that it is perfectly reasonable to be in favour of free trade, and yet simultaneously be against a given free trade agreement. There is no contradiction in taking those two positions, and you wouldn't understand that by reading most of what is written in the media about free trade agreements. All too often, in the debates around free trade agreements, the two sides are completely talking past each other. The pro-free-trade camp uses the 'gains from trade' argument, but essentially ignore the fact that free trade agreements include a bunch of other clauses that have little to do with trade. The anti-free-trade camp focuses on those other clauses, but ignores the fact that there are gains from reducing tariffs and non-tariff trade barriers.

Obviously, I'm not the only one who feels that way. Whether we should support a free trade agreement (including the recently-signed CPTPP) should come down to evaluating the costs and the benefits of the agreement for New Zealand. This point was made in an excellent Jim Rose article in the New Zealand Herald last week. It's difficult to excerpt without losing the key points, so I quote it at length:

Free trade agreements are at best suspect. That is not me saying this, it is Paul Krugman, his generation's leading trade theorist.

Krugman argues you should start as a mild opponent of any free trade agreement. Closely inspect the baggage they carry — environment and labour chapters, intellectual property, investor state dispute settlement (ISDS) and government procurement such as Pharmac. Start with a sceptical eye.

These add-on chapters are the costs of free trade agreements that are relatively obvious to the untrained eye. No technical economics is yet required to suspect that any trade agreement will be an opportunity for special interests on the right and left, unions and big corporations, to feather their own nest. Longer patent lives, more stringent enforcement of overseas copyrights, Pharmac buying more expensive drugs and so on, in return for tariff cuts in export markets.

But let us start with what is claimed as the benefits by the Government. In a TPP without the US, in about 30-years' time, as little as 0.3 per cent extra GDP and at most 1 per cent more GDP in sum will be generated. Less than one quarter of these modest gains over 30 years come from tariff cuts.

The rest of the gains are from behind-the-border changes from streamlining customs to investor state dispute settlement — never easy to quantify because even the most impartial spectators can disagree on whether these regulations are a plus or minus to begin with...

With the US out of the TPP we still have all the baggage from environment and labour chapters, intellectual property, threats to Pharmac, and ISDS. The costs have not gone down but the benefits have, because of the loss of the single biggest market.

Investor state dispute settlement has no place in trade agreements between democracies that have the rule of law where investors can take their chances in domestic politics just like the rest of us. Yes, there will be breathless populism from the left or right from time to time, such as recently over foreign land sales, but by and large foreign investment is welcome and gets a fair deal.

Developing countries offered to sign on to investor state dispute settlement because their own courts are corrupt.

Maybe investor state dispute settlement worked 50 years ago when investment in developing countries was tiny and handled by a few big players who might get picked on by politicians looking for a few cheap votes or more likely, a backhander to the Swiss bank account...

Most of these points were lost in the debate on the TPP because too many of its opponents are driven by anti-capitalist or anti-foreign sentiments rather than cost benefit analysis. They would oppose a trade agreement solely about tariffs that lowered prices to New Zealand consumers.

Not every trade negotiation is successful. For some, you reach the point where you must walk away. More so because of all the baggage loaded into trade agreements in the last few decades.

There should be a hard-nosed benefit cost analysis. When the US was in, the TPP might have been worth the risk, just. More access to the US market may have made up for all the other baggage. Now the price has gone up, so much so we probably should not be signing it today.

It's pretty clear what conclusion Rose is drawing on the CPTPP. Whether you agree with him or not should come down to how you value the benefits in terms of increased trade, against the costs in terms of loss of sovereignty to the investor state dispute settlement process, stricter intellectual property enforcement (which some might see as a benefit) and so on. As I've said before, I'm agnostic and will remain so until I see some defendable analysis of the impacts of ISDS, which has been notably absent from the economic analyses of this agreement.

Read more:

• Free trade agreements, or international commerce agreements

Trade and the Atlas of Economic Complexity

Last week in ECON100 we covered the gains from trade. The simple model we employ is essentially a model based on Ricardian trade, which assumes that each country specialises in producing (and exporting) goods that they have comparative advantage in producing (goods that they can produce at a lower opportunity cost), and imports goods that they have comparative disadvantage in producing (goods that they produce at a high opportunity cost). However, the real world is significantly more nuanced than this simple model, as Noah Smith noted recently:

Most academic models of international trade are pretty simplistic. Some of these models are surprisingly effective for making certain types of predictions -- for example, economists are very good at predicting how much different countries will trade with each other. But they’re not so good at predicting what kind of things the countries will specialize in, which country will have a trade deficit or surplus, how trade will affect growth, or which workers and businesses will benefit from trade...

Now, a number of economists are working on new empirical approaches that take into account the huge variety and complicated connections between the products and services that get traded across international borders.

Two such economists are Ricardo Hausmann of Harvard’s Kennedy School and Cesar Hidalgo of Massachusetts Institute of Technology. They and their research team have a theory that the more different products a country makes, the better positioned it is to grow. This idea runs counter to the conventional wisdom -- and the predictions of many standard models -- that different countries hyperspecialize in only a few goods and services. According to Hausmann and Hidalgo, countries are better off when they can make a multitude of things. Countries such as Saudi Arabia that rely on a single product will perform worse, all else equal, than countries such as Japan that can make almost anything they want.

The economists claim that their so-called economic complexity index is much better at predicting long-term economic growth than other forecasting methods based on things like the level of regulation or the amount of investment in education. They recently put out a report predicting that China’s growth will slow over the next decade, while India’s will remain rapid.

Hausmann and Hidalgo's Atlas of Economic Complexity is well worth looking at. There is a wealth of trade data, and excellent visualisations (if you click on 'Visualizations' in the top bar). For instance, here's New Zealand's exports by category for 2015 (it's much easier to see at the website):

I was surprised that raw aluminium was as much as 1.7% of exports. And here's a similar visualisation of export destinations (again for New Zealand in 2015; here's the direct link):

No surprises about China, Australia, the United States and Japan being the biggest export destinations, but Algeria (1.2%) and Egypt (1.0%) were a bit surprising to me. Anyway, there's lots more to explore on the site, and lots of surprises (try playing the 'which country is the biggest exporter of *some random product*?' game with your family or friends). Minutes of fun, guaranteed. Enjoy!

Tim Harford on trade

Tim Harford quite often writes about trade. I particularly liked some of the things he wrote in this post last week, since they echo ideas that I discuss in both ECON100 and ECON110:

Economists disagree about most things, but for a couple of centuries they’ve agreed about the merits of free trade, basically for the reasons outlined above. But some readers may be faintly aware of cracks in that consensus — haven’t economists realised that free trade is sometimes bad?

Broadly, the answer is “no” — economists remain thoroughly persuaded of the merits of international trade. But there are cautionary notes. First, modern trade agreements tend to be loaded with rules — food safety, financial regulation, intellectual property — that are not about tariffs. Some of these rules are closely connected with trade itself: long arguments at customs can restrict trade just as surely as a border tariff. But others have little to do with trade, and sometimes the rules are simply bad. So you can favour free trade yet oppose some “free-trade” agreements, as many economists do.

I encourage you to read all of Harford's post, if you have any doubts about why free trade is a good idea. However, 'free trade' is not the same as 'free trade agreements' since most free trade agreements aren't about making trade more free at all, in the sense of reducing tariffs and other trade barriers. The Trans-Pacific Partnership is a case in point. While New Zealand may have gained from reduced tariffs for our exports into the U.S. and Japan, the neo-colonial provisions on intellectual property and investor-state dispute resolution to me made it a hard sell that the net effect was positive. And when you consider the distributional impacts of the agreement (where the gains would be concentrated among farmers and other exporters, with the potential costs borne by everyone), it becomes an even harder sell. And it is this last point (the distributional consequences of trade) that has arguably contributed to Brexit, Trumpism, and other populist movements.

Harford also covers a similar point:

But deep down, trade is just another kind of productive technology — a technology that turns Minis into camembert [MC: To understand that point, you need to read Harford's whole post]. Like any productive technology, it makes us richer. But it creates winners and losers, and the winners may take their good fortune for granted while the losers are acutely aware of what they’ve lost. The losers have votes too. And if they’re frustrated about China, let’s see what happens if self-driving vehicles put several million truckers and taxi drivers out of work.

It's important for us not to lose sight of the fact that there are winners and losers in trade, and as this post notes, those who lose may face long-term consequences that governments have not traditionally allowed adequate compensation for.

Why restricting natural gas exports is not a good idea

This week in ECON110 we are covering international trade (and globalisation). The arguments against free trade often focus on the harms to workers (and firms) in import-competing industries - that is, those firms where jobs would be lost by having to compete with lower-cost foreign producers. The counter-argument is that consumers are made better off in these markets by being able to buy the imported products at much lower prices (increasing their consumer surplus).

Much less attention is focused on the impacts of trade restrictions on exporting industries. Consider for example, this 2013 New York Times story about the exporting of natural gas in the U.S.:

As Dow Chemical’s chief executive, Andrew N. Liveris has made himself into something of an outcast among his fellow business leaders.

The reason? He is spearheading a public campaign against increased exports of natural gas, which he sees as a threat to a manufacturing renaissance in the United States, not to mention his own company’s bottom line. But many others say such exports would provide far more benefits to the country than drawbacks, all part of a transformation that promises to increase the nation’s weight in the global economy...

By 2020, new oil and gas production could increase the country’s economic output by 2 to 4 percent beyond what it otherwise would be, add as many as 1.7 million jobs and perhaps reduce the bill for energy imports to zero, according to a report by the McKinsey Global Institute.

“This is a giant turnaround,” said Daniel Yergin, a longtime energy expert and author of a recent book, “The Quest: Energy, Security and the Remaking of the Modern World.” “This is fundamentally improving the competitive position of the United States in the world economy.”

But that windfall is at risk if the government permits natural gas exports to increase quickly, Mr. Liveris warns.

Natural gas is valuable, and on the surface the argument to restrict exports of natural gas in order to keep the value in the U.S. economy makes some intuitive sense. But it would also be quite wrong, and actually make the U.S. worse off.

To see why, let's take a step back and compare an exporting country with trade and without trade. Consider the diagram below, and we'll assume that the U.S. has a comparative advantage in producing natural gas - that means that the domestic price of natural gas (PD) would be below the price of natural gas on the world market (PW). This indicates that U.S. natural gas producers can produce and sell natural gas at a lower cost than foreign producers. Because the domestic price is lower than the world price, if the country is open to trade there are opportunities for traders to buy natural gas in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export natural gas. The domestic consumers would end up having to pay the price PW for natural gas as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 natural gas, while the domestic suppliers sell Qs0 natural gas (assuming that the world market could absorb any quantity of natural gas that was produced). The difference (Qs0 - Qd0) is the quantity of natural gas that is exported. Essentially the demand curve with exports follows the red line in the diagram.

We can also use the diagram to demonstrate the gains from trade for an exporting country. Without trade, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic natural gas consumers) would be the area AEPD, the producer surplus (the gains to domestic natural gas producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade. So, the U.S. is better off with trade, because the total welfare is larger than it is without trade.

Now consider an intermediate case. Instead of having no trade, or having unlimited trade, what would happen if the government allows trade up to some limit? In other words, what happens when there is an export quota? This is demonstrated in the diagram below. Whereas previously, we assumed that the world market could absorb any quantity of exports of natural gas, now the quantity of exports is limited to the agreed quota amount. Let's say that the export quota is limited to the amount between B and G (about half the amount of unrestricted exports). Importantly, the export quota is implemented using licenses - only holders of export licenses are allowed to export natural gas.

Now that there is a quota on exports, consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for natural gas. Then there is a limited quantity of export demand, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce natural gas). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). Export license holders can purchase natural gas at this price, and then sell it on the world market and receive the higher world price (PW), and pocket a profit. The domestic consumers choose to purchase Qd1 natural gas at the price P1, while the domestic suppliers sell Qs1 natural gas at that price. The difference (Qs1 - Qd1) is the quantity of exports (which is also the quantity of the quota).

Now the consumer surplus is larger than it was without the export quota (it is now the area AJP1), the producer surplus is smaller than it was without the export quota (it is now the area P1HF). The export license holders now receive a surplus (profit), equal to the area KLHJ. Total welfare (which is now made up of the consumer surplus, producer surplus, and license holder surplus) is smaller than without the export quota (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the export quota) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no export quota, but have now been lost.

Importantly though, note that the total welfare area is larger with the export quota (AJHF+KLHJ) than with no trade at all (AEF). So, the argument that restricting exports of natural gas makes the U.S. better off and will "fundamentally improve the competitive position of the U.S. economy" is simply untrue. Up to the point where the market-determined quantity of natural gas is exported, there are gains to be had from additional exports. That doesn't mean that more exports are always better. For instance, export subsidies that increase exports beyond the quantity shown in the first diagram above are also bad. And, you might want to restrict natural gas production for environmental reasons (which haven't been accounted for in the diagrams above). But those are stories for another day.

Read more:

• Why export quotas probably failed to help coffee farmers