Genshin Impacts on Chinese trade

During the pandemic, when people were isolated at home, some people discovered a passion for sourdough. Others picked up a book. But plenty of people got (more) heavily into gaming. In late 2020, Genshin Impact was launched into that environment, and immediately exploded in popularity despite being released by a Chinese gaming studio little known to Western gamers. The interesting thing about Genshin Impact is that it doesn't 'Westernise' its Chinese foundations, and through that it may have opened a window to Chinese culture that many Western gamers wouldn't otherwise have noticed.

What effect, if any, did this have? That is essentially the question that this new article by Tianyu Wang (Jiangsu Provincial Academy of Social Sciences) and co-authors, published in the journal China Economic Review (sorry I don't see an ungated version online), tries to answer. Specifically, they look at the impact on Chinese exports, using a difference-in-differences (DiD) strategy. This involves comparing trade between China and countries with more, or less, exposure to Genshin Impact, between the period before and after its release (which they set as October 2020, the first full month after the open beta of Genshin Impact was released on 28 September 2020). Their data is monthly export data from China to other countries, from the UN Comtrade database.

However, there are a couple of oddities with the analysis. First, Wang et al. control for a variety of variables in their regression model. However, two of the variables they control for are the log of GDP and the log of GDP per capita. Because their model is a log-linear model, this means that they are unnecessarily controlling for GDP twice. To see why, consider this equation:

lnY = a + blnX + cln[X/Z]

You can think of X as GDP and Z as population, so X/Z is GDP per capita. Since ln[X/Z] is equal to [lnX - lnZ], that equation is really:

lnY = a + blnX + clnX - clnZ = a + [b+c]lnX - clnZ

So, the coefficients on both GDP and GDP per capita are not directly interpretable and a bit awkward. The coefficient on log GDP per capita in their model is actually the negative of a coefficient on log population, while the coefficient on log GDP is incorrect. Fortunately though, this just adds unnecessary complexity to their model. It doesn't bias the coefficients in the rest of the model.

Second, Wang et al. use Google Trends data as the treatment variable. This seems appropriate, because Google Trends will pick up differences in cross-country interest in Genshin Impact. Specifically, they create a Google Trends Index (GTI) that captures the search intensity for their term of interest. However, in their main analysis, they don't use a GTI based on searches for 'Genshin Impact'. Instead, they use a GTI based on searches for 'Sony'. Their explanation for that is:

There is evidence indicating that Sony and miHoYo maintain a very close relationship, and that Sony has played an important role in the global promotion of Genshin Impact.

They also say that:

...regressing China's exports directly on Genshin Impact GTI is highly endogenous...

Both of those statements may be true, and Wang et al. provide a variety of evidence in support of the close relationship between Sony and Genshin Impact. However, they don't provide similar evidence for why searches for 'Genshin Impact' would be endogenous in a way that searches for 'Sony' wouldn't. One possibility is that they are worried that search intensity for 'Genshin Impact' is correlated with countries' pre-existing closeness to China, or with pre-existing interest in Chinese cultural products. A difference-in-differences strategy, especially one that controls for country-level differences in pre-treatment trade, should already be controlling for those issues. However, time-varying shocks that are correlated with both Genshin Impact searches and Chinese exports after 2020 would remain. For example, the Genshin Impact GTI would also capture changes in favourability of views towards China that change for reasons other than Genshin Impact. Using the 'Sony' GTI may therefore reduce one problem, but it also introduces another, since Sony searches could reflect many things unrelated to Genshin Impact or China.

Fortunately, Wang et al. do report results based on the GTI for 'Genshin Impact' in their online appendix, and the results are not so different from what they get with the 'Sony' GTI. Apparently, this was suggested by one of the journal reviewers. Honestly, I think the results based on the 'Genshin Impact' GTI are the more plausible results, so I'm going to focus on them. And in those results, reported in Table D6 in the online appendix, they find that following the open beta release of Genshin Impact, every one-unit higher GTI for 'Genshin Impact' for a country is associated with a 0.215 percent increase in exports from China to that country. Unfortunately, they don't report the summary statistics for the 'Genshin Impact' GTI, so it is difficult to interpret. It is also difficult to interpret because the GTI is a normalised measure of search intensity relative to all Google searches in a given country and period. However, for comparison, the effect using the 'Genshin Impact' GTI is slightly larger than what they report for the 'Sony' GTI, which is a 0.186 percent increase in exports for each one-unit higher 'Sony' GTI.

Either way, the results suggest that countries where Genshin Impact was a bigger phenomenon experienced larger increases in exports from China than countries where Genshin Impact was less impactful. Wang et al. then turn to the mechanisms that might explain this change, using Pew Global Trends and Attitudes data. They report that:

Although we do not find evidence that Genshin Impact improved favorable perceptions of China, we do find evidence that it reduced unfavorable perceptions. This effect is primarily driven by a decline in mild aversion; there is no significant change in strong aversion. This result is intuitive—individuals who strongly dislike China are unlikely to revise their views solely because of a video game.

They also find that media narratives became more positive following Genshin Impact's release, for countries where the 'Sony' GTI was higher. However, this result is only suggestive as it was statistically insignificant.

One interesting final aspect of the paper is that Wang et al. used data on cultural distance to further explore the results, finding that:

...as bilateral cultural distance increases, the promotional effect of Genshin Impact on China's exports significantly diminishes.

So, Genshin Impact had a larger trade impact for countries with greater cultural similarity to China. That suggests that, while it might be an interesting narrative to suggest that Genshin Impact exposed the world to China, improving perceptions of China and increasing trade, the effect was actually concentrated on the countries that were already most similar to China.

This paper presents some interesting findings. However, it clearly isn't the last word on whether the international sharing of cultural products can have tangible effects on international trade, beyond their effects on the trade of the cultural product itself. It would be interesting to see if there are similar impacts for Korean cultural products, for example, or Bollywood movies (or Nollywood movies, for that matter).

How the 'travelling Pope' affected international trade

Pope John Paul II was known as 'the travelling Pope' because of the large number of international trips ('pastoral visits') he undertook (more than 100 during his reign from 1979 to 2004). He also had a huge following, as you might expect as the leader of the Catholic Church, but the advent of television meant that the public could follow his travels in a much closer way than ever before. And, through his pastoral visits and his following, he exposed Catholics the world over to new places they would otherwise not have seen or, in some cases, even heard of. What effects did that exposure have?

That is essentially the question addressed in this recent article by Alexander Popov (European Central Bank), published in the Economic Journal (ungated earlier version here). Popov focuses on the impact of the Pope's visits on exports from the visited country, and especially exports to Catholic countries. He employs an event study design - looking at how exports changed between the time before and the time after the Pope's first visit to a country, while controlling for GDP growth, population, the US dollar real exchange rate, and the extent of trade liberalisation and democracy. The key results are summarised in Figure 2(a) from the paper:

The figure shows how exports evolve before and after the Pope's visit. Beforehand, there isn't much evidence of a trend (notice that the red line hovers around zero). However, after the Pope's visit, exports increase (the red line is clearly above zero and trending upwards), and the effect is substantial. Popov notes that:

...the point estimate on Year 3 after the pope’s visit to a country is 0.1152, which implies that exports to the rest of the world are higher by 12.2%, relative to the year of the visit.

And the effects are even larger for exports to countries with larger Catholic populations. Specifically:

...exports to a trading partner with 54.3% (75th percentile), relative to a trading partner with 1.1% (25th percentile) Catholics in the population were higher by between 16.5% and 36.9% during years 1 to 5 after a visit by the pope.

Clearly, Catholics were paying attention to where the Pope was visiting. Popov then asks the obvious question: what explains this effect? He examines three hypotheses:

The first one is that during a foreign visit, the pope explicitly encourages Catholics around the world to engage with the host country on economic terms. I analyse 633 speeches given during the pope’s 130 first visits and I find rare occasions when he mentions words like ‘trade’, ‘economic’ or ‘globalisation’.

So, the Pope wasn't explicitly telling Catholics to buy more goods from the countries he was visiting. Then:

The second hypothesis is that, by simply visiting a country, the pope raises its profile, or ‘puts it on the map’ for the global Catholic family, especially if Catholics around the world are for cultural or economic reasons less connected with the visited country. I find that the effect on exports of a pastoral visit to a country is stronger if this country is relatively poor and if it has relatively fewer Catholics and relatively weaker bilateral trade links with the partner country. The third hypothesis is that Catholics around the world are simply buying souvenirs to commemorate the pope’s visit. I analyse data on bilateral trade at the product level, for ten different sectors, and I find that after a pastoral visit, the increase in exports I detect takes place in half of them.

So, the third hypothesis (souvenirs) doesn't have much support. Popov concludes that the second hypothesis shows the likely driver of the increase in exports. This evidence is consistent with the Pope raising the profile of the countries he visited, and those countries benefiting from their higher profile among Catholics in the form of higher exports, especially to Catholic countries.

What makes this paper interesting in an economic sense is that it suggests trade flows don't just depend on prices, trade policy, and distance. They also depend on visibility, familiarity, and the ways that cultural influence can affect economic outcomes. Pope John Paul II's visits appear to have increased visibility and familiarity, which may in turn have boosted trade. The 'travelling Pope' may have also been the 'trade-promoting Pope'.

Distillers don't need tax relief in order to promote their goods internationally - they already have it

Earlier this week, the NBR reported (paywalled):

Kiwi distillers are calling on the Government to introduce an excise tax rebate scheme, arguing the current system is stifling an industry that could follow wine's path from obscurity to international recognition...

The proposal requests an excise duty remission of up to $350,000 annually for each distillery, which would free up funds that could be put towards employment, expansion, and export growth.

In order to be eligible for the DSA proposed scheme, distillers would need to hold a license to manufacture distilled beverages, produce at least 70% of its alcohol content (by volume) within New Zealand, be independent, and be a member of DSA.

The proposal is modelled on Australia's excise remission scheme, which allows domestic distilleries to claim up to A$400,000 ($469,600) a year...

On the outskirts of Auckland, Pōkeno Whisky's Johns estimates about 35% of his company's domestic revenue goes toward tax. He says he holds four roles at New Zealand's largest single malt distillery – running sales, marketing, operations, and general business – but doesn't pay himself. He has halved distillation over the past 18 months because times are tough, and is investing what he can into sales and marketing in an attempt to buck the trend.

"At the end of the day, we're not selling Pōkeno Whisky overseas. We're selling brand New Zealand."

Bluff Distillery's Nash says while a spirits tax made sense historically, the system was overweighted and out of date. He says a lot of distillers that could have explored international markets haven't been able to because the lion's share of returns go toward excise.

The first thing to note is that the excise tax paid by domestic distillers is not a big money-spinner for the government. The article reports that domestic distillers pay about $23 million in excise each year. That is small relative to the overall $800 million in total alcohol excise tax collected each year (see here). The purpose of an alcohol excise tax is to reduce the consumption of a good that has negative externalities - it is an example of a Pigovian tax. Reducing excise tax would lower the price that consumers pay for alcohol, increasing consumption, and increasing the negative externalities associated with alcohol consumption. That is not a proposal that should receive broad support.

Now, I was thinking about this and I had a better idea that would give some excise tax relief for distillers, without increasing alcohol-related harm in New Zealand: zero-rate the excise tax for exports. In other words, distillers would pay excise tax only on products that they sell domestically, and not on exports. If the argument by the distillers (as noted by Matt Johns of Pōkeno Whisky in the quote above, is that they want to explore international markets, then this proposal lets them do so, and on a more level playing field with distillers overseas. The distillers will pay tax on their profits. The government doesn't really need to tax them twice. And, since by definition exports are not sold domestically, there is no increase in negative externalities from removing the excise on those exports, and there may even be a decrease [*].

It turns out my proposal already happens - there is an 'excise duty drawback' that allows distillers to claim back the excise tax paid on any goods that they export. So, the distillers are already free to 'sell brand New Zealand' to their heart's content. They don't need to have their excise on New Zealand sales reduced in order to achieve that goal. Is there a real problem here? Or is this just another case of an industry with its hand out for government support?

*****

[*] Interestingly, the zero-rating of excise tax on exports may produce a further benefit in terms of reducing alcohol consumption (and negative externalities) in New Zealand. If it becomes more profitable to produce and export distilled products, then they may choose to sell less in New Zealand. That would actually increase prices in New Zealand, reducing alcohol sales and consumption.

To see how this works, consider a distiller who could sell overseas at a price P1, receiving the price P0 after paying an excise to the government on all of their production (sold overseas, or sold locally). Call the difference in those two prices T (the excise tax), so P1 - T = P0. It makes sense for the distiller to also sell its products at the price P1 in New Zealand (if they could receive a higher price overseas, they would sell there instead), also receiving P0 after paying the excise tax. Now, what happens when the excise tax is removed for exports? Instead of receiving P0 from exports, the distiller receives P1 (since they no longer have to pay the excise tax T). They won't want to sell their products in New Zealand and receive less than P1. That only happens if they raise the price from P1 to P1 + T (which leaves the distiller with P1 after they pay the excise tax T). So, we would expect the price on distilled products to increase in New Zealand, if the excise tax were removed from exports. In other words, the 'excise duty drawback' scheme likely increases prices on distilled products in New Zealand, although in reality the 'pass-through' of tax to retail prices is likely to be somewhat less than the full amount of T.

Americans' beliefs about trade, and why compensation matters

Do people understand trade policy? Or rather, do they understand trade policy the way that economists understand it? Given current debates in the US and elsewhere, it would be fair to question people's (or politicians') understanding of trade policy, and to consider what it is about trade that generates negative reactions. After all, the aggregate benefits of free trade are one of the things about which economists most agree.

Last year, Stefanie Stantcheva won the John Bates Clark Medal (which is awarded annually to the American economist under age 40 who has made the most significant contributions to the field). Stantcheva's medal-winning work included three main strands, one of which was the use of "innovative surveys and experiments to measure what people know". One of the papers from that strand of research is this 2022 NBER Working Paper (revised in 2023), which describes Americans' understanding of trade and trade policy and importantly, it answers the question of why people support trade (or not).

The paper reports results from three large-scale surveys in the US run between 2019 and 2023, with a total sample size of nearly 4000. The surveys also included experiments that primed respondents to think about trade from particular angles. Overall, Stantcheva is interested in teasing out the factors that affect Americans' support for trade policies. Essentially, she tests the mechanisms that are described in Boxes I-V in Figure 2 from the paper:

Box I picks up views on whether trade lowers prices and increases variety for consumers. Box II picks up the threats from increasing trade to workers in import-competing sectors. Those two boxes together constitute self-interest as an effect on people's views on trade policy. Their views might also be affected by broader social and economic concerns, such as trade's efficiency effects (Box III), its distribution impacts (Box IV), and patriotism, partisanship, or geopolitical concerns (Box V).

Before we turn to the specific results on the mechanisms, it is worth considering Americans' overall views on trade first. Stantcheva reports that:

Most respondents (63%) are supportive of more free trade and decreasing trade restrictions in general... Only 36% believe that import restrictions are the best way to help U.S. workers.

Nevertheless, there is support for more targeted trade restrictions. 40% of respondents believe the US should restrict food imports to ensure food security. 54% think the US should protect their “infant” industries. 78% support protection of key consumer products, namely food items and cars. 50% believe the US should restrict trade in key sectors, such as oil and machinery...

And general knowledge about trade policy is not too bad, as:

...almost 80% of respondents know what an import tariff is, but just around half know what an import quota is. Two-thirds of respondents appear to understand the basic price effects of tariffs and export taxes, i.e., that an import tariff on imported goods will likely raise the price of that good and that an export tax will increase the price of the taxed good abroad. The final question... considers a scenario in which the US can produce a good (“cars”) at a lower cost than the foreign country. Respondents are asked whether, under some circumstances, it would still make sense to import cars from abroad. 68% of respondents agree that it could make sense. This suggests that respondents either understand the concept of comparative advantage or have in mind some model of love-for-variety or quality differential.

So far, so good. How do Americans perceive the impacts of trade? Figure 9 Panel A reports perceptions related to the self-interest motivation (Boxes I and II from the figure above):

From the bottom of that figure, it is clear that a majority of Americans believe that they are better off from trade, but a substantial minority (39%) believe that they are worse off. Still focusing on the self-interest motivations (Boxes I and II), Stantcheva finds that:

In general, a respondent’s (objective) negative exposure to trade through their sector, occupation, or local labor market is significantly positively correlated with a feeling that trade has made them worse off and that it has negatively affected their job. People exposed to trade through their job also feel worse off as consumers and are less likely to believe that trade has reduced the prices of goods they buy, perhaps because they feel that their purchasing power is lower than it would otherwise be. Furthermore, college-educated respondents are significantly less likely to feel negatively impacted in their role as consumers and workers.

Notice those results are mostly consistent with the figure above. What about consumer gains through reduced prices on imported products? Stantcheva reports that:

...the belief that prices decrease from trade is not significantly related to either support for trade or redistribution. Consistent with this lack of correlation, the experiment priming people to think of their benefits as consumers (precisely, the prices and variety of goods they purchase) does not move their support for trade either.

So, in terms of self-interest, Americans' support for trade is more negative when they are negatively affected as workers, but is not more positive when they are positively affected as consumers. In my ECONS102 class, we talk about the tension between the gains from trade and loss aversion. Every trade involves gaining something, in exchange for giving something up. However, quasi-rational decision-makers are affected much more by losses than equivalent gains (what we call loss aversion). So, loss aversion might mean that many profitable trades are not undertaken, because the decision-makers prefer to keep what they have, rather than giving it up for something that may be objectively worth more. In the case of Stantcheva's survey respondents, the workers who are negatively impacted experience a loss, which would be weighed much more heavily than the gain that a consumer receives.

An alternative explanation is salience. Job losses are very visible and impactful on the people who lose their jobs and those around them. Consumers' gains in terms of lower prices and increased variety, on the other hand, are not really as visible - many people wouldn't even notice them, unless they were pointed out to them. So even if people weren’t loss averse, attention would still be drawn disproportionately to the negative impacts of trade, rather than the positive. Taken altogether, Stantcheva's results here are not surprising.

What about the broader social and economic concerns, and their impact on views about trade? In terms of efficiency effects (Box III), Stantcheva reports that:

Respondents are generally optimistic about these effects. For instance, 61% of respondents think that international trade increases competition among firms in the US, 69% that it fosters innovation, and 62% that it generates more GDP growth.

Moreover:

...efficiency gains from trade are significantly associated with more support for free trade... This relation can be seen in the correlations and the experimental effects: the Efficiency treatment significantly improves support for free trade.

And interestingly:

Respondents who believe that trade can improve innovation, competitiveness, and GDP are more supportive of redistribution policy to help those who do not benefit from these efficiency gains.

Turning to distributional impacts (Box IV), Stantcheva reports that:

Overall, respondents know that trade can have adverse distributional consequences through the labor market. Just around half of all respondents believe that trade has, on balance, helped US workers. 79% of people think that trade is the reason for “unemployment in some sectors and the decline of some industries in the U.S..” More respondents (63%) believe that high-skilled workers could easily change their work sector if their jobs were destroyed by trade than that low-skilled workers could switch sectors (37%)...

Consequently, around two-thirds of respondents think that trade is a major reason for the “rise in inequality” in the US. Notably, despite being aware of the potential adverse distributional consequences of trade, a majority (62%) of respondents believe that, in principle, trade could make everyone better off because it is possible to “compensate those who lose from it through appropriate policies.”

It is interesting that so many people believe in the compensation principle (although I bet that few of them would know that term for it). And it turns out that belief in the compensation principle is really important, as:

...the strongest predictor of support for free trade is the belief that, in principle, losers can be compensated... free trade. As long as respondents believe that adverse consequences from trade on some groups can be dampened by redistributive policy, they are likely to support more free trade, even if they believe that there are adverse distributional consequences. The perceived distributional impacts of trade also substantially matter for support for compensatory redistribution. Respondents who believe that trade hurts low-income and low-skilled workers and that it fosters inequality support redistribution much more.

Finally, in terms of patriotism, partisanship, or geopolitical concerns (Box V), Stantcheva reports that:

...those who worry about geopolitical ramifications from trade restrictions, i.e., retaliatory responses, are more likely to support policies to compensate losers from trade rather than support outright trade restrictions. Patriotism is significantly correlated with support for trade restrictions in many industries and to protect U.S. workers, as well as with lower support for compensatory transfers...

Stantcheva draws a number of conclusions from her results, including:

First, respondents perceive gains from trade as consumers to be vague and unclear but perceive potential losses as workers to be concentrated and salient. Actual and perceived exposure to trade through the labor market is significantly associated with policy views...

Second, people’s policy views on trade do not only reflect self-interest. Respondents also care about trade’s distributional and efficiency impacts on others and the US economy...

Third, respondents’ experience, as measured by their exposure to trade through their sector, occupation, and local labor market, shapes their policy views directly (through self-interest) and indirectly by influencing their understanding and reasoning about the broader efficiency and distributional impacts of trade.

Overall, I take away from this paper that Americans have more correct views about trade than I suspected. Their support for trade is not determined simply by self-interest, but is more nuanced. However, negative impacts weigh far more heavily for those who are negatively impacted than the weight attached to positive impacts for those who are positively impacted. That may relate to loss aversion, and to the more concentrated nature of negative impacts compared with more diffuse positive impacts. That asymmetry also explains why a majority have positive views of trade (since fewer people will have been negatively impacted on the whole). The most surprising aspect to me, though, was the views on the compensation principle. Those results provide a clear policy prescription. To get more people on board with trade, making compensatory policy more explicit and salient may help to ensure that there is greater support for trade. On the other hand, politicians who want to exploit the negative views on trade might benefit from obscuring any such compensatory policies. Unfortunately, there are too many who are willing to do just that.

[HT: Marginal Revolution, last year]

The economic impacts of the 2008 NZ-China Free Trade Agreement

New Zealand was the first Western developed country to sign a free trade agreement with China, and it came into force in 2008. At the time, the New Zealand government estimated an increase in exports to China of between NZ$225 million and NZ$350 million (between US$180 million and US$280 million), and Ministry of Foreign Affairs and Trade (MFAT) estimated an increase of 0.25% in GDP. How did things actually turn out?

That is the question addressed in this 2021 article by Samuel Verevis (MFAT) and Murat Üngör (University of Otago), published in the Scottish Journal of Political Economy (ungated earlier version here). Now, the challenge with this sort of exercise is that we can observe what happened to New Zealand with the FTA in place, but we cannot observe what would have happened if there had been no FTA (the counterfactual). And that is a problem, since what we really want to know is the difference in outcome between what really happened and the counterfactual.

Verevis and Üngör solve that problem by using the synthetic control method. Essentially, they use a weighted average of the outcomes of other countries (donor countries), that closely follows the trends in the New Zealand data before the FTA came into force in 2008, and then use the same weights to create a 'synthetic New Zealand' counterfactual for the period after 2008. The key assumption with this approach is that there isn't some other change that affected New Zealand differently from the donor countries at the same time as the FTA came into force.

Verevis and Üngör first look at the effect on New Zealand exports to China. The results are summarised in Figure 3 from the paper:

The black solid line is actual New Zealand exports to China (in nominal US dollar terms). The red dashed line is the counterfactual created using the synthetic control method. The vertical dotted line reminds us that the FTA came into force in 2008. Notice that, prior to 2008, the two lines follow each other closely. That is what we should expect with this method, since the synthetic control is designed to closely mimic New Zealand data. After 2008, the lines diverge dramatically, with actual New Zealand exports to China far higher than the counterfactual. Verevis and Üngör note that:

In the post-intervention between 2009 and 2015, NZ's actual exports to China were more than 120%, on average, higher than the synthetic counterparts.

Eyeballing Figure 3, the increase in exports was in the order of US$6 billion at its peak, so the government's expectations of US$180-280 million wildly underestimated the trade impact of the FTA. What about GDP though? Verevis and Üngör's preferred results for GDP actually show a decrease, as shown in Figure 7 from the paper:

Verevis and Üngör estimate that:

In the post-intervention era, the 2009–2017 period, the synthetic real GDP per capita was 4%, on average, higher than the actual GDP per capita.

However, there is good reason to doubt that there was such a negative impact of the FTA on GDP. The Global Financial Crisis (GFC) also occurred in 2008-2009, alongside this FTA coming into force. Verevis and Üngör argue that the GFC affected all countries, so is not a problem for their analysis. However, they acknowledge that the GFC didn't affect all countries equally. And when, in a robustness check, they exclude all Eurozone countries and Iceland, they find no significant impact of the FTA on New Zealand GDP per capita. Overall, I take from this that there is limited evidence in favour of a GDP impact of the FTA (in either direction). Of course, the concurrent GFC critique also applies to their earlier analysis of the impact on exports to China. When Verevis and Üngör re-run the analysis of exports while excluding Eurozone countries, the impact is smaller, but there is still a very large positive impact of the FTA.

Ultimately, what can we take away from this study? The NZ-China Free Trade Agreement increased trade between New Zealand and China, but didn't really impact income in New Zealand (at least on average). Why might the value of exports to China increase but GDP remain unaffected? Verevis and Üngör show that exports to the rest of the world were largely unaffected, so it wasn't simple substitution from exporting to other countries to exporting to China instead. It's quite possible that the increase in exports to China was offset by an equivalent increase in imports from China, leaving net exports unchanged. Unfortunately, Verevis and Üngör don't look at imports, so we are left to guess.

Finally, an 'upgraded' FTA between the two countries came into force in 2022. Given that many of the trade frictions had already been removed by the original agreement, the upgraded FTA likely had a smaller impact. In terms of GDP, it probably wouldn't be too much of a stretch to think that the impact will be similarly imperceptible to the impact from the original agreement.

International transmission of inequality through trade

Most people will have a view on the contribution (if any) of globalisation and trade to inequality. There are two main theories that suggest that trade increases inequality. The first theory is the Stolper–Samuelson theorem, which in turn comes from the Heckscher–Ohlin model of international trade, which suggests that trade increases inequality in high-income countries, but decreases inequality in low-income countries.

The explanation works like this. The Heckscher-Ohlin model says that when a country opens to trade, the returns to relatively abundant factors of production in that country will increase, while the returns to relatively scarce factors of production will decrease. Now, in a high-income country, skilled labour is relatively abundant, while unskilled labour is relatively scarce. So, in a high-income country trade increases the wages of skilled workers, but decreases the wages of unskilled workers, increasing inequality. For low-income countries though, unskilled labour is relatively abundant, while skilled labour is relatively scare. So, in a low-income country trade increases the wages of unskilled workers, but decreases the wages of skilled workers, decreasing inequality. At least, that's what the theory says. In practice, trade has increased alongside improvements in technology that have increased the productivity of skilled workers (what economists call skills-biased technological change), which means that trade has been associated with higher inequality within all countries.

The second theory for why trade increases inequality comes from a very influential 2023 paper by March Melitz. In this theory, more productive firms are more likely to export than less productive firms. That means that the wages of workers in exporting firms will increase more than those of workers in non-exporting firms, increasing inequality.

Now, if trade increases inequality (at the least for high-income countries), does it matter what countries they trade with? Does trading more with a high-inequality country have a different effect than trading more with a low-inequality country? In other words, is higher inequality transmitted through trade?

Those are the questions that this recent article by Sergey Nigai (University of Colorado Boulder), published in the American Economic Journal: Economic Policy (sorry, I don't see an ungated version online), sets out to answer. The paper is quite complex and not for the faint-hearted. However, once you realise what Nigai is doing, it is quite elegant. Nigai proposes an interesting mechanism for why inequality in the trade partner country should matter, where firms:

...target specific segments in the distribution of consumers, thereby creating connections between consumer income inequality and the distribution of firm profits. Targeting rich population segments is costly such that there is a positive assortative matching between high-productivity firms and rich consumers. Hence, more unequal income distributions in export markets raise the profits of high-productivity firms relatively more, which, in turn, leads to higher incomes of individuals associated with these firms––ultimately increasing domestic income inequality.

Notice that this is a slightly more nuanced version of the Melitz theory. In this case, the more productive exporting firms sell to the highest income foreign consumers, increasing their profits more than the less productive exporting firms, which sell to lower income foreign consumers. This then leads to higher wages at the more productive exporting firms relative to wages at the less productive exporting firms, which leads to higher inequality. Nigai illustrates the mechanism in Figure 2 in the paper:

On this figure, Nigai explains that:

There are three relevant firm-level relationships:

(R1) Higher income inequality in the importing country generates higher dispersion of profits/export revenues across exporter firms in the exporting country.

(R2) Higher dispersion of export profits/export revenues is associated with higher dispersion of worker incomes across exporter firms such that wage inequality in the exporting country also increases.

(R3) Higher income inequality across workers employed in exporter firms increases overall income inequality in the exporting country.

In terms of the aggregate outcomes, R1–R3 result in R4, indicating a positive effect of higher income inequality in the importing market on inequality at home such that:

(R4) Higher exports to high-inequality countries are associated with increasing inequality in the domestic country.

Next, Nigai notes that R2 and R3 are easily established because:

substantial evidence based on aggregate and micro-level data shows that there is a robust, strong, and positive relationship between exporters’ profit and wages... Given this evidence, the relationship in R2 must hold mechanically. Second, the relationship in R3 also holds mechanically, as higher wage inequality among exporter firms that pay higher wages relative to pure domestic producers must have a positive effect on overall income inequality in the exporter country.

Nigai then goes about showing empirical evidence for R1 and R4. I won't get into the weeds of the methods here, because they are fairly complex, but suffice to say that for R1, firm-level evidence suggests that income inequality in the export destination is associated with higher dispersion of profits in the exporting country. Specifically, income inequality has no effect on profits for most firms, but has a significant effect on the profits of the most-productive firms. On this, Nigai notes that:

...the effects of income inequality on the dispersion of profits operate mainly through large exporters in the right tail.

On R4, Nigai uses country-level data and an OLS panel regression model, and finds that:

...the Gini coefficient in country i would increase by approximately 1 percent if the Gini coefficients in all export markets for country i increased by 10 percent.

The effects for an instrumental variable regression are smaller, but still statistically significant. Overall, the results support both R1 and R4.

Nigai then turns to estimating how important this channel is as an explanation for inequality. He parameterises a general equilibrium economic model based on data from 40 mostly OECD countries, and finds that:

...for an average country, consumer targeting and inequality effects transmitted through international trade explain 4.4 percent of the observed levels of the Gini coefficients and 4.8 percent of the observed levels of income shares of the top 1 percent of population.

That doesn't sound like a lot, but 4.4 percent of the Gini coefficient is the difference in Gini coefficient between Australia (ranked 10th highest inequality in the OECD, with a Gini Index of 34.3), and South Korea (ranked 17th, with a Gini Index of 32.8). So, it's reasonable substantial.

Overall, it appears that not only does trade contribute to inequality, but the specific  trade partners also matter. Is there a policy implication from this? Should countries start imposing export tariffs or export controls on exports to more unequal countries? Answering those questions would require a more careful consideration of the welfare impacts of trade, since it suggests a trade-off between the gains from trade and the inequality effects of trade.

Scott Sumner on the Lerner Symmetry Theorem

My ECONS102 class covered international trade this week (hence the flurry of posts on the theme of trade this week). One aspect that we briefly touch on is the Lerner Symmetry Theorem, named for the American-British economist Abba Lerner, which suggests that a tax (tariff) on imports is exactly equivalent to a tax on exports. As luck would have it, Scott Sumner posted yesterday on exactly that topic:

Fortunately, there is a way of making this deeply counterintuitive concept much more intuitive. You may recall from Econ101 that a tax has an identical impact regardless of whether it is legally placed on the seller or the buyer. If Congress writes a law imposing a 23-cent tax on gasoline, it makes no difference whether Congress specifies that the tax is to be paid by the retailer, or whether they specify that the tax is to be paid by the consumer. If you are confused by this distinction, think about the difference between gasoline taxes (paid by the retailer and incorporated into the sticker price) and sales taxes (paid by the consumer and not incorporated into the sticker price.) Either way, the result is the same.

Now imagine that international trade is actually, you know . . . trade. That is, imagine a system of barter. Countries give up valuable goods and in return receive other valuable goods from other countries. In that case, both a 10% import tariff and a 10% export tax are simply two methods of taxing international trade. They represent a 10% tax on the transaction of exchanging one good for another. It makes no difference whether the tax is formally imposed on the importer or the exporter, just as it makes no difference whether a gasoline tax is formally imposed on the seller or the buyer.

I have two other ways that I explain the Lerner Symmetry Theorem to my class. The first explanation comes from Henry Hazlitt's book Economics in One Lesson (which I reviewed here). This explanation goes like this: If a New Zealand exporter exports goods in exchange for foreign currency, then they end up with a handful of foreign currency. They can't spend that foreign currency in New Zealand. The only thing they can then do with that foreign currency is to buy goods overseas (now, or in the future, or trade the currency to someone else who will buy goods overseas now or in the future). If they buy goods, then they end of with a bunch of goods overseas, and in order to consume those goods they would need to import them. If they trade the currency for New Zealand dollars, then those New Zealand dollars must have come from someone overseas who had sold some goods to a New Zealander in exchange for New Zealand dollars (that is, imports). Either way, those earnings from exports get effectively spent on imports. Similarly, if a New Zealand importer buys goods overseas, then people overseas now have New Zealand dollars. The only thing they can then do with those New Zealand dollars is to buy New Zealand exports (now, or in the future, or trade the currency to someone else who will buy New Zealand exports now or in the future). If they buy New Zealand goods, then they end of with a bunch of goods in New Zealand, and in order to consume those goods they would need to export them. If they trade the New Zealand dollars for foreign currency, then that foreign currency must have come from someone in New Zealand who had sold some goods to a foreigner in exchange for foreign currency (that is, exports). Either way, those earnings from New Zealand imports get effectively spent on New Zealand exports.

The second explanation comes from this post last year by Kimberley Clausing and Maurice Obstfeld (both from the Peterson Institute for International Economics). The explanation goes like this: If a trade barrier makes imported goods more expensive, domestic firms in that industry will produce more. Those firms demand more labour, making labour more expensive in that industry, but also in other industries, including export industries. More expensive labour therefore raises the costs of production in export industries, which decreases supply and the quantity of exports.

So there you have it. There are several ways that we can explain intuitively how the Lerner Symmetry Theorem could hold - by noting the equivalence with a domestic excise tax, by explaining what happens with the currency, or by thinking about what happens in the labour market.

Sumner's post explains the Lerner Symmetry Theorem in a bit more detail, and I did appreciate the shout-out to the robustness of the demand and supply model to a violation of the strict assumptions of perfect competition (which is a point that I make in my other class, ECONS101).

[HT: Marginal Revolution]

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.

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.