Krugman, Obstfeld, Baldwin & papers for end-term - Summary by Marcel Stoessel


Case for free trade

- Efficiency gain: Distortion of production and consumption, esp. small country

- Additional gains: scale economies, learning and innovation

- Don’t trust the gvmt to maximize GDP: influenced by special interest groups. Olson’s asymmetry of political action. Hidden tax through price

Tax on consumption (diminishes consumption) + subsidy on production (production distortion) = tariff

1st best solution: correct market failure. 2nd best solution: subsidy. 3rd best solution: tariff


Case against free trade

- TOT gain: Large country that can influence foreign export prices, TOT gain can be bigger than distortion losses (optimal tariff). Thus: small import tariff, export tax. Critique: Could result in trade war. Small countries marginally affect prices.

- Market failure argument. Distortions don’t account for additional social benefits, such as technology, etc. That is the case if the capital or labor market (e.g. inflexible wages) fail. A small country, with a small tariff, can upset the a+b losses by c. 1st best policy: subsidize those responsible for c. 2nd best: intervention. Problems: 1) domestic failures should be corrected by domestic measures (tax or subsidy), but political problems (more visible costs). 2) Hard to identify MF.


Politics of Political Economy

- Olson: Theoretically, parties should seek a median tariff to satisfy the most voters. In trade policy, however, the logic of collective action comes into effect. An individual will not organize (cost of information & of voting) when his benefit is small. A group of individuals will organize if its benefits are big. Those are small groups, special interest groups. They influence (money and otherwise) politicians more than big unorganized groups.

- Political model: auction: reducing social welfare vs. increasing campaign budget.

- Reality: Consumer goods highest protection (clothing, food), intermediate goods lower, raw material lowest.

- International negotiations help to create political support through the principle of reciprocity (implicit in GATT): linking import-competing industries of several countries. Like this, export industries within individual countries become anti-protectionists. Liberalization occurs. As their sector grows in the phase-in period, the pro-liberalization special interest groups gain more weight. Next round: Different political outset, easier to liberalize, and so on. MTN is also better because it helps to avoid a trade war.



- Success: From around 40% trade-weighted average tariff to less than 4% in OECD countries / trade grew faster than income since 1947

- Secretariat: 1) Organizing MTN; 2) Dispute settlement (weak)

- Principles:

Art. 1: Non-discrimination. MFN: lowest tariff/quota given to any country --> all countries
Art. 3: Non-discrimination national - foreign goods (taxes, regulations)
Art. 6: Anti-dumping (not interdiction) and Countervailing Duties (tariffs)
Art 12: Restrictions to safeguard Balance of Payments: suspend GATT when balance of payment crisis
Art. 16: Production subsidies: no export subsidies except for agricultural products / countervailing duty. Long transition periods for poor countries.
Art. 20: Exceptions (i.e. environment, prison labor)
Art. 24: (Territorial Application - Frontier Traffic) - Customs Unions and Free-trade Areas: Exceptions from MFN

- Unwritten principles:

- Reciprocity. Justification for retaliation: „punishment of deviation“

- Predictability: Tariff bindings: ceiling the tariff



- 1-5: Parallel bilateral negotiations, focused on reducing tariffs between rich countries
- 6: Kennedy round 67: TWA -35% tariffs down. Some industries exempted.
- 7: Tokyo Round 79: Attempted to attack non-tariff barriers (technicalities, red tape, etc.; only some members), improve system.
- 8 Uruguay Round 94: Trade liberalization: goods, services, intellectual property / Creation of WTO as an Organization / Administrative Reform: Accelerated Dispute Settlement Mechanism with Dispute Settlement Body (DSB)
Trade liberalization: advanced countries -40% / Agriculture: sub - 36%, Textiles exp. sub -21%, replace quotas with tariffs, phasing out of MFA/ government procurement
Administrative reform: DSB. If non-compliance: retaliation allowed.

GATS established but not yet rules to liberalize services (has since changed)

TRIPS established

Results: around 1% real income rise worldwide. Developed countries: agr & textiles (comp. & workers) losers, pop winners. Developing countries: textiles winners

Why Uruguay succeeded despite enormous problems: 1) Internal political fights turned out in favor of free trade (see above); 2) Fears of protectionism that may undo previous progress

Art. 24: Preferential Trading Agreement: allowed if it leads to free trade between agreeing countries (0%). Free Trade Area: each country sets tariffs against outside world independently. Administratively difficult (rules of origin). Customs Union: same tariff to outside world. Politically difficult. A member country may win or loose from a customs union.


WTO propaganda document (1995 and afterwards)

Goods: GATT 47 & UR =

(see above)





Trade-Related Intellectual Property Rights



Dispute Settlem.

Int’l Court

Trade Policy Review Mech.

Tariff reduction (& binding) of other trade barriers

Extension of goods to agriculture (beginning to liberalize, bound) and textiles/clothing (all non-tariff barriers should be gone by 2004, but some important tariffs remain)

MFN, NT: only if a specific NT commitment has been made

Access Commitments in specified sectors

Transparency: Publish regulations

Recognition: if 2 countries agree, must negotiate with others

Intl payments and transfers: if agreement gvmt must not prevent money leaving the country

Commitments bound

MFN, NT technology transfer



Geographical indications

Industrial designs



Undisclosed information, including trade secrets

Effective and fast (unlike prev.): Has been occupied with more than 150 cases since 1995

Mediation, etc. à panel à DSB à appeals


Improve quality of debates

Notifications of WTO of gvmt measures

WTO Trade Policy Reviews

i.e. zero tariff on information technology products (1997)

i.e. branches of banks, telecommunications, tourism, individuals who travel to provide services

i.e. computer programs as literary works, new medicines

i.e. fishing tuna, kills dolphins


Phasing out of MFA

Negotiations must go on (subs., gvmt procurement, etc.)

Many annexes

Rounds completed after 1995: Basic telecommunications, financial services, movement of natural persons

Developed countries: within a y.

LDC’s: 5 y.

4th world: 11 y.


Agreement on Trade Related Investment Mechanisms


Not mentioned, but also after 95: Anti-Dumping Agreement;

N7on-tariff barriers: Technical regularities and standards à not create unnecessary obstacles;
à procedures simple, rapid, transparent and predictable; some licenses issued automatically;
Rules for the valuation of goods at customs;
Pre-shipment inspection;
Rules of origin: transparent, no distortive or disrupting effect on trade, administered in a consistent, uniform, impartial and reasonable manner;

Investment measures: Country reports provide for transparency; NT IM leading to restrictions in quantities prohibited; inform WTO on measures not compatible with GATT 94

WTO: Developing countries

Ca. 100 of 135 members

Special provisions: GATT non-reciprocity (Part 4), “special and differential treatment (even more than MFN; also in GATS); extra time for implementing, greater market access; legal assistance

Technical assistance; Trade and Development committee; Subcommittee on Least developed countries

Tariff peaks = most tariffs quite low, but some products have high tariffs

Tariff escalation = less tariffs for intermediate goods used to produce our final goods; more tariffs on the final good itself. Headache for raw material producer country to become industrial country. Exists in developing and developed countries. Slowly being reduced


WTO: A member’s organization


Ministerial Conference every two years

All WTO members in: General Council / DSB / Trade Policy Review Body

More committees on lower levels…. on GATT, GATS and TRIPS


To become a member:

1) Presentation of the country
2) What does it have to offer?
3) Draft membership terms
4) Decision

Ch. 10 K&O

1945 – 1975: Import-substituting industrialization (ISI) = watch word; late 80’s Free Trade


Infant industry argument

In order to grow up an industry, it needs to be temporarily protected from industrialized grown up industries: infant industry argument.  LDC’s supposed to have a potential CA in future.

Why not private market, why gvmt protection?

-          Market failure: capital, labor, etc. markets don’t work properly or don’t exist.
1st best solution: correct market failure; 2nd best solution: trade policy

-          Appropriability: Create social benefits like knowledge, technology
1st best: compensate those who make intangible contribution; 2nd best: trade policy

-          Both special cases of market failure argument (Ch. 9), just that it’s a new industry

-          Who warrants special treatment? Those who get it become special interest anti-liberals.

ISI hurts necessarily export sector because it moves resources away from there.


-          Encourage manufactures: yes; promoting overall growth: no

-          If there is no potential CA, ISI will not create one

-          Domestic market very often too small scale

-          More inefficient, more state-owned companies (pol. force against liberalization)

-          Some argue: ISI creates more unemployment, more inequality

Better solutions:

-          Adopt 1st best solutions above

-          For small countries, ES with FT

(For some big countries it has worked in the past (Germany, USA), where internal market was large enough)


Dual economy

Coexistance of a relatively modern, capital-intensive, high wage industrial sector with a very poor traditional agriculture sector.


-          MPLm >> MPLf

-          Wm > Wf

-          Returns capital often smaller in industrial sector (capital becomes cheaper than labor)

-          m often more c-intensive than f

-          Persistant (especially rural) unemployment

Wage differential argument for ISI: if – for some reason – the w in m is higher than in f, moving labor from f to m can increase total output.  1st best: target problem domestically. 2nd best: trade policy. BIG PROBLEM: Landflucht, rise in urban unemployment.

ISI may also re-enforce dualism: With FT, there would be complete factor-price-equalization (also wages).


Export-Oriented Industrialization (EOI)

1960 – 2000: high performance Asian economies (HPAEs): spectacular growth, high trade-ratios and relatively open trade. Help from gvmt to create firms who can export. Correlation between exports and growth, but not clearly established which is cause and  which consequence.


Chronology of 1st wave of globalization (1820 – 1914)

1500 – 1776

Mercantilism, ancient protectionism. Strictly pro-export philosophy


Smith, The Wealth of Nations. Ideas change: trade not only for export.


Repeal of UK corn laws: complete liberalization (removal of all tariffs)


Mill, Principles of Political economy: Infant-industry argument

1860 – 1880

Europe, envious of UK's success, adopts free trade: radical liberalization

1880 – 1914

Recession in 90's. Europe restores protectionism (but liberalized internal markets and still trades with colonies). Philosophy of infant industry born (Hamilton, List).

UK: remains open. US: very protected until post-1945. Political nationalism.

Trade pattern: UK imports raw materials & manufactures, exports manufactures
Europe imports raw materials, exports manufactures.

Massive migration: 10% of UK population left in 30 years

Deindustrializing the South

1820 – 1914

Trade, investment & migration rise rapidly due to the same factors like during the second wave:

-          Transport costs

-          Communication costs

-          Liberalization (UK)

1870 / 1989

1870: UK, 4.6% GDP lending to others, especially colonies
1989: OECD, 2.2% GDP lending to others; FDI = MNC or bonds


Chronology of 2nd wave of globalization (1950 – to date)


GATT signed

1947 – 1979

Industrialized countries progressively liberalize trade on industrial goods, except textiles & agriculture. LDC’s play minor role, keep high barriers on industrial products and export agriculture products.

1979 – to date

S exports to N: LDC’s become exporters of manufacturers.
N exports to both: manufactured goods

1950 – 75

Unemployment increase for unskilled workers

1975 – 80

Narrowing of gap within industrialized countries due to rapid integration within the group of industrialized nations

1980 – to date

Income distribution more widely spread; trade accounts only for about 10-20% of the change

1985 – to date

FDI skyrockets


Asian financial crisis



Comparison 1st - 2nd wave of globalization


1st wave (1820 – 1914)

2nd wave (1950 – to date)

Starting point

World = poor & agrarian.

Sharp rich – poor divide.

Trade in % of GDP

Explosion. Cost of trade falls.
(aggregated level: 1900 » 1999)

Increase. Cost of trade falls (not as much).

Nature of trade
(main trade)


Trade rich – poor. UK: export manufactures and services to periphery, import raw material[1]. Eu: Export manufactures, import raw materials & fruits.

Trade rich – rich. N – N in manufactures (intra-industry trade; imports and exports) and services. LDC’s vastly less important.

Transp. costs

Falls sharply.

Falls (not as much)

Communication costs

Falls. Cost of trading ideas drops not as much like in 2nd wave, so more long-term investment

Falls sharply, more than transp. Cost of trading ideas decline brings more short-term investment.

Capital flows in % of GDP

Sharp rise.

Capital market integration: gold standard & City

Rise (not as much). FDI rises from mid-80’s

CM integration not more than 1900. Probably less than 1914.

Nature of capital flows

FDI/MNC: From developed to colonies’ primary sector.



FDI/MNC: From developed to developed countries for 3rd sector (and 2nd). MNC spread; MNC > trade (value of products). FDI sharp rise mid-80’s




Produces large income differences (landowners – workers). Change in land-labor ratio in favor of labor.

Narrows the gap between certain countries (N-N, N-NICs). Trade only responsible for 10-20% of N-S gap.


Massive Europe to colonies labor migration

Only US high immigration rates.

Industrializing / De-industrializing

De-industrializing the South
Industrializing the North

De-industrializing the North (NICs apart)
Industrializing the South


Radical liberalization, followed by protectionism

Gradual liberalization through GATT and regional FTA / CU

Economic Beliefs and Institutions

Gold standard = fixed exchange rate

Perfect capital mobility

Independent monetary policy by Britain’s central bank; until 1914 stability



Wanted: 1) Fixed exchange rates; 2) perfect capital mobility (not the case); 3) independent monetary policy

Self-fulfilling speculative attacks

Choice: Managed floats or membership in monetary union

Nowadays independent central banks a must

Policy-Making environment

17th/18th: Mercantilism

Smith, Ricardo: Free trade, CA. UK becomes leader in promoting FT.

Modern protectionism, also IIA (Bismarck)

Economic nationalism

Free Trade (IMF, WB, GATT). US becomes leader in promoting FT.

Within EU complete FT

Institutionalization & powerful pro-trade lobby make collapse unlikely today



© 2000 Marcel Stoessel (comments (at) stoessel (dot) ch). All Rights Reserved.

Reproduction of this document or parts of it may be done only after a long evening full of beers with the author (special arrangements can be made in case the person wishing to reproduce this document or parts of it is female, 21 – 29  years of age, nice, intelligent, good-looking and preferably, but by no means necessarily, single)


[1] Import manufactures little importance



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