EXPORT SUBSIDIES AND CUSTOMS UNIONS

Transcription

1 Journal of Internatonal Busness and Economy (008) 9(): - (9 pages) JIBE Journal of Internatonal Busness Journal of Internatonal Busness and Economy Jose Mendez-Naya and J. Tomas Gomez-Aras EXPORT SBSIIES AN CSTOMS NIONS * ABSTRACT Ths paper explores how the formaton of customs unons affects the argument for export subsdes n mperfectly compettve nternatonal markets. It s shown that the exstence of customs unons may elmnate the ncentve for ther members to subsdze exports as customs unons grow larger. Therefore, t can be affrmed that regonalsm and multlateralsm are complementary processes. Key Words: economc ntegraton, strategc commercal polces, export subsdes Jose Mendez-Naya nversty of A Coruña, Span J. Tomas Gomez-Aras Sant Mary s College of Calforna, SA Correspondence: J. Tomas Gomez-Aras Sant Mary s College of Calforna, Graduate Busness, 80 Moraga Rd., Moraga, CA 94575, SA E-Mal: tgomez@stmarys-ca.edu Tel: (+) Fax: (+) / Fax: * Ths work was supported by the Xunta de Galca through project PGIIT05PXIA000PR. Journal of Internatonal Busness and Economy Frst Receved: Jan. 8 th 008 Fall 008 Fnal Revson Accepted: May 8 th 008

2 EXPORT SBSIIES AN CSTOMS NIONS INTROCTION Accordng to tradtonal nternatonal trade theory, the domestc nterest s served by trade restrctons, whch mprove domestc terms of trade, but not by export subsdes, whch are detrmental to domestc terms of trade. Whle drect export subsdes are n fact prohbted by the World Trade Organzaton, many countres n all stages of economc development contnue to subsdze ther exports ndrectly (for example, by affordng ther frms export credts, export credt nsurance, or producton subsdes). In many cases, they have been used as an ncentve to lure domestc olgopolstc ndustres nto acceptng the ncrease n competton derved from the reducton of trade barrers wthn ether blateral, regonal or multlateral frameworks. A theoretcal ratonale for ths practce was provded by Brander and Spencer's papers on strategc export subsdes n olgopolstc ndustral sectors (Brander and Spencer 984, 985). In the latter paper t was shown that when the frms of two countres compete as Cournot duopolsts n a thrd market, a subsdy-promoted ncrease n a frm's share of that market can ncrease both ts profts (net of the subsdy) and the welfare of that frm's country. Snce Brander and Spencer's papers, a number of studes on the effects of export subsdes n mperfectly compettve contexts have ualfed ther conclusons. For example, Tanaka (99) showed that the sze of the optmal export subsdy falls as the effcency of the country ncreases; Ishkawa and Spencer (999) that the ncentve for subsdes under mperfect competton s weaker for ntermedated goods; and Colle (99, 997) that the predctons of an nfnte export subsdy game favour free trade. Colle later provded a ratonale for multlateral agreements prohbtng export subsdes (Colle 000). xt (984) s a selectve revew of the lterature on mperfect competton n nternatonal markets. For many years now, and especally snce the loss of momentum n the oha round of Negotatons at the WTO, a marked feature of the nternatonal tradng scene has been growng focus on regonal ntegraton, whch results n nternatonal trade beng carred on n a network of regonal customs unons * such as the European non or MERCOSR, * In the remander of ths artcle we wll refer to customs unons (C) as groups of countres that have entrely removed tarffs on goods produced on member countres (they are, therefore, free trade agreements or FTA s) and mposed a common external tarff on a gven good. A more general term, preferental trade agreements to PTAs, ncludes also lmted tarff preferences. 4 Journal of Internatonal Busness and Economy

3 JOSE MENEZ-NAYA AN J. TOMAS GOMEZ-ARIAS free trade areas such as NAFTA and CAFTA-R and other preferental trade agreements. For an updated survey of the lterature on customs unons see Lypsey (00). The effect of preferental trade agreements on multlateral trade lberalzaton has attracted much nterest and whether they are a buldng block or a stumblng block to multlateral lberalzaton s an open ueston Bhagwat (99) ever snce Vner (950) n hs semnal paper establshed that economc ntegraton had both a (postve) trade promoton and a (negatve) trade dverson effect. Some authors, lke Feund (000), argue that multlateral trade lberalzaton encourages preferental trade lberalzaton, whle others lke Krshna (998) fnds that the formaton of a preferental trade agreement undermnes support for multlateral trade lberalzaton. Sagg (006) argues that ths result depends on countres characterstcs and when countres are asymmetrc preferental trade agreements could facltate multlateral tarff cooperaton. For a recent analyss of the emprcal research on the effects of.s. and E regonal ntatves on multlateral trade lberalzaton see Lmao (006), who concludes that regonal ntegraton generally hders multlateral free trade. If there s a connecton between export subsdes and free trade (Colle 99; 997), and free trade seems to progress through regonal agreements (over 00 PTA s have been formed snce the ncepton of the WTO), the ueston arses of what s the mpact of export subsdes on regonal trade lberalzaton arrangements and n partcular on customs unons. For example, n the case of the European non, not only have the export subsdy polces of member States been unfed, but subsdes have also been generally reduced, n spte of European exporters havng argued that ths would reduce ther compettveness n foregn markets. In fact, some of the most relevant obstacles n the oha round of negotatons at the WTO have to do wth export subsdes, especally n agrcultural products. oes regonal ntegraton actually make those export subsdes more desrable thus lmtng the appeal of multlateralst approaches to free trade? In ths paper we explore how the formaton of a customs unon can affect whether export subsdes are desrable or not. Ths s relevant from a publc polcy perspectve because export subsdes (ether drect or under more or less subtle dsguses) are often reuested by ndustry leaders n the process of trade lberalzaton. We model trade polcy as a two-stage game n whch export subsdes are set n the frst stage and Cournot competton between frms takes place n the second. We show that the formaton of a customs unon may elmnate the ncentve for export subsdes, Fall 008 5

4 EXPORT SBSIIES AN CSTOMS NIONS and hence that regonalsm, lke multlateralsm, tends to favour free trade. Therefore, the paper complements the debate on regonalsm and multlateralsm and n terms of Bhagwat (99) t gves support to the dea that the result of regonalsm wll be the cooperatve scenaro or open regonalsm. The remander of ths paper s organzed as follows. In Secton II we present the basc model, n Secton III optmal export subsdes are calculated n the absence of regonal agreements, and n Secton IV the effects of the formaton of a custom's unon are explored. Secton V concludes. THE MOEL For the sake of smplcty, we consder a sngle freely tradng consumng country that mports a homogeneous good from three producng countres,, and, each of whch has a sngle frm that produces the good exclusvely for the consumng country's market and competes Cournot-wse wth the other frms. Fxed producton costs are assumed to be zero, margnal costs constant, and there are no plant capacty restrctons. The countres' governments are assumed to know the market structure and that they set export subsdy levels n advance of the frms' uantty decsons. Ths smple model has proven to be robust under a wde range of assumptons (Ma 008) and wll allow us to brng out the man ponts of the paper. The uantty sold by the frm of country wll be denoted and the total uantty of the consumng country's market, so that = + +. Consumers' utlty functons are assumed to be addtvely separable and lnear n a compettve numerare good so that, by Roy's dentty, V () p where V s the aggregate ndrect utlty functon and p s the prce of the homogeneous good. It s further assumed that the nverse demand functon p() s twce contnuously dfferentable, wth ( ) 0 ( ) 0 0,, where prmes ndcate dfferentaton wth respect to. The last of these condtons, whch s necessary to ensure the exstence and unueness of Cournot-Nash eulbrum, () 6 Journal of Internatonal Busness and Economy

5 JOSE MENEZ-NAYA AN J. TOMAS GOMEZ-ARIAS may not be met f the demand functon s very convex, but ths s regarded as unusual (see, for example, Brander and Spencer (985) and Brander and Krugman (98)). The frms' profts are gven by p s c,, () where s s the correspondng export subsdy and c the margnal producton costs, and the frst-order condtons for Cournot-Nash eulbrum are therefore p s c 0 The dependence of the eulbrum outputs on the export subsdes s most easly obtaned by total dfferentaton of these condtons, whch affords d d d followed by soluton of the resultng system, whch gves d d d where 4 0 ds ds ds ds ds ds ds ds ds ds ds ds by es.. These relatons n turn gve the dependence of eulbrum prces on export subsdes, followng total dfferentaton of p: p p p ds ds ds dp d d d (7) In vew of the condtons mposed n es., es.6 and 7 mply that an export subsdy a) ncreases the sales of the subsdzed frm and reduces those of the other two frms; and b) lowers the eulbrum prce and ncreases eulbrum market uantty. OPTIMAL EXPORT SBSIIES IN THE ABSENCE OF CSTOMS NIONS The welfare W of country s gven by W s (8) so that (4) (5) (6) Fall 008 7

6 EXPORT SBSIIES AN CSTOMS NIONS W s p c s p s - (/){(p - c)(p" p" ) () } wth analogous expressons for W /s and W /s. If country has not yet ntroduced any export subsdy (s = 0), then p - c = - (by e.4) and W s 0 where the neualty follows from es.. Snce a country s welfare s monotonously ncreasng on the sze of the export subsdy, country has an ncentve to establsh an export subsdy, and further analyss shows that, at the Nash eulbrum, export subsdes are strctly postve p '' (9) (0) '' s 0 () p The analyses for countres and are of course analogous. Ths secton and the prevous secton thus show that n the absence of customs unons Brander and Spencer's (985) concluson that an export subsdy ncreases domestc welfare by shftng profts from foregn to domestc frms s vald for the model examned here. EXPORT SBSIIES AN CSTOMS NIONS Let us now suppose that countres and form a customs unon wth a common external commercal polcy, so that any export subsdy they set wll be common to the two and wll be set to maxmze the aggregate welfare of the unon. If we denote ths common subsdy by s, calculatons totally analogous to those leadng to es.6 and 7 n Secton II afford and d d d ' ds ' ds ' ds ' ds ' ds ' ds () ds ds () dp 8 Journal of Internatonal Busness and Economy

7 JOSE MENEZ-NAYA AN J. TOMAS GOMEZ-ARIAS wth the same mplcatons as n Secton II; n partcular, ncreasng s ncreases the exports of countres and, reduces the exports of country, lowers the eulbrum prce and ncreases total market sze. The aggregate welfare of the unon, W, s gven by W W W s ( ) (4) and arguments analogous to those leadng to e.0 show that when s = 0, W s nlke the rght-hand sde of e.0, however, the rght-hand sde of e.5 s of ndetermnate sgn, showng that Brander and Spencer's (985) concluson no longer holds n all crcumstances. Specfcally, f we denote the total output of the unon by and defne = ( - )/( + ) = ( - )/ (a measure of the nternal asymmetry of the unon), then W /s s postve or negatve dependng on whether the output rato / s less than or greater than respectvely. In other words, the desrablty of ntroducng an export subsdy depends on the relatve szes of the unon and ts compettor and the nternal asymmetry of the unon: export subsdes are favourable for very asymmetrc unons or unons wth an output that s suffcently smaller than that of ther compettor, but unfavourable f the compettor s smalle than, n whch case the unon's optmal strategy s to tax exports. In partcular, snce 0, an export subsdy s not desrable f the unon s smaller than the thrd country. Snce W = + when s = 0, the effect on the optmal subsdy of ncreasng the thrd country's output can be traced to / beng negatve n ths stuaton ( =,),.e. to the reducton of profts n the unon as the compettor country s exports ncrease. It may also be noted that the more convex the nverse demand curve s, the more senstve s welfare to export subsdes or taxes; ths s because ncreasng p" reduces the effect of output changes on eulbrum prce, and hence on margnal proft. Partcularly, for a lnear demand customs unon welfare s not senstve to export subsdes or taxes. If the unon does ntroduce an export subsdy (or an export tax), further analyss shows that ts optmal value s gven by s ' (5) ' (6) Fall 008 9

8 EXPORT SBSIIES AN CSTOMS NIONS whch s agan postve or negatve dependng on whether / s less than or greater than. Furthermore for lnear demand t s verfed that S = 0 that s, the customs unon optmal commercal polcy s free trade. CONCLSIONS For an olgopolstc ndustry n whch the output of producng countres s sold manly n non-producng countres, the formaton of customs unons among the producng countres modfes the desrablty of export subsdes (whch n the absence of customs unons are supported by Brander and Spencer's well-known proft-shftng argument). Whether an export subsdy s desrable for a customs unon depends on ts nternal asymmetry and the sze of ts output relatve to that of non-member producng countres: export subsdes are favourable for asymmetrc, relatvely small unons, but unfavourable f the unon s larger than ts compettors, n whch case regonalsm favours free trade. The ratonale les n the trade-dstortng effects of export subsdes. The larger the relatve sze of a customs unon, the more dffcult t s to gan addtonal market share from markets n thrd countres to compensate for the cost of the subsdy tself and the lower market prces t brngs about. If a subsdy s desrable, ts effect on welfare wll also depend on the convexty of the nverse demand functon and for a lnear demand welfare s not senstve to export subsdes or taxes. The publc polcy mplcatons of these results are twofold: frst, t shows that large customs unons lke the E can beneft the most from a reducton n export subsdes especally n ndustres where they have a domnant world market share; second, t suggests that regonal ntegraton (at least large regonal groups) does support the process toward freer trade by reducng the ncentves to subsdze exports. Ths would support a unlateral reducton n export subsdes n large customs unons even when smaller or less developed countres wth small market shares offer lmted recprocty. At the same tme, t s mportant to hghlght that customs unons lke the E and other FTAs and PTAs are typcally based on more than pure economc arguments. The E, for example, s at least as much a poltcal unon as a customs unon, and MERCOSR has mportant poltcal, socal and cultural objectves. REFERENCES Bhagwat, J. 99. The world tradng system at rsk. Prnceton, N.J.: Prnceton nversty Press. 0 Journal of Internatonal Busness and Economy

9 JOSE MENEZ-NAYA AN J. TOMAS GOMEZ-ARIAS Bhagwat, J. 99. Regonalsm vs. multlateralsm: An overvew. In J. de Melo and A. Panagarya, edtors, New dmensons n regonal ntegraton. Cambrdge: Cambrdge nversty Press. Brander, J. and P. Krugman. 98. Recprocal dumpng model of nternatonal trade. Journal of Internatonal Economcs 5: -. Brander, J. A. and B. J. Spencer Tarff protecton and mperfect competton. In H. Kerzkowsk, edtor, Monopolstc competton and nternatonal trade. Oxford: Oxford nversty Press. Brander, J. A. and B. J. Spencer, 985. Export subsdes and nternatonal market share rvalry. Journal of Internatonal Economcs 8: Colle,. R. 99. Proft-shftng export subsdes and the sustanablty of free trade. Scottsh Journal of Poltcal Economy 40: Colle,. R Blateralsm s good: Trade blocs and strategc export subsdes. Oxford Economc Papers 49: Colle,. R A ratonale for the wto prohbton of export subsdes: Strategc export subsdes and world welfare. Open Economes Revew : xt, A. K Internatonal trade polcy for olgopolstc ndustres. Economc Journal (suppl.): -6. Freund, C Multlateralsm and the endogenous formaton of preferental trade agreements. Journal of Internatonal Economcs 5: Ishkawa, J. and B. Spencer Rent-shftng export subsdes wth an mported ntermedate product. Journal of Internatonal Economcs 48: 99-. Krshna, P Regonalsm and multlateralsm: A poltcal economy approach. The Quarterly Journal of Economcs : 7-4. Lmao, N Preferental trade agreements as stumblng blocks for multlateral trade lberalzaton: Evdence for the nted States. Amercan Economc Revew 96 (): Lpsey, R. G. 00. The theory of customs unons: A general survey. Economc Analyss of Regonal Tradng Arrangements, 46-6, Elgar Reference Collecton. Internatonal Lbrary of Crtcal Wrtngs n Economcs vol. 6. Cheltenham,.K. and Northampton, Mass.: Elgar. Ma, J. (008), Is an export subsdy a robust trade polcy recommendaton towards a unonzed duopoly? Economcs & Poltcs 0 (): Sagg, K Preferental trade agreements and multlateral tarff cooperaton. Internatonal Economc Revew 47(): Tanaka, Y. 99. The ncentve for export subsdes under mperfect competton. Open Economes Revew : Vner, J The customs unon ssue. New York: Carnege Endowment for Internatonal Peace. Fall 008