Mod-01 Lec-23 Lecture-23International Economics


Today, good afternoon. Today, we going to
discuss about the export subsidies. In the 2005, Hong Kong ministerial meet, it was decided
to dismantle all the export subsidies which are given by countries by 2013. So, in the
next year, you would see there will be an attempt by all the countries to withdraw the
export subsidies. Now, there are heavy export subsidies which
are given by the European Union, especially on products like sugar. US also gives heavy
subsidies on its production of cotton. Now, what export subsidies do is that it depresses
the world prices. Now countries like India, Brazil, Argentina, they are at loss. Because
they lose they lose their competitiveness, specially the farmers here, because once the
prices get depressed the farmers from these large developing countries are at a loss,
because they are not able to sell their products in the international markets.
Now, see the mechanism, how export subsidies work? It is like the same when you impose
tariffs on a product, which are which is coming in, it creates a wedge between the domestic,
and the international prices. The domestic price of the imported good increases, here
when export subsidies are given for a product the export price of the export good goes up.
Why? Because say for example, if the government decides that I we will give rupees s, rupees
s for each unit exported. So, every unit that you export, you will get
rupees s. So, the exporters will get P W plus s. Now what will happen is that? There are
domestic producers also, there are domestic producers and there are exporters. So, domestic
producers will also try to increase their prices to P W plus s. Reason being that, if
the prices were low, then you would have a situation, where there will be only foreign
producers ,only exporters, but the situation is that you have both exporters and you have
domestic producers. So, domestic producers will also charge a
price which is P W plus s and generally as we discussed, the other day some couple of
students also asked, when exports subsidies are given at the same time governments imposes
tariffs, on the export good .Because if you are giving subsidies to the toy, to a product,
it is always possible that the consumers can import a product at P W. See the producers
are charging P W plus s; it is domestic producers or exporters. but consumers can always import
a product at a lower price p w. So, whenever governments impose export subsidies like the
European Union and the U S they with the export subsidies they impose tariffs on the export
good. So, as a result, the domestic price of that
export good also goes up. So, the consumers cannot undercut any of the producers. Now,
see what happens when the exporter start receiving P W plus s, there is a loss in consumer surplus
of minus a minus b. The producers gain a plus b plus c government’s subsidy of the form
of b c d .Because these are the exports after subsidies. So, b c d this is the subsidy into
this much of exports. So, this is the loss to the government. So,
the net welfare works out to be minus b minus d. So, as in the case of tariffs, it is imposing
the tariffs which are imposed by small countries is always bad for it, similarly, subsidies
are also bad for the small country. because there are artificial production and consumption,
distortions which are created in the economy. In the world markets, see the now you see
this is a small country. So, if it is a small country the import demand curve that it faces
is perfectly elastic and there is an export supply curve. Sees the export supply curve
starts from this level. So, as the price of exports goes up the export, this is the export
supply curve. but the import demand curve that this small country faces is perfectly
elastic. So, these were the exports in free trade,
when export subsidies are given the domestic price of that export good goes up. but the
people who buy the product, they buy a product at P W no P W plus s, it is like tariffs.
Remember when tariffs are imposed, the price of the domestic good goes up; the tariffs
accrue to the government. but the foreign suppliers get a price benefit net of tariffs,
because tariffs revenue goes to the government. So, they get a price, if I am supplying products
in case of tariffs I get a lower price here. You are supplying this product. So, the demand,
they will buy the product at P W, this is for a small country .You will see for a large
country; the price of export will go down. So, then this is what happens? When, a small
country imposes the, when small country gives export subsidies. Now, for a large country as I said you can,
we will also make a diagram similar to that, but quickly if you wish to know what happens?
When export subsidies are given. Now come back to this diagram, where you have price
of cloth. By price of manufacturing, this is the terms of the trade, the world prices
.You have cloth by manufacturing on the x axis. So, you have demand for cloth by manufacturing
and you have supply of cloth by manufacturing. Now, when export subsidies are given, the
price that exporters receive is say P W plus s. So, the price of export good goes up, as
the price of export good goes up, the supply goes up. So, when the supply goes up, the
supply curve shifts to the right s c by m, this is the new supply curve. but because
the price of c by m, the price of cloth has gone up producers gain consumers lose. So,
the demand for cloth by manufacturing it comes down.
So, is the government is giving subsidy to the producers then that amount of subsidy
market? No, see, you should understand how these subsidies
are given? It is like rupees s for each unit of goods that you export. So, if you are exporting
say twenty units, twenty into s, will be the subsidies which are given to you.
this amount the d if the producer can charge from the consumers. And the government or
is the government paying that amount? No, this is the price which is received by
the producers. So, it is like an incentive for them that the more that they export. Now
for the consumers the price is still at P W, domestic producers also want to charge
the same price P W plus s. but for consumers they can always get a that same product from
the international markets at P W .Is not it? why would they buy it from the exporters or
domestic producers? So, that is the reason, that when export subsidies
are given, at the same time import tariffs are imposed on the same export good, which
is coming in. Because the you have to think it in such in a manner, if that there is something
like an intra industry trade going on. You are exporting, you are giving subsidies, but
you are importing that product also. So, that is the reason that the domestic prices of
that export good goes up. So, that the consumers cannot undercut the producers or the exporter
that is what happens? So, then this revenue, this is a loss for
the government. So, you are creating distortions in the economy, production and consumption
distortion and at the same time government is losing. So, that is the reason that export
subsidies are always welfare reducing and even for a large country like this you see
a decline in the world prices. So, when they say that export subsidies depresses the world
prices p c by p m goes down. So, the world prices go down. And so, the terms of trade
goes down, and then there are artificial production and consumption distortions. So, if you work
out the net welfare for the large country, for a large country also you will see that
the net welfare goes down. Because the terms of trade fall and there are production and
consumption distortion. So, but the common mans understanding is that
export subsidies are good; they are good for the producers. but at the end the nation at
as an entity or the world welfare also goes down. So, this debate which goes on in the
parliament that at the time of the recession, we should be helping the exporters, the producers,
it is good it is a good, viable short term solution. but in the long run, what you would
see is depression of the world prices? and artificial creation or distortions in the
economy. So, U S, which provides heavy subsidies on
cotton. European Union which provides heavy subsidies for sugar under the common agricultural
policies. They are the ones who have depressed these prices the world prices of sugar and
cotton. So, the losers are the developing countries like us, but the gainers are the
small Caribbean’s .The Caribbean nation and the African nations, because at the end
if the world price goes down, the net food importers, they are the one who will gain.
So, look in the W T O, when you go into W T O and you negotiate on reducing the export
subsidies. There will be one set of developing countries like India, Argentina and Brazil
which will argue that, we should dismantle like export subsidies. but there will be another
lot the small nations the food importing nations which would argue that, we are against dismantling
of export subsidies. So, this crucial decision which was made in
2005, that is probably, that is one success that we got one of the successes that we got
in the W T O. That we were able to decide that, we will dismantle export subsidies by
2013. So, what will happen by 2013, the prices of these agricultural products may increase
by next year. Because as the exports subsidies will get dismantle, you will see what will
happen to the world prices? When export subsidies are given? The world
prices go down. When they dismantle? You will see a rise or in the prices. So, let me now
discuss the case, when export subsidies are imposed by a large country. So, the only difference
would be that instead of this perfectly elastic import demand curve, you would have a downward
sloping import demand curve. So, you can also think of making it on your own, but let us
now, another thing which follows from here. When we discuss the large country case as
I said, the net result is that the terms of trade fall for the home country. And there
are distortions which are created production and consumption distortions.
So, these large countries which are able to give these export subsidies they are able
to produce more .When they are able to produce more, they can give aid in the form of food,
like India in the 1960 borrowed food from the U S under the P L 480 program. And throughout
the histories, throughout the a seventies and eighties, these developed countries which
had given heavy subsidies, which were able to produce more, gave aid in the form of food.
That is, but then these are the things which will happen the world prices will go down,
there are artificial distortions which will come in. The argument is that, instead of
giving food aid, it is always better to identify the problem and give cash aid instead of food
aid. So, now, you see that, this even in the W
T O they have been people have been arguing that dismantle the export subsidies. And if
you have to give the aid, just give the cash transfers are better than the food aid. Because
at the end it creates distortions and the world welfare goes down. When you give the
export subsidies, but it is very easy to get effected by the argument that goes on
in newspapers and parliament that export subsidies, probably it is good. but it is good in the
short run, because in the long run you will see that the terms of trade falls, world prices
fall and their distortions which are created in the economy. So, this is export subsidies. And once we
discuss this, then I will come to the other type of support that the farm gets. That is
called domestic farm support, because subsidies, these are export subsidies. but you can always
give production subsidies also instead of export subsidies .You can give production
subsidies, whatever they do with the producers? Whether, they want to sell it domestically
or in the foreign markets, that is separate. So, there are different types of subsidies,
there is a production subsidy, that is domestic farm support. W T O is relatively silent on
domestic farm subsidies. And I will tell you why? Export subsidies are more pernicious,
than production subsidies. So, all countries have domestic farm support. There in W T O
s parlance there is some economists, they distinguish the subsidies in the form of red
subsidies, blue subsidies, and yellow subsidies. Red subsidies are those which are not allowed
at all, yellow subsidies where you can impose tariffs, because the countries have imposed,
have given subsidies and there are blue or amber subsidies which are also trade distorting.
but they are allowed under certain circumstances. So, I will come back to the other types of
subsidies which are given, I am only talking of export subsidies. There are production
subsidies, but they are less pernicious than export subsidies. That is the reason that
every country maintains this domestic farm support, even India has support production
subsidies which are given for certain products especially agricultural products.
world prices. That also depresses the world prices, but
the difference is, remember when you have the export subsidies, the domestic producers
also charge a price which is P W plus s. Reason being, that if they had charged a price lower
than this then there will be only one set of people. There will be only exporters. Now,
here when you give production a subsidy, the difference is that the they will get the price
that they will receive is P W plus s. But, the price that they will charge to the
consumers will only be P W, because whatever is their produce they can either sell it domestically
or they can export it. Is it not? The case of the export subsidies, where they receive
s for each unit exported, they receive s for each unit produced. So, if they are producing,
they can either sell it domestically or outside. So, the charge, the price that they will charge
for the consumers will be P W. So, then supply.
So, the supply curve will change, because what they will see is? What they will receive
is? P W plus s. These are the producers, the price that they will charge to the consumers
will remain P W, and there will be no change in demand. Only the supply curve will shift
to the right. So, the exports, whatever it will be, will be smaller than the case when
you have export subsidies. So, the export supply curve will shift to
the right, but not by the amount of the export subsidies. So, then prices will be depressed,
but not by the amount when you give the export subsidies. So, that is the argument? I will
make a diagram for that also, and that is the reason that W T O is relatively silent
on. The fact that countries give production subsidies, but this will be dismantled by
two thousand thirteen export subsidies. So, the diagram in the exam, you have to be
careful in making the diagram. So, this is the large country. So, you have the home market
and you have the world market. So, you make the demand curve, you have the supply curve.
This is will be price of exports; this will be the export supply curve. This will be the
import demand curve, wherever this will be the world prices. So, when subsidies are given. So, this diagram. So, you start by making
this demand curve and you have the supply curve. Look at the export supply curve it
starts from here, as the price of exports go up, the exports supply goes up.
So, this is an upward sloping export supply curve, it is a large country. Whatever it
transacts, it is it has an impact on the world prices. It cannot take the world a price has
given. So, the import demand curve is downward sloping, wherever the import demand and the
export supply curve intersect, that is the world prices. So, P W is the world prices
in the free trade, now this country decides to give subsidies, export subsidies.
So, what it does is that? The exporter start receiving something extra for whatever they
are exporting? That gives the boost, they start producing more, and exporting more .When
they start exporting more the export supply curve shifts to the right .That is what happened?
The export supply curve shifts to the right, this is the export supply curve, it shifts
to the right. This is the import demand curve. So, the new
world prices are lower than, what it were before? That is what? That is how it depresses
the world prices? You are producing more; there are distortions which are created? You
are given a subsidy. So, you produce more. So, the export supply curve shifts down these
are the world prices. So, p star is lower than p w. So, price of exports go down. So,
the terms of trade goes down. So, terms of. So, then your net welfare is
minus e, this is the terms of trade loss and b and d are production and consumption distortions
which are created. When the large country impose tariffs, the net welfare was e minus
b minus d. Remember, because there is a terms of trade gain, when you impose tariffs. When
you impose tariffs, when you give subsidies, this is the net welfare minus e minus b minus
d. What about the people who are buying products
from you? Because the world prices go down, there is a loss, which is this entire area.
You see this rectangle, because now the world prices are lower P W instead of p star .These
are the world prices which prevail. So, if I am an agricultural producer from India and
I am producing the same product, if I find that the world prices have gone down, I will
be at loss. Because I am a producer, I will get less price
for my exports, and if my cost of production which is increasing after liberalization,
because of various increase in input cost I will be at loss. So, producers in Brazil
large developing country, they are at loss. This is, this rectangle do you see this rectangle,
this till here, till here, till here. This I have divided into this portion which I call
as e dash and f which is the distortions which are created, because the world prices go down.
So, this e is this area e is e dash plus f. So, whatever are my terms of trade loss is
the terms of trade gain for the other partner, the buyer. But then this e is the terms of
trade gain. So, the terms of trade loss for me is terms of trade gain for the foreigner
plus something which is lost. Because now, you are getting the prices have gone down.
So, then the net welfare of the foreign countries e minus f, why e because? e is the terms of
trade loss for me, it is a terms of trade gain for the people who are buying products
from me. And f is a distortion which is created because; the world prices have gone down.
So, the net welfare works out to be minus e minus b minus d plus e minus f minus b minus
d minus f. So, the world welfare goes down, your welfare
goes down. So, export subsidies are always welfare reducer, now if you have to consider
the case of production subsidies .And if you are considering small country, the only difference
in this diagram and that diagram would be that there will be the shift of this supply
curve, but it will not be by this amount it will be like this. So, therefore, the export
supply curve will not be here, it will be, it will be here. So, then the fact is that
the exports do not increase by x 2 they are not x 2, but they are less than x 2.
So, production subsidies also tend to have an impact on the exports, but it the exports
do not increase by that amount. Because remember the prices that the producers charge are still
P W no P W plus s that is what they will receive they will produce more, but what they will
charge to the domestic producer is P W. Reason that they can do anything with their produce,
they can either sell it domestically or they can sell it in the international markets.
So, they will keep charging P W and what they will receive is P W plus s. So, there will
be a shift in export supply curve, no change in the demand. Because what consumers will
give will only be p w. So, small change in export supplies the export supply and therefore,
less change in the exports. Now, you can visualize, what happens if there
is a large country? There will be a depression in prices, but it will be lower than, what
will happen when export subsidies are given? So, that is the reason in the W T O they are
relatively silent on domestic farm support. but it is the Indians and the Brazilians who
are saying that, whatever it is whether you are giving export subsidies or production
subsidies? You are distorting you are depressing the prices.
So, the negotiations are still going on the do ha development round is yet to be concluded.
These are the things that they will discuss to dismantle all sort of export, all sort
of subsidies .why do you have to think about export subsidies? Any subsidy, you will give
it will distort the production structure. It will depress the prices and remember for
the large developing countries around 65 percent of the work force is still in the agricultural
sector. And, for the developed nations, may be only 3 to 4 percent of the work force is
in the agricultural sector. And the value added the agricultural contribution of towards
G D P unfortunately it is coming down for at least for India.
So, you have the same set of work force in the agricultural sector, but what they are
getting? is shrinking. So, for each person in the agricultural sector what they are getting?
Is going down. So, something needs to be done and that something is that at least you have
to take care of these world prices, which are getting artificially depressed. Because
you are giving subsidies, but as you say in the W T O, it is like a mercantilist organization.
If you say that you dismantle the subsidies, they would ask you to reduce subsidies on
the industrial goods. So, it is not very simple or they will say
that we want to promote our service sector. So, you open your markets. Let our banks also
come in; let our insurance companies also come in India. So, it is like give and take.
So, it is up to the negotiators to do a good homework back it up by some empirical studies
which are not very easy in when you are analyzing trade policy. So, once you do that then I
think you will be in a better position to argue your case for dismantling all type of
subsidies. I will end up here; we will have some new
issues on regional trade agreements specially trade creation and trade diversion. And why
r t a s are becoming a bone of contention? Because there is one article in the W T O
which says that r t a s are allowed. So, on the one hand they say that you liberalize
all country should liberalize. And at the same time W T O also says that four people
can come together four countries can come together and then liberalize.
So, whether regional trading organizations are a stepping stone towards multilateral
liberalization, these are the issues that we will be discussing in the next few lectures.
Sir, this production subsidy that domestic price should decrease? Why it remains as t
w? If there is competition in the domestic market producers can even charge less and
still be in profit. That is so, this is a case of a small country,
if it were a large country the supply curve shifts, and the export supply curve shifts
downwards, and if you have a downward sloping import demand curve. So, the, so there is
a the world prices will come down, only thing I am saying is that world prices will not
come down to the level, when export subsidies are given. Because when you are a small country
you keep charging P W, for a large country, the export supply curve will shift down, there
will be a reduction, but smaller reduction. Then, when the case of, when you have the
case, where export subsidies are imposed by small country. Thank you so much.

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