IFT Notes for Level I CFA^® Program

LM07 International Trade and Capital Flows

Part 4

6.3 Export Subsidies

Export subsidies are payments by the government to a firm for each unit exported:

The objective is to stimulate exports, increase production in certain industries, and create domestic employment.
The exporter has an incentive to focus on the export market because the firm receives the international price plus the per-unit subsidy for each unit of the good exported.
The most export subsidized industry in the world is agriculture.
Countervailing duties are duties levied by the importing country against subsidized exports entering the country. This tariff is imposed to offset the effect of subsidy.
If a small country imposes export subsidies, domestic price rises.
If a large country imposes export subsidies, world prices decline as quantity increases.
For example the European Union subsidizes sugar and is the second largest exporter in the world.
Net welfare is down in the large and small country.

The exhibits below are reproduced from the curriculum.

Note: these are important and testable. They summarize the effects of all the alternative trade policies we have seen so far.

Effects of Alternative Trade Policies
	Tariff	Import quota	Export subsidy	VER
Impact on	Importing country	Importing country	Exporting country	Importing country
Producer surplus	Increases	Increases	Increases	Increases
Consumer surplus	Decreases	Decreases	Decreases	Decreases
Government revenue	Increases	Mixed (depends on whether the quota rents are captured by the importing country through the sale of licenses or by the exporters)	Falls (government spending rises)	No change (rent to foreigners)
National welfare	Decreases in small country (could increase in large country).	Decreases in small country (could increase in large country).	Decreases	Decreases

Effects of alternative trade policies on price, production, consumption, and trade
	Tariff	Import quota	Export subsidy	VER
Impact on	Importing country	Importing country	Exporting country	Importing country
Price	Increases	Increases	Increases	Increases
Domestic consumption	Decreases	Decreases	Decreases	Decreases
Domestic production	Increases	Increases	Increases	Increases
Trade	Imports decrease	Imports decrease	Exports increase	Imports decrease

7. Trading Blocs, Common Markets, and Economic Unions

A regional trading bloc, is an agreement between a group of countries that are geographically close to each other, to reduce and eliminate barriers to trade and movement of factors of production among the members of the bloc. They have zero or very low tariffs on imports from members.

The diagram below shows the various types of regional trading blocs in an increasing order of integration.

8. Capital Restrictions

Key points related to capital restrictions are given below:

Some governments restrict the inward and/or outward flow of capital.
Restrictions on inflows might be due to strategic or defense-related reasons.
During an economic crisis, capital might flow out of the country.
Countries with scarce foreign exchange might restrict outflows and might also want to boost local investment.
Over the long term, capital restrictions reduce welfare.