More imports => lower exchange rate => exporting becomes more profitable => we do more of it. To do more of it, exporters reduce their prices (slightly).

The argument regarding the exchange rate is a red herring. Yes there are plenty of other things going on. Always have been. Always will be. If we have a wages boom or cut wages by 20% tariffs would also be a small part of the relative story for producers and importers. So what?

Tariffs are a combination of consumption tax and rent and so the general benefit comes from the reduction in the rent and the missing tax could be made up with a different tax. Even a general tariff produces something of a rent because it benefits manufacturers focusing mainly on the local market at the expense of everyone. But a small general tariff to pay for AQIS etc seems like a good idea to me.

Yesterdays drop in the currency did more for Holden than any tariff retention could. don’t know how much ford and toyota export.

It’s true, it’s basically impossible to estimate the long run elasticity of export demand with any accuracy - so you have to go with your best guess. Ten is a big number.

Below is an extract from the discussion on elasticities of export demand our paper.

Your point about double counting is a reasonable one, but we discussed that and concluded that the whole cost of replacing the revenue from the tariff was not accommodated in the normal modelling.

It is certainly not surprising that export elasticities of demand are very high for numerous Australian export commodities. Australia occupies a small fraction of the world economy and accordingly enjoys a small market share in most of the markets into which it exports. Where commodities are relatively homogenous and export market shares are small, this is a recipe for very high elasticities of export demand. Australia is very close to being a ‘price taker’ in world markets, selling as much as it is able to export at the world price without having much effect on it.

It is true that in many commodities, Australia is a substantial exporter. But in many commodities Australian exports are competing not just with exports from other countries but also with domestic production in the export market. Thus for instance Australia is a substantial sugar exporter exporting over 4 million tonnes. Yet world consumption of sugar is over thirty times this figure.
In such circumstances and in the absence of convincing empirical estimates, it seems likely that export demand for Australia’s sugar is highly elastic. Then again, with one thirtieth of the world market, how much would one need to lower prices to double our exports? Would export demand be more elastic than -12 which implies that one would need to lower prices by a little over 5%? It is not clear that it would be this high. Then again, we cannot be sure that it is not higher.

But even a commodity like sugar provides an important ‘reality check’ on our thinking. Because, if Australia’s export markets were all like the market into which we export our sugar, and its elasticity of export demand was -12, as we have seen, the tariff rate at which a tariff reduction program goes from helping our economy to harming it is 1/(1+e) = 1/(1-12) = 9.1%.

In other words making fairly moderate assumption that all export markets exhibit an elasticity of export demand of -12, the current rate of automotive tariffs is already around the optimal point, and a move to 5 or even 7.5% will harm Australia more through its effect on our export prices than it will benefit us with a more efficient production base. Indeed, if we take automotive tariffs as being at an average rate of around 8% as is suggested in the attached paper, it may be that we have already cut tariffs beyond the optimal point.

We stress that modelling such as that undertaken in this study – like most economic modelling – should not be taken as more than broadly indicative. As a result we would be cautious about using it to conclude that we should increase tariffs on motor vehicles or other commodities. But it should give us pause that the clearest thinking we can do suggests that a course of action which many commentators take as a precondition of good policy intent – a kind of a badge of policy seriousness – seems more likely to harm than help our economy.
And yet the assumptions on which we arrived at an optimal tariff of 9.1% (or somewhat higher in some plausible MONASH simulations) seem to place the arguments for further reductions of tariffs in their best light. In fact however, the evidence is overwhelming that Australia’s average export elasticity is substantially below the elasticity of export demand for sugar and similar relatively homogeneous commodities.

Markets in which elasticity of export demand is not very high

Australia’s most substantial export commodities by a substantial margin, and certainly at current prices, are iron ore and coal. In each case there is evidence that export demand is substantially less elastic than it would be for sugar. Thus for instance in iron ore, Australia is a massive exporter along with Brazil, but Australia’s iron ore enjoys freight advantages into China over Brazil which have grown substantially in recent years. Australia also exports some very high quality iron ore. As a result, the elasticity of export demand for iron ore seems unlikely to be very high. In one study of Australian exports to China (Tcha and Wright, 1999, p. 147) it was found that “when the relative real price of iron ore between Australia and the world average increases by 1%, China reduces its imports of iron ore from Australia by about 1.13%”.

In the case of coal, Australia is a major exporter. However although Australian coal represents around 20 percent of the world’s coal exports this volume makes up only a little more than 5 percent of the world’s coal production. With relatively high costs of transport as a share of value, coal is not as highly traded as many commodities. However, as one would expect, trade is much more prominent in specific types of coal, particularly higher value coal. Thus for instance Australia produces very highly valued metallurgical coal and is the dominant global exporter of metallurgical coal. It is hard to imagine that our elasticity of export demand is particularly high in this circumstance.
With iron ore and coal being Australia’s largest export industries, education and travel are the next biggest respectively. Each of these areas is characterised by finely and qualitatively differentiated product offerings and thus to very imperfect competition. In each area it seems most unlikely that elasticities of export demand are very high.

Export elasticities in the area of tourism were last subject to substantial public scrutiny during the debates over the GST in 1999. There, the export elasticity of demand for tourism was assumed to be in the vicinity of -2 to -3, not -8 or -16. Those championing the GST at the time argued that the figure was even lower again than the figures used in the MONASH and Murphy modelling.
Other commodities likely to be characterised by lower elasticities of export demand include fine wool (because of our high share of world fine wool markets), beef (because we are a major exporter and some of our exports face trade barriers including quotas which apply specifically to Australian exporters) and natural gas (because of high transport costs limiting exports to the region). These comprise another 5% of our total exports each of which would be likely to have elasticities of export demand that were lower than commodities more generally.

In summary, commodities which cannot be expected to have very high elasticities of export demand elaborated above amount to somewhere between 15-20% of our total exports. In addition services amount to 22% of exports and elaborately transformed manufactures contribute another 14% (DFAT – STARS database.)
In other words, over fifty percent of Australia’s exports face elasticities of export demand that are substantially lower than the textbook cases in which Australia exports a homogenous commodity with very low export market shares. Recent and expected price rises for iron ore and metallurgical coal bring the figure to over 60%.

I’m still not sure that our long run pricing power in commodities is significant - the time series econometrics can really only pick up the short run quantity responses. These are always much higher than the long run ones because we have competitors who will eventually react.

But why single out cars? It seems to me you’re only making a case for a low and broad-based tariff (with consequent effects on the exchange rate), rather than one that picks out a single narrow import sector. Even if the optimal rate of the broad-based tariff was 11%, it doesn’t follow that the optimal rate of a narrow based one is, because a narrow tariff will only have a muted effect on the exchange rate while causing the internal distortions of resource use that traditional theory predicts.

I think your penultimate sentence may be double counting, BTW - the conventional comparative static net welfare calculations of tariffs implicitly includes the transfer of consumer and/or producer surplus to the tariff imposer (ie the government).

It might be better to have the debate without cutout figures like ‘monopoly’.

You don’t need monopoly. You just need to believe in the proposition that you’re in a market where you can’t expand your exports without (slightly) cutting their price. That’s a completely mainstream assumption. I know of no modellers of the Australian economy who don’t just make that assumption in their modelling but who don’t also believe it.

The PC’s modelling assumes that this parameter is 10 - ie that for each one percentage point of price reduction we get a ten percentage point expansion in sales. I’d guess it’s a bit lower than that - say 6-8 and Peter Dixon (thinks it’s closer to 4). But let’s go with the PC’s latest preference. That makes the optimal tariff 11%. The current auto tariff, which we will shortly announce unilateral intention to cut, is 10%. So it will reduce welfare by a small amount. And that’s before you scrabble round trying to collect the revenue that it gives away - imposing additional costs.

Go figure.

- the traditional view, founded in some rigorous logic, that tariffs always cause you a net loss in income, no matter what others do. So you cut them no matter what others do.

(Personally I agree with this but unlike Harry I think our current tariffs are so small that it’s not a big issue anyway).

- Nic’s view, only slightly less traditional and just as logically rigorous, that if your exports are monopolies or near monopolies you can make an extra buck by keeping some tariffs, no matter what others do. So you keep them no matter what others do.

(The logic’s fine, but just point us to the export monopolies, Nic).

- the “strategic” one that our tariffs cause us loss in net income but cause others even more loss. So you keep them “temporarily” as bargaining chips in agreements to make others reduce their tariffs.

(This one is beloved of trade negotiators - it gives them a reason for existing. In the real world keeping tariffs makes others more, not less, likely to keep theirs - as you point out.)

Nice to see you back here - I don’t know how you manage to do it but you always turn up with a few views for us whenever I mention this topic.

What do you think of Peter Dixon. Is he reputable?

NPOV,

You have the wrong end of the stick. The level of others’ tariffs is largely irrelevant to the argument except in the specific way in which they were brought into the discussion. That is, there is no case for cutting tariffs below some level unilaterally because the result will bring more costs than benefits (this is regardless of others’ tariff levels). The exception is that if it helps us get access to others’ markets - if its part of a deal in which they cut tariffs reciprocally with us, then the costs of reducing our tariffs are lower and the benefits greater and we should go further. But if tariffs were higher, there would be a strong case for cutting unilaterally. The point is however that the level of others’ tariffs does not enter directly into the question of whether there’s a good case for reducing our own tariffs - what’s relevant to the unilateral case is (generally) the level of one’s own tariffs.

“In the next few weeks the Federal Government will lower tariffs for cars and apparel even though simple economics says tariffs shouldn’t fall further unless matched by our trading partners. Why? Because if we cut tariffs we import more – that’s the point of the exercise. And to pay for those imports we export more. And exporting more will slightly cut our export prices. Bearing that small cost is fine if we’re reducing high tariffs, but low tariffs impose miniscule costs, and they raise revenue that will have to be raised some other (costly) way.”

Simple economics? My ass. There is no presumption in international trade theory that a small country such as Australia should condition tariff reductions on tariff reductions by neighbours. What you are recycling is your idiosyncratic and absurd theory that because Australia has price setting power in export markets and does not exploit this power, by setting an optimal tariff that this failure can be redressed by imposing low tariffs on imports.

Even if I was wrong in my claims (and I am not) there is no way that this is ’simple economics’. It is absolutely not ’simple economics’.
At best it is idiosyncratic economics.

It is also just wrong because what you are suggesting is that the factor substitutions that would be engendered by a tax on exports will be equivalently achieved by input shifts resulting from a tariff on imports. That’s wrong in fact - restricting exports by an optimal tariff will not shift resources in the same way that a tax on imports will in an economy with more than two economic sectors - and doubly wrong because of the a priori assumption you make that monopolies governing our mineral exports are not already extracting rents. If monopoly power captures these rents then an optimal tariff on these exports is redundant anyway.

There is not a reputable international economist in Australia who would agree with your views and I wonder about your motives for expressing them. Is there a commercial interest or just a pig-headed insistence that a theory that you espouse which would have zero support from anyone who knows anything about trade is right regardless of the illogic?

The article is a harmful input (one repeated many times before) into Australian trade policy debate.

I asked one of Australia’s most prominent trade theorists about your earlier attempt to rescue protectionism and before I got half way through my inquiry he said ‘Don’t tell me its one of these silly ‘optimal tariff’ arguments. But in the end it was and I felt embarrassed that I even wasted 10 minutes of his time with the inquiry.

Try another line in op-eds. Perhaps one that doesn’t draw on international trade theory.