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Posts Tagged ‘microeconomics’

The term “beggar thy neighbor” refers to protectionism policies which have become more popular in this economic crisis. Due to heavy deflation, which causes unemployment and illness of the domestic market, some countries have to carry out policies seeking for their own benefits first, rather than to contribute to the global economic balance and stability.

As opposed to free trade, protectionism restrains trade among nations. Those policies aim to enhance domestic market and to reduce the rate of unemployment. Protectionism governments might impose either tariffs or quotas on imports to restrain imports and by doing so, they shift demand onto domestic production. Two instances are from Mexico and Russia. Another measure which is often used by protectionists is to devaluate the domestic currency, or to use exchange rate manipulation. Doing so will raise the cost of imports and lower the cost of exports, thus improve that country’s trade balance. (Noted that this policy can lead to inflation.) China is one of the recent examples that use this policy.

The benefits of free trade can be explained by David Ricardo’s comparative advantage theory, as the illustration below.

P[world] is the original price of the product and P[tariff] is the higher price after imposing a tariff. Because of the tariff, a tax revenue is created and consumer surplus decreases by a higher rate than the increase of producer surplus. As a result, there is societal loss as the two pink pieces.

In this crisis, a cure for the economics downturn is to inhance the global trade, which was predicted two days ago in the WTO’s most pessimistic report in its 62-year history. This report estimates that the global trade will slump by 9 per cent in this year and the falling rate in developed countries will be higher than that of developing ones, which is just 2-3 percent. Therefore, protectionism policies as a barrier against free trade should be prevented by all the countries. According to World Bank, it is estimated that 17 of the 20 countries coming to London on April 2 had already broken free-trade promises. So, the firm stand against protectionism which many expect the G-20 to take seems having lack of the support from its own members.

Update (27/3): Hanoi plans to support its export by widening the daily trading band for VND, which means allowing the dong to deppreciate faster. (@Financial Times)

An excise tax or excise duty is a special type of tax imposed on products in domestic market, as opposed to customs tax charged on foreign products. The word “excise” and the idea of tax was derived from Dutch.

Whenever a government is about to raise the excise tax, it must concern considerably about which products to tax, particularly based on their elasticity of demand. An increasing price resulted from the use of excise tax will affect the quantity demanded of that product. If the demand is elastic, such as the demand of necessity goods, higher excise tax will bring less revenue because a given percentage increase in price results in a larger percentage decrease in quantity demanded. Otherwise, excise taxes levied on goods with relatively inelastic demand will bring more revenue. It is not suprising, then, that typical example of excise taxes are taxes on alcohol, tobacco and petrol.

Let’s examine more specifically on just these above-mentioned products.

In positive consequences, excise taxes on tobacco and alcohol are beneficial for two main reasons. By the use of excise taxes, the government will raise new revenue, as we have discussed above. In addition, the quantity demanded of these products will fall and this consequence protects people from harming their health by abusing substances such as alcohol and tobacco. In this point, we can call excise tax sumptuary tax/Pigovian tax, a kind of tax aimed to correct the market outcome/activities. Adam Smith, a classical economist, indicates:

The motive for the implementation of excise should be nothing more than to curb the pursuit of goods and services harmful to our health and morals.

Nevertheless, excise taxes as a law enforcement to reduce the amount of harmful goods also bring negative effects. As in case of heroin, the higher price of those products the more flourishing black markets and the more expenditures the addicts have to spend. As a result, social crime committed by addicts, such as shoplifting, burgaly, prostitution, muggings and so on, will increase.

Therefore, although it is about raising the price by the use of excise tax, the government should attempt to reduce the consumption rather than to restrict the supply of those products.