CHAPTER 16 International Trade

In This Chapter You Will Learn Learning Objective 16.1: Some key facts about Canada s international trade Learning Objective 16.2 : About specialization, comparative advantage, and international trade Learning Objective 16.3 About supply and demand analysis of exports and imports Learning Objective 16.4 : About trade barriers and their negative effects on nations economic well-being Learning Objective 16.5 : The usual arguments against free trade Learning Objective 16.6: The role played by free- trade zones and the World Trade Organization (WTO) in promoting international trade Chapter 16 2

16.1 Canada and International Linkages Figure 16-1 International Linkages Goods & Services Canadian Economy Capital & Labour Info & Technology Other National Economies Money LO16.1.1 3

Canada and World Trade Volume Exports are about 35% of Canadian GDP Imports are about 33% of Canadian GDP LO16.1 4

16.1 Global Perspective LO16.1 5

Figure 16-2 Canadian Trade as Percentage of GDP LO16.1 6

Canada and World Trade Dependence Canada almost entirely dependent on other countries for bananas, cocoa, coffee, spices, tea, raw silk, tin, and natural rubber Many Canadian industries rely on sales abroad: agricultural products, computers, chemicals, aircraft, automobiles, etc. LO16.1 7

Canada and World Trade Trade Patterns A trade surplus occurs when exports exceed imports. Canada had a trade surplus in goods in 2008: A trade deficit occurs when imports exceed exports. Canada had a trade deficit in services in 2008 Canada imports some of the same categories of goods that it exports, called intraindustry trade Canada s export and import trade is mainly with other industrially advanced nations LO16.1 8

Table 16-1 Principal Canadian Exports and Imports of Goods, 2008 LO16.1 9

Table 16-2 Canadian Exports and Imports of Goods by Area, 2008 LO16.1 10

Rapid Trade Growth Transportation Technology Communications Technology General Decline in Tariffs LO16.1 11

Participants in International Trade Germany, the United States, China, and Japan had combined exports of $3.6 trillion in 2006 Along with Germany, other western European nations such as France, Britain, and Italy are major exporters Southeast Asian countries of South Korea, Taiwan, and Singapore have combined exports which exceed those of France, Britain, or Italy China with its reintegration of Hong Kong, has quickly emerged as a major international trader LO16.1 12

16.2 Global Perspective 13

The Economic Basis for Trade Why do nations trade? The distribution of resources is uneven Efficient production requires different technologies or resource combinations Products are differentiated as to quality & other non-price attributes LO16.2 14

The Economic Basis for Trade labour-intensive goods land-intensive goods capital-intensive goods LO16.2 15

Specialization and Comparative Advantage The Basic Principle Specialization according to comparative advantage reduces costs This is true even if a nation has an absolute advantage LO16.2 16

Specialization and Comparative Advantage Two isolated nations (Canada and Brazil) 1. Constant Costs straight-line production possibilities curves 2. Different Costs different technology & resources 3. Canada has absolute advantage in both steel and soybeans LO16.2 17

Soybeans (tonnes) Soybeans (tonnes) 30 Production Possibilities Curve Canada Figure 16-3 30 Brazil 25 20 15 12 10 5 18 steel 12 soybeans A 25 20 15 10 4 B 8 steel 4 soybeans 0 5 10 15 18 20 25 30 0 5 8 10 15 20 Steel (tonnes) Steel (tonnes) LO16.2 18

Specialization Based on Comparative Advantage Opportunity Cost Table Country 1 Steel Cost 1 Soybean Cost Canada 1 soybean 1 steel Brazil 2 soybeans.5 steel Who has the comparative advantage in steel? LO16.2 19

Soybeans (tonnes) Soybeans (tonnes) Production Possibilities Curve after specialization, Figure 16-3 30 Canada 30 Brazil 25 20 15 12 10 5 30 steel 0 soybeans A 25 20 15 10 4 0 steel 20 soybeans B 0 5 10 15 18 20 25 30 0 5 8 10 15 20 Steel (tonnes) Steel (tonnes) LO16.2 21

Terms of Trade What will the terms of trade be? Many possibilities For trade to be mutually beneficial the terms of trade must be between each nation s opportunity costs LO16.2 22

Terms of Trade Opportunity Cost Table Country 1 Steel Cost 1 Soybean Cost Canada 1 soybean 1 steel Brazil 2 soybeans.5 steel for example: 1 steel for 1.5 soybeans gains from trade can be illustrated with trading possibilities line LO16.2 23

Soybeans (tonnes) Soybeans (tonnes) Trading Possibilities Lines and the Gain from Trade Canada Figure 15-4 Brazil 45 40 35 30 1.5 soy for 1 steel 30 25.67 steel for 1 soy 25 20 20 15 12 10 5 0 A Trading possibilities line 5 10 15 18 20 25 30 5 8 10 15 20 Steel (tonnes) Steel (tonnes) 15 10 4 0 B Trading possibilities line LO16.2 24

Table 16-3: Comparative Advantages & the Gain from Trade Canada Brazil steel soybeans steel soybeans Outputs before specialization 18 12 8 4 Outputs after specialization 30 0 0 20 Amounts exported (- ) & imported (+) -10 +15 +10-15 Outputs available after trade 20 15 10 5 Gains from specialization & trade 2 3 2 1 LO16.2 25

Gains from Specialization and Trade Improved Options Added Output LO16.2 26

Soybeans (Tonnes) Soybeans (Tonnes) Economic Basis for Trade 45 40 C (a) Canada 45 40 (b) Brazil 35 30 C Trading Possibilities Line 35 30 25 20 25 20 c Trading Possibilities Line 15 A 15 12 10 A 10 5 0 0 5 10 15 18 20 25 30 5 8 10 15 20 Steel (Tonnes) LO16.2 W 5 4 B B w w Steel (Tonnes) 27

Trade with Increasing Costs A more realistic model: increasing opportunity costs less than complete specialization LO16.2 28

The Case for Free Trade Restated Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources & a higher level of material well-being than without free trade Side benefits: promotion of competition, deterrence of monopoly linking of national interests, reduction of national animosities LO16.2 29

16.3 Supply & Demand Analysis of Exports and Imports When world prices increase relative to domestic prices, domestic exports will increase, resulting in an upward sloping export supply curve When world prices decrease relative to domestic prices, domestic imports will increase, resulting in a downward sloping import demand curve LO16.3 30

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) Cdn. domestic aluminum market $1.75 1.50 Canadian Export Supply and Import Demand, Figure 16-5 S d $1.75 1.50 Cdn. export supply and import demand If the world price exceeds the Cdn. price by 25 cents... 1.25 1.25 1.00 1.00.75.75 D d 50 75 100 125 150 50 100 LO16.3 31

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) Canadian Export Supply and Import Demand, Figure 16-5 Cdn. domestic aluminum market S d Cdn. export supply and import demand $1.75 1.50 SURPLUS = 50 $1.75 1.50 EXPORTS = 50 1.25 1.00 1.25 1.00 If the world price goes further up....75.75 D d 50 75 100 125 150 50 100 LO16.3 32

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) Canadian Export Supply and Import Demand, Figure 16-5 Cdn. domestic aluminum market S d Cdn. export supply and import demand $1.75 1.50 1.25 SURPLUS = 100 $1.75 EXPORTS = 100 1.50 1.25 Cdn. export supply 1.00.75 1.00.75 If world prices fall below $1.25... D d 50 75 100 125 150 50 100 LO16.3 33

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) Canadian Export Supply and Import Demand, Figure 16-5 Cdn. domestic aluminum market S d Cdn. export supply and import demand $1.75 1.50 1.25 $1.75 1.50 1.25 Cdn. export supply 1.00.75 1.00 SHORTAGE = 50 IMPORTS = 50.75 D d 50 75 100 125 150 50 100 LO16.3 34

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) Canadian Export Supply and Import Demand, Figure 16-5 Cdn. domestic aluminum market S d Cdn. export supply and import demand $1.75 1.50 $1.75 1.50 Cdn. export supply 1.25 1.00.75 SHORTAGE = 100 1.25 1.00.75 IMPORTS = 100 Cdn. import demand D d 50 75 100 125 150 50 100 LO16.3 35

Price (per kg. Cdn. dollars) Price (per kg. Cdn. dollars) U.S. Export Supply and Import Demand Figure 16-6 U.S. domestic aluminum market S d U.S. export supply and import demand $1.50 1.25 1.00.75.50 SURPLUS = 100 EXPORTS = 100 $1.50 SURPLUS = 50 EXPORTS = 50 1.25 1.00.75 SHORTAGE = 50 IMPORTS = 50.50 SHORTAGE = 100 IMPORTS = 100 D d U.S. export supply U.S. import demand 50 75 100 125 150 50 100 LO16.3 36

Price (per kg. Cdn. dollars) Equilibrium World Price, Exports & Imports, Figure 16-7 Cdn. export supply World price is where: U.S. export supply =Cdn. import demand 1.25 1.125 1.00 e U.S. export supply Cdn. import demand U.S. import demand 25 LO16.3 37

Equilibrium World Price, Exports & Imports, Two-Nation Model International equilibrium occurs when one nation s demand curve intersects another nation s export supply curve Americans will pay more for aluminum with trade than without it Americans are willing to export aluminum to Canada because they can gain from the trade (to import other goods) Canadian pay less for aluminum with trade. Canadian gain from the trade LO16.3 38

16.4 Trade Barriers Tariffs Revenue tariffs Protective tariffs Nontariff Barriers (NTB) Import Quotas Voluntary Export Restrictions (VER) LO16.4 39

The Economic Effects of a Protective Tariff or an Import Quota, Figure 16-8 price supply open to world markets: p D quantity demanded increases to d p W imports a q d Domestic Market demand quantity quantity supplied decreases to a imports are d-a LO16.4 40

The Economic Effects of a Protective Tariff or an Import Quota, Figure 16-8 tariff p D p T p W price imports a b q c d Domestic Market supply demand quantity effects of a tariff: price rises to p T quantity supplied increases to b quantity demanded decreases to c imports are c-b Copyright 2010 McGraw-Hill Ryerson Ltd. Chapter 15.4 41

The Economic Effects of a Protective Tariff or an Import Quota, Figure 16-8 price supply p D p T tariff revenue = (c-b)x(p T -p W ) =imports X tariff p W imports a b q c d Domestic Market demand quantity LO16.4 42

Economic Impact of Tariffs Direct Effects: Decline in consumption Increased domestic production Decline in imports Tariff revenue Indirect Effects: expansion of inefficient industries at the expense of relatively efficient ones LO16.4 43

Economic Impact of Quotas the same as a tariff, without the tariff revenue for the government foreign firms reap the benefit of higher prices LO16.4 44

Net Costs of Tariffs and Quotas Consumer costs price of imported product goes up some consumers shift purchases from imports to higher-priced domestic goods prices of domestic goods rise gains to protected industries & workers come at the expense of much greater losses for the entire economy LO16.4 45

16.5 The Case for Protection: A Critical Review Self-Sufficiency Argument Diversification for Stability Argument Infant-Industry Argument Counter-arguments: which industries? how long? other methods which are better Strategic Trade Policy LO16.5 46

The Case for Protection: A Critical Review Protection Against Dumping Argument Driving Out Competitors Price Discrimination Increased Domestic Employment Argument job creation from imports fallacy of composition possibility of retaliation long-run feedbacks Cheap Foreign Labour Argument LO16.5 47

The Case for Protection: A Critical Review Summing Up the arguments for protection are not convincing there is compelling historical evidence that free trade has led to prosperity & protectionism has led to the opposite LO16.5 48

16.6 Multilateral Trade Agreements and Free-Trade Zones High tariffs a contributing cause of the Great Depression Reciprocal Trade Agreements most-favoured-nation clauses LO16.6 49

General Agreement on Tariffs and Trade (GATT) First signed in 1947 equal, non-discriminatory trade treatment for all member nations reduction of tariffs by multilateral negotiation elimination of import quotas Eight rounds of negotiations Uruguay Round took effect in 1995 LO16.6 50

World Trade Organization (WTO) successor to the GATT 151 member organization oversees trade agreements rules on trade disputes forum for further rounds of negotiations Doha Round launched in 2001 LO16.6 51

World Trade Organization (WTO) Trade liberalizations implemented by 2005: tariff reductions new rules for trade in services reductions in agricultural subsidies new protections for intellectual property phasing out quotas on textiles & apparel, & replacing them with tariffs LO16.6 52

World Trade Organization (WTO) GATT & WTO have been positive forces for liberalized trade WTO is highly controversial concerns about environment, labour LO16.6 53

The European Union (EU) free-trade zones, trade blocs EU initiated in 1958 as the Common Market Expanded to 27 countries in 2007 nearly all internal tariffs & import quotas abolished common system of tariffs on non-eu goods liberalized movements of capital & labour within the EU common internal economic policies LO16.6 54

The European Union (EU) effects mixed: Canada benefits from increasing prosperity in EU market but trade barriers make it difficult to compete with EU companies the Euro Zone established in early 2000s ends the inconvenience & expense of exchanging currencies LO16.6 55

North American Free Trade Agreement (NAFTA) Canada, Mexico, United States formed a trade bloc in 1993 greatly reduced tariffs tariffs will be eliminated by 2008 concerns about job losses not realized standard of living has been enhanced in all three countries LO16.6 56

The Last Word: Fair Trade Products In economic terms, the purpose of the fair-trade movement is to redistribute more of the total gains from international trade directly to low-income producers and workers by increasing the demand for fair-trade imports. Fair Trade Standards guarantee the producers higherthan-market prices if they agree to pay their workers higher-than-market wages. Economists agree that some of the efforts of fair-trade advocates have succeeded in channelling sizable purchases away from otherwise identical substitutes and toward fair-trade goods.

Chapter 16 Summary 16.1 Canada & International Linkages 16.2 The Economic Basis for Trade 16.3 Supply & Demand Analysis of Exports & Imports 16.4 Trade Barriers 16.5 The Case for Protection: A Critical Review 16.6 Multilateral Trade Agreements & Free-Trade Zones Chapter 16 58