INTERNATIONAL TRADE 10 TOPIC
Silk Routes and Sucking Sounds Since ancient times, people have expanded trading as far as technology allowed Marco Polo s silk route between Europe and China is an example. Many people fear free trade because they think that domestic industries may suffer. Some predicted a giant sucking sound as jobs were transferred from high-wage Ohio and Michigan to low-wage Mexico under the NAFTA. Why do we trade with other nations? Do tariffs that restrict trade bring any benefits? Do they bring costs? Who gets the benefits, who bears the costs?
Patterns and Trends in International Trade Imports are the goods and services that we buy from people in other countries. Exports are the goods and services we sell to people in other countries.
Patterns and Trends in International Trade Net Exports and International Borrowing The value of exports minus imports is called net exports. As we know, negative net exports imply international borrowing. Positive net exports on the other hand imply international lending.
The Gains from International Trade Comparative advantage is the fundamental force that generates trade between nations. The basis for international trade is different opportunity costs in different countries. Nations can increase their consumption of goods and services when they allocate resources to the production of those goods and services for which they have a comparative advantage.
The Gains from International Trade Opportunity Cost in Farmland This Figure shows the production possibilities frontier for an imaginary country called Farmland.
The Gains from International Trade Without international trade, Farmland produces and consumes 15 billion bushels of grain and 8 million cars at point A. The opportunity cost of a car is 9,000 bushels of grain.
The Gains from International Trade Opportunity Cost in Mobilia This Figure shows the production possibilities frontier for another imaginary country called Mobilia.
The Gains from International Trade Without international trade, Mobilia produces and consumes 18 billion bushels of grain and 4 million cars at point A'. The opportunity cost of a car is 1,000 bushels of grain.
The Gains from International Trade Comparative Advantage Cars are cheaper for Mobilia to produce than for Farmland, because less grain is given up to produce each car. Grain is cheaper for Farmland to produce than for Mobilia because fewer cars are given up to produce each bushel. A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country. Farmland has a comparative advantage in producing grain, and Mobilia has a comparative advantage in producing cars.
The Gains from International Trade The Gains from Trade: Cheaper to Buy Than to Produce If Mobilia bought grain for the price that Farmland produces it, Mobilia could buy 9,000 bushels of grain for 1 car a much lower price than the opportunity cost of producing grain in Mobilia. If Farmland bought cars for what Mobilia pays for them, Farmland could buy 1 car for 1,000 bushels of grain a much lower price than the opportunity cost of producing cars in Farmland.
The Gains from International Trade The Terms of Trade The quantity of grain that Farmland must pay Mobilia for a car is called Farmland s terms of trade with Mobilia. This Figure shows how the forces of international demand and supply determine the terms of trade and the volume of trade.
The Gains from International Trade With no international trade, Mobilia can produce a car for 1,000 bushels of grain, so at that price, it plans to sell no cars to Farmland. But as the price rises above 1,000 bushels of grain per car, the quantity of cars supplied by Mobilia increases.
The Gains from International Trade With no international trade, Farmland can produce a car for 9,000 bushels of grain, so at that price, it plans to buy no cars from Mobilia. But as the price falls below 9,000 bushels of grain per car, the quantity of cars demanded by Farmland increases.
The Gains from International Trade The equilibrium terms of trade (price) is 3,000 bushels of grain per car and 4 million cars are exported by Mobilia and imported by Farmland.
The Gains from International Trade Balanced Trade The number of cars exported by Mobilia equals the number of cars imported by Farmland. Farmland pays Mobilia with 12 billion bushels of grain (four million cars multiplied by 3,000 bushels for each car) Mobilia imports and Farmland exports 12 billion bushels of grain. Trade is balanced. For each country, the value of exports equals the value of imports 4 million cars are worth the same as 12 billion bushels of grain.
The Gains from International Trade Changes in Production and Consumption Farmland buys cars at a lower price than it would pay if it made them itself, and sells its grain at a higher price. Mobilia buys grain at a lower price than it would pay if it grew the grain itself, and sells its cars at a higher price. Everyone gains from trade. The production possibilities frontier illustrates the production possibilities of a country, but it does not show the consumption possibilities of a country that engages in international trade.
The Gains from International Trade This Figure shows how both countries gain from trade.
The Gains from International Trade Calculating the Gains from Trade Farmland increases its consumption of both cars and grain by decreasing car production and increasing grain production until its own opportunity cost of producing cars equals that of the world terms of trade and exchanging grain for cars at those terms of trade. Mobilia increases its consumption of both cars and grain by increasing car production and decreasing grain production until its own opportunity cost of producing cars equals that of the world terms of trade and exchanging cars for grain at those terms of trade.
The Gains from International Trade Gains for All Both countries gain by consuming output combinations outside their respective production possibilities frontier. Overall, trade does not create winners and losers; it creates only winners. Farmers selling grain and Mobilians selling cars face increased demand and higher prices. Farmers buying cars and Mobilians buying grain face increased supply and lower prices. But how about farmers in Mobilia and autoworkers in Farmland? They may lose
The Gains from International Trade Gains from Trade in Reality Gains from trade occur in the real global economy. The United States buys, e.g., TVs and Blue Ray players from Korea, machinery from Europe, and fashion goods from Hong Kong, in exchange for, e.g., machinery, grain, lumber, airplanes, computers, movies and TV shows, and financial services. Everyone who buys these things gains from trade, because they get them cheaper than they otherwise would. The combination of diverse preferences and economies of scale also create comparative advantages that generate large volumes of international trade in similar but differentiated products.
International Trade Restrictions Governments restrict international trade to protect domestic producers from competition by using two main tools: Tariffs Nontariff barriers A tariff is a tax that is imposed by the importing country when an imported good crosses its international boundary. A nontariff barrier is any action other than a tariff that restricts international trade. Here, we will discuss quantitative restrictions or quotas. There are many, many, other NTB s in the real world, e.g., Thousands of detailed health, safety, and other regulations restrict international trade.
International Trade Restrictions How Tariffs Work This Figure shows the effect of a tariff on imports. Tariffs increase the price that consumers of the importing country must pay for imported goods or services.
International Trade Restrictions How Quotas Work A quota is a quantitative restriction on the import of a particular good, which specifies the maximum amount of the good that may be imported in a given period of time. Importers profit by buying at a lower price than the price at which they sell.
The Case Against Protection Despite the fact that free trade promotes prosperity for all, trade is often restricted. It is often argued that international trade should be restricted to Protect national security Protect infant industries Punish dumping None of these arguments are convincing in the vast majority of cases.
The Case Against Protection Other fatally flawed arguments for protection are that it: Saves jobs Allows rich countries to compete with cheap foreign labor Penalizes nations with lax environmental standards Protects national culture Prevents rich nations from exploiting poor ones
The Case Against Protection The National Security Argument The national security argument is that a country must protect domestic industries that make defense equipment and armaments, and those industries that provide the raw material necessary for defense production. The argument is flawed for two reasons: (1) In time of war, there is no industry that does not contribute to national defense, so it is a plea for economic isolation. (2) It is less inefficient to subsidize defense than to restrict trade with a tariff.
The Case Against Protection The Infant-Industry Argument The infant-industry argument is that it is necessary to protect a new industry from import competition to enable it to grow into a mature industry that can compete in world markets. This argument is based on the concept of dynamic competitive advantage, which can arise from learning-bydoing.
The Case Against Protection Learning-by-doing is a powerful engine of productivity growth, but this fact does not justify protection. If learning-by-doing would lead to comparative advantage, producers should be willing to invest in the learning to reap the later profits. Government action is only needed to encourage learning-bydoing when its benefits spill over to other parts of the economy, so those who invest in the learning cannot capture all the benefits as later profits. And even in this case, it is more efficient to subsidize an infant industry than to protect it by restricting trade.
The Case Against Protection The Dumping Argument Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production. Dumping is seen as a justification for a tariff to prevent a foreign firm from driving domestic firms out of business and then raising its price. This argument is flawed because: (1) It is very hard to determine a firm s costs; and (2) If there ever was a natural global monopoly, it would be more efficient to regulate it than to impose a tariff against it. Note that both WTO and US law permit anti-dumping tariffs in specific circumstances but such cases are always controversial.
The Case Against Protection Saves Jobs The idea that buying foreign goods costs domestic jobs is wrong. Trade destroys some jobs, but creates other usually better -- jobs. It also increases foreign incomes and enables foreigners to buy more of what we produce. Protection to save particular jobs is very costly.
The Case Against Protection Allows rich countries to Compete with Cheap Foreign Labor The idea that a high-wage country cannot compete with a lowwage country is wrong overall. Low-wage labor is usually less productive than high-wage labor that is in part why it is low-wage. The difference in production speed and quality is there. Because of the demand for differentiated products and the existence of high-end consumers especially in high-wage countries, highwage country is able to compete with low wage country.
The Case Against Protection Penalizes Lax Environmental Standards The idea that protection is necessarily good for the environment is wrong. Higher environmental standards are definitely normal goods, the demand for which rises with income. Free trade increases incomes and poor countries tend to have significantly lower environmental standards than rich countries. These countries are likely to buy a better environment as their incomes rise.
The Case Against Protection Protects National Culture The idea that trade restrictions necessarily protect the national culture is wrong. This argument is not heard in the United States as much as it is heard in Canada and European countries, and elsewhere. Many countries are afraid of the Americanization of their culture through the prominence of American films, television programs, art, literature, and even cuisine in world markets. Many countries, including the US, limit foreign ownership of radio and TV stations. Foreign countries often limit imported programs on TV, and imports of movies. A culture, if it is strong enough, which most cultures are, can sustain. We can see different cultures sustaining in harmony. Exposure to other cultures in fact has the potential to enrich own culture.
The Case Against Protection Prevents Rich Countries from Exploiting Poorer Countries The idea that trade restrictions prevent rich countries from exploiting poorer countries is kind of silly. Free trade is the best way of raising wages and improving working conditions in poor countries.
The Case Against Protection The most compelling argument against protection is that it invites retaliation. We saw retaliation to the Smoot-Hawley Act in the United States during the Great Depression. In a speech delivered on March 25, 2013, the formal FED chair and prominent economist Ben Bernanke said: Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression.
Why Is International Trade Restricted? The two key reasons why international trade is restricted are Tariff revenue Rent seeking
Why Is International Trade Restricted? Tariff Revenue It is costly for governments to collect taxes on income and domestic sales. It is cheaper for governments to collect taxes on international transactions because international trade is carefully monitored. This source of revenue is especially attractive to governments in developing nations. In the 19 th century it was important in the US.
Why Is International Trade Restricted? Rent Seeking Rent seeking is lobbying and other political activities that seek to capture the gains from trade. Free trade increases consumption possibilities on the average, but not everyone shares in the gain and some people even lose. Free trade brings benefits to some and imposes costs on others, with total benefits exceeding total costs. It is the uneven distribution of costs and benefits that is the principal source of impediment to achieving more liberal international trade. Despite the fact that protection is inefficient, governments respond to the demands of those who gain from protection and ignore the interests of those who gain from free trade because protection brings concentrated gains and diffused losses.
Why Is International Trade Restricted? Compensating Losers The gains from free trade exceed the losses, but the losers typically are few and would lose a lot each, and the gainers are often many, would gain little each, and usually don t know what protection costs them. Sometimes free trade agreements address the issue of the distribution of gains from trade by compensating those who lose from free trade.