International Trade

Chapter 33

Why Nations Trade

Natural Resources U.S. has a lot of fertile soil Southwest Asia has large oil and natural gas

reserves Resources, climate, and location determine what

goods and services economies produce

Why Nations Trade

Human Capital Literacy rate – percentage of people over 15 who

can read and write Countries with high literacy rates: educated,

skilled work force

Why Nations Trade

Physical Capital Factories, machinery, computers, roads and

bridges

Specialization

When nations decide to produce only certain goods and services, rather than producing all the goods ad services they need

Determined by its natural resources, human and physical capital

U.S. grows wheat and soybeans, but we can’t produce diamonds or coffee

Absolute and Comparative Advantage

Absolute Advantage – when a country can produce more of a given product using a given amount of resources (they are simply better at producing something) Even if we have an absolute advantage in producing

everything, does that mean we shouldn’t trade with another country?

Absolute and Comparative Advantage

…not necessarily! We need to look at comparative advantage.

When a country has comparative advantage, they can produce a good at a lower marginal cost than another country (David Ricardo’s idea).

In other words, they give up less in order to produce that good.

France and Germany’s production possibilitiesFrance and Germany’s production possibilities

France and Germany’s opportunity costs (what they give up)

France and Germany’s opportunity costs (what they give up)

Wine Cheese

France 6 2

Germany 2 1

Wine Cheese

France

Germany

Finding Comparative Advantage

France has the absolute advantage in both wine and cheese (they are better at both).

Who has the comparative advantage in wine? In cheese?

Comparative Advantage for Input Problems

If the problem is expressed in terms of how many HOURS it takes a person/country to produce something, then you calculate opportunity cost the opposite way.

Gains from Trade

Terms of trade – the exchange rate between two goods (ex: 2 bananas for 30 grapes)

Gains from trade – the additional amount of goods a country has after specialization and trade in comparison with the combination before specialization and trade. (ex: a country may gain 5 bananas relative to the total amount it had when producing only with its own resources)

Gains from Trade

Oats Bagpipes

U.S. 3 2

Scotland 4 5

Oats Bagpipes

U.S. 3/2 2/3

Scotland 4/5 5/4

How do Americans feel about Trade?

Statement A: The United States needs to focus on keeping American jobs for American workers. Each time an American corporation agrees to send work outside the country, the company also gives away jobs. In the end, even if some new business is created for American exporters, free trade is not worth it because local jobs are lost.

How do Americans feel about Trade?

Statement B: Today large companies that intend to sell their products to worldwide customers must also operate worldwide. Just as American companies build plants in foreign countries where they sell their products, foreign companies build plants in the United States so they can sell their products here. In the end, free trade is worth it because foreign companies and our exports create jobs here.

When asked different questions about international trade…

57% believed that international trade was good for the U.S. economy. 39% said it was bad.

67% said they had a very or somewhat favorable opinion of international trade.

79% agreed that “freer trade helps to increase prosperity, both in the U.S. and in other parts of the world.”

Arguments FOR free trade

Improved product selectionLower prices for consumer productsPromotes good relations between countries

Arguments AGAINST free trade

Benefits are not equally distributed Helps the rich but hurts workers LOSS OF JOBS

Bad for the environmentConcerns about international labor standardsTrade is unfair to poor countriesOther countries benefit more than the U.S.

Trade Barriers and Agreements

Barriers to Trade

There are three main types of barriers to trade. They are:

(1) Tariffs(2) Export Subsidies(3) Quotas

Tariffs

Tariff – a tax on imported goods What goods do you know of that the U.S. places

tariffs on?The U.S. places tariffs on steel, foreign-

made cars, and many other products

Export Subsidies

Export Subsidies - government payments to domestic firms to encourage exports (foreign companies not subsidized can’t compete with the artificially low prices)

What is dumping? – when a firm or industry sells products on world market at prices below cost of production to dominate the market After competition driven out, they raise prices Recently accused: Japanese automobiles,

electronics, silicon computer chips

Quotas

Quota – limit on the quantity of imports (mandatory or voluntary) U.S limits amount of cotton coming into the

country each year Ex: China can only export 621,780 kilograms

Voluntary Export Restraint (VER) - a voluntary limitation on the number of products that a country ships to another country Japan agreed in 1981 to reduce automobile exports to

U.S. by 7.7% to 1.68 million units Why would a country volunteer to decrease its exports to

another country? Reduce the chances that the importing country will set up trade

barriers

Less formal trade barriers…

Can you think of some other, less formal ways that countries limit imports? Sometimes governments will require foreign

companies to get a license to sell (high licensing fees or slow processes)

Health and safety regulations (ex: won’t import anything with insecticides used)

Arguments for Free Trade: Effects of Trade Barriers

(1) Effect on pricesFirst, trade barriers limit supply. Who benefits from the quotas put on cotton imports?

Why? American cotton growers because U.S.

manufacturers of jeans / cotton clothing will have to buy some cotton grown in the U.S.

What happens to prices when there are trade barriers, such as tariffs on foreign cars? They go up

Who benefits from this? Domestic producersWho loses? Domestic consumers

Arguments for Free Trade: Effects of Trade Barriers

(2) Effects on international relations What is a trade war? One country restricts imports, so trading partner imposes

more restrictions – a cycle of increasing trade barriers What problems did the trade war that resulted from the

Smoot-Hawley tariff cause for the U.S. in the 1930s? Raised average tariff on all products to 50% (trying to

protect American jobs) other countries responded by raising tariffs against

American-made goods decreased international trade, (esp. demand for our goods)

and made worldwide depression much worse

Arguments for Free Trade: Effects of Trade Barriers

See graph

Arguments for Protectionism

What is protectionism? the use of trade barriers to protect industries from

foreign competition

Protectionism

Protecting JobsWhen we buy foreign goods, American goods

go unsold. Ideally, people would get jobs in other industries, but this is difficult in reality for some people.

The question is: Are we willing to pay premium prices to save domestic jobs in industries that can produce more efficiently abroad?

Protectionism

What other ways could we help victims of free trade? Retrain them for jobs with a future Programs to relocate people in expanding regions If East Asia has a comparative advantage in producing

textile and the U.S. reduced tariffs on these imports, what might happen? American textile manufacturers may not be able to compete

with East Asian imports – lay off workers. In an ideal world, what would laid-off textile workers do?

Take new jobs in other industries In reality, why doesn’t this always happen?

Retraining and relocation is difficult – takes time and money.

Some Countries Engage in Unfair Trade Practices

Cheap Foreign Labor Makes Competition Unfair

Protection Safeguards National Security

Protection Safeguards National SecurityWhat industries does the United States want to

ensure remain active? anything essential to defending our country – need steel

and other products from heavy industries; need industries that provide energy and advanced technologies

Why do most people agree that these types of industries need to be protected?

Don’t want to depend on other nations during a crisis … Protection Discourages Dependency

Protecting Infant IndustriesWhat is an infant industry?

A new industryWhat is the argument for temporarily protecting

them? new industries need time and practice to become

efficient producersDoes it always work out for these industries and for

consumers? (1) A protected infant industry lacks incentive to become

more efficient and competitive (2) it’s difficult to take the protection away

International Agreements

An international free trade agreement is when at least two countries cooperate to reduce trade barriers and tariffs and to trade with each other.

MFN – now NTR – what does this mean? Normal trade relations status All countries with this status pay the same tariffs

The World Trade Organization (WTO) Founded in 1995 to negotiate new trade

agreements and to resolve trade disputes Acts as a referee – enforces rules (Beef war

between U.S. and European Union)

Economic Integration

The European Union Abolished tariffs and trade restrictions among union

members Adopt uniform tariffs for nonmembers Developed slowly over time Single currency: the euro

NAFTA (North American Free Trade Agreement) Eliminate all tariffs and other trade barriers between

Canada, Mexico, and U.S. A lot of controversy

Exchange Rates

Exchange rate – the value of a foreign nation’s currency in relation to your own currency 1 U.S. dollar : 0.762 Euros 1 U.S. dollar : 1.004 Canadian dollars 1 U.S. dollar : 98.95 yen These go up and down daily

Why would you want to know an exchange rate?

If you are traveling to a country, you need to know how expensive items are (in terms of your own currency)!

It affects imports/exportsAny other reasons?

Strong and Weak Currencies

Appreciation – an increase in the value of a currency The currency becomes “stronger” In scenario B, your U.S. dollar could now buy more

pesos, so it has increased in value or appreciated against the peso

When the dollar appreciates, American goods are more expensive for Mexican consumers Mexico will import fewer products from the U.S. Our exports will probably decline

When the dollar appreciates, it also means that foreign products are less expensive for American consumers

We will import more of these cheaper goods

Strong and Weak Currencies

Depreciation – a decrease in the value of a currency The currency becomes “weaker” In scenario C, your U.S. dollar could now buy fewer

pesos, so it has decreased in value or depreciated against the peso

When the dollar depreciates, foreign consumers can afford our products better because their currency can buy more dollars Mexico will import more products from the U.S. Our exports will increase

It also means that foreign products are more expensive for us to buy with our weaker dollars We will import less of these more expensive goods

Foreign exchange market – take care of the buying and selling of foreign currencies

About 2,000 banks and financial institutionsLocated around the world, including New

York, London, Paris, Singapore, Tokyo, and many other cities