Transcript Slide 1

The Market and International
Trade
What we will discuss today
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A closer look at the illegal drug trade
Some downsides of liberal economic theory
Markets and states: the tension
Markets, states, and the Financial Crisis
What’s the difference between liberals and
conservatives?
• Liberal theory of International Trade
Example: A “spontaneous” Market for Drugs
Efficiency
• In an ideal economic system, goods worth more than they
cost to produce get produced, goods worth less than they
cost to produce do not;
• In a perfectly competitive private property system,
producers pay the value of the inputs they use when they
buy them from their owners
• and receive the value of what they produce when they sell
it. If a good sells for more than it costs to produce, the
producer receives more than he pays and makes a profit;
• if the good sells for less than it costs to produce he takes a
loss. So goods that should be produced are produced
• and goods that should not be produced are not.
Illegality distorts prices
• Hard-to-get drugs means demand is high but
supply is restricted
• Raising the price artificially
• Producers are rational….. So…….
• High prices encourage production
Supply is abundant…..
Production costs are low…..
Processing is easy and cheap….
Demand is High and steady despite
illegality
Market is large
Price should be low because
production is cheap and demand high
Illegality represses demand and
supply, raising the price
So It’s rational to produce cocoa…..
Corn: $150 per
acre
Livestock: few $
per acre
Cocoa: $5-10,000
per acre
What crop
would a
rational farmer
grow?
Cocoa trade is development policy
And rational to sell it…..
What should government do in the face of the rationality of
spontaneous markets? It should ensure competition, not
suppress free markets
• Competition is the best!
• Thus, the state should create laws to
ensure competition.
• It’s the most efficient
Fred Hayek • Ensures the most freedom
• Any other method the state uses to
guide economic activity will create huge
problems. (like making certain activities
illegal)
• If the state doesn’t ensure competition,
monopolies will develop
So the State does have an important
role:
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Limit working hours
Require certain sanitary arrangments
Provide social services
All three fully compatible with competition if
applied to all…..
• The state’s main job is to “create conditions in
which competition will be as effective as possible,
prevent fraud and deception, to break up
monopolies-- these tasks provide a wide and
unquestioned field for state activity. "
Why should the State ensure competition?
Because Monopolies oppose freedom
• Because they limit alternatives for
consumers
• Because they block competitors from
entering a market
• And therefore block freedom of
exchange
• Therefore governments must
determine and eforce rules of
competition……
So…applied to the drug trade: Illegality and high prices
create drug lords with market monopoly. Monopoly
creates…..
Obscene profits for drug lords
Govt. efforts to make the market illegal means
using the military to try to get rid of the market
And imposing Harsh Penalties for
participating in the market
Irrational penalties……
Small drug
Dealers vs.
Reckless
Drivers…
And fostering corruption……
And creating a nightmare of jails filled with casual
drug users…..
All adding up toGovernment
Repression of Freedom
The Economic Liberal believes: The
War on Drugs suppresses Freedom…
Furthermore and by the way…..Alcohol
and Tobacco kill (more) but are legal
Summary:
• People make rational choices to produce and sell
• Rational people create spontaneous markets,
even risking state efforts to destroy markets
• Thus markets are “natural” and should be free
• Exchange should be free
• Price would not be distorted if exchange is free
• Thus states should stay out of markets…..
• Their job is to ensure competition
• They will never be powerful or wise enough to
suppress natural and spontaneous markets
What are the downsides?
Some downsides that Liberal Theory
tolerates
• Markets don’t ensure the same economic
growth for everyone
• inequalities in income and wealth are likely
• Inequality is likely to be tolerated in private
economic relations
• because the growth will make everyone better
off even if there is inequality
That’s the market perspective: what’s the “state”
perspective? Markets undermine state sovereignty
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States and markets have different purposes.
Markets can reduce the functions of the state
They can reduce state power
They don’t recognize territorial boundaries
They destabilize
national society
The liberal’s The Business Cycle (government’s
only role: ensure competition)
•Prosperity
•Transition
•Trough
•Recovery
II. So why the current financial crisis?
Is it just a dip in the business cycle or is it the ABSENCE
of the government?
Fred Hayek again: Remember.The State
does have an important role:
The state’s main job is to “create
conditions in which competition will be
as effective as possible, prevent fraud
and deception, to break up monopolies–
these tasks provide a wide and unquestioned
field for state activity.”
But what happened? Freedom from
Governance…le to a Casino Economy
In the financial crisis, the absence of
Govt regulation led to corruption
Let’s Follow the crisis….
• 3. Deregulation of financial markets
• 4. Easy money 
• easy mortgages as bets on  in housing prices +
• No regulation/ oversight: Run of CDOs and derivatives + borrowing to buy
them (betting on  in value) + rating fraud + easy insurance (AIG)  highly
leveraged banks
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Housing supply overwhelms demand  housing prices fall + mortgage
defaults 
CDOs lose value + Bank stock prices fall  credit drys up  Begin the bailout
 (hopefully) more credit  (hopefully) save businesses and jobs 
(hopefully) economic growth
So the state did not do it’s job, even
according to Liberals…….
• Absolute Freedom is impossible (it’s anarchy)
• So the economy needs to be governed: Does
that mean that markets aren’t natural? Is
there a contradiction in Liberal Theory?
III. let’s clear up come confusions (or at
least make them even more confusing)
• Why are liberals opposed to conservatives?
– Social conservatives – restrict individual freedom
– Social liberals – increase individual freedom
– Political conservatives—increase market freedom
– Economic conservatives—classical liberals
• Political Liberals– evolution of the term
“liberal”
IV.
Liberalism and the International Economy
• A. Goal-efficiency, growth, and good life for
all.
• B. Perspective: The Liberal sees the
international system as the appropriate arena
for economic activity.
• C. Instruments—by which global efficiency
and welfare are to be produced: Comparative
advantage.
Theory of Comparative Advantage
Specialization
+
Trade
Production without specialization and
division of Labor
Wine
Cloth
Engla
nd
3
5 (Total production =8)
Portu
gal
9
6 (Total production=15)
Total goods produced = 23
Production with specialization before
trade
• Before Trade: Resources put where they are
most efficient (specialization
Wine
Cloth
England
1
10
Portugal
16
0
Total goods produced = 27 note: efficiency increases total number of goods available
With Specialization and Trade
England trades Portugal 4 units of cloth for 4 units of wine
Exchange rate is 1 to 1.
Wine
Cloth
England
5
6 (available goods =11)
Portugal
12
4 (available goods =16)
Total goods produced is still 27 but each country is better off than before
trade and both are better off than before “efficiency”
Assumptions of Ricardo’s Theory
• assumes static givens in a country’s economy
• and doesn’t discuss technology as a factor of
production.
• labor theory of value
• What?
David Ricardo 
Labor Theory of Value
• The real price of every thing, what every thing
really costs to the man who wants to acquire
it, is the toil and trouble of acquiring it. What
every thing is really worth to the man who has
acquired it, and who wants to dispose of it or
exchange it for something else, is the toil and
trouble which it can save to himself, and
which it can impose upon other
people.(Wealth of Nations Book 1, chapter V)
Hechscher-Ohlin-Samuelson
modernizes Ricardo
• This model maintains that a nation’s
comparative advantage is determined by the
relative abundance and most profitable
combination of its several factors of
production, such as capital, labor, resources,
management, and technology.
Krugman expands on Hechscher-Olin and
wins Nobel Prize
• Krugman noticed that the accepted model economists used
to explain patterns of international trade did not fit the
data.
– The Hecksher-Ohlin model predicted that trade would be based
on such factors as the ratio of capital to labor, with "capital-rich"
countries exporting capital-intensive goods and importing laborintensive goods from "labor-rich" countries.
• Mr. Krugman noticed that most international trade takes
place between countries with roughly the same ratio of
capital to labor.
– The auto industry in capital-intensive Sweden, for example,
exports cars to capital-intensive America, while Swedish
consumers also import cars from America.
Paul Krugman Defends Free Trade
• "Ricardo's Difficult Idea,”
• People will specialize in producing the goods and
services in which they have a comparative
advantage.
• The result is that we never need to worry about
low-wage countries competing us out of jobs;
• the most they can do is change those goods and
services in which we have a comparative
advantage.
Free Trade leads to growth in Exports
Krugman: Free Trade is the cause of economic
development in poor countries
• “The raw fact is that every successful example
of economic development this past century-every case of a poor nation that worked its
way up to a more or less decent, or at least
dramatically better, standard of living--has
taken place via globalization; that is, by
producing for the world market rather than
trying for self-sufficiency.” (Krugman in Slate
1999)
Comparative Advantage is Dynamic
• While the United States has long imported oil and
other raw materials from the third world, we used to
import manufactured goods mainly from other rich
countries like Canada, European nations and Japan.
• But recently we crossed an important watershed: we
now import more manufactured goods from the third
world than from other advanced economies. That is, a
majority of our industrial trade is now with countries
that are much poorer than we are and that pay their
workers much lower wages (Krugman 2007)
Sum: Effects of Free Trade
• Efficiency  Growth  Good life for everyone
• Harmonious International Relations
• Role of the State: To let producers produce most
efficiently—to separate politics and economics:
• the key actors for liberals are firms and
consumers, not states.
• Commerce  Peace Why?
• Efficiency should be the basis of all political
relations
• Does Free Trade make the state obsolete?