Transcript International Trade Fall 2016 Without Picturesx

INTERNATIONAL TRADE
A Macroeconomic Unit
INTERNATIONAL TRADE
Voluntary exchange of goods and services
between people of different nations
MERCANTILISM
Ruling trade theory from 1500-1750
 Promoted international trade for the purpose of
gaining riches by running a trade surplus
 Trade winners v. Trade losers
 Refuted by David Ricardo’s theory of comparative
advantage
 Everybody wins

EXPORTS

Goods and services a nation produces and sells in other
nations
IMPORTS

Goods and services a nation buys from other nations
TRADE SURPLUS

Selling more exports than buying imports.
TRADE DEFICIT

Buying more imports
than selling exports
DAVID RICARDO (1772-1823)
British market
economist
 Developed theory of
comparative
advantage as the
basis for international
trade
 Supported free trade

DAVID RICARDO (1772-1823)

Suggested a country
should concentrate on
industries it is the
most internationally
competitive


Abandon all others
Trade with other
nations to obtain the
goods and services in
which those nations
are the most
competitive
TRADING RANGE

The terms of trade
between which trade
is beneficial to both
parties
If the terms of trade
are outside the trading
range then one party
is likely being
exploited
 Voluntary exchange
presumes this would
never happen because
it presumes perfect
information

ABSOLUTE ADVANTAGE


Ability to produce more of a given product than another
country
Which country has the absolute advantage in the
production of: Boats? Telescopes?
ABSOLUTE ADVANTAGE


It is possible for a country to hold the absolute
advantage in producing both products.
Which country has the absolute advantage in the
production of: Fish? Figs?
COMPARATIVE ADVANTAGE

Whoever has the lowest opportunity cost to
produce a good or service
COMPARATIVE ADVANTAGE

A country may only have the comparative
advantage in the production of one good or service

Even if it has the absolute advantage in both
COMPARATIVE ADVANTAGE

To determine, one must calculate the opportunity
cost for producing 1 of each product
COMPARATIVE ADVANTAGE:
OUTPUT METHOD EXAMPLE


The denominator stays the same
High Tech Country

Opportunity cost of producing 1 Boat = 3 Telescopes


Divide both by 3 (3/3 = 1; 9/3 = 3)
Opportunity cost of producing 1 Telescope = 1/3 Boat

Divide both by 9 (9/9 = 1; 3/9 = 1/3)
COMPARATIVE ADVANTAGE:
OUTPUT METHOD EXAMPLE

Low Tech Country

Opportunity cost of producing 1 Boat = 1/2 Telescope


Divide both by 2 (2/2 = 1; 1/2 = ½)
Opportunity cost of producing 1 Telescope = 2 Boats

Divide both by 1 (1/1 = 1; 2/1 = 2)
COMPARATIVE ADVANTAGE:
OUTPUT METHOD EXAMPLE

Compare Opportunity Costs
Opportunity Cost
1 Boat
1 Telescope
High Tech
Country
3 Telescopes 1/3 Boat
Low Tech
Country
1/2 Telescope 2 Boats
COMPARATIVE ADVANTAGE:
OUTPUT METHOD EXAMPLE

Trading Range:
High Tech Country will trade 1 Telescope for between
1/3 a Boat up to 2 Boats
 Low Tech Country will trade 1 Boat for between ½
Telescope up to 3 Telescopes

Opportunity Cost
1 Boat
1 Telescope
High Tech Country
3 Telescopes
1/3 Boat
Low Tech Country
1/2 Telescope
2 Boats
COMPARATIVE ADVANTAGE:
INPUT METHOD EXAMPLE


The numerator stays the same.
Abba

Opportunity Cost to Produce 1 Fish = ¾ Fig


Numerator stays the same (6/6 = 1; 6/8 =3/4)
Opportunity Cost to Product 1 Fig = 1 1/3 Fish

Numerator stays the same (8/8 = 1; 8/6 = 1 1/3)
COMPARATIVE ADVANTAGE:
INPUT METHOD EXAMPLE

Zarin

Opportunity Cost to Produce 1 Fish = 1 2/5 Fig


Numerator stays the same (14/14 = 1; 14/10 = 1 2/5)
Opportunity Cost to Product 1 Fig = 5/7 Fish

Numerator stays the same (10/10 = 1; 10/14 = 5/7)
COMPARATIVE ADVANTAGE:
INPUT METHOD EXAMPLE

Compare Opportunity Cost
Opportunity Cost
1 Fish
1 Fig
Abba
3/4 Fig
1 & 1/3 Fish
Zarin
1 & 2/5 Fig
5/7 Fish
COMPARATIVE ADVANTAGE:
INPUT METHOD EXAMPLE

Trading Range:
Abba will trade 1 Fish for ¾ of a Fig up to 1 & 2/5 of a Fig
 Zarin will trade 1 Fig for 5/7 of a Fish up to 1 & 1/3 of a
Fish

Opportunity Cost
1 Fish
1 Fig
Abba
3/4 Fig
1 & 1/3 Fish
Zarin
1 & 2/5 Fig
5/7 Fish
HOW TO SPOT AN OUTPUT METHOD
PROBLEM:

Given fixed inputs, one is asked to compare
how many outputs are being produced by
two entities (e.g. countries or people.)
HOW TO SPOT AN INPUT METHOD
PROBLEM

Given a fixed number of outputs, one is asked
to compare how many inputs it takes to
produce those outputs.
INPUTS V. OUTPUTS


Inputs – Factors of production/resources (land,
labor, capital, and entrepreneurship)
Outputs – Final goods and services
LONG RUN V. SHORT RUN



Neither is a fixed period of time (such as a year)
Short Run – the
quantity of at
least one input is
fixed
Long Run – the
quantities of no
inputs are fixed
FREE TRADE

The elimination of trade barriers.

Allows countries to enjoy the benefits of the gains from
trade
GAINS FROM TRADE
1.
Increased output
Total amount of goods and services produced goes up
 = higher standard of living
 = wealthier

GAINS FROM TRADE
2. Increased political
stability

International
interdependence


Countries with strong
trade relations are
more cooperative and
likely to find
alternatives to war to
resolve conflict
War would make both
countries poorer =
make citizens angry
GAINS FROM TRADE:
2. Increased political
stability
 Frederic Bastiat:

“When goods do not
cross borders, soldiers
will.”
What does he mean?
 Why would he say
that?
 Does he have a point?

GAINS FROM TRADE
3. Faster economic
growth

Access to:
Raw materials used
in production
 Markets in which to
sell products


Shifts PPC outward
Resources
 Technology
 International Trade

3 VARIABLES THAT AFFECT THE PPC

Resources
more resources = more
production = PPC
expands outward
 fewer resources = less
production = PPC
contracts inward

Spindletop – the oil well near
Beaumont, which became the then
most productive oil field in the
nation, whose discovery lead to the
Texas Oil Boom
3 VARIABLES THAT AFFECT THE PPC/LRAS

Technology

New technology = More efficient use of current
resources = PPC Expands outward
3 VARIABLES THAT AFFECT THE PPC/LRAS

Technology

Destruction or loss of technology = less efficient use of
current resources = PPC contracts inward
3 VARIABLES THAT AFFECT THE PPC

International Trade

More trade = access to additional resources and new
technologies = PPC expands
3 VARIABLES THAT AFFECT THE PPC

International Trade

Less trade = access to fewer resources and
technologies = PPC contracts inward
STANDARD OF LIVING

The level of wealth, comfort, material goods, and
necessities available

Basically: How much stuff can you get and how good is
the stuff? (Quality and Quantity)
STANDARD OF LIVING
Goes up when PPC expands
 Goes down when PPC contracts

COST OF LIVING

Cost of maintaining a
particular standard of
living


Inversely proportionate
to Standard of Living
Cost of living =
Standard of living

Cost of living =
Standard of living
Source: Sperling’s Best Places
COST OF LIVING: HOUSTON V. NYC
Source: Sperling’s Best Places
If one earns
$50,000 in
Houston, one
would require
a salary of
$111, 064 to
maintain the
same lifestyle
in the
Manhattan
borough of
New York
City, NY
PROTECTIONISM

Erecting trade barriers to shield
domestic industry from international
competition.
TRADE BARRIERS

Tariff





Tax on imports
Raise the price of
imported goods relative
to domestic goods
Protective tariff = so
high that trade is
significantly
diminished/eliminated
Revenue tariff =
designed to raise money
instead of specifically
restrict trade
Who really pays tariffs?
TRADE BARRIERS

Import quota

Limit on the quantity
of goods that can be
produced
internationally and
sold domestically.
TRADE BARRIERS

Subsidies

Government giving $ to businesses and industry to protect
them from competition.
• Makes domesticallyproduced goods cheaper in
foreign markets.
• Results in as lower
domestic price.
• Raises price of
internationally-produced
goods relative to
domestically-produced
goods.
SUBSIDIES
TRADE BARRIERS

Embargo

Blockade or political
agreement that limits
a foreign country's
ability to export or
import.

Which countries do the
United States
currently have trade
embargoes against?
TRADE BARRIERS

Regulations

Rules on the
standards imported
products must meet
are higher than those
for domestic products
Inspections
 Licenses

PRO-PROTECTIONIST ARGUMENTS

National Defense

Protect domestic industries critical to waging war:
Key resources (energy, uranium)
 Industrial production (steel, aircraft, armaments)

PRO-PROTECTIONIST ARGUMENTS

Protect infant
industries

Temporarily
protect new
industries
from global
competition
until they
can survive
on their own
PRO-PROTECTIONIST ARGUMENTS

Protect domestic jobs
Ignores jobs created by
trade in the import
sector
 Dispersed costs,
concentrated benefits



Entire nation suffers
from lower standard of
living which seems small
when calculated on a per
person basis but is
enormous when the
entire amount is totaled
A few receive huge
benefit of staying in
business which is
significant to them but
small compared to the
overall impact on the
national economy
PRO-PROTECTIONIST ARGUMENTS

Keep $ at home
Ignores that foreign nations use dollars they earn selling
products to the U.S. to buy American-made goods (e.g. cotton,
soybeans, aircraft, technology) which benefits other American
industries
 U.S. is still the #2 manufacturer in the world (behind China)

PRO-PROTECTIONIST ARGUMENTS

Help
balance of
payments
Trade
deficit v
Trade
surplus
 Difference
between $
paid to and
$ received
from other
nations in
trade (X-M)

PRO-PROTECTIONIST ARGUMENTS

National pride
Protect
industries/companies
the nation derives part
of its identity from
 U.S. protecting iconic
Harley-Davidson
brand
 French erecting
barriers to protect
wine and cheese
industries

ANTI-PROTECTIONIST ARGUMENTS
1.
It lowers our standard of living

2.
Causes domestic industries to become less efficient

3.
Makes nation poorer overall as a nation with the exception of
those receiving concentrated benefits
Less competition = less competitive behavior on price and quality
Erodes international alliances and cooperation
TRADE WAR

When countries raise trade barriers in retaliation
for other trade barriers.
SMOOT-HAWLEY TARIFF ACT OF 1930

Raised tariffs on
agricultural and
industrial products


Herbert Hoover
campaigned in 1928
on raising tariffs on
agricultural products,
but reducing them on
industrial products
Dutiable tariff rate
(average rate on goods
on which tariffs were
assessed) on 900-3,200
products reached
59.1%
Rep. Hawley (R-Oregon), on the left,
and Sen. Smoot (R-Utah), on the
right
SMOOT-HAWLEY TARIFF ACT OF 1930

Goal:
Protect American jobs
and farmers from
foreign competition
 Great Depression’s
initial stages


Result:
Unemployment rates:
 1930: 8%
 1931:16%
 1932-1933: 25%

SMOOT-HAWLEY TARIFF ACT OF 1930

Notably opposed by:

Irving Fisher



Henry Ford


The greatest American market
economist until Milton Friedman
1,028 other economists
 “Economic faculties that
within a few years were to be
split wide open on monetary
policy, deficit finance, and the
problem of big business, were
practically at one in their
belief that the Hawley-Smoot
bill was an iniquitous piece of
legislation.” – Princeton
University’s first economics
department chair Frank
Fetter (a market economist)
Called it an “economic stupidity.”
J.P. Morgan CEO Thomas
Lamont

“I almost went down on my knees
to beg Herbert Hoover to veto
the…Hawley-Smoot Tariff.”
SMOOT-HAWLEY TARIFF ACT OF 1930

23 major trading
partners retaliated by
increasing tariffs on
American goods:
Canada
 Great Britain
 France
 Germany


Imports decreased 66%


$4.4 bil to $1.5 bil (-$2.9
billion)
Exports decreased 65%

$7 billion to $2.4 billion
(-$3.1 billion)
SMOOT-HAWLEY TARIFF ACT OF 1930
Smoot and Hawley both lost their re-election campaigns
in 1932
 Repealed by the Reciprocal Trade Agreements Act of 1934
that enabled the president to bilaterlally negotiate tariff
rates and treat those agreements as regular legislation
instead of as a treaty.


Most economists
agree SmootHawley
contributed to the
Great Depression
in the U.S. but
was not the
primary cause of
it.
FREE TRADE AGREEMENT

Treaty between
nations to reduce
trade barriers to
increase trade
between them
FREE TRADE AGREEMENT



Usually focused on trade
of goods and services
Capital and labor may or
may not move freely as
well
Usually impose a uniform
tariff on non-member
countries to prevent
gaming the agreement
TRADE PROMOTION AUTHORITY

Special legislation written by Congress giving the
Executive Branch power to negotiate free trade
agreements
TRADE PROMOTION AUTHORITY

Negotiated agreements are then voted up or down
by Congress (without the possibility of adding
amendments)
TRADE PROMOTION AUTHORITY
1934: First TPA legislation passed
 2007: TPA expired
 2014: TPA renewed
 Constitutional controversy:
whether Congress
has the ability to
abdicate its
legislative
authority to the
Executive Branch

TRADE PROMOTION AUTHORITY

Obama administration has
sought renewal


Counter-intuitively:
Republicans generally
supportive


Update: Is this changing
now that the Republican
Party has nominated an
anti-trade candidate
(Donald Trump) to be their
presidential nominee? Time
will tell if he is an outlier or
a new trend.
Democrats generally
opposed

Trade unions are very
hostile to free trade and are
pro-protectionism. They are
also an important
Democratic Party
constituency.
NORTH AMERICAN FREE TRADE
AGREEMENT (NAFTA)

Trilateral FTA
between:

U.S.


Canada


Largest economy in the
world @ $16.2 trillion
GDP
11th largest economy @
$1.8 trillion GDP
Mexico

14th largest economy @
$1.2 trillion GDP
NORTH AMERICAN FREE TRADE
AGREEMENT (NAFTA)

Negotiated by President George H.W. Bush (1992)

Signed into law by President Bill Clinton (1993)
NORTH AMERICAN FREE TRADE
AGREEMENT (NAFTA)


Eliminated all tariffs
and investment
barriers between the 3
countries
Reduced or eliminated
non-tariff trade
barriers (quotas,
certain regulations)
NORTH AMERICAN FREE TRADE
AGREEMENT (NAFTA)


Annual U.S. trade
with Canada &
Mexico increased from
$337 billion (1993) to
$1.2 trillion (2011)
24% American job
growth (1993-2007)
WORLD TRADE ORGANIZATION (WTO)

Organization intent
on supervising and
liberalizing
international trade

Getting nations to
lower trade barriers
WORLD TRADE ORGANIZATION (WTO)


Member countries
can file complaints
against each other for
unfair trade practices
WTO may allow one
country to seek
remedies against
another for engaging
in unfair trade
practices
CAFTA-DR (2005)

Central American
countries plus the
Dominican Republic

Dominican Republic


Guatemala


109th largest @ $19 billion
Nicaragua


101st largest at $23 billion
Honduras


81st largest economy @ $45
billion
El Salvador


76th largest @ $50 billion
Costa Rica


70th largest economy @ $59
billion
128th largest @ $11 billion
Total: $207 billion GDP
which would be 46th
largest economy if it were
a single nation
CAFTA-DR (2005)
CAFTA-DR (2005)

House of Rep. Passed:
217-215
202 Republicans + 15
Democrats in favor
 187 Democrats + 27
Republicans against


U.S. Senate Passed:
54-45
46 Republicans + 8
Democrats in favor
 34 Democrats + 11
Republicans against


What does this tell us?
SKORUS (2007)

South Korea

15th largest economy in the world @ $1.1 trillion GDP
SKORUS (2007)
NORTH KOREA & SOUTH KOREA AT NIGHT
SKORUS (2007)

House of Reps Passed:
278-151
219 Republicans + 59
Democrats in favor
 130 Democrats + 21
Republicans against


U.S. Senate Passed:
83-15
45 Republicans + 37
Democrats in favor
 14 Democrats + 1
Republican opposed

COLOMBIA FTA (2011)

32nd largest economy
@ $370 billion
COLOMBIA FTA (2011)
COLOMBIA FTA
(2011)

House of Reps Passed:
262-167
231 Republicans + 31
Democrats in favor
 158 Democrats + 9
Republicans against


U.S. Senate Passed:
66-33
44 Republicans + 21
Democrats in favor
 31 Democrats + 2
Republicans against

TRADE AGREEMENTS IN NEGOTIATIONS

Transatlantic Trade &
Investment
Partnership (T-TIP)

European Union

Largest single economic
zone in the world at
$17.4 trillion
TRADE AGREEMENTS IN SUSPENSION

Trans-Pacific
Partnership (TPP)

Would add as
American trade
partners:
Malaysia
 New Zealand
 Japan – 3rd largest
economy in the world @
$6 trillion GDP
 Vietnam


The United States
withdrew on January
24, 2017
TRADE AGREEMENTS IN SUSPENSION
COUNTRIES WE CURRENTLY HAVE TRADE
AGREEMENTS WITH
Australia
 Bahrain
 Canada
 Chile
 Colombia
 Costa Rica
 Dominican Republic
 El Salvador
 Guatemala
 Honduras

Israel
 Jordan
 South Korea
 Mexico
 Morocco
 Nicaragua
 Oman
 Panama
 Peru
 Singapore

INTERNATIONAL FINANCE
Global currencies
have their own
supply and demand
 To buy products in
a foreign county,
one must often first
buy that country’s
currency, pay an
exchange fee, then
buy the product

INTERNATIONAL FINANCE

Example:
Mexican bakery Grupo Bimbo wants to buy $1 million dollars
worth of wheat
 $18.83 MXN (Mexican pesos) = $1 USD (U.S. dollar)
 Bimbo must use $18.83 million MXN to buy $1 million USD
 Bimbo uses $1 million USD to buy the wheat

FOREIGN EXCHANGE (FX)

Currencies used by countries to conduct international
trade
RESERVE CURRENCY
Currency held in
significant quantities
to make purchases
and pay off
international debts
 U.S. dollar is said to
be the world’s reserve
currency because it is
accepted as payment
in a large number of
countries

FOREIGN
EXCHANGE
RATE

Price of one
country’s
currency in
terms of
another
Source: Bloomberg (September 12, 2016)
FIXED FX RATE
Country commits to maintain a stable currency value
relative to another country’s currency
 Example: $1 USD = 1 euro


Country’s central bank must increase or decrease the supply
of the currency in reaction to changes in the economy of the
other nation
FLEXIBLE/FLOATING FX RATE

Laws of supply and
demand determine the
value of a country’s
currency
STRONG DOLLAR



$ value increases
Imports become cheaper
to American consumers
relative to Americanmade goods
American exports
become more expensive
to international
consumers


Demand for $ falls,
weakening its value
Currency’s value
increases when its
economy grows faster
than the supply of the
currency
WEAK DOLLAR



$ value decreases
Imports become more
expensive to American
consumers relative to
American-made goods
American exports
become cheaper to
international consumers


Demand for $ increases,
strengthening its value
Currency’s value
decreases when the
supply of the currency
grows faster than the
nation’s economy
STRONG DOLLAR V. WEAK DOLLAR

Which is best?
Neither!
 Stable dollar
