Transcript Free Trade is for the Rich

Free Trade is for the Rich
Comparative Advantage
Athletes involved in team sports embody
the theory of comparative advantage.
Even players who are better in all positions
than everyone else will enable the team to
win more games being a team player.
Numerical Example
International trade is a team activity.
Countries at war, hot or cold, lose income
themselves and inflict economic losses on
their rivals through embargoes.
Countries at peace, even if unstable, can
help themselves and their rivals by trading.
Numerical Example
Let us think about the bilateral trade
between two countries called JPN &
USA. Both countries have agricultural
and manufacturing sectors. Let’s call
them Rice & Autos for short. I have
left out services to keep the analysis
as simple as possible.
Numerical Example:
Continued
Both countries also have resources, labor,
land and capital in differing quantities. We
call these resources “Labor” for short.
USA’s labor resources total 108000, while
JPN’s total 72000. Adding three zeros to
the end of these numbers would be more
realistic, but would take up valuable space.
Don’t worry about differing labor/capital/
land intensities. We’ll include that later.
Numerical Example:
Continued
Now, how much do they produce of each
output, rice & autos? That depends on
productivity of the resources, of labor.
Highly productive labor produces a large
quantity of output. But this also means
that the production of any unit of output
requires a small amount of labor.
Numerical Example:
Continued
To put the matter differently,
If (Output/Labor) is a large number, labor
is highly productive. If it is a small number,
labor is not very productive.
The reciprocal, Labor/Output, measures how
much labor it takes to produce one unit of
output. The same unit might be produced by
small numbers of highly productive labor or
by large numbers of less productive labor.
Numerical Example:
Continued
Now we must decide on a measurement
for output. We can start in manufacturing
with one standard automobile. Rice,
however, comes in many quantities.
Assume that the unit is large, one container
load, so that its market value is the same as
that of one automobile.
Numerical Example:
Continued
This assumption is very convenient and,
due to the quantities going into trade, not
unrealistic.
If, for example, JPN’s output is 100000
autos & 200000 units of rice, total output
is worth 300000 in the market. That is
JPN’s GDP. Furthermore, if JPN exports
50000 autos they get back (import) 50000
units of rice.
Numerical Example:
Continued
Now we need to get down to business.
Labor input requirements (costs of
production) for one unit of each good
are given in the following table.
Resource Costs per Unit
USA
JPN
AUTOS
9
5
RICE
8
6
Numerical Example:
Continued
To clarify, in a one year time period, the
efforts of 9 workers in the USA will be
able to produce one automobile.
In JPN, it takes only 5 workers. Also, 8
workers in USA & 6 workers in JPN can
produce one unit of rice.
Numerical Example:
Continued
JPN, clearly, has a very significant cost
advantage. This is called an “absolute
advantage” and would lead most observers
to conclude that JPN has nothing to gain
in trade with USA.
In fact, it appears that low cost JPNese
imports would flood into USA and cause
widespread unemployment. Sounds awful!
Let’s pass some laws!
Numerical Example:
Continued
The next step is to go from productivity
to output possibilities. Remember the
assumed labor endowments of 108k & 72k.
The next table shows
Maximum Possible Outputs.
USA
JPN
AUTOS
12000
14400
RICE
13500
12000
Note: 12000 = 108000/9; 14400 = 72000/5; etc. Each number assumes total
specialization in the one industry.
Numerical Example:
Continued
What good are these numbers?
First, they give us endpoints of a spectrum
of possible output combinations.
Second, because they are in the same ballpark, they tell us that USA & JPN have
about the same GDP, USA’s earned with
greater labor power & JPN’s earned with
greater productivity. We will return to
this point later.
Numerical Example:
Continued
Now, let’s assume that JPN & USA are
completely self-sufficient; no trade at all.
Demand & consumer taste conditions cause
labor to be divided evenly between the two
industries. In USA, 54k workers are
allocated each to autos and to rice.
In JPN, 36k workers end up in each industry.
The following table summarizes the results.
Numerical Example:
Continued
Production & Consumption: No Trade
WORLD
USA
JPN
TOTALS
AUTOS 6000
7200
13200
RICE
6750
6000
12750
GDP
12750
13200
25950
Note that each of the four numbers in the center cells is exactly half what they
were in the preceding table. GDP is equal to the sum of the outputs as
explained before.
Numerical Example: Free
Trade
Under free trade, each country will end up
producing only one good. This is because
this example does not take into account
economies of scale, diminishing returns or
other problems that would arise. However,
there are many assumptions as to partial
specialization that could be made. The
results will be much the same.
Numerical Example: Free
Trade
The following table contains figures only
for consumption in the two countries. The
figures for output were given in the second
table above. Both countries specialize in one
of the goods, export about half of their
output and import an equivalent amount
of the other good.
Numerical Example: Free
Trade
Consumption: Free Trade & Specialization
WORLD
USA
JPN
TOTALS
AUTOS 6500
7900
14400
RICE
7000
6500
13500
GDP
13500
14400
27900
Note: USA produces 13500 units of rice and exports 6500 in return for 6500 autos.
JPN produces 14400 automobiles and exports 6500 in return for rice from USA.
USA keeps 7000 units of rice for home consumption; JPN keeps 7900 automobiles.
Numerical Example:
Conclusion
In the next table, the four earlier tables
are all put together. Notice that the final
results with free trade enable both countries
to consume more of both goods and to have
larger GDPs than would exist under selfsufficiency.
USA & JPN: TRADE
RESOURCE COSTS PER UNIT
CONSUMPTION & PRODUCTION: NO TRADE
USA
AUTOS
9
RICE
8
LABOR 108000
USA
AUTOS 6000
RICE
6750
GDP 12750
JPN
5
6
72000
MAXIMUM POSSIBLE OUTPUT
AUTOS
RICE
USA
12000
13500
JPN
14400
12000
JPN TOTALS
7200
13200
6000
12750
13200
CONSUMPTION: FREE TRADE
USA
AUTOS 6500
RICE
7000
GDP 13500
JPN TOTALS
7900
14400
6500
13500
14400
Geometric Diagram of
Trade
Some students like geometry, some
don’t. All can ignore it.
Autos
(13500, 14400)
MAXIMUM PRODUCTION &
CONSUMPTION WITH TRADE &
COMPLETE SPECIALIZATION.
JPN: 14400
(12750, 13200)
PRODUCTION & CONSUMPTION WITH
NO TRADE.
USA: 12000
EQUAL
DISTRIBUTION
7200
6000
USA: 13500
6000
6750
JPN: 12000
Rice
Between the Lines
We assumed quantities of autos & rice such
that the world exchange ratio was 1:1. Under
self-sufficiency, the ratios would be 8/9 in
USA and 6/5 in JPN. That is, 8 autos would
have a market price (due to labor costs) such
that 8 autos would exchange for 9 units of
rice, the higher value of autos due to the
fact that they require more labor & are
therefore more costly than rice.
Between the Lines
Hence, the world exchange ratio is between
the two national ratios: (8/9) < (1/1) < 6/5.
Why 1/1? I assumed it for two reasons: it
falls between the two ratios and it is easy.
But lots of ratios fall between 8/9 & 6/5.
An economist/philosopher named John
Stuart Mill published a paper in 1844 in
which he solved the problem using linear
programming. But LP was not invented
until 1944. Ahead of the curve.
Free and Fair Trade
Low productivity means low wages. By
and large, poor people are not very productive, at least not in economic markets.
Increased productivity means more output
per person and, of course, more income.
Trade, when free, raises incomes above
non-free levels, but increased productivity
(compare JPN & USA incomes per capita)
can do lots more.
Free Trade & Fair Trade
Raising productivity is the key to raising
incomes, but the process is not easy.
Fair trade will increase the incomes of
less productive people by taking income
from the more productive. There will
invariably be less to go around in total
and probably slower growth rates. Free
trade is definitely fairer that fair trade.
Reality Calling
This model can be generalized and most
of the ideas remain intact. This is an
example of the complaint that economics
is trivial in two dimensions and
impossibly difficult in three or more.
But it is not a good example: was this
exercise trivial?