Transcript International Trade - University of Michigan

Arguments for Free Trade and
the costs of restricting Free
Trade
Why Trade with other nations?
1. To get a good which cannot be produced locally,
or to obtain a resource that is not available locally.
For the U.S., coffee would be such a good;
Certain metals for cars and military goods, etc
2. To obtain a good which can be produced in your
country but to get that good at a cheaper price
(that is at a lower opportunity cost).
Trade is a positive-sum game.
Both Nations will benefit by engaging in
international trade.
Facts about international trade
• International trade is as large as it ever has been and
is growing every year. 2005 - value in U.S. dollars
$10.5 trillion dollars
• Top 10 exporting countries (as a % of world trade):
Germany 9.3, U.S. 8.7 , China 7.3, Japan 5.7, France
4.4, Netherlands 3.9, U.K. 3.7, Italy 3.5, Canada 3.4,
Belgium 3.2
• Top 10 importing countries(as a % of world trade):
U.S. 16.1, Germany 7.2, China 6.1, Japan 4.8, U.K.
4.7, France 4.6, Italy 3.5, Netherlands 3.3, Canada
3.0, Belgium 3.0
• Most trade (73%) is from manufactured goods, of
which machinery and transportation equipment are the
most traded.
• Food, raw materials, and fuel make up 24.5% of trade.
Principal U.S. Exports & Imports of goods, 2006(in billions of $)
Imports
(in billions of $)
Exports (in billions of $)__
Auto Vehicles & Parts 256.6
Auto Vehicles & Parts 107.1
Crude Oil
216.8
Semiconductors
52.4
Computers & acc.
101.4
Computers & acc.
47.4
Apparel
91.1
Chemicals
45.4
Pharmaceutical Prep
64.6
Civilian Aircraft
40.7
Other Petrol Products
44.1
Engines(Aircraft & Ind) 32.8
T.V., VCR’s, etc
41.8
Industrial Machines
32.7
Telecommunications
40.2
Pharmaceutical Prep
30.8
Electric Apparatus
33.6
Electric Apparatus
29.7
Chemicals
32.7
Telecommunications
28.9
Industrial Machines
29.0
Plastic Materials
27.8
Sporting goods, toys
28.8
Medical Equipment
22.7
Natural Gas
28.5
Civilian Aircraft Parts
17.4
Semiconductors
27.3
Fuel Oil
12.1
U.S. exports & imports of goods by area, 2006(in billions of $)
Exports to: Value % of total Imports from: Value % of total
1,855
100
Total
1,037
100 Total
330.6
17.8
Canada
230.6
22.2 Euro Union
303.4
16.3
Euro Union 213.9
20.6 Canada
287.8
15.5
Mexico
134.1
12.9 China
NICS
97.9
9.4 Mexico
198.3
10.7
South America 89.0
8.6 Japan
148.1
8.0
Japan
59.6
5.7 OPEC
145.5
7.8
China
55.2
5.3 South America 133.7
7.2
OPEC
40.6
3.9 NICS
109.8
5.9
Africa
19.0
1.8 Africa
80.6
4.3
Australia
17.8
1.7 Malaysia
36.5
2.0
Malaysia
12.6
1.2 India
21.8
1.2
Other Europe 10.1
1.0 Russia
19.8
1.1
India
10.1
1.0 Other Europe 12.4
0.6
Russia
4.7
0.4 Australia
8.2
0.4
Source:Bureau of Economic Analysis
Exports of goods & services as a % of GDP
As of August 2005
The Economic Basis for trade
• Trade occurs between countries because the opportunity cost
(relative prices) of various goods differ between countries.
Why do they differ? Because of differences in:
1.Distribution of resources (different quantities of resources in countries)
Examples: Saudi Arabia has much more oil than Japan
Climate may be favorable to the production of certain foods
China has much more labor resources than Canada
Countries specialize in the production of goods that require the
resource they have in abundance because they can produce
that good at a lower opportunity cost than other countries.
2.Technology/Productivity
(different skills of workforce and/or resource quality)
U.S. has a highly skilled workforce that produces computer
software & many pharmaceutical drugs.
Countries that have a greater technology in a good will
produce it more efficiently and at a lower opportunity cost.
Free Trade (no government restrictions)
• Benefit: Countries that engage in international trade, without
restrictions, will have greater consumption possibilities than
without international trade. This is referred to as the gains
from free trade.
• Definitions used in model:
a) Absolute advantage: being able to produce a good with less
resources (per unit of output), or being able to produce more
of a good with same resources (per unit of input) than
another country
b) Comparative advantage: being able to produce a good at a
lower opportunity cost than another country
Law of Comparative Advantage: Countries that specialize in
goods which they produce cheapest (low opportunity cost)
and trade with other countries for goods in which they produce
dearly (high opportunity cost)
will be able to consume more of both goods than without
international trade.
Law of comparative advantage
• Both nations will benefit with more consumption
• However, not all citizens in a country gain from free trade.
Some citizens will be made worse off, but the country as a
whole is better off because:
The gainers are so much better off they could (if possible)
compensate those who lose out and still be better off.
Two Models:
• The Heckscher-Ohlin model. A country has a comparative
advantage in a good whose production is intensive in the
factors that a country has in abundance.
– Countries tend to export goods that are intensive in the
factors they have in abundance.
• The Ricardian model of international trade analyzes
international trade under the assumption of differing
technologies and that opportunity costs are constant.
Economics in Action
Skill and Comparative Advantage
 In 1953, most economists thought that America’s
comparative advantage lay in capital-intensive goods,
but Wassily Leontif discovered that this was not true.
• The main resolution of this paradox, it turns out,
depends on the definition of capital. U.S. exports aren’t
intensive in physical capital—machines and buildings.
Instead, they are skill-intensive—intensive in human
capital.
 U.S. exporting industries use a substantially higher ratio
of highly educated workers compared to other industries
that compete against imports.
 In general, countries with highly educated workforces
tend to export skill-intensive goods, while countries with
less educated workforces tend to export goods whose
production requires little skilled labor.
Free Trade (no government restrictions)
Law of comparative advantage
• PPF Example: Two countries (U.S. & Brazil)
Each produce two goods ( Coffee & Wheat)
Assume:
1.Constant opportunity cost between the two
goods inside each country
(means the PPF will be a straight line)
2. Opportunity costs between U.S. & Brazil are
different
3. Countries are initially isolated (autarky)
U.S.
Brazil
30
20
12
A
4
B
30
18
Wheat(tons)
8 10
Wheat(tons)
U.S. can produce either 30 tons of coffee or 30 tons of wheat
Brazil can produce either 20 tons of coffee or 10 tons of wheat
To make this example more concrete assume the U.S. is
currently producing at point A
and Brazil is producing at point B.
World Production of Coffee = 12 + 4 = 16
World Production of Wheat = 18 + 8 = 26
U.S.
Brazil
30
20
12
A
4
B
30
18
Wheat(tons)
8 10
Wheat(tons)
U.S. can produce either 30 tons of coffee or 30 tons of wheat
Brazil can produce either 20 tons of coffee or 10 tons of wheat
U.S. has an absolute advantage in both goods.
Does this mean the two countries cannot benefit from trade?
No. Benefits from trade are based on comparative, not
absolute advantage.
U.S.
Brazil
30
12
Slope of PPF = -1
A
20
Slope of PPF = -2
4
B
30
8 10
Wheat(tons)
Wheat(tons)
Opportunity cost of wheat for U.S.= 30 coffee / 30 wheat =1 coffee
Opportunity cost of wheat for Brazil =20 coffee/10 wheat=2 coffee
U.S. has comparative advantage in wheat
Opportunity cost of coffee for U.S.=30 wheat/30 coffee=1 wheat
Opportunity cost coffee for Brazil=10 wheat/20 coffee=1/2 wheat
Brazil has comparative advantage in coffee
As long as opportunity costs differ between countries each nation
must have a comparative advantage in at least one good.
18
U.S.
Brazil
Slope of PPF = -1
Slope of PPF = -2
30
20 C
12
A
4
18
W
30 Wheat(tons)
B
8 10
Wheat(tons)
According to the law of comparative advantage the U.S. will
specialize in Wheat (production moves to point W)
Brazil will specialize in Coffee (production moves to point C)
Notice that Wheat production is 30 and coffee production is
20 which is greater world production than without trade!
How do U.S. Citizens get coffee now? By trading with Brazil!
How do Brazilians get wheat? By trading with the U.S.!
What price will wheat producers want to sell at to people in
Brazil?
U.S.
Brazil
Slope of PPF = -2
Slope of PPF = -1
30
20 C
12
A
4
B
W
8 10
18
Wheat(tons)
30 Wheat(tons)
Opportunity cost of wheat for U.S.=30 coffee/30 wheat=1 coffee
Opportunity cost of wheat for Brazil=20 coffee/10 wheat=2 coffee
U.S. firms can get 1 coffee for 1 wheat in U.S. They must get
more than 1 coffee from Brazilians to make them better off.
Brazilians currently pay 2 coffee for 1 wheat. They must pay
less than 2 coffee to make them better off.
Can a price be agreed to?
Yes! Any price between 2 and 1 coffee for 1 wheat. Let’s
assume a price of 1.5 coffee for 1 what is agreed on.
Brazil
U.S.
Slope of PPF = -2
Slope of PPF = -1
30
12
Trading
Possibilities
line (slope =1.5)
20 C
A
4
B
Trading
Possibilities
line (slope =1.5)
W
8 10
18
Wheat(tons)
30 Wheat(tons)
A price of 1.5 coffee for 1 what is agreed on called the Terms of
Trade.
The U.S. exports wheat for coffee and Brazil exports coffee for wheat
Both Nations will now move along the Trading Possibilities line
(instead of their PPF) to get the imported good.
Both nations will now pay the same price for both goods.
Price of the exported good increases compared to the no trade
price; price of the imported good decreases compared to the no
trade price.
U.S.
30
Trading
Possibilities
line (slope =1.5)
20 C
A’
15
12
Brazil
A
5
Trading
B’ Possibilities
line (slope =1.5)
4
B
W
18 20 30 Wheat(tons)
8 10
Wheat(tons)
The Trading possibilities line is further from the origin than the
PPF meaning more consumption is possible with Free Trade
than without.
Example: U.S. can go from point A to point A’ and get more
coffee and wheat. Brazil moves from point B to B’ and also gets
more coffee and wheat.
Gains from Trade: MORE for Both countries!
Insights from the Ricardian model
1) World output of both goods increases with free trade
Because economic efficiency improves. Resources are
moved to produce goods at the lowest opportunity cost.
2) Self interested firms and individuals will achieve this
outcome without government interference.
3) A nation’s exports earn income that allows that nation
to pay for imports from other nations.
Therefore, if a country cuts imports from other nations,
then those nations lose income and buy less exports
from that country
Supply,
Demand,
and International Trade
Domestic The
Supply
Price of
Cars
Consumer
Surplus
PNo Trade
A
Producer
Surplus
Effects of Imports
Producer surplus – measures
how well off producers are in a
market. The difference between
the price in the market and the
supply curve
Total welfare is the addition
of consumer and producer
surplus
Domestic
Demand
QNo Trade
Quantity of Cars
The domestic demand curve shows how the quantity of a good
demanded by domestic consumers depends on the price of that good.
The domestic supply curve shows how the quantity of a good supplied
by domestic producers depends on the price of that good.
Consumer surplus – measures how well off consumers are in a market.
The difference between the demand curve and the price in the market
Domestic
Supply
Price of
Cars
The Effects of Imports
Consumers gain some of the
Producer surplus as price decreases
A
PNo Trade
PWorld
They also gain an area that would
not exist without trade
B
C
Domestic
Demand
QDS
QNo Trade
QDD Quantity of Cars
Imports
When a market is opened to trade, competition among importers or
exporters drives the domestic price to equality with the world price.
If the world price is lower than the autarky price, trade leads to imports
and a fall in the domestic price.
There are overall gains from trade because consumer gains exceed the
producer losses.
Domestic
Supply
Price of
Cars
PWorld
B
C
A
PNo Trade
The Effects of Exports
Producers gain some of the
Consumer surplus as price increases
They also gain an area that would
not exist without trade.
Domestic
Demand
QDD
QNo Trade QDS
Quantity of Cars
Exports
If the world price is higher than the autarky price, trade leads to exports
and a rise in the domestic price.
There are overall gains from trade because the producer gains exceed
the consumers losses.
International Trade and Wages
• Exporting industries produce goods and services
that are sold abroad.
• Import-competing industries produce goods and
services that are also imported.
• International trade tends to increase the demand
for factors that are abundant in our country
compared with other countries.
• It will decrease the demand for factors that are
scarce in our country compared with other
countries.
• As a result, the prices of abundant factors tend to
rise, and the prices of scarce factors tend to fall as
international trade grows.
Effects of Trade Protection
• Policies that limit imports are known as trade
protection or simply as protection.
• Most economists advocate free trade, although many
governments engage in trade protection of importcompeting industries.
• The two most common protectionist policies are tariffs
and import quotas. In rare instances, governments
subsidize export industries.
Why?
Because some citizens are hurt by free trade, especially
in the importing good industry where jobs are lost.
They ask the government to protect them from the
effects of free trade by restricting the quantity of the
imported good.
Trade Barriers
• A tariff is a tax levied on imports.
– It is designed to protect domestic firms from foreign
competition.
• An import quota is a legal limit on the quantity
of a good that can be imported.
– Its effect is like that of a tariff, except that
revenues—the quota rents—accrue to the licenseholder, not to the government.
• Non-tariff barriers(NTB’s) : licensing
requirements, unreasonable product safety
standards, lengthy inspections, various
bureaucratic red tape.
• “Voluntary” export restrictions
Domestic
Supply
Price of
Cars
PNo Trade
A
PTariff
D
Government
Revenue
E
The Effects of a Tariff
It raises the domestic
price above the world
price, leading to a fall
in trade, total
consumption, and a
rise in domestic
production.
Tariff
PWorld
B
QDS
C
QDST QNT QDDT
Domestic
Demand
QDDQuantity of Cars
Imports with free trade
Imports with Tariff
Domestic producers and the government gain, but consumer has
lost more than producers and government gains, leading to a
deadweight loss in total surplus.
Source: Federal Reserve bank of Dallas, 2002 annual report
Costs of
Protectionism
Source: Federal Reserve bank of Dallas,
2002 annual report
Effects of tariffs
In addition tariffs (and other trade barriers):
1) Expand inefficient industries (importing industries)
and contract efficient industries (exporting
industries)
2) May invite retaliation from other nations whose
exports have declined.
3) Price of domestic substitute goods will also
increase (less competition for domestic firms)
4) More than likely also cause exports of the country
to go down.
Trade Protection in the United States


The United States today generally follows a policy of free
trade. Most manufactured goods are subject either to no
or a low tariff.
There are two areas where imports are limited:
Agriculture: A certain amount of imports are subject to low
a tariff rate and this acts like an import quota because only
importers that are license holders are allowed to pay the
low rate.
 Clothing and Textiles: A surge of clothing from China led
to a partial re-imposition of import quotas which had
otherwise been removed at the start of 2005.
According to official U.S. estimates, the total economic cost
of all quantifiable restrictions on imports is about $3.7 billion
a year, or around one-fortieth of a percent on national
income. Of this, about $1.9 billion comes from restrictions on
clothing imports, $0.8 billion from restrictions on sugar, and
$0.6 billion from restrictions on dairy. Everything else is small
change.


International trade policies
• Lower trade barriers among two nations or the entire
world.
• International trade agreements are treaties in which a
country promises to engage in less trade protection
against the exports of other countries in return for a
promise by other countries to do the same for its own
exports.
1. Reciprocal agreements between a few nations:
Canada-U.S. Free trade agreement, NAFTA, European
economic community.
2. General Agreement of Tariffs and Trade (GATT) Now
the WTO. Base on Most Favored Nation (MFN) status.
All nations belonging to must be treated the same.
• The lowest tariff applies to all countries.
• Elimination of import quotas.
World Trade Organization
• Dedicated to continue GATT in a more formal
manner
• A “court” that will settle trade disputes
• Example: U.S. Steel tariffs were found to be in
violation of the WTO agreement…
…therefore, affected nations would legally be able to
punish U.S. with tariffs for violating agreement
unless Steel tariffs were eliminated
• U.S. has agreed to drop tariffs and no punishing
tariffs will be put on U.S. goods.
WTO Members as of August 2008
www.wto.org
Economics in Action: The Doha Deadlock

Since the end of World War II, there have been nine
rounds of global trade negotiations.


The Doha Round started off in Doha, Qatar in 2001
and then moved to Geneva, Switzerland.




A trade round is a multiyear process in which negotiators
from many countries cut complex deals on trade policy.
By late 2007, talks appeared deadlocked.
Poorer countries that still have substantial trade protection
in manufactured goods, refused to reduce that protection
without an agreement by rich countries to reduce the
substantial subsidies they give farmers.
Because the farm lobbies in rich countries have a lot of
political power, these countries weren’t willing to make
sufficient concessions.
Even if the Doha Round fails, previous trade
agreements will remain in force.
Summary
1. International trade is of growing importance to the
United States and of even greater importance to
most other countries. Foreign trade has been
growing rapidly, a phenomenon called
globalization.
2. The Ricardian model of international trade
assumes that opportunity costs are constant. It
shows that there are gains from trade: two countries
are better off with trade than in autarky.
3. The Heckscher–Ohlin model shows how
differences in factor endowments determine
comparative advantage.
•
•
Goods differ in factor intensity.
Countries tend to export goods that are intensive in the
factors they have in abundance.
Summary
4. The domestic demand curve and the domestic
supply curve determine the price of a good in
autarky. When international trade occurs, the
domestic price is driven to equality with the world
price, the price at which the good is bought and sold
abroad.
5. If the world price is below the autarky price, a good is
imported. This leads to an increase in consumer
surplus, a fall in producer surplus, and a gain in total
surplus. If the world price is above the autarky price,
a good is exported. This leads to an increase in
producer surplus, a fall in consumer surplus, and a
gain in total surplus.
6. International trade leads to expansion in exporting
industries and contraction in import-competing
industries.
Summary
7. Most economists advocate free trade, but in practice
many governments engage in trade protection.
8. A tariff is a tax levied on imports. An import quota is a
legal limit on the quantity of a good that can be imported.
9. Although several popular arguments have been made in
favor of trade protection, in practice the main reason for
protection is probably political: import-competing
industries are well-organized and well-informed about
how they gain from trade protection, while consumers
are unaware of the costs they pay.
10. Many concerns have been raised about the effects of
globalization including ncome inequality due to the surge
in imports from relatively poor countries and offshore
outsourcing.