Transcript Document

Chapter 32
Comparative
Advantage
and the Open
Economy
Copyright © 2012 Pearson Addison-Wesley. All rights reserved.
Introduction
In early 2010, President Barack Obama announced his
intention to double U.S. exports of goods and services
by 2015.
Ironically, during the same week, a report documented
barriers that the Chinese government had established to
hinder U.S. exports from entering China.
In this chapter, you will learn how nations can gain from
both exporting and importing goods and services.
You will also learn about tariffs and other mechanisms
that governments often utilize to reduce imports.
Learning Objectives
• Discuss the worldwide importance of
international trade
• Explain why nations can gain from specializing
in production and engaging in international
trade
• Understand common arguments against free
trade
Learning Objectives (cont’d)
• Describe ways that nations restrict foreign
trade
• Identify key international agreements and
organizations that adjudicate trade disputes
among nations
Chapter Outline
• The Worldwide Importance of International
Trade
• Why We Trade: Comparative Advantage and
Mutual Gains from Exchange
• The Relationship Between Imports and
Exports
• International Competitiveness
Chapter Outline (cont’d)
• Arguments Against Free Trade
• Ways to Restrict Foreign Trade
• International Trade Organizations
Did You Know That ...
• Ford Motor Company produces small passenger vans in a
factory located in Turkey and ships them to Baltimore,
Maryland, where employees strip out the vehicles’ rear seats
and replace their rear windows with metal panels?
• In this way, Ford sells the vehicles in the United States as
commercial vans and it avoids a 25 percent tariff on imports
of passenger vans.
• In this chapter, you will learn about the effects of import
restrictions on quantities and prices of domestically produced
goods and services.
The Worldwide Importance of
International Trade
• World GDP today is nearly nine times greater
than it was at the end of World War II
• World trade has increased to more than 28
times what it was in 1950
The Worldwide Importance of
International Trade (cont'd)
• The United States has figured prominently in
this expansion of world trade
– Imports added up to barely 4% of annual U.S. GDP
in 1950
– Today they account for almost 16%
Figure 32-1 The Growth of World Trade, Panel (a)
Figure 32-1 The Growth of World Trade, Panel (b)
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange
• We have learned about the concept of
specialization and the mutual gains from trade
• We can understand gains from trade among
nations by understanding output gains from
specialization between individuals
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Scenario (8-hour day)
– Ad specialist
• 2 pages of ad copy/hour
• 1 art rendering/hour
– Computer artist
• 1 page of ad copy/hour
• 1 art rendering/hour
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
Without Trade
(8-hour day)
Ad Specialist
Computer Artist
Total
Copy
4 hrs × 2 = 8
4 hrs × 1 = 4
12
Renderings
4 hrs × 1 = 4
4 hrs × 1 = 4
8
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
With Trade
(8-hour day)
Ad Specialist
Copy
Renderings
Computer Artist
8 hrs × 2 = 16
Total
16
8 hrs × 1 = 8
Ad copy output
increases by 4
pages per day
8
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Comparative Advantage
– The ability to produce a good or service at a lower
opportunity cost compared with producers
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Specialization among nations
– To demonstrate the concept of comparative
advantage, consider a simple two-country, twogood world
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Production and consumption capabilities in a
two-country, two-good world
– We show maximum feasible quantities of software
and PCs
– Using all resources—land, labor, capital, and
entrepreneurship
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• U.S. residents can utilize all their resources to produce 90
units of software or 225 PCs per hour
• Residents of India are able to utilize all their resources to
produce either 100 units of software or 50 PCs per hour
Table 32-1 Maximum Feasible Hourly Production Rates of Either
Commercial Software or Personal Computers Using All Available
Resources
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Comparative advantage
– The opportunity cost of producing a PC is lower in
the United States than in India
• 1 PC = 0.4 units of software
• 1 unit of software = 2.5 PCs
– The opportunity cost of producing software is
lower in India than the United States
• 1 PC = 2 units of software
• 1 unit of software = 0.5 PC
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Production without trade
– Table 32-2 tabulates two possible production
choices
– “World” output is 55 units of software and 187.5
PCs (per hour)
Table 32-2 U.S. and Indian Production and Consumption
Without Trade
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• The United States and India will specialize in activities with
which they experience a lower opportunity cost
• In other words, they will specialize in the activity in which
they have a comparative advantage
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Specialization in production
– United States will specialize
• Produce 225 PCs, and no software
– India will specialize
• Produce 100 software units, and no PCs
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Consumption with specialization and trade
– The United States is willing to buy 1 unit of Indian
software as long as they provide in exchange no
more than 2.5 PCs
• This is the United States’ opportunity cost of producing
1 unit of software at home
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Consumption with specialization and trade
– India buys a PC from the United States in
exchange for no more than 2 units of software
• This is India’s opportunity cost of producing a PC at
home
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Residents of the two nations agree to a rate of
exchange of 1 PC for 1 unit of software
– Proceed to trade 75 U.S. PCs for 75 units of Indian
software
Table 32-3 U.S. and Indian Production and Consumption with
Specialization and Trade
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• By specializing and engaging in trade:
– The United States consumes 75 units of software
imported from India and consumes 150 PCs
produced at home
– Indian residents consume 25 units of software
produced at home and import 75 PCs from the
United States
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Gains from trade
– The United States’ gain from specialization and
trade is 45 units of software
– India can consume 37.5 more PCs
– These are net gains
Table 32-4 National and Worldwide Gains from
Specialization and Trade
International Example: Gains from International Trade in Used
Merchandise
• Sofronis Clerides of the University of Cyprus has estimated the
gains to residents of Cyprus from a decision by the Cypriot
government to legalize imports of used Japanese cars.
• He finds that the typical buyer of a used imported vehicle
realized a gain from trade of about $2,000.
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Specialization is the key
– Specializing in producing goods for which a nation
has a comparative advantage allows for greater
efficiency
– Production capabilities increase, making possible
greater worldwide consumption through
international trade
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Observations on specialization and trade
– Not everyone gains from trade
– Cannot “run out of exports”
– Every country will always have a comparative
advantage in something
Why We Trade: Comparative Advantage and Mutual Gains From
Exchange (cont'd)
• Other benefits from international trade: the
transmission of ideas
– New goods, services spread
– New processes transmitted
– Intellectual property introduced
Figure 32-2 World Trade Flows
Why Not … obtain gains from trade by subsidizing exports and
discouraging imports?
• Government subsidies for exports and policies induce
domestic and foreign firms to specialize in production of items
based on government incentives or disincentives rather than
actual opportunity costs (comparative advantages).
• As a consequence, industries receive transfers from taxpayers,
but society as a whole does not experience true gains from
trade.
The Relationship Between Exports and Imports
• In the long run, imports are paid for by
exports
• Any restrictions on imports ultimately reduce
exports
• When a country engages in trade, it is not
competing against the other countries
• All nations stand to benefit from trade
International Competitiveness
• Questions
– Is the United States falling behind?
– Do we need to stay competitive internationally?
– What does global competitiveness really mean?
International Competitiveness (cont'd)
• Answer
– The United States leads in overall productive
efficiency, according to the Institute for
Management Development in Lausanne,
Switzerland
International Competitiveness (cont'd)
• Reasons for this ranking:
– Widespread entrepreneurship
– Economic restructuring
– Investment in information-technology
– Sophisticated financial system
– Large investments in scientific research
International Example: Can Africa’s International
Competitiveness Be Improved?
• Despite abundant resources in the heart of Africa, most
African railways and roads are in poor conditions, leading to
high transportation costs and a long time in shipping
containers.
• A French firm, Bolloré, is trying to improve Africa’s
international competitiveness by creating “trade corridors” of
riverways that can substantially reduce shipping times and
costs.
Arguments Against Free Trade
• Infant Industry Argument
– The contention that tariffs should be imposed to
protect from import competition an industry that
is trying to get started
– Presumably, after the industry becomes
technologically efficient, the tariff can be lifted
Arguments Against Free Trade (cont'd)
• Dumping
– Selling a good or a service abroad below the price
charged in the home market or at a price below its
cost of production
Arguments Against Free Trade (cont'd)
• Protecting domestic jobs
– Do imports reduce jobs?
• Gould/Woodbridge/Ruffin study – no casual link
between the rate of imports and unemployment
• In half of the cases studied, when imports rose,
unemployment fell
Arguments Against Free Trade (cont'd)
• The cost of protecting U.S. jobs
– Restrictions on textiles and apparel goods cost
U.S. consumers $9 billion a year
• Cost $50,000 a year for each $20,000 job saved
– Restriction on imports of Japanese cars
• Cost $160,000 per year for each job saved in the auto
industry
Arguments Against Free Trade (cont'd)
• The cost of protecting U.S. jobs
– Glass industry restrictions
• Cost $200,000 per year per job saved
– Steel industry restrictions
• Cost $750,000 per year per job saved
Arguments Against Free Trade (cont’d)
• Emerging arguments against free trade
– Environmental concerns
– Genetic engineering
– New diseases
• National defense
– Exports of new technology
Ways to Restrict Foreign Trade
• Quota System
– A government-imposed restriction on the quantity
of a specific good that another country is allowed
to sell in the United States
– In other words, quotas are restrictions on imports,
usually applied to one or several specific countries
Figure 32-3 The Effect of Quotas on
Textile Imports
Ways to Restrict Foreign Trade (cont’d)
• Voluntary quotas
– Voluntary Restraint Agreement (VRA)
• An official agreement with another country that
“voluntarily” restricts the quantity of its exports
– Voluntary Import Expansion (VIE)
• An official agreement with another country in which it
agrees to import more from the United States
Ways to Restrict Foreign Trade (cont'd)
• Tariffs
– Tax on imported goods
• Benefits import-competing industries
• Harms consumers by raising prices
Figure 32-4 The Effect of a Tariff on Japanese-Made Laptop
Computers, Panel (a)
Japanese-made
notebook computers
Figure 32-4 The Effect of a Tariff on Japanese-Made Laptop
Computers, Panel (b)
U.S.-made
notebook computers
Ways to Restrict Foreign Trade (cont'd)
• Tariffs in the United States
– Have varied widely on imported goods
– Highest rates in twentieth century occurred with
passage of Smoot-Hawley Tariff in 1930
Ways to Restrict Foreign Trade (cont’d)
• The Trade Expansion Act of 1962 gave the
president the authority to reduce tariffs by up
to 50%
• The Trade Reform Act (1974) allowed further
reductions
• The Trade and Tariff Act (1984) resulted in the
lowest tariff rates ever
Ways to Restrict Foreign Trade (cont’d)
• All of these trade agreement obligations were
carried out under the General Agreement on
Tariffs and Trade (GATT)
– An international agreement established in 1947 to
further world trade by reducing barriers and tariffs
– The GATT was replaced by the World Trade
Organization in 1995
Figure 32-5 Tariff Rates in the United
States Since 1820
Ways to Reduce Foreign Trade (cont’d)
• General Agreement on Tariffs and Trade
– An international agreement established in 1947 to
further world trade by reducing barriers and tariffs
– GATT was replaced by the World Trade
Organization in 1995
– In 2002, the U.S. government proposed
eliminating all tariffs on manufactured goods by
2015
International Trade Organizations
• The World Trade Organization (WTO)
– The successor organization to GATT that handles
trade disputes among its member nations
International Trade Organizations
(cont'd)
• The World Trade Organization (WTO)
– Most important international trade organization,
with largest membership
– Fostered most important and far-reaching global
trade agreement covering
• Financial institutions; including banks, insurers and
investment companies
International Trade Organizations
(cont'd)
• Regional Trade Bloc
– A group of nations that grants members special
privileges
– Examples include the European Union, NAFTA,
and the Association of Southeast Asian Nations
International Trade Organizations
(cont'd)
• Some economists worry that regional blocs could lead to a
reduction in members’ trade with nations outside their blocs
• Trade Diversion
– the shifting of trade from countries outside a regional trade bloc to
nations within a bloc
• Most evidence, however, indicates that regional trade blocs
have promoted trade instead of hindering it
International Trade Organizations
(cont'd)
• Numerous studies have found that as
countries from around the world have become
more open to trade, they have tended to join
regional trade blocs that promote even more
openness
International Trade Organizations
(cont'd)
• Trade Deflection
– Moving partially assembled products into a
member nation of a regional trade bloc,
completing assembly, and then exporting them to
other nations within the bloc, so as to benefit
from preferences granted by the trade bloc
– The primary issue associated with regional trade
blocs
International Trade Organizations
(cont'd)
• Rules of Origin
– Regulations that nations in regional trade blocs
establish to delineate product categories eligible
for trading preferences
– Used in regional trade agreements in order to
reduce incentives for trade deflation
Figure 32-6 The Percentage of World Trade Within
Regional Trade Blocs
International Policy Example: Does the Spread of Regional Trade
Blocs Reduce Protectionism?
• Scott Baier of Clemson University and Jeffrey Bergstrand of the
University of Notre Dame found that within a few years after
nations join regional trade blocs, their governments gradually
tend to become less protectionist.
• Thus, the overall net effect of joining a regional trade bloc is
greater trade with nations outside the bloc as well as with
countries that are co-members of the bloc.
You Are There: Union Workers Find Themselves on Opposing
Sides on Trade
• Recently, the U.S. government passed a law that prohibits
Mexican commercial trucks from traveling on U.S. highways.
• This law may prevent Mexican truckers from competing with
U.S. truckers as intended, thus perhaps saving some American
jobs.
• However, as the Mexican government has retaliated for the
ban on Mexican trucks by imposing tariffs on Mexican imports
of U.S.-manufactured paper, workers in the paper industry
may suffer.
Issues & Applications: A U.S. Effort to Expand Exports While
Reducing Imports
• President Obama has announced a trade policy to double U.S.
exports by 2015.
• Some of his advisors have suggested that the government
should “promote exports” by increasing export subsidies.
• A few months before the trade policy announcement, the U.S.
government imposed a new 35 percent tariff on Chinesemanufactured tires.
Issues & Applications: A U.S. Effort to Expand Exports While
Reducing Imports (cont’d)
• Gains from trade are not achieved by promoting certain
industries and protecting others:
– Policies to promote exports, such as subsidies, transfer resources from
taxpayers to subsidized firms.
– Policies to reduce imports, such as tariffs, directly inhibit the realization
of gains from trade by restraining domestic consumption possibilities.
Summary Discussion of Learning
Objectives
• Worldwide importance of international trade
– World trade has grown faster than total world
GDP
• Why nations can gain from specializing in
production and engaging in trade
– Comparative advantage
Summary Discussion of Learning
Objectives (cont'd)
• Arguments against free trade
– Infant industry
– Dumping
– Environmental concerns
– National defense
• Ways that nations restrict foreign trade
– Tariffs
– Quotas
Summary Discussion of Learning
Objectives (cont'd)
• Key international agreements and
organizations
– GATT
– WTO
– More than 230 regional trade blocs
• NAFTA
• European Union