Chapter 20 INTERNATIONAL TRADE

Chapter 20 INTERNATIONAL TRADE

INTRODUCTION This chapter addresses some basic issues related to trade: What benefit, if any, do we get from international trade? How much harm do imports cause, and to whom? Should we protect ourselves from unfair trade by limiting imports? 2

IMPORTS Imports are goods and services purchased from foreign sources. Although imports represent only 14 percent of total GDP, they account for larger shares of specific product markets. Bauxite to manufacture aluminum and chromium to manufacture chrome are not found in the U.S. 3

IMPORTS We import services as well as goods. Flying on a foreign airline and staying in a foreign hotel are both imports. 4

EXPORTS While we are buying goods and services from the rest of the world, foreigners are buying our exports. Exports are goods and services sold to foreign buyers. U.S. exports include farm products, tobacco, machinery and computers, aircraft, automobiles and auto parts, raw materials, and chemicals. 5

TRADE BALANCES While the U.S. is the largest exporter of goods and services, exports represent a relatively modest fraction of our total output compared to the rest of the world. Although we export many products, we often have an imbalance in our trade flows. Trade balance = exports imports 6

TRADE BALANCES Trade deficit is the amount by which the value of imports exceeds the value of exports in a given time period. Trade surplus is the amount by which the value of exports exceeds the value of imports in a given time period. 7

TRADE BALANCES During 2000, we imported much more than we exported and so had a trade deficit. Product Exports Imports Surplus Category (in $billions) (in $billions) (Deficit) Merchandise 773 1,223 (450) Services 296 215 81 Total Trade 1,069 1,438 (369) 8

BILATERAL TRADE BALANCES: TOP DEFICIT COUNTRIES Any imbalance in America s trade must be offset by reverse imbalances elsewhere. Country Trade Balance (in billions of dollars) China 83.8 8 Japan 81.6 Canada 51.9 Germany 29.1 Mexico 24.6 9

BILATERAL TRADE BALANCES: TOP SURPLUS COUNTRIES Country Trade Balance (in billions of dollars) Netherlands +12.22 Australia +6.0 Belgium +4.0 Hong Kong +3.1 Egypt +2.4 24 10

MOTIVATION TO TRADE Why trade when...... we import many of the things we also export.... we could produce many of the other things we import.... we seem to seem to worry so much about trade imbalances. 11

SPECIALIZATION Trade allows nations to specialize and specialization increases total output. Trade increases world output and the standards of living in all trading countries. 12

PRODUCTION AND CONSUMPTION WITHOUT TRADE The gains from trade can be illustrated using production possibilities curves. In the absence of trade, a country s consumption possibilities are identical to its production possibilities. Consumption possibilities - The alternative combinations of goods and services that a country could consume in a given time period. 13

CONSUMPTION POSSIBILITIES WITHOUT TRADE U.S. Production Possibilities French Production Possibilities Bread Wine Bread Wine 100 0 15 0 80 10 12 12 60 20 9 24 40 30 6 36 20 40 3 48 0 50 0 60 14

CONSUMPTION POSSIBILITIES WITHOUT TRADE 100 A U.S. production possibilities OUTPU UT OF BR EAD (zillions of loaves pe er year) 80 B 60 C 40 D 20 E F 0 10 20 30 40 50 60 OUTPUT OF WINE (zillions of barrels per year) 15

CONSUMPTION POSSIBILITIES WITHOUT TRADE 25 French production possibilities T OF BRE EAD loaves pe er year) OUTPU (z zillions of 20 15 G H 10 I 5 J K L 0 10 20 30 40 50 60 OUTPUT OF WINE (zillions of barrels per year) 16

PRODUCTION AND CONSUMPTION WITH TRADE To assess the potential gain from trade, we need to consider the combined output of trading nations. Just by increasing the mix of output in each trading country, we can increase total world output. t 17

MUTUAL GAINS Each country produces those goods it makes best, then trades with other countries to acquire the goods it desires to consume. When a country engages in international trade, its consumption possibilities always exceed its production possibilities. 18

CONSUMPTION POSSIBILITIES WITHOUT TRADE Bread Wine US U.S. (at point D) 40 30 France (at point I) 9 24 World total 49 54 19

CONSUMPTION POSSIBILITIES WITH TRADE Bread Wine US U.S. (at point C) 60 20 France (at point K) 3 48 World total 63 68 20

CONSUMPTION POSSIBILITIES WITH TRADE D ar) OF BREAD es per yea ANTITY O ns of loave QUA (zillion (a) U.S. production and consumption 120 100 A Production with 80 trade C 60 N D 40 Production and 20 consumption without t 0 trade 10 20 30 40 50 60 Consumption with trade QUANTITY OF WINE (zillions of barrels per year) 21

CONSUMPTION POSSIBILITIES WITH TRADE 20 (b) French production and consumption TY OF BRE EAD oaves per year) QUANTIT illions of lo Q (z 15 Consumption with trade I M 10 Production Production and 5 with trade consumption without trade K 0 10 20 30 40 50 60 QUANTITY OF WINE (zillions of barrels per year) 22

GAINS FROM SPECIALIZATION Old Mix of Output New Mix of Output Bread Wine Bread Wine United States 40 30 60 20 (point D) (point C) France 9 24 3 48 (point I) (point K) World totalt 49 54 63 68 23

PURSUIT OF COMPARATIVE ADVANTAGE Although international trade can make everyone better off, it s not obvious which goods should be traded, or on what terms. 24

OPPORTUNITY COSTS The decision to export is based on comparative advantage. Comparative advantage - The ability of a country to produce a specific good at a lower opportunity cost than its trading partners. Opportunity cost - The most desired goods or services that are forgone in order to obtain something else. 25

COMPARATIVE ADVANTAGE Comparative advantage refers to the relative (opportunity costs) of producing particular goods. World output, and thus potential gains from trade, will be maximized when each country pursues its comparative advantage. 26

ABSOLUTE COSTS DON T COUNT Only the relative costs between countries matter for determining who should be producing what. The absolute advantages in production do not matter. Absolute advantage The ability of a country to produce a specific good with fewer resources (per unit of output) than other countries. 27

TERMS OF TRADE It definitely pays to pursue one s comparative advantage by specializing in production. The terms of trade establish the trading rate. Terms of trade is the rate at which h goods are exchanged the amount of good A given up for good B in trade. 28

LIMITS TO THE TERMS OF TRADE A country will not trade unless the terms of trade are superior to domestic opportunities. 29

LIMITS TO THE TERMS OF TRADE The terms of trade between two countries will lie somewhere between their respective opportunity costs in production. 30

SEARCHING FOR THE TERMS OF TRADE United States Bread A 100 80 X 60 C 40 Production 20 possibilities D N Y Consumption possibilities 0 10 20 30 40 50 60 70 80 90 100 110 France 120 90 Consumption possibilities 60 30 L M Production possibilities K 0 10 20 30 40 50 60 70 80 90 100 110 Wine Bread 31

THE ROLE OF MARKETS AND PRICES The decision to import or export a particular good is often left up to the market decisions of individual consumers and producers. The terms of trade, like the price of any good, will depend on the willingness of market participants i t to buy or sell at various prices. 32

PROTECTIONIST PRESSURES Although the potential gains from trade are impressive, not everyone favors free trade. Imports typically compete with a domestic industry. The affected industries will try to restrict imports in order to preserve their own jobs and incomes. Workers and producers who compete with imported products who work in import- competing industries have an economic interest in restricting trade. 33

EXPORT INDUSTRIES Trade not only alters the mix of output but also redistributes income from import-competing industries to export industries. Trade restrictions designed to protect specific microeconomic interests reduce the total gains from trade. Selfish micro interests are not the only source of trade restrictions. Other arguments are used to restrict trade. 34

NATIONAL SECURITY CONCERNS Essential defense-related goods are vital during times of war. A war could disrupt this flow leaving us vulnerable. Exporting vital technology to a potential enemy is not wise. 35

DUMPING Import competing industries are placed at risk when goods are consistently dumped in a nation. Dumping is the sale of goods in export markets at prices below domestic prices. 36

INFANT INDUSTRIES Even normal export prices might make it difficult or impossible for a new domestic industry to develop. These industries may need temporary protection from imports. Trade restrictions are justified only if there is tangible evidence that the industry can develop a comparative advantage reasonably quickly. 37

IMPROVING THE TERMS OF TRADE The distribution of the gains from trade depends on the terms of trade. If the terms of trade moves in our favor, due to trade restrictions, we would end up with a larger share of the gains from trade. The microeconomic losses associated with trade give rise to a constant clamor for trade restrictions. 38

EMBARGOES The sure-fire way to restrict trade is simply to eliminate it. An embargo is a prohibition against trading particular goods. 39

TARIFFS A more frequent trade restriction is a tariff. A tariff is a tax (duty) imposed on imported goods. A tariff on imported goods makes them more expensive to domestic consumers, and thus less competitive with domestically priced goods. 40

BEGGAR-THY-NEIGHBOR NEIGHBOR The curtailment of imports looks like an easy solution to the problem of domestic unemployment. Tariffs inflict harm on foreign producers. 41

BEGGAR-THY-NEIGHBOR NEIGHBOR The Smoot-Hawley Tariff Act was designed to save American jobs by restricting foreign competition through 59% tariffs. When foreign countries retaliated with tariffs of their own, world trade shrank and unemployment increased in all countries. 42

QUOTAS The same effects of a tariff can be attained more directly by imposing an import quota. A quota is a limit on the quantity of a good that may be imported in a given time period. The effect of quotas on trade is different than the effect of tariffs. 43

NO-TRADE EQUILIBRIUM The equilibrium price is completely determined by domestic demand and supply curves. Free trade allows the import of unlimited quantity of foreign supplies at the world price. Free trade results in reduced prices and increased consumption. 44

RESTRICTED TRADE Tariffs raise the price of imports and shifts the import supply curve upward. Domestic prices rise, domestic production rises, and domestic consumption falls. Quotas are a greater threat to competition than tariffs because quotas preclude additional imports at any yprice. 45

IMPACT OF TRADE RESTRICTIONS (a) No-trade equilibrium per unit) D 1 S 1 (dollars p 1 PRICE 0 q 1 QUANTITY (units per year) 46

IMPACT OF TRADE RESTRICTIONS (b) Free-trade equilibrium per unit) D 1 S 1 (dollars PRICE p 1 B p 2 S 2 0 q d q 1 q 2 QUANTITY (units per year) 47

IMPACT OF TRADE RESTRICTIONS (c) Tariff-restricted trade per unit) D 1 S 1 (dollars PRICE p 1 p 3 p 2 C S 3 S 2 0 q d qt q 1 q 3 q 2 QUANTITY (units per year) 48

IMPACT OF TRADE RESTRICTIONS (d) Quota-restricted trade per unit) (dollars p 1 p 4 D 1 Q S 1 S4 PRICE p 2 0 q 1 q 4 q 2 QUANTITY (units per year) 49

VOLUNTARY RESTRAINT AGREEMENTS A light variant of quotas has been used in recent years. A voluntary restraint agreement (VRA)is an agreement to reduce the volume of trade in a specific good a voluntary quota. Embargoes, export controls, tariffs, and quotas are the most visible barriers to trade, but they are only the tip of the iceberg. 50

NONTARIFF BARRIERS The U.S. uses product standards, licensing restrictions, restrictive procurement practices, and other nontariff barriers to restrict roughly 15 percent of imports. Trade policy is a continuing conflict between the proponents of free trade and the special interests that profit from trade protection. The long-term trend is towards lowering trade barriers, thereby increasing global competition. 51

MULTILATERAL TRADE PACTS The principle barrier to protectionist forces is the worldwide recognition of the gains from trade. The granddaddy of the multilateral, multiyear free-trade pacts was the General Agreement on Tariffs and Trade (GATT). 52

GATT In 1947, twenty-three nations pledged to reduce trade barriers and give equal access to all GATT nations to their domestic markets. Since the first GATT pact, seven more rounds of negotiations have expanded the scope of GATT. 117 nations signed the 1994 pact. As a result of these GATT pacts, average tariff rates in developed countries have fallen from 40 percent in 1948 to less than 4 percent today. 53

WTO The 1994 GATT pact also created the World Trade Organization (WTO) to enforce free-trade rules. In effect, the WTO is the world s trade police force. 54

WTO PROTESTS Some people see free trade as a mixed blessing. Environmentalists worry about depletion of resources, congestion and pollution. Labor organizations worry about depressed wages and working conditions. Third World countries worry about an unfair trade playing field. 55

WTO PROTESTS Trade negotiators are trying to find ways to continue dismantling trade barriers while paying more attention to broader social concerns. 56

REGIONAL PACTS: NAFTA AND EU Groups of nations have moved even faster toward open markets by developing regional trade pacts. In December 1992, the United States, Canada, and Mexico signed the North American Free Trade Agreement (NAFTA). The Ultimate goal of NAFTA is to eliminate all trade barriers between these three countries. 57

NAFTA The NAFTA-initiated reduction in trade barriers substantially increased trade flows between Mexico, Canada, and the United States. Overall, NAFTA accelerated economic growth and reduced inflationary pressures in all three nations. 58

EUROPEAN UNION The European Union (EU) is a regional pact that virtually eliminates national boundaries between 15 countries. The EU has not only eliminated trade barriers, but also permitted full inter-country mobility of workers and capital. 59

EUROPEAN UNION In 1999, eleven of the EU nations also created a new currency (the euro) that will replace the German mark, the French franc, and other national currencies. In effect, Europe has become one large unified market. kt 60

End of Chapter 20 INTERNATIONAL TRADE