Chapter 14Chapter 14

International Trade

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning ObjectivesLearning Objectives

• Explain why global trade has increased so much in recent years.

• Summarize the main gains to trade.• Compare and contrast absolute advantage

and comparative advantage.• Discuss the winners and losers from trade

and analyze the arguments for protectionism.

• Describe what it means for a currency to appreciate or depreciate.

• List explanations for why the United States consistently runs a trade deficit.

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Nature of International TradeNature of International Trade

• There has been a boom in international trade over the last decade.

• Both trade in goods and services has been soaring.

• Service exports include such items as foreign students studying in the U.S. and foreigners watching U.S.-produced TV shows and movies.

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Global Exports (and Imports) as a Global Exports (and Imports) as a Percent of Global GDPPercent of Global GDP

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Top Ten Purchasers of Top Ten Purchasers of U.S. ExportsU.S. Exports

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Top Ten Sources of U.S. Top Ten Sources of U.S. ImportsImports

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Barriers to TradeBarriers to Trade

• Historically, businesses that want to sell to buyers in another country faced both the natural barriers to trade and the legal barriers to trade.

• The natural barriers include distance, differences in culture and values, and the difficulty of delivering services remotely.

• The legal barriers include tariffs, quotas, and other regulatory impediments.

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Barriers to TradeBarriers to Trade

• Both natural and legal barriers to trade have fallen due to technology and a commitment among countries toward a policy of free trade.

• Technology has reduced the cost of shipping and made communication over long distances much easier.

• The ease of communication has reduced problems associated with different languages and cultures.

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Lowering of Legal BarriersLowering of Legal Barriers

• Historically, countries have put barriers on trading in the form of tariffs and quotas.– Tariffs are the taxes leveled on imports by

a country. – Quotas are numerical limits on the number

of imported products coming into a country. – Tariffs and quotas are applied to raise

revenues and to protect domestic industries from foreign competition.

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Lowering of Legal BarriersLowering of Legal Barriers

• Since the end of World War II, most countries – led by the United States – have made a concerted global effort to reduce tariffs, quotas, and other trade barriers.

• The reduction of these barriers has led to a significant increase in global trade.

• Tariffs act as a tax on imported goods, and thus raise their price.

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Lowering of Legal BarriersLowering of Legal Barriers

• When the tariff is removed, the price of the import goes down and the quantity demanded for imports rises.

• Quotas are numerical limits on imports which effectively reduce the quantity supplied of the good.– This supply restriction also drives up the

price.

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Eliminating a Tariff Increases the Eliminating a Tariff Increases the Quantity of ImportsQuantity of Imports

Demand curve for imports

Level of imports without a tariff

Market price without a tariff

Price

Imports

Supply curve for importsPrice paid by

consumers with a tariff

Price received by importers with a tariff

Level of imports with a tariff

Tariff

A

C

B

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Gains from TradeGains from Trade

• Countries trade with each other because of the gains from trade.

• The first gain from trade is lower prices.– Goods and services that are produced

overseas have lower prices than the comparable domestic goods and services.

– Also, the increased competition from foreign producers forces domestic companies to keep prices low.

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Furniture Prices versus CPI, Furniture Prices versus CPI, 1990-20101990-2010

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Furniture Imports to the U.S., Furniture Imports to the U.S., 1990-20101990-2010

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Access to Natural ResourcesAccess to Natural Resources

• A second gain from trade is access to natural resources that are either unavailable or too expensive to produce domestically.– The U.S. imports a long list of resources,

with the most important being crude oil.– Countries like Japan have few resources,

and import virtually all of them.

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Access to Global MarketsAccess to Global Markets

• A third gain from trade is that companies obtain access to global markets.– Businesses can benefit because the

market for their product is now much larger than any single nation.

– A global sales strategy is especially beneficial for companies that have development costs such as Boeing.

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Access to New IdeasAccess to New Ideas

• The final gain from trade is the access to new ideas developed in other countries. – This improves growth in the domestic economy, as

knowledge is one of the key factors determining long-term growth.

– In the current economy, many products are either designed overseas or are the result of cross-country collaboration.

– The development of the flat-panel television is a good example.

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Comparative versus Comparative versus Absolute AdvantageAbsolute Advantage

• A country has an absolute advantage in producing a good if it takes less resources to produce the good in that country than in another.

• But countries with an absolute advantage in producing a good may not export it. It depends on the comparative advantage.

• Comparative advantage means that countries specialize in the products or services where they have the biggest productivity advantage – or the smallest productivity disadvantage.

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Labor Costs in Manufacturing, Labor Costs in Manufacturing, 20092009

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Winners and Losers from TradeWinners and Losers from Trade

• While the theory of comparative advantage states that international trade will benefit an overall economy, some companies and individuals will be hurt.

• The benefits from trade are broadly distributed:– The entire population benefits from lower prices

for goods and services.– Countries that are open to trade tend to have a

faster rate of economic growth, and living standards go up.

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Winners and Losers from TradeWinners and Losers from Trade

• The losers from trade are those industries where imported goods and services displace domestically-produced goods and services and cost the country jobs.

• This has been most prevalent in the manufacturing side of the economy, where much of the production has moved to Asia.

• The job losses in manufacturing were, however, more than offset by gains in other sectors, such as healthcare and finance.

• Globalization benefits people whose skills are relatively scarce in world markets.

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Imports and JobsImports and Jobs

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Arguments for ProtectionArguments for Protection

• While the evidence shows that international trade is beneficial to an economy, free trade is often attacked by politicians who believe it is harmful to many workers.

• There are demands by these politicians for a return to protectionism.– That is, using tariffs, quotas, or other

barriers to trade to protect domestic jobs.

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Arguments for ProtectionArguments for Protection

• There are a number of arguments made for protectionism:– One argument against free trade is that it

is disruptive in terms of people’s lives.• The cost of change can be both economic

and social. • A factory moving out of a small town can

leave the people without a livelihood.

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Arguments for ProtectionArguments for Protection

– The infant industry argument is a second argument against free trade.

• An infant industry is a new or developing industry in a country which is vulnerable to being put out of business by better-funded and more mature foreign competitors.

• Given a chance to grow while protected, however, the new industry could be a viable global competitor.

• In theory this argument makes sense, but in practice it rarely works since it reduces competition.

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Arguments for ProtectionArguments for Protection

– Another argument for protectionism is unfair competition.

• In this case, a foreign country subsidizes its exporting industries by lowering its taxes, offering them low-cost loans, or simply by giving them money.

• Given this subsidy, the foreign industry can cut the price of their products in the global market.

• As a result, the subsidized industries may obtain a bigger share of the global market.

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Arguments for ProtectionArguments for Protection

– The final, and perhaps most compelling, argument for some form of protection is national security.

• In the case of war, countries need to protect some of their defense-related production.

• For example, specialty steel and advanced electronics need to be produced domestically.

• A country needs to balance the economic benefits of trade against the potential vulnerabilities of a global supply chain in the case of war.

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Exchange RatesExchange Rates

• Almost every country has a national currency.

• For trade to take place, one country’s currency must be converted to the other country’s currency.

• The exchange rate is the rate at which one currency can be turned into another.

• Exchange rates can be floating or pegged.– Floating rates are set in the foreign exchange

markets, while pegged rates are managed by the country to remain fixed.

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Exchange RatesExchange Rates

• When an exchange rate changes so that one currency can buy more of another, we say the first currency is appreciating and the second currency is depreciating.

• The chart on the next slide shows that the dollar is depreciating against the Chinese Yuan.

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Exchange Rate of the Yuan Exchange Rate of the Yuan versus the Dollarversus the Dollar

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Effects of Appreciation and Effects of Appreciation and DepreciationDepreciation

• When a currency depreciates, imports become more expensive, while exports become cheaper.– Imports should fall, exports should rise, and the

trade deficit should become smaller.

• When a currency appreciates, imports become cheaper, while exports become more expensive.– Imports should rise, exports should fall, and the

trade deficit should become larger.

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How Depreciation WorksHow Depreciation Works

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Trade BalanceTrade Balance

• The trade balance is the difference between exports of goods and services and imports of goods and services.

• If the trade balance is negative – that is, if imports exceed exports – we say that the country is running a trade deficit.

• The U.S. trade deficit has increased significantly in recent years.

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Goods and Services Trade Goods and Services Trade Balance for U.S.Balance for U.S.

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Explanations for the Trade Explanations for the Trade DeficitDeficit

• There are a number of possible explanations for the trade deficit:– First, it is our fault because:

• U.S. manufacturers are unable to compete.• U.S. consumers are overspending, causing

the deficit.• Overspending by the federal government is

the cause.

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Explanations for the Trade Explanations for the Trade DeficitDeficit

– Second, it is their fault because:• Foreign countries put up barriers that keep

out U.S. exports and subsidize their own exports.

– Finally, it is no one’s fault because:• The strength of the U.S. economy allows us

to import more goods.• Other countries want to lend to the U.S.

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Paying for TradePaying for Trade

• The U.S. can pay for what we import in four ways:

– Sell exports to foreigners.– Borrow money from foreign investors.– Sell assets such as stocks, bonds, and

real estate to foreign investors.– Allow foreign companies to build

factories in the U.S.

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