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International Trade

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Chapter 17: International Trade

KEY CONCEPT• Economic interdependence involves producers in one nation that

depend on producers in other nations to supply them with certain goods and services.

WHY THE CONCEPT MATTERS• Nations choose to produce some things and trade for others. For

example, Japan trades for the raw materials it uses to produce automobiles. It then turns around and trades the automobiles for other goods.

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Resource Distribution and SpecializationKEY CONCEPTS

• Nation’s economic patterns based on factors of production it has– patterns change over time; for example, U.S. originally agricultural

• Specialization occurs when narrow range of products made – increased productivity and profit– economic interdependence—reliance on others for products not

made

Benefits and Issues of International Trade

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Resource Distribution and Specialization

Example: Specialization• Costa Rica exports bananas; has warm, wet climate bananas need

– relatively low agricultural wages are beneficial—production is labor intensive

• New Zealand exports wool, lamb, and mutton– has temperate climate, water, open grasslands needed for grazing– has low population density, scientific breeding, mechanized

processing

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David Ricardo: The Theory of Comparative AdvantageExample: Trading in Opportunity

• Ricardo (1772–1823): English economist; lived at turn of 19th century• In his time, international trade based on absolute advantage• Ricardo showed nations can benefit from comparative advantage

– produce products it can make at lower opportunity cost than others

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Absolute and Comparative Advantage

KEY CONCEPTS• Absolute advantage—nation’s ability to make product more efficiently

– due to uneven distribution of production factors in different areas• Comparative advantage—ability to produce at lower opportunity cost

– absolute cost of product not important, just opportunity cost

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Example: Absolute Advantage• Australia produces more iron ore and steel than China with same

labor– Australia has absolute advantage

• Before Ricardo, logic held Australia should not trade for either

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Example: Comparative Advantage• Law of comparative advantage—countries gain when

– produce items they are most efficient at producing– and are at the lowest opportunity cost

• If Australia’s ratio of steel to iron ore is 1:5 tons and China’s is 1:3– China has comparative advantage in steel production

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Example: Advantages of Free Trade• If China, Australia specialize, set trade ratio steel to iron ore at 1:4

– China gets 4 tons iron ore for 1 of steel, got 3 before– Australia gets 1 ton of steel for 4 of iron ore; cost 5 before

• Specialization, trade raise nations’ production ratios, world output• Increased output is mark of economic growth

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International Trade Affects the National EconomyKEY CONCEPTS

• Exports—goods and services produced in one country, sold in others• Imports—products produced in one country, purchased by another • Costs and benefits of international trade vary by nation

– economists examine impact of exports and imports on prices and quantity

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International Trade Affects the National EconomyImpact 1: Exports on Prices and Quantity

• If a country begins exporting product, foreign buyers increase total demand– demand curve shifts right, sets higher equilibrium price

• Higher prices at home offset by more jobs and income – created by production expanded to meet demand

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International Trade Affects the National EconomyImpact 2: Imports on Prices and Quantity

• Imports shift supply curve right, lower equilibrium price• Lower prices lead domestic producers to offer less of product

– improve efficiency, worker productivity, customer service• Trade gives consumers increased selection of goods, lower prices• Gives producers new markets, chance for more profits

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International Trade Affects the National EconomyThe United States in the World Economy

• U.S. is world’s largest exporter; exports more services than imports– tourism, transportation, architecture, construction, information

systems• Also world’s largest importer; imports more goods than it exports

– oil and refined oil products, machinery, raw materials• Main trading partners: Canada, China, Mexico, Japan

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Reviewing Key Concepts

Explain the differences between the terms in each of these pairs:

• specialization and economic interdependence• absolute advantage and comparative advantage• export and import

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Barriers to TradeKEY CONCEPTS

• Most nations pass trade limit laws to protect domestic industries• Laws lead to higher prices, economic retaliation by other nations• In long run, industries can only be saved by becoming competitive• Trade restrictions are basically a political issue

Trade Barriers

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Barriers to Trade

Types of Trade Barriers • Trade barrier—law limiting free trade among nations; most

mandatory • Quota—limits on the amount of a product that can be imported • Dumping—sale of product in other country at lower price than at

home – hurts domestic producers; gives consumers lower price

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Barriers to Trade

Types of Trade Barriers • Tariff—fee charged for goods brought from another country • Revenue tariff—tax on imports, specifically to raise money

– rarely used today• Protective tariff—tax on imported goods to protect domestic products

– raise price of goods more cheaply elsewhere

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Barriers to Trade

Types of Trade Barriers• Voluntary export restraint—nation’s self-imposed limit on exports

– VER used to avoid a quota or tariff• Embargo—law that cuts most or all trade with a specific country• Informal trade barriers—licenses, environmental, health, safety laws

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The Impact of Trade Barriers

KEY CONCEPTS• Trade barriers may temporarily save domestic jobs

– lack of competition promotes inefficiency, higher prices• Trade limits can lead to a trade war—succession of increasing trade

barriers between nations

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Impact 1: Higher Prices• Trade barriers raise prices or keep them high• In 2000, U.S., Japan set tariffs on South Korean semiconductor chips

– Korean and domestic chip prices went up in U.S. and Japan

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Impact 2: Trade Wars• Trade wars often result from disagreements over quotas or tariffs• Can result over other issues

– EU banned U.S hormone-treated beef, U.S. set 100% tax on many EU foods

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Arguments for Protectionism

KEY CONCEPTS• Protectionism—use of trade barriers to protect domestic industries • Purpose to protect jobs, national security, infant industries

– new industries unable to compete with larger, established competitors

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Argument 1: Protects Domestic Jobs?• U.S. workers upset over jobs lost to countries with cheaper labor • Trade barriers generally protect inefficient production, higher prices• Laid-off voters influenced government to fund job training programs

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Argument 2: Protects Infant Industries?• Protection expected to allow new industries to grow until competitive

– used by developing nations to keep out goods from developed nations

• Critics say freedom from competition maintains perpetual infancy– and need for perpetual support

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Argument 3: Protects National Security?• National security affects industries considered vital for safety

– energy industry considered vital by most nations• Political differences exist over which industries are truly vital

– 2006 Dubai forced to abandon deal to operate several port facilities

– critics doubted security concerns, worried over interference with trade

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Explain the relationship between the terms in each of these pairs:

• trade barrier and quota• tariff and voluntary export restraint• trade war and protective tariff• infant industries and protectionism

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Foreign ExchangeKEY CONCEPTS

• Trade needs way to set relative value of trading nations’ currencies• Foreign exchange market—where different currencies bought and

sold – network of major commercial, investment banks linking world

economies• Foreign exchange rate—price of a currency in other currencies

Measuring the Value of Trade

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Foreign Exchange

Rates of Exchange • In 1800s, early 1900s, gold standard determined value of currencies

– fixed rate of exchange—nation’s currency constant in relation to others

• Post–World War II to 1970s, currencies pegged to USD—1 oz gold = $35

• Flexible exchange rate—changes along with currency’s supply, demand – regulates foreign exchange, balancing imports and exports

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Foreign Exchange

Strong and Weak Currencies • Trade-weighted value of the dollar—international value of U.S. dollar

– measured by the Fed• Weak dollar makes imported goods more expensive

– easier for domestic goods to compete– exports become cheaper, easier to sell abroad

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Balance of Trade

KEY CONCEPTS• Balance of trade—difference between value of imports and exports • Balance of payments—all transactions between nation and rest of

world – includes government and private transactions, both trade and

investment• Trade surplus—nation exports more than imports; favorable balance • Trade deficit—nation imports more than exports; unfavorable

balance

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Balance of Trade

Example: U.S.-China Trade• China has undergone one of most rapid industrializations in history• Has pegged yuan at fixed rate versus dollar, keeping yuan weak • Made U.S. top destination for Chinese exports

– China has record trade surplus of $200 billion with U.S.

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Balance of Trade

Example: The U.S. Trade Balance• 1770–1870: U.S. had deficit in products; surplus in capital investment• 1870–1920: paying back debts; was exporting more than importing• 1920–1945: had surplus in exports, deficit in foreign investment• 1945–1980: had deficit in merchandise; deficit in foreign investments• Today has surplus of foreign investment; merchandise deficit

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Explain the differences between the terms in each of these pairs:

• foreign exchange market and foreign exchange rate• fixed rate of exchange and flexible rate of exchange• trade surplus and trade deficit

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Regional and World OrganizationsKEY CONCEPTS

• Free-trade zones—areas where nations trade without protective tariffs

• Customs unions—agreements that abolish trade barriers among members– establish uniform tariffs for non-members

• Some trade groups called common markets

Modern International Institutions

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Regional and World Organizations

Group 1: The European Union • 1957, six European nations created Common Market; became EU in

1993• European Union—economic and political union; no barriers for

members • Euro—currency of the EU, used by 12 of 27 member nations • EU has 20% of global exports and imports, world’s biggest trader

– sets low tariffs; wants to remove all barriers to international trade

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Group 2: NAFTA • NAFTA—North American Free Trade Agreement of 1994

– phases out trade barriers between Canada, Mexico, U.S. in 15 years

• Has led to specialization, efficiency, expanded markets, new jobs– also competitive advantage over EU and Japan

• All countries have had economic gain; trade has more than doubled

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Group 3: Other Regional Trade Groups• Various groups formed to specialize, promote free trade, stay

competitive– include Mercosur, ASEAN, APEC, SADC

• OPEC—Organization of Petroleum Exporting Countries is a cartel– group of producers controls production, pricing, marketing of a

product

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Group 4: World Trade Organization• In 1944, Allied nations formed General Agreement on Tariffs and

Trade• World Trade Organization—formed in 1995 by nations that follow

GATT – negotiates, administers trade agreements; resolves disputes– monitors policies of 149 members; gives support to developing

countries• WTO successful to varying degrees

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Multinationals Bring Changes to International TradeKEY CONCEPTS

• Multinational corporations affect many different nations– must deal with different sets of tariffs, labor restrictions, taxes– often bring jobs and technology to developing nations– boost overall levels of international trade

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Multinationals Bring Changes to International TradeInternational Trade Within Multinationals

• Intrafirm trade is trade between various divisions of a multinational– exchange of goods between two parts of the company– coordination of production between parts of the multinational

• Materials or parts sent to overseas affiliate count as exports– intrafirm imports count as imports in balance of trade

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Multinationals Bring Changes to International TradeExample: A Multinational Telecom Corporation

• Worldwide Cellular is U.S.-based multinational– mines raw material in Australia– manufactures phones in South Korea– markets phones in Europe– provides customer service from India

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Explain the relationship between the terms in each of these pairs:

• free-trade zone and customs union• EU and NAFTA• OPEC and cartel

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Analyzing Tariffs—Who Wins and Who Loses?Background

• The United States has had tariffs on sugar since the days of the early republic.

• In recent WTO talks, less-developed countries have objected to the lack of market access for their goods and their price disadvantage.

What’s the Issue• How do the trade barriers set up by the U.S. government affect producers

(both foreign and domestic) and consumers?Thinking Economically

• Which argument for protection does document C seem to make? Is this argument economically valid? Explain.

• Is the difference in price shown in document B an unavoidable outcome of the program outlined in document A? Explain.

• How does U.S. government intervention in the sugar industry limit the functioning of the economy as a free market? Use examples from the documents in your answer.

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