topic 7 international trade

TOPIC 7 International Trade

Definitions:• Trade or trading: refers to the

transactions or the exchanges of ownership of goods and services.

and,

refers to the transactions made domestically among the domestic traders in a country only.

•Domestic Trade:

while,•International Trade (IT): refers to transactions made among different countries in the world, whereby involves export and import.

• Why do countries tend to trade with the rest of the

world?

• Why don’t they become self-sufficient?

• Indeed, large countries like China and America would also like to trade with other nations in the global economy.

– they do not want to become self-sufficient:

i.e. to produce all goods they consume and restrict foreign

goods into their country.

• While China now tend to become an “open economy” i.e. widely open to their trading partners – allowing exports and imports activities.

this explains how important is the International Trade.

International Trade can also be referred as:

INTERNATIONAL SPECIALISATION

- Specialisation is said as the basis for trade.

- The benefit receives from specialisation is that it may improves economic growth.

M’sia Real GNP with Net Exports

• Real GNP (RM Billion) 101.7 179.8 190.3 192.8 200.6212.2

• Net Merchandise Exports (RM Billion) 0.5 73.1 92.6 53.7 51.1 53.1

(source: Malaysia key economic indicators: Malaysian Export Directory of

Manufacturers)

1999 2000 2001 2002 2003 2004*

M'sian Real GNP with Net Exports

0

50

100

150

200

250

1999 2000 2001 2002 2003 2004*

year

RM(B

illio

n)

•Real GNP (RM Billion) •Net Merchandise Exports

Growth rates and export performance ofselected secondary outward-looking countries

Growth in real GDP and in real exports of goodsand services: total OECD countries


Growth in GDP


Growth in exports of goods and services

Growth in GDP

- one country will specialise in a good that she is best at and will trade among them.

Specialisation means

WHAT ARE THE REASONS or FACTORS FOR COUNTRIES TO

TRADE INTERNATIONALLY OR

TO DO SPECIALISATION?

The factors that may lead these countries to involve in

international trading are:

The reasons for IT to occur:i. Different factor endowments: raw materials, climate, specialist labour, capital or technology that may caused to produce different types of goods.

The reasons for IT to occur:i. Different factor endowments: raw materials, climate, specialist labour, capital or technology that may caused to different types of goods produced.

ii. Limited mobility of factors: human capital usually are non-mobile:

higher cost of production – costly to produce, so import goods from cheap countries.

The reasons for IT to occur:iii. To obtain the benefit from

Specialisation: The theories of specialisation proves that countries which trade internationally (after specialisation) may increase their production, consumption and thus standard of living.

2 types of specialisation to be gained either: i) absolute advantage or

ii) comparative advantage.Specialisation improves the volume of production and lower the cost and benefit countries that involves in trading.- This proves that self-sufficient is inefficient.

The reasons for IT to occur:iv. Wider consumer choice – varieties of goods to choose: may enjoy different types of goods. Differences in taste across countries prompt the global trading and large demand.

The reasons for IT to occur:v. To expand the market and may

benefits from Economies of Scale – decreasing cost:

countries can gain from huge demand of global market by lowering its long run average cost; which declines as the rate of production increases.

vi. Increases national income: specialisation helps to increase the

volume of exports and raises GDP.

The reasons for IT to occur:vii. Increases Competition –the benefits from large

competition may result to greater efficiency and better quality of goods:

Competition among domestic traders is relatively small.

Large competition may arise in global trading among countries in the world which may results to perfect competitive market,

and thus, might benefit them in terms of both the productive and allocative efficiency.

viii. Non-economic advantages – improves relationship and promote political links.

ix. Exchanging knowledge and technological advancement.

The differences between International and Domestic Trade:

1. Size of market and volume of transactions.2. Greater specialisation in countries which

involves in international trade.3. Involves the use of different units of

currency.4. Different nations produce varieties of goods

as world production.5. Large competition between nations may lead

to better quality of goods.6. Higher cost of transportation – involves

longer distance of journey.7. Subject to government policy and controls.

The benefits from Specialisation in INTERNATIONAL TRADE:

• will specialise in its own best production of goods.

TWO TYPES OF SPECIALISATION in international trade:

- may gain either through the: Absolute advantage or Comparative advantage.

1. ABSOLUTE ADVANTAGE• is the benefit received when one country

is relatively more efficient than the other country in a production process:

i) either in terms of the ability to produce the same amount of goods is relatively less costly (or using fewer resources) than the other country;

ii) or with the same resources, it is beneficial and efficient if one country might be able to produce more goods than the other country.

Scarcity of resources relative to material human wants

• permits the use of resources efficiently with larger production.

• Specialisation able to increase efficiency and volume of production.

• One country may specialise in production of goods that has relatively lower cost or greater efficiency with higher output.

Mutual Benefit from Absolute Advantage:

• After specialisation, each of them can benefit from absolute advantage in the production that they are relatively more efficient,

then is said to gain from absolute advantage.

to understand the theory of specialisation, it is assumes that:

i. only two (2) countries trading in the world market.

ii. produces two (2) goods only.iii. constant cost of production (resulting

to linear production possibility curves)iv. fixed resourcesv. no transportation cost or trading

barriers.

Production possibilities for two countries

For Example:

country productFurniture

(units)Computers

(units)MALAYSIA 1800 2500JAPAN 1500 3000

TOTAL 3300 5500

Production Before Specialisation

In Malaysia; 1 unit of furniture = 2500/1800 = 1.4 units of computers (has to be forgone)In Japan; 1 unit of furniture = 3000/1500 = 2 units of computers.In this case, Malaysia has a lower opportunity cost for the production of furniture than Japan. Therefore, Malaysia will specialize in the production of furniture.


(units)Computers


TOTAL 3300 5500

The Opportunity Cost or Relative Price of furniture versus computers:

In Malaysia; 1 unit of computer = 1800/2500 = 0.7 units of furniture. (has to be forgone)In Japan; 1 unit of computer = 1500/3000 = 0.5 units of furniture.In this case, Japan has a lower opportunity cost for the production of computers, therefore Japan will specialize in the production of computers.


(units)Computers


TOTAL 3300 5500

The Opportunity Cost or Relative Price of computers versus furniture :

The Relative Prices can be scheduled as:

CountryOpportunity cost (units)

1 furniture 1 computer

MALAYSIA 1.4 computers 0.7 furniture

JAPAN 2 computers 0.5 furniture

The Opportunity Cost

PRODUCTION AFTER SPECIALISATIONcountry product

Furnitures (units)

Computers (units)

MALAYSIA 3600 xxJAPAN xx 6000

TOTAL 3600 6000After specialization, total production of both goods in the world increases. World production before: furniture= 3300, computers= 5500. World production after : furniture= 3600, computers= 6000.

Terms of Traderefers to: the ratio of exchange between two commodities traded.

Terms of Trade• can be stated by looking at the opportunity cost of two

countries;In Malaysia; 1 unit of furniture = 1.33 units of computers. In Japan; 1 unit of furniture = 2 units of computers.So, Terms of Trade agreed can be: 1 unit of furniture : 1.5 unit of computers OR 1 unit of furniture : 0.8 units of computersOR 1 unit of furniture : 1.33 < computers < 2OR 1 unit of furniture: 1.33 + 2 = 1.67 computers. 2

CONSUMPTION AFTER SPECIALISATION

country productFurnitures

(units)Computers


TOTAL 3600 6000

With Terms of Trade (TOT);

1 FURNITURE : 1.5 COMPUTERS

Can these countries trade, if only one country has the

absolute advantage in producing both goods?

still they can benefit from specialisation through

comparative advantage.

• If absolute advantage does not exist for both countries that trade still they can have the mutual benefit from trading.

2. COMPARATIVE ADVANTAGE

The law of or benefit from comparative advantage:– is the ability of a country to specialise and

produce goods at a relatively less opportunity cost than another country,

even though only one country has the absolute advantage in all goods.

Instead,• when only one country was more efficient

at producing both goods, specialization still may gain both

countries; (provided that one country has a greater

comparative advantage of one good.) - thus, one country will specialize in the

good that she has relatively greater comparative advantage.

So … what’s the difference between Absolute and Comparative Advantages.

• Absolute Adv: is the benefit enjoyed in the production process when one country can produce more than the other country with the same resources used.

• Comparative Adv: is the benefit enjoyed in the production process when one country can produce at a lower opportunity cost in terms of the other goods than the other country.

Production possibilities for two countries

Example of Comparative Advantage:

country productVegetable

(units)Fish

(units)INDONESIA 200 150THAILAND 300 400

TOTAL 500 550

Production Before Specialisation

The Opportunity Cost or Relative Price of vegetables versus fish:


(units)Fish


TOTAL 500 550In Indonesia; 1 unit of vegetable = 150/200 = 0.75 units of fish (has to be forgone)In Thailand; 1 unit of vegetable = 400/300 = 1.33 units of fish.In this case, Indonesia has a lower opportunity cost for the production of vegetable than Thailand. Therefore, Indonesia will specialize in the production of vegetable.

The Opportunity Cost or Relative Price of fish versus vegetables :In Indonesia; 1 unit of fish = 200/150 = 1.33 units of vegetable. (has to be forgone)In Thailand; 1 unit of fish = 300/400 = 0.75 units of vegetable.In this case, Thailand has a lower opportunity cost for the production of fish, therefore Thailand will specialize in the production of fish.


(units)Fish


TOTAL 500 550

The Relative Prices can be scheduled as:

countryOpportunity cost (units)

1 vegetable 1 fish

INDONESIA 0.75 fish 1.33 vegetable

THAILAND 1.33 fish 0.75 vegetable

The Opportunity Cost

PRODUCTION AFTER SPECIALISATION


(units)Fish (units)

INDONESIA 400 xxTHAILAND xx 800

TOTAL 400 800

After specialization, total production of goods in the world increases. World production before: vegetable= 500, fish = 550. World production after : vegetable= 400, fish = 800.

Terms of Trade• looking at the opportunity cost of two countries.In Indonesia; 1 unit of fish = 1.33 units of vegetable. In Thailand; 1 unit of fish = 0.75 units of vegetable.

So, Terms of Trade agreed can be: 1 unit of fish : 1 unit of vegetable. OR 1 unit of fish : 0.8 units of vegetable OR

1 unit of fish : 1.33 > vegetable

> 0.75

Trading/exchange will occur:


(units)Fish (units)

INDONESIA 200 200THAILAND 200 600

TOTAL 400 800 Total Consumption after specialization (Indonesia exports 200 vegetables to Thailand and instead receives 200 fish in return as imports from Thailand, since the TOT is 1Veg : 1 Fish

If the Terms of Trade agreed is: 1 unit of fish = 1 unit of vegetable

The Terms of Trade (TOT) can also be stated as:

» PX / PM

The terms of trade can be stated also as the ratio of prices of exports to imports.

LET’S HAVE A 5 MINUTES

BREAK

….and LET’S TRY ONEEXERCISE (Q1) IN THE “Question to Ponder.”

QUESTION 1

COUNTRY

COMMODITYSHOES(units)

CLOTHS(units)

INDIA 400 2000CHINA 1200 2400

BEFORE SPECIALISATION

Table of Opportunity Cost

COUNTRYCOMMODITY

1 SHOE 1 CLOTH

INDIA 5 CLOTH 0.2 SHOECHINA 2 CLOTH 0.5 SHOE

b) COMPARATIVE ADVANTAGE OF PRODUCING SHOES AND CLOTHS.

COUNTRY

COMMODITYSHOES(units)

CLOTHS(units)

INDIA xx 4000CHINA 2400 xx

AFTER SPECIALISATION

c) Which country specialise in Cloth?

d) Suggestion for TERMS OF TRADE

1 SHOE : 2 < CLOTH < 5 OR

1 CLOTH : 0.2 < SHOE < 0.5

THANK YOUAnd

Try to solve a few more questions in the “Question To

Ponder” AND ALSO

Questions in MODEL ANSWER BOOK page 189…. Q4, 5 and 6.

PROTECTIONISM

Sometimes too much freedom to the International Trade is not advisable.

Some restrictions has to be imposed on International Trade.

PROTECTIONISM / TRADE BARRIERS

• Methods of restricting trade: (Protectionist Policy):– tariff– quota– embargo– foreign exchange control– import licences– export subsidies and grants– administrative barriers

Arguments for Restricting Trade(Reasons for protectionism): To protect infant and local industries. To reduce the deficit in BOP. To diversify economy. To prevent dumping. To control recession and

unemployment. To increase government revenue. For retaliation purposes.

Trading Blocs• Types of preferential trading arrangement

– Free Trade Areas (e.g. NAFTA)– customs unions (e.g. European Union)– common markets

Reasons:• internal and external economies of scale• better terms of trade• increased competition between members etc.

Trading BlocsFree Trade Areas (FTA)

The launching of the FTA negotiations for a Malaysia-US FTA hope to pave the way for stronger investment and trade.

- FTA were expected to focus on: . Liberalisation of trade in goods, services and

investment, . Promote and facilitate trade and investment

flows. . Cooperation to address impediments to trade in

the areas of intellectual property rights, standards, and conformance and development of Mutual Recognition Arrangements.

. Collaborate to enhance competitiveness in specific sectors such as tertiary education, healthcare and tourism, capacity building and technical assistance.

LET’S LOOK AT YOUR EXERCISES!

MODEL ANSWER:• ANY PROBLEMS?

THANK YOU

HAVE A NICE DAY!

PRODUCTION POSSIBILITY CURVEMALAYSIA

JAPANFurniture (units)

Furniture (units)

Computers (units) Computers

(units)

1800

2500 3000

1500

Arguments for Restricting Trade• Arguments for restricting trade (cont.)

– to prevent establishment of a foreign-based monopoly

– to spread risks– externalities– pursuing national interests (but against

world interests)• exploiting monopoly power• protecting declining industries

– non-economic arguments

Arguments for Restricting Trade

• Problems with protection

– protection as ‘second best’

– world multiplier effects

– retaliation

– cushions inefficiency

– bureaucracy

World Attitudes towardsTrade and Protection

• History of protection

– Pre-war growth in protection

– Post-war reduction in protection and the role of GATT

• the growth in world trade


• History of protection– Pre-war growth in protection– Post-war reduction in protection and the

role of GATT• the growth in world trade

– Re-emergence of protectionism in the 1980s




– Re-emergence of protectionism in the 1980s• the use of non-tariff barriers





– The Uruguay Round





– The Uruguay Round• aims of the Uruguay round negotiations


• The Uruguay Round settlement and the creation of the WTO– problems in reaching agreement– the agreement– the work of the WTO

• dispute settlement• conflicting interests in trade disputes

– efficiency in trade versus environmental and social interests

– international protests

Trading Blocs

• Types of preferential trading arrangement– free trade areas– customs unions– common markets

• features of a full common market

• Direct effects of a customs union– trade creation– trade diversion

Trading Blocs• Long-term effects of a customs union

– longer-term advantages• internal economies of scale• external economies of scale• better terms of trade• increased competition between members

– longer-term disadvantages• certain regions of the union may suffer• possibility of oligopolistic collusion• administrative costs

Trading Blocs

• Preferential trading in practice

– the EU

– NAFTA

• differences between the EU and NAFTA

– other examples

The European Union• Historical background

• From customs union to common market– Common Agricultural Policy

– regional policy

– competition policy

– tax harmonisation

– social policy

The European Union• The single market

– historical background– the Single European Act– completing the single market– benefits of the single market

• trade creation• reduction in the direct costs of barriers• economies of scale• greater competition

The European Union• The single market (cont.)

– criticisms of the single market• radical economic change is costly• adverse regional multiplier effects• development of monopoly/oligopoly power• trade diversion

– evidence– the future of the EU

• effect of new members

Trade and Developing Countries

• Trade strategies

– primary outward looking

– secondary inward looking

• import-substituting industrialisation (ISI)

– secondary outward looking

• possibly complemented by primary inward looking


• Approach 1: exporting primaries– justification for exporting primaries

• exploits comparative advantage• a 'vent for surplus'• an 'engine for growth'

– problems with traditional trade theory• comparative costs change over time• benefits may not flow to nationals• trade my lead to greater inequality• externalities from mines and plantations


• Exporting primaries (cont.)– long-term problems for primary exporting

countries• low income elasticity of demand• protection in advanced countries• technological developments

– synthetic substitutes– miniaturisation

• rapid growth in imports• adverse movements in terms of trade


• Approach 2: ISI– justifications

• problems of primary exporting• dynamic potential in manufacturing

– infant industries– rapid technological advance

– patterns of protection• selecting industries for protection• tariff and quota escalation• attracting multinational investment

Trade and Developing Countries• Approach 2: ISI (cont.)

– adverse effects of ISI• often counter to comparative advantage• tends to cushion inefficiency

– encourages establishment of monopolies• artificially low interest rates

– use of capital-intensive techniques• encourages rural–urban migration• adverse effects on rural sector• leads to greater inequality• environmental problems• limit to home market


• Approach 3: exporting manufactures– transition from inward-looking to outward-

looking industrialisation• a neutral trade approach• active promotion of manufactured exports

– benefits from exporting manufactures• conforms with comparative advantage• increased competition• increased investment• more employment and greater equality• faster growth


• Approach 3: exporting manufactures (cont.)– drawbacks of exporting manufactures

• possible retaliation from advanced countries– but attitudes of WTO

• competition from other developing countries• vulnerability to world fluctuations

– world recessions– speculation

– trade between developing countries• trade blocs of developing countries

topic 7 international trade

Documents

gdpazizah uitm kelantan

real gdp

msia real gnp

net merchandise exports

trade internationa

economic growth

total oecd countriesgrowth

average annual growth