On the Economics of Trade: Some Current Trends and Political Economy

Trade patterns and their evolution

2015 Melvin JamesonReasons to study international trade:To better understand the international economic environment including:the dynamics by which it changes, andits impact on the politics of trade policy, and thus the political/regulatory environment.To help identify international business opportunities and to understand why they exist. 2015 Melvin Jameson1. What drives trade?When is Trade is Profitable? 2015 Melvin JamesonTrade results from international differences in supply and demand.U.S. In IsolationSupply and Demand 2015 Melvin JamesonSupplyDemandprice535$2,000634$2,050733$2,100832$2,150931$2,2001030$2,2501129$2,3001228$2,3501327$2,4001426$2,4501525$2,5001624$2,5501723$2,6001822$2,6501921$2,7002020$2,7502119$2,8002218$2,8502317$2,9002416$2,9502515$3,000U.S. In IsolationSupply and Demand 2015 Melvin JamesonSupplyDemandprice535$2,000634$2,050733$2,100832$2,150931$2,2001030$2,2501129$2,3001228$2,3501327$2,4001426$2,4501525$2,5001624$2,5501723$2,6001822$2,6501921$2,7002020$2,7502119$2,8002218$2,8502317$2,9002416$2,9502515$3,000Rest-of-the-World In Isolation 2015 Melvin JamesonpriceSupplyDemand$2,000180220$2,050184216$2,100188212$2,150192208$2,200196204$2,250200200$2,300204196$2,350208192$2,400212188$2,450216184$2,500220180$2,550224176$2,600228172$2,650232168$2,700236164$2,750240160$2,800244156$2,850248152$2,900252148$2,950256144$3,000260140If prices differ when markets are isolated, trade is will occur when it becomes possible.It will continue until the price difference (less any trading costs) is eliminated.To understand why trade occurs, we must ask why prices would differ without it. 2015 Melvin JamesonResults of unimpeded trade 2015 Melvin JamesonU.S.rest of the worldImportSupplyDemandpriceSupplyDemandExport30535$2,000180220-4028634$2,050184216-3226733$2,100188212-2424832$2,150192208-1622931$2,200196204-8201030$2,2502002000Autarky; world181129$2,3002041968Free trade161228$2,35020819216Free trade141327$2,40021218824121426$2,45021618432101525$2,5002201804081624$2,5502241764861723$2,6002281725641822$2,6502321686421921$2,70023616472Autarky U.S.02020$2,75024016080-22119$2,80024415688-42218$2,85024815296-62317$2,900252148104-82416$2,950256144112-102515$3,000260140120Desired export = Desired importU.S. price = world priceCostly trade: $250/unit transportation 2015 Melvin JamesonU.S.rest of the worldImportSupplyDemandpriceSupplyDemandExport30535$2,000180220-4028634$2,050184216-3226733$2,100188212-2424832$2,150192208-1622931$2,200196204-8201030$2,2502002000Autarky; world181129$2,3002041968Costly tradeFree trade161228$2,35020819216Free trade141327$2,40021218824121426$2,45021618432101525$2,50022018040Costly trade81624$2,5502241764861723$2,6002281725641822$2,6502321686421921$2,70023616472Autarky U.S.02020$2,75024016080-22119$2,80024415688-42218$2,85024815296-62317$2,900252148104-82416$2,950256144112-102515$3,000260140120Desired export = Desired importU.S. price (importer) = world price + trade costResults of trade: Traded GoodsPrices of traded goods converge worldwide.

Production is reallocated internationallyBecause of the differences between countries, reallocating production to increase specialization increases total world output.A net welfare improvement results. 2015 Melvin Jameson2. Which prices matter? 2015 Melvin JamesonRelative prices that is price relative to other traded goods

Absolute vs. comparative advantage in production costsAbsolute Advantage (Adam Smith)A country will export those products it can produce more efficiently than anyone else. 2015 Melvin JamesonExample: absolute advantageOutput per hour of laborBeefClothUnited States50 lbs./hour20 yards/hourUnited Kingdom25 lbs/hour40 yards/hour 2015 Melvin JamesonAbsolute AdvantageIn this example:US is more efficient at producing beef50 lbs./hr. Vs. 25 lbs./hr.UK is more efficient at producing cloth40 yards/hr. vs. 20 yards/hr.therefore:US will export beef(import cloth)UK will export cloth (import beef) 2015 Melvin JamesonAbsolute AdvantageProblem: What if one country has an absolute advantage at both products?

Does this mean the other should do nothing?

Comparative advantage: A country exports the products it produces with greatest relative efficiency. 2015 Melvin JamesonComparative AdvantageThe key is not factor productivity 2015 Melvin JamesonBut marginal rate of transformationExample: Comparative advantageOutput per hour of laborBeefClothUnited States50 lbs./hour40 yards/hourUnited Kingdom25 lbs/hour30 yards/hour 2015 Melvin JamesonThus cloth is cheaper in the UK (0.83 lbs. vs. 1.25 lbs.)Comparative advantageWith frictionless markets, the MRT can be expressed as a price ratio. 2015 Melvin JamesonThus cloth is cheaper in the UK (0.83 lbs. vs. 1.25 lbs.)MRT = tradeoff between two products

Product price = tradeoff between product and all-other-goods i.e. relative efficiency (location of supply curve.)

What leads countries to differ wrt relative efficiency of production? 2015 Melvin JamesonSome Examples of Comparative AdvantageCountryCanadaJamaicaMexicoSaudi ArabiaJapan South KoreaNevadaProductLumberAluminum oreTomatoesOilAutomobilesSteel, ships?? 2015 Melvin JamesonDiscussion:Nevadas exports

Nevadas comparative advantages 2015 Melvin JamesonUnited States Census Bureau: International Trade DataExport support in Las Vegas 2015 Melvin Jameson

http://www.trade.gov/cs/services.asp3. Why do local prices differ?orWhy does specialization in production occur? 2015 Melvin JamesonSources of Comparative AdvantageWhat gives each of these countries its particular comparative advantage?

What kinds of differences can lead to greater relative efficiency in particular products? 2015 Melvin JamesonModels of TradeModelClassical Comparative AdvantageFactor ProportionsHeckscher-OhlinTechnology-based models(product life-cycle model)DifferenceNatural Resource endowmentsFactor endowments(capital/labor ratio)Human capital: skilled (educated) vs unskilled labor

2015 Melvin JamesonModels of Trade (continued)ModelIntra-Industry Tradeseasonaltransportation costsproduct differentiationEconomies of Scale (Krugman)internalexternalDifference

seasonal productivitylocation

2015 Melvin JamesonEconomies of ScaleInternal EOS (increasing returns to scale)Producing on a very large scale lowers average costsThe low-cost product can be exportedEven absent comparative-advantage differencesExternal EOS (Clusters)All firms in a region (cluster) enjoy lower average cost due to a concentration of specialized resourcesLarge pool of workers with specialized human capitalSpecialized inputs/subcontractorsShared information and knowledgeSimilar average cost reduction given scale of the region 2015 Melvin JamesonIntra-industry trade: Simultaneous import and export of what appears to be the same product

Possible explanationsproduct differentiationseasonal differencestransportation costs 2015 Melvin JamesonTechnology: The Product CycleProduct life-cycleNewly introduced product is highly innovative- Highly educated human resources are required.Manufacture becomes standardized a skilled work force is required.The product becomes commoditized low-cost labor is well-suited to production.Comparative advantage changes over the life-cycle of the product.

2015 Melvin JamesonProduct life-cycle examples:Radio, TV manufacture: U.S. and Japancomputer manufacture: U.S. Taiwan China

2015 Melvin JamesonTrade: Examples and ApplicationsComparative advantage based on natural resource endowment:- Example: Saudi oilFactor endowments- relative amounts of capital & laborManufacturing in China 2015 Melvin JamesonDiscussion:Manufacturing in China 2015 Melvin JamesonDiscussion: ChinaFactor endowments and tradeCompare US and China on availability ofLabor vs. capitalUnskilled vs. skilled labor

Factor endowment theory predicts a country exports products that use intensively those factors with which it is well endowed. 2015 Melvin JamesonDiscussion: ChinaChina exports to the United StatesApparel, footwear, toys, and the final assembly of electronic machinery and equipmentProducts intensive in unskilled laborUnited States exports to China Aircraft, software, pharmaceuticals, and high-tech components of electrical machinery and equipmentProducts intensive in skilled labor and technology

2015 Melvin JamesonDiscussion: ChinaManufacture, especially of unskilled labor intensive products, migrated to China. Consider the impact onWorld output of manufactured goodsDemand for raw materials (commodities)Price of manufactured products in the USWages in China

2015 Melvin Jameson4. Further results of trade:Non-traded goods 2015 Melvin JamesonFactor-Price EqualizationTrade leads to increased demand for the cheap (abundant; comparative advantage creating) factorits price risesdecreased demand for the expensive (scarce; comparative disadvantage creating) factorits price falls 2015 Melvin JamesonResults of trade: Non-traded goodsPrices of traded goods converge worldwide.

Factor prices converge (factor price equalization)Prices of non-traded substitutes for traded goods converge. 2015 Melvin JamesonDiscussion: China (continued)Trends in Chinese wages and manufacturing

Impact on world trade patterns

Background reading: 2015 Melvin JamesonThe Economist Intelligence Unit: Report on trends in Chinese workforceAugust 26, 2014China Hand: More with lessWhy You May Soon See More Goods Labeled Made in VietnamWSJ October 19, 2015 p. B1Link or see separate pdfLimits to Factor-Price EqualizationTransportation costs and other barriers limit the amount of trade.Real factor productivity varies due to international differences in capital stock, technology, education, legal and economic institutions etc.

2015 Melvin JamesonDynamics of comparative advantageSome sources of comparative advantage are long lastingfavorable climatevast oil reservesOthers are more transientlow-cost labor 2015 Melvin Jameson