International Trade
CHAPTER
19
© 2003 South-Western/Thomson Learning
1
Profile of Imports and Exports
U.S. exports of goods and services
amounted to about 12% of GDP in 2000
High-technology products, such as computer
software and hardware, aircraft,
telecommunications equipment
Industrial supplies and materials
Agricultural products
Entertainment products such as movies and
recorded music
The big change over the last 25 years has
been a growth in the dollar value of
machinery exports
nearly half the capital goods produced in U.S.
are exported
2
Profile of Imports and Exports
U.S. imports of goods and services were
14% the size of GDP in 2000
Manufactured consumer goods such as
automobiles from Japan and Germany
Capital goods such as high-tech printing
presses from Germany
Oil
Metals such as lead, zinc, and copper
Major change in U.S. imports over the
last 25 years has been the increase in
spending on foreign oil
3
Profile of Imports and Exports
Major trading partners of the U.S.
Canada is the largest followed by Mexico
and Japan
Other key trading partners include
Germany, Great Britain, South Korea,
France, Hong Kong, Italy and Brazil
4
Production Possibilities Without Trade
Suppose that we have two countries,
United States and Izodia who produce
two goods, food and clothing
The U.S. has 100 million workers and Izodia
has 200 million
Recall that the production possibilities table
/ curve assumes full employment of all
resources and a fixed state of technology
5
Production Possibilities Without Trade
In our example, each U.S. worker can
produce more of both clothing and food
than can the Izodian worker  U.S. has
an absolute advantage in the production
of both goods
Recall that having an absolute advantage
means being able to produce something
with fewer resources than other producers
require
However, so long as the opportunity
cost of production differs between two
countries, there are gains from
specialization and trade
6
Consumption Possibilities Based on
Comparative Advantage
The opportunity cost of producing 1 more
unit of food in the U.S. is ½ unit of
clothing, compared to 2 units of clothing
in Izodia
Law of comparative advantage says that
each country should specialize in
producing the good with the lower
opportunity cost
Thus, the U.S. should produce food and
Izodia should produce clothing  U.S.
exports food and imports clothing while
Izodia exports clothing and imports food
7
Consumption Possibilities Based on
Comparative Advantage
Before the countries can trade, the
terms of trade must be established
Terms of trade refers to how much of
one good exchanges for a unit of
another good
Suppose that market forces dictate that
1 unit of food trades for 1 unit of
clothing
8
Summary
United States
Without trade U.S. citizens produce and
consume 240 million units of food and 180
million units of clothing
With trade they produce 600 units of food,
consume 400 and exchange the remaining
200 units in return for 200 million units of
clothing
Izodians
Without trade, produce and consume 120
million units of food and 160 million units of
clothing
With trade, they wear 200 million units of
clothing and exchange the remaining 200
million units for 200 million units of food
9
Summary
The only constraint on trade is that, for
each good, total world production must
equal total world consumption
In our two-country world, this means
that the amount of food the United
States exports must equal the amount
of food Izodia imports
The same is true for Izodia’s exports of
clothing
10
Summary
Specialization and trade allow both
countries to consume more of both
goods
Without specialization, total world food
and clothing production were 360 and
340 million units, respectively
After specialization, the two countries
produce 600 million units of food and
400 million units of clothing
11
Reasons for International Specialization
How do we know what each country
should produce and what goods should
be traded?
Differences in Resource Endowments
Economies of Scale
Differences in Tastes
12
Differences in Resource Endowments
Trade is often prompted by differences
in resource endowments, especially
with respect to labor and capital
Countries differ not only in their amounts of
labor and capital but in the qualities of
those resources, including having an
educated labor force
Similarly, capital that reflects the most
recent technological developments is more
productive than obsolete capital
The productivity of both labor and capital
differ because of educational levels of the
work force and because of technologically
sophisticated capital
13
Differences in Resource Endowments
Some countries are blessed with an
abundance of fertile land and
favorable growing seasons
• For example, the United States has been
called the “bread-basket of the world”
because of its rich farmland
• Honduras has the ideal climate for
growing bananas; Columbia, Brazil, and
Jamaica have the best climate for coffee
• Differences in seasons across countries
also serve as a basis for trade
14
Economies of Scale
Whenever production is subject to
economies of scale (long-run average
cost falls as firms expand production),
countries can gain from trade if each
nation specializes
Such specialization allows each nation
to produce at a greater output rate  a
decline in average production costs
The primary reason for establishing the
single integrated market in Western
Europe
15
Differences in Tastes
Even if all countries had identical
resource endowments and combined
those resources with equal efficiency
Each country would still gain from trade
so long as tastes and preferences
differed among countries
English like tea, Americans like coffee
Soft drinks are more popular in America
than in Western Europe
French drink more wine, while Germans
prefer beer
16
Trade Restrictions
Despite the benefits of international
trade nearly all countries at one time or
another erect barriers to impede or
block free trade among nations
Two primary trade restrictions are
Tariffs
Quotas
17
Tariffs
Tariff is a tax on imports and can
be either specific or ad valorem
Specific tariff is a fixed fee amount,
for example a tariff of $5 per barrel of
oil
Ad valorem tariff is a percentage of
the price of imports at the point of
entry
18
Import Quotas
An import quota is a legal limit on the
quantity of a particular commodity that
can be imported
Usually target imports from certain
countries
To have an impact on the domestic
market, or to be effective, a quota must
restrict imports to less than the amount
imported with free trade
19
Quotas in Practice
Quota rights are awarded to exporters
through a variety of means
By rewarding domestic producers with
higher prices and foreign producers
with the right to sell goods to the
United States, the quota system creates
two groups intent on securing and
perpetuating these quotas
Lobbyists for foreign producers work
Congress seeking the right to export to the
United States
This support, coupled with a lack of
opposition from consumers has resulted in
quotas that have lasted for decades
20
Tariffs and Quotas Compared
Similarities and differences
Since the tariff and the quota in our
example had identical effects on the price,
they reflect the same change in quantity
demanded
U.S. consumers suffer the same loss of
consumer surplus and U.S. producers reap
the same gain of consumer surplus
The primary difference is that the revenue
from the tariff goes to the domestic
government, whereas the revenue from the
quota goes to whoever secures the right to
sell foreign goods in the U.S. market
21
Tariffs and Quotas Compared
If quota rights accrue to foreigners, then the
domestic economy is worse off with a quota
than with a tariff
However, even if quota rights go to domestic
importers, quotas, like tariffs, still increase
the domestic price, restrict quantity  reduce
consumer surplus
Quotas and tariffs also encourage foreign
governments to retaliate with quotas and
tariffs of their own  shrinking U.S. export
markets  loss in welfare is greater than
shown in Exhibits 5 and 6
22
Other Trade Restrictions
Export subsidies encourage firms to
export
Low-interest loans to foreign buyers
promote exports of large capital goods
Domestic content requirements specify
that a certain percentage of a final
good’s value must be produced
domestically
Other requirements concerning health,
safety, or technical standards often
discriminate against foreign goods
23
Multilateral Agreement
After World War II, the United States
invited its trading partners to negotiate
less stringent restrictions and the result
was GATT
General Agreement on Tariffs and Trade –
GATT – is an international tariff-reduction
treaty adopted in 1947 that resulted in a
series of negotiated “rounds” aimed at freer
trade
Adopted by 23 countries, including the
United States
24
Multilateral Agreement
Each member of GATT agreed to
Treat all member nations equally with
respect to trade
Reduce tariff rates through multinational
negotiations
Reduce import quotas
Set the stage of many trade rounds which
offer a package approach rather than an
issue-by-issue approach to trade
negotiations
25
Trading Rounds
Most early GATT trade rounds aimed at
reducing tariffs
The Kennedy Round in the mid-1960s
included new provisions against
dumping
Dumping refers to selling a commodity
abroad at a price that is below its cost of
production or below the price charged in the
domestic market
The most recent round in Uruguay
created the World Trade Organization to
take over from GATT
26
The World Trade Organization
The WTO is a permanent institution
located in Geneva, Switzerland
Whereas GATT involved only merchandise
trade, the WTO includes services and traderelated aspects of intellectual property, such
as books, movies, and computer programs
Under the most-favored-nation clause, each
WTO member must offer all other member
countries the same trade concessions
offered to any member country
Average tariffs will fall from 6% to 4%
Includes a dispute settlement body that
should be faster, more automatic, and less
susceptible to blockage than GATT
27
Common Markets
Numerous countries have tried to
develop free-trade pacts of their own
The largest and best known of the freetrade zones being formed is the European
Union.
• This began in 1958 with a half-dozen countries
and now has expanded to more than a dozen
• The idea was to create a barrier-free European
market in which goods, services, people, and
capital are free to flow to their highest-valued use
without restrictions
• Twelve members of the European Union have
adopted a common currency, the euro, that
replaces national currencies in January 2002
28
Common Markets
Other trading blocs
The Association of Southeast Asian nations:
ASEAN
South Africa and its four neighboring countries:
Southern African Customs Union
Half dozen Latin American countries: Mercosur
United States, Canada, and Mexico: NAFTA
• Mexico hopes to increase U.S. investment by
guaranteeing duty-free access to U.S. markets to those
who build manufacturing plants in Mexico
• The U.S. wants access to Mexico’s 100 million people
and its huge oil reserves
• U.S. would like to bolster Mexico’s move toward a
market-oriented economy
29
Arguments for Trade Restrictions
Trade restrictions often appear to be
little more than welfare programs for
the domestic producers they protect
Further, it would be more efficient
simply to transfer money from domestic
consumers to domestic producers
The problem with this is that such a
blatant transfer would be politically
unpopular
Thus, various arguments have been
advanced in support of these trade
restrictions
30
Arguments for Trade Restrictions
National Defense Argument
Infant Industry Argument
Antidumping Argument
Jobs and Income Argument
Declining Industries Argument
31
National Defense Argument
Industries are said to be in need of
protection from import competition
because their production is vital in time
of war  protection is in the national
interest
Trade restrictions may shelter the
defense industry, but other methods,
might be more efficient
Government subsidies
Government could stockpile basic military
hardware so that maintaining an ongoing
productive capacity would become less
essential
32
National Defense Argument
The problem with this argument is that
most industries can play some role in
national defense with the result that
this argument gets out of hand
For example, wool producers benefited
from protective policies because wool
was used in military uniforms
33
Infant Industry Argument
The rationale here is to protect
emerging domestic industries from
foreign competition
In industries where a firm’s average cost
per unit falls as production expands, new
domestic firms may need protection from
foreign competitors until they reach
sufficient size to achieve sufficient
economies of scale
One problem here is how to identify
which industries merit protection, and
when do they become old enough to
look out for themselves?
34
Infant Industry Argument
The very existence of protection may
foster inefficiencies that firms may not
be able to outgrow
The immediate cost of such restrictions
is the net welfare loss from higher
domestic prices
Which may become permanent if the
industry never realizes the expected
economies of scale
35
Antidumping Argument
Dumping is selling a commodity abroad
at a price that is below its cost of
production or below the price charged
in the home market  critics argue that
a tariff should be imposed to raise the
price of dumped goods
Key question: Why should U.S.
consumers be prevented from buying
products for as little as possible even if
these low prices are the result of a
foreign subsidy?
36
Antidumping Argument
If the dumping is persistent, the lower
price may increase consumer surplus by
an amount that more than offsets losses
to domestic producers  there is no
good reason why consumers should not
be allowed to buy imports for a
persistently low price
An alternative form of dumping, termed
predatory dumping, is the temporary
sale of an export at a lower price in
order to drive out competing producers
in that foreign market
37
Antidumping Argument
Problem: when dumpers attempt to take
advantage of their monopoly position by raising
price, other firms, either domestic or foreign,
may enter the market and sell for less
It is also possible that dumping may be
sporadic, as firms occasionally sell at a discount
to unload excess inventories in which case it is
of little concern
The Trade Agreements Act of 1979 effectively
eliminates all dumping by imposing a tariff
whenever a good is sold for less in the U.S. than
in its home market
38
Jobs and Income Argument
One of the more common arguments is
that they protect U.S. jobs and wage
levels
Problem: other countries will likely
retaliate by restricting their imports to
save their jobs with the net result that
international trade is reduced
wage rates in other countries, especially
developing countries, are often a small
fraction of wages in the U.S.
wages represent just one component of the
total production cost and may not
necessarily be the most important
39
Jobs and Income Argument
What is important is not wage rates per
se, rather it is the labor cost per unit of
output which depend on both the wage
rate and labor productivity
Wage rates are high in the United States
partly because labor productivity
remains the highest in the world
Conversely, lower wages in many competing
countries can be partially traced to workers’
lack of education and training, the meager
amount of physical capital available to each
worker, and a business climate that is less
stable and less attractive
40
Jobs and Income Argument
Over time, as labor productivity in
developing countries increases, wage
differentials will narrow
The increasingly global nature of
multinational firms will increase the
amount of capital and technology to
workers in developing countries
To some extent this has already
occurred in the stereo and consumer
electronics market, and General Motors
is planning to make more cars in Mexico
41
Declining Industries Argument
Where an established domestic industry
is in jeopardy of being displaced by
lower-priced imports, there could be a
rationale for temporary import
restrictions to allow the orderly
adjustment of the domestic industry
This is particularly true when there are
many industry-specific resources
42
Declining Industries Argument
The protection offered should not be so
generous as to encourage investment in
the industry
Free trade may displace some U.S. jobs
through imports, but it also creates U.S.
jobs through exports
Where foreign competition appears to
have displaced U.S. workers, many
foreign companies have built plants in
the United States and employ U.S.
workers
43
Problems with Protection
Trade restrictions raise a number of
problems in addition to the ones already
mentioned
First, protecting one stage of production often
requires protecting downstream stages
Second, the cost of protection includes not only
welfare loss arising from the higher domestic
price, but also the cost of the resources used by
domestic producers and groups to secure the
favored protection
• the cost of this rent seeking – lobbying fees,
propaganda, legal actions – can equal or exceed the
direct welfare loss from the restrictions
44
Problems with Protection
Third, other countries often retaliate, thus
further reducing the gains from trade
Finally, the costs of enforcing the myriad
quotas, tariffs, and other restrictions
• Also run into the practice of “port shopping”
where foreign producers and U.S. importers shop
to see where inspections are most lax
45
Import Substitution versus Export
Promotion
Developing countries have two options
with respect to the transformation from
the production of raw materials and
agriculture to manufacturing
Import Substitution
Export Promotion
46
Import Substitution
The country manufactures products that
until then had been imported and
imposes tariffs and quotas to protect
these industries
Popular for several reasons
Demand already existed for these products
Provides infant industries with a protected
market
Those who already supply capital, labor and
other resources to the favored industries
gain
47
Import Substitution
Problems
Reduces the gains from specialization and
comparative advantage
Low-cost foreign goods with high-cost
domestic goods
Since they are shielded from foreign
competition, domestic industries fail to
become efficient
Encourages retaliation from other countries
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Export Promotion
A development strategy that
concentrates on producing for the
export market
Preferable approach because the
emphasis is on comparative advantage
and trade expansion rather than trade
restriction
Also forces producers to grow more
efficient to compete on world markets
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