Extra credit opportunity

Presentations on
◦ a country or
◦ a region (even a town/city in U.S.)
◦ some other subject in global business

An especially good chance to discuss your
home or your ancestors’ home

We’re can schedule some now, and we’ll be
continuing through the term
◦ I had allotted some time for these the last two
sessions of the term, but better to do them earlier
Length –
◦ 6 to 10 minutes (individual)
◦ Up to 18 minutes (group)

A country presentation can describe
◦ The economic environment
 How do people live?
 What is GNI per capita
 Provide both unadjusted and purchasing power parity
(PPP) adjusted statistics
 How does GNI per capita level affect life?
◦ The political environment
 How is the country/region governed?
◦ Something of the cultural environment
 You can’t summarize the culture;
just say one or two things that strike
you as important
◦ The country or region’s role in international
business
 What does the country or region produce?
 How important is it to people elsewhere?
 Can you tell what is likely to happen in the future?

Free Trade occurs when a government
does not attempt to influence, through
tariffs, quotas, or other means,
◦ what citizens can buy from other countries or
◦ produce and sell to other countries

The Benefits of Trade allow countries to be
richer by specializing in products they can
produce most efficiently

There are lots of problems with trade

But government intervening in free trade
is definitely dangerous
◦ There may be some ways that some
governments can make things better by
intervening (that is, by not practicing free trade)
 Restrictions on trade have
 kept some countries very poor
 contributed to huge depressions

A nation’s wealth depends on accumulated
“treasure”
◦ Gold and silver are the currency of trade


Mercantilists sought what we now call
‘development’
They argued their countries should run a
trade surplus
◦ Maximize export through subsidies
◦ Minimize imports through tariffs and quotas

Flaw: “zero-sum game”
◦ Mercantilists neglected to see
the benefits of trade
But there was a flaw in
the mercantilists’ argument


They assumed that trade was a zero-sum
game
As England, France, and the Netherlands
competed with each other, many thought
only about advantage for their country

Adam Smith argued (Wealth of Nations,
1776): Capability of one country to produce
more of a product with the same amount of
input can vary
◦ A country should produce only goods where it is most
efficient, and trade for those goods where it is not efficient

Trade between countries is, therefore,
beneficial
◦ Example: Ghana/cocoa vs.
South Korea/rice

As people specialize and seek higher
incomes, they may learn to do their
specialties better
Suppose one country is more efficient
than another in everything?
 There are still global gains to be made
if a country specializes in products it
produces relatively more efficiently
than other products


David Ricardo (Principles of Political
Economy, 1817):
◦ A country should import products for which it is relatively
inefficient even if the country is more efficient in the
product’s production than country from which it is
buying

Trade is a positive-sum game
Theory of
Comparative Advantage

Countries have comparative advantage in
goods for which the opportunity cost of
production is relatively low
◦ That is, those that can be produced by giving up
relatively little in production of other goods

This means your country
has comparative advantage in the
product or service where the ratio
Resources required in your country .
Resources required in the other country
is low
Ghana has absolute advantage in both cocoa and
rice, but its comparative advantage is in cocoa.
Cocoa Korea has comparative advantage in rice .
20 tons
15
tons
5 tons
Let Korea specialize
in rice – Ghana expands
Ghana
cocoa production to replace
all Korean cocoa production
lost
Then Ghana can replace all Korean
cocoa production and the countries
have more of both goods.
Korea
10 tons
3.75
tons
18
tons
15
tons
Rice
The country less efficient in everything
will be poor …

But it would be even poorer if it did not trade

They believed that if people were left to
trade on their own, they would naturally
trade the goods in which their countries had
comparative advantage
◦ “Every individual seeks the most
advantageous employment for his capital….
◦ “Study of his own advantage necessarily leads
him to prefer that employment most
advantageous to society”
- Adam Smith, 1776

This is a very simple case, but the basic
conclusions are generally valid
◦ We’re assuming no transportation costs
◦ We’re simplifying by not talking about
currencies
◦ We’re assuming constant returns to scale
◦ We’re assuming resources can move freely
from production of one good to another
◦ We’re not thinking about effects on
income distribution


Under free trade, the country that is less
efficient will have low wages
It will be able to sell the products where it has
comparative advantage without any special
tariff or subsidy protection

But it may need to work on infrastructure –
roads, railroads, ports, airports
◦ “Infrastructure” = the basic equipment and
structures (such as roads, bridges) that are needed
for a country, region, etc. to function properly
 Note: This may not be in the reading
◦ China, India both sell cheap manufactured goods
◦ China sells more because it has better
transportation infrastructure and government that
supports manufactured exports

It will need education for its people

And it will need institutions for trade
◦ Banks, government agencies who can
 process exports
 work with foreigners
◦ Honest banks and agencies
Moral element of liberal economies

Successful trading states have to have “two
cultures”
◦ In commercial culture, people trade for profit, and
we hope honesty will be prized largely because it’s
good business
◦ But successful economies also need
guardian culture – government servants who
can use force, but won’t sell themselves to the
highest bidder

Immobile resources:
◦ Resources do not always move easily from one
economic activity to another
 So some rice farms will persist in Ghana no matter what
 (Rice farmers will be losers as cheap rice comes from
Korea)

Diminishing returns:
◦ Diminishing returns to specialization suggests that
after some point, the more units of a good the
country produces, the greater the additional
resources required to produce an additional unit
 So comparative advantage will vary with production

Free trade has additional effects in open
economies:
◦ Free trade might increase a country’s stock of
resources (as labor and capital arrives from abroad)
◦ It could also increase the efficiency of resource
utilization inside each country as well as between
them
◦ It causes knowledge to move between countries
 It also changes tastes and cultures
When might government
intervention help a country?

The infant industry argument: There may be
industries that are uncompetitive today but could
become competitive if protected for a while
◦ Oldest argument - Alexander Hamilton, 1792
◦ Only succeeds if industry makes itself efficient
◦ Japanese automakers – were protected with ‘infant
industry’ tariffs for 20+ years, became world leaders
◦
◦ Brazil automakers - 10th largest - wilted when
protection eliminated
In industries with high fixed costs:
◦ Specialization increases output,
◦ The ability to achieve economies of scale increases
through exporting
◦ Learning effects are high.
 These cost savings come from “learning by doing”


In many industries, world demand will
support few competitors
Successful firms may emerge because of
“First-mover advantage”
◦ Economies of scale may preclude new entrants
◦ Role of the government becomes significant

Some argue that it generates a need for
government intervention and
strategic trade policy

Slides below are not required
These economists favored
free competition

They thought if businesspeople were left
alone, they would naturally export what their
nations could produce cheaply


The U.S. seems to be good at inventing new
products
The important factors may be highly
specialized
◦ Software design engineers


Or the U.S. may have a unique constellation
of factors that produces new products
Production of the new products tends to be
labor intensive at first
◦ The U.S. imports older, heavy industrial products