Comparative Advantage and
Gains from Trade
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We all excel and some kinds of production
and not others.
Everyone gains when we specialize at what
we do best and trade with others
Even those whose skills are very limited have
a comparative advantage at something and
can benefit from specialization
Gains from specialization and trade apply to
trade between countries as well as trade
between individuals.
Tariffs
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Tariff: a tax on imported goods/services
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As a % of monetary value
As an amount per physical unit
Purposes
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Raise revenue for gov’t
Protect domestic industries from competition
Preserve domestic jobs
Effects of tariffs
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Income
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Prices
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Increase for domestic firms who are less efficient
than foreign competitors
Decrease for more efficient foreign firms
Decrease income for domestic businesses who
would benefit from free trade
Domestic consumers pay higher prices
Net world production reduced because
capital and labor are no longer used most
productively.
Likelihood of retaliatory tariffs
Increased international tension
Quotas
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Quota is a limit on the amount of imports of
some specified good
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Purpose
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“voluntary” Japanese car import quotas
sugar quotas
Protect domestic industries and jobs
No revenue as with tariffs
Side effects (unintended consequences)
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Domestic consumers pay higher prices
Deadweight loss
Some consumer surplus transferred to foreign producers.
Retaliation for “dumping”
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Foreign suppliers, usually with foreign
government backing, sell low-priced goods
into domestic markets
Analogous to domestic corporations engaged
in predatory pricing
Supposedly justifies trade barriers
Victims of dumping:
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domestic business owners and workers
foreign consumers and taxpayers
Beneficiaries:
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domestic consumers
foreign producers (if subsidies > lost revenue)
U.S. Tariff history
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1789: Hamilton’s tariff for protection of “infant
industries”
1826: “Tariff of Abominations”
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Tariff on manufactured goods (primarly British)
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Hurt southern cotton growers
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for the benefit of northern U.S. manufacturers
Higher prices for manufactured goods
Reduced British demand for their cotton
S. Carolina legislature considered nullification,
could have led to civil war
1930: Smoot-Hawley Tariff
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Decimated European exporters
Helped Europe’s move to fascism and war
Public choice
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Public choice (C&G p. 190). Examines
incentives that motivate various participants
in the political process:
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Politicians and bureaucrats
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Rent-seekers
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Income, prestige, power, etc.
Businesses and labor unions that try to get
government to provide special favors such as
suppressing their competition
Voters
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Rational ignorance
Voting as an emotive experience
Sugar quotas
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Limits on the amount of sugar that can be
imported into the U.S.
Costs U.S. consumers $1.6 billion per year
The annual cost of each domestic job saved
is about $500,000
Penalty for sneaking sugar into the U.S.
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up to 2 years jail
up to $250,000 fine
Devastating to poor countries who have a
comparative advantage in sugar
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lower income
incentive to grow marijuana instead
Sugar quotas
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Proponents (rent-seekers)
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They have successfully sought quotas to
raise their income through
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Domestic sugar growers
Domestic sugar employees
Lobbying
Campaign contributions
Side effects
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Higher price for foods with sugar
Switch to high-fructose corn syrup
Poor sugar-growing countries turn to drugs
Concentrated benefits,
dispersed costs
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The benefits of sugar quotas are
concentrated among a small number of
growers. They can afford to spend a lot of
money on rent-seeking
Costs are borne by 310 million consumers.
Sugar is a very small amount of our budget.
We have little incentive to resist quotas.
Foreign countries may be devastated
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Poor countries with comparative advantage in
agricultural products (sugar, cotton, etc.)
Globalization
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Trade barriers (tariffs and quotas)
substantially reduced in recent years
World Trade Organization
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Most major governments are members
Rules intended to promote free trade
Some governments flaunt the rules when
convenient (e.g. U.S. sugar quotas)
Multinational trade agreements
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NAFTA (U.S., Canada, Mexico)
European Union
US and South Korea
Why are tariffs and quotas
remain popular
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Nearly all economists advocate free trade
Globalization has vastly increased standards
of living worldwide
Yet free trade remains unpopular. Why?
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Some people do suffer when trade opens up –
business owners and workers. Their losses are
apparent.
Consumer gains are not so evident because they
are spread widely
Losses to foreign suppliers from tariffs/quotas
are not apparent
Racism?