1. Chapter 32 International Trade 32-1 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Specialization and trade Domestic exchange equations Absolute advantage and comparative advantage Tariffs or quotas 32-2 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3. Chapter Objectives The causes of our trade imbalance What can we do to restore our balance of trade? Our trade deficits with Japan and China U.S. Trade policy: A historical view 32-3 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

4. U.S. Trade before 1975 We ran trade surpluses before 1975 and have run trade deficits since We faced increasing trade competition in the 1960s We have been running large and growing trade surpluses on services and growing trade deficits on goods 32-4 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

5. U.S. Tariffs, 1820-2000 32-5 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

6. A Century of High Protective Tariffs Initially the tariff was purely a revenue-raising device After the War of 1812 the tariff took on a protective tinge During the great depression, virtually every industrial power raised its tariffs to keep out foreign goods –This caused world trade to dwindle to a fraction of what it had been and probably made the depression a lot worse 32-6 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

7. International Trade Recent years have seen a growing consensus in the United States that we need more import protection Economic reasoning, however, argues strongly for free trade 32-7 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

8. Specialization and Trade Specialization is the basis for international trade –Country A specializes in making the products that it can make most cheaply; Country B does the same –When they trade, each country will be better off than they would if they didn’t specialize and trade 32-8 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9. Production Possibilities Curves 32-9 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The U.S. has to give up 20 copiers to get 10 VCRs 2 copiers = 1 VCR To get 10 copiers South Korea has to give up 20 VCRs 1 copier = 2 VCRs

10. Domestic Exchange Equations 32-10 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. U.S. 2 copiers = 1 VCR S.K. 1 copier = 2 VCRs Instinct tells us that it that it would be best for each country to produce what it does best and to trade with the other

11. Domestic Exchange Equations 32-11 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. U.S. 2 copiers = 1 VCR S.K. 1 copier = 2 VCRs Obviously the U.S. would be unwilling to trade more than two copiers for one VCR. However, if S.K. offered more than 1 VCR for 2 copiers this would be a better deal If the U.S. used its resources to produce 2 copiers and trade them for more than 1 VCR it would be better off than it would have been using the same resources to produce just 1 VCR Obviously, S.K. would be unwilling to trade 2 VCRs for anything less than 1 copier. If S.K. could trade 2 VCRs and get more than one copier in exchange it would be better off making VCRs and trading some of them for copiers

12. Two General Observations No nation will engage in trade with another nation unless it will gain by that trade The terms of the trade will fall somewhere between the domestic exchange equations of the two trading nations 32-12 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

13. Trade Possibilities Curves 32-13 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Point C = 40 copiers and 20 VCRs Assume Point A = 80 copiers At Point K = 50 copiers and 30 VCRs We produced 80 copiers and traded 30 of the them for VCRs Ended up with 50 copiers and 30 VCRs Point H = 40 VCRs and 20 copiers Instead South Korea produces 80 VCRs and sells 30 VCRs for 30 copiers Ended up with 50 VCR and 30 copiers

14. Absolute Advantage Absolute advantage is the ability of a country to produce a good or service at a lower cost than its trading partners –In the previous example, the bottom line is that Americans can buy South Korean VCRs at half the price that American producers would charge –Thus the south Koreans have an absolute advantage in making VCRs They are better at making VCRs than we are 32-14 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

15. Comparative Advantage U.S. 2 copiers = 1 VCR S.K. 1 copier = 2 VCRs In the U.S. the opportunity cost of producing 1 VCR is 2 copiers In S.K. the opportunity cost of 1 VCR is ½ of one copier The opportunity cost of producing VCRs is lower in S.K Likewise, the opportunity cost of producing copiers is lower in the U.S. 32-15 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

16. Comparative Advantage In the U.S. the opportunity cost of producing 1 VCR is 2 copiers In S.K. the opportunity cost of 1 VCR is ½ of one copier The opportunity cost of producing VCRs is lower in S.K Likewise, the opportunity cost of producing copiers is lower in the U.S. The law of comparative advantage states that total output is greatest when each product is made by the country that has the lowest opportunity cost 32-16 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17. Absolute Advantage versus Comparative Advantage You can’t compare absolute advantage and comparative advantage any more than you can compare apples and oranges Absolute advantage is a comparison of the cost of production in two different countries Comparative advantage states that total output is greatest when each product is made by the country that has the lowest opportunity cost 32-17 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

18. Absolute Advantage versus Comparative Advantage As long as the relative opportunity costs of producing goods differ among nations, there are potential gains from trade even if one country has an absolute advantage in producing everything Therefore absolute advantage is not necessary for trade to take place but comparative advantage is 32-18 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

19. The Arguments for Protection As America continues to hemorrhage manufacturing jobs, there is a growing outcry for protections against the flood of imports –But Americans, as consumers, are virtually addicted to these imports –How do we justify excluding so many things that Americans want to buy? There are four main arguments for protection –Each seems plausible and strikes a responsive chord in the minds of the American public –Closer scrutiny will reveal that all four arguments are essentially pleas by special interest groups for protection against more efficient competitors 32-19 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

20. Four Main Arguments for Protection The National Security Argument The Infant Industry Argument The Low-Wage Argument The Employment Argument 32-20 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

21. The National Security Argument Our dependence on foreign suppliers could make us vulnerable in time of war –It is possible that we need to maintain certain defense-related industries –What if we depended on foreign suppliers for critical components of entire weapons systems? –The continued spread of nuclear arms technology may soon make the national security argument much more relevant 32-21 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

22. The Infant Industry Argument American products are no longer produced by infant industries being swamped by foreign giants About the best that can be said is that some of our infant industries never matured while others have evolved into senility –Textiles, steel, clothing, and automobiles may be in the senile category It is sometime argued that technological change may cause a grown-up industry to need temporary protection from foreign competition 32-22 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

23. The Low-Wage Argument How can American workers compete with foreigners who are paid sweatshop wages in labor intensive industries? –There is no reason for American firms to compete with foreign firms in these industries –We should import labor intensive goods and produce goods and services in which we can excel and compete –We should use the proceeds to buy the goods and services produced by people who are forced to work for very low wages 32-23 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

24. The Employment Argument Hasn’t the flood of imports thrown millions of Americans out out work? –But if we restrict imports, the governments of our foreign competitors will restrict our exports –By curbing imports, we will be depriving other nations of the earnings they need to buy our exports –If we restrict our imports, our exports will go down too We would just lose the jobs connected with these lost exports Which would be best? Lose the jobs of workers who work for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but can’t export their products because of restrictions we ourselves caused? 32-24 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

25. Tariffs or Quotas A tariff is a tax on imports –The government gets the resulting revenue –A tariff affects all foreign sellers equally. Efficient foreign producers will be able to pay a uniform tariff. Less efficient producers will not A quota is a limit on the import of certain goods –Import quotas produce no federal revenues –Imports quotas are directed against particular sellers on an arbitrary basis –Arbitrary quotas may allow relatively inefficient producers in and keep out more efficient producers 32-25 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

26. Tariffs or Quotas A tariff, like any other excise tax, causes a decrease in supply Both tariffs and quotas raise the price that consumers in the importing countries must pay Tariffs are better than quotas But free trade is best 32-26 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

27. Export Subsidies Several countries subsidize their export industries –This makes their products cheaper –Many Americans complain that this gives foreign competitors an “unfair advantage” –Subsidies are a relatively minor expedient in the United States 32-27 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

28. Conclusion Economics is all about the efficient allocation of scarce resources There is no reason why this efficient allocation of resources should not be applied beyond national boundaries International trade helps every country To the degree that we can remove the tariffs, import quotas, and other impediments to free trade we will all be better off The economics profession nearly unanimously backs free trade 32-28 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

29. Our Balance of Trade Our balance of trade compares the dollar value of the merchandise and services we buy from foreigners with the dollar value of the merchandise and services they buy from us Our balance of trade is our country’s record of all transactions between its residents and the residents of all foreign nations 32-29 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

30. What Are the Causes of Our Trade Imbalance We have been losing market share both at home and abroad The biggest culprits are our oil bill and our deficits with Japan and China 32-30 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

31. What Are the Causes of Our Trade Imbalance The Rise of the Dollar –A rising dollar makes our exports more expensive and our imports cheaper Our Low Saving Rate –Americans have become notoriously poor savers averaging less than 5% of their disposable income since the mid-1980s –If you don’t save, you can’t invest and thus grow –American business firms have been left with one choice, borrow from foreigners Foreigners have come here only because of our high interest rates 32-31 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

32. What Are the Causes of Our Trade Imbalance The High Cost of Capital –Mainly because of our low savings rate and partly because of the huge federal budget deficits, high interest rates have discouraged investment in plant and equipment as well as in technological innovation High Defense Spending –The defense expenditures of the United States have dwarfed those of every other industrial power –In a time of diminishing military tension, should we be diverting our dollars to defense from areas where they could be used more productively? 32-32 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

33. What Are the Causes of Our Trade Imbalance Our Failing Educational System –The American educational system, once second to none, is now second to practically everyone About one-third of all college freshman need remedial work in reading, writing, and arithmetic This is why we used to go to K through 12 Almost every college has special classes for students unprepared to do college work One million new functional illiterates every year are not exactly job candidates for today’s high tech economy 32-33 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

34. What Are the Causes of Our Trade Imbalance The Role of Multinationals –Since the 1960s multinational corporations began to move their manufacturing operations abroad to take advantage of lower wages available in low wage countries –Capital has long been much more mobile than labor, and that capital has been flowing very rapidly to low wage nations –Our import business is dominated by our own multinational corporations that have shifted their production overseas and put their name on the goods that are produced in other nations 32-34 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

35. What Are the Causes of Our Trade Imbalance Since 1995 we have had one of the highest rates of economic growth of any industrial nation –Countries with high economic growth rates import more goods and services than they would if they had low growth rates –At the same time demand for U.S. exports has been lagging due to low growth rates in other industrial nations 32-35 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

36. What Can We Do? Devalue the dollar—which would make our exports cheaper while imports would become more expensive –We need to put a lid on consumption –We need to save more –We need to bring back the tax-free IRA –We need to decrease defense spending –We need to really educate our workforce –We need protectionist legislation if our foreign competitors are, in fact, dumping goods below cost on our shores 32-36 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

37. U.S. Trade Deficit With Japan and China 32-37 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

38. Japanese Trading Practices Japanese dumping (selling many of their products below cost) is driving out American competitors The fundamental difference between ourselves and the Japanese is quality –Better quality also means lower prices We sell Japan agricultural products and buy manufactured products from them –This is a colonial relationship The Japanese picks winners and then makes sure they win 32-38 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

39. Japanese Trading Practices The Japanese consumer has long accepted a lower standard of living because it was necessary for the greater economic good –They are willing to pay more for goods they produce when they could have them cheaper if they imported the same good –Can you imagine Americans being willing to make that kind of sacrifice Americans would not stand for restricting Japanese imports because they are addicted to Japanese goods 32-39 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

40. Our Trade Deficit With China We began trading with China in the mid-1970s Although exports to China have grown rapidly, our exports are only about one-quarter of our imports We import so much from China because U.S. retailers are seeking the cheapest goods available and are finding them in China The Chinese are making unauthorized copies of American movies, CDs, and computer software 32-40 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

41. Trading with China and Japan There are more differences than similarities –Our trading position with Japan is much like a colony and a colonial power –We send airplanes, computers, movies, compact disk, cars, cigarettes, power- generating equipment, and computer software to China in exchange for toys, clothing, shoes, and low-end consumer electronics 32-41 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

42. Trading with China and Japan Japan has never been open to foreign direct investment China has been open to foreign direct investment since the mid-1980s Japanese gains in production have led directly to the loss of millions of well-paying American jobs Chinese exports so far have generally not translated into job losses in the United States 32-42 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

43. Trading with China and Japan The Chinese and the Japanese both insist on licensing agreements and large-scale transfer of technology as the price for agreeing to imports These agreements, of course, lead to eventual elimination of imports from the United States 32-43 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

44. 32-44 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Murray Weidenbaum “We are consuming more than we are producing, borrowing more than we are saving, and spending more than we are earning” -

45. A Final Word Reducing Our Overall Trade Deficit –We need to maintain our high rate of productivity growth and keep improving the quality of American goods and services –We need to lower our dependence on oil imports by raising the tax on gasoline –We need, somehow, to reduce our trade deficit with Japan –We need to do something about our rapidly rising trade deficit with China 32-45 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.