© OnlineTexts.com p. 1 Chapter 19 International Trade

© OnlineTexts.com p. 2 Free Trade? Free trade has been a controversial topic in nations throughout history. At the extremes, the “free-traders” would like to open all products to trade while the “protectionists” prefer to impose punitive taxes and/or quotas on imports. International trade is increasing at a rapid pace today, creating enormous globalization tensions. Free trade has been a controversial topic in nations throughout history. At the extremes, the “free-traders” would like to open all products to trade while the “protectionists” prefer to impose punitive taxes and/or quotas on imports. International trade is increasing at a rapid pace today, creating enormous globalization tensions.

© OnlineTexts.com p. 3 Arguments for (U.S.) Protectionism 1.Saves American jobs: –By raising the price of imports via tariffs or quotas, American industries are more competitive in the domestic market and, therefore, American workers' jobs will be spared and/or expanded. 2.Protects infant industries: –It makes sense to protect firms in new industries from the perils of foreign competition at first, until the industry grows and matures. At that time the protection can be lifted. 1.Saves American jobs: –By raising the price of imports via tariffs or quotas, American industries are more competitive in the domestic market and, therefore, American workers' jobs will be spared and/or expanded. 2.Protects infant industries: –It makes sense to protect firms in new industries from the perils of foreign competition at first, until the industry grows and matures. At that time the protection can be lifted.

© OnlineTexts.com p. 4 Arguments for Protectionism 3.Raises government revenue: –Government revenues increase since the U.S. government collects the tariff revenue. 4.Keeps firms in U.S.: –This effect might occur for two reasons. First, firms will face less competition domestically and not feel the pressure to move to low-wage countries. Second, the firm who moves to another country must pay the higher import tax to sell the product at home and thus may not be as willing to relocate. 3.Raises government revenue: –Government revenues increase since the U.S. government collects the tariff revenue. 4.Keeps firms in U.S.: –This effect might occur for two reasons. First, firms will face less competition domestically and not feel the pressure to move to low-wage countries. Second, the firm who moves to another country must pay the higher import tax to sell the product at home and thus may not be as willing to relocate.

© OnlineTexts.com p. 5 Arguments for Protectionism 5.Levels the playing field for those firms who adhere to stricter environmental and labor laws.: –If firms in the U.S. must adhere to costly environmental regulation and give laborers certain rights and minimum working conditions, then U.S. firms are at a cost disadvantage compared with firms in nations that do not have to adhere to such regulations. Trade protection, therefore, makes the playing field more equal. 5.Levels the playing field for those firms who adhere to stricter environmental and labor laws.: –If firms in the U.S. must adhere to costly environmental regulation and give laborers certain rights and minimum working conditions, then U.S. firms are at a cost disadvantage compared with firms in nations that do not have to adhere to such regulations. Trade protection, therefore, makes the playing field more equal.

© OnlineTexts.com p. 6 Arguments for Protectionism 6.Political tit for tat: –If my trading partner plays unfairly, why should I play by the rules? The U.S. accuses Japan quite often of unfair trading practices, hence U.S. firms have a right to impose similar unfair trading practices to make trade more equal. 7.Human rights violations: –Trade policy may give the U.S. political leverage in coercing another country to improve its human rights violations. 6.Political tit for tat: –If my trading partner plays unfairly, why should I play by the rules? The U.S. accuses Japan quite often of unfair trading practices, hence U.S. firms have a right to impose similar unfair trading practices to make trade more equal. 7.Human rights violations: –Trade policy may give the U.S. political leverage in coercing another country to improve its human rights violations.

© OnlineTexts.com p. 7 Economic Theory of Protectionism: Tariffs A tariff is a tax on an import. –When the tariff is imposed, the supply curve in the import market shifts to the left, but the demand curve for the domestic product shifts to the right. A tariff is a tax on an import. –When the tariff is imposed, the supply curve in the import market shifts to the left, but the demand curve for the domestic product shifts to the right.

© OnlineTexts.com p. 8 Winners and Losers from Tariffs Tariffs are controversial because they harm some and benefit others. TABLE 1 Winners and Losers from Tariffs WinnersLosers Domestic producers who compete with importers U.S. consumers who pay a higher price for imports Government via increased tax revenue Importers to U.S.

© OnlineTexts.com p. 9 Economic Theory of Protectionism: Quotas Quotas are restrictions on the quantity of imports allowed to enter the domestic country over a given amount of time.

© OnlineTexts.com p. 10 Winners and Losers from Quota Restrictions TABLE 2 Winners and Losers from Quota Restrictions WinnersLosers Domestic producers who compete with importers U.S. consumers who pay a higher price for products Foreign producers who get in under the quota Importers who are shut out of the U.S. market

© OnlineTexts.com p. 11 The Economic Argument for Free-Trade If some people are made better off and other hurt from protectionism, don’t the costs and benefits just cancel each other out? Economic theory says no. The costs of protectionism exceed the benefits. If some people are made better off and other hurt from protectionism, don’t the costs and benefits just cancel each other out? Economic theory says no. The costs of protectionism exceed the benefits.

© OnlineTexts.com p. 12 The Economic Argument for Free-Trade The theoretical justification for free-trade resides in the concept of comparative advantage. –Comparative advantage dictates that each nation should specialize in those products that it can produce the least inefficiently compared with production in other nations. –If each country specializes in producing what it is relatively good at, then through trading, the world as a whole can achieve higher standards of living. The theoretical justification for free-trade resides in the concept of comparative advantage. –Comparative advantage dictates that each nation should specialize in those products that it can produce the least inefficiently compared with production in other nations. –If each country specializes in producing what it is relatively good at, then through trading, the world as a whole can achieve higher standards of living.

© OnlineTexts.com p. 13 Example: Gains from Trade Given a certain amount of resources, the U.S. can produce 50 airplanes and 200 shirts. With the same resources, Mexico can produce 20 airplanes and 160 shirts. Notice that the U.S. has an absolute advantage in producing both airplanes and shirts. Should the U.S. trade at all?

© OnlineTexts.com p. 14 Determining Comparative Advantage The U.S. has a comparative advantage in making airplanes. –the U.S. can produce one plane for every four shirts that it gives up. Mexico can make one plane for every eight shirts that it gives up. Mexico has a comparative advantage in making shirts. –the U.S. can produce one shirt for every 1/4 plane that it gives up, whereas Mexico can make one shirt for every 1/8 plane it gives up. The U.S. has a comparative advantage in making airplanes. –the U.S. can produce one plane for every four shirts that it gives up. Mexico can make one plane for every eight shirts that it gives up. Mexico has a comparative advantage in making shirts. –the U.S. can produce one shirt for every 1/4 plane that it gives up, whereas Mexico can make one shirt for every 1/8 plane it gives up.

© OnlineTexts.com p. 15 Gains from Trade Suppose that 6 shirts are traded for one plane. If the U.S. specializes in the production of airplanes while Mexico specializes in the production of shirts, and then the two nations trade goods, both countries can consume more than before trade.

© OnlineTexts.com p. 16 Protectionism Revisited 1.Saves American jobs. –By imposing trade protection, the price of foreign and domestic goods rise. In return, certain American jobs are preserved. However, it is often estimated that the cost to American consumers to save one job through protectionism is $100,000 to $150,000. The reason for the high cost is that all the consumers of a particular product pay a higher price than they otherwise would pay. 1.Saves American jobs. –By imposing trade protection, the price of foreign and domestic goods rise. In return, certain American jobs are preserved. However, it is often estimated that the cost to American consumers to save one job through protectionism is $100,000 to $150,000. The reason for the high cost is that all the consumers of a particular product pay a higher price than they otherwise would pay.

© OnlineTexts.com p. 17 Protectionism Revisited 2.Protects infant industries. –If the infant industry is so promising within a particular nation, why won't private financial markets support the firms and carry them through the early years? –In addition, the infant industry tends not to grow up because the protection rarely ends due to political lobbying from the industry. 2.Protects infant industries. –If the infant industry is so promising within a particular nation, why won't private financial markets support the firms and carry them through the early years? –In addition, the infant industry tends not to grow up because the protection rarely ends due to political lobbying from the industry.

© OnlineTexts.com p. 18 Protectionism Revisited 3.Raises government revenue. –this method is an inefficient way to raise revenue because consumers end up paying for much of the tariff via higher consumer prices. 3.Raises government revenue. –this method is an inefficient way to raise revenue because consumers end up paying for much of the tariff via higher consumer prices.

© OnlineTexts.com p. 19 Protectionism Revisited 4.Keeps firms in U.S. –The fallacy of this argument is in assuming that the lost jobs from firms moving overseas or across borders will not be replaced. By allowing production to shift internationally, the U.S. economy can specialize in its comparative advantage and replace the lost jobs with higher skilled, higher paying jobs on average. It can do better, for example, by allowing clothing production to be done in other countries, while the U.S. focuses on, say, software production. 4.Keeps firms in U.S. –The fallacy of this argument is in assuming that the lost jobs from firms moving overseas or across borders will not be replaced. By allowing production to shift internationally, the U.S. economy can specialize in its comparative advantage and replace the lost jobs with higher skilled, higher paying jobs on average. It can do better, for example, by allowing clothing production to be done in other countries, while the U.S. focuses on, say, software production.

© OnlineTexts.com p. 20 Protectionism Revisited 5.Levels the playing field for firms who adhere to stricter environmental and labor laws. –This argument is harder to dismiss. Many nations do have environmental and labor laws that are much less stringent than those in the U.S., and hence, it is less costly to produce in those nations. –We must be careful to measure correctly the cost advantages from differing labor and environmental laws. Differences in labor productivity—not environmental or labor laws—are often the most important sources of comparative advantage. 5.Levels the playing field for firms who adhere to stricter environmental and labor laws. –This argument is harder to dismiss. Many nations do have environmental and labor laws that are much less stringent than those in the U.S., and hence, it is less costly to produce in those nations. –We must be careful to measure correctly the cost advantages from differing labor and environmental laws. Differences in labor productivity—not environmental or labor laws—are often the most important sources of comparative advantage.

© OnlineTexts.com p. 21 Protectionism Revisited 6.National security. –National security may indeed be a good reason to limit trade. Usually the scope of this limitation, however, is narrow and focused. National security concerns will not widely disrupt free trade. 6.National security. –National security may indeed be a good reason to limit trade. Usually the scope of this limitation, however, is narrow and focused. National security concerns will not widely disrupt free trade.

© OnlineTexts.com p. 22 Protectionism Revisited 7.Political tit for tat. –Adopting protective measures because trading partners are not playing fair may force the trading partners to open their economies up. There may be times when this policy is justified. However, it should be used as a last resort. Moreover, the end goal of these types of measures is to have more free trade, not less. 7.Political tit for tat. –Adopting protective measures because trading partners are not playing fair may force the trading partners to open their economies up. There may be times when this policy is justified. However, it should be used as a last resort. Moreover, the end goal of these types of measures is to have more free trade, not less.

© OnlineTexts.com p. 23 Protectionism Revisited 8.Human rights violations. –Using trade policies as leverage for improving human rights may sometimes be justified. There is an on-going discussion, however, of the advantages of engaging in trade with a nation (a long-term approach) rather than taking a more combative approach and erecting trade barriers (a short-term approach). One can make a case for either approach given various circumstances. 8.Human rights violations. –Using trade policies as leverage for improving human rights may sometimes be justified. There is an on-going discussion, however, of the advantages of engaging in trade with a nation (a long-term approach) rather than taking a more combative approach and erecting trade barriers (a short-term approach). One can make a case for either approach given various circumstances.

© OnlineTexts.com p. 24 Is Protectionism Justified? In sum, some non-economic justifications for protectionist policies do exist, but purely economic arguments for trade protection are difficult to justify. Protectionist policies hurt more people than they help, and the economy is less efficient because of it. In sum, some non-economic justifications for protectionist policies do exist, but purely economic arguments for trade protection are difficult to justify. Protectionist policies hurt more people than they help, and the economy is less efficient because of it.

© OnlineTexts.com p. 25 NAFTA The North American Free Trade Agreement (NAFTA): –a pact implemented in 1994 between the U.S., Mexico, and Canada –eliminated or will eliminate most of the tariffs and other trade restrictions between the countries. –was the source of enormous controversy and tension in North America. The North American Free Trade Agreement (NAFTA): –a pact implemented in 1994 between the U.S., Mexico, and Canada –eliminated or will eliminate most of the tariffs and other trade restrictions between the countries. –was the source of enormous controversy and tension in North America.

© OnlineTexts.com p. 26 Impacts of NAFTA NAFTA –hurts U.S. producers that compete with importers from Mexico and Canada because it reduces the prices of U.S. imports from Mexico and Canada. –helps U.S. exporters to Mexico & Canada because it reduces the prices of U.S. exports in those countries. –Despite intense U.S. opposition from labor unions and environmentalists, most of the hardship is begin felt in Mexico due to their severe pre-NAFTA protectionist policies. NAFTA –hurts U.S. producers that compete with importers from Mexico and Canada because it reduces the prices of U.S. imports from Mexico and Canada. –helps U.S. exporters to Mexico & Canada because it reduces the prices of U.S. exports in those countries. –Despite intense U.S. opposition from labor unions and environmentalists, most of the hardship is begin felt in Mexico due to their severe pre-NAFTA protectionist policies.