International Trade Trade patterns and trade politics © 2015 Melvin Jameson

Reasons to study international trade: To better understand the international economic environment including: the dynamics by which it changes, and its impact on the politics of trade policy, and thus the political/regulatory environment. To help identify international business opportunities and to understand why they exist. © 2015 Melvin Jameson

1. What drives trade? Trade results from international differences in supply and demand. © 2015 Melvin Jameson

U.S. In Isolation Supply and Demand price 5 35 $2,000 6 34 $2,050 7 33 $2,100 8 32 $2,150 9 31 $2,200 10 30 $2,250 11 29 $2,300 12 28 $2,350 13 27 $2,400 14 26 $2,450 15 25 $2,500 16 24 $2,550 17 23 $2,600 18 22 $2,650 19 21 $2,700 20 $2,750 $2,800 $2,850 $2,900 $2,950 $3,000 © 2015 Melvin Jameson

Rest-of-the-World In Isolation price Supply Demand $2,000 180 220 $2,050 184 216 $2,100 188 212 $2,150 192 208 $2,200 196 204 $2,250 200 $2,300 $2,350 $2,400 $2,450 $2,500 $2,550 224 176 $2,600 228 172 $2,650 232 168 $2,700 236 164 $2,750 240 160 $2,800 244 156 $2,850 248 152 $2,900 252 148 $2,950 256 144 $3,000 260 140 © 2015 Melvin Jameson

If prices differ when markets are isolated, trade is will occur when it becomes possible. It will continue until the price difference (less any trading costs) is eliminated. To understand why trade occurs, we must ask why prices would differ without it. © 2015 Melvin Jameson

Results of unimpeded trade Desired export = Desired import U.S. price = world price U.S.   rest of the world Import Supply Demand price Export 30 5 35 $2,000 180 220 -40 28 6 34 $2,050 184 216 -32 26 7 33 $2,100 188 212 -24 24 8 32 $2,150 192 208 -16 22 9 31 $2,200 196 204 -8 20 10 $2,250 200 Autarky; world 18 11 29 $2,300 Free trade 16 12 $2,350 14 13 27 $2,400 $2,450 15 25 $2,500 40 $2,550 224 176 48 17 23 $2,600 228 172 56 4 $2,650 232 168 64 2 19 21 $2,700 236 164 72 Autarky U.S. $2,750 240 160 80 -2 $2,800 244 156 88 -4 $2,850 248 152 96 -6 $2,900 252 148 104 $2,950 256 144 112 -10 $3,000 260 140 120 © 2015 Melvin Jameson

Costly trade: $250/unit transportation Desired export = Desired import U.S. price (importer) = world price + trade cost U.S.   rest of the world Import Supply Demand price Export 30 5 35 $2,000 180 220 -40 28 6 34 $2,050 184 216 -32 26 7 33 $2,100 188 212 -24 24 8 32 $2,150 192 208 -16 22 9 31 $2,200 196 204 -8 20 10 $2,250 200 Autarky; world 18 11 29 $2,300 Costly trade Free trade 16 12 $2,350 14 13 27 $2,400 $2,450 15 25 $2,500 40 $2,550 224 176 48 17 23 $2,600 228 172 56 4 $2,650 232 168 64 2 19 21 $2,700 236 164 72 Autarky U.S. $2,750 240 160 80 -2 $2,800 244 156 88 -4 $2,850 248 152 96 -6 $2,900 252 148 104 $2,950 256 144 112 -10 $3,000 260 140 120 © 2015 Melvin Jameson

Results of trade: Traded Goods Prices of traded goods converge worldwide. Production is reallocated internationally Because of the differences between countries, reallocating production to increase specialization increases total world output. A net welfare improvement results. © 2015 Melvin Jameson

2. Why do local prices differ 2. Why do local prices differ? or Understanding why trade patterns evolve © 2015 Melvin Jameson

What drives trade? International differences Differences create business opportunities (trade). Trade creates a political response – often leading to trade barriers. Barriers affect trade patterns and opportunities. To understand the dynamics of the IB environment, we must understand what these differences are and how they are evolving. © 2015 Melvin Jameson

Sources of Comparative Advantage What kinds of differences can lead to greater relative efficiency in particular products? © 2015 Melvin Jameson

Models of Trade Model Difference Classical Comparative Advantage Factor Proportions Heckscher-Ohlin Technology-based models (product life-cycle model) Difference Natural Resource endowments Factor endowments (capital/labor ratio) Human capital: skilled (educated) vs unskilled labor © 2015 Melvin Jameson

Models of Trade (continued) Intra-Industry Trade seasonal transportation costs product differentiation Economies of Scale (Krugman) internal external Difference seasonal productivity location © 2015 Melvin Jameson

Economies of Scale Internal EOS (increasing returns to scale) Producing on a very large scale lowers average costs The low-cost product can be exported Even absent comparative-advantage differences External EOS (Clusters) All firms in a region (cluster) enjoy lower average cost due to a concentration of specialized resources Large pool of workers with specialized human capital Specialized inputs/subcontractors Shared information and knowledge Similar average cost reduction given scale of the region © 2015 Melvin Jameson

Dynamics of comparative advantage Some sources of comparative advantage are long lasting favorable climate vast oil reserves Others are more transient low-cost labor © 2015 Melvin Jameson

Summary: International differences drive trade Natural resource endowments Created endowments (capital) Physical capital Human capital unskilled labor → skilled (trained) labor → educated labor Other Economies of scale including “clusters” Seasonality etc. © 2015 Melvin Jameson

3. Results of trade: Non-traded goods Understanding some political consequences of trade © 2015 Melvin Jameson

Results of trade: Non-traded goods Prices of traded goods converge worldwide. Prices of non-traded substitutes for traded goods converge. Factor prices converge (“factor price equalization”) © 2015 Melvin Jameson

Factor-Price Equalization: Consequences for trade policy “Stolper-Samuelson Theorem” extends theory of factor price equalization. A country has a comparative advantage in products that intensively utilize abundant factors. Trade increases the (domestic) price of these products and thus the wage of the abundant factor. Thus owners of the relatively abundant factor favor free trade and those of scarce factors oppose it. Particularly when the factors are specialized or immobile. Despite net benefit resulting from trade © 2016 Melvin Jameson

Limits to Factor-Price Equalization Transportation costs and other barriers limit the amount of trade. Real factor productivity varies due to international differences in capital stock, technology, education, legal and economic institutions etc. © 2015 Melvin Jameson

Winners and Losers from Trade Producers in exporting country Consumers in importing country Losers Producers in importing country Consumers in exporting country Total gains exceed total losses © 2016 Melvin Jameson

Why trade increases welfare Local prices converge toward a world price Production is reallocated Each region specializes in its comparative advantage Permits an increase in production of all products © 2014 Melvin Jameson

Political Economy of Trade Policy Typically dominated by producers: Well organized, well defined groups that are very aware of their economic interests. Consumers Economic losses, although large in total, are widely dispersed and individually small. Generally not organized or well-informed © 2016 Melvin Jameson

Application EU Trade Policy © 2015 Melvin Jameson

4. Trade Barriers © 2014 Melvin Jameson

Effect of a Tariff P* = world price T = Tariff A = Gain to Suppliers C = Tariff Revenue A+B+C+D = Loss to Consumers price Domestic Supply P*+T A C D B Domestic Demand P* Quantity S S’ D’ D © 2016 Melvin Jameson

A tariff reduces the effects of trade Volume of trade Degree of price convergence Gains of winners Losses of losers Net benefit of trade Partial transfer to government collecting tariff © 2016 Melvin Jameson

Dynamic effects of trade barriers Reduced competitiveness of domestic industry Foreign competitors adjust Direct foreign investment Change product types Substitute more expensive products Seek loopholes in tariff Trade retaliation © 2014 Melvin Jameson

Non-tariff Barriers Alternative means to limit trade The effects are generally similar to tariffs and natural impediments to trade (transportation) But can be some nuance regarding distribution of cost and gains dynamic response domestic politics and international relations surrounding their implementation © 2016 Melvin Jameson

Other direct trade restrictions Quotas Tariff-rate quota Export quotas (“voluntary” export restraint) Subsidies © 2016 Melvin Jameson

Other types of non-tariff Barriers Domestic content requirements Government procurement policies Social Regulations health, safety, environment Sea transport and freight regulations can be costly and restrictive © 2016 Melvin Jameson

5. Regional Trade Agreements © 2016 Melvin Jameson

Regional Trade Agreements Types Preferential trade area – reduced tariffs for members Free trade area- zero tariff for members Customs union – common external tariff policy Common market – all factors mobile within Economic Union: Complete economic integration – common currency, regulation, tax policy etc.

Do regional agreements improve resource allocation? Not necessarily Trade creation occurs when production shifts from high to low cost location as a result of a trade preference Trade diversion occurs production shifts from a low to a high cost source.

Trade creation vs. diversion   Policy Home B C Result 0% tariff 35 26 20 Free Trade 100% tariff 52 40 prohibitive tariff 50% tariff 39 30 free trade w/ B trade diversion