Chapter 28 International trade ©McGraw-Hill Companies, 2010

©McGraw-Hill Companies, 2010 Exports as % of GDP World trade has grown at an average annual rate of 8 % since 1950. Between 1960 and 2009, UK exports as a fraction of GNP rose from 18% to 27%. World exports are now around 20% of world GNP. Source: OECD, Economic Outlook. ©McGraw-Hill Companies, 2010 2

Trade patterns, 1980 -2008 (% of world exports) Destination 1980 2008 Developed Other Developed Other Origin Developed 50 21 41 16 Countries Other 21 8 24 19 Source: UNCTAD, Handbook of Statistics, 2009 (at www.unctad.org). As late as 1980, the developed countries were the origin and destination of 71% of world exports, most of this trade being among themselves. The rapid growth of emerging market economies and the economic liberalization of the former Soviet Union and Eastern Europe has changed this. ©McGraw-Hill Companies, 2010 3

Merchandise trade patterns, 2008, (% of region’s exports) agriculture fuels, manufactures minerals World 8.5 22.5 66.5 N. America 10.4 17 68 Europe 9.3 11.9 76.8 CIS 6.8 66.8 24.9 Africa 6.8 70.6 17.9 Middle East 2.4 74.1 21.6 Asia 6 12.4 79.2 The mature economies of Europe and North America and the Asian economies export mainly manufactures. The Commonwealth of independent states (ex Soviet Union), Africa, and the Middle East mainly export oil and other minerals. Sources: GATT, Networks of World Trade, 1955–76; www.wto.org. ©McGraw-Hill Companies, 2010 4

©McGraw-Hill Companies, 2010 Some important issues Raw materials prices Less-developed countries (LDCs) have claimed exploitation by industrial countries e.g. by buying raw materials cheaply & selling manufactures dear Agricultural protection farmers in rich countries benefit from both subsidies and tariff protection. LDCs lose by selling less and with a restricted market, at lower prices Manufactured exports from LDCs some LDCs have had success in exporting manufactures leading to complaints that jobs are under threat in the industrial countries ©McGraw-Hill Companies, 2010 5

Some important issues (2) Globalisation Lower transport costs and better information technology are gradually breaking down the segmentation of national markets and increasing competition between countries. A trend reinforced by a reduction in tariffs A level playing field? Poor countries feel that the process is largely dictated by rich countries according to their own self-interest. Raising the demand for LDC exports, reducing agricultural protection in rich countries would help LDCs substantially.  ©McGraw-Hill Companies, 2010 6

Comparative advantage Trade offers benefits when there are international differences in the opportunity cost of goods. Opportunity cost of a good the quantity of other goods sacrificed to make one more unit of that good The law of comparative advantage states that countries should specialise in producing and exporting the goods that they produce at a lower relative cost than other countries. ©McGraw-Hill Companies, 2010 7

The source of comparative advantage An important difference between countries is in factor endowments, which will be reflected in different relative factor prices e.g. if country A has relatively abundant capital but relatively scarce labour compared with country B, then A would tend to specialize in capital-intensive goods, and B would tend to specialize in labour-intensive products. Comparative advantage may also reflect a relative advantage in technology. ©McGraw-Hill Companies, 2010 8

©McGraw-Hill Companies, 2010 Gainers and losers Countries may gain from specialisation and trade but not all countries may gain equally Commercial policy is government policy that influences international trade through taxes or subsidies e.g. tariffs or through direct restrictions on imports and exports. ©McGraw-Hill Companies, 2010 9

The economic effects of a tariff DD and SS show the domestic demand and supply for a good. DD SS Quantity Price Pw Qs Qd Pw+T Qs' Qd' If the world price is Pw, and there is free trade, domestic firms supply Qs domestic demand is Qd and the difference is imported. A tariff can stimulate domestic supply and restrict imports. At a domestic price Pw+T, where T is the size of the tariff. Domestic demand falls to Qd', domestic supply rises to Qs‘ and imports fall. ©McGraw-Hill Companies, 2010 10

The welfare costs of a tariff SS The tariff leads both to transfers and net social losses. Price The government raises revenue – i.e. there is a transfer to the government, Pw+T There is a social cost from production inefficiency, given that the good could be imported at Pw, and a loss of consumer surplus. and there is a transfer in the form of extra profits to producers. Qs' Qd' A B Pw Qs Qd DD Quantity A is the amount society spends by producing goods it could import more cheaply. B is the excess of consumer benefits over social marginal cost that is lost. ©McGraw-Hill Companies, 2010 11

©McGraw-Hill Companies, 2010 Tariffs The deadweight burden of a tariff suggests that society suffers from this method of restricting trade. This is the case for free trade. Tariffs have fallen substantially under the GATT General Agreement on Tariffs and Trade ©McGraw-Hill Companies, 2010 12

The case for tariffs – good arguments Optimal tariff a first-best argument only valid where the importing country is large enough to affect the world price. This policy fulfils the principle of targeting which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly. Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities. ©McGraw-Hill Companies, 2010 13

The case for tariffs – second-best arguments Way of life an attempt to preserve ‘traditional’ ways a production subsidy would be better Suppressing luxuries an attempt to curb consumption patterns of the rich in a poor society better achieved by a consumption tax ©McGraw-Hill Companies, 2010 14

The case for tariffs – second-best arguments (2) Infant industries an attempt to nurture new activities via learning by doing a temporary production subsidy probably better Revenue tariffs raise government revenue but there are better ways Cheap foreign labour a non-argument – denies benefits of comparative advantage ©McGraw-Hill Companies, 2010

Other commercial policies Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions quotas non-tariff barriers administrative regulations that discriminate against foreign goods export subsidies ©McGraw-Hill Companies, 2010 16

©McGraw-Hill Companies, 2010 An export subsidy Pw World price Under free trade, with the world price at Pw, Qd consumers demand Qd S Qs production is Qs Exports now rise to AB. A B Subsidy With a subsidy, producers produce Qs’ and supply Qd' to the domestic market. Pw+ s Qd' Q`s' exports are GE. G E and the loss of consumer surplus. Social costs arise from production inefficiency Price DD Quantity ©McGraw-Hill Companies, 2010 17