Ch.20: Trading with the World Trends in the Volume of Trade In 1960, United States exported 3.5 percent of GDP total output imported 4 percent of GDP In 2003, United States exported 10 percent of GDP. imported 15 percent of GDP.

Patterns and Trends in International Trade Trade in Goods Manufactured goods 55% of U.S. imports 68% of U.S. exports. Raw materials and semi-manufactured materials 14% of U.S. exports 15 % of U.S. imports. Largest export item from the United States is capital goods Largest import item is automobiles.

Patterns and Trends in International Trade In 2007, top countries U.S. imports from: China 17% Canada 15% Mexico 11% Japan 7% Top countries U.S. exports to: Canada 22% Mexico 12% China 6% Japan 5%

Patterns and Trends in International Trade Net Exports and International Borrowing net exports = exports-imports In 2007, U.S. net exports = -$546 billion U.S. had a trade deficit. Trade deficit  country borrows from foreign countries or sell some of its assets (net borrower). Trade surplus  country makes loans to foreign countries or buys some of their assets (net lender). In 2007, $2.02 trillion of U.S. government treasuries held by foreign countries $618 billion by Japan $390 billion by China

Gains from International Trade The Law of Comparative Advantage: Nations can increase consumption of goods and services when they allocate resources to the production of those goods and services for which they have a comparative advantage Trade for the goods they do not have comparative advantage in. Note that comparative advantage and its basis is explained in Chapter 2. Remind the students and send them back to that chapter for a quick review. There is an enormously rich heritage of stories, parables, fables, and satires that you can use to enliven your classes on this topic. The following fable, inspired by James Ingram, International Economic Problems, John Wiley, 1970, is powerful way to begin. Make up your own version with local flavor and embellishment. Adam Blackbox announces that he has discovered an amazing way to produce low-price, high-quality automobiles. He sets up a plant on a large tract of land along the coast of Massachusetts, hires 10,000 employees, swears them to secrecy, and begins delivering his low-price, high-quality autos to the nation’s showrooms. Adam Blackbox is hailed as an American industrial hero. Blackbox Enterprises floats stock and Wall Street booms. Consumers love Adam Blackbox. His automobiles are better and cheaper than those they could buy before he came along. Automakers hate him, but their attempts to pass laws to restrict his operations fail. The president and congressional leaders explain that economic adjustment is an inevitable consequence of technological advance. And Adam Blackbox’s new technology for delivering low-price, high-quality automobiles is clearly part of the process of achieving greater prosperity for all. [Continued on the notes page for slide #38] You can easily segue from this story to the analysis of Farmland and Mobilia.

If without trade, Farmland produces at point A and Mobilia produces at point A’: - who has comparative advantage in cars? - who has comparative advantage in grain?

The Gains from International Trade The Gains from Trade: Cheaper to Buy Than to Produce Cost of cars: 1,000 bushels in Mobilia 9,000 bushels in Farmland. Farmland should buy cars from Mobilia. Cost of 1,000 bushels of grain: 1 car in Mobilia 1/9 car in Farmland.  Mobilia should buy grain from Farmland.

The Gains from International Trade The Terms of Trade why won’t Mobilia trade at less than 1,000 bushels per car? Why won’t Farmland trade at more than 9,000 bushels per car? .

The Gains from International Trade The Gains from Trade. Farmland buys cars at a lower price than it would pay if it made them itself, and sells its grain at a higher price. Mobilia buys grain at a lower price than it would pay if it grew the grain itself, and sells its cars at a higher price. Both countries gain from trade. Auto workers in Mobilia vs. Farmland? Farm workers in Mobilia vs. Farmland?

The Gains from International Trade The slope of the line consumption possibilities curve (CPC) is determined by the terms of trade. Explain that Figure 33.4 shows how both countries can gain through international trade by taking advantage of divergent opportunity costs of production. Build the story for Farmland and then for Mobilia. Explain that the red line (in both parts of the figure) shows each country’s consumption possibilities. The slope of this line is the terms of trade--3,000 bushels of grain per car. For each country the consumption possibilities line touches the production possibilities frontier at the one point at which the slope of the PPF equals the terms of trade, point B, and this point is where each country produces. Emphasize that the consumption possibilities line lies outside the PPF except for the one point at which it touches the PPF. Each country then trades along its consumption possibilities line to its consumption point C. Emphasize the distinction between production possibilities—the PPF—and consumption possibilities—the red line along which the countries can trade.

International Trade Restrictions A tariff is a tax that is imposed by the importing country when an imported good crosses its international boundary. A nontariff barrier is any action other than a tariff that restricts international trade.

International Trade Restrictions The History of Tariffs The average tariff rate has generally fallen over the last 70 years.

International Trade Restrictions The General Agreement on Tariffs and Trade (GATT) is an agreement between nations to have a series of trade negotiations, or “rounds,” to reduce tariffs on international trade. The United States joined GATT in 1947. Subsequent rounds of the GATT occurred in the 1960s, late 1970s and 1980s, resulting in gradual decline in the average tariff rate in the United States

International Trade Restrictions The Uruguay round was the most ambitious and led to the creation of the World Trade Organization (WTO). The United States became a WTO member in 1994. WTO membership brings greater obligations to follow the GATT rules governing trade.

International Trade Restrictions In1994, NAFTA passed and gradually reduces trade barriers between Canada, Mexico and the U.S. are being lowered. European Union (EU) is an organization of European countries that have agreed to eliminate trade barriers among them. Asia-Pacific Economic group (APEC) is another agreement to reduce trade barriers among East Asian countries, including China.

International Trade Restrictions Barriers to trade Tariff Quota Voluntary export restraint (VER)

International Trade Restrictions Effect of tariff on cars on Price, output Producer. Consumer Tariff revenue. Excess burden of tax (deadweight loss).

International Trade Restrictions Effect of quota: price, quantity. Consumer Producer Importer Deadweight loss A quota vs. tariff: importer profits but no tax revenue for govt. A VER is similar to a quota except that the exporter captures the economic profit.

Arguments for protection Protect national security Protect infant industries How long? How defined? Punish “dumping” Beneficiaries of dumping? Saves jobs Costs other jobs [Continuing the story of Adam Blackbox.] The press becomes increasingly curious about what is going on in the giant New England auto plant. Investigative journalists create endless hours of speculative television programming on the amazing new technology. Then a tabloid journalist with a big checkbook finds a worker who is willing to talk. Adam Blackbox's secret is revealed. Nothing is produced at the plant. Adam Blackbox is a trader, not a producer. He buys grain from American farmers, exports it to Japan, and imports automobiles from Japan. His secret revealed, Adam Blackbox is hauled before Congressional committees on fair trade and denounced as an evil destroyer of American jobs. The president makes a special State of the Union speech in which he denounces Adam Blackbox, praises a vigilant press for saving Americans from the threat of cheap foreign labor, and announces a new budget initiative that will spend $50 billion on research in technologies to produce low cost, high-quality automobiles. The gains from trade are like a technological advance. Adam Blackbox expanded the nation’s consumption possibilities just like a technological advance might have done. But he didn’t expand production possibilities. Use this fable to generate a classroom discussion of questions such as: Why did the president and Congress accept Adam Blackbox when they thought he had expanded production possibilities but not when the discovered that he had “only” expanded consumption possibilities?

Arguments for protection Brings diversity and stability to our economy At a cost Other ways to stabilize. Penalizes nations with lax environmental standards or poor human rights records Our choice or theirs? Prevents rich nations from exploiting poor ones What is “exploitation”? [Continuing the story of Adam Blackbox.] The press becomes increasingly curious about what is going on in the giant New England auto plant. Investigative journalists create endless hours of speculative television programming on the amazing new technology. Then a tabloid journalist with a big checkbook finds a worker who is willing to talk. Adam Blackbox's secret is revealed. Nothing is produced at the plant. Adam Blackbox is a trader, not a producer. He buys grain from American farmers, exports it to Japan, and imports automobiles from Japan. His secret revealed, Adam Blackbox is hauled before Congressional committees on fair trade and denounced as an evil destroyer of American jobs. The president makes a special State of the Union speech in which he denounces Adam Blackbox, praises a vigilant press for saving Americans from the threat of cheap foreign labor, and announces a new budget initiative that will spend $50 billion on research in technologies to produce low cost, high-quality automobiles. The gains from trade are like a technological advance. Adam Blackbox expanded the nation’s consumption possibilities just like a technological advance might have done. But he didn’t expand production possibilities. Use this fable to generate a classroom discussion of questions such as: Why did the president and Congress accept Adam Blackbox when they thought he had expanded production possibilities but not when the discovered that he had “only” expanded consumption possibilities?

Why Is International Trade Restricted? The two key reasons international trade is restricted are Tariff revenue Rent seeking You can illustrate the rent-seeking political equilibrium of trade restrictions by using the 2002 Farm Bill and the steel subsidies of 2002.

Why Is International Trade Restricted? Tariff Revenue costly to collect taxes on income and domestic sales. cheaper to collect taxes on international transactions because international trade is easily monitored. especially attractive to governments in developing nations.

Why Is International Trade Restricted? Rent Seeking lobbying and other political activities that seek to capture gains from trade. Government may respond to the demands of those protected and ignore the losers. concentrated gains and diffused losses.