International Trade

Benefits of trade International trade: exchange of goods and services across international boundaries. Countries trade with each other because they obtain some benefits. These are: Increases in domestic production and consumption as a result of specialization: the production by a country of a range of goods and services it can produce at a low cost. If you are efficient in producing something, you will be able to produce more of it. If you can produce certain goods and services only at a high cost, then you will be wasting resources. Therefore, if a country specializes→ total output ↑ and consumption ↑

Increases the variety and quality of g&s available to consumers. Differences in factor endowments make specialization possible. Economies of scale involve the ability of a firm to ↓ average costs by increasing its size and Q produced. If a country trades its potential market becomes larger and so the possibility of achieving economies of scale. Increases the variety and quality of g&s available to consumers. ↑Competition → ↑Efficiency → Lower prices for consumers Allows countries to buy needed resources.

Makes possible the flow of new ideas, new technologies and skills. Makes countries interdependent, decreasing possibility of wars. Free trade can lead to a more efficient allocation of resources. All these advantages imply ↑ domestic output and therefore greater economic growth.

Arguments against trade protection From our analysis of trade barrier effects: The gain of producers has a cost in terms of higher costs of production and reduced efficiency. Consumers lose in all cases except for subsidies. Income distribution in most cases worsens. Foreign producers are worse off in all cases. Society as a whole and global resource allocation lose under all forms of trade protection.

Additional points: Trade protection (TP) may have negative effects on a country’s export competitiveness. Some domestically produced goods that are protected may be used as inputs in the production of other goods that are exported. As a result, the price of these exports will be higher, which results in lower competitiveness in export markets. TP may give rise to trade wars, with negative effects on global output and resource allocation. TP creates a potential for corruption: smuggling, payment of bribes, tariff revenues going into the pockets of bureaucrats rather than the gov budget.

Arguments for trade protection Qualified arguments: can be justified under particular conditions. They are valid on the expectation that long term benefits of protectionism are greater than short-term costs. Questionable arguments have limited validity. Might offer short-term solutions to problems. Incorrect arguments. Based on incorrect economic reasoning.

Qualified arguments Infant industry argument. An infant industry is a new domestic industry that has not had the time to become efficient and may therefore be unable to compete with more mature foreign firms. In order to be able to grow in size and achieve economies of scale (lower production costs) a new firm may need protection from imports until it has grown in size. Mainly used by LDCs. It is one of the strongest arguments and is consistent with the theory of comparative advantage. However, protection should be eliminated once the industry is mature enough.

Problems: 1. Identify the industries; 2 Problems: 1. Identify the industries; 2. Protected industres may lose the incentive to become more efficient; 3. Governments may continue to protect an industry longer than needed. Strategic trade policy. Industries considered to be important to the future growth of an economy should receive protection until they achieve the necessary economies of scale. Ex: computers, telecommunications, semiconductors. This argument appeared in the 1980s and is very similar to the previous one, with some differences: It also applies to MDCs. It involves other protection measures such as subsidies, tax advantages, low interest loans and gov financing of R&D.

Used by US and EU to justify protection of high-tech industries Used by US and EU to justify protection of high-tech industries. Source of disagreements under the WTO. Problems: 1. Identification of the industries; 2. Selection of appropriate protectionist policies; 3. It is likely that all or most DCs will use protection for the same industries at the same time, wich contradicts the idea of creating comparative advantage; 4. Gov might continue to protect these industries longer than needed.

Arguments against excessive specialization: Efforts of a LDC to diversify. Diversification means to increase the variety of goods and services produced. It can be thought as the opposite of specialization (basis of comparative advantage). Some countries might be better off diversifying their production and exports, as in the case of LDCs that are highly specialized in the production and export of one or few commodities. Arguments against excessive specialization: Fluctuations in global D or S → fluctuations in prices of primary goods → unstable export revenues. ↓export or export prices → ↓export rev and ↓incomes

Arguments in favour of diversification: When LDCs move away from production of primary products and into manufactured products the benefits are: increased employment, increased use of more advanced technologies and greater use of more highly skilled labour. All these favour growth and development. To be able to diversify, countries may have to use protectionist policies in order to keep out imports of goods that they would like to produce themselves. The expectation is that the long term benefits of diversification will be greater than the short term costs (inefficiencies) of protection. Problem: selection of industries appropriate for protection.

National security. Certain industries that are essential for national defence (aircraft, weapons, chemicals, certain minerals) should be protected so that a country can produce them itself. Problem: it can be used by industries that have an indirect use in defence, such as steel, to try to acquire protection against foreign competition. Also, it is difficult to determine what is essential for national defence. In the US, goods such as candles, gloves and umbrellas receive protection on this argument. Health, safety and environmental standards. There is concern that these standards may sometimes be used as a form of ‘hidden’ protection.

Questionable arguments Tariffs as a source of government revenue. More common in LDCs: ease with which imports can be taxed. In contrast, income taxes are more difficult to levy and collect in LDCs for three reasons: Large shares of the population live on very low incomes. Large proportion of people self-employed and working in the informal sector. Poor enforcement of tax collection and high tax evasion rates.

Disadvantages of tariffs: regressive tax (negative impacts on income distribution) and negative effects on allocative efficiency. LDCs should make efforts to reform their tax systems, improve tax collection systems and gradually phase out reliance on tariffs as a source of government revenue. Means to overcome balance of payments deficit. A balance of payments deficit occurs when the outflow of money from a country is greater than the inflow. It usually happens when imports are greater than exports. Imposing barriers to the entry of imports limits the need to make payments abroad.

However: ↓imports→ ↓exports in the exporting countries However: ↓imports→ ↓exports in the exporting countries. There is a risk that these countries may retaliate by imposing protectionist measures of their own. In this case all countries would be worse off: ↓ in international trade and worsening balance of payments problems (↓imports + ↓exports). Anti-dumping. Dumping is the practice of selling a good in international markets at a price below the cost of production (usually by providing export subsidies). It is considered to be an unfair practice and is illegal according to int’al agreements.

According to this argument, if a country suspects that a trading partner is practising dumping, it should have the right to impose tariffs or quotas in order to limit imports of the dumped good. Main problem: it is difficult to prove that dumping is being practised, so it is often used by many governments as an excuse to protect their domestic producers when this is not necessary or justified.

Protection of domestic jobs Protection of domestic jobs. Import restrictions cause consumers to shift consumption away from imports and towards domestic produced goods. As domestic production increases, unemployment falls. Problem: if UE in the domestic country falls, this means that UE has increased in those countries that now export less. These may retaliate by imposing import restrictions, with the result that all countries will be worse off. If the gov’s objective is to increase employment in the economy, fiscal, monetary or supply-side policies may be more appropriate. A subsidy might be more appropriate if it wants to increase employment in a particular industry.

Incorrect arguments Wage protection argument. Some foreign countries can produce at lower costs because of low wages, so that imports from those countries will sell at lower prices and domestic firms will not be able to compete. Protection becomes necessary to restrict imports from low-wage countries. Although very popular, this argument is based on incorrect economic reasoning. A low wage country likely has a comparative advantage in producing goods that make use of its cheap labour resources. This is the basis of specialization & trade according to the theory of comparative advantage.