Chapter 16 Trading with Other Nations

Copyright © 2008 Pearson Addison Wesley. All rights reserved Did You Know That... U.S. residents spend about $24 billion on imports from Scandinavian nations each year? The U.S. tariff rate on products imported from Scandinavian countries is less than 1%?

Copyright © 2008 Pearson Addison Wesley. All rights reserved The Worldwide Importance of International Trade World GDP is nearly nine times greater than it was at the end of World War II. World trade has increased to more than 26 times what it was in 1950.

Copyright © 2008 Pearson Addison Wesley. All rights reserved The Worldwide Importance of International Trade (cont'd) The United States has figured prominently in this expansion of world trade.  Imports added up to barely 4% of annual U.S. GDP in  Today they account for almost 17%.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Source: Steven Husted and Michael Melvin, International Economics, 3rd ed. (New York: HarperCollins, 1995), p. 11, used with permission; World Trade Organization; Federal Reserve System; U.S. Department of Commerce. Figure 33-1 The Growth of World Trade, Panel (a)

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-1 The Growth of World Trade, Panel (b) Source: Steven Husted and Michael Melvin, International Economics, 3rd ed. (New York: HarperCollins, 1995), p. 11, used with permission; World Trade Organization; Federal Reserve System; U.S. Department of Commerce.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why do nations trade? GAINS!

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange We have learned about the concept of specialization and the mutual gains from trade. We can understand gains from trade among nations by understanding output gains from specialization between individuals.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Comparative Advantage  The ability to produce a good or service at a lower opportunity cost compared with producers

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Example: Kenya’s Green Thumb in Exporting Green Beans The opportunity cost of producing many packaged vegetables is lower in Kenya than in many European countries. This gives Kenya a comparative advantage in producing such goods.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Specialization among nations  To demonstrate the concept of comparative advantage, consider a simple two-country, two-good world.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Let’s do an example in class Two countries Each produces only cars and beer No trade No currency No unemployment No new resources or technology

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Production and consumption capabilities in a two-country, two-good world  We show maximum feasible quantities of software and PCs.  Using all resources—land, labor, capital, and entrepreneurship.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Table 33-4 National and Worldwide Gains from Specialization and Trade

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Specialization is the key  Specializing in producing goods for which a nation has a comparative advantage allows for greater efficiency.  Production capabilities increase, making possible greater worldwide consumption through international trade.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Observations on specialization and trade  Not everyone gains from trade.  Cannot “run out of exports”  Every country will always have a comparative advantage in something.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-2 World Trade Flows

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Example: Japan Loses Its Electronics Advantage to the U.S. From the 1950s until the late 1990s, companies based in Japan—Sony, Panasonic, Pioneer—made the nation a major exporter of electronic devices. Since the 1990s, U.S. companies—Apple, Microsoft, palmOne—have elbowed out Japanese firms. The United States has developed a comparative advantage over Japan in producing a number of modern electronic products.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Why We Trade: Comparative Advantage and Exhausting Mutual Gains From Exchange (cont'd) Other benefits from international trade: the transmission of ideas  New goods, services spread  New processes transmitted  Intellectual property introduced

Copyright © 2008 Pearson Addison Wesley. All rights reserved The Relationship Between Exports and Imports In the long run, imports are paid for by exports. Any restrictions on imports ultimately reduce exports. When a country engages in trade, it is not competing against the other countries. All nations stand to benefit from trade.

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Competitiveness Questions  Is the United States falling behind?  Do we need to stay competitive internationally?  What does global competitiveness really mean?

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Competitiveness (cont'd) Answers  United States leads in overall productive efficiency  According to the Institute for Management Development in Lausanne, Switzerland

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Competitiveness (cont'd) Reasons for ranking  Widespread entrepreneurship  Economic restructuring  Investment in information-technology  Sophisticated financial system  Large investments in scientific research

Copyright © 2008 Pearson Addison Wesley. All rights reserved Arguments Against Free Trade Infant Industry Argument  The contention that tariffs should be imposed to protect from import competition an industry that is trying to get started  Presumably, after the industry becomes technologically efficient, the tariff can be lifted.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Arguments Against Free Trade (cont'd) Countering foreign subsidies and dumping Dumping  Selling a good or a service abroad below the price charged in the home market or at a price below its cost of production

Copyright © 2008 Pearson Addison Wesley. All rights reserved Arguments Against Free Trade (cont'd) Protecting domestic jobs  Do imports reduce jobs?  No empirical evidence  In half of the cases studied, when imports rose, unemployment fell.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Arguments Against Free Trade (cont'd) The cost of protecting U.S. jobs  Restrictions on textiles and apparel goods cost U.S. consumers $9 billion a year.  Cost $50,000 a year for each $20,000 job saved  Restriction on imports of Japanese cars  Cost $160,000 per year for each job saved in the auto industry

Copyright © 2008 Pearson Addison Wesley. All rights reserved Emerging Arguments Against Free Trade Environmental concerns  Genetic engineering  New diseases National defense  Exports of new technology

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade Quota System  A government-imposed restriction on the quantity of a specific good that another country is allowed to sell in the United States  In other words, quotas are restrictions on imports, usually applied to one or several specific countries.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-3 The Effect of Quotas on Textile Imports Equilibrium with restrictions Equilibrium without restrictions

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade Voluntary quotas  Voluntary Restraint Agreement (VRA)  An official agreement with another country that “voluntarily” restricts the quantity of its exports  Voluntary Import Expansion (VIE)  An official agreement with another country in which it agrees to import more from the United States

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Tariffs  Tax on imported goods  Benefits import-competing industries  Harms consumers by raising prices

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Tariffs in the United States  Have varied widely on imported goods  Highest rates in twentieth century occurred with passage of Smoot-Hawley Tariff in 1930

Copyright © 2008 Pearson Addison Wesley. All rights reserved Today’s Agenda Review Schedule Complete Chapter 33  International Trade Chapter 34  Internal Finance

Copyright © 2008 Pearson Addison Wesley. All rights reserved Let’s look at the effects of a tariff

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-5 Tariff Rates in the United States Since 1820 Source: U.S. Department of Commerce

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Current tariff laws  Trade Expansion Act of 1962  Trade Reform Act of 1974  Trade and Tariff Act of 1984  General Agreement on Tariffs and Trade  World Trade Organization

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Trade Organizations General Agreement on Tariffs and Trade  An international agreement established in 1947 to further world trade by reducing barriers and tariffs  GATT was replaced by the World Trade Organization in 1995.

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Trade Organizations (cont'd) World Trade Organization (WTO)  The successor organization to GATT that handles trade disputes among its member nations

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Trade Organizations (cont'd) The World Trade Organization (WTO)  Most important international trade organization, with largest membership  Fostered most important and far-reaching global trade agreement covering  Financial institutions; including banks, insurers and investment companies

Copyright © 2008 Pearson Addison Wesley. All rights reserved International Policy Example: Twin Growth Paths in World Trade Its champions credit the WTO with boosting world trade. Doubters claim gains from trade are fueling membership. In any event, growth in world trade takes place alongside the WTO.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-6 Growth in the World Trade Organization’s Membership and in Global Trade

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Regional Trade Bloc  A group of nations that grants members special privileges  Examples include the European Union, NAFTA, and the Association of Southeast Asian Nations

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Some economists worry regional blocs could lead to a reduction in members’ trade with nations outside their blocs. Most evidence indicates regional trade blocs have promoted trade instead of hindering it.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Ways to Restrict Foreign Trade (cont'd) Numerous studies have found that as countries from around the world have become more open to trade, they have tended to join regional trade blocs that promote even more openness.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: Do Regional Trade Blocs Encourage “Trade Deflection”? Trade diversion versus trade deflection. Is trade deflection “bad”? Is the solution to the trade deflection worse than the problem?

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 33-7 The Percentage of World Trade Within Regional Trade Blocs

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Key Terms and Concepts absolute advantage comparative advantage dumping exports import quota imports specialization tariffs