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: 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 ↑

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. Allows countries to buy needed resources.

↑Competition → ↑Efficiency Knowledge flow Makes countries interdependent, decreasing possibility of wars. All these advantages imply ↑ domestic output and therefore greater economic growth.

Economic Integration Achieved by an agreement to reduce or eliminate trade barriers between countries. In this way countries become economically interdependent. A trading bloc is a group of countries that have agreed to reduce trade and other barriers in order to encourage free or freer trade and cooperation between them. There are different degrees of integration. Starting from the lowest:

Free trade area. A group of countries that agree to gradually eliminate trade barriers between themselves. Each country keeps the right to apply protectionist policies when trading with non-member countries. The trade of some products mught still be protected. Example: NAFTA=CA, MX, US Customs union. Same conditions as free trade area plus adoption of common policy towards non-member countries. Also, in negotiations with other countries the member countries act as a group.

Example: CEFTA (Central European Free Trade Agreement). In a common market, countries that have formed a customs union decide to –eliminate remaining tariffs in trade and –eliminate all restrictions on movements of factors of production (labour and capital) within them... (and continuing to have a common external policy). Example: European Economic Community, precursor of the EU.

Economic and monetary union. Economic union involves the unification of the monetary and fiscal systems of the members, with a unified system of economic policy making. Countries maintain political identity. Monetary union is achieved by adopting a common currency. Ex: eurozone countries. Eurozone countries still have separate fiscal systems and only a partially unified policy- making system.

Pros and cons of trading blocs Benefits: 1.Increased competition. 2.Economies of scale. 3.Use of new technologies (as a consequence of 1). 4.Lower prices for consumers. 5.Increased investment: internal by firms from a member country or external by outsider firms, which escape the tariff imposed by the trading bloc on imports from outside.

6.Better use of factors of production. 7.Improved production efficiency, allocative efficiency and greater economic growth (already mentioned). 8.Political advantages: Reduced likelihood of hostilities between countries becoming increasingly interdependent and political cooperation resulting from economic integration.

Disadvantages: 1.Trading blocs are a ‘second best’ solution, being inferior to a complete elimination of trade barriers (=first best). 2.May create obstacles for global free trade. Some economists believe that conflicts between trading blocs might arise, difficulting the process of global integration. 3.Unequal distribution of gains from trading blocs, as not all members obtain the same benefit.

4.Gains may be limited if major trade links are with outside countries. For instance, LDCs have strong trade links with DCs and more limited trade with each other. What would be the gains of a trading bloc between LDCs???