1. International Trade Trade patterns and trade politics
© Melvin Jameson

2. Reasons to study international trade:
To better understand the international economic environment including:
the dynamics by which it changes, and
its impact on the politics of trade policy, and thus the political/regulatory environment.
To help identify international business opportunities and to understand why they exist.
© 2015 Melvin Jameson

3. 1. What drives trade?
Trade results from international differences in supply and demand.
© Melvin Jameson

4. U.S. In Isolation Supply and Demand
price 5 35
$2,000 6 34
$2,050 7 33
$2,100 8 32
$2,150 9 31
$2,200 10 30
$2,250 11 29
$2,300 12 28
$2,350 13 27
$2,400 14 26
$2,450 15 25
$2,500 16 24
$2,550 17 23
$2,600 18 22
$2,650 19 21
$2,700 20
$2,750
$2,800
$2,850
$2,900
$2,950
$3,000
© Melvin Jameson

5. Rest-of-the-World In Isolation
price
Supply
Demand
$2,000
180
220
$2,050
184
216
$2,100
188
212
$2,150
192
208
$2,200
196
204
$2,250
200
$2,300
$2,350
$2,400
$2,450
$2,500
$2,550
224
176
$2,600
228
172
$2,650
232
168
$2,700
236
164
$2,750
240
160
$2,800
244
156
$2,850
248
152
$2,900
252
148
$2,950
256
144
$3,000
260
140
© Melvin Jameson

6. If prices differ when markets are isolated, trade is will occur when it becomes possible.
It will continue until the price difference (less any trading costs) is eliminated.
To understand why trade occurs, we must ask why prices would differ without it.
© Melvin Jameson

7. Results of unimpeded trade
Desired export = Desired import
U.S. price = world price
U.S.
rest of the world
Import
Supply
Demand
price
Export 30 5 35
$2,000
180
220
-40 28 6 34
$2,050
184
216
-32 26 7 33
$2,100
188
212
-24 24 8 32
$2,150
192
208
-16 22 9 31
$2,200
196
204 -8 20 10
$2,250
200
Autarky; world 18 11 29
$2,300
Free trade 16 12
$2,350 14 13 27
$2,400
$2,450 15 25
$2,500 40
$2,550
224
176 48 17 23
$2,600
228
172 56 4
$2,650
232
168 64 2 19 21
$2,700
236
164 72
Autarky U.S.
$2,750
240
160 80 -2
$2,800
244
156 88 -4
$2,850
248
152 96 -6
$2,900
252
148
104
$2,950
256
144
112
-10
$3,000
260
140
120
© Melvin Jameson

8. Costly trade: $250/unit transportation
Desired export = Desired import
U.S. price (importer) = world price + trade cost
U.S.
rest of the world
Import
Supply
Demand
price
Export 30 5 35
$2,000
180
220
-40 28 6 34
$2,050
184
216
-32 26 7 33
$2,100
188
212
-24 24 8 32
$2,150
192
208
-16 22 9 31
$2,200
196
204 -8 20 10
$2,250
200
Autarky; world 18 11 29
$2,300
Costly trade
Free trade 16 12
$2,350 14 13 27
$2,400
$2,450 15 25
$2,500 40
$2,550
224
176 48 17 23
$2,600
228
172 56 4
$2,650
232
168 64 2 19 21
$2,700
236
164 72
Autarky U.S.
$2,750
240
160 80 -2
$2,800
244
156 88 -4
$2,850
248
152 96 -6
$2,900
252
148
104
$2,950
256
144
112
-10
$3,000
260
140
120
© Melvin Jameson

9. Results of trade: Traded Goods
Prices of traded goods converge worldwide.
Production is reallocated internationally
Because of the differences between countries, reallocating production to increase specialization increases total world output.
A net welfare improvement results.
© Melvin Jameson

10. 2. Why do local prices differ
2. Why do local prices differ? or Understanding why trade patterns evolve
© Melvin Jameson

11. What drives trade? International differences
Differences create business opportunities (trade).
Trade creates a political response – often leading to trade barriers.
Barriers affect trade patterns and opportunities.
To understand the dynamics of the IB environment,
we must understand what these differences are
and how they are evolving.
© Melvin Jameson

12. Sources of Comparative Advantage
What kinds of differences can lead to greater relative efficiency in particular products?
© Melvin Jameson

13. Models of Trade Model Difference Classical Comparative Advantage
Factor Proportions Heckscher-Ohlin
Technology-based models (product life-cycle model)
Difference
Natural Resource endowments
Factor endowments
(capital/labor ratio)
Human capital: skilled
(educated) vs unskilled labor
© Melvin Jameson

14. Models of Trade (continued)
Intra-Industry Trade
seasonal
transportation costs
product differentiation
Economies of Scale (Krugman)
internal
external
Difference
seasonal productivity
location
© Melvin Jameson

15. Economies of Scale Internal EOS (increasing returns to scale)
Producing on a very large scale lowers average costs
The low-cost product can be exported
Even absent comparative-advantage differences
External EOS (Clusters)
All firms in a region (cluster) enjoy lower average cost due to a concentration of specialized resources
Large pool of workers with specialized human capital
Specialized inputs/subcontractors
Shared information and knowledge
Similar average cost reduction given scale of the region
© Melvin Jameson

16. Dynamics of comparative advantage
Some sources of comparative advantage are long lasting
favorable climate
vast oil reserves
Others are more transient
low-cost labor
© Melvin Jameson

17. Summary: International differences drive trade
Natural resource endowments
Created endowments (capital)
Physical capital
Human capital
unskilled labor → skilled (trained) labor → educated labor
Other
Economies of scale including “clusters”
Seasonality etc.
© Melvin Jameson

18. 3. Results of trade: Non-traded goods Understanding some political consequences of trade
© Melvin Jameson

19. Results of trade: Non-traded goods
Prices of traded goods converge worldwide.
Prices of non-traded substitutes for traded goods converge.
Factor prices converge (“factor price equalization”)
© Melvin Jameson

20. Factor-Price Equalization: Consequences for trade policy
“Stolper-Samuelson Theorem” extends theory of factor price equalization.
A country has a comparative advantage in products that intensively utilize abundant factors.
Trade increases the (domestic) price of these products and thus the wage of the abundant factor.
Thus owners of the relatively abundant factor favor free trade and those of scarce factors oppose it.
Particularly when the factors are specialized or immobile.
Despite net benefit resulting from trade
© Melvin Jameson

21. Limits to Factor-Price Equalization
Transportation costs and other barriers limit the amount of trade.
Real factor productivity varies due to international differences in capital stock, technology, education, legal and economic institutions etc.
© Melvin Jameson

22. Winners and Losers from Trade
Producers in exporting country
Consumers in importing country
Losers
Producers in importing country
Consumers in exporting country
Total gains exceed total losses
© Melvin Jameson

23. Why trade increases welfare
Local prices converge toward a world price
Production is reallocated
Each region specializes in its comparative advantage
Permits an increase in production of all products
© Melvin Jameson

24. Political Economy of Trade Policy
Typically dominated by producers:
Well organized, well defined groups that are very aware of their economic interests.
Consumers
Economic losses, although large in total, are widely dispersed and individually small.
Generally not organized or well-informed
© Melvin Jameson

25. Application
EU Trade Policy
© Melvin Jameson

26. 4. Trade Barriers
© Melvin Jameson

27. Effect of a Tariff P* = world price T = Tariff A = Gain to Suppliers
C = Tariff Revenue
A+B+C+D = Loss to Consumers
price
Domestic Supply
P*+T A C D B
Domestic Demand P*
Quantity S S’ D’ D
© Melvin Jameson

28. A tariff reduces the effects of trade
Volume of trade
Degree of price convergence
Gains of winners
Losses of losers
Net benefit of trade
Partial transfer to government collecting tariff
© Melvin Jameson

29. Dynamic effects of trade barriers
Reduced competitiveness of domestic industry
Foreign competitors adjust
Direct foreign investment
Change product types
Substitute more expensive products
Seek loopholes in tariff
Trade retaliation
© Melvin Jameson

30. Non-tariff Barriers Alternative means to limit trade
The effects are generally similar to tariffs and natural impediments to trade (transportation)
But can be some nuance regarding
distribution of cost and gains
dynamic response
domestic politics and international relations surrounding their implementation
© Melvin Jameson

31. Other direct trade restrictions
Quotas
Tariff-rate quota
Export quotas (“voluntary” export restraint)
Subsidies
© Melvin Jameson

32. Other types of non-tariff Barriers
Domestic content requirements
Government procurement policies
Social Regulations
health, safety, environment
Sea transport and freight regulations
can be costly and restrictive
© Melvin Jameson

33. 5. Regional Trade Agreements
© Melvin Jameson

34. Regional Trade Agreements
Types
Preferential trade area – reduced tariffs for members
Free trade area- zero tariff for members
Customs union – common external tariff policy
Common market – all factors mobile within
Economic Union: Complete economic integration – common currency, regulation, tax policy etc.

35. Do regional agreements improve resource allocation?
Not necessarily
Trade creation occurs when production shifts from high to low cost location as a result of a trade preference
Trade diversion occurs production shifts from a low to a high cost source.

36. Trade creation vs. diversion
Policy
Home B C
Result
0% tariff 35 26 20
Free Trade
100% tariff 52 40
prohibitive tariff
50% tariff 39 30
free trade w/ B
trade diversion