1. International Trade
In this chapter we will take a look at some key facts about international trade and then start evaluating international trade using comparative advantage. We will also use demand and supply curves to explain how countries determine which goods they will import, which goods they will export, and the price that is charged for these goods. Lastly we will look at trade barriers and how they impact the outcomes of international trade.

2. U.S. trade deficit in goods $529 billion in 2015
Some Key Trade Facts
U.S. trade deficit in goods
$529 billion in 2015
U.S. trade surplus in services
$220 billion in 2015
Canada largest U.S. trade partner
Trade deficit with China
$366 billion in 2015
Exports are 13% U.S. output
International trade is a key component in most nations’ economies. It is what allows countries to grow. Without it, a nation might not have access to a key resource or a way to exchange their own key resources for other items needed. The U.S. economy has thrived on international trade throughout its history. In one sense, it was founded on the very basis of international trade as Christopher Columbus discovered the new world while looking for a new route to engage in international trade. We can understand why Canada is our largest trading partner given the fact that we share a lengthy border with them that facilitates trade. The trade deficit with China has been decreasing in recent years as their economy grows providing the citizens with more disposable income with which to purchase imported items coming from the U.S. Our dependence on foreign oil still causes concerns in many sectors because if the supply was disrupted for any reason, it could cause severe supply shocks in the economy.
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3. Economic Basis for Trade
Nations have different resource endowments
Labor-intensive goods
Land-intensive goods
Capital-intensive goods
Why trade? The reason is that nations, as well as individuals, can gain by specializing. With trade, everyone ends up better off than before. The benefits are derived from three facts: (1) the distribution of natural, human, and capital resources is uneven among nations, (2) not all nations have the same degree of technology, and (3) people have different preferences. In a country such as China, which has an abundant supply of cheap labor, producing labor-intensive goods makes sense. Other countries may be blessed with an abundance of natural resources and therefore can produce land-intensive goods inexpensively. Industrially-advanced nations can produce goods that require large amounts of capital at a low cost. As countries evolve, their economies will also evolve and change. Countries that once may have focused on labor-intensive goods may move towards more capital-intensive goods as their firms acquire more capital and experience.
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4. Comparative Advantage
Assumptions
Two nations
Same size labor force
Constant costs in each country
Different costs between countries
Comparative Advantage
Country produces good with lowest domestic opportunity cost
Total output is greatest
Comparative advantage is used to explain this relationship between specialization and international trade. A nation does not have to have an absolute advantage in producing a good to benefit by trading. Absolute advantage exists when one nation is the most efficient producer of a good, meaning it can produce the good at the lowest possible price. Under comparative advantage, the country can produce the good at a lower opportunity cost, which measures what must be given up to produce it. In our initial analysis, we will look at two nations with similarities. We will use the U.S. and Mexico and assume that the U.S. has an absolute advantage over Mexico in producing two goods, beef and vegetables.
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5. Comparative Advantage
Case for free trade
Increase total output
Efficient allocation of resources
Promote competition
While we were using a very simple example of two products and two countries, the analysis would be the same for any number of products and countries. In the real world we are also faced with a concave production possibilities curve instead of the linear one from our analysis. This means there are increasing opportunity costs in the real world and, at some point, the underlying basis for further specialization and trade disappears so both countries end up producing some of both products. This is why we do end up with domestically-produced products competing with similar imported products. However the numbers come out, everyone ends up benefitting somehow from trade. In addition to promoting efficiency and competition among firms, nations benefit as they build relationships with their trading partners that can help to prevent disagreements that might lead to wars.
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6. Trade Barriers and Export Subsidies
Tariffs
Revenue tariff
Protective tariff
Import quota
Nontariff barrier (NTB)
Voluntary export restriction (VER)
Export subsidy
Even though a nation gains from trade as a whole, some domestic industries may be hurt by trade and some industries may need to be maintained even if they are not cost effective for reasons such as national security or defense. Countries use several different techniques to protect industries from the harmful effects of trade. Tariffs are one of the most common barriers to trade. A tariff is an excise tax on the dollar value, or quantity of an imported good. Revenue tariffs are applied to a good that is typically not produced in the domestic country and are designed to raise revenue for the domestic government. They tend to be fairly low. Protective tariffs are another matter. They are applied to goods that do have a domestic competitor and are designed to make the imported goods cost at least as much as, or more than, the domestic good so they can be quite high. Import quotas are another common barrier countries use. A quota is a limit on the number of a particular good that could imported in a given amount of time. By limiting the supply, you drive the price up thereby making the imported good more expensive than its domestic competitor. A nontariff barrier can include such things as requiring extensive documentation for imported goods, restricting the location available to receive the imported goods or having unreasonable standards for imported goods. A voluntary export restriction is when foreign firms “voluntarily” agree to limit the amount of their exports to a particular country. The catch is that even though it was voluntary, it was done under the threat of mandatory barriers so it really was not done through free will. Export subsidies consist of government payments to a domestic producer of export goods and is designed to help that producer by reducing their production costs. This should enable them to compete more effectively against the imported goods.
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7. The Case for Protection
Military self-sufficiency
Diversification for stability
Infant industry
Alleged exception to free trade
Protection against dumping
Increased domestic employment
Smoot-Hawley Tariff Act
Cheap foreign labor
There are many different arguments used to support the use of trade barriers. Military self-sufficiency preys on people’s fear of another war and being unable to defend themselves so they argue that the industry related to the military must be protected and maintained domestically. Diversification for stability looks at the need to have a well-rounded economy that is not too heavily invested in any one area that could be subject to collapse. (That is the proverbially eggs in one basket argument.) New or infant industries argue they need protection during the infancy stage to help them grow and become strong enough to compete on their own. This may be needed especially in a developing nation who is just moving into the world economy but care must be taken not to prolong the support and other options besides tariffs or quotas may work better to help the industry develop. Dumping is also considered a big problem that needs addressing. Dumping occurs when a foreign firm deliberately sells goods below their cost in an attempt to drive the domestic industry out of business. Once the domestic industry is gone, the foreign firm would then be free to raise prices to whatever level they desired. This may even be done with the support of the foreign government. Dumping is considered an “unfair trade practice” and sanctions can be imposed against the countries or firms involved. The final arguments deal with labor issues. Saving American jobs is a standard campaign slogan for political candidates. While imports do eliminate some U.S. jobs, they also create new jobs in industries that will be exporting to the foreign country that now has disposable income to spend due to selling their exports. It also creates jobs for individuals involved with importing the good into the country. History has shown that trade barriers often have the reverse effects and can reduce domestic employment especially if foreign countries retaliate. It is argued that the cheap foreign labor will drive the wage rates in the U.S. down reducing our standard of living. Again, the saying is a rising tide lifts all boats. Everyone benefits from trade
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8. Equal, nondiscriminatory trade between member nations
GATT
Three principles
Equal, nondiscriminatory trade between member nations
Reduction in tariffs
Elimination of import quotas
First signed in 1947 by 23 nations, including the U.S., GATT’s aim was to provide a forum for multilateral negotiations to reduce trade barriers. Since the enactment of GATT, tariffs on thousands of products have been eliminated or reduced with overall tariffs decreasing by 33%. Each round of negotiations added more countries to the agreement and further increased international trade.
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9. Established by Uruguay Round of GATT 161 member nations in 2015
WTO
Established by Uruguay Round of GATT
161 member nations in 2015
Oversees trade agreements and rules on disputes
Critics argue may allow nations to circumvent environmental and worker protection laws
The WTO is the largest organization devoted to promoting international trade. The current round of negotiations began in 2001 in Doha, Qatar and are aimed at further reducing tariffs and quotas as well as agricultural subsidies that can distort trade. Critics are concerned that the WTO may supersede the authority of a member nation to protect their own environment and workers by allowing firms to move to countries with less restrictive laws. Proponents respond that these concerns are outside the scope of WTO authority and should be dealt with in other forums. They also feel that as developing nations gain from trade, they will be better equipped to help protect their workers and environment.
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10. Initiated in 1958 as Common Market
European Union
Initiated in 1958 as Common Market
Abolished tariffs and import quotas between member nations
Established common tariff with nations outside the EU
Created Euro Zone with one currency
Increased output, faster economic growth
Currently at 27 member nations, the EU is one of the most dramatic examples of a free-trade zone. In addition to eliminating almost all tariffs and quotas between the member nations, it has also liberalized the movement of capital and labor with the union and created common policies on matters of joint concern, such as agriculture, transportation and business practices. The introduction of the euro currency in the early 2000s which was adopted by 16 of the member nations has enabled those nations to improve their standard of living by making it easier to price and sell their products in those nations.
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11. Agreement between U.S., Canada, Mexico
NAFTA
Agreement between U.S., Canada, Mexico
Establishes free trade zone between the countries
Trade has increased in all countries
Enhanced standard of living
So far, time has proven the critics of NAFTA wrong. Since NAFTA was enacted in 1993, over 20 million jobs have been created in the U.S., trade among the three nations has increased and the standard of living in each nation has also increased.
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12. Trade Adjustment and Offshoring
Trade Adjustment Assistance Act
Designed to help individuals hurt by international trade
Increases political support for reducing trade barriers
Offshoring of jobs
Shifting of work previously done by American workers to workers abroad
The Trade Adjustment Assistance Act of 2002 introduced some innovative policies designed to help those workers who had been displaced by international trade. It provided financial assistance beyond unemployment benefits, relocation allowances, and retraining services. Critics argue that helping one small section of workers is not fair to other workers who lose jobs for a variety of reasons.
Offshoring of jobs is another major concern to American workers, but it is not necessarily bad for the economy. Offshoring can increase the demand for complementary jobs in the U.S. and increase the off-shored workers’ income to purchase goods produced in the U.S.
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