1 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE In this chapter, look for the answers to these questions: Who benefits and who loses from trade? Do efficiency gains outweigh the losses? What are the common arguments for restricting trade? Do they have merit? What are the effects? Resolving trade disputes. Who is the absolute authority among nations? Trade in the real world involves cost levels and exchange rates. Adjustments can be difficult!
2 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Describing the Trade Model with Prices. Countries gain from trade if each exports the goods in which it has a comparative advantage. We describe trade in terms of world and domestic prices: P W = the world price of a good P D = domestic price without trade If P D < P W, a country exports the good. If P D > P W, a country imports the good. We assume all nations are price takers in the world market.
3 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE A Country That Exports Soybeans Without trade, P D = $4 Q = 500 P W = $6 Under free trade, domestic consumers demand 300 domestic producers supply 750 exports = 450 P Q D S $6 $4 500 300 Soybeans exports 750
4 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE A Country That Exports Soybeans: economic welfare analysis. Without trade, CS = A + B PS = C Total surplus = A + B + C With trade, CS = A PS = B + C + D Total surplus = A + B + C + D P Q D S $6 $4 Soybeans exports A B D C gains from trade
5 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE A C T I V E L E A R N I N G 1 : Analysis of Importing TV’s. Without trade, P D = $3000, Q = 400 In world markets, P W = $1500 Under free trade, how many TVs will the country import or export? Identify CS, PS, and total surplus without trade, and with trade. 5 P Q D S $1500 200 $3000 400 600 Plasma TVs
6 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE A C T I V E L E A R N I N G 1 : The welfare gains from free trade. 6 Without trade, CS = A PS = B + C Total surplus = A + B + C With trade, CS = A + B + D PS = C Total surplus = A + B + C + D P Q D S $1500 $3000 Plasma TVs A B D C gains from trade imports
7 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE total surplus producer surplus consumer surplus direction of trade rises falls rises imports P D > P W rises falls exports P D < P W Summary: The Welfare Effects of Trade Whether a good is imported or exported, trade creates winners and losers. But the gains exceed the losses.
8 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Other Benefits of International Trade Consumers enjoy increased variety of goods and lower prices. Producers sell to a larger market and may achieve lower costs through economies of scale. Competition from abroad may reduce market power of some firms at home, which would increase total welfare. Trade enhances the flow of ideas, facilitates the spread of technology around the world. Wealth created abroad fosters better ‘trading partners’.
9 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Then Why All the Opposition to Trade? The winners from trade could compensate the losers and still be better off. Yet, such compensation rarely occurs. Trade losses are often highly concentrated among a small group of people (firms and workers who lose out to imports), who feel them acutely. The gains are often spread thinly over many people, who may not see how trade benefits them. Hence, the losers have more incentive to organize and lobby for restrictions on trade.
11 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE U.S. Largest Trade Deficits (2004) China$175 bill. Europe 118 Japan 79 Canada 72 Mexico 47 South Korea 22 Venezuela 22 Malaysia 18 Saudi Arabia 17 Nigeria 16
12 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Tariff: An Example of a Trade Restriction Tariff: a tax on imports Example: Cotton shirts P W = $20 Tariff: T = $10/shirt Consumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt. In general, the price facing domestic buyers & sellers equals (P W + T ).
13 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE $30 Analysis of a Tariff on Cotton Shirts P W = $20 free trade: buyers demand 80 sellers supply 25 imports = 55 T = $10/shirt price rises to $30 buyers demand 70 sellers supply 40 imports = 30 P Q D S $20 25 Cotton shirts 40 70 80 imports
14 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE $30 Analysis of a Tariff on Cotton Shirts free trade CS = A + B + C + D + E + F PS = G Total surplus = A + B + C + D + E + F + G tariff CS = A + B PS = C + G Revenue = E Total surplus = A + B + C + E + G P Q D S $20 25 Cotton shirts 40 A B D E G F C 70 80 deadweight loss = D + F
15 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE $30 Deadweight Loss of a Tariff on Cotton Shirts D = deadweight loss from the domestic overproduction of shirts (inefficient firms). F = deadweight loss from the domestic under- consumption of shirts (lost consumption P Q D S $20 25 Cotton shirts 40 A B D E G F C 70 80 deadweight loss = D + F
16 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Import Quotas: Another Way to Restrict Trade An import quota is a quantitative limit on imports of a good. Mostly, it has the same effects as a tariff: raises price, reduces quantity of imports reduces buyers’ welfare increases sellers’ welfare A tariff creates revenue for the govt. A quota creates profits for the foreign producers of the imported goods, who can sell them at higher price.
17 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Support or oppose free trade? Almost all economists support freer trade: shifting resources to sectors with a comparative advantage will increase welfare in long run. Opposition to free trade is very strong among certain sectors who will lose out to imports. Support for free trade is strong among sectors who want to compete abroad, especially knowledge-based sectors which feature innovation, where the U.S. has a competitive advantage. Pres. Clinton used high-tech to support passage of NAFTA in 1992-93.
18 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Arguments for Restricting Trade 1. Lose jobs to imports; hard to retrain workers. 2. National security: we must produce certain goods. 3. Infant-industry argument: we must protect young industries until they become competitive. 4. Our firms face unfair competition: Costs held down by govt subsidies, use of child labor, abuse of environment, lax safety standards, dumping products at below costs, etc. 5. Trading with low wage nations requires that we either lower our wages or devalue the dollar.
U.S. labor markets and trade: U.S. imports and unemployment suggest job loss not serious. decade averages, 1956-2005 0% 2% 4% 6% 8% 10% 12% 14% 16% 1956 -65 1966 -75 1976 -85 1986 -95 1996 -2005 imports (% of GDP) unemployment (% of labor force)
20 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Should we endorse trade with anyone, without reference to circumstances? Text suggests yes! Our consumers benefits from lower costs due to other nations’ subsidies, etc. But, should the U.S. argue that it is inhumane to sanctions some labor market practices, or ignore environment abuse in other countries? Will other nations (and the U.S.) argue that it is their own prerogative to decide what is in the best interests of their citizens? Do nations (including the U.S.) really want to enter into agreements that limit decisions in social justice, human rights, income inequality?
21 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Trade Agreements A country can liberalize trade with unilateral reductions in trade restrictions multilateral agreements with other nations Examples of trade agreements: North American Free Trade Agreement (NAFTA), 1993 General Agreement on Tariffs and Trade (GATT), ongoing World Trade Organization (WTO) est. 1995, “enforces” trade agreements, resolves disputes. WTO’s ultimate authority is limited!
22 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Trade Agreements in Practice All nations use tariffs, quotas, import licenses and restrictions, etc. to protect domestic firms. The U.S. protects agriculture, etc. Most agreements are bilateral in nature. The U.S. has a complex set of such agreements.Negotiated agreements reflect economic considerations but also political relations and other issues between nations. Ultimately, nations exercise their right to bargain and influence/control trade.
23 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE A recent trade dispute President Bush, in response to pressures from steel producing states, imposed tariffs of 8-30% in 2002, arguing others were dumping steel. Europe and Japan immediately retaliated with tariffs on U.S. of 15-26%; filed suit with WTO. Nov., 2003, WTO ruled U.S. action illegal, authorizing retaliation. U.S. ignored WTO. Nations threatened massive retaliation of $2.3 billion tariffs across broad range of U.S. products. Dec. 5, 2003, President removes tariffs, saying dumping had eased.
24 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Trading with Low Wage Countries: cut wages or lower the value of dollar? a) Reducing U.S. wages harms workers. b) Alternatively, our exchange rate can be devalued, which lowers our prices (in another nation’s currency) to potential world buyers. **But, our consumers and citizens who invest abroad want a higher dollar, since it means they can buy more goods or investments abroad with each dollar spent. A lower dollar increases U.S. exports, helping our firms, but hurts consumers.
25 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE Trading with China The U.S. has a $200 billion trade deficit with China. At current prices they sell us more than we buy. (Our collective trade deficit with the world is about $800 bill.) Exchange rate now: $1 = 8 yuan (value of $) yuan = 12.5 cents/dollar (value of yuan). Suppose a shirt made in China sells for 160 yuan, or $20 to a U.S. buyer. If the yuan were increased to16 yuan/$1, or 6.25 yuan/$1, this shirt would cost us 160/6.25 = $25.60. We would then buy less from China (which hurts U.S. consumers), but sell more to China. The U.S. government is urging China to increase the yuan.
26 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE China’s View China greatly values the job and wage growth from massive export surpluses. It is moving about 20 million people yearly from rural areas to the cities to produce for the world. Its government controls yuan rate, requiring businesses to turn over dollars to banks/government and accept yuan. China buys U.S. securities with its accumulated dollars (rather than U.S. goods). U.S. concerns: U.S. deficit allows China to “buy” massive amounts of U.S. assets. What if China suddenly decide to dump U.S. securities? Our interest rates would have to increase to entice other nations to hold our debt.
27 CHAPTER 9 APPLICATION: INTERNATIONAL TRADE CHAPTER SUMMARY Exports raises producer surplus, reduces consumer surplus, and raises total surplus. Conversely, imports lowers producer surplus, but raises consumer and total surplus. A tariff benefits producers and generates revenue for the government, but losses to consumers exceed these gains and total surplus is reduced. Trade in the real world requires resources to be reallocated across sectors and costly adjustments in wages and exchange rates.