Chapter 32: International Trade

Chapter Objectives Specialization and trade Domestic exchange equations Absolute advantage and comparative advantage Tariffs or quotas

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Chapter 32International Trade32-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesSpecialization and tradeDomestic exchange equationsAbsolute advantage and comparative advantageTariffs or quotas32-2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesThe causes of our trade imbalanceWhat can we do to restore our balance of trade?Our trade deficits with Japan and ChinaU.S. Trade policy: A historical view32-3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.U.S. Trade before 1975We ran trade surpluses before 1975 and have run trade deficits sinceWe faced increasing trade competition in the 1960sWe have been running large and growing trade surpluses on services and growing trade deficits on goods32-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.U.S. Tariffs, 1820-2000 32-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A Century of High Protective TariffsInitially the tariff was purely a revenue-raising deviceAfter the War of 1812 the tariff took on a protective tingeDuring the great depression, virtually every industrial power raised its tariffs to keep out foreign goodsThis caused world trade to dwindle to a fraction of what it had been and probably made the depression a lot worse32-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.International TradeRecent years have seen a growing consensus in the United States that we need more import protectionEconomic reasoning, however, argues strongly for free trade 32-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Specialization and TradeSpecialization is the basis for international tradeCountry A specializes in making the products that it can make most cheaply; Country B does the sameWhen they trade, each country will be better off than they would if they didn’t specialize and trade 32-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Production Possibilities Curves32-9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The U.S. has to give up 20 copiers to get 10 VCRs2 copiers = 1 VCRTo get 10 copiers South Korea has to give up 20 VCRs1 copier = 2 VCRsDomestic Exchange Equations32-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.U.S. 2 copiers = 1 VCR S.K. 1 copier = 2 VCRsInstinct tells us that it that it would be best for each country to produce what it does best and to trade with the other Domestic Exchange Equations32-11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.U.S. 2 copiers = 1 VCRS.K. 1 copier = 2 VCRsObviously the U.S. would be unwilling to trade more than two copiers for one VCR. However, if S.K. offered more than 1 VCR for 2 copiers this would be a better dealIf the U.S. used its resources to produce 2 copiers and trade them for more than 1 VCR it would be better off than it would have been using the same resources to produce just 1 VCR Obviously, S.K. would be unwilling to trade 2 VCRs for anything less than 1 copier. If S.K. could trade 2 VCRs and get more than one copier in exchange it would be better off making VCRs and trading some of them for copiers Two General ObservationsNo nation will engage in trade with another nation unless it will gain by that tradeThe terms of the trade will fall somewhere between the domestic exchange equations of the two trading nations32-12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Trade Possibilities Curves32-13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Point C = 40 copiers and 20 VCRs Assume Point A = 80 copiers At Point K = 50 copiers and 30 VCRs We produced 80 copiers and traded 30 of the them for VCRs Ended up with 50 copiers and 30 VCRsPoint H = 40 VCRs and 20 copiers Instead South Korea produces 80 VCRs and sells 30 VCRs for 30 copiers Ended up with 50 VCR and 30 copiersAbsolute AdvantageAbsolute advantage is the ability of a country to produce a good or service at a lower cost than its trading partnersIn the previous example, the bottom line is that Americans can buy South Korean VCRs at half the price that American producers would chargeThus the south Koreans have an absolute advantage in making VCRsThey are better at making VCRs than we are 32-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Comparative AdvantageU.S. 2 copiers = 1 VCRS.K. 1 copier = 2 VCRsIn the U.S. the opportunity cost of producing 1 VCR is 2 copiersIn S.K. the opportunity cost of 1 VCR is ½ of one copierThe opportunity cost of producing VCRs is lower in S.KLikewise, the opportunity cost of producing copiers is lower in the U.S.32-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Comparative AdvantageIn the U.S. the opportunity cost of producing 1 VCR is 2 copiersIn S.K. the opportunity cost of 1 VCR is ½ of one copierThe opportunity cost of producing VCRs is lower in S.KLikewise, the opportunity cost of producing copiers is lower in the U.S.The law of comparative advantage states that total output is greatest when each product is made by the country that has the lowest opportunity cost32-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Absolute Advantage versus Comparative AdvantageYou can’t compare absolute advantage and comparative advantage any more than you can compare apples and orangesAbsolute advantage is a comparison of the cost of production in two different countriesComparative advantage states that total output is greatest when each product is made by the country that has the lowest opportunity cost 32-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Absolute Advantage versus Comparative AdvantageAs long as the relative opportunity costs of producing goods differ among nations, there are potential gains from trade even if one country has an absolute advantage in producing everythingTherefore absolute advantage is not necessary for trade to take place but comparative advantage is 32-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Arguments for ProtectionAs America continues to hemorrhage manufacturing jobs, there is a growing outcry for protections against the flood of importsBut Americans, as consumers, are virtually addicted to these importsHow do we justify excluding so many things that Americans want to buy?There are four main arguments for protectionEach seems plausible and strikes a responsive chord in the minds of the American publicCloser scrutiny will reveal that all four arguments are essentially pleas by special interest groups for protection against more efficient competitors 32-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Main Arguments for ProtectionThe National Security ArgumentThe Infant Industry ArgumentThe Low-Wage ArgumentThe Employment Argument32-20Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The National Security ArgumentOur dependence on foreign suppliers could make us vulnerable in time of warIt is possible that we need to maintain certain defense-related industriesWhat if we depended on foreign suppliers for critical components of entire weapons systems?The continued spread of nuclear arms technology may soon make the national security argument much more relevant 32-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Infant Industry Argument American products are no longer produced by infant industries being swamped by foreign giantsAbout the best that can be said is that some of our infant industries never matured while others have evolved into senilityTextiles, steel, clothing, and automobiles may be in the senile categoryIt is sometime argued that technological change may cause a grown-up industry to need temporary protection from foreign competition32-22Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. The Low-Wage ArgumentHow can American workers compete with foreigners who are paid sweatshop wages in labor intensive industries?There is no reason for American firms to compete with foreign firms in these industriesWe should import labor intensive goods and produce goods and services in which we can excel and competeWe should use the proceeds to buy the goods and services produced by people who are forced to work for very low wages 32-23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. The Employment ArgumentHasn’t the flood of imports thrown millions of Americans out out work?But if we restrict imports, the governments of our foreign competitors will restrict our exportsBy curbing imports, we will be depriving other nations of the earnings they need to buy our exportsIf we restrict our imports, our exports will go down tooWe would just lose the jobs connected with these lost exportsWhich would be best? Lose the jobs of workers who work for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but can’t export their products because of restrictions we ourselves caused?32-24Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Tariffs or QuotasA tariff is a tax on importsThe government gets the resulting revenueA tariff affects all foreign sellers equally. Efficient foreign producers will be able to pay a uniform tariff. Less efficient producers will notA quota is a limit on the import of certain goodsImport quotas produce no federal revenuesImports quotas are directed against particular sellers on an arbitrary basisArbitrary quotas may allow relatively inefficient producers in and keep out more efficient producers32-25Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Tariffs or QuotasA tariff, like any other excise tax, causes a decrease in supplyBoth tariffs and quotas raise the price that consumers in the importing countries must payTariffs are better than quotasBut free trade is best32-26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Export SubsidiesSeveral countries subsidize their export industriesThis makes their products cheaperMany Americans complain that this gives foreign competitors an “unfair advantage”Subsidies are a relatively minor expedient in the United States32-27Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.ConclusionEconomics is all about the efficient allocation of scarce resourcesThere is no reason why this efficient allocation of resources should not be applied beyond national boundariesInternational trade helps every countryTo the degree that we can remove the tariffs, import quotas, and other impediments to free trade we will all be better offThe economics profession nearly unanimously backs free trade32-28Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Our Balance of TradeOur balance of trade compares the dollar value of the merchandise and services we buy from foreigners with the dollar value of the merchandise and services they buy from usOur balance of trade is our country’s record of all transactions between its residents and the residents of all foreign nations32-29Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceWe have been losing market share both at home and abroadThe biggest culprits are our oil bill and our deficits with Japan and China32-30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceThe Rise of the DollarA rising dollar makes our exports more expensive and our imports cheaperOur Low Saving RateAmericans have become notoriously poor savers averaging less than 5% of their disposable income since the mid-1980sIf you don’t save, you can’t invest and thus growAmerican business firms have been left with one choice, borrow from foreignersForeigners have come here only because of our high interest rates32-31Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceThe High Cost of CapitalMainly because of our low savings rate and partly because of the huge federal budget deficits, high interest rates have discouraged investment in plant and equipment as well as in technological innovationHigh Defense SpendingThe defense expenditures of the United States have dwarfed those of every other industrial powerIn a time of diminishing military tension, should we be diverting our dollars to defense from areas where they could be used more productively? 32-32Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceOur Failing Educational SystemThe American educational system, once second to none, is now second to practically everyoneAbout one-third of all college freshman need remedial work in reading, writing, and arithmeticThis is why we used to go to K through 12Almost every college has special classes for students unprepared to do college workOne million new functional illiterates every year are not exactly job candidates for today’s high tech economy 32-33Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceThe Role of MultinationalsSince the 1960s multinational corporations began to move their manufacturing operations abroad to take advantage of lower wages available in low wage countriesCapital has long been much more mobile than labor, and that capital has been flowing very rapidly to low wage nationsOur import business is dominated by our own multinational corporations that have shifted their production overseas and put their name on the goods that are produced in other nations32-34Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Are the Causes of Our Trade ImbalanceSince 1995 we have had one of the highest rates of economic growth of any industrial nationCountries with high economic growth rates import more goods and services than they would if they had low growth ratesAt the same time demand for U.S. exports has been lagging due to low growth rates in other industrial nations32-35Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Can We Do?Devalue the dollar—which would make our exports cheaper while imports would become more expensiveWe need to put a lid on consumptionWe need to save moreWe need to bring back the tax-free IRAWe need to decrease defense spendingWe need to really educate our workforceWe need protectionist legislation if our foreign competitors are, in fact, dumping goods below cost on our shores32-36Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.U.S. Trade Deficit With Japan and China32-37Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Japanese Trading PracticesJapanese dumping (selling many of their products below cost) is driving out American competitorsThe fundamental difference between ourselves and the Japanese is qualityBetter quality also means lower pricesWe sell Japan agricultural products and buy manufactured products from themThis is a colonial relationshipThe Japanese picks winners and then makes sure they win 32-38Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Japanese Trading PracticesThe Japanese consumer has long accepted a lower standard of living because it was necessary for the greater economic goodThey are willing to pay more for goods they produce when they could have them cheaper if they imported the same goodCan you imagine Americans being willing to make that kind of sacrificeAmericans would not stand for restricting Japanese imports because they are addicted to Japanese goods32-39Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Our Trade Deficit With ChinaWe began trading with China in the mid-1970sAlthough exports to China have grown rapidly, our exports are only about one-quarter of our importsWe import so much from China because U.S. retailers are seeking the cheapest goods available and are finding them in ChinaThe Chinese are making unauthorized copies of American movies, CDs, and computer software32-40Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Trading with China and JapanThere are more differences than similaritiesOur trading position with Japan is much like a colony and a colonial powerWe send airplanes, computers, movies, compact disk, cars, cigarettes, power-generating equipment, and computer software to China in exchange for toys, clothing, shoes, and low-end consumer electronics 32-41Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Trading with China and JapanJapan has never been open to foreign direct investmentChina has been open to foreign direct investment since the mid-1980sJapanese gains in production have led directly to the loss of millions of well-paying American jobsChinese exports so far have generally not translated into job losses in the United States32-42Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Trading with China and JapanThe Chinese and the Japanese both insist on licensing agreements and large-scale transfer of technology as the price for agreeing to importsThese agreements, of course, lead to eventual elimination of imports from the United States32-43Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-44Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Murray Weidenbaum“We are consuming more than we are producing, borrowing more than we are saving, and spending more than we are earning” -A Final WordReducing Our Overall Trade DeficitWe need to maintain our high rate of productivity growth and keep improving the quality of American goods and servicesWe need to lower our dependence on oil imports by raising the tax on gasolineWe need, somehow, to reduce our trade deficit with JapanWe need to do something about our rapidly rising trade deficit with China32-45Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.