Chapter 33

1. Chapter 33 International Trade

2. Why Nations Trade • Natural Resources • U.S. has a lot of fertile soil • Southwest Asia has large oil and natural gas reserves • Resources, climate, and location determine what goods and services economies produce

3. Why Nations Trade • Human Capital • Literacy rate – percentage of people over 15 who can read and write • Countries with high literacy rates: educated, skilled work force

4. Why Nations Trade • Physical Capital • Factories, machinery, computers, roads and bridges

5. Specialization • When nations decide to produce only certain goods and services, rather than producing all the goods ad services they need • Determined by its natural resources, human and physical capital • U.S. grows wheat and soybeans, but we can’t produce diamonds or coffee

6. Absolute and Comparative Advantage • Absolute Advantage – when a country can produce more of a given product using a given amount of resources • (they are simply better at producing something) • Even if we have an absolute advantage in producing everything, does that mean we shouldn’t trade with another country?

7. Absolute and Comparative Advantage • …not necessarily! We need to look at comparative advantage. • When a country has comparative advantage, they can produce a good at a lower marginal cost than another country (David Ricardo’s idea). • In other words, they give up less in order to produce that good.

8. Finding Comparative Advantage France and Germany’s production possibilities France and Germany’s opportunity costs (what they give up) Who has the comparative advantage in wine? In cheese? France has the absolute advantage in both wine and cheese (they are better at both).

9. Comparative Advantage for Input Problems • If the problem is expressed in terms of how many HOURS it takes a person/country to produce something, then you calculate opportunity cost the opposite way.

10. Gains from Trade • Terms of trade – the exchange rate between two goods (ex: 2 bananas for 30 grapes) • Gains from trade – the additional amount of goods a country has after specialization and trade in comparison with the combination before specialization and trade. (ex: a country may gain 5 bananas relative to the total amount it had when producing only with its own resources)

11. Gains from Trade

12. How do Americans feel about Trade? • Statement A: The United States needs to focus on keeping American jobs for American workers. Each time an American corporation agrees to send work outside the country, the company also gives away jobs. In the end, even if some new business is created for American exporters, free trade is not worth it because local jobs are lost.

13. How do Americans feel about Trade? • Statement B: Today large companies that intend to sell their products to worldwide customers must also operate worldwide. Just as American companies build plants in foreign countries where they sell their products, foreign companies build plants in the United States so they can sell their products here. In the end, free trade is worth it because foreign companies and our exports create jobs here.

14. When asked different questions about international trade… • 57% believed that international trade was good for the U.S. economy. 39% said it was bad. • 67% said they had a very or somewhat favorable opinion of international trade. • 79% agreed that “freer trade helps to increase prosperity, both in the U.S. and in other parts of the world.”

15. Arguments FOR free trade • Improved product selection • Lower prices for consumer products • Promotes good relations between countries

16. Arguments AGAINST free trade • Benefits are not equally distributed • Helps the rich but hurts workers • LOSS OF JOBS • Bad for the environment • Concerns about international labor standards • Trade is unfair to poor countries • Other countries benefit more than the U.S.

17. Trade Barriers and Agreements

18. Barriers to Trade • There are three main types of barriers to trade. They are: (1) Tariffs (2) Export Subsidies (3) Quotas

19. Tariffs • Tariff – a tax on imported goods • What goods do you know of that the U.S. places tariffs on? • The U.S. places tariffs on steel, foreign-made cars, and many other products

20. Export Subsidies • Export Subsidies - government payments to domestic firms to encourage exports (foreign companies not subsidized can’t compete with the artificially low prices) • What is dumping? – when a firm or industry sells products on world market at prices below cost of production to dominate the market • After competition driven out, they raise prices • Recently accused: Japanese automobiles, electronics, silicon computer chips

21. Quotas • Quota – limit on the quantity of imports (mandatory or voluntary) • U.S limits amount of cotton coming into the country each year • Ex: China can only export 621,780 kilograms • Voluntary Export Restraint (VER) - a voluntary limitation on the number of products that a country ships to another country • Japan agreed in 1981 to reduce automobile exports to U.S. by 7.7% to 1.68 million units • Why would a country volunteer to decrease its exports to another country? • Reduce the chances that the importing country will set up trade barriers

22. Less formal trade barriers… • Can you think of some other, less formal ways that countries limit imports? • Sometimes governments will require foreign companies to get a license to sell (high licensing fees or slow processes) • Health and safety regulations (ex: won’t import anything with insecticides used)

23. Arguments for Free Trade: Effects of Trade Barriers (1) Effect on prices • First, trade barriers limit supply. • Who benefits from the quotas put on cotton imports? Why? • American cotton growers because U.S. manufacturers of jeans / cotton clothing will have to buy some cotton grown in the U.S. • What happens to prices when there are trade barriers, such as tariffs on foreign cars? They go up • Who benefits from this? Domestic producers • Who loses? Domestic consumers

24. Arguments for Free Trade: Effects of Trade Barriers (2) Effects on international relations • What is a trade war? • One country restricts imports, so trading partner imposes more restrictions – a cycle of increasing trade barriers • What problems did the trade war that resulted from the Smoot-Hawley tariff cause for the U.S. in the 1930s? • Raised average tariff on all products to 50% (trying to protect American jobs) • other countries responded by raising tariffs against American-made goods • decreased international trade, (esp. demand for our goods) and made worldwide depression much worse

25. Arguments for Free Trade: Effects of Trade Barriers • See graph

26. Arguments for Protectionism • What is protectionism? • the use of trade barriers to protect industries from foreign competition

27. Protectionism Protecting Jobs • When we buy foreign goods, American goods go unsold. Ideally, people would get jobs in other industries, but this is difficult in reality for some people. • The question is: Are we willing to pay premium prices to save domestic jobs in industries that can produce more efficiently abroad?

28. Protectionism • What other ways could we help victims of free trade? • Retrain them for jobs with a future • Programs to relocate people in expanding regions • If East Asia has a comparative advantage in producing textile and the U.S. reduced tariffs on these imports, what might happen? • American textile manufacturers may not be able to compete with East Asian imports – lay off workers. • In an ideal world, what would laid-off textile workers do? • Take new jobs in other industries • In reality, why doesn’t this always happen? • Retraining and relocation is difficult – takes time and money.

29. Some Countries Engage in Unfair Trade Practices • Cheap Foreign Labor Makes Competition Unfair • Protection Safeguards National Security

30. Protection Safeguards National Security • What industries does the United States want to ensure remain active? • anything essential to defending our country – need steel and other products from heavy industries; need industries that provide energy and advanced technologies • Why do most people agree that these types of industries need to be protected? • Don’t want to depend on other nations during a crisis … Protection Discourages Dependency

31. Protecting Infant Industries • What is an infant industry? • A new industry • What is the argument for temporarily protecting them? • new industries need time and practice to become efficient producers • Does it always work out for these industries and for consumers? • (1) A protected infant industry lacks incentive to become more efficient and competitive • (2) it’s difficult to take the protection away

32. International Agreements • An international free trade agreement is when at least two countries cooperate to reduce trade barriers and tariffs and to trade with each other. • MFN – now NTR – what does this mean? • Normal trade relations status • All countries with this status pay the same tariffs • The World Trade Organization (WTO) • Founded in 1995 to negotiate new trade agreements and to resolve trade disputes • Acts as a referee – enforces rules (Beef war between U.S. and European Union)

33. Economic Integration • The European Union • Abolished tariffs and trade restrictions among union members • Adopt uniform tariffs for nonmembers • Developed slowly over time • Single currency: the euro • NAFTA (North American Free Trade Agreement) • Eliminate all tariffs and other trade barriers between Canada, Mexico, and U.S. • A lot of controversy

34. Exchange Rates

35. Exchange rate – the value of a foreign nation’s currency in relation to your own currency • 1 U.S. dollar : 0.762 Euros • 1 U.S. dollar : 1.004 Canadian dollars • 1 U.S. dollar : 98.95 yen • These go up and down daily

36. Why would you want to know an exchange rate? • If you are traveling to a country, you need to know how expensive items are (in terms of your own currency)! • It affects imports/exports • Any other reasons?

37. Strong and Weak Currencies • Appreciation – an increase in the value of a currency • The currency becomes “stronger” • In scenario B, your U.S. dollar could now buy more pesos, so it has increased in value or appreciated against the peso • When the dollar appreciates, American goods are more expensive for Mexican consumers • Mexico will import fewer products from the U.S. • Our exports will probably decline • When the dollar appreciates, it also means that foreign products are less expensive for American consumers • We will import more of these cheaper goods

38. Strong and Weak Currencies • Depreciation – a decrease in the value of a currency • The currency becomes “weaker” • In scenario C, your U.S. dollar could now buy fewer pesos, so it has decreased in value or depreciated against the peso • When the dollar depreciates, foreign consumers can afford our products better because their currency can buy more dollars • Mexico will import more products from the U.S. • Our exports will increase • It also means that foreign products are more expensive for us to buy with our weaker dollars • We will import less of these more expensive goods

39. Foreign exchange market – take care of the buying and selling of foreign currencies • About 2,000 banks and financial institutions • Located around the world, including New York, London, Paris, Singapore, Tokyo, and many other cities