International Trade “Made in China”
What You Should Learn • The principal foreign trade agreements • Comparative advantage and trade decisions: Which nations become exporters or importers? • Who wins and who loses from international trade. • That the gains from winners from international trade exceed the losses to losers. • The welfare effects of tariffs and import quotas. • The arguments people use to advocate trade restrictions.
Some Background Information: Trade Agreements and the WTO • Unilateral: when a country removes its trade restrictions on its own. • Multilateral: a country reduces its trade restrictions while other countries do the same. • NAFTA • The North American Free Trade Agreement (NAFTA) is an example of a multilateral trade agreement. • In 1993, NAFTA lowered the trade barriers among the United States, Mexico, and Canada.
Trade Agreements and the WTO • GATT • The General Agreement on Tariffs and Trade (GATT) refers to a continuing series of negotiations among many of the world’s countries with a goal of promoting free trade. • GATT has successfully reduced the average tariff among member countries from about 40 percent after WWII to about 5 percent today. • GATT became the WTO in 1993.
Consider the market for tires: • Manufactured in many countries • Universal demand • Manufacturing/labor costs vary widely • The following graph shows what a domestic market would look like in the absence of any trade or market restrictions:
The Equilibrium without International Trade Price of tires Domestic supply Consumer surplus E Equilibrium price Producer surplus Domestic demand Equilibrium quantity 0 Quantity of tires
The World Price and Comparative Advantage • If this country decides to engage in international trade, will it be an importer or exporter of tires? That depends on the difference between the domestic price and the world price. • The effects of free trade can be shown by comparing the domestic price of a good without trade and the world priceof the good. • The world pricerefers to the price that prevails in the world market for that good.
The World Price and Comparative Advantage • If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporterof the good. • If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importerof the good.
Some Assumptions:1.This nation has a comparative advantage in tire production.2. This country will be a Price Taker, which means that it must take the market (world) price.3. The world price for tires is higher than the domestic price.
World price Price after trade Price before trade Exports Domestic quantity Demanded Domestic quantity Supplied International Trade in an Exporting Country Exporting Country Price of Tires Domestic supply Domestic demand 0 Quantity of Tires
A World price Price after trade D B Price before trade C Exports Changes in Consumer and Producer Surplus Price of Tires Exporting Country Domestic supply Domestic demand 0 Quantity of Tires
World price Price after trade Price before trade Imports Domestic quantity Demanded Domestic quantity Supplied Meanwhile, trade looks like this in the importing nation: Price of Tires Importing Country Domestic supply Domestic demand 0 Quantity of Tires
World price Price after trade A Price before trade B D C Imports Gains and losses for the importing nation Price of Tires Importing Country Domestic supply Domestic demand 0 Quantity of Tires
Tariffs vs. Quotas A tariff is a tax placed on goods produced abroad and sold domestically. Tariffs raise the price of the imported good closer to the domestically produced good. Import quotas are trade agreements or licenses that limit the quantity of the good that can legally be imported. Both tariffs and quotas raise domestic price and produce deadweight loss.
Equilibrium without trade A B Price with tariff E Tariff F C D Imports without tariffs World price Price without tariff G Imports with tariffs QS2 QD1 QS1 QD2 Effects of a Tariff Price of Tires Domestic supply Domestic demand 0 Quantity of Tires
Equilibrium without trade Domestic supply + Import supply Quota A Equilibrium with quota B Isolandian price with quota F C D Imports without quotas Price without quota = World price World price G Imports with quota QS2 QD1 QS1 QD2 Effects of an Import Quota Domestic supply Price of Tires E E’ Domestic demand 0 Quantity of Tires
Arguments to Protect U.S. Industries • The jobs argument • The national-security argument • The infant-industry argument • The unfair-competition argument • The protection-as-a-bargaining chip argument • Which argument did President Obama recently use to justify a tariff?
NAFTA and U.S. Jobs 1993-2002: 800,000 U.S. jobs added to the economy, 1.6 million jobs lost. 1993-2007: U.S. workforce increased from 110 million to 137 million people. Manufacturing jobs left, service jobs arose. The unemployment rate dropped. Impact greatest on unskilled and semi-skilled labor and manufacturing Elasticity of labor has increased, making wage negotiations difficult for U.S. workers. (threats of outsourcing)
Globalization on Balance • Has globalization been good for the poor? • C.K. Prahalad’s view • Gini coefficient trends: Increasing inequality • Interpreting & responding to the changes • 1. More global income means more global growth • 2. Should income be redistributed? • 3. What is happening with income mobility?