International Trade

1. International Trade Cheng Ming 程铭 School of Economics, Shanghai University chengming@shu.edu.cn

2. Introduction • Importance of foreign trade -- one of the backbones of the growth of the economy -- ties or linkages with the world -- important political means • Overview of Chinese foreign trade

3. Important Terms • International Trade vs. Foreign Trade • tangible goods trade vs. Intangible goods trade -- SITC (Standard International Trade Classification) -- HS (Harmonized System) • A.跨境交付 (cross border supply) • B.境外消费 (consumption abroad) • C.商业存在 (commercial presence) • D.自然人流动 (presence of natural person)

4. Important Terms • International trade value vs. international trade quatumn • international trade quatumn • = International trade value / import and export price index • international trade value= Sum of export value of the world (FOB) • China’s foreign trade value= Export(FOB)+ Import (CIF)

5. Important Terms • general trade vs. special trade • composition of foreign trade • direction of international trade • international trade by region

6. Important Terms a. Net (commodity) terms of trade N = Px/Pm χ 100 b. Income terms of trade I = Px/Pm χ Qx c. Single factor terms of trade Ｓ＝Ｐx/Ｐm χ Ｚx d. Double factor terms of trade D = Px/Pm χ Zx/Zm χ 100 • terms of trade ----The ratio of export price index/import price index --- Improvement and worsening of the terms of trade --- do not mix up with the concept of trade terms ---- Classification of terms of trade

7. China’s Foreign Trade Volume（$US billion）

10. Trade Specialization Coefficient ($US1, %)

11. Degree of Dependence on Foreign Trade

12. Chapter One Absolute Advantages • Free trade theory • Put forward by Adam Smith • When the protectionism was popular at that time -- Mercantilism

13. Mercantilism • It is the first international trade theory, emerged in the mid-16th century in England. • Main representative is Thomas Men, his principle is reflected in his book England’s Wealth from International Trade– regarded as the Bible of Mercantilism.

14. Mercantilism • the assertion was that gold & silver were the mainstays of national wealth & essential to vigorous commerce • under the gold standard system, gold & silver were the currency of trade between countries • the main tenet of Mercantilism was to maintain trade surplus • implication of Mercantilism – no virtue in a large volume of trade per se, rather to maximize exports by subsidies, and minimize imports by tariffs and non-tariff barriers.

15. Mercantilism An inherent inconsistency in the Mercantilism • pointed out by the classical economist David Hume –Specie –flow mechanism • Mercantilism as a bankrupt theory that has no place in the modern world? -- is Mercantism passe?

16. Absolute Advantage • Adam Smith (1723-1790) attacked the Mercantilism assumption that trade is a zero-sum game (therefore is the game of beggar thy neighbor), instead , trade is a positive-sum game. • In his 1776 landmark book An Inquiry into the Nature and the Causes of the Wealth of the Nations (briefly, the Wealth of Nations),absolute advantage theory was put forward

17. Absolute Advantage • Before Specialization

18. Absolute Advantage • After Specialization

19. Chapter TwoComparative Advantage--- The Ricardian Model • The Concept of Comparative Advantage Two basic reasons for International Trade • Countries can benefit from doing things they do well • Reaching economies of scale in production

20. David Ricardo, in his 1817 book “The Political Economy and Taxation” put forward the theory of Comparative Advantage • A company has a comparative advantage in producing a good if the opportunity cost in terms of other goods is lower. • Each country can benefit from the exporting the goods in which it has a comparative advantage.

21. 2. A One-factor Economy • In Ricardian model, international trade is SOLELY due to the differences in the productivity of labor • An Economy – Home Two Goods – Wine & Cheese One Factor – Unit labor requirement • We define: aLW – unit labor requirement in wine aLc – unit labor requirement in cheese L – total labor supply

22. Production Possibility Qw Slop: opportunity cost of cheese in terms of wine L/a LW aLC/aLW Qc L/a LC Production Possibility Frontier

23. Relative Prices and Supply • PPF illustrates the mixture of goods the economy can produce • The actual production mix is based on the relative prices (no profits in One-factor model) • If Pc/Pw > aLC/aLW, specialize in the production in cheese • If Pc/Pw = aLC/aLW, both goods will be produced • The economy will produce cheese if the relative price exceeds it opportunity cost

24. 3. Trade in a One-factor World We assume: Home country is less productive than Foreign in Wine, but more productive in Cheese Therefore: aLC/aLW < a*LC/a*LW Or, equivalently, that aLC/a*LC < aLW/ a*LW Therefore, Home country has comparative advantage in Cheese

25. Determining the Relative Pricafter Trade Relative price of Cheese a*LC/a*Lw Rs 1 aLC/aLw R 2 RD L/aLc Relative Quantity of Cheese Q L/a*LW

26. Point 1, the intersection of demand curve R and RS curve, where the relative price of cheese is between the two countries’ pretrade prices. Each country will specialize in the production of the good in which it has a comparative advantage. • Point 2, the world relative price after trade is the same as the opportunity cost of cheese in terms of wine in Home, Home economy need not specialize, while Foreign does specialize in producing wine.

27. The Gains from Trade • The First Way -- to think of trade as an indirect method of production, i.e. Home can produce wine directly and trade with Foreign for cheese (produce indirectly) -- for an hour of labor, direct production 1/aLW wine, or 1/aLC cheese and be trade with wine -- if (1/aLC)(PC/PW) > 1/aLW, or PC/PW > aLC/aLW trade will be beneficial

28. The second way – how trade will affect the possibilities for consumption. Trade Expands Consumption Possibilities Quantity of wine, Qw Quantity of wine, Qw T F P F P T Quantity of cheese, Qc Quantity of cheese, Qc (a) Home (b) Foreign

29. Relative Wages • Political discussion of international trade often focus on comparisons of wage rates in different countries. Unit Labor Requirements Cheese Wine Home aLC = 1hr per pound aLW = 2hr per gallon Foreign a*LC = 6 hr a*LW = 3hr

30. Since, aLC/aLW < a*LC/a*LW • So, Home will produce Cheese, Foreign produce Wine • Suppose a unit of cheese and wine both sell for $12, Home worker will earn $12 per hour, while Foreign worker will earn $4 • As long as the relative price of cheese to wine is 1, the wage of Home workers will be 3 times that of Foreign workers. • Home still has a comparative advantage in producing cheese since this wage rate lies between the ratios of the two countries productivities in the two countries.

31. 4. Misconceptions aboutComparative Advantage • Productivity and Competitiveness Myth 1: Free trade is beneficial only if your country is strong enough to stand up to foreign competition. • The Pauper Labor Argument Myth 2: Foreign competition is unfair and hurts other countries when it is based on low wages. • Exploitation Myth 3: Trade exploits a country and makes it worse off if its workers receive much lower wages than workers in othernations.

32. 5.Comparative Advantage with many goods • With many goods, we label aLi and a*Li as labor requirement for Home and Foreign, and rearranged as: aL1/a*L1< aL2/a*L2 < aL3/a*L3 < …< aLN/a*LN • Let w and w* be the wage rate per hour in Home and Foreign, respectively • We know that it would produce cheaper in Home if waLi < w*a*Li, and it can be rearranged to yield a*Li/aLi > w/w*

33. Home and Foreign Unit Labor Requirements Relative Home Good Home Unit Labor Foreign Unit Labor Productivity Requirements(aLi) Requirements(a*Li) Advantage(a*Li/aLi) Apples 1 10 10 Bananas 5 40 8 Caviar 3 12 4 Dates 6 12 2 Enchiladas 12 9 0.75

34. 6. Adding Transport Cost and Nontraded Goods There are three reasons why specialization in the real international economy is not the extreme: • The existence of more than one factor • Countries sometimes protect industries from foreign competitions • It is costly to transport goods and services. i.e. because of the transport cost, there exists nontraded goods

35. Chapter Three Specific Factors and Income Distribution

36. 1.The Specific Factors Model • Although international trade is beneficial to both of the countries, it is, however, has strong effects on the distribution of income. While trade may benefit a nation as a whole, it often hurts significant groups within the country, at least in the short run. • We use the specific factors model to explain.

37. Assumption of the Model: -- an economy produce two goods: manufactures and food. -- three factors: labor(L), capital(K), and land(T) -- labor is the Mobil factor, while K and T are specificfactors for manufactures and food, respectively -- so, QM = Q M(K,LM) QF = QF(T,LF) LM + LF = L

38. Production Possibilities The Production Function for Manufactures Output, QM The more labor input, the larger the output. Because of the diminishing returns, the successive input will have less output. Reflected by a flatter Curve. QM=QM(K,LM) Labor Input,LM

39. The Marginal Product of Labor Marginal product of labor, MPLM The marginal productof labor equal to theslop of the productionfunction. MPLM Labor Input,LM

40. The Production Possibility Frontier in the Specific Factors Model Output of food, QF, (increasing ) Economy’s Production Possibility Frontier(PPF) QF=QF(T,LF) 1’ QF L QM LF PP Labor input In food, LF (increasing ) Output of Manufactures, QM (increasing ) 1 LM L Labor input In manufacturers, LM (increasing ) OM=QM(K,LM)

41. In the Specific Factors Model, the PPF is an convex line (reflecting diminishing returns to labor), while in the Ricardian Model, it is a straight line (reflecting constant returns) • The slop of the production possibility curve = - MPLF/MPLM • The slop represents the opportunity cost for manufactures in terms of food.

42. Price, Wages, and Labor Allocation • Each sector will hire labor to the point until to the point where the value produced by an additional person-hour equals to the cost of employing that hour. In manufacturing sector, for instance: • MPLM хPM = W, because of the diminishing returns, MPLM is a downward curve, giving the constant price of the manufactures. • We can also consider the above equation as the demand curve.

43. Since • MPLMхPM = MPLFхPF = w, therefore, • - MPLF/MPLM = - PM/PF • The result tells us that at the production point the production possibility frontier must be tangent to a line whose slop is minus the price of manufactures divided by that of food. QF Slop = -(PM/PF) QM

44. An equal proportional increase in the pricesof manufactures and food Wage Rate, w 2 PFхMPLF 1 PFхMPLF PM Increase 10% PF Increase 10% w2 10% Wage increase 2 2 PMхMPLM w1 1 1 PMхMPLM Labor used in Manufactures, LM Labor used In food,LF

45. If both goods’ prices increase by 10%, the labor demand curves will both shift up by 10%. The allocation of labor between the sectors and the outputs of the two goods do not change. • So it generates a general principle: changes in the overall price level have no real effects, that is, do not change any physical quantities in the economy. Only changes in relative prices -- affect welfare or the allocation of resources.

46. A change in relative prices Wage Rate,w 1 PFхMPLF 7% upward Shift in labor demand 2 W1 w2 2 Wage rate Rises by Less than 7% PMхMPLM 1 1 PMхMPLM Labor used in Manufactures, LM Labor used In food, LF Amount of labor shifted from food to manufactures

47. Two important facts about the results of the shift of the labor in the above diagram • First, although the wage rate rises, it rises by less than the increase in the price of manufactures. • Second, when only PM rises, in contrast to the case of a simultaneous rise in PM and PF, labor shifts from the food sector to the manufacturing sector and the output of manufactures rises while that of food falls. (This is why w dose not rise as much as PM: because manufacturing employment rises, the marginal product of labor in that sector falls.

48. Relative prices and the distribution of Income • Let’s discuss the the results of the shifts of labor for the incomes of three groups: • 1) Workers – their wage rate has risen, but less than in the proportion to the rise in PM. Thus, their real wage in terms of manufactures (w/PM) falls, while (w/PF) rises. • So, the warfare of workers are uncertain, depending upon their preferences of consumption.

49. 2) Owners of capital, are definitely better off. The real wage rate in terms of manufactures has fallen, so that the profits of capital owners in terms of what whey produce rises. • 3) Owners of land are definitely worse off. The lose for two reason: --- the real wage in terms of food rises, squeezing their income, and --- the rise in manufactures prices reduces the purchasing power of any given income.

50. 2. International Trade in the Specific Factors Model • We know that an increase in the supply of manufactures (or land) would increase manufactures (food) output and reduce the food (manufactures) output. • Now we suppose that American has a larger supply of land than Japan; while Japan has a larger supply of capital than American.