The International Economy: Why We Trade

1. Last Chapter! The International Economy: Why We Trade “President Bush left for Canada today to attend a trade summit. Reportedly, the trade summit got off to an awkward start when the president pulled out his baseball cards.” Conan O’Brien

2. Exports, Imports – Why Bother? • “By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?” • Adam Smith • The Wealth of Nations, Book IV, Chapter II The International Economy

3. Exports, Imports – Why Bother? • Comparative advantage is the fundamental force that generates trade between nations. • A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than any other country. • The basis for comparative trade is differentials in opportunity costs between countries (and individuals). • Example – If the US can produce automobiles at a lower opportunity cost than Mexico, and Mexico can produce wheat at a lower opportunity cost than US, then US should produce all the cars, Mexico should produce all the wheat, and they should trade the excess. • This deal gets us more cars and wheat than any other production combination. The International Economy

4. Barriers to International Trade Types of International Trade Restrictions Tariff Tax, or duty, levied on a product when it crosses a nation’s boundaries. • Import Tariff • Most common • Imposed on imported goods • Export Tariff • Imposed on exported goods • Unconstitutional in US • Protective Tariff • Designed to protect domestic producers from import competition • Not total prohibition, just an edge for domestic industries • Revenue Tariff • Imposed specifically to raise tax revenues The International Economy

5. Barriers to International Trade Types of International Trade Restrictions Tariff Tax, or duty, levied on a product when it crosses a nation’s boundaries. Quota Quantitative restriction on imported goods. • Negative welfare effects – Benefits concentrated in select group, generally domestic producers of protected goods. • Pushes up price of imported good AND domestic good • Costs (higher prices, loss of welfare) tend to spread out to all consumers. • Makes barriers politically appealing, but economically unattractive. The International Economy

6. The Argument for Free Trade • Nations (and individuals) can increase the consumption of goods and services when they allocate resources to the production of those goods and services for which they have a comparative advantage. • Incomes Increase • Employment Increases • Competition Increases • Efficiency Increases • Free trade does not have to create a winner and a loser . . . .BOTH partners gain. The International Economy

7. Common Arguments Against Free Trade • Despite the fact that free trade promotes prosperity for all countries, trade is restricted. • Arguments most often heard are: • Important to keep jobs in the US • We don’t want money leaving the country • National security is at stake • Other nations don’t treat their workers fairly • Other nations “dump” cheap goods into the US and don’t open their markets to us The International Economy

8. Common Arguments Against Free Trade • Important to keep jobs in the US • Protecting industries in which we do not have comparative advantage is subsidizing inefficiency. • Free trade destroys some jobs and creates other, often better, jobs. • Free trade also increases foreign incomes and enables foreigners to buy more domestic production. • Protection to save particular jobs is very costly. • Example: The steel industry is protected from free trade by import taxes. Steel workers benefit by keeping their jobs, everyone else pays the cost in terms of higher prices of steel and everything made from steel. • Research shows that the cost to society of the protection is about $750,000 per steel worker per year. • We would be better off paying the steel workers something less than $750k each NOT to work. The International Economy

9. Common Arguments Against Free Trade • We don’t want money leaving the country • We don’t export to keep money in the US, but to fuel domestic production and incomes. • We can then use increased incomes to import more goods. • When other countries have increased incomes, they can afford to buy more US goods. The International Economy • National security is at stake • Some industries do warrant protection under this argument. • Not all industries that claim this protection actually warrant it. • Example: the American watchmakers

10. Common Arguments Against Free Trade • Other nations don’t treat their workers fairly • Difficult to document because everything is relative. • “Sweatshop” jobs may be better than no jobs. • When we limit imports from those nations we may be harming the very people we want to help. The International Economy • Other nations “dump” goods in US • If US producers can prove dumping is taking place, US has laws to prevent it and drive up price of the goods. • Dumping is rare – very little empirical evidence to support the claims made by industries that want protection.

11. International Trade Agreements • North American Free Trade Agreement (NAFTA) • US, Canada, Mexico - 1992 • Controversial because of industrialized economies joining trade union with developing nation. • European Union • Twenty-seven member nations (potential members – Croatia, Macedonia, Turkey). • Monetary union, most nations use euro as common currency (11 EU nations do not, including Denmark, Sweden, and UK). Why Use Common Currency? • Benefits of common currency • Lower transaction costs • Easier wage/price comparisons • Common measure of value. • Costs • Changing ATM’s, vending, posted prices, cash registers • Learning curve for using currencies The International Economy

12. Is Trade “Fair” for Everyone? • EU’s Common Agricultural Policy (CAP) • Subsidies, import tariffs and quotas keep prices artificially high on agricultural products in EU, restrict import of agricultural goods from developing countries. • Subsidies paid to farmers make up nearly half of the EU’s annual expenditures, though only 5% of population are farmers. • Highly criticized in current trade negotiations as being detrimental to development in poor nations that have nothing but agriculture to export. • Famous “butter mountains and wine lakes” • Reported by 2003 Human Development Report: average dairy cow in the year 2000 in EU received $913 in subsidies annually, while an average of $8 per human being was sent in aid to Sub-Saharan Africa. The International Economy