The United States and the Global Economy COI1 The United States and the Global Economy Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

International Linkages United States Economy Other National Economies Goods & Services Capital & Labor Information & Technology Several economic flows link the U.S. economy and the economies of other nations. The first of these are the flows of goods and services, or simply the trade flows. The United States exports goods and services to other nations and imports goods and services from other nations. Capital and labor flows represent the movement of resources between nations. For example, a Japanese car manufacturer may choose to establish a production facility in the United States while a U.S. parts manufacturer may choose to establish a plant abroad. Information and technology flows represent the transfer of information between countries, such as investment opportunities, and the use of technologies created in the U.S. and abroad. Financial flows represents the movement of money to pay for imports, buy foreign assets, provide foreign aid and other money-related transactions. Money LO1

World Trade Volume as a percentage of GDP Larger for small countries Larger for countries with restricted resources Dependence on world market Lack key resource Sell surplus goods Over the past several decades, the monetary value of U.S. exports and imports has grown substantially. In 2007, U.S. exports and imports were 12 and 17 percent of GDP, respectively. As a percentage of total world trade, however, the U.S. now accounts for a diminishing percentage, although in absolute volumes, the U.S. is still the world’s leading trading nation. LO2

World Trade Trade deficit Trade surplus Imports exceed exports Borrow from foreigners Sell real assets to foreigners Trade surplus Exports exceed imports Lend to foreigners The U.S. is almost entirely dependent on other countries for bananas, cocoa, coffee, spices, tea, raw silk, nickel, tin, natural rubber, and diamonds. Imported goods compete with U.S. goods in many domestic markets. Japanese cameras and cars, French and Italian wines, and Swiss and Austrian snow skis compete side by side with similar domestically produced goods. LO2

Rapid Trade Growth Transportation technology Communications technology General decline in tariffs All nations participate Factors contributing to rapid trade growth include advances in transportation technology, dramatic improvements in communication technology and declines in barriers (tariffs) to international trade. Tariffs are excise taxes (duties) levied on imported goods. LO2

Exports of Goods and Services Exports of Goods and Services as a Percentage of GDP, 2012 Belgium Netherlands South Korea Germany New Zealand Canada Italy France Spain United Kingdom United States Japan 13% 92% 72% 47% 41% 26% 25% 21% 19% 14% Many countries, with restricted resources and limited domestic markets, cannot efficiently produce the variety of goods their citizens want. So they must import goods from other nations. Although the total volume of trade is huge in the United States, it constitutes a smaller percentage of GDP than it does in a number of other nations. Source: IMF, International Financial Statistics, 2012 LO2

United States Trade U.S. imports and exports have increased in volume and as a percentage of GDP since 1975. LO2

U.S. Imports and Exports Exports Imports Energy Products Agricultural Products Metals Chemicals Consumer Durables Aircraft Computers Pharmaceuticals Semiconductors Generating Equipment $167.1 145.0 128.9 118.8 99.3 94.1 49.2 47.9 42.4 38.3 Petroleum Household Appliances Metals Apparel Computers Automobiles Pharmaceuticals Chemicals Generating Equipment Telecommunications Equipment $424.3 141.3 128.4 126.9 122.2 101.4 87.2 75.6 65.0 52.8 This table shows some of the major commodity exports and imports of the United States. The top U.S. exports include agricultural products, chemicals, metals, and energy products. The top imports include petroleum, household appliances, apparel, and metals. The U.S. imports some of the same categories of goods that it exports. Source: Bureau of Economic Analysis LO2

U.S. Imports and Exports Imports Exceed Exports by $735 Billion Exports to Value Imports from Value Canada European Union Mexico China Japan OPEC countries All other TOTAL $294 270 217 112 72 81 518 $1564 Canada European Union Mexico China Japan OPEC countries All other TOTAL $329 384 283 427 149 182 545 $2299 Canada is the United States’ most important trading partner quantitatively. In 2012, about 19 percent of U.S. exported goods were sold to Canadians, who in turn provided 14 percent of the U.S. imports of goods. Imports Exceed Exports by $735 Billion LO2

Exports of Goods China, Germany, and the United States are the world’s largest exporters. LO2

Specialization Shift resources to export industry Achieve higher overall output and income Absolute advantage Higher output per worker for a good Comparative advantage Lower domestic opportunity cost for a good Specialization and international trade increase the productivity of a nation’s resources and allow for greater total output than would otherwise be possible. LO3

Comparative Advantage Mexico’s Production Possibilities Table (in Tons) Production Alternatives Avocados 0 20 24 40 60 Soybeans 15 10 9 5 0 U.S.’s Production Possibilities Table (in Tons) Both tables reflect constant costs. Each country must give up a constant amount of one product to secure a certain increment of the other product. Production Alternatives Product A B C D E Avocados 0 30 33 60 90 Soybeans 30 20 19 10 0 LO3

Comparative Advantage These tables summarize the advantages to each country from trade under the theory of comparative advantage. LO3

Comparative Advantage Mexico will produce avocados U.S. will produce soybeans U.S. gives up 3 A for 1 S Mexico gains 4 A for 1 S Terms of trade 3.5 A for 1 S Both countries benefit Both countries end up with more of everything when they trade. LO3

Comparative Advantage Gains from trade Mexico starts at C (24 A and 9S) Move to E (60 A and 0 S) Trade 35 A for 10 S U.S. starts at T (33 A and 19 S) Move to R (0 A and 30 S) Trade 10 S for 35 A Overall gains? Another example of the gains resulting from trade. LO3

Exchange Rates One U.S. dollar will buy 54.54 Indian rupees May 2013 54.54 Indian rupees 1.54 British pounds 1.01 Canadian dollars 12.01 Mexican pesos 0.95 Swiss francs 1.30 European euro The amount of foreign currency that a dollar will buy varies greatly from nation to nation and fluctuates in response to supply and demand changes in the foreign exchange market. The amounts shown here are for May 2013. 100.94 Japanese yen 1,087 South Korean won 6.58 Swedish kronors LO4 Source: International Monetary Fund

The Foreign Exchange Market Dollar – Yen Market P Sy Exchange Rate: $.01=¥1 .01 Dollar price of 1 yen U.S. imports from Japan create a demand for yen, while U.S. exports to Japan create a supply of yen. The dollar price of 1 yen – the exchange rate- is determined at the intersection of the supply and demand curves. In this example the equilibrium price is $.01 meaning that 1 cent will buy 1 yen. Dy Qe Q Quantity of yen LO4

Changing Exchange Rates Shifts in demand for currency Shifts in supply of currency Rise in dollar price of yen Dollar depreciates Currency appreciation The determinants for the supply and demand of a currency are similar to the determinants of demand and supply for almost any product. LO4

Trade Barriers Protective tariffs Import quotas Nontariff barriers Export subsidies In spite of the benefits derived from trade governments still try to restrict the free flow of goods and services between nations. These are the common methods used. Tariffs are one of the most common barriers to trade. A tariff is an excise tax on the dollar value, or quantity of an imported good. Revenue tariffs are applied to a good that is typically not produced in the domestic country, and they are designed to raise revenue for the domestic government. Revenue tariffs tend to be fairly low. Protective tariffs are another matter. They are applied to goods that do have a domestic competitor and are designed to make the imported goods cost at least as much as, or more than, the domestic good, so these tariffs can be quite high. Import quotas are another common barrier countries use. A quota is a limit on the amount of a particular good that could imported in a given amount of time. By limiting the supply, you drive the price up, thereby making the imported good more expensive than its domestic competitor. A nontariff barrier can include such things as requiring extensive documentation for imported goods, restricting the location available to receive the imported goods, or having unreasonable standards for imported goods. A voluntary export restriction is when foreign firms “voluntarily” agree to limit the amount of their exports to a particular country. The catch is that even though it was voluntary, it was done under the threat of mandatory barriers so it really was not done through free will. Export subsidies consist of government payments to a domestic producer of export goods and are designed to help that producer by reducing its production costs. This should enable the producer to compete more effectively against the imported goods. LO5

Reasons for Trade Barriers Misunderstanding gains from trade Political considerations Costs to society The reasons for the restrictions are varied but some of the more common reasons are here. Some are legitimate (such as national security), others not so much. There are many different arguments used to support the use of trade barriers. Military self-sufficiency preys on people’s fear of another war and being unable to defend themselves, so they argue that the industry related to the military must be protected and maintained domestically. Diversification for stability looks at the need to have a well-rounded economy that is not too heavily invested in any one area that could be subject to collapse. (That is the proverbial “all of our eggs in one basket” argument.) New or infant industries argue that they need protection during the infancy stage to help them grow and become strong enough to compete on their own. This may be needed especially in a developing nation that is just moving into the world economy, but care must be taken not to prolong the support. Other options besides tariffs or quotas may work better to help the industry develop. Dumping is also considered a big problem that needs addressing. Dumping occurs when a foreign firm deliberately sells goods below their cost in an attempt to drive the domestic industry out of business. Once the domestic industry is gone, the foreign firm is then free to raise prices to whatever level they desire. This may even be done with the support of the foreign government. Dumping is considered an “unfair trade practice,” and sanctions can be imposed against the countries or firms involved. The final arguments deal with labor issues. Saving American jobs is a standard campaign slogan for political candidates. While imports do eliminate some U.S. jobs, they also create new jobs in industries that will be exporting to the foreign country that now has disposable income to spend due to selling their exports. It also creates jobs for individuals involved with importing the good into the country. History has shown that trade barriers often have the reverse effects and can reduce domestic employment especially if foreign countries retaliate. It is argued that the cheap foreign labor will drive the wage rates in the U.S. down, reducing our standard of living. Again, the saying is “a rising tide lifts all boats.” Everyone benefits from trade. LO5

Multilateral Trade Agreements Trade Wars Long history of U.S. tariffs Smoot-Hawley Tariff Act of 1930 Reciprocal Trade Agreements Act of 1934 Reduce tariffs Negotiating Authority Most-Favored-Nation Clause The Smoot-Hawley Act is a classic example of a law used to create barriers to trade. To prevent trade wars, Congress later passed the Reciprocal Trade Agreement Act to begin building relationships with other countries. LO6

Multilateral Trade Agreements General Agreement on Tariffs and Trade (GATT) Equal trade treatment Reduction in tariffs Elimination of import quotas Uruguay Round 1995 GATT is the most widely adopted of all trade agreements. First signed in 1947 by 23 nations, including the U.S., GATT’s aim was to provide a forum for multilateral negotiations to reduce trade barriers. Since the enactment of GATT, tariffs on thousands of products have been eliminated or reduced with overall tariffs decreasing by 33%. Each round of negotiations added more countries to the agreement and further increased international trade. LO6

Multilateral Trade Agreements World Trade Organization (WTO) Successor to GATT 151 nations belong Doha Round (Doha, Qatar) Trade negotiation Latest round 2001 Some 153 nations belong to the WTO as of 2010. The WTO is the largest organization devoted to promoting international trade. The current round of negotiations began in 2001 in Doha, Qatar and are aimed at further reducing tariffs and quotas as well as agricultural subsidies that can distort trade. Critics are concerned that the WTO may supersede the authority of a member nation to protect its own environment and workers by allowing firms to move to countries with less restrictive laws. Proponents respond that these concerns are outside the scope of WTO authority and should be dealt with in other forums. They also feel that as developing nations gain from trade, they will be better equipped to help protect their workers and environment. LO6

Free Trade Zones European Union (EU) Established 1958 The euro zone North American Free Trade Agreement (NAFTA) Established 1993 Canada, Mexico, and U.S. These are other trade agreements to which countries are members. Currently at 27 member nations, the EU is one of the most dramatic examples of a free-trade zone. In addition to eliminating almost all tariffs and quotas between the member nations, it has also liberalized the movement of capital and labor with the union and created common policies on matters of joint concern, such as agriculture, transportation, and business practices. The introduction of the Euro currency in the early 2000s, which was adopted by 17 of the member nations, has enabled those nations to improve their standard of living by making it easier to price and sell their products in the euro zone nations. So far, time has proven the critics of NAFTA wrong. Since NAFTA was enacted in 1993, over 20 million jobs have been created in the U.S., trade among the three nations has increased, and the standard of living in each nation has also increased. LO6

Trade-Related Issues Trade adjustment assistance Offshoring of jobs Outsourcing Benefits and costs Fair-trade products The purpose Increased international trade and offshoring of jobs have harmed some specific U.S. workers and have led to policies such as trade adjustment assistance to help them with their transitions to new lines of work. Fair-trade products are designed to help redistribute more of the total gains from international trade directly to the low-income producers and workers by increasing the demand for these products relative to otherwise identical imports. The Trade Adjustment Assistance Act of 2002 introduced some innovative policies designed to help those workers who had been displaced by international trade. The Act provided financial assistance beyond unemployment benefits, relocation allowances, and retraining services. Critics argue that helping one small section of workers is not fair to other workers who lose jobs for a variety of reasons. Offshoring of jobs is another major concern to American workers, but it is not necessarily bad for the economy. Offshoring can increase the demand for complementary jobs in the U.S. and increase the off-shored workers’ income to purchase goods produced in the U.S. LO7