The Principle of Comparative Advantage Comparative advantage and differences in opportunity costs are the basis for specialized production and trade. Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. 16

The Principle of Comparative Advantage Every country has different Factor Endowments Natural Resources Capital Goods Human Capital – labor skills Technology This is the basis of trade 16

Interdependence Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. 25

Philosophically speaking… It is our differences that make trade beneficial and therefore it is our differences that make us interdependent on one another. If we were all the same there would be no benefit in our working together. It is our differences that should encourage us to get along. 25

Philosophical Applications? Countries that trade together are less likely to fight with one another. If you care about someone’s welfare, trade with them. You will both be better off for it. 25

Murphy’s Law of Economics “Economists have the least influence on policy where they know the most and are most agreed. They have the most influence on policy where they know the least and disagree most vehemently.” Alan Blinder (Princeton Professor, former member of Council of Economic Advisors, and Fed Board of Governors)

Free Trade vs. Protectionism Free Trade (Consumers) Goods and services can be exported and imported by anyone in any country with no restrictions. Free flow of goods between countries vs. Protectionism (Producers) Philosophy that it is in the best interest of a country to restrict free trade. Restrictions to protect domestic producers

Free Trade Arguments Benefits Consumers: Trade, Specialization, and Efficiency Permits the markets in which goods and services are bought & sold to expand, leading to more specialization. Specialization leads to efficiency, and this allows more goods and services to be produced. Increased Availability of Goods Leads to larger quantities of goods. Ex: Boeing and Airbus

Free Trade Arguments Trade & Competition Increases competition leads to lower prices.

Protectionism Arguments Benefits Producers: 1. Protect Jobs/Labor Protection of Domestic Employment & Output Restrictions make it near impossible for foreign goods to compete in domestic markets, thereby increasing employment and output in the domestic markets. Protecting Domestic Jobs – protect domestic jobs from cheap foreign labor – most often used argument

Protectionism Arguments 2. Cheap Foreign Labor Argues that it is impossible to compete with cheap labor Comparative Advantage says this is not true Trade lowers wages and living standards There will be losers Adjustment assistance (temporary aid) Pg 81:

Protectionism Arguments 3. Creates Employment True for those industries that are protected Cost of jobs created False for the macro economy With protection we gain jobs with less compensation and lose jobs with more compensation Growth in US Imports = Growth in Jobs From 1980 – 2005 there was a 477% growth in US imports and a 47% growth in US jobs (50 million jobs)

Protectionism Arguments 4. Infant Industries New or emerging industries should be protected from foreign competition Valid for Less Developed Countries How do you get rid of it? Only for those industries you have a comparative advantage in In Industrialized Countries they often claim to be a “temporarily sick industry”

Protectionism Arguments National Defense Without trade barriers a country could become too specialized and therefore dependent upon other countries (not an economic argument) “Strategic production independence” Diversification in anticipation of interruptions of foreign supplies resulting from military or economic aggression - Prevents dependencies on foreign goods from forming

“What protection teaches us to do to ourselves in times of peace is what enemies do to us in times of war.” Henry George (over 100 years ago)

Trade Restrictions If trade barriers are bad, then why do we do it? Politics Lack of understanding Feelings about lost jobs Public Choice Theory

Public Choice Theory Direct Benefits vs. Indirect Costs Fewer producers who get larger gains individually = direct benefits Costs are spread out over many consumers = indirect costs Protectionist measures usually come through Congress - their jobs depend on it Presidents are usually more free trade oriented

Trade Restrictions How do we restrict trade? What policies can be put in place to restrict trade?

Trade Restrictions Tariffs – taxes placed on imports to increase their price in the domestic market Winners – producers and government Losers – consumers Producers typically have more political power than consumers

Trade Restrictions Tariff - Tax on an import

Trade Restrictions Quotas – limits placed on the quantities of a product that can be imported Import quotas produce no federal revenues Are directed against particular sellers

Trade Restrictions Example: Sugar Quotas Click on photo to show Colbert Report video on Sugar online

Trade Restrictions Embargo - Ban on trade in a particular commodity or with a particular country The sure-fire way to restrict trade is simply to eliminate it North Korea and Cuba

Trade Restrictions Non-Tariff Barriers (NTB) - government regulations that hinder trade Mexican avocados can only be sold in 19 North Eastern states during winter months NAFTA is full of NTBs Russians restrict US chicken as not healthy to consumers (“dirty chicken”) NTBs are difficult to undo once they are in place

Trade Restrictions Voluntary Export Restrictions (VER) A country may choose to voluntarily reduce the amount of a product they export to certain countries Japan and the auto industry in 1980s under Reagan (Bush’s idea)-politically expedient Japanese government could then allocate the right to export to the US Not really voluntary - it was that or else After 5 years these restrictions went away VERs are easier to undo than NTBs

Real World of International Trade Real World Policies Trade Subsidies Government payment to domestic producer of an exported good Dumping Selling a product in a foreign market below cost or below its price in its own domestic market

International Trade Policy International Trade Agreements (1947) General Agreement on Tariffs and Trade (GATT) – 23 nations No quotas on manufactured goods Dispute settlement mechanism Sponsorship of multilateral protection reduction negotiations (Doha rounds are round #9) Since 1947 Expanded to 147 nations Lower tariffs (US = 20-25% tariffs reduced to under 4%) Higher Non-Tariff Barriers

International Trade Policy General Agreement on Tariffs and Trade (GATT) Failures Exclusion of agricultural products and services Does not cover NTBs

International Trade Policy GATT Uruguay Round (8th) (1993-1994) The 1994 GATT pact created the World Trade Organization (WTO) to enforce free-trade rules Tariffs on services now covered

International Trade Policy WTO Doha Round (9th) (2001 - 2014??) Official start in Doha, Quatar(2001) Discussion suspended after disagreements over agricultural subsidies and tariffs

Approaches to Achieving Free Trade Multilateral Agreements World Trade Organization (WTO) Organization founded in 1995 to take over responsibilities of GATT Regional Trade Blocks North American Free Trade Agreement (NAFTA) European Union (EU) Single market formed by majority of Western European nations Bilateral Agreements between 2 countries

Approaches to Achieving Free Trade Sometimes trade blocks put up barriers with the rest of the world May lead to competing trade blocks with trade barriers US focus on NAFTA and bilateral agreements US has stopped playing a central role in WTO

Government Barriers to Trade Include tariffs, domestic subsidies, quotas, etc. Do not create or destroy domestic jobs; they just shuffle them around. Create inefficiencies in the protected industries, forcing domestic consumers to pay higher prices.

International Trade: Imports and Exports Trade restrictions that reduce imports will also reduce the ability of foreigners to buy our exports. Quotas and tariffs decrease the number of dollars earned by foreigners through the sale of imports to us. Therefore, reductions in imports simultaneously reduce exports.

The Evidence Indicates The countries with the highest levels of economic freedom have the highest per capita GDP and growth rates. The institutions and policies outlined in Part II of CSE produce results. Free economies spur savings and investment resulting in economic growth and prosperity. Differing institutions and policies explain why growth rates vary across countries and time.