Chapter 14 International Trade McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives Explain why global trade has increased so much in recent years. Summarize the main gains to trade. Compare and contrast absolute advantage and comparative advantage. Discuss the winners and losers from trade and analyze the arguments for protectionism. Describe what it means for a currency to appreciate or depreciate. List explanations for why the United States consistently runs a trade deficit. 14-2

Nature of International Trade There has been a boom in international trade over the last decade. Both trade in goods and services has been soaring. Service exports include such items as foreign students studying in the U.S. and foreigners watching U.S.-produced TV shows and movies. 14-3

Global Exports (and Imports) as a Percent of Global GDP 14-4

Top Ten Purchasers of U.S. Exports 14-5

Top Ten Sources of U.S. Imports 14-6

Barriers to Trade Historically, businesses that want to sell to buyers in another country faced both the natural barriers to trade and the legal barriers to trade. The natural barriers include distance, differences in culture and values, and the difficulty of delivering services remotely. The legal barriers include tariffs, quotas, and other regulatory impediments. 14-7

Barriers to Trade Both natural and legal barriers to trade have fallen due to technology and a commitment among countries toward a policy of free trade. Technology has reduced the cost of shipping and made communication over long distances much easier. The ease of communication has reduced problems associated with different languages and cultures. 14-8

Lowering of Legal Barriers Historically, countries have put barriers on trading in the form of tariffs and quotas. Tariffs are the taxes leveled on imports by a country. Quotas are numerical limits on the number of imported products coming into a country. Tariffs and quotas are applied to raise revenues and to protect domestic industries from foreign competition. 14-9

Lowering of Legal Barriers Since the end of World War II, most countries – led by the United States – have made a concerted global effort to reduce tariffs, quotas, and other trade barriers. The reduction of these barriers has led to a significant increase in global trade. Tariffs act as a tax on imported goods, and thus raise their price. 14-10

Lowering of Legal Barriers When the tariff is removed, the price of the import goes down and the quantity demanded for imports rises. Quotas are numerical limits on imports which effectively reduce the quantity supplied of the good. This supply restriction also drives up the price. 14-11

Eliminating a Tariff Increases the Quantity of Imports Price Supply curve for imports Price paid by consumers with a tariff A Tariff C Market price without a tariff Price received by importers with a tariff B Demand curve for imports Level of imports with a tariff Level of imports without a tariff Imports 14-12

Gains from Trade Countries trade with each other because of the gains from trade. The first gain from trade is lower prices. Goods and services that are produced overseas have lower prices than the comparable domestic goods and services. Also, the increased competition from foreign producers forces domestic companies to keep prices low. 14-13

Furniture Prices versus CPI, 1990-2010 14-14

Furniture Imports to the U.S., 1990-2010 14-15

Access to Natural Resources A second gain from trade is access to natural resources that are either unavailable or too expensive to produce domestically. The U.S. imports a long list of resources, with the most important being crude oil. Countries like Japan have few resources, and import virtually all of them. 14-16

Access to Global Markets A third gain from trade is that companies obtain access to global markets. Businesses can benefit because the market for their product is now much larger than any single nation. A global sales strategy is especially beneficial for companies that have development costs such as Boeing. 14-17

Access to New Ideas The final gain from trade is the access to new ideas developed in other countries. This improves growth in the domestic economy, as knowledge is one of the key factors determining long-term growth. In the current economy, many products are either designed overseas or are the result of cross-country collaboration. The development of the flat-panel television is a good example. 14-18

Comparative versus Absolute Advantage A country has an absolute advantage in producing a good if it takes less resources to produce the good in that country than in another. But countries with an absolute advantage in producing a good may not export it. It depends on the comparative advantage. Comparative advantage means that countries specialize in the products or services where they have the biggest productivity advantage – or the smallest productivity disadvantage. 14-19

Labor Costs in Manufacturing, 2009 14-20

Winners and Losers from Trade While the theory of comparative advantage states that international trade will benefit an overall economy, some companies and individuals will be hurt. The benefits from trade are broadly distributed: The entire population benefits from lower prices for goods and services. Countries that are open to trade tend to have a faster rate of economic growth, and living standards go up. 14-21

Winners and Losers from Trade The losers from trade are those industries where imported goods and services displace domestically-produced goods and services and cost the country jobs. This has been most prevalent in the manufacturing side of the economy, where much of the production has moved to Asia. The job losses in manufacturing were, however, more than offset by gains in other sectors, such as healthcare and finance. Globalization benefits people whose skills are relatively scarce in world markets. 14-22

Imports and Jobs 14-23

Arguments for Protection While the evidence shows that international trade is beneficial to an economy, free trade is often attacked by politicians who believe it is harmful to many workers. There are demands by these politicians for a return to protectionism. That is, using tariffs, quotas, or other barriers to trade to protect domestic jobs. 14-24

Arguments for Protection There are a number of arguments made for protectionism: One argument against free trade is that it is disruptive in terms of people’s lives. The cost of change can be both economic and social. A factory moving out of a small town can leave the people without a livelihood. 14-25

Arguments for Protection The infant industry argument is a second argument against free trade. An infant industry is a new or developing industry in a country which is vulnerable to being put out of business by better-funded and more mature foreign competitors. Given a chance to grow while protected, however, the new industry could be a viable global competitor. In theory this argument makes sense, but in practice it rarely works since it reduces competition. 14-26

Arguments for Protection Another argument for protectionism is unfair competition. In this case, a foreign country subsidizes its exporting industries by lowering its taxes, offering them low-cost loans, or simply by giving them money. Given this subsidy, the foreign industry can cut the price of their products in the global market. As a result, the subsidized industries may obtain a bigger share of the global market. 14-27

Arguments for Protection The final, and perhaps most compelling, argument for some form of protection is national security. In the case of war, countries need to protect some of their defense-related production. For example, specialty steel and advanced electronics need to be produced domestically. A country needs to balance the economic benefits of trade against the potential vulnerabilities of a global supply chain in the case of war. 14-28

Exchange Rates Almost every country has a national currency. For trade to take place, one country’s currency must be converted to the other country’s currency. The exchange rate is the rate at which one currency can be turned into another. Exchange rates can be floating or pegged. Floating rates are set in the foreign exchange markets, while pegged rates are managed by the country to remain fixed. 14-29

Exchange Rates When an exchange rate changes so that one currency can buy more of another, we say the first currency is appreciating and the second currency is depreciating. The chart on the next slide shows that the dollar is depreciating against the Chinese Yuan. 14-30

Exchange Rate of the Yuan versus the Dollar 14-31

Effects of Appreciation and Depreciation When a currency depreciates, imports become more expensive, while exports become cheaper. Imports should fall, exports should rise, and the trade deficit should become smaller. When a currency appreciates, imports become cheaper, while exports become more expensive. Imports should rise, exports should fall, and the trade deficit should become larger. 14-32

How Depreciation Works 14-33

Trade Balance The trade balance is the difference between exports of goods and services and imports of goods and services. If the trade balance is negative – that is, if imports exceed exports – we say that the country is running a trade deficit. The U.S. trade deficit has increased significantly in recent years. 14-34

Goods and Services Trade Balance for U.S. 14-35

Explanations for the Trade Deficit There are a number of possible explanations for the trade deficit: First, it is our fault because: U.S. manufacturers are unable to compete. U.S. consumers are overspending, causing the deficit. Overspending by the federal government is the cause. 14-36

Explanations for the Trade Deficit Second, it is their fault because: Foreign countries put up barriers that keep out U.S. exports and subsidize their own exports. Finally, it is no one’s fault because: The strength of the U.S. economy allows us to import more goods. Other countries want to lend to the U.S. 14-37

Paying for Trade The U.S. can pay for what we import in four ways: Sell exports to foreigners. Borrow money from foreign investors. Sell assets such as stocks, bonds, and real estate to foreign investors. Allow foreign companies to build factories in the U.S. 14-38