Chapter 19: International Trade Policy, Comparative Advantage, and Outsourcing

Trade Allows specialization and division of labor Gives us choices and we do not need to produce everything ourselves Generally, most economists oppose trade restrictions

U.S. Trade The majority of U.S. exports and imports involve large amounts of manufactured goods U.S. exports to Canada and Mexico make up the largest portion of U.S exports (based on individual countries) Looking at regions, U.S. exports to the EU and Pacific Rim make up the largest portion of exports

The Changing Nature of Trade In recent years the U.S. has increased the amount of goods it has imported from China, India, and other Asian countries About 16% of imports come from China

The Changing Nature of Trade What the U.S. is importing has also changed Today the U.S. is importing more high-tech goods than before It can also be said that service jobs, such as customer service call centers are jobs that have shifted abroad

Outsourcing This concept is not a “new” form of trade Manufacturers have done this for years to save money Countries like China and India are willing to accept jobs for lower wages which makes outsourcing attractive to firms

Balance of Trade This is the difference between the value of exports and imports The U.S. has a trade deficit—importing more than it is exporting This has been the case since the 1970s The U.S. is financing its trade deficit by selling off assets

Comparative Advantage Countries trade simply because it makes them better off Comparative advantage: as long as the opportunity costs of producing goods differ among countries they can gain from trade

Gains from Trade The more competition, the less the trader gets Smaller countries gain more than larger countries Countries with economies of scale gain more from trade

Comparative Advantage Today Generally, people have concerns about what is really gained from trade if they see that jobs are being lost Again, we are talking about opportunity cost and what a nation can do best when compared to another nation

Comparative Advantage Today U.S. firms have an advantage in facilitating trade Goods manufactured elsewhere create jobs in the U.S. for advertising, management, and distribution

Sources of U.S. Comparative Advantage Skills of the U.S. labor force: we have a highly productive labor force U.S. government institutions are stable and non-corrupt Physical and technological infrastructure: roads, telecommunications networks, etc. English is the international language of business

Sources of U.S. Comparative Advantage 5. Wealth from past production 6. Presence of natural resources 7. Cachet: U.S. goods/culture is in demand 8. Inertia: it takes time and costs money to relocate production

Sources of U.S. Comparative Advantage 9. Patents/intellectual property rights are held in large numbers 10. Immigration policy allows entrepreneurs and educated people to settle here

Inherent Comparative Advantage This is comparative advantage based on things that are generally not changeable Such as climate or resources

Transferable Comparative Advantage This is comparative advantage based on things that can change relatively easily Such as capital, technology, or education

Review: Absolute and Comparative Advantage Absolute Advantage: the producer that can produce the most output Comparative Advantage: The producer with the lowest opportunity cost

Review: Absolute and Comparative Advantage Countries should specialize in the good that is “cheaper” for them to produce (lower opportunity cost) and trade it for goods that they have a higher opportunity cost to produce

Determining Comparative Advantage: The Output Method Output Questions: OOO=Output: Other goes Over

Determining Comparative Advantage: The Output Method Chicken Beef U.S. 4 2 Canada 6 The chart indicates the amount of chicken and beef that can be produced by workers in one hour. 1. Which country has an absolute advantage in producing chicken? Why? Neither—both can produce 4 units with the given amount of resources

Determining Comparative Advantage: The Output Method 2. Which country has an absolute advantage in producing beef? Why? Canada because with the given resources it can produce more (6 units compared to 2 units for the U.S.)

Determining Comparative Advantage: The Output Method Chicken Beef U.S. 4 (2/4) 1C=1/2B 2 (4/2) 1B=2C Canada 4 (6/4) 1C=3/2B 6 (4/6) 1B=2/3C 3. Which country has a comparative advantage in producing chicken? The U.S. has the comparative advantage because it can produce chicken at a lower opportunity cost (it gives up 1/2 unit of beef to produce 1 unit of chicken compared to Canada which gives up 1.5 units of beef to produce 1 unit of chicken)

Determining Comparative Advantage: The Output Method Chicken Beef U.S. 4 (2/4) 1C=1/2B 2 (4/2) 1B=2C Canada 4 (6/4) 1C=3/2B 6 (4/6) 1B=2/3C 4. Which country has a comparative advantage in producing beef? Canada has the comparative advantage because it can produce beef at a lower opportunity cost because it gives up 2/3 a unit of chicken to produce 1 unit of beef compared to the U.S. who gives up 2 units of chicken to produce 1 unit of beef)

Determining Comparative Advantage: The Output Method 5. Should the U.S. specialize in chicken or beef? The U.S. should specialize in chicken because it can produce this good at a lower opportunity cost. 6. Should Canada specialize in chicken or beef? Canada should specialize in beef because it can produce this good at a lower opportunity cost.

Determining Comparative Advantage: The Input Method Input Questions IOU= Input: Other goes Under

Determining Comparative Advantage: The Input Method Bread Corn U.S. 4 2 France 6 1. Which country has an absolute advantage in producing bread? Neither since both countries since with the given resources they can both produce 4 units. 2. Which country has an absolute advantage in producing corn? France—they can produce the most units (6 units to 2 units)

Determining Comparative Advantage: The Input Method Bread Corn U.S. 4 2 France 6 Bread Corn U.S. 4 (4/2) 1B=2C 2 (2/4) 1C=1/2B France 4 (4/6) 1B=2/3C 6 (6/4) 1C=3/2B 3. Which country has a comparative advantage in producing bread? France has the lower opportunity cost (has to give up 2/3 unit of corn to produce 1 unit of bread; U.S. has to give up 2 units of corn to produce 1 unit of bread )

Determining Comparative Advantage: The Input Method Bread Corn U.S. 4 (4/2) 1B=2C 2 (2/4) 1C=1/2B France 4 (4/6) 1B=2/3C 6 (6/4) 1C=3/2B 4. Which country has a comparative advantage in producing corn? The U.S. has a comparative advantage in producing corn because they can do so with a lower opportunity cost (gives up ½ unit of bread to produce 1 unit of corn compared to 2/3 unit of bread for 1 unit of corn for France)

Terms of Trade Pineapples Radios Kenya 30 (1P=1/3 R) 10 (1R=3P) India 40 (1P=1R) 40 (1R=1P) Pineapples Radios Kenya 30 10 India 40 Figure out who has a comparative advantage in each good. Kenya has a comparative advantage in pineapples (they want to import radios) India has a comparative advantage in radios (they want to import pineapples)

Terms of Trade What terms of trade benefit both countries? Pineapples Radios Kenya 30 (1P=1/3 R) 10 (1R=3P) India 40 (1P=1R) 40 (1R=1P) What terms of trade benefit both countries? Kenya wants radios If the terms of trade for 1 radio is greater than 3 pineapples then Kenya is worse off and should make radios on their own. India wants pineapples If the terms of trade for 1 radio is less than 1 pineapple then India is worse off and should make pineapples on their own.

Terms of Trade Trading 1 radio for 2 pineapples will benefit both If Kenya produces radios by itself, it would give up 3 pineapples for each radio. If they can trade 2 pineapples for each radio they are better off. If India produces pineapples by itself, it would give up 1 pineapple for one radio. If they can get 2 pineapples for one radio they are better off. Therefore, the countries trade at a lower opportunity cost than if they made the products themselves.

The Law of One Price This states that in competitive markets there is a pressure for equal factors to be priced equally The convergence hypothesis is the tendency of economic forces to get rid of transferable comparative advantage Production will shift to the country with the lowest wage and eventually this country will “catch up”

Equalizing Trade Balances Adjustments occur due to wages and the fluctuation of exchange rates In the coming years we can expect the wage gap between China and the U.S. to decrease

Tariffs Tariffs: taxes placed on imported goods This is the most used and most familiar type of trade restriction They average about 3% today but historically have been as high as 60% Tariffs shift the supply curve up (left) by the amount of the tax and raise equilibrium price

GATT/WTO GATT was created in 1947 as a conference to reduce trade barriers In 1995, GATT was replaced by the WTO which works to promote free and fair trade among countries

Quotas Quotas: quantity limits placed on imported goods Like a tariff, quotas increase price and reduce quantity

Voluntary Restraint Agreements To avoid new tariffs on goods, countries will voluntarily restrict their exports This is similar to a quota Countries limit the quantity of exports which increases the price of the good and helps domestic producers of the good

Embargos Embargo: a total restriction on the import or export of a good Usually enacted for political rather than economic reasons

Regulatory Trade Restrictions These are indirect methods to restrict international trade They are government-imposed procedural rules that limit imports For example, a country could restrict the import of crops that are grown where a known pesticide is used

Nationalistic Appeals—Buy Domestic Requirements Think of “Buy American” campaigns Or MADE IN THE USA goods

Reasons for Trade Restrictions Gains from trade are not equally distributed as not everyone gains The EU restricts the import of food from nonmember nations This causes higher prices for consumers and benefits farmers In other cases those who bargain the hardest gain the most from trade

Haggling over Trade Restrictions Trade restrictions or the threat of them play a major role in limiting trade The threat of a tariff may be enough to bring about concessions from another country This is known as strategic trade policies

Specialized Production Learning by doing: refers to becoming better at a task the more you do it Economies of scale: per unit cost of output decreases at output increases

Why Economists Oppose Trade Restrictions Free trade increases total output Trade restrictions reduce international competition Trade restrictions are addictive—the more you have the more you want

Free Trade Associations WTO 150 member nations EU Removed all trade barriers in 1992 NAFTA 1993; formed by U.S., Canada, and Mexico