Agriculture and the Basis for International Trade Dr. George Norton Agricultural and Applied Economics Virginia Tech Copyright 2009 AAEC 3204

Objectives Discuss why countries trade Discuss why countries trade Identify impediments to trade Identify impediments to trade

Why do countries trade? Need certain inputs Need certain inputs Obtain gains from trade and specialization based on comparative advantage Obtain gains from trade and specialization based on comparative advantage Temporary shortages Temporary shortages To earn foreign exchange to pay off debts To earn foreign exchange to pay off debts

What is comparative advantage? A country has a comparative advantage over another country in producing good A if it has to give up less of good B to produce good A than would the other country. In other words, its efficiency in producing good A relative to good B is greater than is the case for the other country. A country has a comparative advantage over another country in producing good A if it has to give up less of good B to produce good A than would the other country. In other words, its efficiency in producing good A relative to good B is greater than is the case for the other country.

Graphical Illustration of comparative advantage Country A Country B M A M A Which country has the comparative advantage in A and why? Production possibility curves

Why is the concept of comparative advantage powerful? If each country produces those goods it can produce relatively best and trades for other goods, all countries can be better off than they otherwise would be. If each country produces those goods it can produce relatively best and trades for other goods, all countries can be better off than they otherwise would be.

In Summary: Why Trade? To increase the standard of living by obtaining goods that others can produce at lower opportunity cost in exchange for things we can produce relatively cheaper To increase the standard of living by obtaining goods that others can produce at lower opportunity cost in exchange for things we can produce relatively cheaper By lowering the cost of living, it makes a household’s purchasing power go furtherBy lowering the cost of living, it makes a household’s purchasing power go further Trade increases a country’s GNP by employing its land, labor & capital where they are most productiveTrade increases a country’s GNP by employing its land, labor & capital where they are most productive

Why do some argue that developing countries should restrict their trade? Exploitation by developed countries and wealthy elites Exploitation by developed countries and wealthy elites Terms of trade problem Terms of trade problem Infant industry argument Infant industry argument What do you think about each of these points?

Why Do Governments Often Seek Self-Sufficiency & Restrict Ag Trade? National security (security of food supply) National security (security of food supply) Protect existing/create new jobs Protect existing/create new jobs Favor to rent-seekers Favor to rent-seekers Benefit friends and relativesBenefit friends and relatives Response to bribery or campaign contributionsResponse to bribery or campaign contributions Little public concern because, while benefits are concentrated, costs are diffuse. Little public concern because, while benefits are concentrated, costs are diffuse. Example: US sugar program gives each grower over $100,000 per year, but costs the average consumer only $12 per year.Example: US sugar program gives each grower over $100,000 per year, but costs the average consumer only $12 per year.

Changing World Food Trade Food demand is stable in developed countries but growing rapidly in developing countries as middle class grows Food demand is stable in developed countries but growing rapidly in developing countries as middle class grows Percent of world ag production that is traded is growing Percent of world ag production that is traded is growing Trade in high value & processed products growing faster than in commodities Trade in high value & processed products growing faster than in commodities Explosion of commodity exports from South America; expect more from Eastern Europe and former Soviet Union countries Explosion of commodity exports from South America; expect more from Eastern Europe and former Soviet Union countries

Importance of Exports to U.S. Ag U.S. agriculture exports a third of its production of many commodities U.S. agriculture exports a third of its production of many commodities without exports, farm sector would shrinkwithout exports, farm sector would shrink Exports can grow by expanding the total size of the market or by increasing market share. Exports can grow by expanding the total size of the market or by increasing market share. Need economic growth in developing countries to increase size of marketNeed economic growth in developing countries to increase size of market Preserve competitiveness to protect market sharePreserve competitiveness to protect market share

Food Demand is Changing 1.25 billion people live on less than $1 per day, of whom 850 million suffer under-nutrition 1.25 billion people live on less than $1 per day, of whom 850 million suffer under-nutrition 3 billion live on less than $2 per day. 3 billion live on less than $2 per day. With $2 per day, most hunger (calorie) problem is solved With $2 per day, most hunger (calorie) problem is solved With $3 to $9 per day people eat more animal protein, fruits, vegetables & edible oils, causing rapid growth in demand for raw agricultural commodities With $3 to $9 per day people eat more animal protein, fruits, vegetables & edible oils, causing rapid growth in demand for raw agricultural commodities With $10 per day or more, people buy more processing, services, packaging, variety, and luxury forms, but not more raw agricultural commodities With $10 per day or more, people buy more processing, services, packaging, variety, and luxury forms, but not more raw agricultural commodities How many presently low income consumers are lifted out of poverty will be the most important determinant of the future size of world food and ag product markets How many presently low income consumers are lifted out of poverty will be the most important determinant of the future size of world food and ag product markets

Projected Population Growth (U.N. medium projections, billions) Region Region World World High Income High Income Low Income Low Income Africa Africa Asia Asia Latin America Latin America

Percent of World Food Production That is Traded Will Increase Arable land and fresh water not distributed in the world in the same proportions as population. Arable land and fresh water not distributed in the world in the same proportions as population. Asia or Middle East can not be self-sufficient in foodAsia or Middle East can not be self-sufficient in food With population growth and economic development, world food demand is expected to double by 2050 With population growth and economic development, world food demand is expected to double by 2050 Processed Food Trade Growing Even Faster Processed Food Trade Growing Even Faster Food demand in many developing countries will exceed their production capacity. Food demand in many developing countries will exceed their production capacity.

Trade impediments in developing countries External demand constraints External demand constraints Terms of trade problem (price of exports versus price of imports)Terms of trade problem (price of exports versus price of imports) Trade Restrictions (quotas, tariffs, subsidies, etc.)Trade Restrictions (quotas, tariffs, subsidies, etc.) Internal restrictions on trade Internal restrictions on trade Direct (tariffs, export taxes, etc.)Direct (tariffs, export taxes, etc.) Indirect (exchange rate manipulation)Indirect (exchange rate manipulation) Market instability Market instability

Conclusions Strong economic rationale for trade Strong economic rationale for trade Trade is important to developed and developing countries Trade is important to developed and developing countries Trade will grow in the future Trade will grow in the future Still many impediments to trade Still many impediments to trade