M03EFA: Economic Environment of Business Key Aspects of International Trade This Lecture Aims to: a) Introduce concepts of absolute/ comparative advantage b) Assess key arguments for free-trade & protectionism c) Considers the impact of tariffs d) Evaluate key trade theories

The gains From Trade: A. The Law of Comparative Advantage

U.S.A.1 Car306 shirts 1 Shirt51/6 car U.K.1 Car6010 shirts 1 Shirt61/10 car Production Hours Opportunity Cost  USA absolute advantage  USA relative advantage in cars Student Task 1: Suppose the USA opts to make 10 more cars whilst the UK opts to make 60 more shirts. What is the outcome & what are the gains from trade between the USA & UK?

 USA makes + 10 cars = - 60 shirts  UK makes + 60 shirts = - 6 cars  Globally cars = (+ 10 – 6 = + 4)  Globally shirts = ( = 0)  Globally more cars/ no fewer shirts  This is a Pareto efficient improvement Comparative Advantage:  The ability to produce a particular good or service at a lower opportunity cost

Arguments for Protectionism:  Prevent dumping (e.g. pharmaceuticals)  Protecting ‘fledgling’ industry (innovation/ invention)  Strategic industry (defence/ water/ farming)  Protect employment (e.g. U.S. car industry; U.S. steel)  Transition….. “When particular manufacturers have been so far extended as to employ a great multitude of hands, humanity may require that the freedom of trade should be restored only by slow graduations and with a good deal of reserve” (Adam Smith, 1776)

Types of Protection:  Voluntary export restraints (VER)  Quota (volume/ value)  Tariff (essentially a tax on importers)  Technology standard (e.g. cars)  Subsidy (assume unit subsidy)

Effects of a Tariff on Trade: a) Domestic supply rises b) Domestic demand falls c) Consumer faces higher prices d) Govt. revenue rises

Infant Industry Rationale for protectionism: IIs lack economies of scale Industrialize behind tariff barriers Only until II is internationally competitive Hence, intended as a temporary measure Historic use by industrialized counties, but was that the reason for success?

Infant Industry II Overall, poor track record How to pick a ‘winner’? Subject to lobbying and emotional pleas Infants may never grow up Infants may never catch up (perpetually inefficient) High costs to society & Retaliation

Trade Theories: Ricardian Model I Labour is the only factor of production Countries will have a comparative advantage in the good that their labour produces relatively efficiently, i.e. the good that has a lower domestic opportunity cost. Countries will export the good in which they have comparative advantage while importing the good that their labour produces relatively inefficiently.

Trade Theories: Specific Factors Model I Two fixed, specific factors and one mobile factor. Countries will have a comparative advantage in the good that requires the specific factor in relative abundance (defined by comparing ratios of specific factors across countries). Countries will export the good in which they have comparative advantage and import the good that requires the specific factor that is relatively scarce domestically.

Trade Theories: Heckscher- Ohlin model I Countries have a comparative advantage in the good that uses intensively the factor a country has in relative abundance. It will export the good in which it has comparative advantage and import the good that uses intensively the factor that is relatively scarce domestically A country should specialize production and export using the factors that are most abundant, and thus the cheapest, not to produce the goods it produces most efficiently.