1 LECTURE 7 International Trade and Development

2 The Basis for Trade International trade is the exchange of goods and services between countries. International trade greatly enhances living standards for all parties involved because: (a) every country lacks some vital resources that it can get only by trading with others. (b) each country’s climate, labor force, and other endowments make it a relatively efficient producer of some goods and an inefficient producer of other goods. (c) specialization permits larger outputs and can therefore offer economies of large-scale production.

3 Specialization Specialization means that a country devotes its energies and resources to only a small proportion of the world’s productive activities.

4 Theory of Comparative Advantage According to the law of comparative advantage, each country should specialize in producing the good with the lower opportunity cost.

5 Example Assume that there are only 2 countries: (a) Malaysia with a labor force of 100 million workers and (b) Japan with a labor force of 200 million workers. Assuming at a given technology and that labor is fully and efficiently employed; (a) each worker in Malaysia can produce either 6 units of food or 3 units of clothing per day; where else (b) each worker in Japan can produce only 1 unit of food or 2 units of clothing per day.

6 From the example above, since each Malaysian worker can produce both more food and clothing per day than each Japanese worker, Malaysian workers have an absolute advantage in the production of both goods. However, this does not mean that Malaysian workers have a comparative advantage in the production of both goods too.

7 If all 200 million Japanese workers specialize in food, they can produce million units of food per day. On the other hand, if they were to specialize in clothing, total output is million. This means that the opportunity cost of 1 more unit of food is units of clothing.

8 How about the opportunity cost of producing 1 more unit of food for a Malaysian worker? Which country has a comparative advantage in the production of food? Which country has a comparative advantage in the production of clothing?

9 Trade Restrictions Trade restrictions are barriers to impede or block free trade among nations. They usually benefit domestic producers but harm domestic consumers. Consumer surplus – the difference between the maximum sum of money that consumers are willing to pay and how much they actually pay for the good / service. Producer surplus – the difference between the actual sum of money producers receive and the minimum sum they would accept for the quantity sold.

10 Tariff Import Export quota subsidy Types of Trade Restrictions Low-interest loans Domestic content to domestic buyers requirements

11 Tariffs Tax on Imports 2 types: Specific tariff Ad valorem * Tariff based on the * A percentage of the number of goods price of imports at imported. the port of entry.

12 Import Quotas Legal limits on the quantity of a particular commodity that can be imported. Export Subsidy Subsidies given to firms to encourage them to export. Low-interest Loans Loans given out to foreign buyers to promote exports of large capital goods. Domestic Content Requirements A certain percentage of a final good’s value must be produced domestically.

13 Why Protectionism? Military Self-Sufficiency Increased Domestic Employment Diversification for Stability Infant Industry Protection against Dumping Cheap Foreign Labor

14 Free Trade Through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well-being than it can without free trade. Benefits of free trade: Promotes competition and deters monopoly. It links national interests and breaks down national animosities.

15 Examples Japan-Malaysia Economic Partnership Agreement (JMEPA): (a) Malaysia’s main exports – palm oil, polymer of ethylene, plywood, lauric and strearic acids. (b) Japan’s main products – CKD parts, car parts, excavators, televisions. (c) Exports to Japan, approved investments from Japan have increased Malaysia-Pakistan Free Trade Agreement (MPFTA) ASEAN – China Free Trade Agreement (ACFTA)