Trade patterns and their evolution © 2015 Melvin Jameson

Reasons to study international trade: To better understand the international economic environment including: the dynamics by which it changes, and its impact on the politics of trade policy, and thus the political/regulatory environment. To help identify international business opportunities and to understand why they exist. © 2015 Melvin Jameson

1. What drives trade? When is Trade is Profitable? © 2015 Melvin Jameson Trade results from international differences in supply and demand.

U.S. In Isolation Supply and Demand © 2015 Melvin Jameson SupplyDemandprice 535$2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $3,000

U.S. In Isolation Supply and Demand © 2015 Melvin Jameson SupplyDemandprice 535$2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $3,000

Rest-of-the-World In Isolation © 2015 Melvin Jameson priceSupplyDemand $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $2, $3,

If prices differ when markets are isolated, trade is will occur when it becomes possible. It will continue until the price difference (less any trading costs) is eliminated. To understand why trade occurs, we must ask why prices would differ without it. © 2015 Melvin Jameson

Results of unimpeded trade © 2015 Melvin Jameson U.S. rest of the world ImportSupplyDemandpriceSupplyDemandExport 30535$2, $2, $2, $2, $2, $2, Autarky; world $2, Free trade161228$2, Free trade $2, $2, $2, $2, $2, $2, $2, Autarky U.S.020 $2, $2, $2, $2, $2, $3, Desired export = Desired import U.S. price = world price

Costly trade: $250/unit transportation © 2015 Melvin Jameson U.S. rest of the world ImportSupplyDemandpriceSupplyDemandExport 30535$2, $2, $2, $2, $2, $2, Autarky; world $2, Costly trade Free trade161228$2, Free trade $2, $2, $2, Costly trade81624$2, $2, $2, $2, Autarky U.S.020 $2, $2, $2, $2, $2, $3, Desired export = Desired import U.S. price (importer) = world price + trade cost

Results of trade: Traded Goods Prices of traded goods converge worldwide. Production is reallocated internationally Because of the differences between countries, reallocating production to increase specialization increases total world output. A net welfare improvement results. © 2015 Melvin Jameson

2. Which prices matter? © 2015 Melvin Jameson Relative prices – that is price relative to other traded goods Absolute vs. comparative advantage in production costs

Absolute Advantage (Adam Smith) A country will export those products it can produce more efficiently than anyone else. © 2015 Melvin Jameson

Example: absolute advantage Output per hour of labor BeefCloth United States50 lbs./hour20 yards/hour United Kingdom25 lbs/hour40 yards/hour © 2015 Melvin Jameson

Absolute Advantage In this example: US is more efficient at producing beef 50 lbs./hr. Vs. 25 lbs./hr. UK is more efficient at producing cloth 40 yards/hr. vs. 20 yards/hr. therefore: US will export beef(import cloth) UK will export cloth (import beef) © 2015 Melvin Jameson

Absolute Advantage Problem: What if one country has an absolute advantage at both products? Does this mean the other should do nothing? Comparative advantage: A country exports the products it produces with greatest relative efficiency. © 2015 Melvin Jameson

Comparative Advantage The key is not factor productivity © 2015 Melvin Jameson But marginal rate of transformation

Example: Comparative advantage Output per hour of labor BeefCloth United States50 lbs./hour40 yards/hour United Kingdom25 lbs/hour30 yards/hour © 2015 Melvin Jameson Thus cloth is cheaper in the UK (0.83 lbs. vs lbs.)

Comparative advantage With frictionless markets, the MRT can be expressed as a price ratio. © 2015 Melvin Jameson Thus cloth is cheaper in the UK (0.83 lbs. vs lbs.)

MRT = tradeoff between two products Product price = tradeoff between product and “all-other- goods” i.e. relative efficiency (location of supply curve.) What leads countries to differ wrt relative efficiency of production? © 2015 Melvin Jameson

Some Examples of Comparative Advantage Country Canada Jamaica Mexico Saudi Arabia Japan South Korea Nevada Product Lumber Aluminum ore Tomatoes Oil Automobiles Steel, ships ?? © 2015 Melvin Jameson

Discussion: Nevada’s exports Nevada’s comparative advantages © 2015 Melvin Jameson United States Census Bureau: International Trade Data

Export support in Las Vegas © 2015 Melvin Jameson

3. Why do local prices differ? or Why does specialization in production occur? © 2015 Melvin Jameson

Sources of Comparative Advantage What gives each of these countries its particular comparative advantage? What kinds of differences can lead to greater relative efficiency in particular products? © 2015 Melvin Jameson

Models of Trade Model Classical Comparative Advantage Factor Proportions Heckscher-Ohlin Technology-based models (product life-cycle model) Difference Natural Resource endowments Factor endowments (capital/labor ratio) Human capital: skilled (educated) vs unskilled labor © 2015 Melvin Jameson

Models of Trade (continued) Model Intra-Industry Trade seasonal transportation costs product differentiation Economies of Scale (Krugman) internal external Difference seasonal productivity location © 2015 Melvin Jameson

Economies of Scale Internal EOS (increasing returns to scale) Producing on a very large scale lowers average costs The low-cost product can be exported Even absent comparative-advantage differences External EOS (Clusters) All firms in a region (cluster) enjoy lower average cost due to a concentration of specialized resources Large pool of workers with specialized human capital Specialized inputs/subcontractors Shared information and knowledge Similar average cost reduction given scale of the region © 2015 Melvin Jameson

Intra-industry trade: Simultaneous import and export of what appears to be the same product Possible explanations product differentiation seasonal differences transportation costs © 2015 Melvin Jameson

Technology: The Product Cycle Product life-cycle 1. Newly introduced product is highly innovative- Highly educated human resources are required. 2. Manufacture becomes standardized – a skilled work force is required. 3. The product becomes commoditized – low-cost labor is well-suited to production. Comparative advantage changes over the life-cycle of the product. © 2015 Melvin Jameson

Product life-cycle examples: Radio, TV manufacture: U.S. and Japan computer manufacture: U.S. – Taiwan – China © 2015 Melvin Jameson

Trade: Examples and Applications 1. Comparative advantage based on natural resource endowment: - Example: Saudi oil 2. Factor endowments - relative amounts of capital & labor Manufacturing in China © 2015 Melvin Jameson

Discussion: Manufacturing in China © 2015 Melvin Jameson

Discussion: China Factor endowments and trade Compare US and China on availability of Labor vs. capital Unskilled vs. skilled labor Factor endowment theory predicts a country exports products that use intensively those factors with which it is well endowed. © 2015 Melvin Jameson

Discussion: China China exports to the United States Apparel, footwear, toys, and the final assembly of electronic machinery and equipment Products intensive in unskilled labor United States exports to China Aircraft, software, pharmaceuticals, and high-tech components of electrical machinery and equipment Products intensive in skilled labor and technology © 2015 Melvin Jameson

Discussion: China Manufacture, especially of unskilled labor intensive products, migrated to China. Consider the impact on World output of manufactured goods Demand for raw materials (commodities) Price of manufactured products in the US Wages in China © 2015 Melvin Jameson

4. Further results of trade: Non-traded goods © 2015 Melvin Jameson

Factor-Price Equalization Trade leads to increased demand for the cheap (abundant; comparative advantage creating) factor its price rises decreased demand for the expensive (scarce; comparative disadvantage creating) factor its price falls © 2015 Melvin Jameson

Results of trade: Non-traded goods Prices of traded goods converge worldwide. Factor prices converge (“factor price equalization”) Prices of non-traded substitutes for traded goods converge. © 2015 Melvin Jameson

Discussion: China (continued) Trends in Chinese wages and manufacturing Impact on world trade patterns Background reading: © 2015 Melvin Jameson The Economist Intelligence Unit: Report on trends in Chinese workforce August 26, 2014 “China Hand: More with less” “Why You May Soon See More Goods Labeled ‘Made in Vietnam’” WSJ October 19, 2015 p. B1 Link Link or see separate pdf

Limits to Factor-Price Equalization Transportation costs and other barriers limit the amount of trade. Real factor productivity varies due to international differences in capital stock, technology, education, legal and economic institutions etc. © 2015 Melvin Jameson

Dynamics of comparative advantage Some sources of comparative advantage are long lasting favorable climate vast oil reserves Others are more transient low-cost labor © 2015 Melvin Jameson