© The McGraw-Hill Companies, 2005 Chapter 33 International trade David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 8th Edition, McGraw-Hill, 2005 PowerPoint presentation by Alex Tackie and Damian Ward

© The McGraw-Hill Companies,

2

3 Exports as % of GDP

© The McGraw-Hill Companies, Source: GATT, Directions of Trade

© The McGraw-Hill Companies, Destination of world exports, 2003 Source: GATT, Directions of Trade

© The McGraw-Hill Companies,

7 The composition of world exports

© The McGraw-Hill Companies, The composition of Turkey’s exports Source:SPO

© The McGraw-Hill Companies, Some important issues Raw materials prices –Less-developed countries (LDCs) have claimed exploitation by industrial countries e.g. by buying raw materials cheaply & selling manufactures dear Manufactured exports from LDCs –some LDCs have had success in exporting manufactures –leading to complaints that jobs are under threat in the industrial countries Trade disputes between industrial countries –In some countries, established producers of certain goods are being undercut by efficient modern producers –especially from Japan & East Asia –should such exports be restricted?

© The McGraw-Hill Companies, Comparative advantage Trade offers benefits when there are international differences in the opportunity cost of goods. Opportunity cost of a good –the quantity of other goods sacrificed to make one more unit of that good The law of comparative advantage –states that countries should specialise in producing and exporting the goods that they produce at a lower relative cost than other countries.

© The McGraw-Hill Companies,

© The McGraw-Hill Companies, The source of comparative advantage An important difference between countries is in factor endowments which will be reflected in different relative factor prices –e.g. if the UK has relatively abundant capital but relatively scarce labour as compared with India, –then the UK would tend to specialise in capital-intensive goods, –and India would tend to specialise in labour-intensive products Comparative advantage may also reflect a relative advantage in technology

© The McGraw-Hill Companies,

© The McGraw-Hill Companies, Figure 33.1: Comparative advantage and export composition (125 countries and regional averages)

© The McGraw-Hill Companies, Gainers and losers Countries may gain from specialisation and trade –but not all countries may gain equally Commercial policy –is government policy that influences international trade through taxes or subsidies e.g. tariffs –or through direct restrictions on imports and exports.

© The McGraw-Hill Companies, The economic effects of a tariff DD and SS show the domestic demand and supply for a good. If the world price is P w, and there is free trade, domestic firms supply Q s domestic demand is Q d A tariff can stimulate domestic supply and restrict imports. At a domestic price P w + T, where T is the size of the tariff. Domestic demand falls to Q d ', domestic supply rises to Q s ' and the difference is imported. and imports fall. DD SS Quantity Price PwPw QsQs QdQd P w + T Qs'Qs' Qd'Qd'

© The McGraw-Hill Companies, The government raises revenue – i.e. there is a transfer to the government There is a social cost from production inefficiency, given that the good could be imported at P w, and a loss of consumer surplus. and there is a transfer in the form of extra profits to producers. The welfare costs of a tariff DD SS Quantity Price QsQs QdQd P w + T Qs'Qs' Qd'Qd' The tariff leads both to transfers and net social losses. PwPw

© The McGraw-Hill Companies, Tariffs The deadweight burden of a tariff suggests that society suffers from this method of restricting trade. This is the case for free trade. Tariffs have fallen substantially under the GATT –General Agreement on Tariffs and Trade

© The McGraw-Hill Companies,

© The McGraw-Hill Companies, The case for tariffs – good arguments Optimal tariff –a first-best argument –only valid where the importing country is large enough to affect the world price. This policy fulfils the principle of targeting –which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly. –Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities.

© The McGraw-Hill Companies, The case for tariffs – second-best arguments Way of life –an attempt to preserve ‘traditional’ ways –a production subsidy would be better Suppressing luxuries –an attempt to curb consumption patterns of the rich in a poor society –better achieved by a consumption tax Infant industries –an attempt to nurture new activities via learning by doing –a temporary production subsidy probably better Revenue –tariffs raise government revenue –but there are better ways Cheap foreign labour –a non-argument – denies benefits of comparative advantage

© The McGraw-Hill Companies, Other commercial policies Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions –quotas –non-tariff barriers administrative regulations that discriminate against foreign goods –export subsidies

© The McGraw-Hill Companies, Social costs arise from production inefficiency and the loss of consumer surplus. An export subsidy DD S Quantity Price PwPw World price Under free trade, with the world price at P w, QdQd consumers demand Q d QsQs production is Q s exports are GE. G E Subsidy With a subsidy, producers produce Q s ’ and supply Q d ' to the domestic market. P w + s Qd'Qd' Q `s ' Exports now rise to AB. A B