1. The Principle of Comparative Advantage
Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. 16

2. The Principle of Comparative Advantage
Every country has different Factor Endowments
Natural Resources
Capital Goods
Human Capital – labor skills
Technology
This is the basis of trade 16

3. Interdependence
Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services. 25

4. Philosophically speaking…
It is our differences that make trade beneficial and therefore it is our differences that make us interdependent on one another.
If we were all the same there would be no benefit in our working together.
It is our differences that should encourage us to get along. 25

5. Philosophical Applications?
Countries that trade together are less likely to fight with one another.
If you care about someone’s welfare, trade with them. You will both be better off for it. 25

6. Murphy’s Law of Economics
“Economists have the least influence on policy where they know the most and are most agreed. They have the most influence on policy where they know the least and disagree most vehemently.”
Alan Blinder (Princeton Professor, former member of Council of Economic Advisors, and Fed Board of Governors)

7. Free Trade vs. Protectionism
Free Trade (Consumers)
Goods and services can be exported and imported by anyone in any country with no restrictions.
Free flow of goods between countries
vs.
Protectionism (Producers)
Philosophy that it is in the best interest of a country to restrict free trade.
Restrictions to protect domestic producers

8. Free Trade Arguments Benefits Consumers:
Trade, Specialization, and Efficiency
Permits the markets in which goods and services are bought & sold to expand, leading to more specialization.
Specialization leads to efficiency, and this allows more goods and services to be produced.
Increased Availability of Goods
Leads to larger quantities of goods.
Ex: Boeing and Airbus

9. Free Trade Arguments Trade & Competition
Increases competition leads to lower prices.

10. Protectionism Arguments
Benefits Producers:
1. Protect Jobs/Labor
Protection of Domestic Employment & Output
Restrictions make it near impossible for foreign goods to compete in domestic markets, thereby increasing employment and output in the domestic markets.
Protecting Domestic Jobs – protect domestic jobs from cheap foreign labor – most often used argument

11. Protectionism Arguments
2. Cheap Foreign Labor
Argues that it is impossible to compete with cheap labor
Comparative Advantage says this is not true
Trade lowers wages and living standards
There will be losers
Adjustment assistance (temporary aid)
Pg 81:

12. Protectionism Arguments
3. Creates Employment
True for those industries that are protected
Cost of jobs created
False for the macro economy
With protection we gain jobs with less compensation and lose jobs with more compensation
Growth in US Imports = Growth in Jobs
From 1980 – 2005 there was a 477% growth in US imports and a 47% growth in US jobs (50 million jobs)

13. Protectionism Arguments
4. Infant Industries
New or emerging industries should be protected from foreign competition
Valid for Less Developed Countries
How do you get rid of it?
Only for those industries you have a comparative advantage in
In Industrialized Countries they often claim to be a “temporarily sick industry”

14. Protectionism Arguments
National Defense
Without trade barriers a country could become too specialized and therefore dependent upon other countries (not an economic argument)
“Strategic production independence”
Diversification in anticipation of interruptions of foreign supplies resulting from military or economic aggression - Prevents dependencies on foreign goods from forming

15. “What protection teaches us to do to ourselves in times of peace is what enemies do to us in times of war.”
Henry George (over 100 years ago)

16. Trade Restrictions If trade barriers are bad, then why do we do it?
Politics
Lack of understanding
Feelings about lost jobs
Public Choice Theory

17. Public Choice Theory Direct Benefits vs. Indirect Costs
Fewer producers who get larger gains individually = direct benefits
Costs are spread out over many consumers = indirect costs
Protectionist measures usually come through Congress - their jobs depend on it
Presidents are usually more free trade oriented

18. Trade Restrictions How do we restrict trade?
What policies can be put in place to restrict trade?

19. Trade Restrictions
Tariffs – taxes placed on imports to increase their price in the domestic market
Winners – producers and government
Losers – consumers
Producers typically have more political power than consumers

20. Trade Restrictions
Tariff - Tax on an import

21. Trade Restrictions
Quotas – limits placed on the quantities of a product that can be imported
Import quotas produce no federal revenues
Are directed against particular sellers

22. Trade Restrictions Example: Sugar Quotas
Click on photo to show Colbert Report video on Sugar online

23. Trade Restrictions
Embargo - Ban on trade in a particular commodity or with a particular country
The sure-fire way to restrict trade is simply to eliminate it
North Korea and Cuba

24. Trade Restrictions
Non-Tariff Barriers (NTB) - government regulations that hinder trade
Mexican avocados can only be sold in 19 North Eastern states during winter months
NAFTA is full of NTBs
Russians restrict US chicken as not healthy to consumers (“dirty chicken”)
NTBs are difficult to undo once they are in place

25. Trade Restrictions Voluntary Export Restrictions (VER)
A country may choose to voluntarily reduce the amount of a product they export to certain countries
Japan and the auto industry in 1980s under Reagan (Bush’s idea)-politically expedient
Japanese government could then allocate the right to export to the US
Not really voluntary - it was that or else
After 5 years these restrictions went away
VERs are easier to undo than NTBs

26. Real World of International Trade
Real World Policies
Trade Subsidies
Government payment to domestic producer of an exported good
Dumping
Selling a product in a foreign market below cost or below its price in its own domestic market

27. International Trade Policy
International Trade Agreements
(1947) General Agreement on Tariffs and Trade (GATT) – 23 nations
No quotas on manufactured goods
Dispute settlement mechanism
Sponsorship of multilateral protection reduction negotiations (Doha rounds are round #9)
Since 1947
Expanded to 147 nations
Lower tariffs (US = 20-25% tariffs reduced to under 4%)
Higher Non-Tariff Barriers

28. International Trade Policy
General Agreement on Tariffs and Trade (GATT)
Failures
Exclusion of agricultural products and services
Does not cover NTBs

29. International Trade Policy
GATT
Uruguay Round (8th) ( )
The 1994 GATT pact created the World Trade Organization (WTO) to enforce free-trade rules
Tariffs on services now covered

30. International Trade Policy
WTO
Doha Round (9th) ( ??)
Official start in Doha, Quatar(2001)
Discussion suspended after disagreements over agricultural subsidies and tariffs

31. Approaches to Achieving Free Trade
Multilateral Agreements
World Trade Organization (WTO)
Organization founded in 1995 to take over responsibilities of GATT
Regional Trade Blocks
North American Free Trade Agreement (NAFTA)
European Union (EU)
Single market formed by majority of Western European nations
Bilateral Agreements
between 2 countries

32. Approaches to Achieving Free Trade
Sometimes trade blocks put up barriers with the rest of the world
May lead to competing trade blocks with trade barriers
US focus on NAFTA and bilateral agreements
US has stopped playing a central role in WTO

33. Government Barriers to Trade
Include tariffs, domestic
subsidies, quotas, etc.
Do not create or destroy domestic jobs; they just shuffle them around.
Create inefficiencies in the protected industries, forcing domestic consumers to pay higher prices.

34. International Trade: Imports and Exports
Trade restrictions that reduce imports will also reduce the ability of foreigners to buy our exports.
Quotas and tariffs decrease the number of dollars earned by foreigners through the sale of imports to us.
Therefore, reductions in imports simultaneously reduce exports.

35. The Evidence Indicates
The countries with the highest levels of economic freedom have the highest per capita GDP and growth rates.
The institutions and policies outlined in Part II of CSE produce results. Free economies spur savings and investment resulting in economic growth and prosperity.
Differing institutions and policies explain why growth rates vary across countries and time.