1. Macroeconomics (ECON 1211) Lecturer: Dr B. M. Nowbutsing Topic: International Trade and Commercial Policy

2. 33.1 1.Exports as % of GDP

3. 33.2 Destination of world exports, 1996 Source: Direction of Trade Statistics

4. 33.3 The composition of world exports

5. 33.4 Imports and Exports (Rs M) – Mauritius Imports Exports

6. 33.5 Imports and Exports (Rs M) – Mauritius Imports Exports

7. 33.6 Imports and Exports (% of GDP) – Mauritius Imports Exports

8. 33.7 Openness: (Imports and Exports)/GDP

9. 33.8 1.Some Important Issues n Raw materials prices – Less-developed countries (LDCs) have claimed exploitation by industrial countries n e.g. by buying raw materials cheaply & selling manufactures dear n Manufactured exports from LDCs – some LDCs have had success in exporting manufactures – leading to complaints that jobs are under threat in the industrial countries n 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?

10. 33.9 2.Comparative Advantage n Trade offers benefits when there are international differences in the opportunity cost of goods. n Opportunity cost of a good – the quantity of other goods sacrificed to make one more unit of that good n The law of comparative advantage – states that countries should specialize in producing and exporting the goods that they produce at a lower relative cost than other countries.

11. 33.10 2.Comparative Advantage n This concept is best understood in its classical form, the Ricardian theory of comparative advantage. n Main assumptions: -Markets are perfectly competitive. -There are two goods say cds and shirts that are produced under constant returns to scale. -There is a single factor which is mobile across sector but immobile across countries -There are two countries (UK and USA) each with a fixed endowment of labour

12. 33.11 2.Comparative Advantage USAUK Unit Labour Requirement (hours per unit of output) Cds3060 Shirts56 Opportunity cost of Cds6 shirts10 shirts Shirts1/6 Cds1/10 Cds

13. 33.12 2.Comparative Advantage n Absolute advantage: USA – 30 hours to produce a cd; 60 hours in UK n Similarly, a shirt is produced with 5 hours of labour in USA compared to 6 hours in UK n Thus, USA has absolute advantage in the production of both goods

14. 33.13 2.Comparative Advantage n Opportunity cost table n It is cheaper to produce cds in USA (6<10) n It is cheaper to produce shirts in UK (1/10<1/6) n Ricardian model: requires that each country specialises completely in the activity in which it has comparative advantage

15. 33.14 2.Comparative Advantage – Terms of Trade n Suppose terms of trade are 1 cd = 5 shirts (or 1 shirt = 1/5 cd) n USA exporter of cd: for each video it exports, USA can obtain 5 UK made shirts n However, it cost 6 shirts to produce cd in USA n Surely, it does not make sense to produce a cd at the domestic cost of 6 shirts and sell it to get 5 shirts. n The proposed TOT implies a loss to the USA n The TOT must lie in the range 1 cd = (6, 10) shirts

16. 33.15 3.The Source of Comparative Advantage n An important difference between countries is in factor endowments n 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 specialize in capital-intensive goods, – and India would tend to specialize in labour-intensive products n Comparative advantage may also reflect a relative advantage in technology

17. 33.16 3.The Source of Comparative Advantage n According to the Heckscher-Ohlin model or Ricardian model, countries specialize in one production. Trade occurs only between industries: inter-industry trade. n Suppose now that the global cloth industry is described by the monopolistic competition model. Because of product differentiation, suppose that each country produces different types of cloth. n Because of economies of scale, large markets are desirable: the foreign country exports some cloth and the domestic country exports some cloth. Trade occurs within the cloth industry: intra-industry trade.

18. 33.17 3.The Source of Comparative Advantage n Gains from inter-industry trade reflect comparative advantage. n Gains from intra-industry trade reflect economies of scale (lower costs) and wider consumer choices. n The monopolistic competition model does not predict in which country firms locate, but a comparative advantage in producing the differentiated good will likely cause a country to export more of that good than it imports.

19. 33.18 3.The Source of Comparative Advantage n The relative importance of intra-industry trade depends on how similar countries are. n Countries with similar relative amounts of factors of production are predicted to have intra-industry trade. n Countries with different relative amounts of factors of production are predicted to have inter- industry trade

20. 33.19 4.Gainers and Losers n Countries may gain from specialization and trade – but not all countries may gain equally n Commercial policy – is government policy that influences international trade through taxes or subsidies n e.g. tariffs – or through direct restrictions on imports and exports.

21. 33.20 5.The Effect of a Tariff n A specific tariff is levied as a fixed charge for each unit of imported goods, For example, Rs. 10 per kg of cheese n An ad valorem tariff is levied as a fraction of the value of imported goods. For example, 125% tariff on the value of imported cars.

22. 33.21 5.The Effect of a Tariff DD SS Quantity Price DD and SS show the domestic demand and supply for a good. PwPw If the world price is P w, and there is free trade, QsQs domestic firms supply Q s QdQd domestic demand is Q d A tariff can stimulate domestic supply and restrict imports P w + T At a domestic price P w + T, where T is the size of the tariff Qs'Qs' Qd'Qd' Domestic demand falls to Q d ', domestic supply rises to Q s ' and the difference is imported. and imports fall.

23. 33.22 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. There is also a loss of consumer surplus. and there is a transfer in the form of extra profits to producers 5.The Effect of a Tariff – Welfare Effect DD SS Quantity Price PwPw QsQs QdQd P w + T Qs'Qs' Qd'Qd' The tariff leads both to transfers and net social losses.

24. 33.23 5.The Effect of a Tariff n The deadweight burden of a tariff suggests that society suffers from this method of restricting trade. n This is the case for free trade. n Tariffs have fallen substantially under the GATT/WTO – General Agreement on Tariffs and Trade

25. 33.24 6.The Case for Tariffs – Good Arguments n Optimal tariff – a first-best argument – only valid where the importing country is large enough to affect the world price n 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.

26. 33.25 7.The Case for Tariffs – Second- Best arguments n Way of life – an attempt to preserve ‘traditional’ ways – a production subsidy would be better n Suppressing luxuries – an attempt to curb consumption patterns of the rich in a poor society – better achieved by a consumption tax n Infant industries – an attempt to nurture new activities via learning by doing – a temporary production subsidy probably better n Revenue – tariffs raise government revenue – but there are better ways n Cheap foreign labour – a non-argument – denies benefits of comparative advantage

27. 33.26 7.Other Tariffs Schedule n Preferential Duties: Tariffs applied to imports from particular group of countries; Countries are charged a lower tariff than countries outside the group. n Generalized System of Preferences: Developing countries charge a lower tariffs for specific imports from developing countries; It depends on a list chosen by developed countries (textiles and clothing not included) n Most Favoured Nation Treatment : WTO principles ; A country must give all countries who are part of the WTO the same tariff treatment as the most favoured nation with which the country is trading.

28. 33.27 9.Other commercial policies n Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions – quotas – non-tariff barriers n administrative regulations that discriminate against foreign goods – export subsidies

29. 33.28 Social costs arise from production inefficiency and consumer surplus. 10.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 supply Q d ' to the domestic market and produce Q s '. P w + s Qd'Qd' Q `s ' Exports are now AB. A B

30. 33.29 11.Other Non Tariffs Barriers n Import Quota: a restriction on the quantity of a good that may be imported. This restriction is usually enforced by issuing licenses to domestic firms that import, or in some cases to foreign governments of exporting countries. n Voluntary Export Restrictions: Bilateral agreements negotiated between an exporting and an importing country under which the exporting country agrees to limit its exports of particular products to the importing country to a fixed amount or share of the market. A relatively new form of barrier to trade