Download Chapter 35 INTERNATIONAL TRADE AND

11
International Trade and
Comparative Advantage
Outline
● Why Trade?
● International versus Intranational Trade
● The Law of Comparative Advantage
Puzzle: How Can Americans Compete
with “Cheap Foreign Labor”?
● Why do Americans want government to limit or prevent
import-competition?
♦ Common belief that imports ↓ U.S. jobs and wages.
♦ “Cheap foreign L” steals jobs from U.S. L and puts pressure on
U.S. firms to cut wages.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
“Cheap Foreign Labor”
● Empirical evidence doesn’t support this view.
♦ ↑wages in industrialized countries that X to U.S. over past 30
years.
♦ Wages in Britain rose from ½ U.S. standards to above U.S.
levels.
♦ Wages in South Korea have dramatically increased from just
5% of U.S. wages to nearly 60% –all during a time when X of
textiles, toys, and consumer electronics soared.
♦ Clearly, cheap L abroad does not explain our ↑ trade deficit.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
TABLE 1. Labor Costs in
Industrialized Countries
1975
2005
73%
104%
United Kingdom
54
109
Spain
41
75
Japan
48
92
South Korea
5
57
Taiwan
6
27
Mexico
24
11
Canada
99
101
France
Note: Labor costs in industrialized countries as a percentage of U.S.
Labor Costs
Why Trade?
● Differences in resources
♦ U.S. can produce coal and wheat but relies on rest of the world
for rubber and oil.
♦ Saudi Arabia has poor farming T but sits on a massive pool of
oil.
● Differences in climate
♦ Bananas and coffee are more efficiently grown in Latin
America.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Why Trade?
● Differences in labor skills
♦ New Zealand has skilled sheep farmers, while Singapore has
skilled manufacturing workers.
● Economies of Scale
♦ Small country that tried to produce everything for itself would
end up with many industries whose scale of operation was too
small to benefit from mass-scale production techniques.
♦ Argentina does not have enough domestic consumers to
support 1 efficient scale automobile producer.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Mutual Gains from Trade
● Late 1700s, Adam Smith and David Ricardo argued that
2 countries must gain from voluntary exchange. If not,
they would refuse to trade.
● Exchange of goods ↑ welfare of two parties, even though
no goods are created in the act of trading.
♦ U.S. and Mexico are both better off if Mexico ships fruits and
vegetables in exchange for telecommunications equipment.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Intranational Trade
● 50 states in U.S. with no trade barriers shows the
incredible gains from specialization and trade.
♦
♦
♦
♦
♦
♦
California –movies and computer chips
Wisconsin –beer and cheese
Michigan –cars
Nebraska –corn
Florida –oranges
New York –financial services
● Your standard of living would be much lower if you
were only allowed to purchase goods made in CA.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
International versus
Intranational Trade
● Political factors
♦ Domestic trade occurs under one government.
♦ U.S. Constitution prohibits trade restrictions across states.
● Many currencies
♦ Trade in U.S. (or EU) is carried out with same currency.
● Restrictions on L and K mobility
♦ No immigration laws restrict flow of L across state borders.
♦ Many countries have laws that restrict foreign ownership of
domestic assets.
♦ K invested abroad faces greater risks of expropriation.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
The Law of Comparative
Advantage
● Gains from trade are obvious when 1 country is better at
producing 1 good and its trading partner is better at
producing another.
♦ U.S. X aircraft to Columbia in exchange for coffee.
♦ U.S. has more K equipment and experience with aircraft
production and Columbia has cheaper L and a warmer climate.
♦ U.S. has an absolute advantage in aircraft production and
Columbia has an absolute advantage in coffee production.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
The Law of Comparative
Advantage
● Less obvious: if 1 country is better at producing
everything, then 2 countries can gain from trade.
♦ E.g., Top neurosurgeon who is the best car mechanic. Should
she repair her own car? No! Even though she’s a better car
mechanic, she should concentrate on surgery and leave car
repair to a lower skilled (and lesser paid) auto mechanic.
Opportunity cost of 1 hour devoted to car repair is 1 less hour
spent in brain surgery which is higher paying.
● Comparative advantage is at work here. Surgeon
specializes in medicine despite her absolute advantage in
car repair because she has an even greater absolute
advantage as a doctor.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
The Law of Comparative
Advantage
● Law of comparative advantage: even if one country is
worse at producing every good, relative to another
country, it has a comparative advantage in making the
good at which it is the least inefficient.
● A country can gain importing a good, even if that good
could be produced at home more efficiently than it could
be produced abroad. These imports allow the country to
specialize in goods at which it is even more efficient.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Arithmetic of Comparative
Advantage
● Trade Model: 2 countries –U.S. and Japan; 1 input –L;
and 2 goods –computers and televisions
● Assume U.S. has absolute advantage in producing both
goods. It still pays for U.S. to trade with Japan.
● In Table 2, U.S. has a comparative advantage in PCs and
Japan has a comparative advantage in TVs.
● U.S. is 5 times more efficient in PCs and 1.25 times as
efficient in TVs.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
TABLE 2. Alternative Outputs from
One Year of Labor Input
Graph of Comparative
Advantage
● Assume U.S. and Japan have same amount of L –1
million person years.
♦ Actual graph for U.S. would be even further out from Japan
because U.S. has more L. Here we want to highlight the
differences in L efficiency.
● Absolute advantage is shown by PPF of U.S. lies outside
PPF for Japan.
♦ U.S. can produce more of both goods using same amount of L.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Graph of Comparative
Advantage
● Comparative advantage is shown by the relative slopes
of PPFs.
♦ Slope of PPF = ∆Y/∆X = opportunity cost of producing the
good on X-axis.
♦ Slope of U.S. PPF = 1 = (50/50) → U.S. must give up 1 TV to
get 1 PC, so opportunity cost of 1 PC = 1 TV.
♦ Slope of Japan PPF = 4 = (40/10) → Japan must give up 4 TVs
to get 1 PC, so opportunity cost of 1 PC = 4 TVs.
● Because opportunity costs differ across 2 countries, it is
possible for both to gain from trade.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Graph of Comparative
Advantage
● It is cheaper to purchase PCs in U.S. than in Japan.
♦ U.S. → give up 1 TV to get 1 PC versus Japan → give up 4
TVS to get 1 PC.
● It is cheaper to purchase TVs in Japan than in U.S.
♦ U.S. → give up 1 PC to get 1 TV versus Japan → give up 1/4
PC to get 1 TV.
● If opportunity costs are the same across 2 countries, then
no gains from trade are possible.
● Gains occur because the countries are different.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
FIGURE 1. Per-Capita PPFs for Two
Countries
60
U
Television Sets
(millions)
50
J
40
U.S. production
possibilities frontier
30
Japanese
production
possibilities
frontier
20
10
N
0
10
S
20
30
40
Computers
(millions)
50
60
Gains From Trade
● Gains from trade depend on prices that emerge from
trade.
● When trade opens: 1 TV < price of PC < 4 TVs.
♦ Why? If 1 PC costs ½ of a TV → U.S. will refuse to trade.
Why should U.S. give up 2 PCs to get 1 TV?
♦ If 1 PC costs 5 TVs → Japan will refuse to trade. Why should
Japan give up 5 TVs to get 1 PC?
● Assume traded price of 1 PC = 2 TVs.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Gains From Trade
● We can show gains from trade graphically in Figure 2.
♦ CPF with trade > PPF = CPF without trade
● Labor is twice as productive with trade:
♦ U.S. gets 2 TVs for every PC (instead of 1 TV before trade).
♦ Japan gets ½ PC for every TV (instead of ¼ PC before trade).
♦ Thus, L in both countries has become twice as productive after
trade.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
FIGURE 2. The Gains from Trade
90
90
80
80
70
70
60
50
J
40
Japanese consumption
possibilities
30
Japanese production
possibilities
20
10
Television Sets
100
Television Sets
100
A
U.S. consumption
possibilities
60
U
50
40
30
U.S. production
possibilities
20
10
N
0
10
P
20
S
30
40
50
60
0
10
20
30
40
50
60
Computers
Computers
(a) Japan
(b) United States
?
Comparative Advantage:
“Cheap Foreign Labor”
● In our example, U.S. workers are more productive than Japanese
workers, so their wages must be higher (wage = MRPL).
● U.S. workers will complain about competing with cheap Japanese
L. And Japanese workers will worry about competing with
productive American L.
● Law of Comparative Advantage says these fears are unfounded.
● Workers in both countries will earn higher wages after trade
because of ↑ productivity from specialization.
● After trade, workers in both countries will have higher real wages
and improved living standards.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.