Download 33 – Comparative Advantage

Chapter 33
Comparative Advantage and the Open Economy
Overview
The most important objective of this chapter is to demonstrate how international trade based on comparative advantage arises and its
benefits. International trade is shown to be important, even to a country like the United States in which the ratio of exports and imports
to GDP is relatively small but growing. The difference between absolute and comparative advantage, the fact that a comparative
advantage will always exist, and that efficiency occurs when nations (or individuals) specialize based on their comparative advantages
is demonstrated and stressed. How two countries can increase total world output by specializing and then trading is demonstrated. A
discussion of costs of free trade and an analysis of the arguments against free trade are presented. Restrictions on trade, tariffs and
quotas, are discussed next. The last topic discussed is the World Trade Organization (WTO).
Outline
I.
The Worldwide Importance of International Trade: World trade has increased to more than 26 times what it was in 1950.
World GDP has only increased by a factor of 9. Imports as a percentage of GDP for the United States has increased from 4 percent in
1950 to almost 17 percent today. (See Figure 33—1.)
II.
Why We Trade: Comparative Advantage and Mutual Gains from Exchange
A.
The Output Gains from Specialization: If specialization and trade occurs along lines of comparative advantage, then
production increases above what would be otherwise possible.
B.
Specialization Among Nations: A two country numerical example is presented.
1.
Production and Consumption Capabilities in a Two-Country, Two-Good World:
(See Table 33—1.)
2.
Comparative Advantage: Comparative advantage is the ability to produce a good or service at a lower opportunity cost than
can other producers. (See Table 33—1.)
3.
Production Without Trade: An example of pre-trade production possibilities is presented. (See Table 33—2.)
4.
Specialization in Production: Each country completely specializes in the product in which it has comparative advantage.
5.
Consumption with Specialization and Trade: The basis for trade is explained in terms of opportunity cost ratios in the two
countries and an example of trade is worked out (See Table 33—1 and 33—3.)
6.
Gains from Trade: The gains from trade are shown for each country. (See Table 33—4.)
7.
Specialization Is the Key: Trade along lines of comparative advantage allows increases in production and consumption.
Specialization along lines of comparative advantage allows nations to produce more efficiently and worldwide production capabilities
to increase. Then consumption can increase above what was possible before specialization and trade.
C.
Other Benefits from International Trade: The Transmission of Ideas: Ideas are transmitted through international trade. These
ideas may be in the form of intellectual property, new goods and services, and new processes.
III.
The Relationship Between Imports and Exports: In the long-run, imports are paid for by exports. This is because foreigners
want something in exchange for the goods that are shipped to the United States. Any restriction of imports ultimately reduces exports,
because restrictions on imports lead to a reduction in employment in the export industries.
IV.
International Competitiveness: This term is hard to define precisely because countries do not compete, businesses within each
country compete with businesses in other countries. Based on an international study, the United States leads the world in measures of
competitiveness.
V.
Arguments Against Free Trade: Arguments against free trade point out the costs of trade. They do not consider the benefits of
possible alternatives for reducing costs while still reaping benefits.
A.
The Infant Industry Argument: The argument that tariffs should be imposed to protect an industry that is trying to get started
from import competition. After the industry becomes technologically efficient, the tariff can be lifted.
B.
Countering Foreign Subsidies and Dumping: When a foreign government subsidizes its producers, our producers claim they
cannot compete fairly with these subsidized foreigners. To the extent that such subsidies fluctuate, one can argue that unrestricted free
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trade will seriously disrupt domestic producers. Occasionally, dumping takes place. Dumping is the selling of a good or service abroad
at a price below its cost of production or below the price charged in the home market. This disrupts international trade and may impair
commercial well—being at home.
C.
Protecting Domestic Jobs: The most often used argument against free trade is that unrestrained competition from other
countries will eliminate U.S. jobs because other countries have lower-cost labor and less restrictive environmental standards.
D.
Emerging Arguments Against Free Trade: The environmental concerns that there can be undesirable effects, e.g., genetic
engineering, should lead to trade restrictions. Another is the national defense argument that certain technologies should not be
exported.
VI.
Ways to Restrict Foreign Trade
A.
Quotas: Quotas are government-imposed restrictions on the quantity of a specific good that another country is allowed to sell
in the United States. Quotas restrict imports. These restrictions are usually applied to a specific country or countries. (See Figure 33—
3.)
1.
Voluntary Quotas: A voluntary restraint agreement (VRA) in which a country agrees to voluntarily restrict its exports to the
United States. The opposite is a voluntary import expansion agreement (VIE) in which a foreign country agrees to voluntarily increase
its imports from the United States. Neither a VRA nor a VIE has the force of law.
B.
Tariffs: A tariff is a tax on imported goods. A protective tariff is such that no similar tax is applied to identical domestic
goods. (See Figure 33—4.)
1.
Tariffs in the United States: Tariffs on all imported goods have varied widely. The highest tariff rates in 20th century
occurred with the passage of the Smoot-Hawley tariff in 1930. (See Figure 33—5.)
2.
Current Tariff Laws: The Trade Expansion Act of 1962 permitted the president to reduce
tariffs by up to 50 percent. The Trade Reform Act of 1974 and the Trade and Tariff Act of
1984 allowed the president to reduce tariffs further and resulted in the lowest tariff rates
ever. All of these trade agreement obligations of the United States are carried out under
General Agreement on Tariffs and Trade (GATT), an international agreement formed in
1947 to further world trade by reducing barriers and tariffs.
VII.
International Trade Organizations: Widespread efforts to reduce tariffs around the world have led to a growth of international
trade organizations.
A.
The World Trade Organization (WTO): The successor organization to GATT handles all trade disputes among its 117
member nations. In addition, the WTO agreement will lead to a 40 percent reduction in tariffs worldwide, protection of intellectual
property rights, local content laws will be eliminated, and U.S. service suppliers will be subject to the same rules as foreign suppliers
in their countries.
B.
Regional Trade Agreements: Other international trade organizations such as the EU and NAFTA known as regional trade
blocs also exist. These trade blocs are groups of nations that grant members special trade privileges.
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