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Chapter 14 International Trade McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives • Explain why global trade has increased so much in recent years. • Summarize the main gains to trade. • Compare and contrast absolute advantage and comparative advantage. • Discuss the winners and losers from trade and analyze the arguments for protectionism. • Describe what it means for a currency to appreciate or depreciate. • List explanations for why the United States consistently runs a trade deficit. 14-2 Nature of International Trade • There has been a boom in international trade over the last decade. • Both trade in goods and services has been soaring. • Service exports include such items as foreign students studying in the U.S. and foreigners watching U.S.-produced TV shows and movies. 14-3 Global Exports (and Imports) as a Percent of Global GDP 14-4 Top Ten Purchasers of U.S. Exports 14-5 Top Ten Sources of U.S. Imports 14-6 Barriers to Trade • Historically, businesses that want to sell to buyers in another country faced both the natural barriers to trade and the legal barriers to trade. • The natural barriers include distance, differences in culture and values, and the difficulty of delivering services remotely. • The legal barriers include tariffs, quotas, and other regulatory impediments. 14-7 Barriers to Trade • Both natural and legal barriers to trade have fallen due to technology and a commitment among countries toward a policy of free trade. • Technology has reduced the cost of shipping and made communication over long distances much easier. • The ease of communication has reduced problems associated with different languages and cultures. 14-8 Lowering of Legal Barriers • Historically, countries have put barriers on trading in the form of tariffs and quotas. – Tariffs are the taxes leveled on imports by a country. – Quotas are numerical limits on the number of imported products coming into a country. – Tariffs and quotas are applied to raise revenues and to protect domestic industries from foreign competition. 14-9 Lowering of Legal Barriers • Since the end of World War II, most countries – led by the United States – have made a concerted global effort to reduce tariffs, quotas, and other trade barriers. • The reduction of these barriers has led to a significant increase in global trade. • Tariffs act as a tax on imported goods, and thus raise their price. 14-10 Lowering of Legal Barriers • When the tariff is removed, the price of the import goes down and the quantity demanded for imports rises. • Quotas are numerical limits on imports which effectively reduce the quantity supplied of the good. – This supply restriction also drives up the price. 14-11 Eliminating a Tariff Increases the Quantity of Imports Price Price paid by consumers with a tariff A Tariff Market price without a tariff Price received by importers with a tariff Supply curve for imports C B Demand curve for imports Level of imports Level of imports with a tariff without a tariff Imports 14-12 Gains from Trade • Countries trade with each other because of the gains from trade. • The first gain from trade is lower prices. – Goods and services that are produced overseas have lower prices than the comparable domestic goods and services. – Also, the increased competition from foreign producers forces domestic companies to keep prices low. 14-13 Furniture Prices versus CPI, 1990-2010 14-14 Furniture Imports to the U.S., 1990-2010 14-15 Access to Natural Resources • A second gain from trade is access to natural resources that are either unavailable or too expensive to produce domestically. – The U.S. imports a long list of resources, with the most important being crude oil. – Countries like Japan have few resources, and import virtually all of them. 14-16 Access to Global Markets • A third gain from trade is that companies obtain access to global markets. – Businesses can benefit because the market for their product is now much larger than any single nation. – A global sales strategy is especially beneficial for companies that have development costs such as Boeing. 14-17 Access to New Ideas • The final gain from trade is the access to new ideas developed in other countries. – This improves growth in the domestic economy, as knowledge is one of the key factors determining long-term growth. – In the current economy, many products are either designed overseas or are the result of crosscountry collaboration. – The development of the flat-panel television is a good example. 14-18 Comparative versus Absolute Advantage • A country has an absolute advantage in producing a good if it takes less resources to produce the good in that country than in another. • But countries with an absolute advantage in producing a good may not export it. It depends on the comparative advantage. • Comparative advantage means that countries specialize in the products or services where they have the biggest productivity advantage – or the smallest productivity disadvantage. 14-19 Labor Costs in Manufacturing, 2009 14-20 Winners and Losers from Trade • While the theory of comparative advantage states that international trade will benefit an overall economy, some companies and individuals will be hurt. • The benefits from trade are broadly distributed: – The entire population benefits from lower prices for goods and services. – Countries that are open to trade tend to have a faster rate of economic growth, and living standards go up. 14-21 Winners and Losers from Trade • The losers from trade are those industries where imported goods and services displace domestically-produced goods and services and cost the country jobs. • This has been most prevalent in the manufacturing side of the economy, where much of the production has moved to Asia. • The job losses in manufacturing were, however, more than offset by gains in other sectors, such as healthcare and finance. • Globalization benefits people whose skills are relatively scarce in world markets. 14-22 Imports and Jobs 14-23 Arguments for Protection • While the evidence shows that international trade is beneficial to an economy, free trade is often attacked by politicians who believe it is harmful to many workers. • There are demands by these politicians for a return to protectionism. – That is, using tariffs, quotas, or other barriers to trade to protect domestic jobs. 14-24 Arguments for Protection • There are a number of arguments made for protectionism: – One argument against free trade is that it is disruptive in terms of people’s lives. • The cost of change can be both economic and social. • A factory moving out of a small town can leave the people without a livelihood. 14-25 Arguments for Protection – The infant industry argument is a second argument against free trade. • An infant industry is a new or developing industry in a country which is vulnerable to being put out of business by better-funded and more mature foreign competitors. • Given a chance to grow while protected, however, the new industry could be a viable global competitor. • In theory this argument makes sense, but in practice it rarely works since it reduces competition. 14-26 Arguments for Protection – Another argument for protectionism is unfair competition. • In this case, a foreign country subsidizes its exporting industries by lowering its taxes, offering them low-cost loans, or simply by giving them money. • Given this subsidy, the foreign industry can cut the price of their products in the global market. • As a result, the subsidized industries may obtain a bigger share of the global market. 14-27 Arguments for Protection – The final, and perhaps most compelling, argument for some form of protection is national security. • In the case of war, countries need to protect some of their defense-related production. • For example, specialty steel and advanced electronics need to be produced domestically. • A country needs to balance the economic benefits of trade against the potential vulnerabilities of a global supply chain in the case of war. 14-28 Exchange Rates • Almost every country has a national currency. • For trade to take place, one country’s currency must be converted to the other country’s currency. • The exchange rate is the rate at which one currency can be turned into another. • Exchange rates can be floating or pegged. – Floating rates are set in the foreign exchange markets, while pegged rates are managed by the country to remain fixed. 14-29 Exchange Rates • When an exchange rate changes so that one currency can buy more of another, we say the first currency is appreciating and the second currency is depreciating. • The chart on the next slide shows that the dollar is depreciating against the Chinese Yuan. 14-30 Exchange Rate of the Yuan versus the Dollar 14-31 Effects of Appreciation and Depreciation • When a currency depreciates, imports become more expensive, while exports become cheaper. – Imports should fall, exports should rise, and the trade deficit should become smaller. • When a currency appreciates, imports become cheaper, while exports become more expensive. – Imports should rise, exports should fall, and the trade deficit should become larger. 14-32 How Depreciation Works 14-33 Trade Balance • The trade balance is the difference between exports of goods and services and imports of goods and services. • If the trade balance is negative – that is, if imports exceed exports – we say that the country is running a trade deficit. • The U.S. trade deficit has increased significantly in recent years. 14-34 Goods and Services Trade Balance for U.S. 14-35 Explanations for the Trade Deficit • There are a number of possible explanations for the trade deficit: – First, it is our fault because: • U.S. manufacturers are unable to compete. • U.S. consumers are overspending, causing the deficit. • Overspending by the federal government is the cause. 14-36 Explanations for the Trade Deficit – Second, it is their fault because: • Foreign countries put up barriers that keep out U.S. exports and subsidize their own exports. – Finally, it is no one’s fault because: • The strength of the U.S. economy allows us to import more goods. • Other countries want to lend to the U.S. 14-37 Paying for Trade • The U.S. can pay for what we import in four ways: – Sell exports to foreigners. – Borrow money from foreign investors. – Sell assets such as stocks, bonds, and real estate to foreign investors. – Allow foreign companies to build factories in the U.S. 14-38