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Chapter 21
INTERNATIONAL TRADE
POLICY, COMPARATIVE
ADVANTAGE, AND
OUTSOURCING
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21-2
Today’s lecture will:
• Present some important data of
•
•
•
trade.
Explain the principle of comparative
advantage.
Discuss three determinants of the
terms of trade.
Explain why economists’ and
laypeople’s views of outsourcing
differ.
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21-3
Today’s lecture will:
• Explain why the U.S. is losing some
•
•
•
of its comparative advantage.
Discuss three policies countries use
to restrict trade.
Explain why economists generally
oppose trade restrictions.
Explain how free trade associations
both help and hinder international
trade.
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21-4
Increasing but
Fluctuating World Trade
• World trade was 50% of GDP in 1928,
•
•
20% in 1950 and 200% today.
World trade fluctuates as world
output and trade restrictions change.
The importance of trade differs
among nations.
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21-5
Differences in the
Importance of Trade
Total Output Export Ratio Import Ratio
Netherlands
$ 461
62%
57%
959
44%
40%
Germany
2,271
36%
32%
Italy
1,550
27%
26%
France
1,661
27%
25%
United Kingdom
1,666
26%
28%
Japan
3,582
11%
10%
11,000
10%
14%
Canada
United States
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21-6
What and With Whom
the U.S. Trades
• The majority of U.S. exports and
•
•
imports involve manufactured goods.
The primary trading partners of the
U.S. are Canada, Mexico, the
European Union, and Pacific Rim
countries.
U.S. imports have exceeded exports
in recent years.
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U.S. Exports by Region, 2004
OPEC 3%
Central and
South America 7%
Canada 23%
Other 6%
Pacific Rim
26%
Mexico 14%
European
Union 21%
Total = $819 billion
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U.S. Imports by Region, 2004
Central and
South America 7%
OPEC 6%
Other 6%
Canada 17%
Mexico 11%
Pacific Rim
33%
European
Union 19%
Total = $1,470 billion
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21-9
The Changing Nature of Trade
• The nature of trade is continually changing
•
•
both in terms of countries with which we trade
and the goods and services traded.
U.S. imports from China, India, and other East
Asian countries have recently increased
substantially.
Previously we imported manufactured goods
and raw materials from these countries; today
we import high tech manufactured goods.
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21-10
The Changing Nature of Trade
• As technological changes in
•
•
telecommunications reduce costs,
foreign countries will be able to
provide more services.
Customer service calls for U.S.
companies are often answered in
India.
This trade in services is often called
outsourcing.
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21-11
Is Chinese and Indian Outsourcing
Different that Previous Outsourcing?
• Using overseas suppliers is not a new
•
•
development in trade.
The difference is the potential size of
outsourcing to India and China with
combined populations of 2.5 billion
educated people.
Because technology is growing in these
countries, the U.S. economy must develop
new technologies to remain competitive.
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21-12
Balance of Trade
• Balance of trade – the difference between the
value of exports and the value of imports.
 Trade deficit – imports > exports
 Trade surplus – exports > imports
• The U.S. has a significant trade deficit of
•
approximately 5% of GDP.
The U.S. is financing its trade deficit by selling
off financial assets, stocks and bonds, and real
assets, corporations and real estate.
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21-13
The Principle of
Comparative Advantage
• The principle of comparative
•
advantage states that as long as the
relative opportunity costs of
producing goods differ among
nations, there are potential gains
from trade.
Some of the gains from trade will go
to traders who facilitate trade.
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21-14
Comparative Advantage:
Saudi Arabia and the U.S.
Saudi Arabia
U.S.
Oil
140
120
100
Oil
The U.S. has a
comparative advantage
in food because it can
produce 10 times as
much food as oil.
1000
800
The U.S. should
produce 1000 tons
of food.
A
B
80
C
60
D
400
F
F
200
400
600 800
Food
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Saudi Arabia
should produce
1000 barrels of oil.
600
200
E
20
C
E
D
40
Saudi Arabia has a
comparative advantage
A
in oil because it can
produce 10 times as
B much oil as food.
1000
20 40 60 80
100 120
140
Food
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21-15
The Gains from Trade
•
•
•
A trader, I.T., arranges for Saudi Arabia to trade 500 barrels of
oil to the U.S. for 120 tons of food.
The U.S. will trade 500 tons of food to Saudi Arabia for 120
barrels of oil.
I.T., the trader keeps 380 barrels of oil and 380 tons of food.
Production
Consumption
S.A. U.S. S.A. U.S.
Oil (barrels) 1000
Food (tons)
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0
0
I.T.
500
120
380
1000 120
500
380
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21-16
The Gains from Trade
U.S.
Oil
140
120
100
After trade the U.S. is
consuming 120 barrels
of oil and 500 tons of
food, point H, beyond its
original production
possibilities.
A
Saudi Arabia
Oil
1000
A
B
800
C
H
After trade Saudi Arabia
is consuming 500
barrels of oil and 120
tons of food, point G,
beyond its original
production possibilities.
600
B
D
80
400
C
60
D
40
E
200
E
20
F
200
400
600 800
Food
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G
F
1000
20 40 60 80
100 120
140
Food
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21-17
Dividing up the Gains from Trade
• The more the competition, the less
•
•
the trader gets.
Smaller nations get a larger
proportion of the gain than larger
nations.
Nations producing goods with
economies of scale get a larger gain
from trade.
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21-18
Comparative Advantage
in Today’s Economy
• If trade is good, why do so many people
oppose it?
 The gains of trade, lower prices, are harder
to see than the cost, lost jobs.
 The public believes that lower wages in other
countries give them the comparative
advantage in everything, so we will lose all
jobs.
 Laypeople usually think of trade only in
manufactured goods.
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Comparative Advantage
in Today’s Economy
• The U.S. has the comparative advantage in
•
•
facilitating trade, which generates jobs in the
U.S. in research, management, advertising, and
the distribution of goods.
Trade increases income abroad, increasing
demand for U.S. exports.
The concentrated nature of the costs of trade
and the dispersed nature of benefits present a
challenge to policy makers.
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21-20
Other Sources of U.S.
Comparative Advantage
• Skills of the U.S. labor force make it highly
productive.
• U.S. government institutions are stable and
relatively non-corrupt.
• U.S. physical and technological infrastructure
is the best in the world.
• English is the international language of
business.
• Wealth from past production makes the U.S.
the world’s largest consumer.
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21-21
Other Sources of U.S.
Comparative Advantage
• The U.S. has many natural resources.
• Cachet – the U.S. is a cultural trendsetter.
• Inertia – the current place of production has
•
•
an advantage over other potential places
because it is familiar.
U.S. companies hold a large number of
intellectual property rights.
The U.S. has a relative open immigration
policy.
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21-22
Inherent and Transferable
Comparative Advantage
• Inherent comparative advantages –
•
•
comparative advantages based on factors
that are relatively unchangeable, such as
resources and climate.
Transferable comparative advantages –
comparative advantages based on factors
that can change relatively easily, such as
capital, technology, and types of labor.
Whether a country can maintain a much
higher standard of living in the long run
depends in part on whether its comparative
advantage is inherent or transferable.
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21-23
The Law of One Price
• The law of one price – in a competitive market
•
•
there will be pressure for equal factors to be
priced equally.
If factor prices aren’t equal, firms reduce costs
by reorganizing production in countries with
lower factor prices.
Convergence hypothesis – the tendency of
economic forces to eliminate transferable
comparative advantage.
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21-24
Methods of Equalizing
Trade Balances
• Adjustments eventually occur to
•
•
make surplus countries less
competitive and deficit countries
more competitive.
Wages rise in the surplus countries,
making their goods more expensive.
The exchange rate of the deficit
country falls and makes its goods
less expensive.
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21-25
Varieties of Trade Restrictions
• Tariffs
• Quotas
• Voluntary restraint agreements
• Embargoes
• Regulatory trade restrictions
• Nationalistic appeals
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21-26
Tariffs
• Tariffs (customs duties) are taxes governments
•
•
•
place on internationally traded goods,
encouraging the consumption of domestic
goods.
The Smoot-Hawley Act of 1930 raised tariffs to
60%, causing other countries to respond with
similar trade restrictions.
General Agreement on Tariffs and Trade
(GATT) was established in 1947 to reduce trade
barriers.
The World Trade Organization (WTO) was
established in 1995 to promote free and fair
trade.
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Quotas
• Quotas are quantity limits placed on
•
•
•
imports.
Both tariffs and quotas increase
price and reduce quantity.
Under a tariff, the government
collects the tariff revenue.
With a quota, the domestic price
increases, and the importer, not the
government, gets the revenue.
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21-28
Tariffs When the Domestic
Country is Small
Price
Domestic
supply
$3.00
World price with
tariff = $2.50
2.50
t = $.50
Tariff revenue
World price = $2
2.00
Initial
imports
100
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125
175
Domestic
demand
200 Quantity
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21-29
Quotas When the Domestic
Country is Small
Domestic
supply
Price
World
supply with
quota
$3.00
2.50
World price=$2=
World supply
2.00
Domestic
demand
Quota
100
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125
175
200 Quantity
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21-30
Voluntary Trade Agreements
• Voluntary trade agreements are
•
•
agreements to limit exports.
To avoid the imposition of new tariffs
on their goods, countries often
voluntarily restrict their exports.
The quantity of imports decreases
and the price of the good increases,
helping domestic producers.
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21-31
Embargoes
• An embargo is a total restriction on
•
•
import or export of a good.
Embargoes are usually established
for international political reasons
rather than for economic reasons.
The U.S. has imposed embargoes on
Iraq, Iran, Libya, and Cuba.
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Regulatory Trade Restrictions
and Nationalistic Appeals
• Regulatory trade restrictions are
•
•
government-imposed procedural rules
that limit imports.
Some regulatory restrictions are
legitimate, but others are designed
simply to make importing more difficult.
Nationalistic appeals, such as the “Buy
American” campaign are also intended to
limit trade.
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21-33
Reasons for Trade Restrictions
• Unequal internal distribution of the trade gains
• Haggling by companies over the trade gains
• Haggling by countries over trade restrictions
• Specializing production: learning by doing and
•
•
•
•
economies of scale
Macroeconomic aspects of trade
National security
International politics
Increased revenue from tariffs
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21-34
Unequal Distribution of Trade Gains
• Benefits of trade are generally widely
•
•
spread among the entire population, but
costs often fall on specific small groups.
Setting up tariffs or quotas to save
domestic jobs costs the economy money.
Governments may institute trade
adjustment assistance programs –
programs designed to compensate losers
for reductions in trade restrictions.
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21-35
Why Economists Generally
Oppose Trade Restrictions
• Free trade increases total output
•
•
•
globally.
International trade provides
competition for domestic companies.
Restrictions based of national
security are often abused or evaded.
Trade restrictions are addictive.
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21-36
Institutions Supporting Free Trade
• Free trade associations – groups of nations that
•
•
allow free trade among its members and put up
trade barriers against all other nations.
The European Union (EU) and the North
American Free Trade Association (NAFTA) are
examples.
Countries strengthen trading relationships with
most-favored nation status – those countries
will be charged as low a tariff on its exports as
any other country.
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Summary
• The nature of trade is continually changing.
• The U.S. is importing more and more high-tech
•
•
goods and services from India and China and
other East Asian countries.
Outsourcing, a form of trade, is a larger
phenomenon today compared to 30 years ago
because the countries where jobs are
outsourced – China and India – are much
larger.
According to the principle of comparative
advantage, as long as the relative opportunity
costs of producing goods differ among
countries, there are potential gains from trade.
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21-38
Summary
• The more competition exists in international
•
•
•
trade, the less the trader gets and the more the
involved countries get.
Once competition prevails, smaller countries
tend to get a larger percentage of the gains
from trade than do larger countries.
Gains from trade go to countries that produce
goods that exhibit economies of scale.
The gain from trade in the form of low
consumer prices tend to be widespread and not
easily recognized, while the costs in jobs lost
tend to be concentrated and readily identifiable.
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21-39
Summary
• The United States has comparative advantages
•
•
due to its skilled workforce, its institutions, and
its language, among other things.
The U.S. established comparative advantages
during the two world wars, which is slowly
eroding.
Trade restrictions include tariffs and quotas,
embargoes, voluntary restraint agreements,
regulatory trade restrictions, and nationalistic
appeals.
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21-40
Summary
• Economists generally oppose trade restrictions
•
•
because of the history of trade restrictions and
their understanding of the advantages of free
trade.
The World Trade Organization is an
international organization committed to
reducing trade barriers.
Free trade associations, such as the European
Union, help trade by reducing barriers to trade
among member nations.
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21-41
Review Question 21-1 Suppose that using all of their resources,
South Carolina can produce 90 tons of apples or 30 tons of peaches
in a day. Washington can produce 120 tons of apples or 15 tons of
peaches in a day. Can these states benefit from trade? If so, explain
why.
According to the principle of comparative advantage, these states
can benefit from trade. Washington should specialize in apples
because they can produce 8 times as many apples as peaches and
South Carolina should produce peaches because they can only
produce 3 times as many apples as peaches.
Review Question 21-2 Explain the adjustments that will eventually
occur in countries that have persistent trade deficits.
Deficits occur because imports are greater than exports. Wages in
the deficit country will eventually fall relative to wages in surplus
countries, causing costs and then prices of that country’s goods and
services to decrease and exports increase. Exchange rates in the
deficit country may fall, making their products cheaper in foreign
countries.
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