Chapter 32 International Trade 32-1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved

Chapter 32

International Trade

32-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• Specialization and trade

• Domestic exchange equations

• Absolute advantage and comparative advantage

• Tariffs or quotas


Chapter Objectives

• The causes of our trade imbalance

• What can we do to restore our balance of trade?

• Our trade deficits with Japan and China

• U.S. Trade policy: A historical view


U.S. Trade before 1975

• We ran trade surpluses before 1975 and have run trade deficits since

• We faced increasing trade competition in the 1960s

• We have been running large and growing trade surpluses on services and growing trade deficits on goods


U.S. Tariffs, 1820-2000


1840 1860 1880 1900 1920Year

1940 1960 1980 20001820

70

60

50

40

30

20

10

A Century of High Protective Tariffs

• Initially the tariff was purely a revenue-raising device

• After the War of 1812 the tariff took on a protective tinge

• During the great depression, virtually every industrial power raised its tariffs to keep out foreign goods– This caused world trade to dwindle to a fraction of

what it had been and probably made the depression a lot worse


International Trade

• Recent years have seen a growing consensus in the United States that we need more import protection

• Economic reasoning, however, argues strongly for free trade


Specialization and Trade

• Specialization is the basis for international trade– Country A specializes in making the

products that it can make most cheaply; Country B does the same

– When they trade, each country will be better off than they would if they didn’t specialize and trade


Production Possibilities Curves


C

B

A

D

E

A. United States

VCRs

10

10

20

20

30

30

40

40

50

60

70

80

H

G

F

I

J

B. South Korea

VCRs

10

20

30

10 20 30 40

40

50 60 70 80

The U.S. has to give up 20 copiers to get 10 VCRs

2 copiers = 1 VCR

To get 10 copiers South Korea has to give up 20 VCRs

1 copier = 2 VCRs

Domestic Exchange Equations


U.S. 2 copiers = 1 VCR

S.K. 1 copier = 2 VCRs

Instinct tells us that it that it would be best for each country to produce what it does best and to trade with the other

Domestic Exchange Equations


U.S. 2 copiers = 1 VCR


Obviously the U.S. would be unwilling to trade more than two copiers for one VCR. However, if S.K. offered more than 1 VCR for 2 copiers this would be a better deal

If the U.S. used its resources to produce 2 copiers and trade them for more than 1 VCR it would be better off than it would have been using the same resources to produce just 1 VCR

Obviously, S.K. would be unwilling to trade 2 VCRs for anything less than 1 copier. If S.K. could trade 2 VCRs and get more than one copier in exchange it would be better off making VCRs and trading some of them for copiers

Two General Observations

• No nation will engage in trade with another nation unless it will gain by that trade

• The terms of the trade will fall somewhere between the domestic exchange equations of the two trading nations


Trade Possibilities Curves


B

C

D

A. United States

VCRs

Tradepossibilitiescurve

Productionpossibilitiescurve

10 20 30 40 50 60 70 80

80

70

60

50

40

30

20

10

A

K

E

I

G

H

J

B. South Korea

VCRs

L

Tradepossibilitiescurve

Productionpossibilitiescurve

10 20 30 40 50 60 70 80

80

70

60

50

40

30

20

10

F

Point C = 40 copiers and 20 VCRs Assume Point A = 80 copiers At Point K = 50 copiers and 30 VCRs We produced 80 copiers and traded 30 of the them for VCRs Ended up with 50 copiers and 30 VCRs

Point H = 40 VCRs and 20 copiers Instead South Korea produces 80 VCRs and sells 30 VCRs for 30 copiers Ended up with 50 VCR and 30 copiers

Absolute Advantage

• Absolute advantage is the ability of a country to produce a good or service at a lower cost than its trading partners– In the previous example, the bottom line is that

Americans can buy South Korean VCRs at half the price that American producers would charge

– Thus the south Koreans have an absolute advantage in making VCRs

• They are better at making VCRs than we are


Comparative AdvantageU.S. 2 copiers = 1 VCR


• In the U.S. the opportunity cost of producing 1 VCR is 2 copiers

• In S.K. the opportunity cost of 1 VCR is ½ of one copier

• The opportunity cost of producing VCRs is lower in S.K

• Likewise, the opportunity cost of producing copiers is lower in the U.S.


Comparative Advantage• In the U.S. the opportunity cost of producing 1

VCR is 2 copiers• In S.K. the opportunity cost of 1 VCR is ½ of

one copier• The opportunity cost of producing VCRs is

lower in S.K• Likewise, the opportunity cost of producing

copiers is lower in the U.S.• The law of comparative advantage states that

total output is greatest when each product is made by the country that has the lowest opportunity cost


Absolute Advantage versus Comparative Advantage

• You can’t compare absolute advantage and comparative advantage any more than you can compare apples and oranges

• Absolute advantage is a comparison of the cost of production in two different countries

• Comparative advantage states that total output is greatest when each product is made by the country that has the lowest opportunity cost


Absolute Advantage versus Comparative Advantage

• As long as the relative opportunity costs of producing goods differ among nations, there are potential gains from trade even if one country has an absolute advantage in producing everything

• Therefore absolute advantage is not necessary for trade to take place but comparative advantage is


The Arguments for Protection• As America continues to hemorrhage

manufacturing jobs, there is a growing outcry for protections against the flood of imports– But Americans, as consumers, are virtually addicted

to these imports– How do we justify excluding so many things that

Americans want to buy?

• There are four main arguments for protection– Each seems plausible and strikes a responsive chord

in the minds of the American public– Closer scrutiny will reveal that all four arguments

are essentially pleas by special interest groups for protection against more efficient competitors


Four Main Arguments for Protection

• The National Security Argument

• The Infant Industry Argument

• The Low-Wage Argument

• The Employment Argument


The National Security Argument

• Our dependence on foreign suppliers could make us vulnerable in time of war– It is possible that we need to maintain

certain defense-related industries– What if we depended on foreign suppliers

for critical components of entire weapons systems?

– The continued spread of nuclear arms technology may soon make the national security argument much more relevant


The Infant Industry Argument

• American products are no longer produced by infant industries being swamped by foreign giants

• About the best that can be said is that some of our infant industries never matured while others have evolved into senility– Textiles, steel, clothing, and automobiles may be in

the senile category

• It is sometime argued that technological change may cause a grown-up industry to need temporary protection from foreign competition


The Low-Wage Argument• How can American workers compete with

foreigners who are paid sweatshop wages in labor intensive industries?– There is no reason for American firms to

compete with foreign firms in these industries

– We should import labor intensive goods and produce goods and services in which we can excel and compete

– We should use the proceeds to buy the goods and services produced by people who are forced to work for very low wages


The Employment Argument

• Hasn’t the flood of imports thrown millions of Americans out out work?– But if we restrict imports, the governments of our foreign

competitors will restrict our exports

– By curbing imports, we will be depriving other nations of the earnings they need to buy our exports

– If we restrict our imports, our exports will go down too• We would just lose the jobs connected with these lost exports

• Which would be best? Lose the jobs of workers who work for companies who can’t or won’t compete or lose the jobs of workers who work for companies who can compete but can’t export their products because of restrictions we ourselves caused?


Tariffs or Quotas• A tariff is a tax on imports

– The government gets the resulting revenue

– A tariff affects all foreign sellers equally. Efficient foreign producers will be able to pay a uniform tariff. Less efficient producers will not

• A quota is a limit on the import of certain goods– Import quotas produce no federal revenues

– Imports quotas are directed against particular sellers on an arbitrary basis

– Arbitrary quotas may allow relatively inefficient producers in and keep out more efficient producers


Tariffs or Quotas

• A tariff, like any other excise tax, causes a decrease in supply

• Both tariffs and quotas raise the price that consumers in the importing countries must pay

• Tariffs are better than quotas

• But free trade is best


Export Subsidies

• Several countries subsidize their export industries– This makes their products cheaper– Many Americans complain that this gives

foreign competitors an “unfair advantage”– Subsidies are a relatively minor expedient in

the United States


Conclusion• Economics is all about the efficient allocation of

scarce resources• There is no reason why this efficient allocation

of resources should not be applied beyond national boundaries

• International trade helps every country• To the degree that we can remove the tariffs,

import quotas, and other impediments to free trade we will all be better off

• The economics profession nearly unanimously backs free trade


Our Balance of Trade

• Our balance of trade compares the dollar value of the merchandise and services we buy from foreigners with the dollar value of the merchandise and services they buy from us

• Our balance of trade is our country’s record of all transactions between its residents and the residents of all foreign nations


What Are the Causes of Our Trade Imbalance

• We have been losing market share both at home and abroad

• The biggest culprits are our oil bill and our deficits with Japan and China



• The Rise of the Dollar– A rising dollar makes our exports more expensive

and our imports cheaper

• Our Low Saving Rate– Americans have become notoriously poor savers

averaging less than 5% of their disposable income since the mid-1980s

– If you don’t save, you can’t invest and thus grow– American business firms have been left with one

choice, borrow from foreigners• Foreigners have come here only because of our high

interest rates



• The High Cost of Capital– Mainly because of our low savings rate and partly

because of the huge federal budget deficits, high interest rates have discouraged investment in plant and equipment as well as in technological innovation

• High Defense Spending– The defense expenditures of the United States have

dwarfed those of every other industrial power

– In a time of diminishing military tension, should we be diverting our dollars to defense from areas where they could be used more productively?



• Our Failing Educational System– The American educational system, once second to

none, is now second to practically everyone• About one-third of all college freshman need remedial

work in reading, writing, and arithmetic

• This is why we used to go to K through 12

• Almost every college has special classes for students unprepared to do college work

• One million new functional illiterates every year are not exactly job candidates for today’s high tech economy



• The Role of Multinationals– Since the 1960s multinational corporations began to

move their manufacturing operations abroad to take advantage of lower wages available in low wage countries

– Capital has long been much more mobile than labor, and that capital has been flowing very rapidly to low wage nations

– Our import business is dominated by our own multinational corporations that have shifted their production overseas and put their name on the goods that are produced in other nations



• Since 1995 we have had one of the highest rates of economic growth of any industrial nation– Countries with high economic growth rates

import more goods and services than they would if they had low growth rates

– At the same time demand for U.S. exports has been lagging due to low growth rates in other industrial nations


What Can We Do?

• Devalue the dollar—which would make our exports cheaper while imports would become more expensive– We need to put a lid on consumption– We need to save more– We need to bring back the tax-free IRA– We need to decrease defense spending– We need to really educate our workforce– We need protectionist legislation if our foreign

competitors are, in fact, dumping goods below cost on our shores


U.S. Trade Deficit With Japan and China


1990 1991 1992 1993 1994 1995 1996 1997

60

50

40

30

20

10

1998 1999 2000

80

Japa

nChi

na

70

Japanese Trading Practices• Japanese dumping (selling many of their

products below cost) is driving out American competitors

• The fundamental difference between ourselves and the Japanese is quality– Better quality also means lower prices

• We sell Japan agricultural products and buy manufactured products from them– This is a colonial relationship

• The Japanese picks winners and then makes sure they win


Japanese Trading Practices• The Japanese consumer has long accepted a

lower standard of living because it was necessary for the greater economic good– They are willing to pay more for goods they produce

when they could have them cheaper if they imported the same good

– Can you imagine Americans being willing to make that kind of sacrifice

• Americans would not stand for restricting Japanese imports because they are addicted to Japanese goods


Our Trade Deficit With China

• We began trading with China in the mid-1970s• Although exports to China have grown rapidly,

our exports are only about one-quarter of our imports

• We import so much from China because U.S. retailers are seeking the cheapest goods available and are finding them in China

• The Chinese are making unauthorized copies of American movies, CDs, and computer software


Trading with China and Japan

• There are more differences than similarities– Our trading position with Japan is much like

a colony and a colonial power– We send airplanes, computers, movies,

compact disk, cars, cigarettes, power-generating equipment, and computer software to China in exchange for toys, clothing, shoes, and low-end consumer electronics



• Japan has never been open to foreign direct investment

• China has been open to foreign direct investment since the mid-1980s

• Japanese gains in production have led directly to the loss of millions of well-paying American jobs

• Chinese exports so far have generally not translated into job losses in the United States



• The Chinese and the Japanese both insist on licensing agreements and large-scale transfer of technology as the price for agreeing to imports

• These agreements, of course, lead to eventual elimination of imports from the United States



Murray Weidenbaum

“We are consuming more than we are producing, borrowing more than we are saving, and spending more than we are earning”

-

A Final Word

• Reducing Our Overall Trade Deficit– We need to maintain our high rate of productivity

growth and keep improving the quality of American goods and services

– We need to lower our dependence on oil imports by raising the tax on gasoline

– We need, somehow, to reduce our trade deficit with Japan

– We need to do something about our rapidly rising trade deficit with China


Documents

Chapter 32 International Trade 32-1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved