Economicsby David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch

TENTH EDITION

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Chapter 28International trade

Exports as % of GDPWorld trade has grown at an average annual rate of 8 % since 1950.

Between 1960 and 2009, UK exports as a fraction of GNP rose from 18% to 27%.

World exports are now around 20% of world GNP.

Source: OECD, Economic Outlook.

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Trade patterns, 1980 -2008 (% of world exports)

Destination

1980 2008

Developed Other Developed Other Origin

Developed 50 21 41 16

Countries

Other 21 8 24 19

Source: UNCTAD, Handbook of Statistics, 2009 (at www.unctad.org).

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As late as 1980, the developed countries were the origin and destination of 71% of world exports, most of this trade being among themselves. The rapid growth of emerging market economies and the economic liberalization of the former Soviet Union and Eastern Europe has changed this.

Merchandise trade patterns, 2008,(% of region’s exports)

The mature economies of Europe and North America and the Asian economies export mainly manufactures.

The Commonwealth of independent states (ex Soviet Union), Africa, and the Middle East mainly export oil and other minerals.

agriculture fuels, manufactures minerals World 8.5 22.5 66.5N. America 10.4 17 68Europe 9.3 11.9 76.8CIS 6.8 66.8 24.9Africa 6.8 70.6 17.9Middle East 2.4 74.1 21.6Asia 6 12.4 79.2

Sources: GATT, Networks of World Trade, 1955–76; www.wto.org.

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Some important issues• Raw materials prices

– Less-developed countries (LDCs) have claimed exploitation by industrial countries

• e.g. by buying raw materials cheaply & selling manufactures dear• Agricultural protection

– farmers in rich countries benefit from both subsidies and tariff protection.– LDCs lose by selling less – and with a restricted market, at lower prices

• Manufactured exports from LDCs– some LDCs have had success in exporting manufactures– leading to complaints that jobs are under threat in the industrial countries

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Some important issues (2)• Globalisation

– Lower transport costs and better information technology are gradually breaking down the segmentation of national markets and increasing competition between countries.

– A trend reinforced by a reduction in tariffs• A level playing field?

– Poor countries feel that the process is largely dictated by rich countries according to their own self-interest.

– Raising the demand for LDC exports, reducing agricultural protection in rich countries would help LDCs substantially. 

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Comparative advantage• Trade offers benefits when there are international

differences in the opportunity cost of goods.• Opportunity cost of a good

– the quantity of other goods sacrificed to make one more unit of that good

• The law of comparative advantage– states that countries should specialise in

producing and exporting the goods that they produce at a lower relative cost than other countries.

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The source of comparative advantage

• An important difference between countries is in factor endowments,

• which will be reflected in different relative factor prices– e.g. if country A has relatively abundant capital but

relatively scarce labour compared with country B,– then A would tend to specialize in capital-intensive goods,– and B would tend to specialize in labour-intensive

products.• Comparative advantage may also reflect a relative

advantage in technology.

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Gainers and losers• Countries may gain from specialisation and

trade – but not all countries may gain equally

• Commercial policy– is government policy that influences

international trade through taxes or subsidies•e.g. tariffs

– or through direct restrictions on imports and exports.

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The economic effects of a tariffDD and SS show the domestic demand and supply for a good.

If the world price is Pw,and there is free trade,

domestic firms supply Qs

domestic demand is Qd

A tariff can stimulate domesticsupply and restrict imports.

At a domestic price Pw+T,where T is the size of the tariff.

Domestic demand falls to Qd', domestic supply rises to Qs‘ and imports fall.

and the difference is imported.DD

SS

Quantity

Pri

ce

Pw

Qs Qd

Pw+T

Qs' Qd'

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Qs' Qd' Quantity

The government raisesrevenue – i.e. there is atransfer to the government,

There is a social cost from production inefficiency, given that thegood could be imported at Pw, and a loss of consumer surplus.

and there is a transfer in the form of extra profits to producers.

The welfare costs of a tariff

DD

SS

Pri

c e

Qs Qd

Pw+T

The tariff leads both to transfers and net social losses.

PwA B

A is the amount society spends by producing goods it could import more cheaply.

B is the excess of consumer benefits over social marginal cost that is lost. ©McGraw-Hill Companies, 2010

Tariffs• The deadweight burden of a tariff

suggests that society suffers from this method of restricting trade.

• This is the case for free trade.

• Tariffs have fallen substantially under the GATT

– General Agreement on Tariffs and Trade

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The case for tariffs – good arguments

• Optimal tariff– a first-best argument– only valid where the importing country is large

enough to affect the world price.• This policy fulfils the principle of targeting

– which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly.

– Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities.

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The case for tariffs – second-best arguments

• Way of life– an attempt to preserve ‘traditional’

ways– a production subsidy would be better

• Suppressing luxuries– an attempt to curb consumption

patterns of the rich in a poor society– better achieved by a consumption tax

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The case for tariffs – second-best arguments (2)

• Infant industries– an attempt to nurture new activities via

learning by doing– a temporary production subsidy probably

better• Revenue

– tariffs raise government revenue– but there are better ways

• Cheap foreign labour– a non-argument – denies benefits of

comparative advantage

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Other commercial policies• Although tariff rates have fallen under

GATT, there has been a proliferation of other trade restrictions– quotas– non-tariff barriers

•administrative regulations that discriminate against foreign goods

– export subsidies

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Social costs arise fromproduction inefficiency

and the loss of consumer surplus.

An export subsidy

DD

S

Quantity

Pri

ce

Pw Worldprice

Under free trade, with the world price at Pw,

Qd

consumers demand Qd

Qs

production is Qs

exports are GE.G E Subsidy

With a subsidy, producersproduce Qs’ and supply Qd' tothe domestic market.

Pw+ s

Qd' Q`s'

Exports now rise to AB.

A B

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