International Trade and Economic Development

Chapter 15

CHAPTER 15: SECTION 1

International TradeWhy Do People in Different Countries Trade with Each

Other?

Individuals trade to make themselves better off.

Some countries are able to produce certain goods that other countries either cannot produce or can produce only at extremely high costs.

What Are Exports and Imports?

Trade between countries consists of exporting and importing goods.

• An export is a good that is produced in the domestic country and sold to residents of a foreign country.

• An import is a good produced in a foreign country that is purchased by residents of the domestic country.

Between 1980 and 2005, the value of U.S. exports and imports generally increased.

• Exports increased by more than 400 percent, from just over $200 billion to just under $900 billion.

• Imports increased by more than 600 percent, from about $250 billion to about $1,600 billion.

The Value of U.S. Imports and Exports, 1980–2005

Balance of Trade

A country’s balance of trade is the difference between the value of a country’s exports and the value of its imports.

If a country has a positive balance of trade, it is said to have a trade surplus.

A country with a negative balance of trade is said to have a trade deficit.

Absolute and Comparative Advantage

A country has an absolute advantage in the production of a good when it can produce more of a good than another country can produce with the same quantity of resources.

Countries tend to specialize, or do only one thing. A country will specialize in the production of the good, or goods, that it can produce for less than other countries.

A country has a comparative advantage when it can produce a good at a lower opportunity cost than another country.

Benefits of Specialization and Trade

Countries can have more of a good if they specialize in producing goods for which they have a comparative advantage. They can then trade some of these goods for other goods. With specialization and trade, they can make themselves better off.

For example, let’s consider two cases for Japan and the United States.

• In the first case, neither country specializes and neither country trades. Both countries have only what they produce. In this case, Japan has less food and more clothing than it needs. The United States has the opposite—more food and less clothing.

The Benefits of Specialization and Trade

In the second case, each country specializes in producing the good for which it has a comparative advantage. Japan produces only clothing, and the United States produces only food. Then the countries trade some of their goods. Both countries end up with more of the goods they need.

Outsourcing and Offshoring

The term outsourcing describes work done for a company by another company or by people other than the original company’s employees.

When a company outsources certain work to individuals in another country, it is said to be engaged in offshoring.

Some jobs are lost in offshoring.

Offshoring is simply people producing a good or service at a lower cost than other people. It is comparative advantage at work.

The Costs of Offshoring Are Easier to See than the Benefits

We often see news reports about people who lose their jobs owing to offshoring.

At the same time, some foreign companies are offshoring jobs to the United States.

Lower prices result from offshoring. However, steady increases in the money supply (inflation) eat up much of the benefit.

CHAPTER 15: SECTION 2

Trade RestrictionsTrade Restrictions: Tariffs and Quotas

A tariff is a tax on imports.

A quota is a legal limit on the amount of a good that may be imported.

Both tariffs and quotas raise the price of imported goods to the U.S. consumer.

The U.S. Government and Producer Interests

Why does the government impose tariffs and quotas if they result in higher prices for U.S. consumers?

Government is sometimes more interested in producer interests. A producer has more to gain by eliminating foreign competitors, and will lobby the government to implement tariffs and quotas. The costs to consumers are relatively less than the benefits received by producers.

Tariffs and the Great Depression

The Smoot-Hawley Tariff Act proposed substantially higher tariffs on many imported goods.It was thought that with higher tariffs, Americans would buy fewer imports and more domestic goods. Some believed that this would be good for the country.

The expectation of this act being signed into law may have led to the sharp decline in the stock market in 1929. Some say this decline was the start of the Great Depression.

Many economists today believe that the act also made the Great Depression last longer than it would have otherwise.

Arguments for Trade Restrictions

Responding to producer interests is only one of the reasons governments restrict trade. They also restrict trade for other reasons.

The national-defense argument states that certain industries are necessary to the national defense and therefore should be protected from foreign competition.

The infant-industry argument states that new industries often need to be protected from older, more established foreign competitors until the new industries are mature enough to compete on an equal basis. However, removing the protection in the future is difficult.

Dumping is the sale of goods abroad at prices below their costs and below the prices charged in domestic (home) markets. Critics of dumping say that dumpers seek only to get into a market, drive out competitors, and then raise prices.

• Do consumers benefit from lower prices as a result of dumping practices? Some economists argue that once dumpers raise their prices, competitors will return. The dumpers will have experienced only a string of losses.

The low-foreign-wages argument states that U.S. producers cannot compete with low wages in foreign countries.

• For example, it may seem obvious that producers in Australia cannot compete with producers in South Korea. After all, in 2003, production workers made $20.05 per hour in Australia, compared with $10.28 in South Korea.

• However, this argument overlooks one possible reason that wages are high in some countries and low in others: productivity. Suppose workers in Australia were four times more productive than workers in South Korea. Then the cost for each unit of a good produced in Australia would be about half the cost of the same good produced in South Korea.

Average Hourly Compensation

Hourly compensation includes wages, bonuses, vacations, holidays, insurance, health benefits, and more.

• Some people argue that if a foreign country uses tariffs or quotas against U.S. goods, the United States ought to apply equal tariffs and quotas against that country in hopes of reducing or eliminating its trade restrictions.

• This has the potential to turn into a trade war, with tariffs and quotas being placed on many items and the cost of goods increasing.

International Economic Integration

Economic integration is the combining of nations to form either a common market or a free trade area.

• In a common market, member nations trade without restrictions, and all share the same trade barriers with the outside world.

• A major common market is the European Union (EU), which consists of 25 countries.

• In a free trade area, trade barriers among the member countries are eliminated, and each country is allowed to set its own trade rules with the rest of the world.

• A major free trade area created by the North American Free Trade Agreement (NAFTA) includes Canada, Mexico, and the United States. NAFTA took effect in 1994.

International Organizations

Many economists predict that countries are likely to join in common markets and free trade areas in the near future.

Countries of the world are finding that it is in their best interests to lower trade barriers between themselves and their neighbors.

The World Trade Organization (WTO) provides a forum for its member countries to discuss and negotiate trade issues.

The World Bank, officially known as the International Bank for Reconstruction and Development (IBRD), lends money to the world’s poor and less-developed countries.

The International Monetary Fund (IMF) is an international organization that provides economic advice and temporary funds to nations with economic difficulties.

CHAPTER 15: SECTION 3

The Exchange Rate

What Is an Exchange Rate?

The exchange rate is the price of one country’s currency in terms of another country’s currency.

• With a flexible exchange rate system, currency exchange rates are determined by the forces of supply and demand.

• In a fixed exchange rate system, currency exchange rates are fixed, or pegged, by countries’ governments.

To find out how much of your money you have to pay to buy a foreign good, you need to follow three steps:

1. Find the current exchange rate. For example, on October 28, 2005, it took €0.82 to buy $1 U.S.

2. Figure out how much of your money it takes to buy one unit of the foreign money. For the example, you divide $1 by €0.82, which gives you $1.22.

3. Multiply the price of the foreign good by the answer in step 2. Suppose you want to buy something that costs €100. You multiply 100 by $1.22, and you get $122.

Exchange Rates

Appreciation and Depreciation

Depreciation is a decrease in the value of one currency relative to other currencies.

Appreciation is an increase in the value of one currency relative to other currencies.

If the Dollar Depreciates, Foreign Goods Are More Expensive

What will happen to the price of a foreign good if the dollar depreciates? (Answer: The price will go up.)

What will happen to the price of a foreign good if the dollar appreciates? (Answer: The price will go down.)

CHAPTER 15: SECTION 4

Economic DevelopmentHow Countries Are Classified

A developed country, such as the United States, has a relatively high per capita GDP.

A less-developed country has a relatively low per capita GDP.

Obstacles to Economic Development

Why are some countries poor while other countries are rich?

The population growth rate is equal to the birthrate minus the death rate. The population growth rate is typically higher in less-developed countries.

A low savings rate leaves banks with less money to lend, and capital goods cannot be purchased to improve productivity. This situation is called the vicious circle of poverty. Many nations that are rich today, however, were poor in the past.

Cultural differences may pose a barrier to economic development. Change may be viewed as dangerous or risky, or good fortune may be left to fate instead of education and hard work.

Political instability and government seizure of personal property reduce personal investment.

Countries with low tax rates tend to have higher per capita income growth.

Factors That Aid Growth and Development

Economists believe that a poor country has the potential to become a rich country if it does the following things:

• Promotes free trade. Free trade allows residents of a country to buy inputs from the cheapest supplier, and opens up a world market to domestic firms.

• Taxes at a lower rate. A country with lower taxation provides a greater incentive for workers to work, and provides more incentive for investors to invest.

• Reduces or eliminates restrictions on foreign investment.

• Reduces government influence on bank lending activity.

• Allows the free market to determine equilibrium prices and wages.

• Establishes simple and easy business licensing requirements.

• Protects private property. Countries that protect private property often develop faster than those that do not.