Lecture 4 Econ Case-For Trade

7/29/2019 Lecture 4 Econ Case-For Trade

1/21

International Political Economy #4

The Economic Case for Trade

William Kindred Winecoff

Indiana University Bloomington

September 10, 2013

W. K. Winecoff | IPE #4: Economics of Trade 1/19
http://find/


2/21

The Bargain

No more gold standard; instead a dollar standard with the $ pegged to

gold.

US holds veto power in IMF.

US funds reconstruction, first via the Marshall Plan and later via World

Bank.

Capitalism becomes inextricably linked with democracy ever since, butthis is historically a new phenomenon.

Democratic peace.

Capitalist peace.

The geopolitical goal: foster interconnectedness with the US at thecore of the system that is governed by institutions that the US could

influence in order to preserve global capitalism.

Europes goal: keep the Russians out, the Germans down, and the US

in. US was willing to acquiesce... on its terms.

http://find/http://goback/


3/21

Why Trade?

The postwar system was designed to facilitate trade.

Capital flows were actually heavily restricted: not laissez-faire.

Trade, it was thought, could serve two purposes:1 Rebuild the postwar economy and improve standards of living.

2 Foster a cooperative rather than competitive international

politics.

Well spend more time on #2 later; today well focus on #1.

http://find/


4/21

The General Idea

Imagine your life as it exists.

http://find/


5/21

The General Idea


Now imagine it if you had to produce everything you consume yourself.

http://find/


6/21

The General Idea


Now imagine it if you had to produce everything you consume yourself.

That, in a nutshell, is the economic case for trade.

That doesnt seem to so contentious, but historically it has been and

remains so today (at least in some quarters).

http://find/


7/21

The Pre-Industrial View

Accumulation of wealth enhanced a countrys prestige and power.

Currencies are denominated in precious metals.

To accumulate:

Push exports via subsidies.Limit imports via tariffs.

The goal is to run a persistent trade surplus and thus stockpile gold,

silver, etc.

This is known as mercantilism, and it was practiced by basically

everyone.

Trade is thus a zero-sum game.

http://find/


8/21

The Critique of Mercantilism

David Hume (1752):

Increased exports leads to higher prices (i.e. inflation).

Increased imports leads to lower prices.

In the long run no country can run a persistent trade surplus,

because relative prices would force an adjustment.

Tariffs and subsidies can delay that day, but only at increasing

cost.

Mercantilism is an inherently inefficient system.

http://find/


9/21

The Critique of Mercantilism, con.

Adam Smith (1776):

Division of labor allows folks to use their natural gifts most

productively, esp when mixed with industrial capital.

Trade allows nations to maximize their natural gifts: Britain

sends coal to Greece in exchange for olives.Countries should focus production on most efficient use of their

resources >

By assumption: Countries each have different absolute advantages

something they produce better than everyone else which they should

produce.

In this way all countries benefit from trade: productivity is maximized,

so consumption is maximized.

http://find/


10/21

The Critique of Mercantilism, con.

David Ricardo (1817):

Not all countries have absolute advantages.

All countries do have comparative advantages: goods that

they produce more efficiently than other goods that they can

produce.

Even if they are absolutely disadvantaged countries can gain

from trade. (Wut?)

Trade is a positive-sum game.



11/21

The Economics of Trade: Heckscher-Ohlin

These ideas were intuitive. Later, economists built models to make

precise predictions of output under different trade regimes. H-O (early

20th century):

Two countries (e.g. US & UK).

Two factors of production: capital (land, actually, but well

use capital) and labor.Both countries can use their factor endowments to produce

two goods.

Goods which use the abundant factor more intensively can be produced

more efficiently.

I.e., If you have a lot of labor, you have a comparative

advantage in labor-intensive goods.

Countries should export those goods, and import goods in which the

intensively-used factor is scarce.



12/21

A Silly Example

Two countries: U.S. & U.K.; former is relatively capital abundant, latter

is relatively labor abundant.

Two goods: Jay-Zs and Beatles; Jay-Zs require more capital (bling).

Production schedule (per hour):

Jay-Zs Beatles

U.S. 20 10

U.K. 6 16

U.S. is comparatively advantaged in Jay-Zs while U.K. is in Beatles.

http://find/


13/21

Why Trade Is Efficient

Under autarky:

U.S. gets 10 Jay-Zs and 5 Beatles per hour.

U.K. gets 3 Jay-Zs and 8 Beatles per hour.

The world gets 13 Jay-Zs and 13 Beatles per hour.Under trade:

U.S. produces 20 Jay-Zs; trades 8 for Beatles.

U.K. produces 16 Beatles; trades 8 for Jay-Zs.

The world gets 20 Jay-Zs and 16 Beatles. (More of each).

Or:

http://find/


14/21

Expanding the Production Possibility Frontier

http://find/


15/21

Details of the model

Building off of the logic of comparative advantage, Heckscher-Ohlin

predicts gains from trade.

Assumptions:

1 Constant returns to scale (+1 unit input = +1 unit of output).

2 Labor & capital mobility within countries, & immobility

between countries.

3 Perfect (internal) competition.



16/21

What Is Missing?

Prices (technically assumed to be constant).

Technology (ditto).

Money.

Politics.

Transaction costs.

http://find/


17/21

Does It Matter?

Well get into the politics and money aspects down the line, but the

answer is: yes and no.

Yes, in that other variables matter.

No, in that these simple models actually work fairly well in the real world.

http://find/


18/21

The Trade Boom

http://find/


19/21

The Story in East Asia

http://find/


20/21

The General Relationship

http://goforward/http://find/http://goback/


21/21

Complicating the Model

Looking forward:

How domestic and international politics influence, and are

influenced by, trade.How trade is a complex system: agglomeration economies

and network theory.

These processes are related to power hierarchy and lead

to particular patterns of interdependence.

http://goforward/http://find/http://goback/

Documents

Lecture 4 Econ Case-For Trade