Lecture 8(i) Announcements

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Lecture 1. Finish

Robinson 1-Robinson 2 trade (trade based on increasing returns)

2. Unilateral Free Trade?

3. Some Discussion of Trade between China and the U.S.

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Trade Based on Increasing Returns

Interest in the theory driven by the empirical observation that much trade is between similar countries

U.S. and Canada, U.S. and Europe U.S. and Japan

all high skill countries.

With increasing returns, through trade possible for: (1) have large production volumes of any given product (2) consumers have a large variety

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2. Trade Policy bilateral trade agreemento You lower tariffs on me, I lower tariffs you.

o US/Korea trade agreement from a few years ago

multilateral agreemento Let’s all lower tariffs on each other oWorld Trade Organization (WTO)oN. Amererican Free Trade Agreement

(NAFTA)oTrans Pacific Partnership

unilateral free trade o I lower tariffs (or other trade barriers)

on you, regardless of what you do. o England repeals corn laws (tariff) in

1846

Let’s look at unilateral free trade, using our original diagram

Remember Econland gain from trade at world price of $1...

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What if the world price were instead equal to Pworld = 0?

Domestic producers are sure to complain that this is an “unfair” price. (For example, may only be zero because of subsidies of foreign governments.

In this analysis, from the perspective of Econland, it doesn’t really matter why the price is zero. Overall surplus in Econland is higher when Pworld = 0

Appropriate policy: send thank you note to foreign governments for subsidizing our free widgets. (Unilateral free trade is in Econland’s interest overall.)

If you want to argue that unilateral free trade is not in Econland’s interest, you need to explain what’s missing in the analysis. Here are three possibilities:

(1) Argument assumes price equals the opportunity cost to product the good in Econland. Suppose instead price is greater than marginal cost because of increasing returns. Example: Boeing Dreamliner

$170 million dollar price tag Marginal cost less (eventually), let’s say $150 million. Profit margin of 20 million is a return on $5 billion R&D investment. If Delta Airlines is deciding between a Dreamliner or an Airbus plane, if it

goes with the Dreamliner, a profit margin of $20 million stays here (in the form of going to Boeing). This is a benefit that is external to Delta in its decision making. Can see that the U.S. has an incentive to encourage U.S. airlines to buy Boeing planes while Europe has an incentive to encourage European airlines to buy Airbus planes. (Not in U.S. interests to adopt free trade in aircraft unilaterally) Still may be gains from a bilateraltrade agreement between U.S. and Europe where they have free trade in aircraft and enjoy gains from variety like in Robinson 1/Robinson 2 trade.

(2) .Argument that unilateral free trade in widgets is good for Econland assumes no positive externalities from widget production in Econland.

Suppose instead widgets are a high-tech, strategic industry with knowledge spillovers for other industries.

There will be an incentive to promote these industries with subsidies and by restricting imports.

Countries may want to engage in bilateral agreements to limit subsidies and import restrictions.

Be wary of this argument, everybody seeking projection loves to claim their industry is “strategic.”

(2) National Defense. Suppose that widgets are used in warfare. Suppose that after the zero price widget imports drive out the domestic industry in Econland, there is an invasion of Econland by the army of PoliticalScienceland. PoliticalScienceland cuts off exports of widgets, and Econland has no widgets to use in self-defense.

The national defense argument for protectionist policy obviously doesn’t make sense for industries like slippers, furniture, etc.

3. China/US TradeSome industries are intensive in low-skill labor. China has a comparative advantage in these.

Other industries are intensive in high-skill labor and high technology. The U.S. has a comparative advantage in these.

The homework provides some evidence that the pattern of trade is consistent with specialization according to comparative advantage. (Note: you still have to do the homework to calculate the slope of the regression line!)

Low skill industries tend to pay low wages. There is pattern in the data that China has tended to gain the most market

share in those industries that paid low wages within the U.S.

Example: House slipper manufacturing wage = $7.16 in 1997. As of 2007, this industry has been virtually wiped out by Chinese.

Relationship Between Chinese Imports and U.S. Wages across Manufacturing Industries

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Manufacturing jobs that involve labor-intensive, repetitive tasks in the manufacture of standardized good have been wiped out in the U.S.

The textile and furniture industries, that had earlier located in places like North Carolina for low wages, have been decimated.

Another example: recall discussion of division of labor of iPhone

Design: Apple headquarters in California Assembly: Foxconn in Shenzhen.