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Theory of Trade MIAGE Foundations Class

September 6, 2017 IAGE 6800

International trade refresher

Stephen C. Bannister, Ph.D. Department of Economics

University of Utah

Trade is forever

International trade, “globalization,” has been going on far longer than international trade theory

: World–Systems Theory – 5000 years!! (Andre Gunder Frank – ReOrient, Immanuel Wallerstein, Karl Polyani)

Ancient trade (we often call it long–distance trade to distinguish it from local markets) is unquestionable – but it was luxury trade

The nineteenth century, during the “Pax Britannica,” was a period of greatly increased trade, partly due to reduced transportation and communications costs

The late twentieth century saw another large boost in global trade due to reduced transportation and communication costs

Trade is forever

International trade, “globalization,” has been going on far longer than international trade theory: World–Systems Theory – 5000 years!! (Andre Gunder Frank – ReOrient, Immanuel Wallerstein, Karl Polyani)

Ancient trade (we often call it long–distance trade to distinguish it from local markets) is unquestionable – but it was luxury trade

The nineteenth century, during the “Pax Britannica,” was a period of greatly increased trade, partly due to reduced transportation and communications costs

The late twentieth century saw another large boost in global trade due to reduced transportation and communication costs

Trade is forever

Ancient trade (we often call it long–distance trade to distinguish it from local markets) is unquestionable – but it was luxury trade

The nineteenth century, during the “Pax Britannica,” was a period of greatly increased trade, partly due to reduced transportation and communications costs

The late twentieth century saw another large boost in global trade due to reduced transportation and communication costs

Trade is forever

Ancient trade (we often call it long–distance trade to distinguish it from local markets) is unquestionable – but it was luxury trade

The nineteenth century, during the “Pax Britannica,” was a period of greatly increased trade, partly due to reduced transportation and communications costs

The late twentieth century saw another large boost in global trade due to reduced transportation and communication costs

Trade is forever

Ancient trade (we often call it long–distance trade to distinguish it from local markets) is unquestionable – but it was luxury trade

The nineteenth century, during the “Pax Britannica,” was a period of greatly increased trade, partly due to reduced transportation and communications costs

The late twentieth century saw another large boost in global trade due to reduced transportation and communication costs

Robert Allen, Global Economic History, A Very Short Introduction

I 1500–1800, the mercantilist era

I 1800-1900, the catch–up era I 1900–, the “big push” era

Robert Allen, Global Economic History, A Very Short Introduction

I 1500–1800, the mercantilist era I 1800-1900, the catch–up era

I 1900–, the “big push” era

Robert Allen, Global Economic History, A Very Short Introduction

I 1500–1800, the mercantilist era I 1800-1900, the catch–up era I 1900–, the “big push” era

Peter Frankopan, The Silk Roads: A New History Of The World

I History is written by the victors

I Much of history is Eurocentric I Frankopan is an antidote

Peter Frankopan, The Silk Roads: A New History Of The World

I History is written by the victors I Much of history is Eurocentric

I Frankopan is an antidote

Peter Frankopan, The Silk Roads: A New History Of The World

I History is written by the victors I Much of history is Eurocentric I Frankopan is an antidote

Trade in macroeconomic theory

Y = C + I + G + NX

Common trade theories

Challenges and Opportunities in International Business

http://2012books.lardbucket.org/books/challenges-and-opportunities-in-international-business/s06-01-what-is-international-trade-th.html

Classical trade theories–Mercantilism

Accumulate gold and silver, run an export surplus

Still the way countries develop today, but want to accumulate dollar surpluses

Economists are paying more attention to this even in modern economies–Concrete Economics: The Hamilton Approach to Economic Growth and Policy, Cohen and DeLong (2016)

We’ll call this neo–Mercantilism

Classical trade theories–Mercantilism

Accumulate gold and silver, run an export surplus

Still the way countries develop today, but want to accumulate dollar surpluses

Economists are paying more attention to this even in modern economies–Concrete Economics: The Hamilton Approach to Economic Growth and Policy, Cohen and DeLong (2016)

We’ll call this neo–Mercantilism

Classical trade theories–Mercantilism

Accumulate gold and silver, run an export surplus

Still the way countries develop today, but want to accumulate dollar surpluses

Economists are paying more attention to this even in modern economies–Concrete Economics: The Hamilton Approach to Economic Growth and Policy, Cohen and DeLong (2016)

We’ll call this neo–Mercantilism

Classical trade theories–Mercantilism

Accumulate gold and silver, run an export surplus

Still the way countries develop today, but want to accumulate dollar surpluses

Economists are paying more attention to this even in modern economies–Concrete Economics: The Hamilton Approach to Economic Growth and Policy, Cohen and DeLong (2016)

We’ll call this neo–Mercantilism

Classical trade theories–Absolute Advantage

Adam Smith

Specialize and gain efficiencies

US absolute advantage in beef, Mexico absolute advantage in vegetables

Suggests US does all beef, Mexico does all vegetables, and both trade

Classical trade theories–Absolute Advantage

Adam Smith

Specialize and gain efficiencies

US absolute advantage in beef, Mexico absolute advantage in vegetables

Suggests US does all beef, Mexico does all vegetables, and both trade

Classical trade theories–Absolute Advantage

Adam Smith

Specialize and gain efficiencies

US absolute advantage in beef, Mexico absolute advantage in vegetables

Suggests US does all beef, Mexico does all vegetables, and both trade

Classical trade theories–Absolute Advantage

Adam Smith

Specialize and gain efficiencies

US absolute advantage in beef, Mexico absolute advantage in vegetables

Suggests US does all beef, Mexico does all vegetables, and both trade

Classical trade theories–Comparative advantage

David Ricardo

Countries will trade based on their comparative advantages

Based on opportunity costs

Classical trade theories–Comparative advantage

David Ricardo

Countries will trade based on their comparative advantages

Based on opportunity costs

Classical trade theories–Comparative advantage

David Ricardo

Countries will trade based on their comparative advantages

Based on opportunity costs

38-9

Comparative Advantage

(a) United States (b) Mexico

V e g

e ta

b le

s (

T o

n s )

5 10 15 20

Beef (Tons)

V e g

e ta

b le

s (

T o

n s )

5 10 15 20 25 30

Beef (Tons)

18 8

LO2

38-11

Comparative Advantage

LO2

38-12

Comparative Advantage

• Terms of trade

• U.S. 1V = 1B

• U.S. will sell 1B for more than 1V

• Mexico 2V = 1B

• Mexico will pay less than 2V for 1B

• Settle between the two

• Depends on supply/demand factors

• Assume 1B = 1.5V

LO2

38-14

Gains from Trade

(a) United States (b) Mexico

V e g

e ta

b le

s (

T o

n s ) 30

5 10 15 20

Beef (Tons)

V e g

e ta

b le

s (

T o

n s ) 30

5 10 15 20 25 30

Beef (Tons)

18 8

A’

Z’

V’

b b’

Trading Possibilities Line

LO2

Classical trade theories–Heckscher–Ohlin (H–O)

Factor proportion theory

A country will produce and trade goods using the cheapest (highest supply) factor of production

Land (Argentina) Labor (China) Capital (US)

But . . .

Classical trade theories–Heckscher–Ohlin (H–O)

Factor proportion theory A country will produce and trade goods using the cheapest (highest supply) factor of production

Land (Argentina) Labor (China) Capital (US)

But . . .

Classical trade theories–Heckscher–Ohlin (H–O)

Factor proportion theory A country will produce and trade goods using the cheapest (highest supply) factor of production

Land (Argentina) Labor (China) Capital (US)

But . . .

Classical trade theories–Heckscher–Ohlin (H–O)

Factor proportion theory A country will produce and trade goods using the cheapest (highest supply) factor of production

Land (Argentina) Labor (China) Capital (US)

But . . .

Leonteif paradox

Empirically, the capital–rich US exported labor–intensive goods and imported capital–intensive goods.

Why?

Very high US labor productivity?

US abundance in natural resources which was not controlled for in the Leontief model

Leonteif paradox

Empirically, the capital–rich US exported labor–intensive goods and imported capital–intensive goods. Why?

Very high US labor productivity?

US abundance in natural resources which was not controlled for in the Leontief model

Leonteif paradox

Empirically, the capital–rich US exported labor–intensive goods and imported capital–intensive goods. Why?

Very high US labor productivity?

US abundance in natural resources which was not controlled for in the Leontief model

Leonteif paradox

Empirically, the capital–rich US exported labor–intensive goods and imported capital–intensive goods. Why?

Very high US labor productivity?

US abundance in natural resources which was not controlled for in the Leontief model

Flexible Exchange Rates

39-10

Q 0

D o

ll a r

P ri

c e o

f 1 P

o u

n d

Quantity of Pounds

Flexible Exchange Rates

The Market for Foreign Currency (Pounds)

Exchange Rate: $2 = £1

Exchange Rate: $3 = £1

Balance Of Payments

Deficit

x a

LO3

Firm–based trade theories–

Responses to reality of MNCs and intraindustry trade

Incorporate brand and customer loyalty, technology, and quality

Firm–based trade theories–

Responses to reality of MNCs and intraindustry trade

Incorporate brand and customer loyalty, technology, and quality

Firm–based trade theories–Linder–Country similarity theory

First production for domestic market

Expand into countries with similar domestic markets, think GDP per capita

Firm–based trade theories–Linder–Country similarity theory

First production for domestic market

Expand into countries with similar domestic markets,

think GDP per capita

Firm–based trade theories–Linder–Country similarity theory

First production for domestic market

Expand into countries with similar domestic markets, think GDP per capita

Firm–based trade theories–Product Life Cycle

Innovation centered in US when US had 50% of manufacturing VA

Less true now with R&D around the world

Firm–based trade theories–Global strategic rivalry–Krugman, Lancaster

Firms seeking competitive advantage,

raise barriers to entry

Increasing returns to scale

Firm–based trade theories–Global strategic rivalry–Krugman, Lancaster

Firms seeking competitive advantage, raise barriers to entry

Increasing returns to scale

Firm–based trade theories–Porter’s National Competitive Advantage Theory

National competitive advantage

Local market resources and capabilities

Local market demand

Local suppliers and networks

Local firm characteristics

Firm–based trade theories–Porter’s National Competitive Advantage Theory

National competitive advantage

Local market resources and capabilities

Local market demand

Local suppliers and networks

Local firm characteristics

Firm–based trade theories–Porter’s National Competitive Advantage Theory

National competitive advantage

Local market resources and capabilities

Local market demand

Local suppliers and networks

Local firm characteristics

Firm–based trade theories–Porter’s National Competitive Advantage Theory

National competitive advantage

Local market resources and capabilities

Local market demand

Local suppliers and networks

Local firm characteristics

Firm–based trade theories–Porter’s National Competitive Advantage Theory

National competitive advantage

Local market resources and capabilities

Local market demand

Local suppliers and networks

Local firm characteristics

Industrial policy?

Edward III

, Alexander Hamilton, Fredrick List, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton

, Fredrick List, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List

, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List, Ha-Joon Chang

, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List, Ha-Joon Chang, East Asian Tigers

, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Industrial policy?

Edward III, Alexander Hamilton, Fredrick List, Ha-Joon Chang, East Asian Tigers, Brad DeLong

A neo-mercantilism?

Negative reaction to TPP and TTIP

Other theories–New trade theory

From Wiki–The value of protecting“infant industries” has been defended at least since the 18th century; for example, Alexander Hamilton proposed in 1791 that this be the basis for US trade policy. What was “new” in new trade theory was the use of mathematical economics to model the increasing returns to scale, and especially the use of the network effect to argue that the formation of important industries was path dependent in a way which industrial planning and judicious tariffs might control

Paul Krugman: Sveriges riksbanks pris i ekonomisk vetenskap till Alfred Nobels minne, or the Swedish National Bank’s Prize in Economic Sciences in Memory of Alfred Nobel, 2008

Leveraged monopolistic competition theory and increasing returns to scale

Other theories–New trade theory

Paul Krugman: Sveriges riksbanks pris i ekonomisk vetenskap till Alfred Nobels minne, or the Swedish National Bank’s Prize in Economic Sciences in Memory of Alfred Nobel, 2008

Leveraged monopolistic competition theory and increasing returns to scale

Other theories–New trade theory

Paul Krugman: Sveriges riksbanks pris i ekonomisk vetenskap till Alfred Nobels minne, or the Swedish National Bank’s Prize in Economic Sciences in Memory of Alfred Nobel, 2008

Leveraged monopolistic competition theory and increasing returns to scale

Other theories–Gravity theory (or model)

First applied to international trade by Jan Tinbergen in 1962

Fij = G Mβ1

i Mβ2 j

Dβ3 ij

I F is trade flow, G is constant, M is is the GDP of each country, D is the distance between them

Empirically successful, less so theoretically

Other theories–Gravity theory (or model)

First applied to international trade by Jan Tinbergen in 1962

Fij = G Mβ1

i Mβ2 j

Dβ3 ij

I F is trade flow, G is constant, M is is the GDP of each country, D is the distance between them

Empirically successful, less so theoretically

Other theories–Gravity theory (or model)

First applied to international trade by Jan Tinbergen in 1962

Fij = G Mβ1

i Mβ2 j

Dβ3 ij

I F is trade flow, G is constant, M is is the GDP of each country, D is the distance between them

Empirically successful

, less so theoretically

Other theories–Gravity theory (or model)

First applied to international trade by Jan Tinbergen in 1962

Fij = G Mβ1

i Mβ2 j

Dβ3 ij

I F is trade flow, G is constant, M is is the GDP of each country, D is the distance between them

Empirically successful, less so theoretically

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

I Thirwall adds that for most trading countries their balance of payments on international accounts–trade–constrain growth; emphasizes that export and import income (demand) elasticities will determine the size of the multiplier

Importantly, this appears to be empirically supported

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

Importantly, this appears to be empirically supported

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

Importantly, this appears to be empirically supported

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

I Thirwall adds that for most trading countries their balance of payments on international accounts–trade–constrain growth

; emphasizes that export and import income (demand) elasticities will determine the size of the multiplier

Importantly, this appears to be empirically supported

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

Importantly, this appears to be empirically supported

Other theories–Thirwall’s Law

And now for a change of pace from the supply–side driven theories

Anthony Thirwall leveraged Roy Harrod’s static foreign trade multiplier by making it dynamic

Y = X m

Importantly, this appears to be empirically supported

And how does this all appear in the twenty–first century?

21st century regionalism and global trade governance

Note that Baldwin goes “there”–the Thucydides Trap

http://voxeu.org/article/21st-century-regionalism-and-global-trade-governance

And how does this all appear in the twenty–first century?

21st century regionalism and global trade governance

Note that Baldwin goes “there”

–the Thucydides Trap

http://voxeu.org/article/21st-century-regionalism-and-global-trade-governance

And how does this all appear in the twenty–first century?

21st century regionalism and global trade governance

Note that Baldwin goes “there”–the Thucydides Trap

http://voxeu.org/article/21st-century-regionalism-and-global-trade-governance