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Gaining From International Trade

GWARTNEY – STROUP – SOBEL – MACPHERSON

To Accompany: “Economics: Private and Public Choice, 15th ed.”

James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson

Slides authored and animated by: James Gwartney & Charles Skipton

Full Length Text —

Micro Only Text —

Part: 4

Chapter: 18

Chapter: 16

Macro Only Text —

Part: 4

Chapter: 18

First page

The Trade Sector of the United States

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The Growth of the U.S. Trade Sector

As is shown here, both exports & imports have grown substantially as a share of the U.S. economy during the last several decades. Their growth has accelerated since 1980.

Reductions in both transportation and communication costs, as well as lower trade barriers have contributed to this growth.

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1960

1970

1980

1990

2000

2010

Imports as a Share of GDP

1960

1970

1980

1990

2000

2010

Imports

(% of GDP)

Exports

(% of GDP)

Exports as a Share of GDP

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Leading Trading Partners of the U.S.

Today, Canada, China, Mexico, and Japan are the leading trading partners with the United States.

The impact of international trade varies across industries. In some industries, U.S. firms are able to compete quite effectively, while in others they find it difficult to do so.

Brazil

South Korea

U.K .

Germany

Japan

Mexico

China

Canada

–––––––– Percent of Total U.S. Trade, 2012 ––––––––

All other

France

Saudi Arabia

1.9%

2.0%

2.6%

2.9%

4.1%

5.7%

12.9%

14.0%

16.1%

35.9%

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Gains from Specialization and Trade

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Gains from Trade: An Overview

Most international trade is not between the governments of different nations but rather between the people and firms located in different countries.

Like other voluntary exchanges, international trade occurs because both the buyer and seller expect to gain, and generally do.

If both parties did not expect to gain, they would not agree to the exchange.

With trade, a country’s residents can gain by specializing in the production of goods they can produce economically.

They can sell those goods in the world market and use the proceeds to import goods that would be expensive to produce domestically.

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Law of Comparative Advantage

Law of Comparative Advantage: A group of individuals, regions, or nations can produce a larger joint output if each specializes in the production of goods in which it is a low-opportunity cost producer and trades for goods for which it is a high opportunity cost producer.

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Gains from Specialization and Trade

International trade leads to mutual gain because it allows each country to specialize more fully in the production of those things that it does best according to the law of comparative advantage.

Trade makes it possible for each country to use more of its resources to produce those goods and services that it can produce at a relatively low cost.

With trade, it will be possible for the trading partners to consume a bundle of goods that it would be impossible for them to produce domestically.

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The Importance of Economic Growth

Columns (1) and (2) indicate the daily per worker output of the food and clothing industry in the U.S. & Japan.

If the U.S. moves 3 workers from clothing to food, it produces 6 more units of food and only 3 fewer of clothing.

If Japan moves 1 worker from food to clothing, it produces 9 more units of clothing and only 3 fewer of food.

With such a reallocation of labor, the U.S. and Japan are able to increase their aggregate output of both food and clothing.

Country

U.S.

Japan

Output per worker day

Potential change in output*

Food

(1)

Clothing

(2)

Clothing

(4)

Food

(3)

* Change in output if US shifts 3 workers from clothing to food industry and if Japan shifts one from food to clothing.

Change in total output

+ 6

- 3

+ 9

+ 3

+ 6

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PPC Before Specialization and Trade

Here we illustrate the daily production of the labor force of both the US (200 million) and Japan (50 million) given the production costs of food and clothing from the previous slide.

In the absence of trade, consumption possibilities will be restricted to points like US1 in the U.S. & J1 in Japan.

Each of these points lies along the production possibilities curve (PPC) of the respective nation.

Food (million units)

Production possibilities, U.S.

Clothing (million units)

100

200

300

400

100

200

300

250

150

350

400

450

US1

Japan

Production possibilities, Japan

Clothing (million units)

150

300

450

375

225

450

300

225

Food (million units)

United States

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Trade Expands Consumption Possibilities

Specialization and trade expand consumption possibilities.

If the U.S. trades food for clothing (1-for-1), it can specialize in the production of food and consume along the O-N line (rather than its original production-possibilities constraint, M-N).

Similarly, if Japan trades clothing for food (1-for-1), it can specialize in the production of clothing and consume any combination along the R-T line (rather than its original, R-S).

United States

Food (million units)

Clothing (million units)

100

200

300

400

100

200

300

250

150

350

400

450

US1

Japan

Clothing (million units)

150

300

450

375

225

450

300

225

Food (million units)

Consumption possibilities of Japan with trade

Consumption possibilities of U.S. with trade

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For example, with specialization and trade, the U.S. could increase its consumption from US1 to US2, gaining 50 million units of clothing and 100 million units of food.

Simultaneously, Japan could increase consumption from J1 to J2, a gain of 125 million units of food and 25 million units of clothing.

Food (million units)

Clothing (million units)

100

200

300

400

100

200

300

250

150

350

400

450

US1

Japan

Clothing (million units)

150

300

450

375

225

450

300

225

Food (million units)

200

US2

250

200

Trade Expands Consumption Possibilities

United States

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How exactly do the U.S. and Japan consume at US2 and J2?

The U.S. produces 400 million units of food, consumes 200 million, and exports 200 million to Japan.

Japan produces 450 million units of clothing, consumes 250 million, and exports 200 million to the U.S..

Each consumes more than it could produce domestically.

Food (million units)

Clothing (million units)

100

200

300

400

100

200

300

250

150

350

400

450

US1

Japan

Clothing (million units)

150

300

450

375

225

450

300

225

Food (million units)

200

250

US2

200

US imports

Japan imports

US exports

Japan exports

Trade Expands Consumption Possibilities

United States

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International Trade

is a Key to Prosperity

In addition to gains from specialization in areas of comparative advantage, international trade also leads to gains from:

Economies of Scale: International trade allows both domestic producers and consumers to gain from reductions in per-unit costs that often accompany large-scale production, marketing, and distribution.

More Competitive Markets: International trade promotes competition in domestic markets and allows consumers to purchase a wider variety of goods at economical prices.

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Supply, Demand, and International Trade

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The price of soybeans and other internationally traded commodities is determined by the forces of supply and demand in the world market.

If U.S. soybean producers were prohibited from selling to foreigners, the domestic price would be Pn.

Free trade permits U.S. soybean producers to sell Qp units at the higher world price of Pw.

Soybeans

(bushels)

Price

Soybeans

(bushels)

Price

U.S. Market

World Market

U.S. Has a Comparative Advantage

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At the world price of Pw, the quantity (Qp – Qc) is exported.

Compared to the no-trade situation, the producers’ gain from the higher price (area) Pw – b – c – Pn exceeds the cost imposed on domestic consumers (area) Pw – a – c – Pn by the triangular (area) a – b – c.

Soybeans

(bushels)

Price

Soybeans

(bushels)

Price

U.S. Market

World Market

U.S. exports

U.S. Has a Comparative Advantage

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Foreigners Have a Comparative Advantage

Consider the international market for manufactured shoes.

In the absence of trade, the domestic price would be Pn.

As many foreign producers have a comparative advantage in the production of shoes, international trade leads to lower prices Pw.

Shoes

(pairs)

Price

Shoes

(pairs)

Price

U.S. Market

World Market

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Foreigners Have a Comparative Advantage

At the price Pw, U.S. consumers demand Qc units of which (Qc – Qp) are imported.

Compared to no trade, consumers gain (area) Pn – a – b – Pw, while domestic producers lose (area) Pn – a – c – Pw.

A net gain of (area) a – b – c results.

Price

U.S. Market

World Market

Shoes

(pairs)

Shoes

(pairs)

U.S. imports

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Summary: Supply, Demand, and Gains from Trade

International trade and specialization result in lower prices (and more domestic consumption) for imported products and higher prices (and less domestic consumption) for exported products.

Trade makes it possible for domestic producers to obtain higher prices for the items they export and for domestic consumers to buy imported items at lower prices.

As a result, the residents of each nation are able to focus more of their resources on the things they do best (produce at a low cost), while trading for those goods for which they are high opportunity cost producers.

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Questions for Thought:

State the law of comparative advantage in your own words.

Under what conditions can a nation gain from international trade?

Do you think the 50 states of the United States would be better off if each imposed trade barriers limiting trade across state boundaries? Do you think the countries of North and South America would be better off if there were no trade restrictions limiting trade across national boundaries? Explain your response.

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Questions for Thought:

4. Are the following statements true or false?

(a) “If a nation is going to produce its maximum potential output and achieve full employment, it must impose tariffs and quotas in order to protect domestic industries & jobs.”

(b) “Everyone benefits when trade barriers (for example, tariffs and quotas) are removed.”

(c) “When a country trades for those things for which it is a high cost producer, it will be able to use more of its resources to produce items it can produce at a low cost.”

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The Economics of Trade Restrictions

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Economic Freedom and Growth

The average tariff rate (taxes levied upon imports) for the United States (since 1890) is illustrated here.

1890

1910

1930

1950

1970

1990

2010

U.S. Average Tariff Rate

Duties Collected as a Percentage of Dutiable Imports

3.5%

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U & V are deadweight losses.

Trade Restrictions: Impact of a Tariff

Consider a tariff on auto imports.

Quantity (automobiles)

Qd1

SDomestic

Price

DDomestic

Pw+ t

Qd2

Tariff = t

Imports after tariff

Qd1 from U.S. producers and …

Q1 – Qd1 from foreign producers.

A tariff (t ) makes it more costly for Americans to purchase autos from abroad. U.S. prices rise to Pw+ t and purchases fall from Q1 to Q2.

U.S. purchases from domestic producers rise from Qd1 to Qd2 …

imports fall to Q2 – Qd2.

T tax revenues (from the tariff) are generated …

Producers gain S …

Consumers lose S + U + T + V in the form of higher prices and a reduction of consumer surplus.

Initial imports

Without a tariff, world price is Pw. At Pw consumers in the U.S. purchase Q1 units …

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Q1 – Qd1 from foreign producers.

Areas U & V are deadweight losses. Consumers lose S + U + T + V in the form of higher prices and a reduction of consumer surplus.

Trade Restrictions: Impact of a Quota

Consider a quota on peanuts.

Quantity (peanuts)

Qd1

SDomestic

Price

DDomestic

Qd2

Import quota: Q2 – Qd2

Qd1 from U.S. producers and …

A quota of Q2 – Qd2 imports pushes the U.S. price up to P2.

While total U.S. purchases fall (from Q1 to Q2 ), those from U.S. rise (from Qd1 to Qd2) and …

imports fall to Q2 – Qd2.

U.S. producers gain S. Area T goes to foreign producers with permits to import.

Initial imports

Without trade restraints, Pw (world price) would be the domestic price. At Pw U.S. consumers would purchase Q1 …

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Why do Nations Adopt Trade Restrictions?

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Proponents of trade restrictions often use the following arguments in an effort to justify their position:

National defense argument: domestic industry is needed for national defense purposes.

Dumping: the sale of goods abroad at a price below the cost of production (and below the domestic market price of the exporting nation).

Dumping is illegal under U.S. law.

Infant Industry argument: new industry needs protection so it can mature.

Arguments Used to Justify Trade Restrictions

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When considering the merits of anti-dumping restrictions, remember that:

Firms with large inventories (either domestic or abroad) may find it in their interest to offer goods at prices below their original cost of production.

Domestic firms are legally allowed to engage in this practice.

Lower prices benefit domestic consumers.

A Few Additional Issues Related to Dumping

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“Protectionism is a politician's delight because it delivers visible benefits to the protected parties while imposing the costs as a hidden tax on the public.” —Murray L. Weidenbaum

The special interest effect provides the primary explanation for trade restrictions.

Trade restrictions almost always provide highly visible, concentrated benefits for a small group of people, while imposing widely dispersed costs that are often difficult to identify on the general citizenry.

Politicians have a strong incentive to favor special interest issues, even if they conflict with economic efficiency.

Trade Restrictions are a Special Interest Issue

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Trade Barriers and Popular Trade Fallacies

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Trade fallacies abound because people often fail to consider the secondary effects.

Key elements of international trade are often linked – you cannot change one element without changing the other.

This is the case with imports and exports; policies that restrain imports also restrain exports.

Trade Fallacies

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Trade fallacy 1: “Trade restrictions that limit imports save jobs for Americans.”

This view is false because if foreigners sell less to us they will have fewer dollars with which to buy things from us. Thus, restraints on imports will also restrain exports.

Trade restrictions do not “save” jobs; they merely reshuffle them. Jobs “saved” in protected industries will be offset by jobs “lost” in export industries.

As the result of trade restrictions, fewer Americans are employed in areas where we have a comparative advantage.

Trade Fallacies

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Trade fallacy 2: "Free trade with low-wage countries, such as Mexico and China, will reduce the wages of Americans."

Both high- and low-wage countries will gain when they are able to focus more of their resources on those productive activities that they do well.

The key to this issue is how will U.S. resources be used. If a low-wage country can supply a good cheaper than we can produce it, the U.S. can gain by purchasing the good from the low-wage country and using its resources to produce other goods for which it has a comparative advantage.

Trade Fallacies

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Institutions and the Changing Nature of Global Trade

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Economic Freedom as a Measure of Institutional Quality

Gains from trade, entrepreneurial discovery, and investment are largely dependent on institutions and policies supportive of voluntary exchange, market allocation, freedom to compete, and protection of people and their property from aggressors.

These ingredients comprise the foundation of economic freedom.

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Trade Openness, Income, and Growth

The income levels and growth rates of the ten most and ten least open economies (as measured by the Trade Openness Index – TOI) are displayed here.

Note that more open economies both achieved higher income levels and grew more rapidly.

TOI

10 Most Open

Economies,

1980-2002

Singapore

Hong Kong

Bahrain

Belgium

Malaysia

Luxembourg

Netherlands

Taiwan

Ireland

Australia

Average:

10.0

8.7

9.9

8.6

8.5

8.4

8.1

7.9

3.9 %

4.3 %

1.0 %

1.7 %

3.6 %

3.7 %

1.6 %

5.1 %

4.5 %

1.9 %

3.1 %

$ 30,989

$ 26,390

$ 19,112

$ 28,575

$ 9,681

$ 53,583

$ 29,078

$ 20,868

$ 34,256

$ 29,981

$ 28,251

2005 GDP per capita

1980-2005

Growth rate

10 Least Open Economies,

1980-2002

India

Tanzania

Egypt

Pakistan

Syria

Algeria

Sierra Leone

Average:

Burundi

Iran

Bangladesh

4.3

3.5

4.1

3.9

3.8

3.4

3.0

2.9

2.5

4.0 %

2.3 %

2.5 %

2.4 %

0.6 %

0.5 %

- 1.1 %

- 1.0 %

1.1 %

2.2 %

1.4 %

$ 3,072

$ 662

$ 3,858

$ 2,109

$ 3,388

$ 6,283

$ 717

$ 622

$ 7,089

$ 1,827

$ 2,963

TOI

2005 GDP per capita

1980-2005

Growth rate

Sources: TOI data are from Charles Skipton, The Measurement of Trade Openness. Doctoral Dissertation, Florida State University, 2003. Per capita GDP & growth data are from The World Bank, World Development Indicators, CD-ROM, 2004.

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Countries like Hong Kong and Singapore that have persistently followed more open trade policies, have achieved higher income levels, and grown more rapidly than more closed economies.

During the last two decades, trade restrictions have declined sharply, particularly in less developed economies.

Following the passage of NAFTA, U.S. trade with both Canada and Mexico grew rapidly.

The U.S. economy performed impressively, as the size of the trade sector grew during the 1990s.

Trade Openness, Income, and Growth

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U.S. Trade with Canada and Mexico

Measured as a share of GDP, U.S. trade with both Canada and Mexico has increased sharply as a result of NAFTA during the last 18 years.

1980

1985

1990

1995

2000

2005

2010

0.5%

1.0%

U.S. Trade with Canada and Mexico, 1980-2012 (Exports and Imports as a Share of GDP)

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Mexico

Canada

4.5%

5.0%

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Trade Openness, Income, and Growth

Today, less developed countries are often at the forefront of those pushing for greater trade openness, while high-income countries often impose restrictions in order to protect various domestic industrial interests and preserve their farm subsidy programs.

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Questions for Thought:

“If the revenue collected by the government is taken into account, a tariff has no net impact on the welfare of a society.”

-- Is this statement true?

2. Politicians have a strong incentive to support restrictions that limit international trade because

(a) trade restrictions generally benefit all, or nearly all, voters.

(b) trade restrictions generally provide highly visible, concentrated benefits for a relatively small number of people while imposing hard-to-identify-costs on others.

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Questions for Thought:

The imposition of tariffs, quotas, & other trade barriers are often referred to as protectionist policies. Who is being protected? What are they being protected from?

“Exports are good. They create jobs and help make America prosperous. On the other hand, imports destroy jobs and reduce our standard of living.” Do you agree or disagree?

“Policies that reduce the volume of imports will also reduce the volume of exports.” -- Is this statement true?

Why would political officials want to prohibit their citizens from trading with foreigners?

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Questions for Thought:

7. In 2002, the Bush administration imposed tariffs of up to 25% on imported steel products. This action

(a) reduced the supply of steel in the domestic market and led to higher steel prices.

(b) increased U.S. employment because it saved jobs in the steel industry.

(c) reduced employment in the U.S. steel container industry because the higher steel prices made it more difficult for them to compete with foreign rivals.

(d) helped George Bush carry the state of Ohio in the 2004 presidential election.

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End of

Chapter 18

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