INTERNATIONAL TRADE: COMMERCE AMONG NATIONS
Clarke Ricks School of Business,
Liberty University
BUSI 690: Policy and Strategy in Global Competition
Dr. Hicks
April 9, 2022
INTERNATIONAL TRADE: COMMERCE AMONG NATIONS
Nations are usually better off when they buy and sell from one another
If there is a point on which most economists agree, it is that trade among nations makes
the world better off. Yet international trade can be one of the most contentious of political
issues, both domestically and between governments.
When a firm or an individual buys a good or a service produced more cheaply abroad,
living standards in both countries increase. There are other reasons consumers and firms buy
abroad that also make them better off—the product may better fit their needs than similar
domestic offerings or it may not be available domestically. In any case, the foreign producer
also benefits by making more sales than it could selling solely in its own market and by earning
foreign exchange (currency) that can be used by itself or others in the country to purchase
foreign-made products.
Still, even if societies as a whole gain when countries trade, not every individual or
company is better off. When a firm buys a foreign product because it is cheaper, it benefits—
but the (more costly) domestic producer loses a sale. Usually, however, the buyer gains more
than the domestic seller loses. Except in cases in which the costs of production do not include
such social costs as pollution, the world is better off when countries import products that are
produced more efficiently in other countries.
Those who perceive themselves to be affected adversely by foreign competition have long
opposed international trade. Soon after economists such as Adam Smith and David Ricardo
established the economic basis for free trade, British historian Thomas B. Macaulay was
observing the practical problems governments face in deciding whether to embrace the
concept: “Free trade, one of the greatest blessings which a government can confer on a people,
is in almost every country unpopular.”
Two centuries later trade debates still resonate.
Why countries trade
In one of the most important concepts in economics, Ricardo observed that trade was
driven by comparative rather than absolute costs (of producing a good). One country may be
more productive than others in all goods, in the sense that it can produce any good using fewer
inputs (such as capital and labor) than other countries require to produce the same good.
Ricardo’s insight was that such a country would still benefit from trading according to
its comparative advantage—exporting products in which its absolute advantage was greatest,
and importing products in which its absolute advantage was comparatively less (even if still
positive).
Comparative advantage
Even a country that is more efficient (has absolute advantage) in everything it makes
would benefit from trade. Consider an example:
Country A: One hour of labor can produce either three kilograms of steel or two shirts.
Country B: One hour of labor can produce either one kilogram of steel or one shirt.
Country A is more efficient in both products. Now suppose Country B offers to sell Country
A two shirts in exchange for 2.5 kilograms of steel.
To produce these additional two shirts, Country B diverts two hours of work from
producing (two kilograms) steel. Country A diverts one hour of work from producing (two)
shirts. It uses that hour of work to instead produce three additional kilograms of steel.
Overall, the same number of shirts is produced: Country A produces two fewer shirts, but
Country B produces two additional shirts. However, more steel is now produced than before:
Country A produces three additional kilograms of steel, while Country B reduces its steel output
by two kilograms. The extra kilogram of steel is a measure of the gains from trade.
Though a country may be twice as productive as its trading partners in making clothing, if
it is three times as productive in making steel or building airplanes, it will benefit from making
and exporting these products and importing clothes. Its partner will gain by exporting clothes—
in which it has a comparative but not absolute advantage—in exchange for these other
products (see box). The notion of comparative advantage also extends beyond physical goods
to trade in services—such as writing computer code or providing financial products.
Because of comparative advantage, trade raises the living standards of both countries.
Douglas Irwin (2009) calls comparative advantage “good news” for economic development.
“Even if a developing country lacks an absolute advantage in any field, it will always have a
comparative advantage in the production of some goods,” and will trade profitably with
advanced economies.
Differences in comparative advantage may arise for several reasons. In the early 20th
century, Swedish economists Eli Heckscher and Bertil Ohlin identified the role of labor and
capital, so-called factor endowments, as a determinant of advantage. The Heckscher-Ohlin
proposition maintains that countries tend to export goods whose production uses intensively
the factor of production that is relatively abundant in the country. Countries well endowed with
capital—such as factories and machinery—should export capital-intensive products, while
those well endowed with labor should export labor-intensive products. Economists today think
that factor endowments matter, but that there are also other important influences on trade
patterns (Baldwin, 2008).
Recent research finds that episodes of trade opening are followed by adjustment not
only across industries, but within them as well. The increase in competition coming from
foreign firms puts pressure on profits, forcing less efficient firms to contract and making room
for more efficient firms. Expansion and new entry bring with them better technologies and new
product varieties. Likely the most important is that trade enables greater selection across
different types of goods (say refrigerators). This explains why there is a lot of intra-industry
trade (for example, countries that export household refrigerators may import industrial
coolers), which is something that the factor endowment approach does not encompass.
There are clear efficiency benefits from trade that results in more products—not only
more of the same products, but greater product variety. For example, the United States imports
four times as many varieties (such as different types of cars) as it did in the 1970s, while the
number of countries supplying each good has doubled. An even greater benefit may be the
more efficient investment spending that results from firms having access to a wider variety and
quality of intermediate and capital inputs (think industrial optical lenses rather than cars). By
enhancing overall investment and facilitating innovation, trade can bring sustained higher
growth.
Indeed, economic models used to assess the impact of trade typically neglect influences
involving technology transfer and pro-competitive forces such as the expansion of product
varieties. That is because these influences are difficult to model, and results that do incorporate
them are subject to greater uncertainty. Where this has been done, however, researchers have
concluded that the benefits of trade reforms—such as reducing tariffs and other nontariff
barriers to trade—are much larger than suggested by conventional models.
Why trade reform is difficult
Trade contributes to global efficiency. When a country opens up to trade, capital and
labor shift toward industries in which they are used more efficiently. That movement provides
society a higher level of economic welfare. However, these effects are only part of the story.
Trade also brings dislocation to those firms and industries that cannot cut it. Firms that
face difficult adjustment because of more efficient foreign producers often lobby against trade.
So do their workers. They often seek barriers such as import taxes (called tariffs) and quotas to
raise the price or limit the availability of imports. Processors may try to restrict the exportation
of raw materials to depress artificially the price of their own inputs. By contrast, the benefits of
trade are spread diffusely and its beneficiaries often do not recognize how trade benefits them.
As a result, opponents are often quite effective in discussions about trade.
Trade policies
Reforms since World War II have substantially reduced government-imposed trade
barriers. But policies to protect domestic industries vary. Tariffs are much higher in certain
sectors (such as agriculture and clothing) and among certain country groups (such as less
developed countries) than in others. Many countries have substantial barriers to trade in
services in areas such as transportation, communications, and, often, the financial sector, while
others have policies that welcome foreign competition.
Moreover, trade barriers affect some countries more than others. Often hardest hit are
less developed countries, whose exports are concentrated in low-skill, labor-intensive products
that industrialized countries often protect. The United States, for example, is reported to collect
about 15 cents in tariff revenue for each $1 of imports from Bangladesh (Elliott, 2009),
compared with one cent for each $1 of imports from some major western European countries.
Yet imports of a particular product from Bangladesh face the same or lower tariffs than do
similarly classified products imported from western Europe. Although the tariffs on Bangladesh
items in the United States may be a dramatic example, World Bank economists calculated that
exporters from low-income countries face barriers on average half again greater than those
faced by the exports of major industrialized countries (Kee, Nicita, and Olarreaga, 2006).
The World Trade Organization (WTO) referees international trade. Agreements devised
since 1948 by its 153 members (of the WTO and its predecessor General Agreement on Trade
and Tariffs) promote nondiscrimination and facilitate further liberalization in nearly all areas of
commerce, including tariffs, subsidies, customs valuation and procedures, trade and investment
in service sectors, and intellectual property. Commitments under these agreements are
enforced through a powerful and carefully crafted dispute settlement process.
Under the rules-based international trading system centered in the WTO, trade policies
have become more stable, more transparent, and more open. And the WTO is a key reason why
the global financial crisis did not spark widespread protectionism. However, as seen most
recently with the Doha Round of WTO trade negotiations, the institution faces big challenges in
reaching agreements to open global trade further. Despite successes, restrictive and
discriminatory trade policies remain common. Addressing them could yield hundreds of billions
of dollars in annual global benefits. But narrow interests have sought to delay and dilute further
multilateral reforms. A focus on the greater good, together with ways to help the relatively few
that may be adversely affected, can help to deliver a fairer and economically more sensible
trading system.
