3. Chapter Focus
• Review several trade theories that explain why it
is beneficial for a country to engage in
international trade.
• Explain the pattern of international trade
observed in the world economy.
4. Mercantilism: Mid-16th century
• A nation’s wealth depends on accumulated treasure
• Gold and silver are the currency of trade (and
measure of wealth).
A country that has no gold must import it
• To increase wealth, countries must have trade
surplus
• Therefore government policies should promote
exports and discourage imports
Importation of gold depends on exports of
goods
Importation of other goods tightly controlled
• Flaw: “zero-sum game”
if country advances economically, another loses
4-8
5. The 7 Instruments of Trade Policy
Antidumping
Duties
Local
Content
Requirements
Tariffs
Voluntary
Exports
Restraints
Subsidies
Administrative
Policies
Import
Quotas
6. Tariffs
Tariffs
Specific
Fixed charge
per unit
Ad Valorem
Charge is
a proportion of the
goods value
Oldest form of protection.
Good for the Government.
Good for producers.
Leads to inefficiency.
Bad for consumers.
8. Subsidies
Agriculture
1.Keeps inefficient
farmers in business.
2.Encourages production
of subsidized products.
3.Produce products grown
more cheaply elsewhere.
4.Reduces agriculture
trade.
Helps domestic
producers to
compete internationally.
Paid by taxing
individuals
9. Import Quotas and Voluntary Export
Restraints
Direct restriction
on the quantity of a
good that can
be imported into
a country.
Import Quotas
Quota on trade imposed
by the exporting
country at the request
of the importing
country’s government.
VERs
Helps
producers
Quota
rent
10. Local Content Requirements
A specific
fraction of a
good must be
domestically
produced.
A specific
fraction of a
good must be
domestically
produced.
Physical
amount
Value
Widely used
by developing
countries to
develop their
manufacturing
base.
Used by developed
countries to
protect local jobs
and industry from
foreign competition.
11. Administrative Policies
• Bureaucratic rules designed to make it difficult for imports to enter
a country.
• Japanese ‘masters’ in imposing rules.
• Tulip bulbs.
• Federal Express.
12. Antidumping Policies
• Selling goods into a foreign market below
production costs, or
• Selling below “fair market value”.
• Used to unload excess production.
• Or, predatory pricing.
• Antidumping policies are used to punish
foreign firms.
• Protect local industry from “unfair” practices.
• Impose “countervailing” duties.
13. Political Arguments for Intervention
Further
Foreign Policy
Objectives
Protect
Industry
and Jobs.
National
Security
Retaliation
Protect
Consumers
Protect
Human
Rights
14. Economic Arguments for Intervention
Infant
Industry
Strategic
Trade
Policy
Infant industry is the oldest economic
argument for government intervention,
dating to 1792 and Alexander Hamilton.
Protect developing country’s new industry
from developed countries better
established industries. Recognized by
GATT.
Strategic trade policy can help a
firm gain ‘first mover’ advantages
or overcome barriers created by a
different (foreign) first mover.
15. Revised Case for Free Trade
Paul Krugman, MIT economist, argues that strategic
trade policies can lead to trade wars. The best way to
handle disputes is to work to establish rules that minimize
trade-distorting subsidies - a function of the World
Trade Organization.
He also argues that government intervention usually favors
special interest groups that distort the subsidy to their
own ends.
Therefore, “a blanket policy of free trade, with exceptions
granted only under extreme pressure … may be the best
policy that the country is likely to get.”
18. Absolute Advantage
To have an absolute advantage a country must
be able to produce:
1) a larger amount of a good or service for the
same amount of inputs as can another country
2) the same amount of a good or service using
fewer inputs than can another country
• In classic economics a “unit of input” is
measured in: land, labor, capital
19. Absolute Advantage: Example
Assumptions:
• We consider two countries: USA and China that produce only
soybeans and cloth
• Each has two “units of input” and uses one to produce tons of
soybeans and the other bolts of cloth
• The U.S. has an absolute advantage producing soybeans
• China has an absolute advantage producing cloth
20. Absolute Advantage Example
• A “unit of input” is made of: land, labor, capital
• If each specializes, the total tons of soybeans
and bolts of cloth available to the world
increases
• Soybeans from 4 to 6; cloth from 6 to 8
23. Theory of Comparative Advantage:
Example
• Each has two “units of input” and uses one to produce tons of
soybeans and the other bolts of cloth
• The quantities have changed from the prior example
• China has the absolute advantage producing both soybeans and bolts
of cloth
• The U.S. does a better job producing soybeans, it has a a comparative
advantage or lower comparative disadvantage in soybeans
24. Theory of Comparative Advantage: Example
• The U.S. specializes in soybeans and China in cloth
• There are one fewer tons of soybeans three more bolts
of cloth
• If the U.S. exports four tons of soybeans to China for 3
bolts of cloth the U.S. consumer has more cloth
• China is left with two surplus bolts of cloth; it can trade
one with another country for more soybeans and be left
with more cloth for its citizens
25. A Link Between Trade and Growth
Sachs and Warner: 1970 to 1990 study
Open economy developing countries grew 4.49%/year.
Closed economy developing countries grew 0.69%/year.
Open economy developed countries grew 2.29%/year.
Closed economy developed countries grew 0.74%/year.
Frankel and Romer:
On average, a one percentage point increase in the ratio
of a country’s trade to its GDP increases income/person
by at least 0.5%. For every 10% increase in the
importance of international trade in an economy, average
income levels will rise by at least 5%.
27. Heckscher-Ohlin Theory of Factor
Endowments
• Reasons for countries to export products requiring large amounts of their abundant production
factors:
• Lower cost to produce; more attractive abroad
• Imported products have low relative cost as producing locally would require large
amounts of the importing country’s scarce production factors
• Does not consider
• Government influence on factor prices - no perfect market
• Transportation costs
• Differences in tastes
• Differences in climates
• Population diversity and income levels
45. Implications for Business
• Location implications: makes sense to disperse
production activities to countries where they can be
performed most efficiently.
• First-mover implications: It pays to invest substantial
financial resources in building a first-mover, or early-
mover, advantage.
• Policy implications: promoting free trade is generally in
the best interests of the home-country, although not
always in the best interests of the firm. Even though,
many firms promote open markets.