IDEAS & THEORIES ON INTERNATIONAL TRADE

1. IDEAS & THEORIES ON INTERNATIONAL TRADE

2. ANCIENT CHINESE TRADE Guan Zhong and the book Guan Zi (725-645 BC) The light/heavy theory Guan Zhong argued that when a good was abundant, it became light, and its price would fall--- when the good was “locked away”, it became heavy, and the good’s price would rise There are movements of goods into and out of markets based on their lightness and heaviness, with a tendency toward one price– equilibrium --- hence a statement of the law of supply & demand The movement “IN and OUT” of markets was trade

3. A TRANSELATED QUOTEGuan Zhong “INDEED, IT IS THE NATURE OF MEN THAT WHENEVER THEY SEE PROFIT, THEY CANNOT HELP CHASING AFTER IT, AND WHENEVER THEY SEE HARM, THEY CANNOT HELP RUNNING AWAY. WHEN THE MERCHANT ENGAGES IN TRADE AND TRAVELS TWICE THE ORDINARY DISTANCE IN A DAY, USES THE NIGHT TO EXTEND THE DAY, AND COVERS A THOUSAND LI WITHOUT CONSIDERING IT TOO FAR, IT IS BECAUSE PROFIT LIES AHEAD. WHEN THE FISHERMAN PUTS OUT TO SEA, THE SEA MAY BE TEN THOUSAND-REN DEEP, AND WHEN HE HEADS INTO ITS WAVES AND STRUGGLES AGAINST ITS TIDES, RAISES HIS SMALL MAST AND SAILS OUT A HUNDRED LI, NEVER LEAVING THE WATER FROM MORNING TO NIGHT, IT IS BECAUSE PROFIT LIES IN THE WATER. THUS, WHEREVER PROFIT LIES, EVEN THOUGH IT BE ATOP A THOUSAND-REN PEAK, THERE IS NO PLACE PEOPLE WILL NOT CLIMB. EVEN THOUGH IT IS AT THE BOTTOM OF THE DEEPEST DEPTHS, THERE IS NO PLACE PEOPLE WILL NOT ENTER.

4. INDEED, THOSE WHO ARE SKILLED IN GOVERNMENT CONTROL THE PRESENCE OF WEALTH SO THAT THE PEOPLE ARE NATURALLY CONTENT. WITHOUT PUSHING THEM, THEY GO; WITHOUT PULLING THEM, THEY COME. WITHOUT TROUBLE OR WORRY, THE PEOPLE ENRICH THEMSELVES. IT IS LIKE A BIRD SITTING ON ITS EGGS; THERE IS NEITHER SHAPE NOR SOUND, BUT THE YOUNG SUDDENLY APPEAR QUITE COMPLETE” GUAN ZHONG, GUAN ZI, VOL. II, TRANSELATED BY W. ALLYN RICKETT (PRINCETON, N.J.: PRINCETON UNIVERSITY PRESS, 1998), pp. 219-220.

5. MERCANTILISM THE RISE OF THE MERCHANTS IN ECONOMIC AND SOCIAL LIFE THE TENETS OF MERCANTILISM: BULLIONISM – INCREASE GOLD (PRECIOUS METALS), HENCE INCREASE WEALTH OF A NATION VIA INTERNATIONAL TRADE KEEP EXPORTS > IMPORTS – BRING IN SPECIES INTERNATIONAL TRADE IDEAS – RESTRICTIONS ON OUTWARD MOVEMENT OF RAW GOODS KEEP DOMESTIC PRICES LOW KEEP PRICES LOW ON INBOUND RAW INPUTS AND GOODS COLONIZATION- MONOPOLIZE COLONIAL TRADE KEEP COLONIES DEPENDENT ON MOTHER LAND RESTRICT COLONY MANUFACTURING THIS IS THE IMPACT OF THE EARLY NAVIGATION ACT BARRIERS IN THE EARLY AMERICAN COLONIES – BRITISH SHIP MONOPOLY

6. MORE ON MERCANTILISM STRONG CENTRAL GOVERNMENT – MONARCHY LANDED CLASS (LORDS), MERCHANTS BECOME RENT SEEKERS THE “ROYAL MANUFACTURERS” THE ONLY EXPORTERS A GRANT TO SHIPPING MONOPOLY GRANTED BY THE KING THE KING IS A LORD WHICH KEEPS THE ARMY AND NAVY TAXES PAID BY THE OTHER LORDS TO KEEP THE MILITARY AND THE KING IN COMFORTABLE POSITION NEED A LARGE HARD WORKING POPULATION – HENRY VIII DECREE ON NO IDLENESS NOR BEGGING LOW PAY TO KEEP WORKERS ENGAGED IN PRODUCTION (A SLUTSKY SUBSTITUTION EFFECT NOTION– THE INCOME EFFECT DOMINATES THE SUBSTITUTION EFFECT OF A WAGE CHANGE--- IF PAY INCREASES, THEN WORKERS PURCHASE MORE LEISURE--- CAN’T HAVE THAT BEHAVIOR – IT IS BACKWARD BENDING SUPPY CURVE OF LABOR IDEA

7. WHO BENEFITED? MERCHANT CAPITALISTS --- THEY BECOME PART OF SOCIETY--- THEY ARE ACCEPTED NOW THE MONARCHY – GOVERNMENT OFFICIALS THE RENT SEEKERS --- PARTICULARLY IN FRENCH MERCANTILISM THE FRENCH HAD STRONG FEUDAL FLAVOR TO MERCANTILISM THERE IS A LASTING IMPACT --RENT SEEKING BEHAVIOR AND ORGANIZATION OF GOVERNMENT SUPPLY OF GOODS AND SERVICES --INTERNATIONAL TRADE – ONE OF THE MAIN THEORIES OF INTERNATIONAL TRADE DEVELOPS

8. AND THE DEBATE GOES ON MERCANTILISM – CONNECTION TO MODERN POLICY A STATEMENT BY ROBERT E. LUCAS, JR. (UNIVERSITY OF CHICAGO) (NOBEL LAUREATE IN ECONOMICS) ON THE OCCASION OF BEING INTERVIEWED BY REASON MAGAZINE ABOUT THE IMPACTS OF THE NEW ADMINISTRATION COMING TO POWER IN 1993 IN THE U.S. THE QUESTION BY REASON – WHAT WILL BE THE ECONOMIC IMPACT OF THE NEW CLINTON ADMINISTRATION? LUCAS – “IN ECONOMIC POLICY, THE FRONTIER NEVER CHANGES. THE ISSUE IS ALWAYS MERCANTILISM AND GOVERNMENT INTERVENTION VS. LAISSEZ FAIRE AND FREE MARKETS. AND THAT’S EXACTLY WHAT’S ON THE FRONTIER RIGHT NOW WITH WITH THE NEW ADMINISTRATION. HOW MERCANTILIST ARE THEY GOING TO BE? WE DON’T KNOW” -This could be said of any incoming administration -This debate could apply to any government formation/operation What do you think?

9. Adam Smith --attack on Mercantilism-- • In 1776, Adam Smith published the first modern statement of economic theory, An Inquiry into the Nature and Causes of the Wealth of Nations • The Wealth of Nations attacked mercantilism—the system of nationalistic economics that dominated economic thought in the 1700s • Smith proved wrong the belief that trade was a zero sum game—that the gain of one nation from trade was the loss of another • Trade is a positive sum game—both nations gain

10. THE MERCANTILIST BELIEVED THAT WHAT YOU GOT IN TRADE, SOME OTHER NATION DID NOT GET ---- ASSUMED THE ZERO-SUM GAME --- ONE NATION HAS DIABOLICALLY OPPOSED PREFERENCES FROM ANOTHER NATION PAYOFFS SUM TO ZERO IN A ZERO-SUM GAME FOR ANY SET OF PAYOFFS THE SOLUTION IS A MIXED STRATEGY --- AN ATTEMPT TO MASK THE STRATEGIES ON THE PART OF THE PARTICIPANTS FRANCE CHOOSES I (1/6 PROBABILITY), II ( DOES NOT CHOOSE) , III (5/6 PROBABILITY) SPAIN CHOOSES A (2/3 PROBABILITY), B (1/3 PROBABILITY), C (DOES NOT CHOOSE) A Bit of Game Theory here CONSTANT SUM GAME PAYOFFS SUM TO SOME CONSTANT k, BUT k COULD BE 0

11. What was Smith implying here? • Access to foreign markets helps create wealth • In the extreme, If no nation imports, every company will be limited by the size of its home country market • Imports enable a country to obtain goods that it cannot make itself or can make only at very high costs --- consumers have a variety of choices of goods --- consumer economic welfare increases • Trade barriers decrease the size of the potential market, hampering the prospects of specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth creation

12. Free Trade Restricted trade Free Trade 50, 50 20, 60 Restricted trade 60, 20 27, 27 DAVID HUME – PHILOSOPHER – ECONOMIST ONE-SIDED TRADE SOLUTION IS A DILEMMA MORE GAME THEORY ----NASH EQUILIBRIUM --- DO THE BEST YOU CAN THOUGH IT MAY NOT BE AN OPTIMUM POSITION– NO PLAYER HAS INCENTIVE TO MOVE FROM THE NASH EQUILIBRIUM DOMINANT STRATEGY– ONE PLAYER PLAYS A STRATEGY IRRESPECTIVE OF THE STRATEGY CHOICE OF THEIR COMPETITOR PLAYER PAYOFFS STRATEGIES DAVID HUME SUGGESTED RESTRICTED TRADE IS A ZERO-SUM GAME OR LEADS TO A PRISONER’S DILEMMA IN MODERN NASH GAME THEORY ANALYSIS The Solution is a restricted trade strategy-restricted trade strategy

13. What is this game theory bit?? What is a Nash equilibrium? A Nash equilibrium is an action exercised from which there is no incentive to move --- in a game there are players (firms, consumers, etc), say player A, B, C, etc, actions taken by the players, say a = (a1, . . an) and payoffs given by π = f(a1, . . an), where, f( . . . ) means “function of” A Nash equilibrium exists in actions if: π = f(a1, ., ai-1, ai*, . . an) >= π = f(a1, ., ai-1, ai, . . an) , that is, the payoff to a player, πA = f(a1, ., ai-1, ai*, . . an) of all actions including action ai* is greater than the payoff with out action ai* for player A as π = f(a1, ., ai-1, ai, . . an) This position may not be an optimum such as maximum profit or maximum economic welfare, but there is no incentive to move from this position --- if this occurs for all players, then a Nash equilibrium exists One can also find a similar “resting point” if a player chooses action set (a1, ., ai-1, ai*, . . an) irrespective of what other players choose – This is the property of arriving at a solution by dominance in action strategies --- the set (a1, ., ai-1, ai*, . . an) is dominant over other play action

14. ABSOLUTE ADVANTAGE & COMPARATIVE ADVANTAGE A nation has Absolute productivity advantage if it produces more of a certain good per hour worked than another (other inputs could be used in the example in addition to labor) -- Adam Smith A nation has Comparative productivity advantage (or comparative advantage) if it has lower opportunity costs of producing a good than its trading partners –David Ricardo Comparative advantage allows a country that lacks absolute advantage to sell its products abroad

15. Let Output = Q, Input = X,PQ = price of Q, W = cost of input • Absolute advantage: • Greatest Q/X of trading nations, or greatest average product • Or lowest X/Q ---- lowest input per unit of output • Comparative advantage: • Lowest opportunity cost of trading nations • Or PQ =(X/Q)(W) is lowest, or lowest pre-trade price of trading nations, PQ=(X/Q)(W)

16. Notice that comparative advantage also incorporates absolute advantage • PQ= (X/Q)(W), since input per unit of output, (X/Q), is contained within the idea of comparative advantage • Notice also that these ideas are mainly based on production efficiency • A nation may not have any absolute advantage, but may have a sector that has least disadvantage and can trade

17. The idea of absolute advantage Which nation has absolute advantage in soybeans? Which nation has absolute advantage in textiles? Nation A has absolute advantage in soybean production, while nation B has absolute advantage in textile production (lowest labor employed per unit of each output)

18. NATION A HAS ABSOLUTE ADVANTAGE IN SOYBEANS NATION B HAS ABSOLUTE ADVANTAGE IN TEXTILES SO THE NATIONS SHOULD SPECIALIZE IN THE PRODUCT THAT HAS ABSOLUTE ADVANTAGE HOW? MOVE 6 UNITS OF LABOR FROM TEXTILES IN NATION A TO BE USED IN THE PRODUCTION OF SOYBEANS --- SO THIS NATION LOSES 1 UNIT OF TEXTILES (6 UNITS OF LABOR PER 1 UNIT OF TEXTILES), BUT GAINS 2 UNITS OF SOYBEANS (3 UNITS OF LABOR TOPRODUCE 1 UNIT OF SOYBEAN OUTPUT) WHAT THEN IS THE GAIN IN NATION A? – 1 OF TEXTILES AND + 2 OF SOYBEANS FOR AN OVERALL GAIN OF +1

19. WHAT ABOUT NATION B? MOVE LABOR FROM SOYBEANS (12 UNITS OF LABOR PER1 UNIT OF OUTPUT) INTO PRODUCING TEXTILES NATION B, IN THIS CASE WOULD LOSE 1 UNIT OF SOYBEANS, BUT GAIN 3 UNITS OF TEXTILES PRODUCTION (4 UNITS OF LABOR PER 1 UNIT OF OUTPUT) SO NATION B LOSES 1 UNIT OF SOYBEANS BUT GAINS 3 UNITS OF TEXTILES--- THE NET GAIN IS + 2 THERE IS A COMPLETE SPECIALIZATION

20. DEMAND FOR TEXTILES IN A FALLS, BECAUSE NATION A CAN GET THE TEXTILES CHEAPER FROM NATION B PRODUCERS OF TEXTILES WORKERS LEAVE TEXTILES AND GO TO THE SOYBEAN SECTOR IN NATION A THE OPPOSITE HAPPENS IN NATION B --- WORKERS MOVE TO THE TEXTILE INDUSTRY---- TEXTILE DEMAND HAS RISEN BECAUSE NATION AWANTS THE TEXTILES --- SOYBEAN PRODUCTION FALLS BECAUSE LABOR HAS MOVED TO TEXTILES Notice --- this works if the labor is mobile --- the probLem THAT ARISES IS IN THE CASE WHERE LABOR IS IMMODILE EITHER BECAUSE OF LACK OF SKILLS OR THE IMPOSITION OF RESTRICTIONS ON LABOR MOBILITY BETWEEN SECTOR AND NATIONS

21. WHAT IS GOING ON HERE? IT APPEARS THAT BRAZIL HAS ABSOLUTE ADVANTAGE IN BOTH SOYBEANS & SHOES WHAT NOW? This is where comparative advantage takes hold MEXICO DOES HAVE LEAST DISADVANTAGE IN PRODUCING SHOES AND COULD TRADE IN SHOES SINCE BRAZIL WOULD WANT TO CONCENTRATE ON THE BIG ADVANTAGE THEY HAVE IN PRODUCING SOYBEANS --- BOTH CAN TRADE WITH EACH OTHER AND OTHER NATIONS (THE LATTER ACTION DEPENDING ON COMPARATIVE ADVANTAGE AS WELL)

22. SUPPOSE AN ANOTHER EXAMPLE: THERE ARE TWO NATIONS, MARYDOM AND HEYBIA, AND TWO PRODUCTS, DAIRY PRODUCTS AND COMPUTER CHIPS. THE AVERAGE PRODUCTS OF LABOR FOR THE TWO PRODUCTS IN EACH NATION ARE GIVEN IN THE TABLE BELOW FANTASTIC NIGHT LIFE IN THIS HAVEN IN WHICH PRODUCT DOES EACH NATION HAVE COMPARATIVE ADVANTAGE? WHICH NATION ACCORDING TO COMPARATIVE ADVANTAGE SHOULD HAVE THE HIGHER WAGE?? Look again --- we are now in average product terms here

23. MARYDOM APPEARS TO HAVE ABSOLUTE ADVANTAGE IN BOTH INDUSTRIES --- BUT MARYDOM HAS COMPARATIVE ADVANTAGE IN PRODUCING COMPUTER CHIPS --- HEYBIA HAS COMPARATIVE ADVANTAGE IN PRODUCING DAIRY PRODUCTS MARYDOM SHOULD HAVE THE HIGHER WAGE --- THE LOWER LIMIT ON THE RELATIVE HIGHER WAGE WOULD BE 3 / 2.4 = 1.25, OR THE WAGE IN MARYDOM SHOULD BE NOT LESS THAN 1.25 TIMES THE WAGE ( OR 25% HIGHER) IN HEYBIA--- BUT THE WAGE IN MARYDOM COULD BE UPWARD TO 4 / 2 = 2 TIMES HIGHER THAN THE WAGE IN HEYBIA, BUT NOT MORE THAN THAT AS JUSTIFIED BY THE PRODUCTIVITY DIFFERENCE IN MARYDOM RELATIVE TO HEYBIA