International trade - theory and challenges

1. International trade - theory and challenges

2. Extra credit opportunity • Presentations on • a country or • a region(even a town/city in U.S.) • some other subject in global business • An especially good chance to discuss your home or your ancestors’ home

3. We’re can schedule some now, and we’ll be continuing through the term • I had allotted some time for these the last two sessions of the term, but better to do them earlierLength – • 6 to 10 minutes (individual) • Up to 18 minutes (group)

4. A country presentation can describe • The economic environment • How do people live? • What is GNI per capita • Provide both unadjusted and purchasing power parity (PPP) adjusted statistics • How does GNI per capita level affect life? • The political environment • How is the country/region governed?

5. Something of the cultural environment • You can’t summarize the culture; just say one or two things that strike you as important • The country or region’s role in international business • What does the country or region produce? • How important is it to people elsewhere? • Can you tell what is likely to happen in the future?

7. Overview of Trade Theory • Free Trade occurs when a government does not attempt to influence, through tariffs, quotas, or other means, • what citizens can buy from other countries or • produce and sell to other countries • The Benefits of Trade allow countries to be richer by specializing in products they can produce most efficiently

8. Trade Theory-Overview • There are lots of problems with trade • There may be some ways that some governments can make things better by intervening (that is, by not practicing free trade) • But government intervening in free trade is definitely dangerous • Restrictions on trade have • kept some countries very poor • contributed to huge depressions

10. Mercantilism: Mid-16th Century • A nation’s wealth depends on accumulated “treasure” • Gold and silver are the currency of trade • Mercantilists sought what we now call ‘development’ • They argued their countries should run a trade surplus • Maximize export through subsidies • Minimize importsthrough tariffs and quotas • Flaw: “zero-sum game” • Mercantilists neglected to see the benefits of trade

11. But there was a flaw in the mercantilists’ argument • They assumed that trade was a zero-sum game • As England, France, and the Netherlands competed with each other, many thought only about advantage for their country

13. Theory of Absolute Advantage • Adam Smith argued (Wealth of Nations, 1776): Capability of one country to produce more of a product with the same amount of input can vary • A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient • Trade between countries is, therefore, beneficial • Example: Ghana/cocoa vs.South Korea/rice

14. Absolute Advantage and the Gains From Trade

15. Theory of Absolute Advantage

16. There may also be long-term benefits to free trade • As people specialize and seek higher incomes, they may learn to do their specialties better

18. Comparative Advantage • Suppose one country is more efficient than another in everything? • There are still global gains to be made if a country specializes in products it produces relativelymore efficiently than other products

19. David Ricardo (Principles of Political Economy, 1817): • A country should import products for which it is relatively inefficient even if the country is more efficient in the product’s production than country from which it is buying • Trade is a positive-sum game

20. Comparative Advantage and the Gains From Trade

21. Theory of Comparative Advantage

22. Countries have comparative advantage in goods for which the opportunity cost of production is relatively low • That is, those that can be produced by giving up relatively little in production of other goods

23. This means your country has comparative advantage in the product or service where the ratioResources required in your country . Resources required in the other country is low

24. How Comparative Advantage works Ghana has absolute advantage in both cocoa and rice, but its comparative advantage is in cocoa. Korea has comparative advantage in rice . Cocoa 20 tons Let Korea specialize in rice – Ghana expands cocoa production to replace all Korean cocoa production lost 15 tons Ghana Then Ghana can replace all Korean cocoa production and the countries have more of both goods. 5 tons Korea 15 tons 10 tons 18 tons 3.75 tons Rice

25. The country less efficient in everything will be poor … • But it would be even poorer if it did not trade

26. Smith, Ricardo advocated free competition in the economy • They believed that if people were left to trade on their own, they would naturally trade the goods in which their countries had comparative advantage • “Every individual seeks the most advantageous employment for his capital…. • “Study of his own advantage necessarily leads him to prefer that employment most advantageous to society”- Adam Smith, 1776

27. Assumptions • This is a very simple case, but the basic conclusions are generally valid • We’re assuming no transportation costs • We’re simplifying by not talking about currencies • We’re assuming constant returns to scale • We’re assumingresources can move freelyfrom production of one good to another • We’re not thinking about effects on income distribution

28. Under free trade, the country that is less efficient will have low wages • It will be able to sell the products where it has comparative advantage without any special tariff or subsidy protection

29. But it may need to work on infrastructure– roads, railroads, ports, airports • “Infrastructure” = the basic equipment and structures (such as roads, bridges) that are needed for a country, region, etc. to function properly • Note: This may not be in the reading • China, India both sell cheap manufactured goods • China sells more because it has better transportation infrastructure and government that supports manufactured exports

30. It will need education for its people • And it will need institutionsfor trade • Banks, government agencies who can • process exports • work with foreigners • Honest banks and agencies

31. Moral element of liberal economies • Successful trading states have to have “two cultures” • In commercial culture, people trade for profit, and we hope honesty will be prized largely because it’s good business • But successful economies also need guardian culture – government servants who can use force, but won’t sell themselves to the highest bidder

33. As we alter the Comparative Advantage Model toward realism, we get complexity • Immobile resources: • Resources do not always move easily from one economic activity to another • So some rice farms will persist in Ghana no matter what • (Rice farmers will be losersas cheap rice comes from Korea) • Diminishing returns: • Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional unit • So comparative advantage will vary with production

34. Production Possibility Frontier Under Diminishing Returns

35. Simple Extensions of the Comparative Advantage Model • Free trade has additional effects in open economies: • Free trade might increase a country’s stock of resources (as labor and capital arrivesfrom abroad) • It could also increase the efficiency of resource utilizationinside each country as well as between them • It causes knowledge to move between countries • It also changes tastes and cultures

36. Influence of Free Trade on PPF

38. When might government intervention help a country? • The infant industry argument: There may be industries that are uncompetitive today but could become competitive if protected for a while • Oldest argument - Alexander Hamilton, 1792 • Only succeeds if industry makes itself efficient • Japanese automakers – were protected with ‘infant industry’ tariffs for 20+ years, became world leaders • Brazil automakers - 10th largest - wilted when protection eliminated

39. ‘New Trade Theory’ (developed 1970s & after) In industries with high fixed costs: • Specialization increases output, • The ability to achieve economies of scale increases through exporting • Learning effects are high. • These cost savings come from “learning by doing”

40. New Trade Theory-Applications • In many industries, world demand will support few competitors • Successful firms may emerge because of “First-mover advantage” • Economies of scale may preclude new entrants • Role of the government becomes significant • Some argue that it generates a need for government intervention and strategic trade policy

42. Slides below are not required

43. These economists favored free competition • They thought if businesspeople were left alone, they would naturally export what their nations could produce cheaply

44. The U.S. seems to be good at inventing new products • The important factors may be highly specialized • Software design engineers • Or the U.S. may have a unique constellation of factors that produces new products • Production of the new products tends to be labor intensive at first • The U.S. imports older, heavy industrial products