Chapter 33 International trade

1. Chapter 33International trade David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 8th Edition, McGraw-Hill, 2005 PowerPoint presentation by Alex Tackie and Damian Ward

4. Exports as % of GDP

5. Source: GATT, Directions of Trade

6. Destination of world exports, 2003 Source: GATT, Directions of Trade

8. The composition of world exports

9. The composition of Turkey’s exports Source:SPO

10. Some important issues • Raw materials prices • Less-developed countries (LDCs) have claimed exploitation by industrial countries • e.g. by buying raw materials cheaply & selling manufactures dear • Manufactured exports from LDCs • some LDCs have had success in exporting manufactures • leading to complaints that jobs are under threat in the industrial countries • Trade disputes between industrial countries • In some countries, established producers of certain goods are being undercut by efficient modern producers • especially from Japan & East Asia • should such exports be restricted?

11. Comparative advantage • Trade offers benefits when there are international differences in the opportunity cost of goods. • Opportunity cost of a good • the quantity of other goods sacrificed to make one more unit of that good • The law of comparative advantage • states that countries should specialise in producing and exporting the goods that they produce at a lower relative cost than other countries.

13. The source of comparative advantage • An important difference between countries is in factor endowments • which will be reflected in different relative factor prices • e.g. if the UK has relatively abundant capital but relatively scarce labour as compared with India, • then the UK would tend to specialise in capital-intensive goods, • and India would tend to specialise in labour-intensive products • Comparative advantage may also reflect a relative advantage in technology

15. Figure 33.1: Comparative advantage and export composition (125 countries and regional averages)

16. Gainers and losers • Countries may gain from specialisation and trade • but not all countries may gain equally • Commercial policy • is government policy that influences international trade through taxes or subsidies • e.g. tariffs • or through direct restrictions on imports and exports.

17. SS Price Pw+ T Pw DD Qs Qd' Qd Qs' Quantity The economic effects of a tariff DD and SS show the domestic demand and supply for a good. If the world price is Pw, and there is free trade, domestic firms supply Qs domestic demand is Qd and the difference is imported. A tariff can stimulate domestic supply and restrict imports. At a domestic price Pw + T, where T is the size of the tariff. Domestic demand falls to Qd', domestic supply rises to Qs' and imports fall.

18. The government raises revenue – i.e. there is a transfer to the government Pw+ T Pw and there is a transfer in the form of extra profits to producers. Qs Qd' Qd Qs' There is a social cost from production inefficiency, given that the good could be imported at Pw, and a loss of consumer surplus. The welfare costs of a tariff The tariff leads both to transfers and net social losses. SS Price DD Quantity

19. Tariffs • The deadweight burden of a tariff suggests that society suffers from this method of restricting trade. • This is the case for free trade. • Tariffs have fallen substantially under the GATT • General Agreement on Tariffs and Trade

21. The case for tariffs – good arguments • Optimal tariff • a first-best argument • only valid where the importing country is large enough to affect the world price. • This policy fulfils the principle of targeting • which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly. • Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities.

22. The case for tariffs – second-best arguments • Way of life • an attempt to preserve ‘traditional’ ways • a production subsidy would be better • Suppressing luxuries • an attempt to curb consumption patterns of the rich in a poor society • better achieved by a consumption tax • Infant industries • an attempt to nurture new activities via learning by doing • a temporary production subsidy probably better • Revenue • tariffs raise government revenue • but there are better ways • Cheap foreign labour • a non-argument – denies benefits of comparative advantage

23. Other commercial policies • Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions • quotas • non-tariff barriers • administrative regulations that discriminate against foreign goods • export subsidies

24. Under free trade, with the world price at Pw, consumers demand Qd production is Qs A B Pw+ s exports are GE. Subsidy E G Pw With a subsidy, producers produce Qs’ and supply Qd' to the domestic market. World price Exports now rise to AB. Social costs arise from production inefficiency Q`s' Qd' Qd Qs and the loss of consumer surplus. An export subsidy S Price DD Quantity