Ch 10 – Protectionism vs. Free Trade

1. Ch 10 – Protectionism vs. Free Trade “Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular.”Lord Thomas Macauley

2. Common Fallacies Trade is a zero-sum game. Imports reduce employment, exports promote employment. Tariffs and quotas save jobs and promote employment. Ch 10 – Protectionism vs. Free Trade

3. Protectionist Arguments • Need to protect ourselves from foreign competition • Cheap foreign labor makes us lose jobs in United States • Need to protect industries vital to United States security, welfare, defense • Cars • Steel • Petroleum • Nuclear energy • Need to protect the environment Free Trade Arguments • Worldwide interests are best served by free trade because resources are used more efficiently. • We are all better off with voluntary, free market transactions. Ch 10 – Protectionism vs. Free Trade

4. Ch 10 – Protectionism vs. Free Trade Mercantilists (1500 – 1800) Wealth = Nation’s supply of gold Need exports > imports to be wealthy Advocated trade barriers Believed trade to be zero sum game

5. “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question, had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind. Their interest is, in this respect, directly opposite to that of the great body of the people.” Adam Smith, Wealth of Nations Ch 10 – Protectionism vs. Free Trade

6. Types of International Trade Restrictions (Barriers to Trade) Tariff Tax, or duty, levied on a product when it crosses a nation’s boundaries. Quota Quantitative restriction on imported goods. • Negative welfare effects – Benefits concentrated in select group, generally domestic producers of protected goods. • Costs (higher prices, loss of welfare) tend to spread out to all consumers. • Makes barriers politically appealing, but economically unattractive. Ch 10 – Protectionism vs. Free Trade

7. Types of International Trade Restrictions (Barriers to Trade) Embargoes Government prevention of trade for reasons of national security, human rights issues, to combat terrorism. • Takes form of export restrictions, mandatory trade limits. • Designed to ruin the target nation’s economy. • Most effective in nations that elect their leaders. • Imposes costs on target AND imposing nations. • Examples: • Cuba, over 40 years • N. Korea, 45 years • N. Vietnam, 30 years Ch 10 – Protectionism vs. Free Trade

8. Foreign Exchange Market Where foreign currencies are bought and sold • All foreign transactions involve foreign exchange. Exchange Rate Price of one country’s currency expressed in terms of another country’s currency. Ch 10 – Protectionism vs. Free Trade • Market for US Dollar • Price is expressed in terms of British pounds (how many pounds it would take to buy one US dollar). • At equilibrium price of £2, quantity demanded = Q1. • If demand for US dollars increases in foreign exchange market, demand curve shifts right, price of US dollar increases to £3. Exchange Rate (price in pounds) S £ 2 D1 Q Q1

9. Foreign Exchange Market Where foreign currencies are bought and sold • All foreign transactions involve foreign exchange. Exchange Rate Price of one country’s currency expressed in terms of another country’s currency. Ch 10 – Protectionism vs. Free Trade • Market for US Dollar • Because of increased demand for US dollar, dollar is now more expensive for British. • Conversely, British pounds are less expensive for US consumers. • Dollar has appreciated with respect to the pound. • Pound has depreciated with respect to the dollar. Exchange Rate (price in pounds) S £ 3 £ 2 D2 D1 Q Q1 Q2

10. Foreign Exchange Market Where foreign currencies are bought and sold • All foreign transactions involve foreign exchange. Exchange Rate Price of one country’s currency expressed in terms of another country’s currency. Ch 10 – Protectionism vs. Free Trade • Market for US Dollar • With cheaper pounds, British goods have become cheaper for US consumers (price of British imports has fallen). • With more expensive dollars, US good have become more expensive for British consumers (price of US exports has risen). Exchange Rate (price in pounds) S £ 3 £ 2 D2 D1 Q Q1 Q2

11. Regional Trade Agreements • North American Free Trade Agreement (NAFTA) • US, Canada, Mexico - 1992 • Controversial because of industrialized economies joining trade union with developing nation. • European Union • Fifteen nations (10 more by end of 2004) • Monetary union, most nations use euro as common currency (Denmark, Sweden, UK, and Greece have not switched to using euro). Why Use Common Currency? • Benefits of common currency • Lower transaction costs • Easier wage/price comparisons • Common measure of value. • Costs • Changing ATM’s, vending, posted prices, cash registers • Learning curve for using currencies Ch 10 – Protectionism vs. Free Trade