EC 367: International Trade

1. EC 367: International Trade

2. Two waves of globalization • Economic historians tell us that a global economy, with strong economic linkages, between even distant nations, is not new. In fact, there have been two great waves of globalization, with the first wave relying not on jets and the Internet, but on railroads, steamship, and the telegraph.

3. Logistics • Dr. Nadia Campaniello • Email: ncampa@essex.ac.uk • Room: 5B.340 • Office hours: Wednesday 2.30 p.m– 4.30 p.m. (but it could change, so please check my web page!) • Textbook: International Economics: Theory and Policy by P. R. Krugman, M. Obstfeld & M. Melitz, Ninth Edition, Publisher: Pearson • Other good reference text: • International Economicsby R. C. Feenstra & A. M. Taylor

4. Logistics (cont.) • Class: Thursday, 4-5 p.m. (Not this week) • Questions, Discussion, Sample Problems • Presentations? • Formative Assessment: • Evaluation: max{50% term paper +50% exam, 100% exam} • Term paper due on the 17th January at 12:00 (mid-day) • Attendance is not compulsory, but highly recommended. • Please do not forget to sign the attendance sheet!

5. Why Is International Economics important? • International trade has never been as important as it is now because in the early 21st century, nations are more closely linked through trade in goods and services, flows of money, and investments in each other’s economies than ever before. • In the U.S: International trade as a fraction of the national economy has tripled in the past 40 years.

6. Exports and Imports as a percentage of US National Income Source: U.S. Bureau of Economic Analysis

7. Comments on the previous graph • Both imports and exports fell in 2009 as a consequence of the global economic crisis that started in 2008. It reflects the fact that there are close links between world trade and the overall state of the world economy • Compared to the U.S., other countries are even more tied to international trade.

8. Exports and Imports as Percentage of National Income in 2007 Source: Organization for Economic Cooperation and Development

9. Comments on the previous graph • International economic relations have become crucial not only for the US, but also, and even more, for other countries. The figure shows the average of imports and exports as a share of GDP for a sample of countries. The US relies less on international trade than almost any other country, thanks to its size and diversity of its resources.

10. What is International Trade about? • Issues raised by the special problems of economic interaction between sovereign states: • the gains from trade; • the pattern of trade; • protectionism; • the balance of payment; • exchange rate determination; • international policy coordination; • the international capital market.

11. Gains from Trade Several ideas underlie the gains from trade. When a buyer and a seller engage in a voluntary transaction, both can be made better off. • Norwegian consumers import oranges that they would have a hard time producing. • The producer of the oranges receives income that it can use to buy other things that it desires.

12. Gains from trade (cont.) • Two countries can trade to their mutual benefit even when one of them is more efficient than the other at producing everything, and when producers in the less efficient country can compete only by paying lower wages. • Trades provides benefits by allowing countries to export goods whose production makes relatively high use of resources that are locally abundant while importing goods whose production makes heavy use of resources that are locally scarce. • International trade allows countries to specialize in producing narrower ranges of goods , giving them greater effeiciencies of large scale production

13. Gains from trade (cont.) • The benefits of international trade are not just limited to trade tangible goods: international migration and international borrowing and lending are also forms of mutually beneficial trade. International migration  trade of labor for goods and services International borrowing and lending  trade of current goods for the promise of future goods

14. Gains from Trade (cont.) • Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups within a country. • International trade can harm the owners of resources that are used relatively intensively in industries that compete with imports and cannot find alternative employment in other countries. • Trade may therefore affect the distribution of income within a country. Ex. Real wages of less skilled workers in the US have been declining even though the country as a whole is continuing to grow richer. Can be due to the rapidly growing exports of manufactured goods from low wage countries?

15. Patterns of Trade • Attempts to explain the pattern of international trade (who sell what to whom) have been a major preoccupation of international economists. • Differences in climate and resources can explain why Brazil exports coffee and Australia exports iron ore. • But why does Japan export automobiles, while the U.S. exports aircraft? • Why some countries export certain products can stem from differences in: • Labor productivity • Relative supplies of capital, labor and land and their use in the production of different goods and services

16. Effects of Government Policies on Trade • Policy makers affect the amount of trade through • tariffs: a tax on imports or exports, • quotas: a quantity restriction on imports or exports, • export subsidies: a payment to producers that export, • or through other regulations (ex., product specifications) that exclude foreign products from the market, but still allow domestic products. • What are the costs and benefits of these policies?

17. The Effects of Government Policies on Trade (cont.) • If a government must restrict trade, which policy should it use and how much should it restrict trade? • If a government restricts trade, what are the costs if foreign governments respond likewise? • Cost of a trade war • Trade policies are often chosen to cater to special interest groups, rather than to maximize national welfare. • Protection for Sale • Governments tend to adopt tariffs, then negotiate them down in exchange for reduction in trade barriers of other countries.

18. Who trades with whom?Total U.S. Trade with Major Partners, 2008 Source: U.S. Department of Commerce

19. What are the factors that determine who trades with whom? . The Role of Size: The Gravity Model • 3 of the top 10 trading partners with the U.S. in 2008 were also the 3 largest European economies: Germany, U.K., and France. • Why does the U.S. trade most with these European countries and not other European countries? • The answer is that these are the three largest European economies: they have the highest value of GDP, which measures the total value of all goods and services produced in an economy.

20. The Size of European Economies, and the Value of Their Trade with the United States Source: U.S. Department of Commerce, European Commission, 2008

21. The Gravity Model Tij = A * Yi * Yj/ Dij Tij is the value of trade between country iand country j A is a constant term Yi is the country i’s GDP Yjis the country j’s GDP Dij is the distance between the two countries

22. Economic Size and Trade with the United States Source: U.S. Department of Commerce, European Commission.

23. Distance, Barriers and Borders • Canada and Mexico are US neighbors and this the reason why they trade so much with the US. • Canada has an economy that is roughly the same size as Spain’s, but trades as much with the US as all of Europe does • All estimated gravity model show a strong negative effect of distance on international trade: 1% increase in the distance between two countries is associated with a fall of 0.7 to 1 % in the trade between those countries.

24. Distance, Barriers and borders (cont.) • Why?: • Increased cost of transportations • Less tangibles factors play a crucial role: trade tends to be intense when countries have close personal contacts. • Ex. It is easy for a US sales representative to pay a quick visit to Toronto, but it’s much more difficult and costly to go to Rome. • In addition, Canada and Mexico are part of a trade agreement with the US: the North America Free Trade Agreement (NAFTA), which ensures that most goods shipped among the three countries are not subject to tariffs or other barrier to international trade.

25. The Gravity Model (cont.) Other things besides size matter for trade: • Distance between markets influences transportation costs and therefore the cost of imports and exports. • Distance may also influence personal contact and communication, which may influence trade. • Cultural affinity: if two countries have cultural ties, it is likely that they also have strong economic ties. • Geography: ocean harbors and a lack of mountain barriers make transportation and trade easier. • Multinational corporations: corporations spread across different nations import and export many goods between their divisions. • Borders: crossing borders involves formalities that take time and perhaps monetary costs like tariffs. • These implicit and explicit costs reduce trade. • The existence of borders may also indicate the existence of different languages (see 2) or different currencies, either of which may impede trade more.

26. Trade with British Columbia, as Percent of GDP, 1996

27. Barriers do matter • Although trade agreements often end all formal barriers to trade between countries, they rarely make borders irrelevant. • The Canadian-US border is a case in point. • The two countries are part of a free trade agreement • Most Canadians speak English • The citizens of either countries are free to cross the border with a minimum of formalities. • Yet data on the trade of individual Canadian provinces both with each other and with US states show that, other things equal, there is much more trade between provinces than between provinces and the US Canada-US border deter trade! Different currencies? Reaserach is still ongoing…

28. Has the World Become Smaller?

29. Has the World Become “Smaller”? • The negative effect of distance on trade according to the gravity models is significant, but has grown smaller over time due to modern transportation and communication. • Technologies that have increased trade: • Wheels, sails, compasses, railroads, telegraph, steam power, automobiles, telephones, airplanes, computers, fax machines, Internet, fiber optics, personal digital assistants, GPS satellites…

30. Has the World Become “Smaller”? (cont.) • Political forces can change trade patterns much more than innovations in transportation and communication. • World trade grew rapidly from 1870 to 1913. • Then it suffered a sharp decline due to the two world wars and the Great Depression. • It started to recover around 1945 but did not recover fully until around 1970. • Since 1970, world trade as a fraction of world GDP has achieved unprecedented heights.

31. World Exports as a Percentage of World GDP

32. Has the world gotten smaller?

34. Vertical disintegration • Since 1970 world trade as a share of world GDP has risen to unprecedented heights. • Much of this rise in the value of world trade reflects the so called “vertical disintegration” of production: before a product reaches the hands of consumers, it often goes through many production stages in different countries

35. Changing Composition of Trade • Today, most (about 55%) of the volume of trade is in manufactured products such as automobiles, computers, clothing and machinery. • Trade in mineral products (copper ore, coal, etc. but especially oil) remains an important part of world trade (about 18%). • Agricultural products (wheat, soybeans, cotton, etc.) are another key piece of the picture (about 7%). • Services play an important role and are expected to become more important in the future (about 20%).

36. The Composition of World Trade, 2008 Source: World Trade Organization

37. Changing Composition of Trade (cont.) • In the past, a large fraction of the volume of trade came from agricultural and mineral products. • The current picture, in which manufactured goods dominate world trade, is relatively new.

38. Manufactured Goods as a Percent of Merchandise Trade

39. The Changing Composition of Developing-Country Exports Source: United Nations Council on Trade and Development

40. Service Outsourcing • Service outsourcing (or offshoring) occurs when a firm that provides services moves its operations to a foreign location. • Service outsourcing can occur for services that can be performed and transmitted electronically. • For example, a firm may move its customer service centers whose telephone calls can be transmitted electronically to a foreign location. • Producers might decide whether they should set up a foreign subsidiary to provide services (and operate as a multinational firm) or outsource those services to another firm.

41. Service Outsourcing (cont.) • Service outsourcing is currently not a huge part of trade, but it is growing rapidly. • Some jobs are “tradable” and thus have the potential to be outsourced. • Most jobs are “non tradable” because they need to be done close to the customer.

42. Service outsourcing (cont.) • Alan Blinder: “in the future, and to a great extent already in the present, the key distinction for international trade will no longer be between things that can be put in a box and things that cannot. It will, instead, be between services that can be delivered electronically over long distances with little or no degradation of quality, and those that cannot”. • Ex. The nurse who take your pulse has to be nearby, while but the radiologist who reads your X-ray could receive the images electronically anywhere that has a high speed connection.

43. Tradable Industries’ Share of Employment Source: J. Bradford Jensen and Lori G. Kletzer, “Tradable Services: Understanding the Scope and Impact of Services Outsourcing,” Peterson Institute of Economics Working Paper 5-09, May 2005

44. Comment on the previous graph • The figure shows the results of one study that used data on the location of industries within the US to determine which services are and are not tradable at long distances. As the fig. shows, the study concluded that about 60% of total US employment consists of jobs that must be done close to the customer, making them non tradable. But the 40% of employment that is in tradable activities include more service than manufacturing jobs. • This suggests that the current dominance of world trade by manufacturers may be only temporary. In the long run, trade in services, delivered electronically, may become the most important component of world trade.

45. Summary • The 5 largest trading partners with the U.S. are Canada, China, Mexico, Japan, and Germany. • The largest economies in the EU undertake the largest fraction of the total trade between the EU and the U.S. • The gravity model predicts that the volume of trade is directly related to the GDP of each trading partner and is inversely related to the distance between them.

46. Summary (cont.) • Besides size and distance, culture, geography, multinational corporations, and the existence of borders influence trade. • Modern transportation and communication have increased trade, but political factors have influenced trade more in history. • Today, most trade is in manufactured goods, while historically agricultural and mineral products made up most of trade.