international economics lecture 4

PAOLO V. VALLADAREZ, LL.B.Instructor

EARLY TRADE THEORIES

MERCANTILISM

• 1500-1750

• Collection of similar attitudes toward :

- domestic economic activity

and

- the role of international trade

“POLITICAL ECONOMY OF NATION-BUILDING”

OR

“AKO, AKO, AKO, PALAGI NA LANG AKO …. Dapat lang!”

* NATIONAL WEALTH WAS REFLECTED IN A COUNTRY’S

HOLDINGS OF PRECIOUS METALS.

NATIONAL WEALTH = PRECIOUS METALS “SPECIE”

(THEY HAVE A STATIC VIEW OF WORLD RESOURCES)

Mercantilist doctrines:

•Acquisition of precious metals thus became the means for increasing wealth and well-being and the focus of the emerging European Nation-states.

• Believed that in a hostile world, the enhancement of state power was essential to the growth process

Strong army, strong navy and

Merchant marine and productive economy

ACCUMULATION OF PRECIOUS METALS

SYSTEM WHERE GOVERNMENTS CONTROL

THE USE AND EXCHANGE OF PRECIOUS METALS

* Economic activity can be viewed as a ZERO-SUM

GAME in which one country’s economic gain was at the

expense of another.

* Employed the LABOR THEORY OF VALUE

Commodities were valued relatively in terms of their relative labor content

●ECONOMIC ACTIVITY SHOULD BE REGULATED AND NOT LEFT TO INDIVIDUAL

PREROGATIVE.

* POLICIES ON POPULATION AND LABOR WERE INFLUENCED BY

TRADE POLICIES

1. FORMATION OF CRAFT GUILDS

2. POLICIES THAT KEPT WAGES LOW

1. GROWING POPULATION WAS CRUCIAL TO GROWTH IN PRODUCTION:

a. Encouraging large families

b. Giving subsidies for children

c. Giving financial incentives for marriage

* MERCANTILISTS STRESSED THE IMPORTANCE OF A

FAVORABLE TRADE BALANCE

=

● CRITICIZED MERCANTILISM

● THE WEALTH OF THE NATION IS NOT MEASURED BY GOLD AND SILVER, INSTEAD THE WEALTH OF THE NATION IS BEING MEASURED ON THE GOODS AND SERVICES AVAILABLE FOR THE CONSTITUENTS OF THE SOCIETY

ADAM SMITH

THEORY OF ABSOLUTE ADVANTAGE

-Each country should export those commodities it produced more efficiently because the absolute labor required per unit was less than that of the prospective trading partner.

- The ability of country A to produce a commodity more efficiently than country B

-The assumption is that nations trade if they can mutually benefit from

THEORY OF COMPARATIVE ADVANTAGE

-“A nation, like a person, gains from trade by exporting the goods or services in which it has its greatest comparative advantage in productivity and importing those in which it has the least comparative advantage.” – DAVID RICARDO (19TH CENTURY)

- even if a nation had an absolute DISadvantage in production of both commodities with respect to other nation, mutual advantageous trade could still take place

- less efficient nation should specialize in production and export of commodity which its absolute disadvantage is less.

-This is the commodity in which the nations has comparative advantage

United States United Kingdom

SHOES 6/ labor-hr 1

CORN 3 2

ANALYSIS:

1. UK has absolute disadvantage with respect to U.S. in production of both corn and shoes.

2. However, disadvantage is less in corn than in shoes.

3. Hence, U.K. has a comparative advantage with respect to the U.S. in corn and comparative disadvantage in shoes.

4. U.S. has greater absolute advantage over U.K. in shoes than in corn – U.S. has a comparative disadvantage in corn and a comparative advantage in shoes.

SEATWORK

United States U.KingdomWheat (bushels/labor-hr)

6 1

Cloth (yards/Labor-hr) 4 3

Indicate:

1. Whether the U.S. has an absolute advantage or a disadvantage in wheat and/or cloth?

2. The commodity in which the U.S. and U.K. have a comparative advantage.

3. The gains to the US and the UK if they exchange 6w for 6c.

INSTRUMENTS OF TRADE POLICY

• In April 2001, Japan restricted imports of agricultural goods from China, two months later, China returned the “favor” by putting 100% tariffs on Japanese autos, cellphones and air conditioners. Japan then considered limiting imports of Chinese towels.

• In November 2003, the European Union threatened to slap retaliatory tariffs on over $ 2 billion of U.S. exports because of tariffs that the United States had placed on steel imports in 2002.

Why are tariffs / quotas imposed?

•1. It may move the terms of trade to the benefit of the country

•2. Protect “Infant Industries”

•3. Reduce Unemployment

In what ways can a country interfere with trade?

• IMPORT TARIFFS1. Specific Tariff- Is an import duty that assigns a fixed monetary

tax per physical unit of the good imported- The total import tax bill is levied in accordance

with the number of units coming into the importing country and not according to the price or value of the imports

2. Ad valorem tariffs

- Is levied as a constant percentage of the monetary value is levied as a constant percentage of the monetary value of 1 unit of the imported good

- Makes it possible for domestic producers to overcome the loss of protective value that the specific tariff was subject to during infaltion

OTHER FEATURES OF TARIFF LEGISLATION

• Preferential duties

- Tariff rates applied to an import according to its geographical source

• Most favored nation treatment (MFN) or Normal Trade Relations (NTR)

- Suppose the U.S. and India conclude a bilateral tariff negotiation whereby India reduces its tariffs on U.S. computers and the U.S. reduces its tariffs on Indian clothing. MFN or NTR states that any 3rd country with which the U.S. has an MFN or NTR agreement will get the same tariff on clothing from the U.S.

• EXPORT TAXES and SUBSIDIES1. Export tax – is levied only on home

produced goods that are destined for export and not for home consumption

2. Export Subsidy – a negative export tax or a payment to a firm by the government when a unit of a good is exported

- Attempts to increase the flow of trade of a country

NONTARIFF BARRIERS

• IMPORT QUOTAS

- Operates directly on the quantity of the import instead of on the price

- Specifies that only a certain physical amount of the good will be allowed into the country usually the time period

• “VOLUNTARY” EXPORT RESTRAINTS

- An importing country that has been preaching the virtues of free trade may not want to impose an outright import quota

- Instead, a country may choose to negotiate an administrative agreement with a foreign supplier whereby that supplier “voluntarily” agrees to refrain from sending some exports to the importing country

• GOVERNMENT PROCUREMENT PROVISIONS

-these provisions restrict the purchasing of foreign products by home government agencies

• DOMESTIC CONTENT PROVISIONS

- Attempt to reserve some of the value added and some of the sales of product components for domestic suppliers