Chapter 6 : International Trade

February 15 2012 Dimitar Gueorguiev

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Framework• Trade is in the interest of society as a whole by making

the economy more efficient ( pay less get more )

• But…. there are always winners and losers! owners of abundant factors win | owners of scarce factors lose

• The interactions between winners and losers, and the institutions which structure these interactions, explain much of what we observe in domestic and international politics.

Comparative Advantage and the Political Economy of Trade

• Is there a difference between comparative advantage and absolute advantage?

• Absolute Advantage: The ability of a country or firm to produce more of a good or service than another country or firm using the same resources.

• Comparative Advantage: The ability of a country or firm to produce one good or service more efficiently than producing another.

This is Neven

Neven likes Bread and Butter. Neven has two producers: Mom and Dad

Neven’S World Bread Butter

Mom 4 x hour 8 x hour

Dad 2 x hour 6 x hour

Average Work Day

Mom = 6 hours = (3x4Br + 3x8Bu) ==

Dad = 8 hours = (4x2Br + 4x6Bu)

==

12 breads or 24 butters

8 breads or 24 butters

Mom's Opportunity Cost [1 bread = 2 butters] or [1 butter = 1/2 bread]Dad's Opportunity Cost [1 bread = 3 butters] or [l butter = 1/3 bread]

Mom is great! But Dad has a comparative advantage in making butter!

If they split their work equally Neven can have 20 Breads and 48 ButtersBut if they exploit their comparative advantage Neven can have 24 Breads and 48 butters

• An economy has a comparative advantage in products that are derived from its abundant factor.

• Once trade begins differences in prices will motivate entrepreneurs to export the relatively inexpensive product that utilize their abundant factor, and import products which utilize their scarce factor.

• End Result = an economy changes (adapts) factors are reallocated production specializes prices become more uniform

Comparative Advantage and the Political Economy of Trade, cont'd.

Production Factors

• Labor: workers

• Capital: “produced assets”

• Land

• Human Capital: education, skill, health.

Economies can be characterized by their relative factor abundance or scarcity

For example:• A capital-abundant, land-scarce economy.• A capital-abundant, and land-abundant

economy.• A capital-scarce, land abundant economy.

*** We can only judge a factor of production to be abundant or scarce in relation to some other factor of production in the same economy! ***

• If a country is capital-scarce and land-scarce, in relation to labor, then it is “labor abundant”.

• If we were to rank, which of the following countries would be the most “labor scarce”?

a) Bangladeshb) Haitic) Rwandad) Sri Lankae) Vietnam f) China

• The degree to which various production activities utilize different factors is called “factor intensity”.

• A “labor-intensive” process uses a lot of labor relative to the amount of land or capital it requires.

• Using this rule we can characterize industries as labor-intensive, capital-intensive, land-intensive , (skill-intensive)

• What is the factor intensity bio of the coal industry? • What about the petroleum industry? • What about the cotton industry?

• Before the cotton gin? • After the cotton gin?

Politics of Trade and Openness

• The most simple perspective Rich vs. Poor/North vs. South

– Rich: Export raw materials and agriculture and Import manufactured goods

– Poor: Export manufactured goods and Import raw materials and agriculture

• In general, we expect owners of abundant factors to favor free trade and the owners of scarce factors to oppose it.

• In other words, protectionism favors the owners of scarce factors while imposing a cost on the owners of abundant factors.

Protection

What types of industries do trade agreements tend to free up and which do they tend to protect?

Which producers do rich countries protect?

Which producers do poor countries protect?

What happens when you divide up the production process? …..Well, a big mess of convoluted interests and preferences.

Economic Interests and Trade Policy

• Domestic: industry; farmers; consumers; workers; public servants..

• Transnational: multinational corporations; investors..

• Concentrated Benefits and Diffuse Costs– Protection? Who gains? _______ Who loses? _______

– Liberalization? Who gains? _______ Who loses? _______

– Who has the collective action problem? ________

Representation and Trade

Take the US – China prism as a frame of reference.

• If you are a representative of a district composed largely of low-skill manufacturing industries like brake-pads, are you more likely to be pro-trade or protectionist.

• What if you are Obama?

Which of the following is necessarily true?a) Gains from trade a universalb) Producers always gain from tradec) Consumers always gain from trade d) Rich countries always gain from trade e) Only (b) and (c) f) All of the above

Obstacles to trade: Transaction Costs Contracts

• Protectionism: The tools of the Trade:TariffsQuotas Non-Tariff Barriers: regulatory mechanismsAlternatives

• (subsidies, dumping, boycotts) • Exchange Rate Manipulation

• Can we apply the bargaining model to trade policy?

• Is Mutually Assured Destruction analogous to trade policy?

International institutions facilitate free trade by changing the structure of domestic interests, solving coordination problems, and creating a standard of behavior

Take the GATT/WTO for Example

• Create Reciprocity: by linking tariff reductions in one country to tariff reductions in others, mobilize exporters to counter-balance importers.

• Solve coordination problem (how to liberalize, under which rules..)

• Create standards of behavior• Facilitate monitoring and record keeping. • WTO dispute settlement body akin to courts in adjudicating

complaints.• Authorize retaliation.

Strengthen Executives by giving them agenda setting and informational advantages over domestic actors and constituencies.

“Rising exposure [to trade with China] increases unemployment, lowers labor force participation, and reduces wages in local labor markets. Conservatively, it explains one-quarter of the contemporaneous aggregate decline in U.S. manufacturing employment. Transfer benefits payments for unemployment, disability, retirement, and healthcare also rise sharply in exposed labor markets. The deadweight loss of financing these transfers is one to two-thirds as large as U.S. gains from trade with China.”

Source: Autor Dorn and Hanson 2011 “The China Syndrome”

Source: Autor Dorn and Hanson 2011 “The China Syndrome”

Moral of the story

• Trade is good and Free Trade is great. But there are winners and losers. There are also risks to being interdependent.

• In order to take advantage of comparative advantage, politicians have to make side-payments to the losers and create safety-nets to mitigate the risks.

Source: Rordik 1998 “Why More Open Economies Have Bigger Governments?

Trade – What is it good for? • Absolutely nothing ?

• 90 % of economists believe trade barriers reduce national well-being.

• 60 % of Americans view protection favorably.

• How can we explain moves towards liberalization?