5 Trade COMPLETE PDF

International trade Outline 1. Why do countries trade? A brief history of models 2. Intra-industry trade 3. Protectionism 4. WTO & the principles of the multilateral system Outline 1. Why do countries trade? A brief history of models 1. Mercantilism (XVI-XVIII century) 2. Adam Smith: absolute...

International trade Outline 1. Why do countries trade? A brief history of models 2. Intra-industry trade 3. Protectionism 4. WTO & the principles of the multilateral system Outline 1. Why do countries trade? A brief history of models 1. Mercantilism (XVI-XVIII century) 2. Adam Smith: absolute advantage theory 3. David Ricardo: comparative advantage 4. Specific factors model 5. Heckser-Ohlin (H-O) model 6. Economies of scale 7. Gravity model Cargando… 2. Intra-industry trade 3. Protectionism 4. WTO & the principles of the multilateral system History: models on trade 1. Mercantilism (XVI-XVIII century) The world´s wealth is fixed When we import, we “give away” some of that wealth. It´s best to export, not import. The government should provide the means to favor and protect national production and foster exports. History: models on trade 2. Adam Smith: absolute advantage theory Which country has absolute advantage? That is, which country can produce the good more cheaply (using less labor)? Cargando… Adam wrote in The Wealth of Nations: “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.” (Adam Smith, The Wealth of Nations, New York: The Modern Library 1937, p. 424). Problem: what happens if a country has absolute advantage in everything? History: models on trade 3. David Ricardo: comparative advantage Assumptions: 2x2x1 model 2 countries (home country and foreign country) 2 goods (wheat and cloth) 1 f.o.p (L) The factor of production (L) is not mobile. Fixed opportunity cost of goods for both countries No transportation or transaction costs Technology will determine which country has the highest labor productivity 3. David Ricardo: comparative advantage Max production /per worker Home country Cloth Wheat 2 4 3. David Ricardo: comparative advantage How much can home country produce? Home Production Possibilities Frontier Assume L = 25 workers The slope coincides with the opportunity cost: next best use for the resources used in the production of a good 3. David Ricardo: comparative advantage How much of each good will Home Country consume in autarky (in the absence of trade)? 3. David Ricardo: comparative advantage How high will prices and wages be? In perfect competition: Cost of extra worker = value of extra production 3. David Ricardo: comparative advantage How high will prices and wages be? In perfect competition: Cost of extra worker = value of extra production wageW = pW * MPLW wageC = pC * MPLC Cargando… 3. David Ricardo: comparative advantage How high will prices and wages be? 3. David Ricardo: comparative advantage How high will prices and wages be? Relative price of wheat (wrt cloth) Slope of the PPF (Production Possibilities Frontier) 3. David Ricardo: comparative advantage Max production /per worker Cloth Wheat Home country 2 4 Foreign country 1 1 3. David Ricardo: comparative advantage How much can foreign country produce? Home Production Possibilities Frontier Assume L* = 100 workers 3. David Ricardo: comparative advantage How much of each good will Foreign Country consume in autarky? What will prices and wages look like? 3. David Ricardo: comparative advantage Opening up to trade 3. David Ricardo: comparative advantage Opening up to trade Home country will export Wheat and Foreign Country will export Cloth (each country exports the good in which it has comparative advantage) How will this change relative prices and consumption? 3. David Ricardo: comparative advantage consumption and production under free trade 3. David Ricardo: comparative advantage consumption and production under free trade 3. David Ricardo: comparative advantage Changes in consumption and production 3. David Ricardo: comparative advantage Wages under free trade Perfectly competitive labor markets and mobility across industries (but not countries): wages equal the value of (marginal) production Max production /per worker Cloth Wheat Home country 2 4 Foreign country 1 1 History: models on trade 3. David Ricardo: comparative advantage Each country should specialize in producing (and exporting) the good in which it has a comparative advantage As a result, consumers in both countries will be able to consume more and be better off Workers will not be paid the same across countries. Instead, workers get compensated according to their absolute advantage (which is exogenously given by technology) Problems: 1 f.o.p only where does the comparative advantage come from? History: models on trade 4. Specific factors model Assumptions: 2x2x3 model (2 countries, 2 goods (agriculture, 3 f.o.p) 2 countries: HC and FC 3 f.o.p: L, K and land (T) 2 sectors (agriculture using land and L , manufacture using K and L) None of the factors of production (L, K, land) can move across countries L is mobile across industries. The «specific» factors of production (K, land) are not mobile across industries. There are diminishing returns to L Technology will determine which country has the highest labor productivity 4. Specific factors model Diminishing returns 4. Specific factors model Production in home country 4. Specific factors model Wages in home country: one sector 4. Specific factors model Wages in home country: both sectors 4. Specific factors model Opening up to trade: overall gains of trade Cargando… 4. Specific factors model Opening up to trade: overall gains of trade 4. Specific factors model Opening up to trade: overall gains of trade The gains from trade are positive, but this does not mean that everyone is better off 4. Specific factors model Opening up to trade: what happens to wages in both sectors 4. Specific factors model Opening up to trade: what happens to wages in both sectors 4. Specific factors model Opening up to trade: what happens to capital (used in M) and land (used in A) So an increase in the relative price of a good will increase the real rental (the return in real terms) earned by the factor of production used (specifically) in that industry but will decrease the real rental of factors used only in other industries. History: models on trade 4. Specific factors model The overall effect of trade liberalization is positive, but not all factors of production benefit The effect on labor is unclear and it depends on each worker´s consumption mix The returns to the «specific» factors of production follow the logic dictated by the Stolper-Samuelson theorem. They change due to changes in relative prices and their effects on marginal productivity, because specific factors cannot move to other sectors (at least not in the short run) History: models on trade 5. Heckser-Ohlin (H-O) model Assumptions: 2x2x2 model 2 f.o.p (K and L) 2 goods (shoes (L intensive) and computers (K intensive)) 2 countries (HC (abundant in K) and FC (abundant in L) Countries are endowned with different amounts of f.o.p (K,L). K and L have constant returns to scale K and L cannot move across countries, but can move between industries Both countries have the same technologies No transportation or transaction costs Consumers in both countries have the same preferences Relative factor endowments will determine comparative advantage 5. Heckser-Ohlin (H-O) model Production and consumption without trade HC is abundant in K, which is intensively used to produce C FC is abundant in L , which is intensively used to produce S 5. Heckser-Ohlin (H-O) model Opening up to trade «trade triangle» History: models on trade 5. Heckser-Ohlin (H-O) model • Each countries specializes in the production (and export) of the good that uses intensively the f.o.p they have an abundance of • As a result, consumers in both countries will be able to consume more and be better off • Note: how is this different from Ricardo? • • In the Ricardian model: it´s the efficiency of the production process that drives trade In H-O: it´s the relative abundance of the factors of production that drives trade. Comparative advantage Key concept for both Ricardo and H-O: opportunity cost: next best use for the resources used in the production of a good 1. 2. A country has comparative advantage if it has a lower opportunity cost than others when it comes to the production of that particular good NOTE: Comparative advantage ≠ Absolute advantage = lower absolute cost. Comparative advantage: not just theory The revealed comparative advantage (RCA) index is a measure of a country’s relative advantage or disadvantage in a specific industry as evidenced by trade flows. A country has revealed comparative advantage in a given product when its ratio of exports of that product to its total exports of all goods exceeds the same ratio for the world as a whole An index above 1 indicates that a country’s share of exports in that sector exceeds the global export share of the same sector. If this is the case, we infer that the country has a comparative advantage in that sector. Comparative advantage: not just theory https://unctadstat.unctad.org/en/RcaRadar.html Problem: the models so far all rely on differences across countries. Will there be no trade amongst very similar countries? History: models on trade 5. Economies of scale Large scale production reduces average costs Each country concentrates in producing a few goods (or different varieties of a similar good) to achieve large scale This reduces production costs, but not the variety of goods available because they are still available through trade Average cost Average cost Q Gravity equation trade model 6. Gravity model In summary: Why do nations trade? 1. Trade occurs because it is mutually beneficial (winwin, efficiency) 2. Trade can be seen as a productive technology: It allows us to turn resources into products in the most efficient way. We can get goods at a lower price by importing them, rather than producing them domestically (so trade allows for the production of more goods with the same resources) Outline 1. Why do countries trade? A brief history of models 2. Intra-industry trade What is it How do we measure it Different types What causes it (kind of)? What are its macro effects? 3. Protectionism 4. WTO & the principles of the multilateral system Intra-industry trade • So far, we have talked about inter-industrial trade, where a country specializes in producing and exporting certain goods to import others • There is also intra-industrial (or even intra-firm) trade: where the same products are exchanged across borders. A country then acts as a producer, exporter and importer of the same goods. • This type of trade cannot be explained with traditional trade theories. Measurement of intra-industry trade • Intra-industry trade is measured using the Grubel – Lloyd index GLi = (X i + M i ) − X i − M i (X i + M i ) = 1− Xi − Mi Xi + Mi • The higher the index value, the greater the importance of this trade (values between 0 and 1 or between 0% and 100%) Measurement of intra-industry trade The value of the Grubel – Lloyd index depends on how we define “i” (the product) and the country/ region for which it´s calculated. More aggregation results in higher values of the index: • Aggregation of product: the index will be higher for broader categories (clothing) than for more narrow categories (coats, wool) • Aggregation of commercial partners: the index will be higher for groups of countries (European Union) than for a specific country (a country) Types of intraindustrial trade • Trade in similar goods but with different varieties Types of intraindustrial trade • Trade in goods that differ in quality and / or price Types of intraindustrial trade • Trade in the same goods at different stages of production (vertical intra-industrial trade) Tipos de comercio intraindustrial Weight of the intraindustrial trade across sectors • Intraindustrial trade is higher for manufactured goods, especially in the more sophisticated sectors: chemicals, electronics, electrical equipment, transportation equipment,… These sectors: • have large economies of scale • include many components, and processes may occur in places all over the world Weight of the intraindustrial trade across countries It is important in countries where international trade represents a high percentage of GDP It is important in countries that have received a lot of Foreign Direct Investment It is important in countries with lots of multinational companies It is more important in developed countries, but increasing in developing countries It is higher when regional agreements exist Intraindustrial trade: macro effects 1) It causes a greater relationship between exports and imports, which could mean less overall impact on GDP (X-M is smaller) positive relation sheep https://www.oecd.org/economy/outlook/2752923.pdf Intraindustrial trade: macro effects 2) World trade is more sensitive to the economic cycle https://www.federalreserve.gov/econres/ifdp/files/ifdp1282.pdf Intraindustrial trade: macro effects 3) Economic shocks are transmitted more quickly https://edition.cnn.com/2020/02/09/business/china-coronavirus-global-auto-industry-impact/index.html Outline 1. Why do countries trade? A brief history of models 2. Intra-industry trade 3. Protectionism • Why does it exist • What can be done about it • Protectionist measures: instruments • Traditional trade policy instruments • • Tariffs, quotas, VERs Other types of protectionist instruments Free trade vs protectionism If international trade generates benefits for every part, why is there opposition to free trade? Why ask for protectionist measures? Free trade vs protectionism Because free trade has redistributive effects. Economics + Politics = Decision making Free trade vs protectionism • Openness to trade generates costs and benefits • In net terms, this openness tends to be positive • Efficiency gains • Estimulates competition • Access to capital, technology, knowledge • But the costs show through more unemployment and falling production in some sectors (and cities/ regions!) Free trade vs protectionism • It is necessary to facilitate the adjustment process to improve the cost/benefits ratio in those places where it is negative • Flexible operation of the economy • Establish appropriate safety nets • Proceed gradually in trade liberalization • Rely on international agreements Protectionist measures: instruments of trade policy Instruments of trade policy For trade contraction Via price Specifi For trade expansion Via quantity Via price - Tariff (taxes on imports) -Import quota - Import subsidy - Export tax - Voluntary export restraint/restriction (VER) - Export subsidy tarrif > per amount Via quantity Voluntary import expansion (VIE) Instruments of trade policy: tariffs • Two main types of tariffs: • A specific tariff is levied as a fixed charge for each unit of imported goods. • For example, $1 per kg of cheese • An ad valorem tariff is levied as a fraction of the value of imported goods. • • For example, 25% tariff on the value of imported cars. A compound duty (tariff) is a combination of an ad valorem and a specific tariff. Instruments of trade policy: welfare effects of tariffs • What are the welfare effects of a tariff (costs and benefits)? • • The price of the good in the importing country increases: • Domestic producers are better off • Domestic consumers are worse off The government gets some revenue from the tariff • For a small country, the losses will always be greater than the gains because price is not affected. • For a large country the effects are ambiguous because the imposition of a tariff may cause a decrease in demand large enough to reduce the world price of the good Well-fare effect surplus m -consumer tarrif p 8 . s produces surplos with tarrifs e-worse off P-better of Instruments of trade policy: tariffs (in a small country) The following graph illustrates the small country case (a country is “small” if it ´s not able to change the world price of a product by changing its demand (the country is a price-taker)). • The effect of the tariff is an increase in the price it pays for the good • What are the welfare effects of the tariff? p S Domestic price without trade World price after tariff World price with free trade D QS FT QS T QD T QD FT Q Instruments of trade policy: quotas • An import quota is a restriction on the quantity of a good that may be imported. • This restriction is usually enforced by issuing licenses to domestic firms that import, or in some cases to foreign governments of exporting countries. • Unlike the tariff case, the government receives no revenue from a quota. Instead, the revenue from selling imports at high prices goes to quota license holders. These extra revenues are called quota rents. • Another problem: how are licenses distributed? Instruments of trade policy: VERs • A voluntary export restraint is a limit imposed by the government of the exporting country restricting the amount of a good that may be exported to a specific country during a certain period of time. • It works like an import quota, except that the VER is imposed by the exporting country rather than the importing country. • However, these restraints are usually requested by the importing country. • After the Uruguay Round (1994), WTO member countries agreed not to impose any more VERs and phase out the existing ones Protectionist mesures: other instruments of trade policy • Domestic content requirements: regulations that require a specified fraction of a final good to be produced domestically. • Red tape: bureaucratic and administrative barriers • Environmental, health regulations… imposed as an “excuse” can act as a form of protection. • Public procurement requirements: Government agencies are obligated to purchase from domestic suppliers, even when they charge higher prices (or have inferior quality) compared to foreign suppliers Outline 1. Why do countries trade? A brief history of models 2. Intra-industry trade 3. Protectionism 4. WTO & the principles of the multilateral system The role of the WTO • The World Trade Organization (WTO) was born in 1995, but includes the trading system (the rules of international trade) developed since 1948 in the GATT (General Agreement on Tariffs and Trade) • The WTO is a multilateral organization • • A negotiating forum for trade liberalization • A body of rules governing international trade • A system for resolving disputes The WTO considers free trade as an engine for development and increased welfare The principles of the multilateral system • Non-discriminatory system • Most favored nation: equal treatment for all members • National treaty: equal treatment for domestic and foreign producers • Exemption: regional trade agreements • Promote free trade • Progressive reduction of trade barriers • Provide stability and predictability through legal certainty • Encourage fair competition • Encourage development and economic reform