International Trade

Absolute advantage

When one country produces at a lower direct cost than another

Comparative advantage

When a country produces at a lower opportunity cost than another, it has to forego less of other goods in order to produce it

Constant returns to scale

When an increase in input results in a proportional increase in output

Perfectly mobile factors

Perfect ability to substitute FoP for another

Strategic industry

Industry that is critical for a country’s security, economy or tech

Terms of Trade (ToT)

The rate of exchange of one product for another when two countries trade

Protectionism

Economic policy of restricting imports from other countries

Tariffs

Tax on imports

Quota

Restriction on the quantity of imports entering the country

Subsidies

Payment from govt to producers to lower COP

Globalisation

Spread of the flow of capital, goods and labour across borders

Trade benefits

More efficient allocation of scarce resources

Innovation

Dynamic efficiency gains

More choice for consumers

Resources are unevenly distributed across the world

Comparative advantage and specialisation gains

Spreads risk of production

Trade negatives

Language barriers

Cultural barriers

Supply chain more complex, more issues

Currency changes constantly, businesses don’t like instability

Local taxes and laws make finances and management more difficult

Theory of trade

When countries specialise in goods where they have comparative advantage, there will be an increase in economic welfare.

Theory of trade assumptions

2 countries producing 2 goods

Size of the economies are equal

Perfect mobility of FoP within countries 

Transportation costs ignored

Countries resources are divided equally pre-specialisation

Law of comparative advantage

Trade can benefit all countries if they specialise in the goods in which they have a comparative advantage

Absolute and comparative advantage PPF

Shallow gradient→ lower opp cost in producing x

Steep gradient→ lower opp cost in producing y

Only when the gradients are different will a country have the comparative advantage and only then will trade be possible 

Comparative advantage examples

UK has comparative advantage in oil, chemicals, finance etc.

It has lost it in coal steel, manufacturing etc.→ UK runs structural deficits in these industries

Helsinki has CA in mobile gaming production due to strong tech industry, supportive govt policies and a thriving startup ecosystem

Recent ideas of ‘autarky’ and economic self-reliance globally→ damaging spillover effects on less developed countries

Sources of comparative advantage

Quantity and quality of FoP

Investment in R&D

Fluctuations in exchange rate

Import controls

Non-price competitiveness of producers 

It is often a self reinforcing process (entrepreneurs develop a CA, increased D, economies of scale exploited, profits reinvested, maintained comparative advantage)

Comparative advantage evaluation

Assumes perfect information

Transportation costs assumed to be 0

Patentable products can be made, giving firms the advantage despite not being most efficient producer

Assumes no economies of scale advantages

Ignores impact of exchange rate changes

High inflation rates erode price competitiveness

Protectionist measures can inflate the price of imports and provide domestic producers with artificial advantages

Countries without CA may be highly non-price competitive.

ToT index

(Average export price index/Average import price index)x100

ToT improve if…

a country can buy more imports with a given quantity of exports

Export prices rise faster than import prices

ToT deteriorate if…

a country can buy less imports with a given quantity of exports

Import prices rise faster than export prices

What else can affect the ToT?

Exchange rate

Rate of inflation

Why are ToT important for developing countries?

Primary commodity exports like raw sugarcane, iron ore etc. are a huge part of their economy

Reasons for a deterioration of ToT

Weak exchange rate- P of M increases, P of X decreases, worse ToT

Improvement in international competitiveness- X fall, M will rise, worse ToT

Lower demand for a nation’s exports- X fall, M rise, worse ToT

World incomes are rising, country specialises in exporting primary commodities (income inelastic), and imports capital or manufactured goods (income elastic). X price will stay the same, M price will rise, worse ToT

Reasons for improvement in ToT

Strong exchange rate

Worsening international competitiveness

Higher demand for exports 

Impact of fall in ToT

Reduce AD in the economy if they are dependent on primary commodities→ economic growth will fall in developing countries

Will have to sell more exports to buy same quantity of imports, pushes commodity prices down even further

Worsens the govt budget position, tax revenue on exports will fall and govt will have less money to spend fiscally→ fall in long run performance of the economy

May also lead to higher levels of borrowing and more money being diverted into debt repayment and interest pament rather than promoting growth and development

Is ToT improvement good for an economy?

Higher export demand → improves current account, increases AD

PED for exports determines whether it will have a positive or negative effect

PED for imports also determines this→ all depends on how fast each price changes and in what direction

Is ToT deterioration good for an economy?

Lower export demand → worsens current account, decreases AD

PED for exports determines whether it will have a positive or negative effect

PED for imports also determines this→ all depends on how fast each price changes and in what direction

Why do countries implement protectionist measures?

Response to import ‘dumping’

Response to chronic trade deficits

Domestic employment protection

Protecting infant sectors

Protecting key strategic industries

Raising extra revenues for govt with budget deficits

Response to a recession/stagnant domestic demand

Forms of protectionism

Tariffs

Quotas

Voluntary Export Restraint

Intellectual property laws

Technical barriers to trade

Preferential state procurement policies

Export subsidies

Domestic subsidies

Import licensing

Exchange controls

Financial protectionism

Murky protectionism (discrimination against foreign workers, deliberate intervention in currency markets etc.)

Exchange rate policy (devaluation)

Arguments against protectionism

Market distortion/loss of allocative efficiency

Higher prices for consumers

Reduction in market access for producers

Loss of economic welfare→ deadweight loss of consumer and producer surplus

Extra costs for exporters

Regressive effect on the distribution of income

Production inefficiencies

Trade wars/ political instability

Negative multiplier effects

Globalisation

The process of deeper economic integration between countries and regions of the world

Characteristics of globalisation

Expanision of trade

Transfers of capital

Development of global brands

Global division of labour

High levels of labour migration

Shift in the balance of economic and financial power

Increased spending on investment, innovation and infrastructure

A more interdependent world economy

Main drivers of globalisation

Containerisation→ lower cost of shipping products around the world

Technological change, ‘the death of distance’, reduction of the cost of transmitting and communicating information

economies of scale, MES is rising and so domestic markets cannot support such large outputs

Opening up of global financial markets removed capital controls

Differences in tax systems spread corporations around the globe

Less protectionism recently (may be coming back?)

Benefits of globalisation

Improvements in efficiency

Enhances specialisation and division of labour

Economies of scale

Competitive markets reduce monopoly profits

Higher per capita incomes

Freer movement of labour

Competition may prompt improved governance and better labour protection

Allows developing countries to borrow money to cover a domestic savings gap

Increases consumer choice

Risks of globalisation

Rising inequality of income and wealth (China, India, Brazil)

Demand-pull inflation

More vulnerable to external economic shocks

Threats to the Global Commons

Race to the bottom→ tempt govt to lower taxes, laws, safety nets until damages social consequences.

Trade imbalances

Increased unemployment

Standardisation of cultural and economic diversity

Dominant global brands may stifle competition

Environmental degradation