Economics S2W11

Aim of this Lecture

• Introduce international trade.

• Discuss advantages of trade.

• Present methods and arguments for restricting trade.

The Advantages of Trade

• World merchandise exports as a percentage of world GDP have increased significantly from 1960 to 2020.

World Merchandise Exports

• Data: Shows the increase in world exports of goods and commercial services in billions from 1980 to 2020.

• World exports of goods.

• World exports of commercial services.

• Trends: Demonstrates the growth in merchandise exports by developing and developed economies from 1990 to 2020.

Share of World Merchandise Exports of BRICS

• BRICS: Brazil, Russia, India, China, and South Africa.

• Data: Illustrates the percentage share of world merchandise exports by BRICS countries from 1992 to 2022.

Share of World Merchandise Exports, by Value (2022)

• Key regions: Charts showing the distribution of world merchandise exports by different regions in 2022.

• Leading Exporters: China (Incl. Hong Kong) at 16.9%, Other Europe at 17.1%.

Top Trading Countries by Value and World Share, 2022

• Exporters: Presents a table of top exporting countries, their export value in billions, and their share of world exports.

• China: 3594 billion, 14.4

• USA: 2065 billion, 8.3

• Germany: 1655 billion, 6.6

• Importers: Presents a table of top importing countries, their import value in billions, and their share of world imports.

• USA: 3376 billion, 13.2

• China: 2716 billion, 10.8

• Germany: 1571 billion, 6.1

Merchandise Trade by Destination and Origin, 2022

• Export Destinations: Lists the top export destinations for China, USA, Germany, Japan, and the UK as percentages.

• Import Origins: Lists the top import origins for China, USA, Germany, Japan, and the UK as percentages.

Specialisation as the Basis for Trade

• Instead of self-sufficiency, countries specialize in producing certain goods and services.

• Specialization allows for economies of scale, increased output, and lower unit costs.

• Surplus production is exported, and insufficient domestic production is imported.

• Key Question: What should a country specialize in, and what should it export/import?

The Law of Comparative Advantage

• Law of comparative advantage: Trade can benefit all countries if they specialize in the goods in which they have a comparative advantage.

• Countries have different endowments of factors of production (land, labor, capital).

• Absolute advantage: Producing more efficiently than competitors.

• Comparative advantage: Producing at a lower opportunity cost than competitors.

• Gains from trade are based on comparative advantage.

The Terms of Trade

• The terms of trade: The price index of exports divided by the price index of imports, expressed as a percentage.

• Terms \ of \ Trade = (Price \ Index \ of \ Exports / Price \ Index \ of \ Imports) * 100$$

• The terms of trade will be 100 in the base year.

• Example: If the average price of exports relative to imports has risen by 20% since the base year, the terms of trade will be 120, indicating improvement.

Terms of Trade for Goods and Services (2015 = 100)

• Graphs illustrating the terms of trade for goods and services for various countries (Australia, Canada, Japan, Germany, UK, USA) over time.

Trade Restrictions

Methods of Restricting Trade

• Ad valorem tariffs: Tariffs levied as a percentage of the price of the import.

• Example: Customs duties on tobacco and alcoholic drinks.

• Quotas: Limits imposed on the quantity of a good that can be imported.

• Example: Number of cars that may be imported.

• Exchange controls: Limits on how much foreign exchange can be made available to the public; charges for the purchase of foreign currencies.

• A tax imposed by the government on foreign currency deals.

• Embargoes: Total government bans on certain imports (e.g., drugs) or exports to certain countries (e.g., to enemies during war).

• Administrative barriers: Exclusion of imports that do not meet safety standards.

• Dumping: Where exports are sold at prices below marginal cost, often as a result of government subsidy.

Why Restrict Trade?

• Economic arguments with some general validity:

• To protect infant or senile industry (e.g., auto industry).

• To prevent ‘dumping’ (e.g., Chinese steel).

• To prevent the establishment of foreign-based monopoly (e.g., Boeing and Airbus).

• To take account of externalities (e.g., shipping CO2 emission).

Fallacious Arguments for Restricting Trade

• ‘Imports reduce the standard of living’:

• Imports are consumed and thus add directly to the standard of living.

• If imports are matched by exports, there is no net outflow of money.

• ‘Protection is needed from cheap foreign labor’:

• Producing certain goods at home requires more resources than importing them.

• Foreign competition, however, may reduce certain domestic jobs.

• Domestic labor can specialize in other, better-paid jobs.

Problems with Protection

• Impact on global income.

• Retaliation may lead to a trade war.

• Protection may allow firms to remain inefficient.

• Bureaucracy and administrative costs.

• Corruption and special interest groups.

The World Trade Organization (WTO)

• Historical background:

• The Great Depression and growth in protectionism in the 1930s.

• Post-1945 reduction in protection: General Agreement on Tariffs and Trade (GATT).

• The World Trade Organization formed in 1995.

• Since 2016, 164 members accounting for 98% of world trade.

• Member countries meet periodically to negotiate reductions in trade restrictions.

• The aim is to liberalize trade.

WTO Rules

• WTO principles governing trade:

• Non-discrimination: Trade concession granted to one country is valid for all.

• Reciprocity: A country receiving tariff reductions must reciprocate.

• General prohibition of quotas.

• Fair competition: WTO can sanction retaliatory action.

• Binding tariffs: Countries cannot raise tariffs without negotiation.

• The WTO has the power to impose sanctions on countries breaking trade agreements.

Lecture Summary

• Without international trade, we would all be much poorer.

• Countries can gain from trade if they specialize along their comparative advantage, i.e., produce goods and services at relatively low opportunity costs.

• Countries can use tariffs, quotas, exchange controls, import licensing, export taxes, and legal and administrative barriers to restrict trade.