International Political Economy #4

The Economic Case for Trade

W. K. Wineco | IPE #4: Economics of Trade

raf t
William Kindred Wineco
Indiana University Bloomington

September 10, 2013

1/19

The Bargain

No more gold standard; instead a dollar standard with the $ pegged to gold. US holds veto power in IMF.

US funds reconstruction, rst via the Marshall Plan and later via World Bank. Capitalism becomes inextricably linked with democracy ever since, but this is historically a new phenomenon.

Democratic peace. Capitalist peace.

The geopolitical goal: foster interconnectedness with the US at the core of the system that is governed by institutions that the US could inuence in order to preserve global capitalism. Europes goal: keep the Russians out, the Germans down, and the US in. US was willing to acquiesce... on its terms.
W. K. Wineco | IPE #4: Economics of Trade 2/19

raf t

Why Trade?

The postwar system was designed to facilitate trade.

Capital ows were actually heavily restricted: not laissez-faire. Trade, it was thought, could serve two purposes:
1 2

Rebuild the postwar economy and improve standards of living. Foster a cooperative rather than competitive international politics.

Well spend more time on #2 later; today well focus on #1.

W. K. Wineco | IPE #4: Economics of Trade

raf t

3/19

The General Idea

Imagine your life as it exists.

W. K. Wineco | IPE #4: Economics of Trade

raf t
4/19

The General Idea

Imagine your life as it exists.

Now imagine it if you had to produce everything you consume yourself.

W. K. Wineco | IPE #4: Economics of Trade

raf t

4/19

The General Idea

Imagine your life as it exists.

Now imagine it if you had to produce everything you consume yourself.

That, in a nutshell, is the economic case for trade.

That doesnt seem to so contentious, but historically it has been and remains so today (at least in some quarters).

W. K. Wineco | IPE #4: Economics of Trade

raf t

4/19

The Pre-Industrial View

Accumulation of wealth enhanced a countrys prestige and power. Currencies are denominated in precious metals. To accumulate:

Push exports via subsidies. Limit imports via taris.

The goal is to run a persistent trade surplus and thus stockpile gold, silver, etc. This is known as mercantilism, and it was practiced by basically everyone. Trade is thus a zero-sum game.

W. K. Wineco | IPE #4: Economics of Trade

raf t
5/19

The Critique of Mercantilism

David Hume (1752):

Increased exports leads to higher prices (i.e. ination). Increased imports leads to lower prices. In the long run no country can run a persistent trade surplus, because relative prices would force an adjustment. Taris and subsidies can delay that day, but only at increasing cost.
Mercantilism is an inherently inecient system.

W. K. Wineco | IPE #4: Economics of Trade

raf t

6/19

The Critique of Mercantilism, con.

Adam Smith (1776):

Division of labor allows folks to use their natural gifts most productively, esp when mixed with industrial capital. Trade allows nations to maximize their natural gifts: Britain sends coal to Greece in exchange for olives.
Countries should focus production on most ecient use of their resources >

By assumption: Countries each have dierent absolute advantages something they produce better than everyone else which they should produce. In this way all countries benet from trade: productivity is maximized, so consumption is maximized.

W. K. Wineco | IPE #4: Economics of Trade

raf t

7/19

The Critique of Mercantilism, con.

David Ricardo (1817):

Not all countries have absolute advantages. All countries do have comparative advantages : goods that they produce more eciently than other goods that they can produce. Even if they are absolutely dis advantaged countries can gain from trade. (Wut?)
Trade is a positive-sum game.

W. K. Wineco | IPE #4: Economics of Trade

raf t

8/19

The Economics of Trade: Heckscher-Ohlin

These ideas were intuitive. Later, economists built models to make precise predictions of output under dierent trade regimes. H-O (early 20th century):

Two countries (e.g. US & UK). Two factors of production: capital (land, actually, but well use capital) and labor. Both countries can use their factor endowments to produce two goods.
Goods which use the abundant factor more intensively can be produced more eciently.

I.e., If you have a lot of labor, you have a comparative advantage in labor-intensive goods.

Countries should export those goods, and import goods in which the intensively-used factor is scarce.
W. K. Wineco | IPE #4: Economics of Trade 9/19

raf t

A Silly Example

Two countries: U.S. & U.K.; former is relatively capital abundant, latter is relatively labor abundant. Two goods: Jay-Zs and Beatles; Jay-Zs require more capital (bling). Production schedule (per hour):

U.S. is comparatively advantaged in Jay-Zs while U.K. is in Beatles.

W. K. Wineco | IPE #4: Economics of Trade

raf t
Jay-Zs 20 6 Beatles 10 16 U.S. U.K.

10/19

Why Trade Is Ecient

Under autarky:

U.S. gets 10 Jay-Zs and 5 Beatles per hour. U.K. gets 3 Jay-Zs and 8 Beatles per hour. The world gets 13 Jay-Zs and 13 Beatles per hour.
Under trade:

U.S. produces 20 Jay-Zs; trades 8 for Beatles. U.K. produces 16 Beatles; trades 8 for Jay-Zs. The world gets 20 Jay-Zs and 16 Beatles. (More of each).
Or:

W. K. Wineco | IPE #4: Economics of Trade

raf t

11/19

Expanding the Production Possibility Frontier

W. K. Wineco | IPE #4: Economics of Trade

raf t
12/19

Details of the model

Building o of the logic of comparative advantage, Heckscher-Ohlin predicts gains from trade. Assumptions:
1 2

Constant returns to scale (+1 unit input = +1 unit of output). Labor & capital mobility within countries, & immobility between countries. Perfect (internal) competition.

W. K. Wineco | IPE #4: Economics of Trade

raf t

13/19

What Is Missing?

Prices (technically assumed to be constant). Technology (ditto). Money. Politics.

Transaction costs.

W. K. Wineco | IPE #4: Economics of Trade

raf t
14/19

Does It Matter?

Well get into the politics and money aspects down the line, but the answer is: yes and no. Yes, in that other variables matter.

No, in that these simple models actually work fairly well in the real world.

W. K. Wineco | IPE #4: Economics of Trade

raf t

15/19

The Trade Boom

W. K. Wineco | IPE #4: Economics of Trade

raf t
16/19

The Story in East Asia

W. K. Wineco | IPE #4: Economics of Trade

raf t
17/19

The General Relationship

W. K. Wineco | IPE #4: Economics of Trade

raf t
18/19

Complicating the Model

Looking forward:

How domestic and international politics inuence, and are inuenced by, trade. How trade is a complex system: agglomeration economies and network theory. These processes are related to power hierarchy and lead to particular patterns of interdependence.

W. K. Wineco | IPE #4: Economics of Trade

raf t

19/19