International Trade Policy, Comparative Advantage, and Outsourcing

CHAPTER 9

International Trade Policy, Comparative Advantage, and Outsourcing

One of the purest fallacies is that trade follows the flag. Trade follows the lowest price current. If a dealer in any colony wished to buy Union Jacks, he would order them from Britains worst foe if he could save a sixpence.

Andrew Carnegie

McGraw-Hill/Irwin

Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

International Trade Policy, Comparative Advantage, and Outsourcing

Patterns of Trade
Differences in the importance of trade
Total Output ($) Netherlands Germany Canada Italy France United Kingdom Japan United States 754 3,279 1,326 2,107 2,562 3,280 4,377 14,264 Export Ratio (%) 74 45 38 28 27 29 14 11 Import Ratio (%) 66 40 34 29 28 33 13 16

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International Trade Policy, Comparative Advantage, and Outsourcing

The Changing Nature of Trade

The nature of trade is continually changing, both in terms of the countries with which the U.S. trades and the goods and services traded As technological changes in telecommunications reduce costs, foreign countries will be able to provide more services Customer service calls for U.S. companies are now more frequently answered in India This trade in services is often called outsourcing

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International Trade Policy, Comparative Advantage, and Outsourcing

Balance of Trade
The balance of trade is the difference between the value of exports and the value of imports Trade deficit = exports < imports Trade surplus = exports > imports The U.S. has a significant trade deficit of approximately $820 billion which is 5.5% of GDP

The U.S. is financing its trade deficit by selling off financial assets, stocks and bonds, and real assets, corporations and real estate
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International Trade Policy, Comparative Advantage, and Outsourcing

Balance of Trade
Percent of GDP
2

1
0 -1 -2 -3 -4 -5

The United States has been running trade deficits since the 1970s

-6
-7

1970

1980

1990

2000

2010
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International Trade Policy, Comparative Advantage, and Outsourcing

Debtor and Creditor Nations

Running a deficit isnt necessarily bad
The U.S. is currently financing its trade deficit by selling off assets

The U.S. has not always had a trade deficit, following WWII, it had trade surpluses
The U.S. has gone from a large creditor nation to being a large debtor nation, international considerations have been forced on the nation

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International Trade Policy, Comparative Advantage, and Outsourcing

The Principle of Comparative Advantage

The principle of comparative advantage is that as long as the relative opportunity costs of producing goods differ among countries, then there are potential gains from trade
Opportunity cost is what must be given up in one good in order to get another good

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International Trade Policy, Comparative Advantage, and Outsourcing

Application: The Gains from Trade

A trader, I.T., arranges for Saudi Arabia to trade 500 barrels of oil to the U.S. for 120 tons of food The U.S. will trade 500 tons of food to Saudi Arabia for 120 barrels of oil

I.T. keeps 380 barrels of oil and 380 tons of food

Production U.S. Oil (barrels) Food (tons) 0 1,000 Saudi Arabia 1,000 0 U.S. 120 500 Consumption Saudi Arabia 500 120 I.T. 380 380
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International Trade Policy, Comparative Advantage, and Outsourcing

Comparative Advantage in Todays Economy

If trade is good, why do so many people oppose it?
The gains of trade, lower prices, are harder to see than the cost, lost jobs

The public believes that lower wages in other countries give them the comparative advantage in everything, so we will lose all jobs
Laypeople often think of trade as trade only in manufactured goods

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International Trade Policy, Comparative Advantage, and Outsourcing

Some Concerns about the Future

Inherent and transferable comparative advantage
Inherent comparative advantages are based on factors that are relatively unchangeable, such as resources and climate

Transferable comparative advantages are based on factors that can change relatively easily, such as capital, technology, and types of labor Whether a country can maintain a much higher standard of living in the long run depends in part on whether its comparative advantage is inherent or transferable
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International Trade Policy, Comparative Advantage, and Outsourcing

Some Concerns about the Future

The law of one price The law of one price means that in a competitive market there will be pressure for equal factors to be priced equally

If factor prices arent equal, firms reduce costs by reorganizing production in countries with lower factor prices
The convergence hypothesis is the tendency of economic forces to eliminate transferable comparative advantage.

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International Trade Policy, Comparative Advantage, and Outsourcing

Varieties of Trade Restrictions

Tariffs are taxes governments place on internationally traded goods (generally imports) Quotas are quantity limits placed on imports Voluntary restraint agreements are when countries voluntarily restrict their exports An embargo is a total restriction on the import or export of a good Regulatory trade restrictions are government-imposed procedural rules that limit imports Nationalistic appeals, such as Buy American can help to restrict international trade
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International Trade Policy, Comparative Advantage, and Outsourcing

Application: Tariffs when the domestic country is small

P
Tariffs decrease imports, increase domestic production, and generate tariff revenue
Tariff revenue

SDomestic

$3.00 $2.50 $2.00

Imports

PWorld + $0.50Tariff = SWorld PWorld = SWorld DDomestic

Q
Imports
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International Trade Policy, Comparative Advantage, and Outsourcing

Application: Quotas when the domestic country is small

P
Quotas decrease imports and increase domestic production

SDomestic
$3.00 $2.50 $2.00
Quota = 50

Quota = SWorld PWorld = SWorld DDomestic

Q
Imports w/o quota
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International Trade Policy, Comparative Advantage, and Outsourcing

Why Economists Generally Oppose Trade Restrictions

From a global perspective, free trade increases total output
International trade provides competition for domestic companies Restrictions based on national security are often abused or evaded Trade restrictions are addictive

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