Agriculture and the Basis for International Trade

Dr. George NortonAgricultural and

Applied EconomicsVirginia Tech

Copyright 2009

AAEC 3204AAEC 3204

Objectives

Discuss why Discuss why countries tradecountries trade

Identify impediments Identify impediments to tradeto trade

Why do countries trade?

• Need certain inputsNeed certain inputs

• Obtain gains from trade and specialization Obtain gains from trade and specialization based on comparative advantagebased on comparative advantage

• Temporary shortagesTemporary shortages

• To earn foreign exchange to pay off debtsTo earn foreign exchange to pay off debts

What is comparative advantage?

A country has a comparative advantage A country has a comparative advantage over another country in producing good A over another country in producing good A if it has to give up less of good B to if it has to give up less of good B to produce good A than would the other produce good A than would the other country. In other words, its efficiency in country. In other words, its efficiency in producing good A relative to good B is producing good A relative to good B is greater than is the case for the other greater than is the case for the other country.country.

Graphical Illustration of comparative advantage

Country A Country B

30

30

40

20

M

A

M

A

Which country has the comparative advantage in A and why?

Production possibility curves

Why is the concept of comparative advantage powerful?

If each country produces those goods it If each country produces those goods it can produce relatively best and trades for can produce relatively best and trades for other goods, all countries can be better off other goods, all countries can be better off than they otherwise would be. than they otherwise would be.

In Summary: Why Trade?

To increase the standard of living by To increase the standard of living by obtaining goods that others can produce at obtaining goods that others can produce at lower opportunity cost in exchange for lower opportunity cost in exchange for things we can produce relatively cheaperthings we can produce relatively cheaper• By lowering the cost of living, it makes a By lowering the cost of living, it makes a

household’s purchasing power go furtherhousehold’s purchasing power go further• Trade increases a country’s GNP by Trade increases a country’s GNP by

employing its land, labor & capital where they employing its land, labor & capital where they are most productiveare most productive

Why do some argue that developing countries should restrict their trade?

• Exploitation by developed countries and Exploitation by developed countries and wealthy eliteswealthy elites

• Terms of trade problemTerms of trade problem• Infant industry argumentInfant industry argument

What do you think about each of these points?

Why Do Governments Often SeekSelf-Sufficiency & Restrict Ag Trade?

• National security (security of food supply)National security (security of food supply)• Protect existing/create new jobsProtect existing/create new jobs• Favor to rent-seekersFavor to rent-seekers

• Benefit friends and relativesBenefit friends and relatives• Response to bribery or campaign contributionsResponse to bribery or campaign contributions

• Little public concern because, while benefits are Little public concern because, while benefits are concentrated, costs are diffuse.concentrated, costs are diffuse.• Example: US sugar program gives each grower over Example: US sugar program gives each grower over

$100,000 per year, but costs the average consumer $100,000 per year, but costs the average consumer only $12 per year.only $12 per year.

Changing World Food Trade

• Food demand is stable in developed countries Food demand is stable in developed countries but growing rapidly in developing countries as but growing rapidly in developing countries as middle class grows middle class grows

• Percent of world ag production that is traded is Percent of world ag production that is traded is growing growing

• Trade in high value & processed products Trade in high value & processed products growing faster than in commoditiesgrowing faster than in commodities

• Explosion of commodity exports from South Explosion of commodity exports from South America; expect more from Eastern Europe and America; expect more from Eastern Europe and former Soviet Union countriesformer Soviet Union countries

Importance of Exports to U.S. Ag

U.S. agriculture exports a third of its production U.S. agriculture exports a third of its production of many commoditiesof many commodities• without exports, farm sector would shrinkwithout exports, farm sector would shrink

Exports can grow by expanding the total size of Exports can grow by expanding the total size of the market or by increasing market share. the market or by increasing market share. • Need economic growth in developing countries to Need economic growth in developing countries to

increase size of market increase size of market • Preserve competitiveness to protect market sharePreserve competitiveness to protect market share

Food Demand is Changing

• 1.25 billion people live on less than $1 per day, of whom 1.25 billion people live on less than $1 per day, of whom 850 million suffer under-nutrition850 million suffer under-nutrition

• 3 billion live on less than $2 per day. 3 billion live on less than $2 per day. • With $2 per day, most hunger (calorie) problem is solvedWith $2 per day, most hunger (calorie) problem is solved• With $3 to $9 per day people eat more animal protein, With $3 to $9 per day people eat more animal protein,

fruits, vegetables & edible oils, causing rapid growth in fruits, vegetables & edible oils, causing rapid growth in demand for raw agricultural commoditiesdemand for raw agricultural commodities

• With $10 per day or more, people buy more processing, With $10 per day or more, people buy more processing, services, packaging, variety, and luxury forms, but not services, packaging, variety, and luxury forms, but not more raw agricultural commoditiesmore raw agricultural commodities

• How many presently low income consumers are lifted How many presently low income consumers are lifted out of poverty will be the most important determinant of out of poverty will be the most important determinant of the future size of world food and ag product marketsthe future size of world food and ag product markets

Projected Population Growth (U.N. medium projections, billions)

RegionRegion 2006 2006 20502050 World 6.5World 6.5 9.0 9.0 High Income 1.2 High Income 1.2 1.2 1.2 Low Income 5.3 Low Income 5.3 7.8 7.8 Africa 0.9 Africa 0.9 1.8 1.8 Asia 3.9 Asia 3.9 5.2 5.2 Latin America 0.6 Latin America 0.6 0.8 0.8

Percent of World Food Production That is Traded Will Increase

• Arable land and fresh water not distributed in the Arable land and fresh water not distributed in the world in the same proportions as population. world in the same proportions as population. • Asia or Middle East can not be self-sufficient in foodAsia or Middle East can not be self-sufficient in food

• With population growth and economic With population growth and economic development, world food demand is expected to development, world food demand is expected to double by 2050double by 2050

• Processed Food Trade Growing Even FasterProcessed Food Trade Growing Even Faster• Food demand in many developing countries will Food demand in many developing countries will

exceed their production capacity.exceed their production capacity.

Trade impediments in developing countries

External demand constraintsExternal demand constraints• Terms of trade problem (price of exports Terms of trade problem (price of exports

versus price of imports)versus price of imports)• Trade Restrictions (quotas, tariffs, subsidies, Trade Restrictions (quotas, tariffs, subsidies,

etc.)etc.) Internal restrictions on tradeInternal restrictions on trade

• Direct (tariffs, export taxes, etc.)Direct (tariffs, export taxes, etc.)• Indirect (exchange rate manipulation) Indirect (exchange rate manipulation)

Market instabilityMarket instability

Conclusions

• Strong economic rationale for tradeStrong economic rationale for trade• Trade is important to developed and Trade is important to developed and

developing countriesdeveloping countries• Trade will grow in the futureTrade will grow in the future• Still many impediments to trade Still many impediments to trade