INTERNATIONAL TRADE

Eva Hromádková, 3.5 2010

Macroeconomics ECO 110/1, AAULecture 11

Trade Patterns of CR

Czech Republic is a small open economy: Imports are goods and services

purchased from foreign sources: CR (2009): 1,981 bil. CZK; 82% of 2008

values Exports are goods and services sold to

foreign buyers. CR (2009): 2,132 bil. CZK; 86% of 2008

values GDP = 3,627 bil CZK; export ratio = 59%

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Export Ratios3

Trade Balances

The trade balance is the difference between the value of exports and imports.

Any imbalance in one country’s trade must be offset by reverse imbalances elsewhere.

Trade balance = exports – imports

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Trade Balances II

Trade deficit is the amount by which the value of imports exceeds the value of exports in a given time period.

Trade surplus is the amount by which the value of exports exceeds the value of imports in a given time period.

CR is running a trade surplus 151 bil. CZK (2009); 67 bil. CZK (2008)

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Bilateral Trade Balances:Top Deficit Countries

Country Trade Balance

(in billions of CZK) China –183 Japan –54 Russia –53 South Korea –20 Azerbaijan –11

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Bilateral Trade Balances:Top Surplus Countries

Country Trade Balance

(in billions of dollars) Germany +162 Slovakia +84 UK +62 France +43 Austria +27

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Motivation to Trade

Why trade when . . .. . . we import many of the things we also export.. . . we could produce many of the other things we import.. . . we seem to seem to worry so much about trade imbalances.

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Specialization

Trade allows nations to specialize and specialization increases total output. Example: Would you grow your food and

produce all your possessions? Or would you rather work in your field and buy everything else on the market?

Trade increases world output and the standards of living in all trading countries.

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Production and Consumption Without Trade

The gains from trade can be illustrated using production possibilities curves. Production possibilities – The alternative

combinations of final goods and services that could be produced in a given time period with all available resources and technology.

Consumption possibilities - The alternative combinations of goods and services that a country could consume in a given time period.

In the absence of trade, a country’s consumption possibilities are identical to its production possibilities.

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Consumption Possibilities Without Trade

U.S. Production Possibilities

French Production Possibilities

Bread Wine Bread Wine 100 0 15 0 80 10 12 12 60 20 9 24 40 30 6 36 20 40 3 48 0 50 0 60

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Consumption Possibilities Without Trade - US

OU

TP

UT

OF

BR

EA

D

(zill

ions

of l

oave

s pe

r ye

ar)

60

10OUTPUT OF WINE (zillions of barrels per year)

U.S. production possibilities

0 20 30 40 50 60

20

40

80

100 A

B

C

D

E

F

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Consumption Possibilities Without Trade - France

OU

TP

UT

OF

BR

EA

D(z

illio

ns o

f loa

ves

per

year

)

15

10OUTPUT OF WINE (zillions of barrels per year)

French production possibilities

0 20 30 40 50 60

5

10

20

25

G

H

I

J

K

L

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Production and Consumption With Trade

To assess the potential gain from trade, we need to consider the combined output of trading nations.

By changing the mix of output in each trading country, we can increase total world output.

Each country produces those goods it makes best, then trades with other countries to acquire the goods it desires to consume. E.g.: US is better in bread and France in wine making

When a country engages in international trade, its consumption possibilities always exceed its production possibilities.

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Consumption Possibilities Comparison without and with trade

Bread Wine U.S. (at point D) 40 30 France (at point I) 9 24

World total 49 54

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Bread Wine

U.S. (at point C) 60 20 France (at point K) 3 48

World total 63 68

Consumption Possibilities With Trade – US and France

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Comparative Advantage

Although international trade can make everyone better off, it’s not obvious which goods should be traded, or on what terms.

The decision to export is based on comparative advantage: The ability of a country to produce a specific good at a lower relative opportunity cost than its trading partners. 1 wine = 2 breads – USA advantage in bread making 1 wine = 0.25 breads – France advantage in wine

making World output, and thus potential gains from

trade, will be maximized when each country pursues its comparative advantage.

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Absolute Advantage

The absolute advantages in production do not matter Absolute advantage – The ability of a country

to produce a specific good with fewer resources (per unit of output) than other countries.

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Terms of Trade

The terms of trade establish the trading rate. Terms of trade is the rate at which goods

are exchanged – the amount of good A given up for good B in trade. A country will not trade unless the terms of

trade are superior to domestic opportunities. The terms of trade between two countries will

lie somewhere between their respective opportunity costs in production.

Ex: 1 loaf of bread between ½ barrel of wine (US) and 4 barrels of wine (France); in our example 1 loaf of bread = 3.33 barrel of wine (large gain for US)

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Searching for the Terms of Trade

Wine

France

0 10 20 30 40 50 60 70 80 90 100 110

306090

120

Bre

ad Consumption possibilities

Production possibilitiesL M K

UnitedStates

0 10 20 30 40 50 60 70 80 90 100 110

20406080

100

Bre

ad

DC

X

N

YConsumptionpossibilities

Productionpossibilities

A

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The Role of Markets and Prices

The decision to import or export a particular good is often left up to the market decisions of individual consumers and producers.

The terms of trade, like the price of any good, will depend on the willingness of market participants to buy or sell at various prices. But will stay within the limit terms of trade

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Protectionist Pressures

Although the potential gains from trade are impressive, not everyone favors free trade.

Imports typically compete with a domestic industry.

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Protectionist PressuresMicroeconomic Pressures

The affected industries will try to restrict imports in order to preserve their own jobs and incomes:

Import competing industries E.g. wine producers in CaliforniaBut also a positive pressure:

Export industries: import redistributes income from import-competing industries to export industries E.g. wheat producers in KansasIn total, everybody should be better off…

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Protectionist Pressures Additional Pressures

Selfish micro interests are not the only source of trade restrictions.

Other arguments are used to restrict trade1. National Security Concerns2. Dumping3. Infant Industries4. Improving the Terms of Trade

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Protectionist pressures1. National Security Concerns

Essential defense-related goods are vital during times of war.

A war could disrupt this flow leaving us vulnerable.

Exporting vital technology to a potential enemy is not wise.

E.g: food, steel industry

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Protectionist pressures2. Dumping

Dumping is the sale of goods in export markets at prices below domestic prices (even below production costs) Q: What is he main goal of importers then?

Import competing industries are placed at risk

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Protectionist pressures3. Infant Industries

Even normal export prices might make it difficult or impossible for a new domestic industry to develop.

These industries may need temporary protection from imports.

Trade restrictions are justified only if there is tangible evidence that the industry can develop a comparative advantage reasonably quickly. (e.g. computer industry in Brazil)

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Protectionist pressures4. Improving the Terms of Trade

The distribution of the gains from trade depends on the terms of trade.

Putting restrictions on imports can move the terms of trade in our favor

We would end up with a larger share of the gains from trade.

This strategy can backfire - retaliations

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Barriers to Trade

The microeconomic losses associated with trade give rise to a constant clamor for trade restrictions.

1. Embargoes

2. Tariffs

3. Quotas

4. Voluntary restraint agreements

5. Non-tariff barriers

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Barriers to trade1. Embargoes

The sure-fire way to restrict trade is simply to eliminate it.

An embargo is a prohibition against trading particular goods. Ex.1: on Soviet mink and fur (US) Ex.2: on Cuban goods (cigars, sugar) Ex.3: on Georgian wine and mineral water

(Russia)

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Barriers to trade2. Tariffs

A more frequent trade restriction is a tariff.

A tariff is a tax (duty) imposed on imported goods.

A tariff makes imported goods more expensive to domestic consumers, and less competitive with domestically priced goods.

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Barriers to trade3. Quotas

The same outcome of a tariff can be attained more directly by imposing an import quota.

A quota is a limit on the quantity of a good that may be imported in a given time period. Ex.1: max 950 gal. of Jamaican ice-cream (US) Ex.2: lower quotas on the import of US chicken

meat (Russia) Russia is the biggest export market for US chicken

meat

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Comparative Effects

The effect of quotas on trade is different than the effect of tariffs.

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No-Trade Equilibrium

The equilibrium price is completely determined by domestic demand and supply curves. Equilibrium price – The price at which the

quantity of a good demanded in a given time period equals the quantity supplied.

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No-Trade Equilibrium

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

(a) No-trade equilibrium

D1

p1

0 q1

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Free-Trade Equilibrium

Free trade allows the import of unlimited quantity of foreign supplies at the world price.

Free trade results in reduced prices and increased consumption.

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Free Trade Quilibrium

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p2

p1

q2qd

S2

0

(b) Free-trade equilibrium

B

q1

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Tariff-restricted Trade

Tariffs raise the price of imports and shifts the import supply curve upward.

Domestic prices rise, domestic production rises, and domestic consumption falls.

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Tariff-restricted trade

p3

qt

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p1

q3

S3

C

0

(c) Tariff-restricted trade

S2p2

q2qd q1

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Quota-restricted Trade

Quotas are a greater threat to competition than tariffs because quotas preclude additional imports at any price.

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Quota-restricted trade

S1

PR

ICE

(do

llars

per

uni

t)

QUANTITY (units per year)

D1

p1

q40

(d) Quota-restricted trade

p2

q2q1

p4

S4

Q

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Barriers to trade4. Voluntary Restraint Agreements

A slight variant of quotas has been used in recent years.

A voluntary restraint agreement (VRA) is an agreement to reduce the volume of trade in a specific good – a “voluntary” quota. Based on negotiation E.g. Japan’s agreement not to export more

than 1.68 mil cars to US in 1981

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Barriers to trade5. Nontariff Barriers

Embargoes, export controls, tariffs, and quotas are the most visible barriers to trade, but they are only the tip of the iceberg.

e.g: product standards, licensing restrictions, restrictive procurement practices, and other nontariff barriers restrict roughly 15 percent of imports (US).

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Multilateral Trade Pacts

Trade policy is a continuing conflict between the proponents of free trade and the special interests that profit from trade protection.

The long-term trend is towards lowering trade barriers, thereby increasing global competition. Protectionist forces are being countered by the

worldwide recognition of the gains from trade. Exporters and firms that use imported inputs

push for free trade.

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Global Pacts: GATT and WTO The granddaddy of the multilateral,

multiyear free-trade pacts was the General Agreement on Tariffs and Trade (GATT) in 1947.

The 1994 GATT pact created the World Trade Organization (WTO) to enforce free-trade rules.

The WTO has become the world’s trade police force.

Latest round – Doha (2001) - 141 countries

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WTO Protests

Some people see free trade as a mixed blessing. Environmentalists worry about depletion of

resources, congestion and pollution. Labor organizations worry about depressed

wages and working conditions. Third World countries worry about an unfair

trade playing field.

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Regional Pacts

Groups of nations have moved even faster toward open markets by developing regional trade pacts.

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European Union

The European Union (EU) is a regional pact that virtually eliminates national boundaries between 25 countries.

The EU eliminated trade barriers and permits full inter-country mobility of workers and capital.

In effect, Europe has become one large unified market.

EFTA (Iceland, Norway, Swiss, Liechtenstein) + CEFTA

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NAFTA

In December 1992, the United States, Canada, and Mexico signed the North American Free Trade Agreement (NAFTA).

The ultimate goal of NAFTA is to eliminate all trade barriers between these three countries.

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CAFTA

The success of NAFTA prompted a similar 2005 agreement between the U.S. and central American nations.

The Central American Free Trade Agreement (CAFTA) aims to eliminate tariffs and standardize trade and investment policies in CAFTA nations.

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