International trade - theory and challenges Flashcards
when free trade occurs ?
Free Trade occurs when a government does not attempt to influence, through tariffs, quotas, or other means,
what citizens can buy from other countries or
produce and sell to other countries
What is the benefits of trade ?
The Benefits of Trade allow countries to be richer by specializing in products they can produce most efficiently
Trade Theory problem
There are a lots of problems with trade :
there may be some ways that some governments can make things better by intervening (that is, by not practicing free trade)
But government intervening in free trade can be problematic
Restrictions on trade have
kept some countries very poor
contributed to huge depressions
Mercantilism trade theories
Mercantilism (pre-16th century)
Takes an us-versus-them view of trade
Other country’s gain is our country’s loss
Classical trade theories
-Absolute Advantage (Adam Smith, 1776)
-Comparative Advantage (David Ricardo, 1817)
-Specialization of production and free flow of goods benefit all trading partners’ economies
free trade refined theory
Factor-proportions (Heckscher-Ohlin, 1919)
International product life cycle (Ray Vernon, 1966)
What the new trade theory consist in ?
As output expands with specialization, an industry’s ability to realize economies of scale increases and unit costs decrease
Because of scale economies, world demand supports only a few firms in such industries (e.g., commercial aircraft, automobiles)
Countries that had an early entrant to such an industry have an advantage:
Fist-mover advantage
Barrier to entry
mercantilism main points
A nation’s wealth depends on accumulated “treasure”
Gold and silver are the currency of trade
Mercantilists sought what we now call ‘development’
They argued their countries should run a trade surplus
Maximize export through subsidies
Minimize imports through tariffs and quotas
Flaw: “zero-sum game”
Mercantilists neglected to see the benefits of trade
What noemercantilism/ mercantilism consist in ?
Prevailed in 1500 - 1800
Export more to “strangers” than we import to amass treasure, expand kingdom
Zero-sum vs positive-sum game view of trade
Government intervenes to achieve a surplus in exports
King, exporters, domestic producers: happy
Subjects: unhappy because domestic goods stay expensive and of limited variety
Today neo-mercantilists = protectionists: some segments of society shielded short term
What is the flaw in the mercantilist’s argument ?
They assumed that trade was a zero-sum game »»» It ain’t!!
As England, France, Spain, Portugal and the Netherlands competed with each other, many thought only about advantage for their country
What is Absolute advantage ?
Adam Smith: The Wealth of Nations, 1776
Mercantilism weakens country in long run; enriches only a few
A country should specialize in production of and export products for which it has absolute advantage; import other products
Has absolute advantage when it is more productive than another country in producing a particular product
Definition of absolute advantage according to Adam Smith
Adam Smith argued (Wealth of Nations, 1776): Capability of one country to produce more of a product with the same amount of input can vary.
A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient
Trade between countries is, therefore, beneficial »» “positive sum game”!
Example: Ghana/cocoa vs.South Korea/rice
Suppose one country is more efficient than another in everything?
There are still global gains to be made if a country specializes in products it produces relatively more efficiently than other products.
What is the Comparative advantage according to David Ricardo ?
David Ricardo: Principles of Political Economy, 1817
Country should specialize in the production of those goods in which it is relatively more productive… even if it has absolute advantage in all goods it produces
Absolute Advantage is a special case of Comparative Advantage
What is the definition of comprative advantage ?
David Ricardo (Principles of Political Economy, 1817):
A country should import products for which it is relatively inefficient even if the country is more efficient in the product’s production than country from which it is buying
Trade is a positive-sum game
What is the relation between the opportunity cost and the comparative advantage ?
Countries have comparative advantage in goods for which the opportunity cost of production is relatively low
That is, those that can be produced by giving up relatively little in production of other goods
Meaning : your country has comparative advantage in the product or service where the ratio : (Resources required in your country/ Resources required in the other country)
is low.
Example of how comprarative advanatge works.
Ghana has absolute advantage in both cocoa and rice, but its comparative advantage is in cocoa. Korea has comparative advantage in rice .
Let Korea specialize in rice – Ghana expands cocoa production to replace all Korean cocoa production lost.
Then Ghana can replace all Korean cocoa production and the countries have more of both goods.
What is the meaning of free competition ?
They believed that if people were left to trade on their own, they would naturally trade the goods in which their countries had comparative advantage
“Every individual seeks the most advantageous employment for his capital….
“Study of his own advantage necessarily leads him to prefer that employment most advantageous to society” - Adam Smith, 1776
Assumptions about comparative advantage
This is a very simple case, but the basic conclusions are generally valid
We’re assuming no transportation costs
We’re simplifying by not talking about currencies
We’re assuming constant returns to scale
We’re assuming resources can move freely from production of one good to another
We’re not thinking about effects on income distribution
Is free trade advantageous for country less efficient ?
IN one hand, under free trade, the country that is less efficient will have low wages
It will be able to sell the products where it has comparative advantage without any special tariff or subsidy protection.
In other hand, the country less efficient in everything will be poor but it will be even poorer if it did not trade.
Def of infrastructure
the basic equipment and structures (such as roads, bridges) that are needed for a country, region, etc. to function properly.
Why it may need to work on infrastructure ?
China, India both sell cheap manufactured goods
China sells more because it has better transportation infrastructure and government that supports manufactured exports
Why it will need education and institutions for its people ?
Banks, government agencies who can
process exports
work with foreigners
Honest banks and agencies
what immobile resources consist in ?
Resources do not always move easily from one economic activity to another.
So some rice farms will persist in Ghana no matter what.
(Rice farmers will be losers as cheap rice comes from Korea)
