lecture 1 - trade overview(1)

7/21/2019 Lecture 1 - Trade Overview(1)

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Lecture 1

What Good is Trade?



Overview of EA

• Welcome back to everybody who took EP and welcome to all new students.

• In EA (and the second semester of EPA) we will be discussing a variety ofeconomic applications.

• Given we will be discussing several different topics in depth, this course will beheavily lecture based.

– I wont make you buy 5 different books. Think of the lecture notes as the textbook.They should be reasonably comprehensive

– Therefore, lecture attendance is very important!

• Required reading associated with each lecture is posted to Learn.

– The required reading is meant to compliment the lecture rather than repeat it.

– This will be one or two short articles. Questions about reading may appear ontutorial sheets/online quizzes.

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Overview of EA

• For this term, you are going to be assessed on – Tutorial attendance

– Online quizzes (one posted to Learn each Wednesday) – Only top 5 / 10 count.

– Poster project

– Degree exam

• General issues should be directed to the course administrator [email protected]. For example, if you have a tutorial time conflict you shouldemail this address.

• Academic queries should be directed to me, the course organiser, [email protected] – My office hour is Thursday 11-12 in room 4.11 of the economics building. I am

very happy to discuss these topics in more depth.

• Please check the location of your tutorial in semester 2 on yourtimetable, most of you are not in the same tutorial you were last term.

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mailto:[email protected]







Overview of EA

Outline

Weeks 1-5: Nicholas Myers

Lecture 1. What Good is Trade?

Lecture 2. Darwin, Gravity, and Trade

Lecture 3. Currency Unions

Lecture 4. Who Migrates and Why?

Lecture 5. The Effects of Migration

These 5 lectures cover 3 broad topics; international trade, currency unions

and the economics of immigration.

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Overview of EA

Outline

Weeks 6-8: Nancy Arnokourou

Frontiers of Microeconomics (coverage will include Game

Theory, Experimental Economics, and so forth)

Week 9 and week 10: Guest Lectures

Michèle Belot and Philipp Kischer

(Both are renowned economists based in Edinburgh)

More detail will be provided about teaching block 2 later in the term.

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Outline of Lecture 1

1. Introduction to Trade

Data and Definitions

2. Why Do Countries Trade?

Comparative AdvantageWinners and LosersIntra-Industry Trade

3. Trade Protection

Overview of Trade Policies Welfare ImplicationsArguments for Protection

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Introduction to Trade

Some basic facts about UK trade (Mostly from the ONS Pink Book):

• In 2013, the United Kingdom exported (sold to other countries) onaverage £16,000 a second.

• In 2013, the United Kingdom imported (bought from othercountries) on average £17,000 a second.

• For every £1 produced in the United Kingdom in 2013, £0.31 worthof goods and services are exported and £0.33 is imported.

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Some basic facts (Mostly from the ONS Pink Book):

• In 2013, about 40% of UK exports were of services and 60% of exportswere of goods.

– Goods are tangible products (e.g. steel) whereas services areintangible (e.g. financial services or tourism)

– Most world trade is in goods. Only about 18% of world trade in termsof value is in services.

• In 2013, about 23% of UK imports were of services and 77% of imports

were of goods.

• In 2013, 44% of the UK’s total exports and 52% of total imports in goodsand services were to/from EU28 countries.

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• For each of the past 16 or years, the United Kingdom has imported more

than it has exported.

• A country’s trade balance is the difference between how much a country

exports to the rest of the world and how much it imports.

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• A country runs a trade surplus if they export more than they import.

• A country runs a trade deficit if they export less than they import.

• What determines a country’s trade balance? – Tastes of consumers for foreign goods

– Relative competitiveness

– Relative incomes

– Government policies

– Real exchange rates

– And so forth

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UK’s top export

destinations

(2012)

Export value -

Mill £ (% of Total)

UK’s top import

destinations

(2012)

Import value -

Mill £ (% of Total)

UNITED STATES 41,089 (13.7) GERMANY 52,644 (12.9)

GERMANY 31,970 (10.6) CHINA 31,498 (7.7)NETHERLANDS 24,527 (8.2) NETHERLANDS 31,421 (7.7)

FRANCE 20,860 (6.9) UNITED STATES 29,913 (7.3)

R. IRELAND 17,417 (5.8) FRANCE 22,585 (5.5)

BELGIUM/LUX 14,627 (4.9) NORWAY 22,388 (5.5)

CHINA 10,542 (3.5) BELGIUM/LUX 18,910 (4.6)

SPAIN 8,482 (2.8) ITALY 14,325 (4.5)

ITALY 8,082 (2.7) R. IRELAND 12,862 (3.1)

SWITZERLAND 6,778 (2.3) SPAIN 11,549 (2.8)

Source: ONS Pink Book




• The point I hope we have made so far is that countries trade a lot with

each other.

• But why? Why shouldn’t the UK produce everything they want (wine,

cars, wheat etc…) within their own borders?

• The first reason why countries trade, is that they are different.

• Countries are relatively better than others at producing particular

products.

– Considering climate alone, it would be very silly if avocados were produced in

the UK instead of Mexico.

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Comparative Advantage

“It is the maxim of every prudent master of a family,

never to attempt to make at home what will cost him

more to make than to buy. The taylor does not

attempt to make his own shoes, but buys them from

the shoemaker. The shoemaker does not attempt to

make his own clothes, but employs a taylor … If a

foreign country can supply us with a commodity

cheaper than we ourselves can make it, better buy it

of them with some part of the produce of our own

industry, employed in a way in which we have someadvantage” -Adam Smith “The Wealth of Nations.”

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• Suppose, for simplicity, that there are only two products and only twocountries in the world. – Spain and France can produce either wool or wine.

• Each country has 100 acres of land. For one reason or another, land in Spainand land in France is not equally suitable for production in both products.

• Each country can choose how much of their land to devote to the productionof either good.

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Wool (kilo/acre) Wine (bottles/acre)

France 5 10

Spain 4 2




• It is useful to place all of this information in a production possibilities

frontier (PPF) – this shows all combinations of wool/wine that a country

can produce.

•

Countries could feasibly produce inside of the frontier, but not outside ofit.

• If France were to devote all of their land to wool production, they could

produce 500 kilos of wool and 0 bottles of wine.

• If France were to half of their land to either good, they could produce 250

kilos of wool and 500 bottles of wine.

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• France could produce at point A, but they would be wasting land (could

produce more of either good without reducing production of the other).

• France could not produce at point B.




• If Spain and France cannot trade with each other, people in both countries

can only consume what they produce.

• Suppose that Spain uses half of their land to produce each product. Spain

will produce and consume 200 kilos of wool and 100 bottles of wine.

• Suppose that France uses 60% of their land to produce wine and 40% of

their land to produce wool. France will produce and consume 600 bottles

of wine and 200 kilos of wool.

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• Neither country can consume outside of their PPF’s if there is no trade.

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• Now let’s suppose that, for whatever reason, both countries can starttrading with each other.

• Is it possible that they can both be made better off?

• Notice that France is better than Spain at producing both wool and wine.

• France has an absolute advantage in the production of both goods.

• A country has an absolute advantage in some activity if they are flat outbetter.

• Does this mean that France cannot gain by trading with Spain?

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• Recall the definition of opportunity cost. The opportunity cost ofengaging in some activity is the cost of what was foregone.

• If France produces a bottle of wine, what does that cost?

• To produce wine, France must take some resources away from theproduction of wool.

• The opportunity cost of producing wine is less wool.

• The opportunity cost of producing wool is less wine.

• The slope of each country’s PPF shows the opportunity cost of production

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• If France were to stop producingwool on one acre, they wouldlose 5 kilos of wool.

• If France produced wine on this

now empty acre, they wouldproduce 10 bottles of wine.

• To get one bottle of wine,France must give up ½ of a kilo

of wool.

• To get one kilo of wool, Francemust give up 2 bottles of wine.

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• Similarly, if Spain produces one kilo of wool, they must give up ½ of abottle of wine.

• If Spain were produces one bottle of wine, they must give up 2 kilos ofwool.

• A country has a comparative advantage in some activity if theopportunity cost of performing that activity is lower than other countries.

• The opportunity cost of producing wine is lowest in France. France has a

comparative advantage in producing wine.

• The opportunity cost of producing wool is lowest in Spain. Spain has acomparative advantage in producing wool.

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• Both countries should specialise in producing the good in which they have a

comparative advantage and then trade with each other, they both will be made

better off by doing so.

• In this model, let’s assume that countries completely specialise (Spain only

produces wool and France only produces wine).

– This is unrealistic, of course, but we are illustrating a simple model of the real

world.

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Production Without Trade With Trade and Specialisation

France Wine 600 1000

France Wool 200 0

Spain Wine 100 0

Spain Wool 200 400

Total Wine 700 1000

Total Wool 400 400




• Now Spain can send wool to France in exchange for wine.

• Let’s suppose the terms of trade happen to be 1 kilo of wool for 1 bottle of wine.

• The terms of trade refer to ratio at which a country can trade domestic products forimported products.

• Would France agree to these terms? Yes, to produce 1 kilo of wool on their own,France would have to give up 2 wine. With trade, they would only have to give up 1bottle of wine.

• Would Spain agree to these terms? Yes, to produce one bottle of wine on their ownSpain would have to give up 2 kilos of wool. With trade they would only have to give

up one kilo of wool.

• The terms of trade will end up being such that both countries are made better off (orthey wouldn’t agree)

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• Both countries enjoy lower prices with trade.

• Spain can buy one bottle of wine for one kilo of wool (as opposed to 2

when there is no trade).

• France can buy one kilo of wool for one bottle of wine (as opposed to 2

when there is no trade).

• Suppose that France sends 200 bottles of wine over to Spain in exchange

for 200 kilos of wool...

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• Both countries are now able to consume a basket of goods outside of

their production possibilities frontier.

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• Example: Australia and New Zealand each have 1,000 people.

• Who has the absolute/comparative advantage in the production of wheat

and cotton?

• What is the opportunity cost to each country from producing each good?

• What will the terms of trade be?

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BushelsWheat/Worker BalesCotton/Worker

Australia 1 bushel 3 bales

New Zealand 3 bushels 3 bales




• What are the sources of comparative advantage?

• Economists often point to different endowments in factors of production.

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Norway Myanmar

Average years of schooling 11.8 2.8

Bangladesh Libya

Annual Rainfall (mm) 2,666 56

Libya SwitzerlandProven oil reserves

(millions of barrels)

48,014 0

South Korea Mongolia

Population Density (pop

per sq. km)

505 2




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Winners and Losers

• As we have illustrated, trade between countries allows the world

economy to produce more output.

• If trade across national borders is completely without barriers, each

country would produce the goods and services that they are relatively

best at.

• But now that France specialises in wine and Spain specialises in wool,

what happens to the French wool producers? What happens to the

Spanish wine producers?

• Free trade creates winners and losers.

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Winners and Losers

• Consider the case of Argentina in the 1900s.

• Argentina was relatively better at raising livestock than a lot of other countries in

the world (a lot of good land, not a huge population density…)

• But Argentina is far from the large markets of North America and Europe. Beef

produced in Argentina would spoil by the time it made it to the large markets.

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Winners and Losers

• By 1900, Argentina exported nearly no meat. The United States,

however, exported about 150,000 tonnes of meat annually.

• With the advent of refrigeration, this was no longer the case.

• Argentina could now export meat to world markets. Because they are

relatively better at producing meat than the U.S., the U.S. meat exporters

could not compete.

•

By 1913, Argentina exported 400,000 tonnes of meat to the rest of theworld and the United States exported practically none.

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Winners and Losers

• Who won and who lost?

• When trade becomes easier, there will be an expansion in the export orientedsector (where comparative advantage lies) and a contraction in the sectors

where your economy is disadvantaged.

• In principle, it should be possible for the winners to compensate the losersand still have something leftover.

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Winners Losers

Argentinian meat producers American meat producers

Consumers around the world(meat is now cheaper)

Non-meat producing landowners inArgentina (land now more expensive)



Winners and Losers

• Example: In 2002, President George W. Bush implemented protectionistpolicies which would make it expensive for foreign companies to sell steelin the United States.

• Who do you think won and who lost as a result of this policy?

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Intra-Industry Trade

• The sources of comparative advantage we have discussed do a good job

of describing inter-industry trade.

– Inter-industry trade refers to trade in products from different industries

(export wool and import wine).

– That is, countries trade because they are different!

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• But how can we describe this?




• Intra-industry trade refers to trade in products from the same industry

(beer for beer, cars for cars…)

– Germany exported $146 billion and imported $40 billion of motor

vehicles in 2012 (Source: Comtrade)

• Intra-industry trade disproportionately occurs between countries that are

wealthy (and similar)

• Intra-industry trade exists (and is welfare improving) for two reasons.

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• The first is the notion that there is love for variety.

– There will always be some people in France that love BMW, and there

will always be some Germans that love Citroen.

– International trade leads to more varieties from which consumers can

choose. More product choices is welfare improving.

• Note that love of variety only matters for certain types of

products. For example, all plain white T-shirts are pretty much

the same, but I like having a choice over different types of wine.

• The second is the existence of economies of scale. – Economies of scale exist if the average cost of producing some

product decreases when more is produced.

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• Suppose it costs £100,000 to heat yourcar factory and £1,000 to produce eachcar.

• If you produce 2 cars, the average costis (£100,000+£2,000)/2 = £51,000.

• If you produce 200 cars, the averagecost is (£100,000+£200,000)/200 =£1,500.

• The average cost falls as more isproduced.

• Suppose there are two countries (Franceand Germany) and two types of cars(compact and full-size)…

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• Consider the case where France makes both types of cars and Germany makesboth types of cars, but they cannot trade with each other.

– Each car manufacturer faces a small market because they can only sell cars in theirown country.

•

But now, let’s let them trade. What will happen? Both countries will want totake advantage of economies of scale by focusing production on one type ofcar.

– France will start specialising in one type of car and Germany will start specialisingin the other.

•

France will export one type of car to Germany, Germany will export the othertype of car to France. Both countries can take advantage of selling to thelarger combined market and consumers get the variety they love.

• Paul Krugman won a Nobel Prize in part for his work on this.

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Overview of Trade Policies

• Now let’s turn to a new topic.

• We have learned that trade can be welfare improving

– Countries can take advantage of their comparative advantages

– Consumers can get a greater choice of product varieties

– Firms can take advantage of economies of scale.

• Despite this, most countries have some trade restrictions in place of oneform or another.

• There are specific cases in which trade restrictions are well-advised in thesense they are welfare improving, but often times they create economicinefficiency.

– With free trade, products tend to be produced where they should beproduced.

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• There are many ways in which governments can make trade more difficult.Perhaps what we hear about the most are tariffs and quotas.

• A tariff is a tax placed on a good or service when it crosses a nationalborder.

• Tariffs are the oldest (and perhaps most important) form of trade policy.

– They used to be a very important source of government revenue.

– In 1795, about 95% of US federal government revenue was from tariffs.

•Tariffs have been dramatically reduced since WWII, but they are stillubiquitous.

• Very few countries have no tariffs whatsoever (Singapore, Hong Kong, andMacau are among the handful).

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Average Tariff in EU by Selected Product

Group (2007)

Product Ave. Tariff ( Ad

Valorem)

Fish and fish

products

10%

Minerals and Metals 2%

Petroleum 2.3%

Textiles 6.6%

Clothing 11.5%

Wood, paper, etc… 0.9%

Countries with Highest Tariffs (2011)

Country Ave. Tariff ( Ad

Valorem)

Iran 22%

Bahamas 19%

Djibouti 18%

Bermuda 17%

Benin 15%

Chad 15%

Sudan 8%

Source: WTO




• Rather than a tariff, countries sometimes impose import quotas on certain

products.

• An import quota is a limit on the total quantity of imports of a product

allowed into a country during a given period of time.

• For example

– The United States, in 2013, limited the import of sugar from the rest of the

world to about 3 million tonnes.

–

China, in 2014, imposed an import quota of 5.3 million tonnes of rice and894,000 tonnes of cotton.

– Russia, in 2012, limited imports of pork to about 350,000 tonnes.

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• There are many other ways that governments can restrict international trade.A few other ways include…

• Government Procurement – Some national governments will sometimeschoose not to purchase goods and services produced in other countries

• Content Requirement – A minimum percent of value added in every productproduced and sold in a country must be domestic.

– For example, perhaps to sell a car in a particular country, you need to use tyres thatwere produced domestically.

• Sometimes trade barriers are a bit “sneakier.” Countries will occasionally setup “red-tape” barriers.

– These aren’t explicit restrictions, but they are meant to make it a hassle forforeigners to sell their products.

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• In 1982, there was a French decree whichstated that all Japanese VCRs needed topass through the customs house inPoitiers.

• The Poitiers customs house had 4

employees (eventually expanded to 8).

• All documents had to be in French (ratherthan English/German as per the norm)

• All documents and VCRs were

meticulously examined (some VCRs weredisassembled for inspection).

• Japanese VCR exports fell from 64,000 amonth to 10,000 a month following this.

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Economic Impact of Trade Restrictions

• Most economists agree that trade restrictions reduce total welfare.

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• To illustrate the inefficiency that can be created, let’s analyse the effect of tradebarriers using the tools of supply/demand and consumer/producer surplus.

• Consider the market for wheat in the United Kingdom in the early 1790s.

• During the Napoleonic Wars, the United Kingdom blockaded European ports. Thisprotected UK farmers from foreign competition.

• The price of wheat in the UK was persistently higher than the price of wheat in the restof Europe.

• At the end of the Napoleonic wars, UK landowners feared the price of wheat wouldplummet in the UK following influx of cheap imports – the profits of UK landowners

would fall.

• In 1815, the UK “corn laws” heavily regulated the import of foreign wheat to make surethe price of wheat in the UK remained sufficiently high.

• Let’s explore the effects of a tariff on wheat and a quota on wheat.

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• We will look at this at the industry level using supply and demand.

• We can presume that during this period, the equilibrium price of wheat in theUK (where supply equals demand) was greater than the world price.

• Before proceeding, let’s make two technical assumptions to make this easier.

If we relaxed this assumptions we might get some different conclusions (butwe wont go into them here).

• First, assume that the wheat market is highly competitive and the wheatproduced in one country is a good substitute for wheat produced in another.

– People will buy wheat from where it is cheapest – no “love of variety”

• Second, assume that the UK’s corn laws did not affect the “world price” ofwheat.

– This is called the “small country” assumption. We assume that a change in theUK market will not shift supply/demand in the world market.

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• The equilibrium price of wheat in the UK is 90 shillings. The equilibrium worldprice is 40 shillings.

• If wheat from the rest of the world freely enters the UK market, the price ofwheat in the UK cannot stay at 90 shillings a unit.

• At these prices, people will buy only foreign wheat – UK producers will beforced to start selling their wheat for 40 shillings a unit.

– With free trade, the price of wheat in the UK will be no more than 40 shillings.

• The decline in the UK price of wheat from 90 shillings to 40 shillings willreduce supply in the UK and it will increase demand.

• UK supply will no longer equal UK demand at a price of 40 shillings… thedifference between UK supply and demand will be imported from othercountries.

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• Recall our measure of economic welfare from semester one (EA onlystudents may wish to look at lecture 3 of block 1 for further review)

• Consumer Surplus – measure of economic welfare for consumers.

– Remember the demand curve illustrates “willingness to pay”

– Consumer surplus is the area below the demand curve and above the price.

– E.G. if you value a cup of Starbucks for £3.00, and you buy it for £1.20, consumer surplus

is £1.80.

• Producer Surplus – measure of economic welfare for producers.

– Remember that the supply curve illustrates the cost of production. – Producer surplus is the area above the supply curve and below the price.

– E.G. if it cost you £10 to build a lawnmower and you sell it for £30, producer surplus is

£20.

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• Now let’s suppose the UK government imposes an import tariff on foreignwheat.

• Assume that the tariff is equal to 10 shillings for every unit of wheat imported.

•The price of foreign wheat sold in the UK will then be 40 shillings + 10 shillings= 50 shillings.

• Because foreign wheat is selling for 50 shillings in the UK, UK wheat producersare now able to sell their product for 50 shillings as well.

– UK wheat producers will produce more and UK wheat consumers willconsume less relative to the case without the tariff.

• The difference between UK supply and UK demand will be smaller – importsto the UK will be smaller

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• Imports fell from 80,000 to 50,000 units as a result of this 10 shilling tariff.

• What happened to welfare in the UK?

• It is clear that UK producers will be better off (sell more at a higher price)

• It is clear that UK consumers will be worse off (buy less at a higher price).

• It is clear that the UK government will earn revenue (50,000 units imported times atariff of 10 shillings per unit).

•

But, the losses to consumers are greater than the gains to producers and the gains tothe government.

• This tariff reduces welfare in the UK. There is deadweight loss.

– Remember that deadweight loss is surplus that is lost relative to the social optimum.

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• After the tariff, 50,000 units of wheat were imported to the UK. Shouldthe UK set an import quota of 50,000 units a year instead of a tariff toachieve the same result?

• The price of wheat in the UK will still end up being 50 shillings following

50,000 unit quota. – Price in UK after quota will occur where UK Demand – UK Supply = 50,000.

This happens at price of 50 shillings.

• Consumers and producers will be just as well off under equivalenttariffs/quotas.

• But, the government typically does not earn any revenue (unless they sellimport licences). Welfare losses are therefore greater with quotas.

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•In summary, trade restrictions usually generate deadweight loss.

Case Study: India and Apples

Source: Devadoss and Wahl “Welfare Impacts of Indian Apple Trade Policies”Applied Economics (2004)



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• Apple production only takes place in very few parts of India, but the Indiangovernment has implemented a 50% import tariff on apples. – For example, £10 worth of apples coming in from China will incur £5 in import

taxes.

• As a result of this policy, the price of apples in India is much higher than itotherwise would be. – Apple producers in India are happy, the Indian government earns revenue, but all

1.2 billion potential apple consumers are worse off.

• Devadoss and Wahl (2004) estimate that relative to a case of no restrictionseffects of the import tariff are as follows: – Apple imports decreased by about 25%

– Indian apple producers gain an additional surplus of 929 million Rs – The Indian government earns 2,270 million Rs in revenue

– Indian apple consumers lose surplus of 10,077 Rs.

– Therefore, there is a deadweight loss of 6,878 million Rs

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• Are there any other problems associated with trade restrictions?

• In addition to inefficiencies created, trade restrictions might be ill advisedas they may lead to retaliation from other countries.

• Partly in response to the Corn Laws, for example, the Spanish governmentincreased the tariff on UK goods by 50 per cent.

• Trade policies can therefore lead to trade wars between countries, whereprotectionist policies are bilaterally applied as a form of punishment.

• An example of a trade war: the United States imposed a series of tariffs in1930 (Smoot-Hawley Tariff Act) - 60 countries raised tariffs on U.S.products as a response.




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• If the losses to the losers are larger than the gains to the winners, why areinefficient protectionist policies being used?

• The most simple argument is that the squeakiest wheel gets the grease.

• The gains from free trade arediffuse – a lot of people benefit atiny amount. There is littleincentive to lobby government forfree trade (free rider problem).

• The costs of free trade areconcentrated – there exists a hugeincentive to try and influencepolicy



Arguments for Trade Restrictions

• But there are economists and politicians that argue that some traderestrictions might be okay.

• Let’s go over some of these arguments (there are more we could talk about).

– Infant Industry Argument

– Source of Revenue for Developing Governments

– Way of Life

– National Defence

– Equality

• Some more issues are raised in the required reading by Nobel Prize winnerJoseph Stiglitz.

– If you are really interested in this, I can recommend the book “Globalisationand its Discontents” by the same author.

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Infant Industry Argument

• A country might potentially have a comparative advantage in some industry, but thisindustry may be undeveloped and cannot compete with the mature foreigncompetitors.

•Argument is that the government should temporarily protect new industries with tariffsand quotas until these industries are developed enough to compete with foreign firmsthat are “grown up.”

• The idea is that it takes time for firms in an industry to learn to compete or to takeadvantage of economies of scale.

• While domestic consumers will suffer higher prices in the interim, they will be better offin the long run when the domestic industry is mature and costs are low.

• This is a widely used argument in developing countries.

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• In 1984, Brazil essentially banned the import of foreign computers toprotect their fledgling computer industry.

• The problem is, the Brazilian computer industry never “grew up.” – they

couldn’t achieve prices as low as the US

• Infant industry protection is very difficult in practice

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Source of Revenue in Developing Governments

• Governments need to raise revenue to provide public goods and services.

• Tariffs are a very cheap and easy way to raise revenue – just put a few

customs officers at every port and border crossing.

• For some countries this is a much more practical way to raise income thanmonitoring the incomes and purchases of every single person andbusiness in the country.

• In many developing countries, upwards of 60% of government revenue isfrom import duties. – In Canada, on the other hand, this number is about2%

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Way of Life

• The production of some products entails national pride and identity

• This is an important argument for Japan’s protection of the rice industry –

rice production is embedded in rural Japanese culture.

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National Defence

• Some argue that countries need to produce certain products at home incase of a conflict.

• For example, some argue the United States should produce their ownsteel – if war breaks out the U.S. can produce their own weapons todefend themselves.

• Or, Norway should produce at least some food themselves in case there is

an international conflict after which food supplies from other countriesbecome insecure.

• This argument, of course, is becoming less valid in today’s world.

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•This argument is often abused, however…

• The U.S. footwear industry had a hard time competing against low-priceproducers from abroad and tried to get protection by claiming footwear isimportant for national security…

• The president of the Footwear Industry of America testified before congress in1984 that…

“In the event of war or other national emergency, it is highly unlikely that the

domestic footwear industry could provide sufficient footwear for the military

and civilian population… We won’t be able to wait for ships to deliver shoes from Taiwan, or Korea, or Brazil, or Eastern Europe …. [I]mproper footwear

can lead to needless casualties and turn sure victory into possible defeat” – Quote from Pugel “International Economics” Ch 10

f




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Equality

• Following free trade, people employed in jobs where their country is

comparatively disadvantaged will lose.

• The gains to the winners will be greater than the losses to the losers, so in

theory governments can just redistribute income.

• But does this happen in practice?

• The cost of adjustment might be long and

painful.



Summary

•

The growth in global trade has dramatically outpaced the growth in globalGDP.

• One reason why countries is trade is that they are different. When countriesspecialise according to their comparative advantage, they can be made betteroff through trade.

• Intra-industry trade is driven by economies of scale and a love of variety.

• Trade protection can lead to deadweight loss relative to the outcome with nogovernment intervention. – Producers win, the government can earn revenue, but the losses to consumers

outweigh the gains.

• However, there are many valid arguments for restricting trade in somecases.

lecture 1 - trade overview(1)

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