Macroeconomics (ECON 1211)Lecturer: Dr B. M. Nowbutsing

Topic: International Tradeand Commercial Policy

33.2

1. Exports as % of GDP

0

20

40

60

80

%

1967

1998

33.3

Destination of world exports, 1996

EU38%

Asia28%

Middle East3%

Latin America

5%

North America

17%

Africa2%

Other7%

Source: Direction of Trade Statistics

33.4

The composition of world exports

0%

20%

40%

60%

80%

100%

1955 1995

Food, ag Fuels Other primary Manufactures

33.5

Imports and Exports (Rs M) – Mauritius

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1985 1990 1995 2000 2005

Year

Rs

M

Imports

Exports

33.6

Imports and Exports (Rs M) – Mauritius

0

10

20

30

40

50

60

1991 1993 1995 1997 1999 2001 2003 2005

Year

%

Imports

Exports

33.7

Imports and Exports (% of GDP) – Mauritius

0

10

20

30

40

50

60

1991 1993 1995 1997 1999 2001 2003 2005

Year

%

Imports

Exports

33.8

Openness: (Imports and Exports)/GDP

0

10

20

30

40

50

60

1991 1993 1995 1997 1999 2001 2003 2005

Year

%

33.9

1. Some Important Issues Raw materials prices

– Less-developed countries (LDCs) have claimed exploitation by industrial

countries e.g. by buying raw materials cheaply & selling manufactures dear

Manufactured exports from LDCs

– some LDCs have had success in exporting manufactures

– leading to complaints that jobs are under threat in the industrial countries

Trade disputes between industrial countries

– In some countries , established producers of certain goods are being

undercut by efficient modern producers

– especially from Japan & East Asia

– should such exports be restricted?

33.10

2. Comparative Advantage

Trade offers benefits when there are international differences in the opportunity cost of goods.

Opportunity cost of a good– the quantity of other goods sacrificed to make one

more unit of that good

The law of comparative advantage– states that countries should specialize in producing

and exporting the goods that they produce at a lower relative cost than other countries.

33.11

2. Comparative Advantage

This concept is best understood in its classical form, the Ricardian theory of comparative advantage.

Main assumptions: - Markets are perfectly competitive.

- There are two goods say cds and shirts that are produced under constant returns to scale.

- There is a single factor which is mobile across sector but immobile across countries

- There are two countries (UK and USA) each with a

fixed endowment of labour

33.12

2. Comparative Advantage

  USA UK

Unit Labour Requirement    

(hours per unit of output)    

Cds 30 60

Shirts 5 6

Opportunity cost of    

Cds 6 shirts 10 shirts

Shirts 1/6 Cds 1/10 Cds

33.13

2. Comparative Advantage

Absolute advantage: USA – 30 hours to produce a cd; 60 hours in UK

Similarly, a shirt is produced with 5 hours of labour in USA compared to 6 hours in UK

Thus, USA has absolute advantage in the production of both goods

33.14

2. Comparative Advantage

Opportunity cost table It is cheaper to produce cds in USA (6<10) It is cheaper to produce shirts in UK

(1/10<1/6) Ricardian model: requires that each

country specialises completely in the activity in which it has comparative advantage

33.15

2. Comparative Advantage – Terms of Trade Suppose terms of trade are 1 cd = 5 shirts (or 1

shirt = 1/5 cd) USA exporter of cd: for each video it exports,

USA can obtain 5 UK made shirts However, it cost 6 shirts to produce cd in USA Surely, it does not make sense to produce a cd at

the domestic cost of 6 shirts and sell it to get 5 shirts.

The proposed TOT implies a loss to the USA The TOT must lie in the range 1 cd = (6, 10) shirts

33.16

3. The Source of Comparative Advantage An important difference between countries is in factor

endowments which will be reflected in different relative factor prices

– e.g. if the UK has relatively abundant capital but relatively scarce labour as compared with India,

– then the UK would tend to specialize in capital-intensive goods,

– and India would tend to specialize in labour-intensive products

Comparative advantage may also reflect a relative advantage in technology

33.17

3. The Source of Comparative Advantage According to the Heckscher-Ohlin model or Ricardian

model, countries specialize in one production. Trade occurs only between industries: inter-industry trade.

Suppose now that the global cloth industry is described by the monopolistic competition model. Because of product differentiation, suppose that each country produces different types of cloth.

Because of economies of scale, large markets are desirable: the foreign country exports some cloth and the domestic country exports some cloth. Trade occurs within the cloth industry: intra-industry trade.

33.18

3. The Source of Comparative Advantage Gains from inter-industry trade reflect

comparative advantage. Gains from intra-industry trade reflect

economies of scale (lower costs) and wider consumer choices.

The monopolistic competition model does not predict in which country firms locate, but a comparative advantage in producing the differentiated good will likely cause a country to export more of that good than it imports.

33.19

3. The Source of Comparative Advantage

The relative importance of intra-industry trade depends on how similar countries are.

Countries with similar relative amounts of factors of production are predicted to have intra-industry trade.

Countries with different relative amounts of factors of production are predicted to have inter-industry trade

33.20

4. Gainers and Losers

Countries may gain from specialization and trade – but not all countries may gain equally

Commercial policy– is government policy that influences

international trade through taxes or subsidies

e.g. tariffs– or through direct restrictions on imports

and exports.

33.21

5. The Effect of a Tariff

A specific tariff is levied as a fixed charge for each unit of imported goods, For example, Rs. 10 per kg of cheese

An ad valorem tariff is levied as a fraction of the value of imported goods. For example, 125% tariff on the value of imported cars.

33.22

5. The Effect of a Tariff

DD

SS

Quantity

Pric

e

DD and SS show the domestic demand and supply for a good.

Pw

If the world price is Pw,and there is free trade,

Qs

domestic firms supply Qs

Qd

domestic demand is Qd

A tariff can stimulate domesticsupply and restrict imports

Pw+ T

At a domestic price Pw + T,

where T is the size of the tariff

Qs' Qd'

Domestic demand falls to Qd', domestic supply rises to Qs'

and the difference is imported.

and imports fall.

33.23

The government raisesrevenue – i.e. there is atransfer to the government

There is a social cost from production inefficiency,given that the good could be imported at Pw.

There is also a loss of consumer surplus.

and there is a transfer in the form of extra profits to producers

5. The Effect of a Tariff – Welfare Effect

DD

SS

Quantity

Pric

e

Pw

Qs Qd

Pw+ T

Qs' Qd'

The tariff leads both to transfers and net sociallosses.

33.24

5. The Effect of a Tariff

The deadweight burden of a tariff suggests that society suffers from this method of restricting trade.

This is the case for free trade. Tariffs have fallen substantially

under the GATT/WTO – General Agreement on Tariffs and Trade

33.25

6. The Case for Tariffs – Good Arguments

Optimal tariff– a first-best argument– only valid where the importing country is large

enough to affect the world price

This policy fulfils the principle of targeting– which says that the most efficient way to attain a

given objective is to use a policy that influences that activity directly.

– Policies that attain the objective, but also influence other activities are second-best, because they distort those other activities.

33.26

7. The Case for Tariffs – Second-Best arguments Way of life

– an attempt to preserve ‘traditional’ ways– a production subsidy would be better

Suppressing luxuries– an attempt to curb consumption patterns of the rich in a poor society– better achieved by a consumption tax

Infant industries– an attempt to nurture new activities via learning by doing– a temporary production subsidy probably better

Revenue– tariffs raise government revenue– but there are better ways

Cheap foreign labour– a non-argument – denies benefits of comparative advantage

33.27

7. Other Tariffs Schedule

Preferential Duties: Tariffs applied to imports from particular group of countries; Countries are charged a lower tariff than countries outside the group.

Generalized System of Preferences: Developing countries charge a lower tariffs for specific imports from developing countries; It depends on a list chosen by developed countries (textiles and clothing not included)

Most Favoured Nation Treatment : WTO principles ; A country must give all countries who are part of the WTO the same tariff treatment as the most favoured nation with which the country is trading.

33.28

9. Other commercial policies

Although tariff rates have fallen under GATT, there has been a proliferation of other trade restrictions– quotas– non-tariff barriers

administrative regulations that discriminate against foreign goods

– export subsidies

33.29

Social costs arise fromproduction inefficiency

and consumer surplus.

10. An Export Subsidy

DD

S

Quantity

Pric

e

Pw Worldprice

Under free trade, with the world price at Pw,

Qd

consumers demand Qd

Qs

production is Qs

exports are GE.G E Subsidy

With a subsidy, producerssupply Qd' to the domestic market and produce Qs'.

Pw+ s

Qd' Q`s'

Exports are now AB.

A B

33.30

11. Other Non Tariffs Barriers

Import Quota: a restriction on the quantity of a good that may be imported. This restriction is usually enforced by issuing licenses to domestic firms that import, or in some cases to foreign governments of exporting countries.

Voluntary Export Restrictions: Bilateral agreements negotiated between an exporting and an importing country under which the exporting country agrees to limit its exports of particular products to the importing country to a fixed amount or share of the market. A relatively new form of barrier to trade