MarketsChapter 9

On November 30, 1999, the World Trade Organization met in Seattle to launch a new round of free-trade

negotiations to bring in the new millennium. Massive protests rocked the streets outside the Washington

State Convention and Trade Center. It was the largest demonstration ever against an organization

dedicated to globalization and trade in U.S. history. It came to be known as the “Battle of Seattle.”

Afterwards, the Seattle police chief said the protesters had won. He resigned.

Is Free Trade the Answer?

Source: Artizans Art Works

Source: Photovalet.com

…for the Poor?

Source: Artizans Art Works

…or Only the Rich?

Source: Artizans Art Works

No Doubt About It: Trade Is Growing (Fast!)

Trade Is Especially Important for Smaller Countries

The Case for Trade• Opens up vast markets for products produced in low and

middle income countries– Growing low-skilled employment– Reducing poverty

• Gives firms, consumers access to huge diversity of goods, quality, and prices not available from domestic firms

• Gives everyone access to new technologies, raising productivity and incomes

• "We want NAFTA because we want to export goods, not people." – Mexico’s President Salinas, in calling for a North American Free Trade

Agreement (NAFTA)

The Case Against It

• There are winners and losers• In theory the winners could compensate the losers, making

everyone better off, but…• In practice that doesn’t happen enough• Global production shifts to countries that have a

comparative advantage in producing a given good or service– Labor intensive to Asia, Africa, Latin America– Capital intensive to OECD countries– Rich countries have comparative advantage in human capital-

intensive activities (like R&D)– Lots of exceptions (like Bangalore)

Ricardian Basics

• In Country A, each unit of cloth costs 100• Suppose by trading with Country B it can “buy” one unit of wine with one unit

of cloth– So through trade it can get a unit of wine for 100 (< 110)

• Country B can get a unit of cloth for 80 (< 90) by producing wine and exporting it

• Trade is optimal even though Country A has an absolute disadvantage in both cloth and wine

– A has a comparative advantage in cloth; B has a comparative advantage in wine

Country Unit labor costs

Cloth Wine

A 100 110

B 90 80

Welfare Basics: Producer Surplus

• Producer surplus is given by the area between price and the supply curve– Our measure

of producer welfare

Welfare Basics: Consumer Surplus

• Consumer surplus is given by the area between the demand curve and price– Our measure

of consumer welfare

Price DiscoveryThe intersection of supply and demand give the equilibrium price and quantity for a nontradable in the economy (nation, region, household)

Everything in ZS and ZD is reflected in the price (see boxes: “All in One Price” and “Estimating the Shadow Price of Corn”)

Trade “Decouples” Local Supply from Demand for Tradables

• At world price pw, the economy supplies QS and demands QD

• The difference, M, is imports

• Producers lose “Producer Surplus” (A)

• …but consumers gain more (“Consumer Surplus” = A+B)

A B

A High Import Tariff Can Drive the Country into Autarky

Import tariff: tim per unit

…So consumers would have to pay pw(1+ tim) for imports

They’re better off paying the autarkic price, pe

The tradable becomes a non-tradable, i.e., it is no longer traded with the rest of the world

Tariffs Create a “Deadweight Loss”• The lost consumer

surplus is (a+b+c+d)

• The government gets the tax (c)

• The gain in producer surplus is (a)

• What happened to (b+d)?– It’s the efficiency

cost of the tariff, or deadweight loss

Without the tariff everyone could be better off!

On Globalization

“This has created many new opportunities, but also new questions regarding the roles, functions and core capacities of the various key players. Deep-rooted principles and paradigms have been cut down in a short period. It is sometimes like mixing an Italian basketball team with Nigerian soccer players, and trying to play in a volleyball tournament. The new situation raises many questions about how the game is played, and who are the winners and losers.” (KIT, 2006)