Merchandise exports as % of GDP In 2007 World Exports was 31% of World GDP
Top Ten Exporting Countries Country Exports as a Fraction of World Exports Top Ten Exporting Countries Account for 52% of World Exports Source: WDI Online, World Bank.
Growing Role of Services in World Trade Services Now Account for Approx. 20% of World Trade
Comparative Advantage Example Output per Worker U.S. is more efficient (higher productivity) than China in producing both goods. Hence the US has a competitive advantage in producing both goods. U.S. is relatively more efficient in producing Butter (20/8>5/4) and China is relatively more efficient in producing Wheat, so the U.S. has a comparative advantage in producing Butter and China has a comparative advantage in producing Wheat.
Gains from Trade due to Comparative Advantage Bu t t er Production possibility set for the U.S Trading Line: 2 Butter = 1 Wheat U.S.:comparative advantage in Butter. 200 80 100 Bu t t er China:comparative advantage in Wheat. 80 Production possibility set for China 50 Trading Line: 2 Butter = 1 Wheat 40 Wheat - Without trade, each country consumes somewhere on its production possibility set. - With trade and specialization in production (US in Butter and China in Wheat), each country consumes on its Trading Line. - Both countries are better off with trade. Why?
Comparative Advantage Key Prediction: Countries will export those goods for which they have a comparative (relative productivity) advantage. • China has a productivity/cost advantage in producing labor-intensive goods. • The G3 countries (U.S., Germany, Japan) have a productivity/cost advantage in producing capital-intensive goods
Comparative Advantage and Production Cost • Wages are determined in the aggregate labor market • Wage = economy-wide average labor productivity • Production cost affected by wages relative to labor productivity • Unit labor cost for a given industry = Wage / labor productivity in the industry • A country will have a Comparative Advantage in an industry in which unit labor costs are low • Industry unit labor cost = Wage/Industry labor productivity = economy-wide average labor productivity / industry labor productivity • For an industry to maintain its comparative advantage, it must raise its labor productivity at least as fast as other potential industries within the country
Trade and Firm Productivity More productive firms export more, even within industries. Source: Eaton, Kortum, and Kramarz, “An Anatomy of International Trade: Evidence from French Firms,” 2004.
Intra-Industry Trade Index = 1 – |Imports-Exports|/(Imports+Exports) • Intra-industry trade is trade within an industry. • A significant portion of world trade is intra-industry trade. Why? • Industries with significant intra-industry trade are characterized as follows • sophisticated • product differentiation • monopolistic competition • Krugman Nobel Prize • Fixed costs leads to economies of scale (global brands) • New Trade Theory Industry Index in the US
Trade and Conflict Given the gains from trade, why is there so much conflict surrounding trade issues? • Trade encourages some industries within a country to expand and others to contract • Factors of production tied to the contracting industries will lose and those tied to the expanding industries will win. • Low-skill workers in the U.S. are hurt from trade • Owner’s of natural resources (e.g., oil) benefit from trade as the demand for these goods rise • Farmers in the U.S. may be hurt from trade • Often there are a few big losers and many small winners from trade, so the losers tend to exploit the political system to their advantage
Subsidies Tariffs Local Content Requirements Voluntary Exports Restraints Antidumping Duties Administrative Policies Import Quotas The 7 Instruments of Trade Policy
Tariffs and Florida OJ Florida: 40 percent of the World OJ market. Brazil: 45 percent of the World OJ market. Brazil controls World market except the US. 29.5 cent per gallon tariff on Brazilian OJ concentrate.
Agricultural Subsidies • Very common in North America, Europe and Japan • EU-sugar; US-cotton • Keeps inefficient farmers in business. • Encourages production of products that can be grown more cheaply elsewhere. • Reduces world trade. • Perpetuates global poverty. • Poor countries are predominantly agrarian • Rich country subsidy to farmers prevents poor countries from growing
US Cotton Subsidies – Impact on Mali "Subsidies are a catastrophe for us," said Zakariyaou Diawara, who heads the union of Mali's cotton farmers. "Our cotton is of better quality; it's the subsidies that crush us." U.S. subsidises cotton farmers by $3 billion per year, significantly reducing the world price of cotton.
Development of the World Trading System • Prior to WWI, free trade as government policy • Britain’s (1846) repeal of the Corn Laws. • Britain continued free trade policy. • WWI to WWII • Great Depression led to Smoot-Hawley Act (1930) that started a trade war (US exports tumbled) • General Agreement on Tariffs and Trade (GATT) proposed by US in 1947. • 19 original members grew to 120 nations • World Trade Organization (WTO) replaced GATT in 1995 • Currently 158 member countries
History of Tariffs Tariffs were raised during the global economic depression in the 1930s as an attempt to protect domestic industries Trade in second half of century boosted by declining tariffs
Regional Trade Agreements • EU: Complete elimination of restrictions on goods flows, capital flows, and labor flows within Europe. • NAFTA: Free trade among Canada, US, Mexico. • Andean Pact: Bolivia, Colombia, Ecuador, Peru, Venezuela. • Mercosur: Argentina, Brazil, Paraguay, Uruguay. • ASEAN: Brunei, Indonesia, Laos, Malaysia, the Philippines, Myanmar, Singapore, Thailand and Vietnam. • APEC: US, Canada, Japan, China, many in S.E. Asia, Australia. • African trade blocs: 9 different trade blocs. Encourage trade within the trading bloc, but tend to Balkanize the world and discourage trade between trading blocs.