Lecture Notes

1
Lecture Notes

• December 2, 2003
• Unit 6 The International Economy
• Readings text, Ch. 17, 18
• Krugman, Ch. 10, Appendix, Epilogue

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Globalization

• International trade, capital flows have increased
  much more rapidly than GDP
• Political, economic unification (Europe)
• Reform of regulations on trade, capital flows
• A hot-button term for radicals
• globalization now is what used to be called
  imperialism
• privatization
• Some truth to this in many respects the global
  economy looks like it did in the pre-WW I era

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Ch. 17 -- International Trade and Public Policy

• International trade economic theory gives more
  guidance here than in most areas of
  macroeconomics
• With some qualifications, international trade is
  beneficial
• But its very controversial politically
• Seen as threatening jobs
• Bush agricultural, steel tariffs

4
The case for international trade

• Two countries, Chipland and Shirtland
• The populations are the same
• Chipland is more productive in both chips and
  shirts
• Chipland can produce more of either chips or
  shirts than Shirtland
• Chipland has an absolute advantage in both shirts
  and chips
• But a comparative advantage in chips
• Shirtland has a comparative advantage in shirts

5
Production possibility curves
6
Rationale for linear PPC

• Simplest technology labor is the only input
  each worker can produce a certain number of
  shirts, chips, in each country.
• No diminishing returns under this technology.
• So its an oversimplification. But it
  illustrates the point

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production function
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Assume no trade

• Without trade, relative prices in the two
  countries are different
• Relative equilibrium prices determined by
  opportunity cost
• Chipland price of 1 chip is 1 shirt
• Shirtland price of 1 chip is 3 shirts
• These are autarky prices (prices that would occur
  in the absence of trade)

9
Arbitrage

• If one agent (a smuggler) could trade between the
  two countries, there would be arbitrage
• trading in a circle
• Start with one chip in Chipland
• Take it to Shirtland, exchange for 3 shirts
• Take the 3 shirts back to Chipland, exchange for
  3 chips
• Take the 3 chips to Shirtland, exchange for 9
  shirts

10
International Trade

• If the countries allow free trade, what will
  happen?
• Relative prices will equalize
• Each country will tend to specialize production
  in the good in which it has a comparative
  advantage
• Export that good
• Import the other
• (Note its not necessarily true that both
  countries will specialize, especially if one is
  bigger than the other. In this setting, at least
  one will certainly specialize.)
• Chipland will specialize in chips, Shirtland in
  shirts

11
Comparative Advantage

• Trade depends on comparative advantage, not
  absolute advantage!
• Specifically, Shirtland will export shirts even
  though it takes more labor to produce a shirt in
  Shirtland than in Chipland
• Wages will turn out to be lower in Shirtland, of
  course, which is why this works

12
Prices

• Were thinking of a barter economy here, so the
  relevant prices are relative prices - prices of
  chips in terms of shirts (or vice-versa).
• Equilibrium price of chips will be established at
  some intermediate price
• Suppose it is 2 shirts per chip
• Can calculate consumption possibility curves

13
Consumption Possibilities
14
Role of Specialization

• By specializing and trading with each other, each
  country can consume more of both goods when they
  trade.
• Note this analysis is incomplete we havent
  shown what determines equilibrium prices, or how
  much each country will export
• These depend on demands in each country

15
Employment Effects of Free Trade

• Does this mean everyone in both countries is
  benefited by free trade?
• In this simple world, yes.
• In reality, of course not.
• Suppose, realistically, that there exists capital
  specialized to shirt production in Chipland.
• Owners of this capital will lose under free
  trade,
• Will complain that shirt producers in Shirtland
  are competing unfairly because their wages are
  lower

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Similarly

• Similarly, chip producers in Shirtland are made
  worse off by trade they cant compete with the
  chip producers in Chipland
• Who can undersell the chipmakers in Shirtland
  even though the chip makers in Chipland earn
  higher wages

17
Protection

• Should the Chipland government protect the jobs
  of Chipland shirt producers?
• (Should the US government protect the jobs of US
  steel workers?)
• By preventing imports, you also prevent exports
• So protecting jobs of Chipland shirt producers
  costs jobs of Chipland chip producers

18

• If trade is suppressed, Chipland consumers can no
  longer consume on the higher consumption-possibili
  ty curve
• Most economists think that, on balance, trade is
  good
• Most politicians dont. Harder to identify who
  is hurt by suppressing trade than who is helped

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Protectionist Policies

• Import ban
• As noted, banning imports is equivalent to
  banning exports, since foreign producers buy our
  exports with their exports
• So if Chipland prohibits trade, the price of
  shirts will rise from ½ chip to 1 chip
• Equivalently, the price of chips will fall from 2
  shirts to 1 shirt

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Supply-Demand Analysis

• The supply of any good is the horizontal sum of
  domestic supply plus foreign supply

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Effect of an Import Ban

• Total supply coincides with domestic supply,
  raising equilibrium price

22
Quotas, Voluntary Export Restrictions

• Quota a limit on how many shirts Chipland can
  import
• Works like a partial ban foreign supply cant
  exceed the quota
• Voluntary Export Restriction the exporting
  country limits exports

23
WSJ article on quotas

• Bangladesh has benefited from quota system on
  textile exports (limits exports from China,
  mostly)
• Despite this, Bangladesh pays high tariffs
  (France, with 10 times the export volume, pays
  about the same total tariffs to US)
• Quotas will end China will undersell Bangladesh.
• Link to the article on class page.

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Quotas
25
Tariffs

• AKA duties
• Tariff a tax on imports
• Shifts supply curve, raises equilibrium price

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Comparison

• With tariffs, the government gets the revenue
• With quotas, somebody gets issued an import
  license. Usually, its a friend of the prime
  minister, who can therefore make a lot of money.

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Voluntary export restrictions

• With VER, the supplying country gets to issue
  export licenses.
• Japanese cars in Europe
• So by imposing VER, Europe is requiring the
  Japanese auto makers to form a cartel to restrict
  supply.
• This raises the price of imports exporters get
  the money
• How much sense does that make?

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Response to Protectionism

• Bush administration imposed tariffs on steel
  imports
• Recently declared a violation of tariff
  agreements by World Trade Organization
• Also, restrictions were imposed on China
• China may retaliate against imports from US
• Possible result trade war.
• World reverts to autarky?

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NAFTA

• North American Free Trade Agreement
• Gradual phasing out of tariffs between US, Mexico
  and Canada
• No big deal tariffs were already around 4
• Big political issue giant sucking sound as
  jobs went south of the border
• Of course, it didnt happen

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NAFTA

• Youd expect small increase in exports, imports,
  some jobs would move to Mexico, Canada produce
  for re-export to US
• Did it happen? Hard to tell
• Mexico had a financial crisis in 1994. Resulted
  in a big devaluation of Mexican peso.
• US imports from Mexico rose exports to Mexico
  dropped.

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Rationale for Protectionist Policies

• 1. Protects (some) workers
• 2. Infant industries
• 3. Help domestic firms establish monopolies
• Airbus v. Boeing

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Trade Agreements

• WTO (World Trade Organization)
• administers trade disputes
• Environmental issues third world countries may
  have lower standards
• hardwoods from Brazil rainforests
• Seattle Protests
• Domestic groups wanting protection can always
  allege environmental damage from imports
• WTO often doesnt buy it

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WTO

• Rule We can only ban imports if they cause
  damage to our environment.
• US cant ban tuna caught with nets, even though
  they also catch dolphins
• Cant ban imports from Brazil rain forest.

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Example

• Hormone-treated beef Europe refused to import
  it
• WTO sided with US Europe wouldnt back down, so
  US was permitted to impose tariffs in retaliation
• Pretty confusing the tariff hurts (the
  consumers in) the country imposing it at least as
  much as the exporting country

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• HAVE A PLEASANT HOLIDAY!
• SEE YOU NEXT WEEK.