Trading
Rudiments of economics :
Why countries trade
Brad McDonald
If there is a point on which most economists agree, it is that trade
among nations makes the world better off. Yet international trade can be
one of the most contentious of political issues, both domestically and
between governments.
When a firm or an individual buys a good or a service produced more
cheaply abroad, living standards in both countries rise. There are other
good reasons consumers and firms buy abroad - the product may better fit
their needs than similar domestic offerings or it may not be available
domestically.
Foreign producers also benefit by making more sales than by selling
solely at home and by earning foreign exchange that can be used to
purchase foreign-made products.
Still, even if societies as a whole gain when countries trade, not
every individual or company is better off. When a firm buys a foreign
product because it is cheaper, it benefits - but the (more costly) home
producer loses a sale.
However, the buyer usually gains more than the domestic seller loses.
Generally, the world is better off when countries import products that
are produced more efficiently and cheaply abroad. The exception is if
the foreign costs of production do not include social costs, such as
pollution.
But those who feel they are adversely affected by foreign competition
have long opposed international trade.
Soon after economists such as Adam Smith and David Ricardo
established the economic basis for free trade, British historian Thomas
B. Macaulay was observing the practical problems governments face in
deciding whether to embrace the concept: “Free trade, one of the
greatest blessings which a government can confer on a people, is in
almost every country unpopular.”
Two centuries later trade debates still resonate.
Why countries trade
Ricardo observed that trade was driven by comparative rather than
absolute costs (of producing a good). One country may be more productive
than others in all goods, in the sense that it can produce any good
using fewer inputs (such as capital and labour) than other countries
require to produce the same good.
Ricardo’s insight was that such a country would still benefit from
trading according to its comparative advantage-exporting products for
which its absolute advantage was greatest and importing those for which
its absolute advantage was comparatively less.
Comparative advantage
Even a country that is more efficient (has absolute advantage) in
everything it makes would benefit from trade. Consider an example:
Country A: One hour of labour can produce either three kilograms of
steel or two shirts. Country B: One hour of labour can produce either
one kilogram of steel or one shirt.
Country A is more efficient in both products. Now suppose Country B
offers to sell Country A two shirts in exchange for 2.5 kilograms of
steel.
To produce these additional two shirts, Country B diverts two hours
of work from producing (two kilograms) steel. Country A diverts one hour
of work from producing (two) shirts. It uses that hour of work to
instead produce three additional kilograms of steel.
Overall, the same number of shirts is produced: Country A produces
two fewer shirts, but Country B produces two additional shirts.
However, more steel is now produced than before: Country A produces
three additional kilograms of steel, while Country B reduces its steel
output by two kilograms. The extra kilogram of steel is a measure of the
gains from trade.
Though a country may be twice as productive as its trading partners
in making clothing, if it is three times as productive in making steel
or building airplanes it will benefit from making and exporting these
products and importing clothes. Its partner will gain by exporting
clothes-where it has a comparative but not absolute advantage-in
exchange for these other products.
The notion of comparative advantage also extends beyond physical
goods to trade in services-such as writing computer code or providing
financial products.
Because of comparative advantage, trade raises the living standards
of both countries. Douglas Irwin (2009) calls comparative advantage
‘good news’ for economic development.
“Even if a developing country lacks an absolute advantage in any
field, it will always have a comparative advantage in the production of
some goods” and will trade profitably with advanced economies.
Differences in comparative advantage may arise for several reasons.
In the early 20th century, Swedish economists Eli Heckscher and Bertil
Ohlin identified the role of labour and capital, so-called factor
endowments, as a determinant of advantage.
The Heckscher-Ohlin proposition maintains that countries tend to
export goods whose production makes intensive use of relatively abundant
factors of production. Countries rich in capital-such as factories and
machinery-export capital-intensive products, while those rich in labour
export labour-intensive products. Economists today think that although
factor endowments matter, there are also other important influences on
trade patterns (Baldwin, 2008).
Recent research shows that when trade opens up, it is followed by
adjustment not only across industries, but within them as well.
Increased competition from foreign firms puts pressure on profits,
forcing less-efficient firms to contract, making room for more efficient
firms.
Expansion and new entry introduce better technologies and new product
varieties. Likely most important, trade enables greater selection across
different types of goods (say refrigerators).
This explains the prevalence of intra-industry trade (for example,
countries that export household refrigerators may import industrial
coolers), which the factor endowment approach does not encompass.
There are clear efficiency benefits from trade that result in more
products - not only more of the same products, but greater product
variety.
For example, the United States imports four times as many varieties
(say different types of cars) as it did in the 1970s, while the number
of countries supplying each good has doubled. An even greater benefit
may be the more efficient investment spending that results from firms’
access to a wider variety and quality of intermediate and capital inputs
(think optical lenses rather than cars).
Economic models used to assess the impact of trade typically neglect
technology transfer and pro-competitive forces such as the expansion of
product varieties.
This is because these influences are difficult to model, and results
that do incorporate them are subject to greater uncertainty. Where this
has been done, however, researchers have concluded that the benefits of
trade reforms-such as reducing tariffs and other nontariff barriers to
trade-are much larger than suggested by conventional models.
Why trade reform is difficult
Trade contributes to global efficiency. When a country opens up to
trade, capital and labour shift toward industries in which they are used
more efficiently.
Societies derive a higher level of economic welfare. But these
effects are only part of the story.
Trade also brings dislocation to firms and industries that cannot cut
it. Such firms often lobby against trade.
So do their workers. They often seek barriers such as import taxes
(called tariffs) and quotas to raise the price or limit the availability
of imports.
Processors may try to restrict exports of raw materials to
artificially depress the price of their own inputs.
By contrast, the benefits of trade are diffuse, and its beneficiaries
often do not recognize how trade benefits them.
Trade policies
Reforms since World War II have substantially reduced
government-imposed trade barriers. But policies to protect domestic
industries vary.
Tariffs are much higher in certain sectors (such as agriculture and
clothing manufacturing) and among certain country groups (such as
less-developed countries).
Many countries have substantial barriers to trade in services in
areas such as transportation, communications, and the financial sector;
others have policies that welcome foreign competition.
Moreover, trade barriers affect some countries more than others.
Often hardest hit are less-developed countries whose exports are
primarily low-skilled, labour-intensive products that industrialized
countries often protect.
The United States, for example, is reported to collect about 15 cents
in tariff revenue for each $1 worth of imports from Bangladesh (Elliott,
2009), compared with one cent for each $ one worth of imports from some
major western European countries-even though imports of a particular
product from Bangladesh face the same or a lower tariff than a similarly
classified product imported from western Europe.
World Bank economists calculated that exporters from low-income
countries face barriers on average 50 percent higher than those of major
industrialized countries (Kee, Nicita, and Olarreaga, 2006).
Members of the World Trade Organization, which referees international
trade, are engaged in a complex effort to reduce and level out
government-imposed obstacles to trade in a round of negotiations begun
in Doha, Qatar, in 2001.
The talks cover a wide range of issues, many of them politically
sensitive, including elimination of remaining farm export subsidies,
limiting domestic farm subsidies, and sharply cutting advanced
economies’ tariffs on farm and industrial products.
Doha also seeks to address other crucial issues such as barriers to
trade and investment in services, trade rules in areas such as fishery
subsidies and antidumping, and customs and trade facilitation.
If successful, the Doha Round could yield hundreds of billions of
dollars in annual global benefits. But some groups have sought to delay
and to dilute the deal.
A focus on the greater good, together with ways to help the
relatively few that may be adversely affected, can help deliver a fairer
and economically more sensible trading system.
Brad McDonald is a Deputy Division Chief in the IMF’s Strategy,
Policy, and Review Department.
- IMF F&D
ASEAN-China open free trade area to rival world’s biggest
China and Southeast Asia establish the world’s biggest free trade
area (FTA) on Friday, liberalising billions of dollars in goods and
investments covering a market of 1.7 billion consumers.
Eight years in the making, the ASEAN-China FTA will rival the
European Union and the North American Free Trade Area in terms of value
and surpass those markets in terms of population.
Officials hope it will expand Asia’s trade reach while boosting
intra-regional trade that has already been expanding at 20 percent a
year.
“In 2010 we are sending a strong signal that ASEAN is open,” H.E
Sundram Pushpanathan, of the Association of Southeast Asian Nations
(ASEAN), told AFP.
China has just overtaken the United States to become ASEAN’s third
largest trading partner, and will leap Japan and the EU to become
“number one” within the first few years of the FTA, said Pushpanathan,
Deputy Secretary-General for the ASEAN Economic Community.
Under the agreement, China and the six founding ASEAN countries —
Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand — are
to eliminate barriers to investment and tariffs on 90 percent of
products. Later ASEAN members, including Vietnam and Cambodia, have
until 2015 to follow suit. Zhang Kening, the director-general of the
department of international trade and economic affairs in Beijing, said
the average tariff rate China charged on ASEAN goods would be cut to 0.1
percent from 9.8 percent.
Average tariffs imposed on Chinese goods by ASEAN states will fall to
0.6 percent from 12.8 percent.
ASEAN-China trade has exploded in the past decade, from 39.5 billion
dollars in 2000 to 192.5 billion last year, Pushpanathan said.
At the same time, ASEAN-China trade with the rest of the world has
reached 4.3 trillion dollars, or about 13.3 percent of global trade.
Teng Theng Dar, chief executive of the Singapore Business Federation,
said sectors likely to reap the most benefits from the FTA included
services, construction and infrastructure, and manufacturing. “Other
than product and service innovations, this is one great new business
opportunity for the establishment of a regionally-based innovative
supply chain for market reach and growth,” he said.
Officials said there was more to the deal than sating China’s thirst
for Asian raw materials like palm oil, timber and rubber, and opening up
regional markets for its manufactured products, steel and textiles.
JAKARTA, AFP
China’s manufacturing activity expands in December
China’s manufacturing activity expanded for the 10th straight month
in December as the recovery in the world’s third-largest economy
continued to gather pace, official data showed Friday.
The China Manufacturing PMI, or Purchasing Managers’ Index, rose to
56.6 percent in December from 55.2 in November, the China Federation of
Logistics and Purchasing said in a statement on its website.
A reading above 50 means the sector is expanding, while a reading
below 50 indicates an overall decline.
“The rising index suggests the Chinese economy has further
consolidated its recovery,” researcher Zhang Liqun said in the
statement.
But a pullback in new export orders in December suggested China’s key
trading partners were still suffering from the impact of the financial
crisis, Zhang said.
New export orders slipped one point to 52.6 percent in December from
the previous month, the data showed. “It is too early to be optimistic
about the recovery in the global market,” Zhang said.
China’s export-driven economy is expected to easily exceed the
government’s oft-stated target of eight percent growth in 2009, mainly
as a result of massive stimulus spending to combat the crisis. The
nation’s economy expanded by 8.9 percent in the third quarter, up from
7.9 percent in the second quarter and 6.1 percent in the first three
months.
In 2008, manufacturing accounted for more than 40 percent of economic
output in China, which has been hit hard by evaporating demand for its
products in key export markets such as the United States and Europe.
HSBC is due to release its China Manufacturing PMI on Monday.
BEIJING, AFP |