Macroeconomics understanding the global economy 3rd edition miles solutions manual

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CHAPTER 8 International Trade

CHAPTER 8: INTERNATIONAL TRADE INTRODUCTION Despite the introduction of a number of theoretical concepts, this should be an easy chapter to teach. By and large, students tend to be interested in trade issues. It should be easy to find good current examples to motivate this material as there is almost always some important trade dispute going on.

Teaching Tips ALTERNATIVE ROUTES THROUGH THE CHAPTER Although the historical perspective on trade is a good introduction, you may prefer to start by referring to current events such as recent trade talks and disputes, or recent protectionist measures. Showing how comparative advantage works then highlights the potential gains from trade. The Case Study on globalization below could be used to generate useful discussion.

CHAPTER GUIDE 8.1 Introduction: Patterns of World Trade. The Background Material includes more data on the share of services in trade.

8.2 Comparative Advantage – How Countries Benefit from Trade. The discussion of US and UK comparative advantage before the second World War links with the Background Material of Chapter 6 (How did the US overtake the UK at the beginning the 20th century?).

8.3 The Terms of Trade. The Prebisch-Singer Thesis is discussed in more detail in Chapter 9.

Also, some of the issues are discussed in the case study on Vietnamese Coffee Production.

8.4 What Goods Will Countries Trade In? Note that the tendency for developed countries to import and export similar goods means that their terms of trade are very stable. Only huge commodity price shocks like the oil price inflation of the 1970’s have a significant effect.

Developing countries on the other hand tend to have much more specialized trade patterns and therefore face far more volatile terms of trade. Macroeconomic policy-making is accordingly far more problematic.

8.5 Distributional Impacts of Trade. The analysis in this section parallels the discussion of immigration in the previous chapter. In economic terms immigration and trade have almost identical effects in terms of equalizing factor returns (i.e. raising wages and lowering the return on capital in labor abundant countries whilst lower wages and raising the return on capital in capital abundant countries.

8.6 Competitiveness. Krugman cites many examples of politicians who misuse the idea of competitiveness. President Clinton described a nation as being “like a big corporation © 2012 John Wiley & Sons Ltd. www.wiley.com/college/miles 43

CHAPTER 8 International Trade

competing in the global marketplace”. Jacques Delors (former head of the EU) ascribed Europe’s unemployment problems as being due to a “lack of competitiveness with the US and Japan” 8.7 Strategic Trade Theory. Another possible economic justification for protectionism is the establishment of industries that have important knowledge spillovers into the rest of the economy (e.g. Technology). Certainly, the example of the US and UK at the beginning of the 20th century shows the benefits of being in the right industries (see Background Material to Chapter 7). The track record of such policies, however, is not good.

8.8 Political Economy and Vested Interest. In practice, the two areas most subject to protection by developed countries are agriculture (through systems like the European Common Agricultural Policy - CAP) and textiles (through restrictions like the Multi-Fiber Arrangement, MFA). Although these are amongst the lowest paid industries in the developed world they have strong pressure groups in support. They are also key industries for developing countries. Textiles in particular have been important growth industries for countries in the early stages of development. As a result, pressure to remove restrictive protection is growing, and the MFA is now virtually dismantled.

CASE STUDY: ANTI-DUMPING Introduction Although trade restrictions such as the European protection of agriculture (the CAP) and worldwide restriction of textile trade (the MFA) are widely discussed and disputed, both of these have now probably been overtaken, in terms of economic impact, by the use of antidumping legislation as a way of restricting trade. Not only do the number of anti-dumping cases dwarf all other trade disputes (Between 1995 and 2000, WTO members reported 61 safeguard investigations, 115 countervailing duty investigations, and 1441 antidumping investigations), their impact can be substantial – the duties imposed after a successful case often reduces trade from the affected country by over 50%. Added to this, although other forms of restriction on trade are gradually being eliminated, as the chart below shows, anti-dumping cases are steadily rising.

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CHAPTER 8 International Trade

Number of Anti-Dumping Cases Filed 1600 1400 1200 1000 800 600 400 200 0 1980-84

1985-89

1990-94

1995-99

2000-04

What is Anti-Dumping and can it be justified?

Anti-Dumping legislation is used by a country who suspects that goods being exported to their country are being sold at bargain basement prices as a way of driving out the local competition (i.e. dumped on their market). If the recipient country can prove that the price of the imported good is in some sense too low, then it can impose special duties on that exporting country with the full blessing of the WTO. On the face of it, anti-dumping legislation seems justified as an extension of normal competition policy (anti-trust). In most countries, the government can act against predatory pricing when a large company tries to kill of the competition by setting its price below cost for a temporary period. Therefore it seems a logical extension to say that a government can stop a foreign company doing the same. However, a more detailed look at anti-dumping shows that is goes a lot further than predatory pricing. In predatory pricing, a company is usually only convicted if it can been shown that it set prices below marginal cost (i.e. below the cost of producing one extra unit). In anti-dumping cases, not only are average costs used as a benchmark (i.e. not just the cost of producing an extra unit but also a share of the fixed cost of the business – such as the cost of buildings etc.) but often a ‘normal’ level of profit is added as well. As a result, a company making profits can be found guilty of dumping (in fact if antidumping criteria were applied to judge domestic predatory pricing cases then it is likely that most companies could be convicted!). This system can easily result in a company being charged with dumping in foreign markets even if the price it sells good abroad is higher than in its home market.

With this system, it is perhaps unsurprising that that most anti-dumping cases are successful and over the last 25 years around 98% of US anti-dumping cases have been successful.

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CHAPTER 8 International Trade

Trends in the use of Anti-Dumping Given its weak economic justification, it is perhaps surprising that anti-dumping cases are so prevalent. One argument for their success is that, up until recently, almost all cases were brought by four major economies (largely against Asia) - 25 years ago Canada, US, EU, and Australia brought 98% of all cases. Thus it is possible that anti-dumping was effectively protectionism by the back door for these countries. Recently, however, new users such as India and China have become active users of anti-dumping legislation so that the original four now only account for 40% of all cases.

Growth in Anti-Dumping (AD) legislation No. of countries with AD No. of countries filing % of cases from ‘new statute actions users’ 198034 8 1% 84 198538 10 11% 89 199045 24 36% 94 199561 32 61% 99 200087 30 60% 02 Notes: countries with statute calculated at beginning of period, ‘New users’ = not US, EU Canada Australia Whilst these new users have been responsible for the dramatic rise in anti-dumping cases filed in recent years, it is possible that now most countries have anti-dumping legislation, the perceived economic advantage the original users saw from it use is now declining suggesting perhaps that some international agreements to curtail it may be on the way

Discussion Questions 1) Should Anti-Dumping legislation be abolished?

2) Do you think Anti-Dumping is an example of how the rich countries write the rules in their favor?

Source “The Growing Problem of Anti-Dumping”(2004) Prusa R. © NBER International Trade, East Asia Seminar on Economics Volume 14

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CHAPTER 8 International Trade

Background Material TRADE-SPEAK GLOSSARY Some additional terms not covered in the main text : ACP Countries A group of African, Caribbean, and Pacific less developed countries that were included in the Lomé Convention and now the Cotonou Agreement. As of July 2000, the group included 77 countries.

Cairns Group A group of agricultural exporting countries, currently (2001) numbering 18, that was formed in 1986 to act as a counterweight especially to the EU in international negotiations on agriculture. Named after the city in Australia where the group first met.

Common Agricultural Policy (CAP) The regulations of the European Union that seek to merge their individual agricultural programs, primarily by stabilizing and elevating the prices of agricultural commodities. The principal tools of the CAP are variable levies and export subsidies.

Countervailing Duty. A retaliatory duty placed on imports from a country that subsidizes its exporters.

Dumping. Selling surplus goods overseas for less than it costs to produce.

Entrepot trade The import and then export of a good without further processing.

European Economic Area (EEA) The group of countries comprising the EU and EFTA. The two groups have agreed to deepen their economic integration.

European Free Trade Association (EFTA). Free trade area made up of countries in Europe that have not joined the European Economic Community. EFTA was established in 1960 between Austria, Denmark, Norway, Portugal, Sweden, Switzerland, and the United Kingdom. As of 2000, it includes only Iceland, Liechtenstein, Norway, and Switzerland.

General Agreement on Trade in Services (GATS) An agreement that brings international trade in services into the WTO..

Generalized System of Preferences Tariff preferences for developing countries, by which developed countries let certain manufactured and semi-manufactured imports from developing countries enter at lower tariffs than the same products from developed countries.

Marshall-Lerner condition The condition that the sum of the elasticities of demand for exports and imports exceed one. Under certain assumptions, this is the condition for a real exchange rate depreciation to improve the trade balance.

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Mercantilism An economic philosophy of the 16th and 17th centuries which held that international commerce should primarily serve to increase a country's financial wealth especially of gold and foreign currency. To that end, exports are viewed as desirable and imports as undesirable unless they lead to even greater exports.

MERCOSUR A common market comprising Argentina, Brazil, Paraguay and Uruguay, known as the "Common Market of the South" ("Mercado Comun del Sur"). It was created by the Treaty of Asunción on March 26, 1991, and added Chile and Bolivia as associate members in 1996 and 1997.

Most Favored Nation (MFN) status Countries charged the lowest tariffs.

Multifiber Arrangement An agreement between developed country importers and developing country exporters of textiles to regulate and restrict the quantities traded. It was negotiated under GATT as an exception to the rules that would otherwise apply.

Nontariff barrier Any policy that interferes with exports or imports other than a simple tariff, prominently including quotas and Voluntary Export Restraints (VERs).

North American Free Trade Agreement (NAFTA) A free trade area comprising the United States, Canada, and Mexico that went into effect January 1, 1994.

Quota A government-imposed restriction on quantity, or sometime total value. An import quota specifies the maximum amount of an import per year - typically administered by import licenses that may be sold or directly allocated to individuals or firms, domestic or foreign.

Section 301 The provision of U.S. trade law that permits private parties to seek redress through the U.S. government if their commercial interests have been harmed by illegal or unfair actions of foreign governments.

Tariff A tax on trade, usually on imports but sometimes used to denote an export tax.

World Trade Organization A global international organization that specifies and enforces rules for the conduct of international trade policies and serves as a forum for negotiations to reduce barriers to trade. Formed in 1995 as the successor to the GATT, it had 136 member countries as of April 2000.

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CHAPTER 8 International Trade

Additional Questions Question 1) The chart below shows the share of trade taken by commercial services over a range of countries. What explains the share of trade in services in the UK and US. Is this the same explanation as for countries like Egypt and Turkey?

Commercial Services as percentage of total trade 70 60 50 40 30 20 10

In di a Ko Ja re p a a, R n Ne ep . w Ze of al Si and ng ap o Th re ai la nd

W or C ld Un an ite ad a d St at es Br az M il ex ico Fr an c G er e m an y Ita ly Sp a Sw in e Sw d itz en er la nd Un T ite ur ke d Ki ng y do m So Egy ut pt h Af ric a Tu ni s Au ia st ra lia Ch Ho in ng a Ko ng

0

Source: WTO Answer 1) The US and UK also have high proportions of trade in services largely due to the financial sector. For the others, tourism is the main contributor.

Question 2) Study the table below Productivity per Worker in each good (number of units produced per worker) Good Good Good 1 2 3 Country 4 4 4 A Country 2 1 1 B Country 3 2 3 C a) Spot each country’s comparative advantage b) Which country will end up poorest? © 2012 John Wiley & Sons Ltd. www.wiley.com/college/miles 49

CHAPTER 8 International Trade

c) Can any country be made worse off with trade than without it?

Answer 2) a) Country A’s comparative advantage is in good 2, Country B’s comparative advantage is in good 1 and Country C’s comparative advantage is in good 3 b) Country B will end up poorest since despite the fact it has a comparative advantage in good 2 it has no absolute advantage in anything. It will have to sell good 1 at quite a low price in order to stop countries A or C producing it themselves, but since productivity is quite low, wages will have to be very low. c) No, since no country is forced to engage in trade.

Question 2) Analyse the trade profile of a selection of countries using the WTO trade profile tool http://stat.wto.org/Home/WSDBHome.aspx?Language=E. How important is trade to each of these countries? What are theirs main exports and trading partners?

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