Aug 20 2008
International Trade Made Simple
Published by Steve Latter at 8:30 am under
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WikipediaIs international trade really as good for a nation’s standard of living as economists say? And, what the heck is comparative advantage anyway? And what about the foreign currency market and those confusing supply & demand curves? Yes, the quest to understand the economic benefits of international trade is enough to make any citizen or first-year economic student vomit, tremble, get a headache, or at least curse.
Having been an AP Economics’ teacher for 8 years now, I must candidly admit that it took me a few years of study and research to try to reduce international trade to pure simplicity and understanding. Let me give it a shot below. I love simplicity.
The average “Joe Citizen” in almost any country in the world is suspicious of trade, and rightfully so, since he reads or observes factories being closed, jobs lost, and the feeling that somehow his country is going down the toilet as his own home fills up with foreign-made products. Unfortunately, what Joe Citizen does not understand is that the money his own nation is spending for those foreign products (imports) is spent right back into the pockets of his own country, increasing employment and income.
Let’s take a single, real-world, international trade example being careful to accurately explain the whole economic story:
Let’s say that the United States (we’ll say Wal-Mart) decides to buy several shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying those same shirts from a shirt manufacturer in Elon, North Carolina (USA). As a US AP Economics’ teacher I am one of about only 47 Americans in Fairfax County Virginia, which not coincidentally ties to the number of AP Students I taught this year, that quickly understand that the decision to purchase the shirts from China, in lieu of the US manufacturer in North Carolina, is actually BETTER for America and will make my home country better off in the long run! What? Mr. Latter, are you Benedict Arnold, the American traitor, reincarnated?
Let me explain how the US benefits (and China too!) in simple terms ignoring foreign currency transactions, which will just confuse the discussion and cause the student to lose sight of what is really happening:
The first key point is that when Wal-Mart buys the shirts from China for $400 it can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! It has no Chinese currency (Yuan). It literally drains its bank account of US dollars that are transferred/paid to China!
The second key point is that when China receives that same $400 US dollars for the shirts, China cannot, unfortunately, spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is now forced to either throw the currency away (not advised!), or immediately spend the money back to the USA (advised!).
In summary, China has actually traded a product (shirts!) for paper (US dollars!), and those US dollars cannot be spent in China. For China to receive any value at all for the shirts it sent to America, China must now spend the $400 back into the US economy for, say, a global positioning system (GPS) from FleetMatics out of Waverly, Massachusetts (USA). Cutting through to simplicity, in essence, it’s almost as if Wal-Mart (USA) just paid FleetMatics (USA) $400 directly for the shirts!
Yes, the “punch line” is that all home-currency spending by the domestic nation on foreign products (imports), in turn, are spent right back to the domestic nation increasing the domestic nation’s employment, income, and standard of living. (Note; this is shown in a nation’s balance of payments schedule which always nets to zero, but, yuk, who cares about that right now with summer coming!)
And, yes, let’s not forget that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Our nation loves competition (ready for the Olympics?) and I am excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity), and hopefully get the next shirt contract from Wal-Mart or some other firm! If not, well, that North Carolina firm may just have to close down.
If you are still reading this post at this point, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so China may not immediately buy that GPS system from FleetMatics for $400”. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing right now is deciding to temporarily save or invest a minority percentage of their US dollars received back into America in lieu of buying US products. Said another way, China is not buying as many GPS’ as the US is buying shirts and, of course, we call that phenomenon the US trade deficit which immediately seems to speak “problem”. But it is really no problem at all! China is still spending their “saved” US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for the war in Iraq, the war against terrorism, and several other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and buy that GPS system or build more plants to employ more Americans!
Now one last thing. Promise! Let’s get back to why trade is really so economically advantageous to any nation that pursues it. And by advantageous, I mean how it increases our incomes and standards of living. In one word, the answer is “productivity”. If we go back to the original example of the US buying shirts from China and China taking the US dollars to buy the GPS, we remember that the shirt manufacturer from North Carolina was “left out in the cold” because Wal-Mart did not buy the shirts from them. We can logically conclude that perhaps some Chinese manufacturer of GPS systems was “left out in the cold” because some Chinese business elected to buy from FleetMatics in the USA, and not the Chinese GPS manufacturer. Wow, I love global competition! What a great way to incent businesses in both the USA and China to compete against each other and increase their productivity and conserve our nations’ scarce resources, increase our choice, and lower our costs!
Discussion Questions:
- Which basic economic principles underly the emergence of international trade as a global economic force.
- Who are the winners and losers of trade between the US and China as explained above?
- Why do you think free trade is such a controversial topic among certain groups of Americans an other Western nations’ people?
About the author: Mr. Latter teaches various business courses at Paul VI Catholic High School in Fairfax, Virginia (USA) including AP Economics,
Accounting, Marketing, and Personal Finance.
Mr. Latter is a Certified Public Accountant (CPA) and former Chief Financial Officer with 9 years of high school business teaching experience. Prior to his career change to teaching in 2000, Mr. Latter spent 21 years in various auditing, accounting, and financial positions with Price Waterhouse, Sprint, and Teleglobe. 
Submit your Econ questions here. Replies will be posted to the blog
Another great post, Steve. Thanks, what a clear and concise explanation of the gains from trade and the balance of payments! Will definitely use this post when I teach international trade again!
Keep them coming! -Jason
I think the basic principles of economics behind trade are those to do with production and the allocation of resources. As I understand it, the “great idea” of global free trade is to let each country produce what they are best at. In other words, to allocate resources into their best use, countries should specialise in the production of goods in which they have an advantage over others.
In this fairly bilateral trade between the US and China, one could argue that both are benefitting from each other’s specialist advantages in different market areas. However, in my opinion this is a very contained and indeed idealistic example of free trade.
I know of a few disadvantages of free trade. There are examples of countries, such as the US, introducing heavy subsidies for their farmers (due to powerful lobby groups), effectively protecting them from the low prices at which they sell their goods. However, this artificial sustenance is not enjoyed by poor farmers in third world nations. Farmers and manufacturers may be driven out of business by such practices as their domestic markets are flooded with artificially cheap imports.
I can understand why the West, and America especially, is supportive of free trade. Through the relative strengths of our economies, we retain a clear advantage over other nations.
One final thought which I would like to submit for debate concerns itself directly with the idea of specialisation in production. I acknowledge that it is more efficient to let each country produce the good for which it is best suited, but this would surely lead to a potentially dangerous interdependence. Let’s imagine that only Japan produced electronics. If it was suddenly flooded due to global warming or a natural disaster, no other countries would be able to produce electronics. On the other hand, could this interdependence promote world peace, and provide powerful incentives for countries not to wage war on each other (you wouldn’t want to attack the only country which makes your iPods)?
What do you think guys?
Joel, you mention that if one country would specialize in one thing (Japan and electronics) and that if there were a natural disaster that the world would “forget” to make electronics. Here I would have to disagree with you. The whole world would have examples of these electronics and would be able to mimic them, and eventually find out a way to replicate them. ( Or does Japan just produce electronic goods and not export them?) You also stated the speciziliation of a country in one good. How on earth would one country be able to supply the vast amounts of demand that would exsist in the whole world? On the rest I completely agree with Joel.
BASQUE INDEPENDENCE!!!
The basic economic principle underlying the emergence of international trade as a global economic force is that without trade barriers, countries have access to cheaper and higher-quality goods. Theoretically, as countries specialize and export goods which they can produce with least cost, a more fair and equal playing field will emerge. Developing countries, often times rich in natural resources, will experience economic growth as they sell larger quantities of their goods and raw materials to developed countries who need these goods but cannot produce them as easily. Hence, in theory, free trade will decrease economic disparity between nations. However, as Joel said, governments of developed countries often give subsidies to firms in order to protect certain sectors of their economy. Because subsidized companies are protected from going out of business, they can lower prices significantly. On the contrary, companies in developing countries that do not receive subsidies cannot afford to sell their goods at such low prices, and they will simply be driven out of business.
There are also inevitable short-term costs to some sectors of the economy. The North Carolina firm that “may just have to close down” exemplifies these short-term costs. However, the long-term effects of free trade outweigh short-term costs. Not only will countries increase output and grow, the benefits of free trade also extend to the average person. When resources are allocated to the most productive areas of an economy, more people will be employed and wages will rise. Finally, I don’t think free trade will lead to dangerous interdependence, as countries will specialize in certain goods, but will by no means only produce one good. What is more worrying is that free trade will lead to a “race to the bottom”. As free trade encourages competition and “survival of the fittest”, environmental and humanitarian concerns will always be a second priority.
I would have to agree with Gorka. I don’t think the world would forget how to produce electronics if Japan were involved in some horrific disaster. I agree with Gorka because although Japan would be(or would have been) the leading producer of electronics it does not mean other countries are not also producing electronics, it is just they do not produce the electronics quite as good or are maybe not quite as advanced as the Japanese products and would not therefore lead to “but this would surely lead to a potentially dangerous interdependence”. I also agree with the rest of the answers contributed by Joel for the discussion questions.
The basic economic principles, which underlie the emergence of international trade as a global economic force, are comparative advantage and absolute advantage. For example: If countries X and Y only produced chocolate and clothing. Although Country X may have absolute advantage (if a country is able to produce that good using fewer resources than another country) at producing both chocolates and clothing, country X might still gain from trade as it might not have comparative advantage (if a country is able to produce that good with a lower opportunity cost than all other countries) on one of the products.
If both countries have comparative advantage on both of the two goods that they are trading, they would both benefit from trading; therefore there would be gains from trade.
I think free trade is a very controversial topic between among certain groups of Americans an other Western nations’ people because of its disadvantages. Although free trade has a large upside, for example lower prices, greater competitiveness and increased growth; it also has a lot of disadvantages. An example of this is if developing countries have industries that are still developing, then at the moment these countries industries would struggle against international competition.
I mostly agree with Joel, and I believe that he already mentioned most of the relevant arguments. On the other hand though, I believe that all of you forget that there is a political aspect to the subsidies of famers. As I am a patriotic Swiss person I know that one of the strongest and most supported parties in Switzerland is Die Schweizerisch Volkspartei, which is the representative party of the Swiss farmers. Farmers have a big lobby in the Swiss government and would obviously vote against this change (Not considering that such change would not be very welcome in Switzerland anyway, we aren’t even in the UN after voting twice about it!!!). A whole class of people would just be swept away, a class that very much makes up a big part of our culture. Due to the very conservative and somewhat xenophobic views Switzerland. This is economically, for obvious reasons not efficient but politically understandable.
I do believe that every country should produce the goods or services that they are best at. Therefore, Switzerland could specialize in banking services and luxury goods like the world famous watches (which is also our culture for hundreds of years, btw).
I to agree with Gorka and Josh. Joel suggested that single countries could specialize in the production of one good, using Japan and electronics as an example. However I don’t even think this would be possible, seeing as China is another leading country in the production of electronics. Would they agree to this? Id say most likely not.
The rest I fully agree with. However Eithan talked about free trade between nations, free trade certainly helps the poorer nations to trade fairly to the richer nations in the West or in America. But as soon as those nations go into a depression or their economies start to decrease, free trade wouldn’t occur anymore and the West and America would (most likely) put heavy tariffs on the goods being imported by the poorer nations, I think that this could result in a dispute between the different countries.
Is free trade the same as international trade?
I would have to agree with Gorka’s argument against Joel. It is too idealistic to think that one country could supply the rest of the world with one good. The world economy is mostly made up of the ‘powerhouse’ countries like China, America, Great Britain, Australia, etc.. And yes, Australia do produce more than dirt! Or would you rather that production in and economic growth in China slowed down because they have no mining commodities?
Specialisation in one particular good creates a cycle throughout the world economy, but it does not necessarily always work. Politics create tension between trading nations and could effect the supply of necessities for one country.
The losers in America and China are the small businesses being overrun by the big corporations. Of course the country benefits, but the working men and women are ignored. Now jobless, they have to seek employment elsewhere, which could require retraining.
Free trade also puts the ‘powerhouse’ economies above the rest of the world. Free to trade amongst each other, these countries create an oligopoly which makes it even harder for developing countries to grow.
Joel, in your third paragraph you talk about disadvantages of free trade, where you mention that the US introduces heavy subsidies for the farmers and that it drives local industries out of business and makes people lose their job. Well for what you have said, I can think of the perfect example, which I think a lot must know from Ms. Darling: The US want to give aid to the third world country, so they decided to export their corn to the Philippines. Then the US placed a subsidy on the production of corn, so it would cost less to produce. The corn in the Philippines was sold at a cheap price, cheaper than the local corn. Local farmers couldn’t make any profit on their corn because everyone else was buying the cheaper corn. Due to the lack of profits made, the local corn industry drove out of business and left the local farmers unemployed. So Joel you are right, artificial sustenance is not enjoyed by poor farmers in third world nations.
Economic trade definitely has numerous positive effects on all economies taking part in international trade; national revenue will experience an increase as not only local customers part with their money, but also overseas consumers pump foreign capital into the nation’s economy. Nations specializing in production of a certain good will continue to produce that good in greater and greater quantities as foreign demand rises. The nation will be able to partake in economies of scale, allowing them to produce more at a lower price; and thus reduce their prices in order to compete with rival nations, earn yet more revenue, and strive to become the most efficient producer of that good on the entire globe. But though International trade may be a great source of income for those countries at the top (those with the technology and capacity to produce “their” good in mass quantities at low prices), it is a constant threat to other countries producing the same good. Countries who rely heavily on the production of this good, as a result of limited resources, insufficient technology or merely a lack of capital to improve their production possibilities, may be locked into this good’s production, and the extremely efficient nations will cause a threat to the entire economies of these nations. One possible outcome could be the shutdown of many firms producing the good, thus releasing a mass of unemployed workers, unskilled or unable to work in other fields of labor, onto the economy. The massive unemployment cannot merely be stopped, as the nation may have limited resources or capital to begin retraining workers or building new businesses. Overall the dominance of one nation over the market of the particular good may lead to the downfall of economies of rivaling nations. I also strongly agree with Eithan. Economic growth is a rat race, and given the chance, firms and nations have incentive to do anything and everything possible to be the best competitor as long as they are not threatened by rules and regulations. Regulations, such as those to prevent negative externalities, only work to a certain point, and like Eithan said, protecting the planet and it’s inhabitants is a low second priority.
Surely though the problems you are bringing up about the problems of the lobbyist’s influence in Washington could be read into as a move towards a command system of economics, where the government is able to artificially alter and modify events that would not have occured through a true free trade system. Couldn’t it be argued that the level of success and benefits arising from a “free trade” system, actually grow as the word free becomes true.
I’m not sure if even personally believe these views, but I’ll volunteer to act as devils advocate in response to Elisabeths post. The exporting of cheap US grain to the Phillippines, i’m sure we can all agree, shows us that, yes, the US makes a lot of grain. Too much grain in fact. They have the labour and land allocated to making this a possibility. The US is not at fault in trying to drive competetion within the world. The local corn industry in Indonesia will quickly face a reality-check that they need to a) Shape up, and damned fast or b) Switch into something they can do better.
It may be harsh, but it’ll drive innovation and development like a socialist policy couldn’t hope to do. The barriers of government intervention can be seen as a hinderence to world development on an economic and technological front. The question can be put down to the basics by asking: (a little from Ayn Rand) Is a man not entitled to the sweat of his own brow?
Basic sum up for debate points: International trade works in a lasseiz-faire system, it boosts productivity, development and innovation. The biggest hinderence to aforementioned growth is government intervention.
Damn it, I didn’t think I was a capitalist.
Also: Who is John Galt? Cookie points if someone has actually managed to go through that huge tome that is Atlas Shrugged?
I completely agree with Nic’s post, especially on the the last point he made. If lets take for example Australia and Japan are trading, and we generalize that Australia has absolute advantage in agriculture because of the vast amount of arable land available to them, and Japan is able to produce capital goods such as factories for building tractors, then what use would it be for them to trade with developing countries?
They could, at will, force the developing countries to accept less than fair terms of trade (for example the equivalent offered by either Australia or Japan) This would make it near impossible for the developing country to increase their production as their “work” spent does not match the “work” recieved, making it impossible to buy more capital goods and strengthen economically. As Miguel pointed out, they are not able to compete with more established economies. Western powers might also want to not allow free trade as they do not have absolute advantage in certain things, that if developing countries were allowed to flourish, would overtake them, jeopardizing the Western nations powers as they would grow stronger.
Let me just clarify a point you all hit on. I think you are all absolutely right that countries would never specialise in just one good. However, I was trying to explain the pure ideology of free trade, not how I think countries should act.
Gorka is right about countries not immediately forgetting how to produce certain goods. However, in the long term this could change if a global pure free trade policy is followed. Referring to the specific example I gave, Gorka is also right about other countries being able to manufacture electronics. I simply gave an imaginary scenario where Japan, because of specialisation, would be the only electronics producer in the world. I was asking “what if pure free trade policy was 100% followed”?
If Japan would be destroyed, you would still have to build up the capital equipment to produce electronics again (if you still have the know-how), and this could take some time. In a world where we are more and more dependent on electronics, this could lead to some serious problems in the short term. This is why I mentioned a “dangerous interdependence”. This was just one example, and not the best one admittedly, but I am sure that there are other products which we need in the short term (such as power), where if the countries producing them stopped, we would have quite a crisis on our hands. Can you imagine living in the dark for years on end while your country tries to retool and produce a nuclear power plant (if it’s possible without power)?
I would have to agree with what Gorka and Josh pointed out, and many people after that, that Joel’s comment on this article is very good, but I do not think that the world could forget how to produce electronics.
Other countries might not be as good as Japan, but they will most likely always be able to produce electronics.
I also agree with what Eithan said about free trades, that it would increase countries output and grow.
Ok I personally think that each country specializing on one good that it is best at producing (obviously not one specific good as Joel corrected, just one type of good) is completely irrational. Imagine a whole country specializing on Agriculture for example. That is completely limiting other job opportunities for the population. If for example there are people with life-long dreams to specialize in technology, they cannot do so within they’re country because it will already be driven out of the market by a country like Japan. This would either require them to leave their country and follow their dream away from home (and if there are too many population shifts we’ll have other problems) or stay in their home stuck with crops and tomatoes. Each country needs the whole variety of goods to be produced and that also increases global competition which is always for the best. And yes, that could lead to companies closing down, but overall there will be more than one country specializing in one type of good which will allow people to have a choice on where they want to import from and will allow more price variety for that good.
Brilliant points Christina. Never even thought of any of that. Indeed immigration is a problem even today when we don’t specialise to the full extent. I can’t imagine growing up in a country with the only option of becoming a shoemaker or something like that. I completely agree with what you have said.
It seems like specialisation could have more far-reaching consequences than we thought.
I mostly agree with what Joel said, as it reflects what we learned last year in class.
Something that nobody has yet mentioned is that a “problem with the model of free trade is that it assumes zero transportation costs” (to quote Mrs. Darling), meaning that it is potentially possible for Wal-Mart to not wish to buy from China in the first place, since it might end up being more expensive.
To that argument, it also means that if the entire world was like *free trade all the way!*, countries who are really far away from producers of neccessities like food might be at a great disadvantage due to high shipping costs, and not be able to prosper
Other than that, it seems you guys have already discussed the major theoretical aspects of free trade, so I’d like to pose a slightly different question:
I think most of us can agree on the fact that free trade is highly advantageous in theory, under ideal condictions. However, how realistic is it really that such free trade be implemented in the real world?
Firstly, (assuming that it is possible for a few nations to tend the needs of the entire world) isn’t it highly probable that two countries would have comparative advantage in the same good? And if so, the chances of the two being equally advantageous are puny. So…wouldn’t one country overshadow the other (say if it is easier for them to produce the good, they would be able to offer lower prices and out-compete the other country) which is definately not advantageous for the country being out-competed
Furthermore, the balance of trade is extremely difficult, since it creates great potential for global monopolies, especially in goods that are demand inelsatic, such as food. Let’s say australia becomes the main producer of wheat on the planet, which accounts for a high percentage of our calorie-intake. Australia could easily raise prices sky-high, and benefit unfairly.
Even if the other countries decide to do something about it, like boycott Australia or begin to produce food themselves (for which they apparantly do not have an advantage), then that would completely render the whole trade-idea pointless in the first place.
I’m sure you could add a bunch more of these arguments on there, but for the sake of simplicity i’ll leave it at that
so to sum up. how realistic is it really for free trade to actual work on earth?
1. International trade forces firms from different countries to persue the least cost method of production and allocate resources in their best use. If companies do not comply to this they will simply be pushed out of the international market and have to face bankrupcy.
2.The winners are both the chinese clothing company and the american GPS company. The loosers are on both sides the local chinese GPS manufaturer, and the american clothing company.
3. Free trade implies that the trade everywhere in the established freetrade zone is trading goods for free, with no taxes. This means that gov. would not get revenue from taxing imports and exports, but more importantly free trade would destroy local domestic markets. For example free trade would allow China to import their cheaply produced toys into Germany. Since China’s cost per toy produced is cheaper than a toy procuced in Germany, German toy companies would have higher costs and therefore go bankrupt. This would create unemployment and plunge the German economy into a recession. Who wants a recession? This is why Western countries do not like the idea of free trade. There are taxes on imports and exports and no free trade, because it would ruin their economies.
I agree with Nic’s answer to question 2, “Who are the winners and losers of trade between the US and China?”. The US dollars that China gives back to America will go into the hands of the big firms, and not the small firms. This is because the small firms cannot compete against the big companies. But overall the American economic can expand.
I agree with what Miguel mentioned about why free trade is such a controversial topic. It has a lot advantages and disadvantages. Free trade is a “gorgeous” and “fabulous” (as Mrs. Darling would say) if the terms of trade are fair. A country might have comparative advantage in the production of a particular good, and still not be able to gain from trade, if the terms of trade are not fair. Some European countries give subsides for agriculture goods. Other African countries that do have comparative advantages in the production of agriculture goods because there are locked into the production of agriculture, for example, tomato or corn, cannot compete with the European countries that subsides their agricultural goods. Since the African countries did not receive any subsidies, they cannot sell their goods at a low price. This makes it harder for them to compete.
I also completely agree with what Crissy said. great points.
And such immigration would basically completely destroy some majorly important things, like culture. (unless you count the culture of shoe-makers after 100 years of specialization as something important…)
‘Each country needs the whole variety of goods to be produced and that also increases global competition which is always for the best. And yes, that could lead to companies closing down, but overall there will be more than one country specializing in one type of good which will allow people to have a choice on where they want to import from and will allow more price variety for that good.’
Christina, specialisation means that countries will sell (export) more of what they’re good at producing and buy (import) more of products that they do not have a comparative advantage in. What does this mean? If a country is rich in natural resources it should take advantage of that and not try to produce goods which are dependent on having access to a large labour force or cheap power or other inputs. It will have the proceeds from exports to be able to buy from other countries what it cannot produce.
In a non specialised world, countries that produce everything will have to produce inefficiently and expensively which will mean a lower standard of living.
Although most of the comments here seem to praise free trade as if it’s the holy grail of economics (and many of the points are valid and true), we would be foolish to assume that optimal WORLD WIDE economic growth can be achieved through this. Assuming there would be some world-wide organization that would actually go through with this and impose laws of production for optimal output on different goods for every nation in the world and sanction those which redistribute their resources in other goods, here is why this system would fail:
1. Necessity vs. Luxury goods
Assuming that countries will be pigeonholed in producing specific goods, certain countries will hold more political power than others. If Romania (only the greatest unitary semi-presidential republic in the world) was to be designated as the world’s only and thus leading producer for wheat whilst Costa Rica was to be designated as the world’s only and thus leading producer of bananas, Romania would be able to command more power on the political playing field due to the nature of the high necessity of the wheat versus Costa Rica’s luxurious bananas (yes bananas are a luxury).
2. Protection by commodity
Due to the fact that countries would specialize in non-critical commodities (e.g. iPods), neighboring countries specializing in critical commodities (e.g. energy) would see no problem with regards to cutting up the oil/gas/uranium rod feed to the non-critical country until it’s demands are met as this won’t impact the non-critical economy at all.
Also, as this energy producer is the one that is specialized in this production, he is able to jack up prices to the point where it would be able to ruin whole economise whilst gigantically boosting their own.
3. No competition
A big factor as to why total free trade would be a miss is with regards to the fact that producers have no competition, and as such, have no incentive to improve. Imagine applying for a basketball team when you are 3 meters tall and the rest of the applicants are all under 1.5 meters tall, how hard are you really going to have to try to reach your goal? Competition only exists among equal forces.
4. Developing economies
Probably the most viable argument against free trade is when we take a look at the developing world. The greatest European powers as well as the United States developed as a result of operating under protective tarrifs. In order to defend against the cheap Indian alternative which could be up to 60% cheaper, Britain implemented tarrifs of up to 80% of the Indian goods. Only after she was able to build herself up as the “workshop of the world” did Britain engage in free trade in order to be able to better exploit other countries as well as her colonies and bring the wealth from the colonies into England herself. The same has been true for the United States after WWII.
When 5 out of the 6 billion people on this planet are living in “developing countries”, allowing for free trade to sprawl would be a disservice not only to the developing countries themselves, but to the economically mature countries as well. New companies being put out of business prematurely as a result of being muscled out by bigger firms before they are able to fully develop is unfair and unproductive for everyone.
Free trade is not fully bad. There are many instances where this has been a real success for “most” parties involved. However, we must understand that the rest of the world is not operating at the standards that we are accustomed to, and that if free trade is going to reach grander scales, it would be a big slap in the face for everyone.
The biggest ‘loser’ with the example created by Mr. Steve Latter are the smaller businesses both in China and America. the reason that the two companies would trade with eachother is most likely for personal gain. each company would need to receive something in order for there to be incentive to trade. In this instance Wal-Mart is taking advantage of the cheap labour supplied by the chines businesses, they are getting the shirts at a substantially lower price then if they where to buy it from the local manufacturer, while at the same time the larger businesses in china who have a much greater capacity to produce are more likely to get contracts from Wal-Mart, as they will be more efficient at meeting the deadline and capacity of shirts needed. The down side to Wal-Mart cost cutting strategy is that it will buy goods (shirts) with a much lower quality of workmanship as more time is spent on the US shirts, also although the money will eventually return to the american market from china, you would in essence cut out the middle man if you went directly to the local producer. furthermore the local producer will have a much grater incentive to put the return from the sold shirts back into his local society/town (buying bikes and stands to encourage tourist to come) as the company feels a greater sense of nationalism then the chines company who would most likely trade with another ‘big’ company for the same reason as america in the first place.
The basic economic principle underlying the emergence of international trade as a global economic force is the fact that, without trade barriers countries are, or should be able to, achieve a better economic and so living condition within their nation. As other have mentioned above, free trade refers to the abolishment of barriers to allow countries to freely transfer goods. A direct consequence of this abolishment is that countries are free to choose any type of good in what we could call a world-wide market. This puts countries in a position to choose the cheaper producer in order to purchase the same good purchasable somewhere alse, simply at the lower price. Logically, this will allow countries to search for the lowest producer in the market. This reasoning leads us to believe that since every country is able to purchase from whoever they like, everyone should begin producing what their best at in order to reduce the production costs and to provide a good that is of lowest cost possible in order to attract the largest number of buyers. Of course this will benefit the whole economy overall, as it will allow producers to sell more and buyers to buy cheaper and better produced goods.
Although, as Joel has mentioned, there is one main problem with free trade. As we saw in class last year, with the example of the American farmer lobbies, rich countries tend to heavily subsidize their weak industries, which would not be able to compete in the world market, in order to keep them alive. An important aspect of free trade is that it would allow poor countries to try and achieve a better condition than the one they are in right now, as most of them are rich of natural resources, which is also one of the reasons why they are poor (think of Africa). Africa would be able to sell its diamonds and its raw materials etc. Free trade is a brilliant idea but it is probably never going to work fairly as countries like the US or Switzerland would probably never stop subsidizing their farmers to purchase far better off good as far as price and quality is concerned.
This issue can be directly connected to Celine’s answer. I have to agree, it is true that for example in Switzerland a whole class of farmers would be swept away but, as you said, since Swiss are very attached to their culture, why not retraim tomato growing farmers, as an example, and introduce them in the cheese making industry which Switzerland is highly superior in. Also, since we are talking about quite simple industries, in which the skills can easily be earned over a short period of time, the transition would be even easier.
To conclude, I wanted to comment on what Joel said. Although I agree on the most part with what he said as, Gorka Nic and Eithan mentioned, I do not think that the interdepence problem is a huge issue. I do not thing that if we attacked the only contry which produced Ipods, as you mentioned, the ability of producing the good would disappear from the face of the Earth.
As Eithan said countries will specialize in producing what their are best at but will still be able to produce other goods. A country would by no means be able to survive off one industry.
I believe the most important aspect of free trade is yes, to allocate the resources into their best use and in order to pursue the least cost method of production but, much more importantly, countries need to learn to avoid situation like the one in the US or in Switzerland concerning ridiculus subsidies for industries which are incredibly week within that country for whatever reason. If these high subsidies were removed, a big step toward a better free trade and toward an overall worldwide economic wellness could be achieved.
My personal opinion is that for mutually beneficial trade to even take place, two nations first have to agree on acceptable rate of exchange of one product for another.
So why do countries even trade? - Well, first of all, as Ms. Darling poited out, because of an increase in variety - not all countries have a spread of natural resources. For example Switzerland has very few natural resources such as oil, thus it has to import inputs for production.
Furthermore international trade allows countries to specialize in the production of the good that they are most effective at and enjoy the benefits of comparative advantage - meaning that resources are allocated into their best use (allocative efficiency) and firms pursue the least cost method of production (technical efficiency)
- as everyone already pointed out correctly.
In addition to that international trade increases competition and therefore efficiency in the nations. And trough trade, firms are able to transfer technology from overseas to themselves.
The other aspects of international trade have already been mentioned by the other students - and I completely agree with them.
I agree with what Joel, Eithan and Christina said, since we all learned that last year and because they are good points.
As said many countries should specialize in the production of a good for which they are best at. However, I disagree with this statement to some extend. If all countries we to specialize in that good at which they are best at producing, generally only one or two countries will specialize and produce a certain good, for example wheat. This would mean that all other countries are dependent on that one country for wheat. This is a not a very good thing to have since if that country has a natural disaster, no country in the world will be able to have wheat since the only source of wheat is now gone. Also if there is only one country that produces wheat, this country now has monopoly power over the good and can exploit this power since there is no competition the drive down price to a minimum. An as Christina said, some people would leave a country because they no longer wish to be wheat farmers. And also if everyone is a wheat farmer there is no incentive for the works to do their job well because there is no competition for jobs or higher positions. And also taking into count how this would affect the environment, it would decrease bio-diversity and most probably, countries that produce chemicals, would kill their entry environment (due to pollution/chemical waste) because there is no incentive to keep their country clean and no pollute.
Also if all countries were to specialize in a certain good, the terms of trade would defiantly be unfair for country trading wheat for cars. This means the country what produces wheat will lose out and there for this country could not longer produce wheat. Also who is to determine the terms of trade? And if only one country has a certain good, countries can not choose different countries to trade with.
Another disadvantage is that countries could not longer trade to increase variety (countries will not produce a variety of the same good, because it uses to many resource which could be saved), countries would not be able to produce complex goods since no countries has all the part to make a certain good (example: one country has oil, metal, fabric and rubber within it boarder to produce a car. To produce a car a country has to trade with other countries for parts, to achieve the production of a car.), countries would not be forced by competition to drive down their cost to a min, economies of scale could not be taken advantage of and research and the study for new and better technologies would stop or slow down significantly; since there is no more competition for being the best at something.
But what is good about it is that there would most probably be less war and trade embargos since all countries would be dependent on each other and could not get their goods from another country. But as Palmi said, no one took into account the transportation cost. It maybe the case in which a country is better of producing a good that it is no best at because it will be cheaper then having to import all the goods for overseas. However, if countries were to specialize in a good, there would most probably be less or no taxes or tariffs on goods since there is no home or domestic market to protect.
However free trade does have some disadvantages, such as country that are good at producing a good, such as Sudan which can produce cotton very well, can not compete in the global market and earn money by doing so since the US has subsidized their cotton production. The US subsidized there cotton to a price in which the Sudanese farmers can not sell at or they would earn no money because no one would by their cotton and they are not subsidized by their government. This means that countries that are rich now ill always have the upper hand in the production of certain for which they are ill suited for. Most of these productions can not be stopped since many people will be working in these productions. A country can not just fire and get rid of all the people that are working a profession that requires subsidize to survive, unless the country wants to suffer from unemployment and disgruntled/angry citizens. Also as Celine said, it may also be a loss of culture and identity for a country and it citizens. Such as Switzerland which still farms land and has many cows. Both land and cows are inefficient and the government has to pay an unbelievable amount of subsidize to keep this industry alive. The government nearly pays more the then the framers earn in profit. So this is actually a complete waste of money since cheaper goods can be bought from other countries which are close by. But farming and cows are a large part of culture and identity for Switzerland and the citizens would never allow the farming industry to die out. Therefore, the subsidizes on Swiss farms will never go away.
Overall, specializing in certain good and free trade have there advantages and disadvantages.
In addition to all these comments, another thing that help countries get more out of trade is if they are all producing the good which they are better at than anyone else, not necessarily the good that they are best at. Say for example Argentina’s resources would be best put into use to produce beef, but they also produce Alpaca wool and are the best producer of Alpaca wool in the world. Without free trade, they would be best off producing all their own beef, but due to free trade, they can get their beef from brazil, which in this example produces more beef than any other country. This means that Argentina is better off just importing beef and producing alpaca wool, even though they could produce more beef. This is because they can produce more alpaca wool than any other country and can acquire more capital to spend on other goods by selling alpaca wool as there is demand for it in other countries, as they cannot produce it as efficiently.
if I can remember correctly from last year… I think this would be an example of argentina having comparative advantage in Alpaca Wool.
Everybody has clearly answered questions 1, 2 and 3.
However, I completely agree with Joel on the point that examples scuh as the one of China and the US “both benefitting from each other’s specialist advantages in different market areas” is idealistic. I also feel that every country producing only the type of products at which it is best at producing is idealistic. This is patrially due to political factors, as Nic said, but also because of greed. It is part of human nature to always want more/be the best; therefore, it is my personal opinion that if the world relied on this system, all hell would eventually break loose. As Joel said, yes, it may theoretically promote world peace. This peace would, however, only be temporary because in the system everybody has to rely on the others and eventually some “powerhouse” country would seek to produce more types of products, breaking down the strong dependence on eachother.
I think that more or less shows my personal response to the question Palmi posed about whether or not it would be realistic for such free trade to work in the real world. (no).
One final note is to Joel’s comment about the iPods. The way I have percieved free trade is that every country produces the type of good that they are best at etc. However, though they may focus on the production of their specialty, they will also have smaller industries within their nation. So maybe whoever wants to invade Japan make iPods too (in much smaller quantities, naturally) and will not have that holding them back.
Referencing the earlier comments about the localized production of goods, I do find myself agreeing with Joel’s comment about “dangerous interdependence”.
As our civilization continues to develop we will be forced to rely more and more upon long chains of production, with each step of the chain tending to be organized in areas that can do it the most efficiently and cost effectively. As the chain of production grows in complexity, the areas that are prone to failure become more numerous as well.
For example let us assume that a major pandemic strikes and people remain at home instead of going to work for fear of catching the illness or to look after family members who have become sick. With many pilots, boat captains and truck unwilling to work, the transportation of goods would grind to near halt; unable to receive fresh supplies supermarkets would run out of food, petrol pumps would run dry, hospitals stocks of important drugs and surgical materials would diminish. Cities typically carry only three days worth of food, and stocks would disappear very quickly. If people failed to come to work at places such as oil refineries during a pandemic the repercussions could be felt worldwide, with not enough petrol to go around transport vehicles would be stuck in place and power stations that rely on burning oil, coal, etc. to generate energy would run out of steam, plunging cities into darkness and severely limiting communication as well as preventing the pumping of water to households. If this scenario was to happen many supply chains would be broken across the world - leading to worldwide shortages - the worlds economy could fall sharply, perhaps causing a major recession. In the months following it could prove very difficult to build up again, as the infrastructure would be damaged significantly, farmers may not be able to plant for fear of a lack in supplies or the struggling marketplace.
The tendency is to create ever longer supply chains to take advantage of economies of scale, but this causes a substantial increase in the fragility of those systems. Trade is important but we should encourage decentralized production and alternatives to oil, as well as focusing on renewable alternative energy sources in case a disaster does result in a major disruption of the supply chains. Although a nation may be able to find out exactly how to make a certain good they may lack the infrastructure to actually produce it, which will be difficult and costly to create - especially under time pressure and the shortage of supplies during a crisis. We should prepare for the worst, because if a major disaster does occur trade may be cut down or even halted, leaving nations without essential supplies, which they are unable to produce internally.
I agree fully with both Joel and Jenny regarding the benefits of free international trade and that different countries specializing in different areas in order to fully support the demand in the market is a positive situation. However, naturally it does not always prove to be idealistic for both participants.
As in almost any situation, there is a compromise; it is difficult for one to be the clear ‘winner’. In this case I do find that it is the smaller firms that lose out to bigger corporations who are the ‘losers’, even though this movement creates more competition, it can of course push firms who do not have the resources to fund themselves out of the market.
Overall I do find that questions 1, 2, and 3 on this controversial issue have all been fully answered by everyone.
Like others, i also agree with some of joels comments, in particular the ones discussing the allocation of resources into their best use and countries needing to specialise in the production of goods in which they have an advantage over others. This economic theory theoretically makes a lot of sense and would seem to benefit everyone, however like Deirdre has said, like many other theories there are exceptions and other factors have to be taken into consideration. Overall i believe that free trade can in most circumstances increase a countries output and should be regarded as a positive thing.
I fully agree with some of Joel’s comments about the advantages and disadvantages of free trade . The controversial theory of free trade can only exist theoretically because it seems so perfect and sounds great that ‘everyone’ can benefit from this, however, in real world, this is not the same case because every country like to export as much as possible, and limit the imports. so, instead of increasing variety and competition, free trade could actually affect some of the markets hugely,to an extent that they might diminish (like Elisabeth has stated using the example of Philippine corns). On the whole, I believe that free trade is just not possible except for the few exceptions such as the trade between US and China stated above in the article.
As many people above said, free trade is the idea of being able to allocate the recourse that a nation has available, to their best use and only concentrated on the on the production of goods which the nation has absolute advantage. This means that subsidies are not helping to achieve this goal. Therefore the nations that say “we are for free trade” and heavily subsidies their industries so that they can keep up with the competion are in fact fighting against free trade. Also the fact that international trade is supposed to by the exchange of goods and services between countries so that each country can specialize in their area of speciality. As a result of “real” free trade their should be no subsides in fact their should be no need for them. So to sum it up international trade is supposed to help countries allocate their resources so that they specialize in an area and if every country does this, then everyone is depended on one another and as a result more than one problem would be solved.
I agree with what Joel said about “what if pure free trade policy was 100% followed”?. he makes a good point about countries shouldn’t having be completly dependent (”dangerouse independence”) and what he said about the pure ideology of trade and that there is a possibilty of there being a negative outcome. I also agree with Lisa’s comment that generally specializing in certain good and free trade has clear advantages and disadvantages. On the whole, free trade is a good thing and will help a coutry’s economy, however it should be used appropriatley and governments should make sure that this is done (taking note of the “being in the dark scenario” suggested by Joel).
I mostly agree with everyone’s answers and comments – naturally free trade has its advantages and disadvantages, but it is not perfect; if it was, it would be in use already. I also strongly agree with those who argue that world monopolies are one of the downfalls of each country specializing in one type of good – there has to be competition for economic growth to happen.
In reply to Ross’ comment: Yes, the corn industry in Indonesia will definitely face a reality check, but how do you expect them to “a) Shape up, and damned fast or b) Switch into something they can do better” when they have no starting ground? Because of the US supplying corn, Indonesian corn industry is completely out of business, so where do they get the money to “produce something better”? In theory, they ARE the better country at producing corn, but they face competition because of a foreign country’s subsidy – without this subsidy the US corn industry wouldn’t stand a chance. Where they are now, Indonesia is perhaps better equipped to produce corn, while the US should channel their resources on something Indonesia can’t produce – then everyone should be happy, apart from the US farmers, who can retrain to produce something efficiently without a subsidy. Like Ross says, “The biggest hindrance to aforementioned growth is government intervention.”, yet when talking about Elisabeth’s example, he seems to be all for said government intervention, even if it is from another country. Say what?
Natalia: You are correct in that I misread Elisabeth’s comment, and did not realise the government subsidy backing the corn production. Thanks for pointing that out. However, that simply adds as another example as to why free trade would work a whole lot better in this circumstance. The situation would not have arisen if the subsidy had not been placed in the first place, creating a visible hand of influence in the market aiding only to direct it to misallocation of resources. The Phillipines would not have had that trouble and could still have enjoyed a fledging corn market. Surely?
(I am aware of the ambiguoity of the morality of this argument, for it goes against trade and labour unions. Yet it makes for good debate).
I agree with many of the people who have left a comment. However, we know there are advantages and disadvantages in free trade, otherwise it would not be such a controversial topic. Those who are for free trade pointed out that it increases variety, since not all the countries have enough natural resources to produce everything for themselves. It also allows countries to import inputs of production, such as oil to Switzerland like someone mentioned above. The Swiss need oil, because its a necessity but they also want to export their products (such as watches, like Celine said).
Increse in competition provides an incentive for firms to improve their products in order to stay in the market and to pursue the least cost method of production. However, no all countries gain from free trade and in that case they can use some type of protection by placing barriers to trade in order to protect their domestic economy. For example a country could place a tariff, but it can only be effective if placed on elastic goods and something that the country is able to produce on its own. Some people here mentioned how Switzerland subsidizes the farmers, they are also protecting their domestic economy in this way, thus there is no need to import as many goods. Elisabeth gave the example of the US subsidizind their corn production and then giving the extra corn as aid to philippines, however after this philippines became dependent on the US corn due to the cheap price.
As said, countries who specialize in a production of a spesific good will increse their output, but as we learnt last year, the terms of trade will determine whether or not the country will gain from free trade. This including absolute and comparative advantages.
I have heard this lecture in class twice now, once last year during Marketing, and once this year during Economics, every time I hear it, I nod my head in agreement. With the idea that the currency we use to pay for the products bought in China cannot be exchanged, therefore forcing China to buy back from the US, makes the idea of international trade brilliant.
It is fundamental knowledge to know that competition is a great thing for the consumers. Competition pushes the manufacturers and sellers to strive for better quality products at the lowest cost in order to stay in contention with their competition and stay in business. As long as it is ensured that China will end up putting that money back into our economic system, then essentially, even when we buy from China, we are still buying American.
Which basic economic principles underly the emergence of international trade as a global economic force.
The basic economic principle that underlies the emergence of international trade as a global economic force is using limited resources in the most efficient way possible. International trade allows countries to specialize in producing goods and services that have the greatest comparative advantage for them. As countries begin to specialize, they trade with other countries that have different comparative costs on the products being traded, so that each country minimizes its domestic opportunity costs and both countries benefit. Trading also raises a country’s GDP, increases domestic economic growth, and raises the standard of living.
Who are the winners and losers of trade between the US and China as explained above?
Everybody is a winner in the US/China trade scenario as described above. US markets get cheaper shirts, China gets US dollars that it can spend in the US economy when importing goods from the US. The factory workers in Elon, NC may not feel like winners since they were outsourced, but on a macroeconomic level trade between the US and China benefits both countries.
Why do you think free trade is such a controversial topic among certain groups of Americans and other Western nations’ people?
Free trade is such a controversial topic among certain groups of Americans and other Western nations’ people because they sympathize with the domestic workers whose jobs were outsourced. They automatically associate international trade with unemployment. People who discourage free trade fail to consider the long term benefits; the countries that the US trades with will import US products and increase demand of certain products, thus the money that leaves the US through trade will eventually return.