U.S. Trade Gap Widens on Oil Imports – WSJ.com

Terms of trade is a term that is often misunderstood by IB Economics students. Simply put, a nation’s terms of trade refers to the relative price of a country’s exports to its imports.

When a country’s imports increase in price, while the value of its exports stays the same, the country’s terms of trade are said to deteriorate. As a nation experiences deteriorating terms of trade, it finds itself moving towards a deficit in its current account, meaning that expenditures on imports are growing more than income from exports, also called a trade deficit.

The United States has run trade deficits for most years since 1970. Since 2004 the US has annually spent over $600 billion MORE on imports than it earned from the sale of its exports. (Balance of trade data going back to 1960 can be found here).

Usually, when a country enters a recession, it would be expected that its balance of trade would improve, since households demand fewer imports and domestic inflation decreases making the country’s products more attractive to foreign households. In fact, in 2008, when the US entered its current recession, its trade deficit actually decreased. Recently, however, due to the weakness of many of its trading partners and a deterioration in terms of trade, America’s recession is accompanied by a deepening trade deficit:

The U.S. trade deficit widened for the first time in eight months during March, as the price and use of imported oil both climbed.

The U.S. deficit in international trade of goods and services increased to $27.58 billion from February’s revised $26.13 billion, the Commerce Department said Tuesday. Originally, the February deficit was estimated at $25.97 billion.

U.S. exports in March slipped by 2.4% to $123.62 billion from $126.63 billion as trading partners bought less consumer goods and cars from the U.S. U.S. imports fell at a lower rate, dropping 1.0% to $151.20 billion from February’s $152.76 billion

Discussion Questions:

1. How did rising oil prices lead to an increase in America’s trade deficit?
2. What determines demand for American exports in the rest of the world? Why is demand for American goods and services falling even as their prices decline due to deflation in the US?
3. Where does America get the money to buy hundreds of dollars more in imports than it sells in exports? What do foreigners do with all the US dollars they earn from their enormous trade surplus with the US?
4. Why doesn’t the US government simply place tariffs or quotas on imports to try and achieve more balanced trade with the rest of the world? Is this an appropriate response to a trade deficit?

FT.com | The Economists’ Forum | The case for forward-looking protectionism in the US

Free trade is an ideal. This is a theme of my IB Economics class which I emphasize repeatedly during year two of the course. Free trade, defined as the exchange of goods, services, resources, and financial assets based on the principle of comparative advantage, results in a more efficient allocation of the world’s resources, an increase in total world output and welfare, and increases the opportunity for growth and development for all countries that prescribe to its principles. This is the ideal, at least.

In the real world, free trade is rarely practiced. Free trade agreements between nations represent managed trade; the selected removal of protections such as tariffs, quotas and subsidies on the exchange of particular goods does not represent free trade, rather managed trade. The problem with free trade in the real world is simply that it has never been truly practiced, therefore the adjustments that both developed and developing countries would have to undergo to adopt widespread free trade would be extremely disruptive both economically and socially. Entire industries would disappear from the developed countries as manufacturing resources were reallocated to low cost countries. Poor countries trying to build their manufacturing industries would lose any competitive advantage offered by protectionism, forcing their “infant industries” to wither and die in the face of global competition from countries that long ago achieved economies of scale in manufacturing. Farmers used to heavy subsidies would see their livelihoods disappear as the world’s food would be sourced from the countries with true comparative advantages in agriculture. Simply stated, the social costs of the widespread adoption of free trade are not politically palatable, thus leaders have only hesitantly pursued this ideal on the world stage.

For decades, America has stood for the ideal of free trade, proselytizing its advantages and urging developing countries to reduce or remove their barriers to the free flow of resources and goods from nation to nation. Today, however, the United States faces the very fate free trade prophesized as its own automobile industries teeters on the edge of collapse. As many as 3 million American jobs stand to be lost if the auto industry goes under. Today, America faces the ultimate test of its will to stand for and defend free trade in the world. Should America erect new barriers to trade, bail out its auto industry, and save this dying sector from collapse to avoid the political hardships its death would incur? Or should America stand for the ideal of market liberalization and allow the auto industry to disolve as the principle of comparative advantage indicates it should?

The question is dire, and it’s one that Barack Obama will be forced to address early in his term as president. Cambridge economcis professor Ha-Joon Chang argues the case for protectionism by America in this time of economic turmoil:

Mr Obama’s trade policy… is already causing controversy. He has vowed to protect American jobs and even argued for re-negotiating the NAFTA. There is already some hand wringing among free-trade economists, worrying that his protectionist policies may destroy the world trading system in the same way the infamous Smoot-Hawley Tariffs of 1930 did after the Great Depression. They counsel that the US should maintain its historical commitment to free trade.

However, contrary to what most people think, the US is the true home of protectionism. Between the 1830s and the 1940s, against superior European competition, the US developed its industries behind literally the highest tariff wall in the world, with the average industrial tariff rate ranging between 35% and 55%. Even the Smoot-Hawley Tariffs were not an aberration – the average US industrial tariff in 1931 was, at 48%, well within the historical range.

Moreover, the theory that justified such protectionism, namely, the ‘infant industry’ argument, had been first developed by none other than the first Treasury Secretary of the US – Alexander Hamilton (that’s the guy you see on the $10 bill). Hamilton argued that producers in relatively backward economies needed to be protected and nurtured through tariffs, subsidies, and other government policies before they mature and can compete with producers from more economically developed countries.

Of course, the protectionism that Mr Obama is advocating is protection to ease the adjustment of mature industries, rather than to promote infant industries. The case for such protectionism is not as overwhelming as that of infant industry protection. However, well-designed and time-bound protection of mature industries can facilitate, rather than hinder, trade adjustment and industrial upgrading. Japan and some European countries in the aftermath of the 1970s Oil Shocks come to mind.

Mr Obama should use protectionism in a similarly forward-looking way. Industries that can be revived through re-tooling of its factories and re-training of its workers should be given protection, but only if they fulfill certain conditions regarding investment and training. Industries that have no future should be given strictly temporary protection to ease phasing-out through orderly liquidation and redundancy.

…Keeping its market open is not enough for the US to play a genuinely positive role in the world trading system. The US should also stop pushing for trade liberalization in developing countries and give them the chance to use (intelligently-designed, of course) infant industry protection, which it invented and benefited so much from. Mr Obama should take a lead in creating a world trading system that allows asymmetric protectionism between the rich countries and the poor countries, with the latter protecting their markets more and gradually opening up in line with their economic development.

All these call for a much more activist role for the US government than it has been the norm. Providing protectionism to facilitate structural changes, and not just to protect existing jobs, would require a much closer coordination between trade policy and those policies to upgrade American industries, such as R&D support and worker training. Redesigning the welfare state as a vehicle to promote skills upgrading and labor mobility would push the US government into an uncharted territory.

These are big challenges. However, the US cannot continue its peculiar mixture of free-trade mythology and uncoordinated, ‘reactive’ protectionism that has served ordinary Americans and the developing nations so poorly.

Mr Obama has turned a new chapter in US history by becoming the country’s first Afro-American president. He will turn a new chapter in world history if he can come up with a forward-looking protectionist strategy that that both protects American jobs better in the long run and help developing countries develop faster.

Discussion Questions:

1. What is the difference between the protectionism America needs today and the protectionism it used in the late 19th and early 20th centuries?
2. How could protectionism be used responsibly by developing countries to promote economic growth and development?
3. Professor Chang argues that responsible protectionism should allow industries with no future to be phased out “through orderly liquidation and redundancy”. What does he mean by this and why is such a policy so hard to accomplish politically?

YouTube – Obama / McCain 3rd Debate, Part 10 – Free Trade

Below is a clip from the third and final presidential debate, in which the candidates discuss the benefits of free trade.

Both candidates support the principles of free trade, one more enthusiastically and with fewer conditions than the other. Only Obama speaks of “fair trade”, which he seems to think means trade that does not encourage the violation of human rights abroad.

Notice how towards the end of the discussion of free trade, McCain attempts to wrap up the conversation when he claims:

“I don’t think there is any doubt that Senator Obama wants to restrict trade and to raise taxes; and the last president of the United States who tried that was Herbert Hoover, and we went from a deep recession into a depression…”

Hoover, of course, was the US president at the time of the Great Depression, when the government’s response to a financial crisis on Wall Street worsened the economic meltdown, throwing the US into its deepest and longest slowdown in history.

Discussion questions:

1. How would a free trade agreement with Columbia help “create jobs in America”? What are the “billion dollars or more that (America) has already paid” through its trade with Columbia?
2. What is the source of Obama’s lack of enthusiasm for the Columbia Free Trade Agreement? Do you agree with his position on the importance of limiting free trade in order to stand for human rights? Why or why not? Is his view a protectionist one?
3. One of Obama’s highest priorities is to hold auto makers responsible for improving the fuel efficiency of American-made automobiles. How does he plan to create “five million new jobs all across America, including in the heartland”? Does Obama’s plan to invest in a clean energy economy sounds remotely protectionist? Why or why not?

FT.com / World – Anti-dumping investigations soar

Free trade is good, right? This sentiment is one that economists typically agree with wholeheartedly. The mutual gains from free trade among nations that specialize in the goods for which they have the comparative advantage results in increased global output and consumption among trading nations. That, at least, is the basic premise of free trade.

But is there such a thing as unfair free trade? The World Trade Organization, whose mission is the removal of barriers to trade among all the world’s nations, thinks there is such a thing as unfair trade. Under certain circumstances, the WTO allows member nations to place protective tariffs on particular imports, and recently, more and more nations have taken action to protect their domestic markets from unfair trade practices of their trading partners:

The number of new anti-dumping investigations soared by nearly 40 per cent in the first six months of this year, the World Trade Organisation said on Monday, reflecting increased trade tensions as the credit crunch began to take its toll on the global economy.

Between January and June 16 WTO members started 85 new investigations compared with 61 in the first six months of 2007. China was the target of nearly half the probes, a jump of 75 per cent over the same period last year.

Under WTO rules, countries can put duties on unfairly priced imports that are sold in export markets more cheaply than at home. But until this year dumping actions had seemed to be on a downward trend, with 164 investigations in the whole of last year compared with over 200 in 2006.

Anti-dumping actions, once mainly taken by rich countries against poor ones, have become a tool increasingly used by developing nations while industrialised countries have increasingly become targets…

The EU was the third-ranking target in the first half of the year, after China and Thailand. Canada, the US, New Zealand and Norway also had investigations opened against their exports.

The WTO said the main products affected were base metals (21 investigations), textiles (20) and chemicals (10).

The number of new measures taken as a result of anti-dumping probes also rose in the first six months of 2008, with 54 measures against 51 measures in the same period in 2007. India applied duties in 16 cases, with the EU some way behind in second place.

China was again the main target followed by Taiwan, the EU, South Korea, Russia and the US.

Discussion Questions:

1. Why would a country want to keep cheap imports out of its domestic markets? Don’t cheap goods make consumers happy?
2. Does dumping refer to the sale of a country’s goods below the importing country’s costs of production or the costs of production in the country where the good is made? Why does this distinction matter?
3. When a nation protects its domestic market from dumping, is the principle of comparative advantage being undermined? Discuss.

“This post was originally published in April, 2008. It has been re-published today for the benefit of my year 2 IB Econ students, who are currently studying barriers to free trade.

Bloomberg.com: Economy – Korea Beef Deal Won’t Yield Trade Vote

Free trade: everyone either loves it or loves to hate it. South Korea and the US have been in negotiations for a landmark free trade agreement for years. Korea, however, has had a “beef” with US beef imports since 2003, when a case of Mad Cow Disease gave Korean officials the jitters and all imports were halted.

Even though Mad Cow has disappeared from American beef, the ban has remained, making it difficult for negotiators to come to any major agreements on the reduction of tariffs and other barriers to trade in other markets in which the US and Korea trade. Just last week, South Korea removed the beef ban, giving some analysts hope that a free trade deal may soon be agreed upon.

President Bush signed the agreement last year but has hesitated to pass it on to Congress; where certain Democratic politicians have refused to approve the agreement until S Korea removed the beef ban. Now that the ban has been lifted, however, it appears that the issues keeping an agreement from being reached may run deeper than the simple beef ban:

In addition, Ford Motor Co., unions and Democrats, including both Hillary Clinton and Barack Obama, all say the accord must be reworked to address what they call South Korea’s barriers to U.S. manufactured goods.

“I understand there are foreign policy considerations, but this is too important for us,” Stephen Biegun, vice president for government affairs at Ford said in an interview earlier this month. “We don’t see any sign that they are ready to change.”

Levin, who represents autoworkers in suburban Detroit, said the accord will need to be changed to address what he calls South Korea’s non-tariff barriers to U.S. manufactured goods, especially autos.

Clinton, in a response to questions from the Pennsylvania Fair Trade Coalition, said the agreement with South Korea “will cost America jobs.”

The S Korea / US Free Trade Agreement should bring a boost in trade between the two countries:

The U.S. is South Korea’s second-largest export market behind China, with shipments totaling $45.8 billion in 2007. Imports from the U.S. last year reached $37.2 billion. The trade agreement would eliminate or reduce tariffs on a wide range of goods including automobiles, vegetables and electronics.

Through free trade there are winners and losers. This is a theme we’ve explored in some depth already during our International Economics unit. The winners, in the case of the S Korea/US FTA will likely be manufacturers in S Korea and service industries in the US. Judging by Ford Motor Company’s response to the FTA, we can assume that American manufacturers will be losers from the accord.

Does this make it bad, however? According to macroeconomic theory, no. The removal of tariffs on imports from S Korea will force American manufacturers to become more competitive and achieve greater efficiency, both which will result in a more efficient allocation of resources in both S Korea and the US. If Ford, for example, sells fewer cars because of in influx of high quality, affordable Korean automobiles, then Ford may be forced to shut down some of its plants in the US. This will lead to the loss of American jobs, just as Hillary Clinton claims it will.

But in the long-run, America as a whole should be better off for it. Manufacturers in the US will focus more on capital intensive goods such as industrial equipment, the manufacture of which requires highly skilled labor, which America has in abundance. In addition to industrial equipment and other high skilled manufactured goods, the US service sector should benefit from freer trade with S Korea.

With beef being resolved, the U.S. banks, insurance companies and other services companies that stand to gain the most from this accord are gearing up their lobbying efforts.

Beef “has been our biggest obstacle in having a meaningful dialogue on the benefits of this agreement,” said Matt Niemeyer, vice president for the business insurer ACE Ltd. and a former U.S. trade official. “It’s now time to work with Congress to find a way to move this important agreement this year.”

As any student of economics knows by now, politics and economics don’t always mix well. The opposition to the S Korea/US FTA among Congressional Democrats is more political than it is economic. Jobs will be lost, that’s true, but overall trade between two technologically advanced, developed countries like the US and S Korea should do more for improvements in efficiency and in resource allocation than it will in harm for a handful of American workers who may find themselves out of work due to greater demand for imported automobiles.

*A tariff on Korean automobiles results in the following outcomes:

• The quantity demanded of automobiles is less than it would be without a tariff (Q4 rather than Q3)
• The quantity supplied by American auto manufacturers is greater than it would be without the tariff (Q2 rather than Q1)
• The difference between Q2 and Q1 represents an overallocation of resources in America towards automobile manufacturing.
• The domestic quantity demanded exceeds the domestic quantity supplied. The difference (Q4 - Q2) is made up for by imports from S Korea.
  
• The government earns revenue equal to the area of the yellow rectangle (amount of tariff x number of cars imported)
• Society experiences a loss of efficiency (deadweight loss) equal to the combined areas of the green triangles Y and X. This is consumer surplus lost, accounted for by the higher price paid by American consumers imposed by the tariff.

In the model above, the removal of a tariff on Korean automobiles will result in a decrease in output by American firms from Q2 to Q1, an increase in imports from Q4 – Q2 to Q3 – Q1, and an increase in consumer surplus, efficiency, and better overall allocation of resources in America.

Discussion questions:

1. How does the graph illustrate the concept of “winners and losers from free trade”?
2. Who gains and who loses from free trade with the US within Korea?
3. Is it possible that a free trade agreement with Korea would actually create jobs in America? Explain…
4. Why do politicians oppose free trade deals that would result in such improvements in efficiency, allocation of resources, and even in the employment opportunities for American workers?

Beyond the Noise on Free Trade – New York Times

Ever wondered which presidential candidate had the most “economistic” views on economic issues? In other words, which candidate supports economic policies most in line with the mainstream economic theories of our day: Obama, Clinton or McCain?

First question is what, exactly, are the mainstream economic views at issue? In Harvard Professor Gregory Mankiw’s article above, he talks about the issue of free trade:

Economists are, overwhelmingly, free traders. A 2006 poll of Ph.D. members of the American Economic Association found that 87.5 percent agreed that “the U.S. should eliminate remaining tariffs and other barriers to trade.”

The benefits from an open world trading system are standard fare in introductory economics courses. In my freshman course at Harvard, we start studying the topic in the second week, and we return to issues of globalization throughout the year. The basic lessons can be traced back to Adam Smith of the 18th century and David Ricardo of the 19th century: Trade between two countries creates winners and losers, but it leaves both nations with greater overall prosperity.

Indeed, all principles of economics courses (including our AP and IB courses here at SAS) teach in the first units the concepts of comparative advantage and trade based on specialization by nations in the production of the goods for which they have a lower opportunity cost than others. This basic tenet, illustrated so clearly with a simple productions possiblity curve, has proven to be the source of endless political turmoil in America, a country whose market economy is built on the principles of free trade, but whose citizens seem to increasingly oppose it today:

In December, an NBC News/Wall Street Journal poll asked Americans, “Do you think the fact that the American economy has become increasingly global is good because it has opened up new markets for American products and resulted in more jobs, or bad because it has subjected American companies and employees to unfair competition and cheap labor?”

When this question was asked a decade ago, the public was almost evenly split. In the recent poll, however, only 28 percent endorsed globalization, while 58 percent opposed it.

The protectionist tide seems to be rising in America in the face of rising unemployment, falling output, inflation and all-around insecurity among households and firms. So the question arises, where do the leading candidates fall on issues of free trade? Is it a threat to Americans’ well-being or the source of our vast wealth and power? Mankiw examines the candidates’ stances on a few major trade issues in the last few years. 

Here’s what he finds: Overwhelmingly, John McCain has shown support for policies aimed at expanding free trade, while Clinton and Obama have taken stances oposing open markets. From opposing tariffs on Chinese imports to advocating a reduction of subsidies to American farmers to supporting the Central American Free Trade Agreement (FTA) and the US/South Korea FTA, McCain has consistently fallen on the side of the mainstream economists on the issue of globalization, while his Democratic counterparts have taken stances opposing trade liberalization and the opening of new markets to competition between American and foreign producers.

What conclusions can be drawn from Mankiw’s observation? Are Democrats economically illitereate? Do Obama and Clinton need to sit through Econ 101 to learn that trade and specialization benefit society through expansion of output and lower prices? Probably not. Mankiw suggests that the rhetoric coming from the “Hillbama” campaigns is probably just populism aimed at gaining support of voters who fear the threat they perceive trade to pose to their livelihoods.

Maybe the candidates’ records as legislators are not good indicators of what their policies might be as president. Maybe campaign rhetoric… is nothing more than that. But counting on it requires, one might say, the audacity of hope.

Personally, I hope Mankiw is right, and that the Democrats prove to be a bit more ”economistic” in their policies should one of them end up in office. What do you think? Should American voters believe everything candidates say in their campaigns? If Hillary and Barack appear to be anti-trade and protectionist now does that mean America will be put on a path of isolation should one of them win the White House? Should we, as economists, be afraid, or hopeful, in this time of “change” and “hope” in America?

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Foreign Policy: Why We Trade

Professor Russ Roberts, host of the EconTalk podcast, has an essay in the latest issues of Foreign Policy journal titled “Why We Trade”. In this piece, Roberts defends the benefits of trade from a broad perspective, beyond the popular political view of trade, usually along the lines of “exports, good – imports, bad”. Roberts compares this line of thinking (characteristic of presidential candidates of both the Republican and Democratic parties), to the 14th century, pre-Adam Smith view of world trade, known as mercantilism.

Mercantilism was a view of global economic interaction that placed emphasis on the accumulation of gold and other precious metals from abroad in exchange for your country’s exports. The doctrine failed to recognize the importance of imports from abroad, as this was viewed as a loss of wealth to foreigners. Mercantilists viewed wealth in terms of bullion or the amount of precious metals a country owned. Today, of course, our understanding of wealth has evolved to account for the amount of output, or products (goods and services), we are able to consume. Herein lies the flaw in the rhetoric of modern politicians who, “are always talking about the necessity of other countries’ opening their markets to American products. They never mention the virtues of opening U.S. markets to foreign products.”

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Understanding the World Trade Organization

Below is an audio introduction to the World Trade Organization, courtesy of my year 2 IB Econ students here at SAS. Our current unit (IB Unit 4) examines free trade, global economic integration, and the WTO among other topics. As an introduction to the WTO, student were asked to record a two-minute podcast of the main ideas from a specific page on the WTO’s website. Below are their summaries of the basic functions and agreements of the organization, summarized and podcasted for your listening pleasure!

Marco Garafolo: "What is the WTO?" [ 0:01 ] Play Now | Play in Popup | Download (50)

Enno Zhang: "Principles of the Trading System" [ 2:40 ] Play Now | Play in Popup | Download (53)

Manon Van Thorenburg: "Tariffs" [ 0:01 ] Play Now | Play in Popup | Download (53)

Dennis Melzer: "Textiles" [ 0:01 ] Play Now | Play in Popup | Download (43)

James Hannam: "Standards and Safety" [ 2:36 ] Play Now | Play in Popup | Download (42)

Kaj Nieman: "Anti-dumping, subsidies, etc." [ 0:01 ] Play Now | Play in Popup | Download (45)

Introduction to the WTO, continued…

Carlos Siu: "Intellectual Property" [ 0:01 ] Play Now | Play in Popup | Download (56)

Lucas Topham: "Non-tariff Barriers" [ 0:01 ] Play Now | Play in Popup | Download (53)

Wan Jin Park: "Services" Play Now | Play in Popup | Download (46)

Danny Witters: "Agriculture" [ 1:20 ] Play Now | Play in Popup | Download (49)

Daniel Yeung: "Plurilaterals" and "Trade Policy Reviews" [ 1:57 ] Play Now | Play in Popup | Download (56)