FT.com / World / Americas - US economy threatens Dominican Republic

Trade based on comparative advantage… the theory originally articulated by Adam Smith, later fine-tuned by David Ricardo, the theory that suggests that if each nation specializes its economic activity on the products for which it faces the lowest opportunity cost, then trades with its neighbors, total world output and efficiency can be maximized: today this theory represents the philosophical underpinning of all free trade agreements signed between and among the nations of the world.

Through trade, countries can exchange their extra output with other nations for the goods specialized in by others, enabling all nations to enjoy a level of consumption beyond what they’d be able to achieve if they tried to produce all goods domestically.

For many developing countries, with their abundance of either land or labor, comparative advantages tend to lie in either agricultural goods or low-skilled manufactured goods. Since global prices for food are highly unstable and dependency on healthy harvests, good weather, and stable rainfall are all highly risky endeavors for a poor country, developing nations prefer to foster the growth of manufacturing sectors in their path towards economic development.

Strategies for economic growth available to developing nations include export-oriented and inward-oriented growth. A country like the Dominican Republic, the largest economy in the Caribbean, has pursued a predominantly export-oriented growth strategy, promoting through “free zones” the growth of a textile industry aimed at producing goods for consumers in developed countries, primarily the US.

To the Domincans, producing textiles for export to America has successfully given the people of this poor nation a grip on a rung of the ladder towards economic development. The import of capital has taken previously unproductive workers out of agriculture and put them into an industry where productivity, thus income, has risen, leading to improvements in living standards. Export-led growth, however, runs some serious risks of its own, as is being realized by the people of the Dominican Republic today.

It had been clear for some time that Luis Caraballo’s textile factory, in one of the Dominican Republic’s largest “free zones”, was struggling.

Finally, last December, he closed the factory gates for the last time: cut-throat competition from China and Vietnam, a weakening US dollar and unsustainable costs had become too much.

Once a hot destination for American companies looking for a cheap place to “off-shore” production of labor intensive textiles, the Dominican Republic today faces new competition, and is finding its comparative advantage slip slowly away from textiles…

The Dominican Republic depends heavily on the US, which is the destination of more than 85 per cent of exports. But textile exports – these days accounting for less than a third of total exports – fell by 32 per cent over 2007.

Although other countries in the Caribbean are also suffering from Asian competition – with Chinese textile exports to the US tripling between 2000 and 2005, while Vietnam’s multiplied almost 117 times – the Dominican Republic has been worst hit.

Here’s the thing: a nation’s comparative advantage may shift over time (from land to labor to capital intensive goods) as the structure of the global economy evolves. Once an economy like the Dominican Republic’s has undergone a period of structural adjustment, away from agriculture and towards industry, the flow of low wage workers from farm to factory begins to slow to a trickle, leading to rising wages and increased competition from countries with more abundant supplies of cheap labor.

The challenge for policy makers is to manage the structural changes as they come, minimizing the deleterious impact such global shifts of productive resources has on the citizens of a country like the D.R. Clearly, it is in the country’s interest to prepare its citizens for a “new economy”, one in which skilled labor will play a larger role. The problem is, this requires a solid education system, which the D.R., it turns out, does not yet have:

There is widespread acceptance of the need to develop a better-educated workforce, but so far education spending has been inadequate.

“The government simply doesn’t have enough resources,” said Mr Montás. About 40 per cent of its budget goes on debt obligations and another 15 per cent is dished out through subsidies. Just 1.5 per cent goes towards education.

It also turns out that this is a balance of payments story:

Mr Montás calculated that for every percentage point the US economy contracted, the Dominican Republic’s GDP would shrink by 0.4 per cent.

Not only will exporters be hit, but also the huge tourism sector and remittance flows…

One possible result of the decline in exports and flows of remittances from the US will be a depreciation of the D.R. peso, as demand for pesos by Americans falls. A weaker peso might make the country’s exports attractive once again, assuming the exchange rate is allowed to adjust on foreign exchange markets. A weaker peso should help slow the decline in the D.R.’s exports to the US, at least until new competition emerges, perhaps elsewhere in Asia, maybe even from Africa or other Latin American countries.

In all likelihood, given the increased competition from Asian textile manufacturers, continued economic growth in the Dominican Republic will depend on the country’s ability to educate and train its workforce to adapt to a more capital, technology and information-based economy, which, if successful, will eventually lead to rising incomes and higher standards of living for the people of the this rising Caribbean nation.

Comparative advantages evolve with the emergence of new competition among developing and developed countries. The negative impacts this evolution has on a particular economy can be managed if wise policy actions are taken to assure a country’s workforce is educated and trained to participate in tomorrow’s economy, rather than yesterday’s or today’s.

Live from Shanghai - OnPoint with Tom Ashbrook

The 21st century has been called “China’s Century”. With the Olympics in Beijing in a couple of months, the torch relay touring the worlds’ major cities has been met with fierce anti-China protests as angry activists have accused China of countless offenses from human rights violations to oppression of democracy movements to environmental destruction. Although it may be “China’s Century”, it sometimes seems that the rest of the world is not too happy about China’s emergence as a global superpower.

Last week, NPR’s Tom Ashbrook, journalist and host of the OnPoint radio program, visited Shanghai and featured daily stories about China in the world today. Below is an excerpt from the first of these stories, which caught my attention because it shared a minor fact that I had never heard before but which I find extremely interesting. Ashbrook’s guest, David Lampton, is a leading scholar on China’s re-emergence as a global superpower. Listen to what he says here:

 

 China's Challenge - OnPoint with Tom Ashbrook: Play Now | Play in Popup | Download

“Re-claim their share of global GDP?” you might be asking? Here’s the thing… for much of the last 2,000 years, China was THE leading superpower in the world. In fact, up to the 1430’s, China had the largest navy in the world, had established tributary relations with dozens of kingdoms from Southeast Asia to India to Africa, had established and secured trade routes stretching overland to Europe and by sea as far away as East Africa, and some even think Chinese explorers had made it to North America seventy years before Columbus! While Europeans were dying of the plague by the millions and struggling under absolute poverty in a feudal society where the idea of national unity was still a century off, China had grown to be the largest empire the world had ever seen, first under the Yuan Dynasty and then the Ming.

As professor Lambert says, China’s GDP, or its total output of goods and services, accounted for ONE THIRD of the world’s output during much of the common era. This fact shocked me, but made sense once I thought about it. China truly was the greatest example of a global superpower the world had known by the 15th Century. Much of its wealth and power was a result of its efforts to globalize, or to integrate itself with the economies of the foreign nations, empires and kingdoms. Trade with its neighbors, near and far, had helped enrich China, but also built among China’s leaders a rightful sense of superiority over the other peoples of the world.

It was this sense of superiority that would lead to a long period of decline in Chinese dominance of the global economy. In 1432, the Ming emperor ordered the trading vessels of Admiral Zheng He destroyed. 3,000 of the largest ships the world had ever seen were sunk to the bottom of the Yangtze river and the East China Sea. The emperor declared China as “The Middle Kingdom” and ordered that all links with the outside world be severed, as China had no need for trade with others. China, the emperor claimed, was totally “self-sufficient” and could flourish without trade with the “barbarian” outsiders.

What followed was a long period of decline in China’s superpower status. From 1432, through the fall of the Ming in 1644 throughout the subsequent Qing Dynasty, into the 20th Century which saw repeated shifts in power between KMT, the Japanese and finally the CCP, China for the most part resisted attempts by its own and by foreigners to open its doors to the world, welcome trade, and encourage globalization of China’s rapidly dwindling domestic economy. The belief that China was “self-sufficient” endured while China’s share of total economic activity in the world dwindled to nearly nothing.

In the mean time, Europeans “discovered” the New World, philosophized about the gains from trade, integrated their own markets and later the markets of the colonies in Asia, America, and Africa, and grew wealthy as a result of these global exchanges. All the while, China stuck to its path of isolationism and self-sufficiency, as its influence and power slipped ever deeper into obscurity.

This period of isolation essentially lasted until the death of Mao Zedong, who could basically be called China’s last emperor. Since 1978, China has followed a new path, one that has attempted to reverse the mistakes of past dynasties, based on the doctrine of isolation and protection of domestic markets. Since its re-emergence as a global economic superpower, China has rapidly seen its share of global GDP increase from less than 2% in the 1970’s to around 16% today; a rebound achieved only through year after year of rapid economic growth, fueled by exports to the rest of the world. Isolation, it appeared, was not the path to wealth and power. China had discovered a new path, one that has done wonders for it income and standing in today’s circles of global power.

China’s re-emergence was made possible by one simple shift in doctrine and philosophy among its leaders: the belief that trade is good. While today the country still has many obstacles to overcome, such as the environmental challenges posed by growth, achieving a more equal distribution of wealth and income, fostering the growth of a domestic market to lessen its dependence on exports, and the challenges relating to human rights and demands for democratization, it would be wrong to say that China has not benefited from economic globalization in many ways.

A little history lesson is sometimes necessary to better understand where China is coming from and where it is going on its path towards re-emerging as a superpower in the global economy. The West, in the mean time, should pause to consider the rightful place the Chinese people believe is theirs based on their long history of economic power and dominance that for hundreds of years placed China at the pinnacle of power in the world economy.

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 had 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 in AP Economics here at Shanghai American School. 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.”

Another theme of our final AP Econ unit, I could say, is that 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?

Bush pushes Congress to vote on Colombia trade pact. - Apr. 14, 2008

Click on the graphs for full-size versions

The benefits of trade, while visibly demonstrated by two basic economic models, the production possiblities curve and a simple supply/demand diagram, are not as straightforward when politics is involved. Case in point: the Bush administration has been trying to push through a free trade deal with Columbia, one of our key allies in a region ripe with anti-American sentiment. The White House views the trade deal as a win-win for the American economy:

The administration insisted the deal would be good for the United States economically because it would eliminate high barriers that U.S. exports to Colombia now face, while most Colombian products are already entering the United States duty-free under existing trade preference laws.

On the surface it appears the US has nothing to lose from extending trade relations with Columbia, since few if any American jobs will be lost by such a deal; so why are some Democrats resisting the trade deal?

In explaining their opposition, Democrats have cited the continued violence against organized labor in Colombia and differences with the administration over how to extend a program that helps U.S. workers displaced by foreign competition.

As is so often the case, what’s best for the economy does not seem to be what’s in the best interests of Americans. Our values extend, in some cases, beyond our pocketbooks. The White House argues that the US/Columbia free trade agreement only promises to increase demand for American products while doing little to affect domestic employment. The fact that most Columbian imports are already tariff-free probably confirms this. But the Democrats oppose this deal on the grounds that it would appear that America endorses the anti-labor activities of the Columbian governments.

Labor is a touchy political issue in America, where union membership among workers has fallen from around 40% in the 1950’s to around 13% today. As Columbia and other developing economies become integrated into the global economy, there is increasing pressure for governments to liberalize their domestic labor markets, weaken unions, lower wages in order to attract more investment from abroad, lower the costs of production, thus increase the quantity of their exports demanded abroad. Labor market flexibility and liberalization is certainly an important step in attracting investment and demand to developing countries, but if it comes at the expense of the well-being of the citizens of a poor country, then perhaps standing against such anti-labor actions is a just cause.

The free trade deal with Columbia poses more of a moral dilemma than an economic one. From America’s stand-point, it appears to be a win-win situation. But from the perspective of international labor standards, approving a trade deal with Columbia threatens to undermine another set of American values: those of human rights.

Discussion questions:

1. Why do you think the White House is so adamant about pushing through the trade deal with Columbia?
2. Are the Democrats correct to oppose a deal that could create jobs in America while at the same time make more goods available to Columbian consumers at lower prices?
3. Should America be trying to dictate the labor standards of its trading partners? Why or why not?

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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How do Chinese granite quarries and a decline in the US death threaten a family business in rural Vermont?

Listen and find out…

 

 Chinese headstones [4:09m]: Play Now | Play in Popup | Download

Source: NPR Economy Podcast, 2/29/2008 

You Are What You Spend - New York Times

Fact: The richest 20% of Americans earn 15 times the income of the bottom 20%.

Fact: The richest 20% of Americans only consumer 4 times as much as the poorest 20%.

Question: Why don’t the richest 20% consume 15 times as much as the poorest 20%?

The author of this NYT opinion piece claims that the gap between America’s rich and poor is not as stark as the income figures suggest. While before tax income of the top 20% is around $150,000, the poorest 20% earn only around $10,000. Clearly these numbers indicate an enormous income gap in America.

However, when it comes to consumption, the poor consume an average of $18,000 on everything from food to housing to entertainment to transportation. The richest 20%, on the other hand, consume an average of only $70,000, less than half their before-tax income.

So the question is, is standard of living based on our income, or on our consumption? If it’s income, then there’s certainly a huge gap in standard of living between the rich and poor. But if we believe it’s consumption, then the gap is narrowed dramatically. The author claims the latter:

To understand why consumption is a better guideline of economic prosperity than income, it helps to consider how our lives have changed. Nearly all American families now have refrigerators, stoves, color TVs, telephones and radios. Air-conditioners, cars, VCRs or DVD players, microwave ovens, washing machines, clothes dryers and cellphones have reached more than 80 percent of households.

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Recently, in AP Economics, we have been learning about Labor markets; in IB Economics we’ve been focusing on the benefits and costs of international trade and global economic integration. As students of market economics, it is ingrained in us that economic liberalization, the freeing of markets, enabling resources to be allocated based on the price mechanism; these are all are good things. Removing barriers to the free movement of products and resources across national and political boundaries should eventually result in greater world output, and subsequently increases in living standards and wealth for the citizens of all free trading countries.

Nations will produce the products for which they have a comparative advantage, and trade with their neighbors for those products for which they don’t. Resources will flow from markets in which they are in low demand to those where they are in high demand. Prices in both product and resource markets will rise and fall, allocating scarce resources to the markets where they are needed most.

So why, in an era where the benefits of free trade and free flow of productive resources seem so visible around the world, do Americans seem so susceptible to views like those exhibited in the video below:

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