Today in class, my IB year 2 students undertook a debate on the extent to which free trade has contributed to or hurt the well-being of the world’s people. In preparation for this debate, students were asked to research and bookmark to our class’s Diigo group one article offering evidence in support of their argument.

The debate was framed around a quote from Paul Krugman from chapter 11 of the excellent book, Naked Economics.

“You could say that globalization, driven not by human goodness but by the profit motive, has done far more good for more people than all the foreign aid and soft loans provided by well-intentioned governments and aid agencies.”

Christopher: Foreign Trade, Not Foreign Aid « John Stossel

The exercise of debating the pros and cons of free trade for rich and poor countries was rewarding and provided an interesting and engaging way to introduce Unit 4 of the IB Economics course. The final two units, on International Trade and Economic Development, are closely tied, as one of the main strategies for achieving improvements in people’s standards of living is to improve the unfettered access to resource, good and service markets across national boundaries. We will be revisiting the debate on the effectiveness of trade versus aid at promoting the objectives of economic development repeatedly throughout the rest of the second year of IB economics.

For now, some questions went unresolved in today’s debate, and I will ask my student and any other interested reader to respond to those questions in the comments below.

Discussion questions:

Obamas Efforts To Boost Exports Face Hurdles : NPR

President Obama thinks the key to recovering the millions of American jobs lost during the recession lies in boosting exports to the rest of the world:

The plan sounds great. As we learn in AP and IB Economics, free trade leads to benefits for nations that choose to participate in it. Of course, promoting free trade will harm some industries and workers whose jobs end up being “off-shored” or “out-sourced” to countries with cheaper or more qualified labor; but Obama’s hope is that promoting free trade will result in a net gain of 2 million American jobs.

The goal of doubling US exports in 5 years, however, may be overly ambitious. According to the CIA World Factbook, the US is currently the fourth largest exporter in the world, sending just around $1 trillion worth of goods and services abroad in 2009, behind the EU with $1.9 trillion, China with $1.2 trillion and Germany with $1.18 trillion of exports. Obama’s goal to double US exports would propel the US to the single largest exporting nation in the world, putting it right around where the 27 nations of the European Union are today.

To achieve his goal, Obama proposals include three strategies for boosting demand and supply of US exports.

• On the supply side he suggests continuing recent guarantees for payment by foreign buyers. Essentially such a scheme reduces the risks that often accompany international commerce, reducing the “costs” of exporting firms, which in essence increases the supply of exports from the US.
• On the demand side the US must pressure China to revalue its currency. A stronger RMB (and a weaker dollar) will increase China’s demand for US goods and services.
• Also on the demand side, the US should push through free trade agreements with South Korea, Panama and Columbia, which have encountered obstacles among US lawmakers who fear that more free trade may actually mean a loss of US jobs.

Free trade agreements, export payment guarantees and a weaker US dollar in China will help Obama reach his goal. Chances are, however, that it will ultimately be unattainable. Doubling US exports would propel the US to the top of the list of exporting countries, surpassing even China, today’s current leader, by $700 billion more than the country exported last year. The impact on US GDP would undoubtedly be enormous, adding upwards of  $1 trillion to the US economy.

Creating jobs through trade is controversial, as many Americans still believe trade is partially to blame for the loss of American jobs in recent years.

“The average voter in the U.S. has been pretty on the fence about whether they want more trade coming into the United States,” Slaughter says. “The income pressures that a lot of households have faced in recent years have sort of shifted that balance where more voters now are a lot more wary of globalization than they used to be.”

While his goal is lofty, Obama is on the right track towards growing the US economy and promoting job creation. Trade benefits Americans not just because it will increase demand for our goods and services abroad, but because it will lead to lower prices for many of the things we enjoy consuming at home, ultimately increasing real incomes in America while also creating jobs.

The graph below presents a simple explanation of how the above strategies can result in more jobs in US export industries.

Discussion Questions:

1. How does China manipulate the value of its currency? Why is such manipulation harmful to US exporters?
2. How does a government payment guarantee for exporters actually reduce the costs of doing business for US exporting firms?
3. Do you believe that more free trade agreements with countries like South Korea and Panama will create jobs or destroy jobs in the United States? Explain.

America, a champion of free trade between the world’s nations… right?

Actually, the United States places tariffs (taxes on import) on virtully every item it trades for with the rest of the world. Below is just one tiny section of the 75 page table of contents (!!) of the “Harmonized Tariff Schedule of the United States”.

JOGGING SUITS knitted or crocheted . . . . . . . . .. . . . . 6112.11-19
JOINERY of wood, for builders . . . . . . . . . . . . . . . . . . . . . . . . . 4418
JOINTS artificial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 9021.11
JOJOBA OIL . . . . . . . .  . . . . . . . . . . . . . . . . . . 1515.90, 1516-1518
JOKE ARTICLES . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 9505.90
JONGKONG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . . . . Ch. 44
JOURNALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . 49-3, 4902
JUDO UNIFORMS of cotton . . . .  . . . . . . . . . . . . 6203.22, 6204.22
JUICES fruit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20-US1-3
fruit and vegetable . . . . . . . . . . . . . . . . . . . . . . . . 20-5, 2009.11-90
meat, fish, or aquatic invertebrates . . . . . . . . . . . . . . . . . .1603.00
JUMPSUITS men’s or boys’ . . .  . . . . . . . . . . . . . . . . . . .  6211.32-33
women’s or girls’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6211.42-43
JUNIPER seeds of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …0909.50

Yes, folks. Even “Joke Articles” made overseas are taxed before ending up in the hands of American consumers (by 70% as it turns out!). But tariffs are no joke. The podcast below offers an excellent evaluation of the effects of America’s tariffs on various stakeholders, including American consumers, producers, and workers and on foreign producers, consumers and workers.

[podcast]http://welkerswikinomics.com/blog/wp-content/uploads/Tariffs.mp3[/podcast]

After listening to the whole podcast, respond the the following questions in a comment.

Discussion Questions:

1. How does a tariff on Chinese tires affect American tire manufacturers? Why are American firms that make tires actually opposed to the tariff on Chinese imports?
2. Which group is the main proponent of higher tariffs on Chinese tires? Why does this group favor higher tariffs?
3. How have the Chinese responded to the American tire tariff? Why are American chicken farmers upset about the tax on Chinese tires?
4. Why do “97% of economists say tariffs are a bad idea?” The commentator says economists hate them because “they are so inefficient”. Discuss the economic reasoning behind this statement.
5. Do you think it is likely that the 35% tariff on Chinese tires will save or create jobs for Americans? Why or why not? What are your conclusions regarding the economic wisdom of tariffs?

YouTube – Lord of the Rings: Fellowship of the Ring of Free Trade

Free trade: one of the most contentious issues in economics. The consensus seems to be in among economists: specialization and trade among nations based on the principle of comparative advantage leads to improvements in access to goods and services, as well as increased wealth and welfare among all countries involved. But that does not mean it’s easy to convince everyone in society to adopt free trade.

In his book “Bound Together”, Yale University Economic Historian Nayan Chanda has this to say about the word “globalization”:

Since the word globalization appeared in the dictionary, its meaning has undergone a massive transformation. Just two of the dozens of definitions of globalization illustrate the problem in grappling with this phenomenon. Writing in the Encyclopedia Britannica, Jeffrey L. Watson defines globalization in cultural terms-as “the process by which the experience of everyday life, marked by the diffusion of commodities and ideas, can foster a standardization of cultural expressions around the world.”

The official World Bank definition of globalization is stated, not surprisingly, in purely economic terms, as the “freedom and ability of individuals and firms to initiate voluntary economic transactions with residents of other countries.”

Left-wing critics, echoing Karl Marx’s observation about the “werewolfsh hunger” of capitalism reaching the four corners of the world, see globalization as synonymous with expansionist and exploitative capitalism.

Looking at globalization through the prism of business and economics helps one to understand the Internet, the mobile phone, and the cable TV-connected world we inhabit, but it does not explain how human life was globalized long before capitalism was formulated or electricity invented.

According to Chanda, globalization and the internationalization of our markets has been going on for thousands of years throughout human history. The anti-globalization views expressed in the video below portray the phenomenon as a recent, oppressive, capitalistic phenomenon. Watch the video and discuss the questions below.

Discussion Questions:

1. Describe the view of free trade depicted in the video. Which of the three definitions in Chanda’s book does the video seem to align itself with?
2. Why does the anti-globalization movement unite such disparate groups as environmentalists, liberals, and labor unions?
3. What is free trade and how can it “foster a standardization of cultural expressions around the world.” Is this a bad thing or a good thing in your opinion?

allAfrica.com: Africa: G20 Leaders Promise Billions for Low-Income Nations

While the G20 leaders meet in England to formulate their plan for increasing aid to Africa, the message from the continent seems to be that not aid, bur more trade, foreign direct investment and the establishment of free markets is the key to achieving meaningful economic growth and development. Dambisa Moyo explains the problem with aid on Colbert Nation on April 1:

What, exactly do the G20 leaders have planned for the less economically developed nations of Africa in the $1.1 trillion global stimulus package?

The leaders of the world’s 20 biggest economies, recognizing that the global financial crisis has “a disproportionate impact” on vulnerable people in poor countries, have promised to make hundreds of billions of United States dollars available to these countries as part of a $1.1 trillion plan to rescue the world economy.

In a communiqué released by the Group of 20′s London Summit on Thursday, the leaders announced what they called “a global plan for recovery on an unprecedented scale.”

They said the rescue package would include resources totalling $850 billion, to be channelled through global financial institutions, “to support growth in emerging market and developing countries by helping to finance counter-cyclical spending, bank recapitalisation, infrastructure, trade finance, balance of payments support, debt rollover, and social support.”

Outlining allocations for materially poor nations, they promised:

• An increase in lending of at least $100 billion by multilateral development banks, including loans to low-income countries;
• An amount of $50 billion for social protection, to promote trade and to safeguard development in low-income countries; and
• The selling of gold reserves to help the International Monetary Fund (IMF) provide $6 billion for the world’s poorest countries over the next two to three years.

The increase in aid from the rich world to sub-Saharan Africa comes mostly in the form of loans from the IMF and the World Bank. Development aid such as this is meant to help poor countries improve their human capital through investments in education, health and infrastructure. Historically, loans from the “multilateral development banks” have been made on the condition that the recipient nations adopt certain “structural adjustment policies”:

Some of the conditions for structural adjustment can include:

• Cutting social expenditures, also known as austerity,
• Focusing economic output on direct export and resource extraction,
• Devaluation of currencies,
• Trade liberalization, or lifting import and export restrictions,
• Increasing the stability of investment (by supplementing foreign direct investment with the opening of domestic stock markets),
• Balancing budgets and not overspending,
• Removing price controls and state subsidies,
• Privatization, or divestiture of all or part of state-owned enterprises,
• Enhancing the rights of foreign investors vis-a-vis national laws,
• Improving governance and fighting corruption.

Critics of such SAPs, which developing countries are forced to adopt as conditions of receiving loans from the IMF and World Bank, say that they limit the extent to which the poor country can direct the loan money towards combating poverty, reducing inequality, and thereby achieving meaningful economic development for the poor.

Recently TIME magazine had an article in which the efficacy of such financial aid from the rich world to the poor world is challenged.

Africa is hopeless, a place of war and famine seemingly populated almost entirely by tyrants and children with flies in their eyes. According to this view, if Africa generates any kind of growth, it is in suffering — and in the overseas aid sent to address that, now a $40-billion-a-year industry. Naturally, with a new appeal every year and a new disaster every other, some people have begun to wonder if all that money is doing any good. They argue that aid creates dependence, fuels corruption, undermines democracy and stifles development.

Aid in any form, at a fundamental level, positions Africa as a dependent child, and the “rich world” as the paternalistic benefactor. Aid, despite the good intentions of the west, does little to do promote meaningful economic development in poor countries:

Though it rarely occurs to Westerners who’ve been instructed that Africa needs their help, charity is humiliating. Not emergency charity, of course: when disaster strikes, emergency aid is always welcome, whether in New Orleans or Papua New Guinea. But long-term charity, living life as a beggar, is degrading. Andrew Rugasira, 40, runs Good African Coffee, a Ugandan company he set up in 2004 to supply British supermarkets under the motto “Trade, not aid.” He is emblematic of a new generation of African antiaid, antistate entrepreneurs. For Rugasira, aid not only “undermines the creativity to lift yourself out of poverty” but also “undermines the integrity and dignity of the people. It says, These are people who cannot figure out how to develop.” Aid even manages to silence those it is meant to help. “African governments become accountable to Western donors,” says Rugasira, “and Africa finds itself represented not by Africans but by Bono and Bob Geldof. I mean, how would America react if Amy Winehouse dropped in to advise them on the credit crisis?”

The G20 nations should keep this view of aid in mind as they further develop their plans to help the poor nations of the world achieve economic growth and development. Trade, not aid, is what Africa needs to achieve meaningful progress towards economic development, defined as an improvement in the quality of life, health, education, and incomes of the people of a nation. Despite over $40 billion a year of aid that has flowed into Africa over the last decade, it is foreign investment and trade that has only recently led to sustained economic growth for the continent.

In 2006, according to the Organization for Economic Cooperation and Development, foreign investment in Africa reached $48 billion, overtaking foreign aid for the first time. That gap has only widened, reflecting a quadrupling of foreign investment since 2000. As the senior adviser in Africa for the International Monetary Fund (IMF), David Nellor, noted in a report last September, sub-Saharan Africa today resembles Asia in the 1980s. “The private sector is the key driver,” wrote Nellor, “and financial markets are opening up.” War is down. Democracy is up. Inflation and interest rates are in single digits. Terms of trade have improved. Crucially, said Nellor, “growth is taking off.” The IMF puts Africa’s average annual growth for 2004 to ’08 at more than 6% — better than any developed economy — and predicts the continent will buck the global recessionary trend to grow nearly 3.3% this year.

Despite the platitudes from Barack Obama, Gordon Brown and Ban Ki Moon about the “disproportionate impact” of the financial crisis on the poor nations of the world, it is Africa that is likely to achieve economic growth this year, even while the rich nations of the world enter recession. It is little thanks to aid that the people of Africa are finally experiencing meaningful growth; rather, the economic ties between the continent and, not the West, but China, have fueled this movement towards higher incomes and quality of life. Perhaps it’s more and fairer trade, not aid, that Africa needs now. And maybe that’s what we in the West need too in this time of economic chaos.

One of the greatest “ah-ha” moments in all of economics is when an economics’ student or citizen learns for the first time that every time a domestic buyer purchases a foreign product or import that those same U.S. dollars spent on the foreign product go to a U.S.-based company, not a foreign company. Yes, I am telling you that when you (or Wal-Mart) buy Chinese shirts, your same U.S. dollars spent quickly end up in the hands of, say, Apple, Microsoft, Garmin, or General Electric to increase U.S. employment, profits, and U.S. stock prices!

I decided to write this particular blog because of the fact that the recently passed $800 Billion U.S. stimulus bill has some “buy American” provisions within it. Based on an intuitive hunch, I believe that over 99% of adult Americans believe that these “protectionist” clauses somehow help our economy. Yes, the vast majority of U.S. adults believe that it is clearly more advantageous to “buy American” in order to keep the money or wealth within America in order to increase U.S. employment, profits, and U.S. stock prices. In true economic fact, however, if U.S. citizens “buy American” solely out of patriotism (and not because they think it is a superior product) they actually HURT America because the U.S. dollars spent out of patriotism on that American company are, therefore, unintentionally withheld from another more efficient and deserving American country via the “trade loop”.

Let me try to explain this “trade loop” in more detail so that I may actually be able to convince you of this amazing “180 degree” revelation: “Buy American” is Un-American

Let’s say that the United States (we’ll say Wal-Mart) decides to buy many shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying those same shirts from, say, a shirt manufacturer in Elon, North Carolina (USA). 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 U.S. currency away (not advised!), or immediately spend the money back to the USA (advised!).

In summary, China has initially 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!

Yes, the economic “punch line” is that all spending by the domestic nation on foreign products (imports), in turn, are spent immediately back to the domestic nation increasing the domestic nation’s employment, income, and standard of living. (Note; this is also shown and reported in a nation’s balance of payments schedule if you are skeptical about what you are reading!)

And, yes, let’s not forget about that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Any good economy promotes competition and I am excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity and/or quality), and hopefully get the next shirt contract from Wal-Mart! If not, well, that North Carolina firm may just have to close down. But remember, the key point, the $400 spent for the shirts went to Fleetmatics in Waverly, Massachusetts, in lieu of the Elon, North Carolina shirt manufacturer. If you would have “bought American” even though the Chinese shirts were preferable, you would have prevented the more effective U.S. business in Waverly from getting your U.S. dollars by giving them to the less efficient Elon manufacturer. In short, you would have contributed to American inefficiency and slowing productivity, hurting our country! And that is un-American!

Now, 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 form U.S. import purchases. 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 not as big a problem as most people think! 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 other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and be forced to use those U.S. dollars to buy that GPS system or build more plants to employ more Americans!

In summary, when citizens of any country in the world buy the product that is best for them based on a combination of quality and price, they will be taking the most patriotic action possible to help their own country they love so much! If a domestic citizen sees the foreign product as a better alternative to the domestic product, buy it! Your money spent will immediately find its way back through the “trade loop” to another business within your country!

Of course, this is why all economists from around the world know that international trade, and not protectionism, helps a country’s standard of living and promotes efficiency and rising standard of livings!

For a video lesson on the Marshall Lerner Condition and the J-curve, click here: The Marshall-Lerner Condition (HL Only) | The Economics Classroom

Read the following article before reading the blog post below:
Managing Globalization » Business Blog » International Herald Tribune » Blog Archive » Here’s that silver lining, finally

In IB Economics we’ve been studying concepts relating to balance of trade and exchange rates. The Marshall-Lerner Condition and the J-curve are two concepts that explain the relationship between a the exchange rate for a nation’s currency and the country’s balance of trade. (click on the graph to see a larger version)

Common sense might indicate that if a country’s currency (let’s say the US dollar) depreciates relative to other currencies, then this should lead to an improvement in the country’s balance of trade (economists call this the current account). The reasoning goes as such: a weaker dollar means foreigners will have to give up less of their money in order to get one dollar’s worth of American output. At the same time, since the dollar is worth less in foreign currency, imports become more expensive, as Americans have to fork over more dollars for a certain amount of another country’s output; hence, imports should decrease.

Fewer imports and more exports means an improvement in the country’s balance of trade, right? Well, not necessarily. What matters is not whether a country is importing less and exporting more, rather, whether the increase in income from exports exceeds the decrease in expenditures on imports. Here is where the Marshall-Lerner Condition can be applied.

The M-L condition examines the price elasticities of demand for exports and imports of a particular country. Say the US experiences a depreciation of its currency (as it has over the last year or so). If foreigners’ demand for exports from America is relatively elastic, then a slightly weaker dollar should cause a dramatic increase in foreign demand for American output, causing export income in the US to rise dramatically. On the other hand, if American’s demand for imports is highly price elastic, then a slightly weaker dollar should likewise cause Americans’ demand for imports to decrease drastically, reducing greatly American’s expenditures on imports. If the combined elasticities of demand for exports and imports is elastic (i.e. the coefficient is greater than 1), then a depreciation of a nations currency will shift its current account towards surplus. This is the Marshall-Lerner Condition.

Marshall-Lerner Condition: If PEDx + PEDm > 1, then a depreciation or a devaluation of a nation’s currency will shift the the balance on its current account towards surplus.

So what if the Marshall Lerner Condition is not met? Demand for exports and imports may not always be so responsive to changes in exchange rates. Imagine a scenario where a weaker dollar does little to change foreign demand for America’s output. In this case income from exports may actually decline (in real terms, since the dollar is weaker) as the dollar depreciates. Likewise, if Americans’ demand for imports is highly inelastic, then more expensive imports will only minimally affect Americans’ demand for imported goods, in which case expenditures on imports may actually rise as they become more expensive. In this case, where the elasticities of demand for exports and imports are highly inelastic, a depreciation of the currency will actually worsen a trade deficit. Americans’ import expenditures will go up while export income from abroad will decline shifting the current account further into deficit.

In the article above, some data is presented that points to evidence that in the US today, the Marshall-Lerner Condition is in fact being met:

“Exports in the year through September are up by 12 percent from 2006, while the dollar’s trade-weighted exchange rate dropped by only 6 percent. That means foreigners may actually be spending more – even in their own currencies – on American products. It’s a support that the American economy, and in turn the global economy, can really use right now.

Of course, this process isn’t helping the trade deficit too much, No one, it seems, can change Americans’ taste for foreign products. But it does show, for all to see, that the risks of an open economy are at least somewhat balanced by the benefits.”

An increase in exports of 12% in response to a 6% weakening of the dollar indicates a price elasticity of demand coefficient for America’s exports of 2, meaning foreigners are highly responsive to cheaper US goods.

We can assume that Americans’ demand for imports is highly inelastic, as the article hints at when it says, “imports to the United States, including oil, are still rising in volume and value.” If a 6% weaker dollar leads to an increase in expenditures on imports, then demand must be less than one. In order for M-L Condition to be met, PEDx+PEDm must be greater than 1. Clearly, with a PEDx of 2, the condition is met, and a weaker dollar in leading to an improvement in America’s balance of trade with the rest of the world.

Discussion Questions:

1. What is the J-curve effect? Based on the evidence from the article, where on the J-curve is the US right now?
2. Is America experiencing an improvement in or a worsening of its current account deficit?
3. What determinants of demand are fueling America’s ever-increasing expenditures on imports?
4. What should happen to the elasticity of demand for imports if the dollar remains weak in the long-run? How will this affect America’s position on the J-curve?

This week the CEOs of the “Big Three” US auto makers boarded their private jets in Detroit and touched down in Washington to beg and plead in front of Congress for a “low-interest bridge loan” from the US government to help them avoid bankruptcy. They are asking Congress for $25 billion of taxpayer money to give them the chance to re-structure and re-equip themselves for the future.

Below are eight arguments based on basic economic principles for why a bailout of the United States automobile industry is a bad idea and is bound to fail:

1. Incentives matter: A bailout of the US auto industry ignores the basic economic principle that incentives matter. Individuals and firms respond to incentives, pursuing behavior that is likely to bring them the greatest rewards. In the face of falling demand for their product and ever-increasing competition from more efficient foreign producers, providing a $25 billion bailout creates a disincentive to drastically reduce costs and increase competitiveness, and an incentive to continue using tired old techniques and providing the same old models for which demand has declined among Americans for over a decade.
2. Comparative advantage: The basic economic principle of comparative advantage states that in an era of free trade and globalization, countries should produce the types of goods for which they have the lowest opportunity cost. Since the average American car of a particular class costs the Big Three $2000 more in wages and benefits for workers than its Japanese counterpart, it makes sense that Japan (and other lower-cost countries) produce more cars, and the Big Three produce less.
3. Efficient allocation of resources: The United Auto Workers Union has a member ship of over 400,000 workers. Since the 1970s the union has lost over 1 million workers. Clearly the US auto industry has been in decline for decades, a fact that should be taken as a sign: resources employed in America’s car industry are inefficient and represent a over-allocation of resources. A drastic down-sizing of the auto industry, while resulting in (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run hardships for the hundreds of thousands whose jobs will be lost, will in the long run strengthen the US economy as labor and other resources will be freed up to be employed in sectors in which the US has comparative advantage.
4. Economic Darwinism or “the survival of the most efficient”: America has stood for free trade in the world since helping found GATT in 1948 and later the WTO. The gains from embracing free trade are shared among all stakeholders in the economy. Consumers enjoy lower prices (thus higher real income), firms enjoy access to cheaper inputs and larger markets for their products, and governments enjoy the increased tax revenues from rising incomes driven by export-led economic growth. To bail out an uncompetitive, inefficient, and long-declining industry is to spit in the eye of free trade and denies America any moral suasion it may hold in the future over potential trading nations in our attempt to open their markets to our nation’s products. To protect our own dying industry now will send a clear message to our trading partners. “America does NOT stand for free trade”. If we believe in free trade and the allocative power of markets, then we must let the dinosaurs of American industry meet the fate the natural selection of the marketplace has determined for it.
5. The benefits enjoyed by the few represent costs born by the many: A bailout by the US government of the auto industry will protect a few hundred thousand jobs for a few years at the most but spells a reduction in the disposable incomes and spending power of millions for years to come. The US does not have $25 billion laying around to give the Big Three, which means the money must be borrowed. Increased government borrowing raises interest rates now (further tightening the credit markets) and will result in increased taxes down the road. All government debt must eventually be paid off, and in the immediate future interest on this debt must be paid directly from tax revenue. A $25 billion bailout is the same as a subsidy, meaning it redistributes income and welfare from consumers to producers. Millions are asked to sacrifice for the continued survival of a few hundred thousand in an industry that has failed to evolve in a global auto market that has seen increased competition and efficiency from foreign firms for decades.
6. Moral hazard: Bailing out the Big Three today represent a classic case of moral hazard. When American industries fail to take steps to increase their efficiency and remain competitive in the face of increased global competition, they find themselves not surprisingly on the brink of collapse. To reward these firms by taking money out of Americans’ pockets and handing it to them to do as they will, we send the wrong message and create the wrong incentives in the American economy. The message is: “Don’t worry, the market doesn’t choose the winners and losers in the economy, the government does, and certain industries are too big to fail”.
7. Market failure, or Firm Failure?: The fate of the auto industry is in the hands of the US government. But so is the fate of the free market. My fear now is that the pendulum will swing too far to the left in America’s state of panic over the ill-fated downfall of the financial markets, rooted in the irrational exuberance and over-leveraging of big financial institutions. The failure of the financial markets, however, is an entirely different story from that of a dinosaur industry like automobiles. The Big Three have had decades to reform themselves, lower their costs, improve their products, and remain competitive. THEY have failed, NOT the market. Government intervention is necessary in instances of market failure, but NOT IN CASES OF FIRMS’ FAILURE TO COMPETE IN A WELL FUNCTIONING MARKET like the global auto industry.
8. Inflexible labor markets: I saw the president of the UAW on the news today giving 101 reasons why the government should approve a bailout deal for the Big Three. In fact, the unions that supposedly represent American Auto Workers are a big part of the problem the industry is facing. For decades the UAW has fought against wage and benefit cuts for auto workers, lobbying instead for higher tariffs and other barriers aimed at keeping foreign cars out of the country. This anti-competitive behavior is a major reason the Big Three cannot compete with European and Asian car makers today. Wage inflexibility leads to higher unemployment. Unions keep wages from going down, leaving the Big Three with one of two choices: Drastically downsize your workforce and employ fewer high paid auto workers, or beg the government for a multi-billion dollar subsidy to that the unions can be placated and you can survive for a couple more years until you’re in the same situation all over again. The unions helped cause the problem, now they should pay the price by experiencing the downsizing their demands inevitably foretold.

The US government should allow the free market to function and let the dinosaurs go extinct. Cars will still be made in America, they’ll just be made by the better, more efficient firms that emerge from bankruptcy when this is all over, as well as the numerous foreign firms already making cars in the US. Survival of the most efficient, that’s what markets are all about. Allowing the market to work will strengthen the US auto industry far more than a “short-term low-interest bridge loan” ever will, it will free up labor and capital resources to be employed by industries the country is better at, and make sure household income is NOT reallocated to inefficient firms to be squandered on the manufacture of a product for which demand has steadily declined for the last decade plus.

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?

A trading bloc is “a group of countries that join together in some form of agreement in order to increase trade between themselves and/or to gain economic benefits from cooperation on some level.”

Below is a list of some of the regional trading blocs. The assignment is to:

• Identify the nations involved in your assigned trading bloc
• Identify the kind of trading bloc (customs union, free trade area, common market, monetary union)
• Discuss the impact that membership in the trading bloc has had on the economy of one member nation

Research your assigned trading bloc, prepare a short summary of the points above, and post your findings as a comment below.

• Pacific Regional Trade Agreement (PARTA or PIF) – Christina, Myrthe and Manka
• European Economic Area (EEA) – Lisa and Pia, Lis and Livia
• Caribbean Community (CARICOM) – Catherine and Sean, Maddie
• Union of South American Nations (Unasur/Unasul) – Eithan and Wilhelm, Alex and Gorka
• East African Community (EAC) – Miguel and Ross, Nick and Dierdre
• Southern African Customs Union (SACU) – Horia,
• Greater Arab Free Trade Area (GAFTA) – Calvin, Magda and Robin
• North American Free Trade Agreement (NAFTA) – Nic
• Association of Southeast Asian Nations (ASEAN) – Matteo, Sebastian and Moritz
• Central European Free Trade Agreement (CEFTA) – Meri and Natasha
  
• African Economic Community (AEC) – Palmi and Celine