International Trade

The following sections are included:

• Preface
• Contents
• List of Figures
• List of Tables
• List of Abbreviations
• Acknowledgments

Trade theory has long been at the heart of economics. Adam Smith, the father of modern economics, identified the division of labour as the key to The Wealth of Nations. This is true at any level; an individual can have much higher material living standards by specialising than by being self-sufficient. If one person produces cloth and another produces the necessary pins and needles and a third sews the garment, more clothing can be made than if each person tries to do all the tasks. In the opening chapter of his book, Smith goes a step further, describing a pin factory in which different specialists make the various components and join them together. Such manufacturing was at the heart of the industrial revolution going on around him in Scotland in 1776…

The benefits from specialisation according to comparative advantage can be powerfully illustrated by a numerical example as with the cabbage growers and clock makers in Chapter 1. A more general approach to illustrating the potential gains from trade is to represent all the production possibilities in both countries. For a pair of goods, we can do this in a two-dimensional diagram showing the production possibility frontiers…

The analysis in previous chapters is very general and could apply equally to individuals or any group of individuals as to countries. The clocks and cabbages example could have involved Teddy and Larry instead of Thailand and Laos. What then is the reason for focusing on the nation as the unit of analysis?…

The Ricardian model is a simple and powerful tool for showing the gains from trade in a very general way. It also captures the empirically supported result that comparative advantage reflects productivity differences. However, the simple Ricardian model has weaknesses, most apparent not only in its implication of complete specialisation and in the absence of demand-side analysis but also in its reliance on unexplained differences in productivity to explain trade…

The standard trade model is a general equilibrium model, which highlights the way in which goods and factor markets are interconnected. The fundamental drivers, the production possibility frontier and community indifference curves are difficult to construct, and in a world of many goods and factors tracking all of the general equilibrium interconnections may be overwhelming. For analysing trade in a good which does not form a large part of total trade, and hence has limited impact on the rest of the economy, it is useful to adopt a partial equilibrium approach with the more familiar and operational constructs of demand and supply curves in a single market…

In the general equilibrium neoclassical model, the one-to-one correspondence between goods market equilibrium and factor market equilibrium means that any change in goods prices will affect the functional distribution of income. Thus, opening up to trade or any changes in world prices will affect the relative returns to the owners of different factors of production. In the examples in Chapter 4 where the export good is capital-intensive, opening up to trade is associated with a movement along the contract curve to a new equilibrium associated with a higher price of capital relative to the price of labour…

Although the Heckscher–Ohlin theorem has been at the centre of standard trade theory since the middle of the 20^th century, its empirical relevance has been challenged for almost as long. In perhaps the most famous empirical study in international economics, Wassily Leontief (1953) aggregated US industries into 50 sectors, of which 38 were directly involved in international trade, and depending on the sign of their trade balance, he divided the latter into import-competing and export industries. The capital/labour ratio for the export industries was $14,010 per man-year and for the import-competing industries $18,180 per man-year. Since the USA was clearly the world's most capital-rich country at that time, the finding that US exports were relatively labour-intensive and US imports relatively capital-intensive directly contradicted the Heckscher–Ohlin theorem and became known as the Leontief Paradox…

A frequent criticism of the neoclassical trade theory in Chapters 4 and 5 is that it is static. To some extent the product cycle model was intended to capture a dynamic element of trade patterns missing from the standard theory. There was also a strong sense that trade theory was inapplicable to the policy debate in developing countries whose governments were concerned about increasing incomes rather than about efficient allocation of resources — an attitude that led to many policy missteps in the third quarter of the 20^th century. Yet, growth can easily be introduced into the neoclassical trade model, and the consequences of growth for trade are readily analysable. The reverse relationship between trade and growth, and the policy implications for countries seeking to promote growth and development will be dealt with in Chapter 19…

Economies of large-scale production can increase the potential gains from specialisation and trade. They did not play a major role in the development of neoclassical trade theory, in part because if scale economies alone are important then the pattern of trade may be arbitrary. This was clearly recognised by, for example, Bertil Ohlin (1933, Chapter 3), who argued that factor proportions determined trade patterns and scale economies might offer additional scope for gains from trade. A second problem is that when scale economies are internal to the firm, they are incompatible with perfectly competitive markets…

Just as differences in goods prices provide an incentive for trade, differences in factor returns provide an incentive for international factor flows. The effects can be analysed in a similar way to the effects of inter-sectoral labour migration in the specific factor model. Assuming that a factor of production is internationally mobile in response to differences in factor rewards, the joint output in two countries will be maximised when the return to the mobile factor is equalised in the two countries, but there will be gainers and losers…

The increasing importance of global value chains (GVCs) has been a major feature of the global economy since the mid-1980s. The subcontracting and global scanning phenomena described in Chapter 7 were early steps in the fragmentation of production. Any stage in the value-added of a product can in principle be separated and carried out at the least-cost location as long as the cost-savings are greater than the transactions costs…

Before the 1990s, economists paid little attention to the costs of trading across borders, which were generally assumed to be insignificant or uninteresting. If transport costs were included in trade theories, it was usually through the iceberg assumption, i.e. part of the value of a good melted away as it went from the exporter to the importer. This neglect was challenged by McCallum (1995), who showed that there was a large difference in trade flows when trade crossed the US–Canada border as opposed to trade among US states or among Canadian provinces even though international trade was free of tariffs and non-tariff barriers appeared negligible (Chapter 3). Limao and Venables (2001) used a standardised maritime shipment (containers of World Bank supplies sent from Baltimore) to show that trade costs varied substantially from country to country. Given such results, economists tried to measure trade costs in order to identify and analyse variations…

Understanding of the significance of trade costs and global value chains has been helped by availability of disaggregated commodity trade statistics and powerful desktop computing capacity since the early 1990s. The same forces have encouraged economists to use firm-level data to analyse international trade with the fundamental finding that behaviour varies considerably across firms in the same industry. This posed a major challenge to existing trade theory in which the country and the industry are the units of analysis. The heterogeneous firms literature initially focused on US data, but high-quality datasets soon became available for a variety of countries at differing income levels. Empirical studies with firm-level data confirm that there is a high degree of firm heterogeneity, and most firms do not export at all…

Governments have long intervened in international trade. This chapter analyses the consequences of government restrictions on trade. Any restriction will create a wedge between the domestic and world prices that reduces the potential gains from trade. This wedge can be most simply represented as a tax on imports, a tariff , and historically this has been the most important instrument of trade policy. The following two chapters will extend the analysis to consider other instruments of trade policy, all of which have the effect of introducing a wedge between domestic and world prices…

The theory of trade policy reaches strong policy conclusions about the desirability of free trade for a small country, and even for a large country attempts to take advantage of market power through an optimum tariff are likely to be self-defeating. To a large extent, these conclusions are reflected in actual policy decisions as trade barriers have been substantially reduced worldwide since the 1940s, but they still beg the questions of why trade barriers have often been high and why trade policy debates remain contentious. The answer largely lies in the distributional impact of trade and of trade barriers. Those who benefit from a trade restriction have an incentive to seek protection, and legislators may respond to such pressure group politics…

Tariffs or export taxes are the simplest trade barriers to analyse because they involve only the wedge between domestic and world prices. Other trade barriers not directly based on price can have equivalent effect if they create the same wedge, but non-tariff barriers (NTBs) often involve additional costs. The conditions for equivalence to hold, and plausible circumstances when it will not hold, can be most clearly shown for quantitative restrictions on trade. Other NTBs may be explicitly aimed at non-trade outcomes, e.g. safety and health standards, while indirectly providing barriers to trade; an important policy issue is identifying when the trade effects are acceptable or not acceptable consequences. Finally, this chapter examines procedural measures, such as countervailing or antidumping duties, which are the most contentious trade policy instruments today.

Long distance trade existed for millennia without a formal legal basis, but as with any market, it will function better within a framework of agreed and enforceable rules of conduct and with an accepted means of exchange. With the emergence of modern nations, states began to negotiate formal agreements to regulate their bilateral trade. In the 19^th century, the gold standard emerged as a widely accepted payments system, although actual payments were usually in a currency which was ‘as good as gold’ (such as the British pound) rather than gold itself. This system worked reasonably well in the relative prosperity of the decades before 1914, although lengthy trade wars were not uncommon. Tensions did mount, however, as leading trading nations began to compete for markets, and economic competition turned into world war in 1914. Attempts to restore a global trading system based on moderate trade barriers and fixed exchange rates between 1919 and 1939 were unsuccessful. Countries were unwilling to cede autonomy over trade and monetary policies and in the 1930s adopted trade policies for national motives (e.g. to combat unemployment or to create spheres of influence) that increased international tensions. Key policymakers in the USA and UK saw the lack of an appropriate international economic system as a contributing force to the outbreak of world war, and as something to be put right in the post-war era…

For several years in the mid-2000s, the WTO website contained a paper with the opening sentence — which sounded like a warning — “Regional Trade Agreements (RTAs) are a major and perhaps irreversible feature of the multilateral trading system” (Crawford and Fiorentino, 2005). The website also featured a dramatic graph illustrating this phenomenon by the number of RTAs notified to GATT/WTO (Figure 18.1). It is surprising because the WTO stands for non-discriminatory trade policies and, with few exceptions, discriminatory trade policies, such as RTAs, are illegal, or at least contrary to the spirit of the GATT/WTO…

One of the most influential criticisms of neoclassical trade theory has been that, although it shows the resource allocation costs of trade barriers, it fails to capture dynamic elements of trade policy. This view was at its peak in the 1940s and 1950s, coinciding with global decolonisation and the coming to power of modernising governments in what became known as the Third World. Without exception, these countries adopted development strategies that shielded their economies from international trade…

The relationship between trade and trade policy has always been influenced by trade costs. Before the 1800s, transport costs were a crucial consideration, with trade largely restricted to items of high value relative to their bulk, such as silk or spices or precious stones. European settlement of the Americas was first based on obtaining gold and silver. In North America, tobacco and furs were exported to Europe to pay for the settlers' imported goods. In Australia, a virtue was made out of distance when the first fleet took convicts to the distant location; imports were provided in return for prison services. Goods with high bulk/value ratios, such as beer or building materials, were seldom if ever traded over long distances…

Governments' attitudes towards the global economy and international trade have changed dramatically in recent decades. This was partly in reaction to global events, but mostly in response to evidence-based understanding of the consequences of trade policies. At the same time, popular reservations about globalisation remain strong, and nationalist politicians can often garner wide support by criticising market forces or international institutions and advocating interventionist polices to limit participation in the global economy…

The following sections are included:

• Epilogue
• References
• Index