11.1 The Gains from TradeCan international trade make people better off?
Specialisation as basis for trade
Just as specialisation can bring benefits at a firm level (through economies of scale) likewise this applies at the level of overall county production where similar economies can be gained from specialisation.
The law of absolute advantage
This is obvious enough. Imagine a simple world with two countries (A and B) and two products (say food and cars).
If A can produce food more efficiently than B and B in turn cars more efficiently than A, then A should specialise in food production and B in cars with trade in both products taking place between them).
The law of comparative advantage
This is even more important (though less obvious).
Even - in the previous example - if A was more efficient at producing both food and cars than B, then specialisation should still take place on the basis of what each country is relatively most efficient.
For example if A was three times as efficient at producing food but only twice as efficient at producing cars, then B, then A has a comparative advantage in food, while B has a comparative advantage in cars.
So A therefore should specialise in food and B in cars (with trade taking place between them).
Perhaps one could appreciate this with a simple – related – illustration. Imagine two students sharing a flat with one student better at both cooking and flat maintenance.
Here responsibilities should be assigned on the basis of comparative advantage. Thus if the first student is a super cook and the other hopeless in this regard and the second reasonably good at maintenance (though not as good as the first), then it makes sense than the first student should concentrate on cooking with the second doing the maintenance.
The importance of the law of comparative advantage is that it creates a case for involvement in trade of all countries (whether developed or undeveloped).
Limits to specialisation
However it does not make sense – even in economic terms – for countries to attain complete specialisation with respect to some goods and services.
For example If Ireland tried to achieve complete specialisation with respect to agriculture, eventually it would become highly inefficient as people with no talent for or interest in farming would have to be employed.
The terms of trade
The law of comparative advantage suggests that overall production will increase through specialisation. However it does not state how gains should be distributed between nations. This is where terms of trade are important
It is defined as
Average price of exports
Average price of imports
Other reasons for gains from trade
Decreasing costs
Economies of scale can be achieved through specialisation thus increasing efficenecy. Indeed this is one of the major reasons for the formation of the EU with its large internal market (free of trading barriers).
Differences in demand
Even if there was no comparative advantage (or cost difference) if there are differences in demand for a product in two countries it makes sense to specialise.
Increased competition
Competition from imports can stimulate greater competition to the benefit of consumers. We are seeing this now in the retail trade in Ireland since the arrival of Lidl and Aldi.
Trade as engine of growth
Trade opens up the possibility of an economy growing much more rapidly trough high export growth.
Non-economic advantages
There can be significant political cultural and social advantages to trade. So for example the formation of the EU was seen primarily as a means of preventing the possibility of another major war in Europe.
Methods of restricting trade
Tariffs (customs duties)
- tax or levy on imports; has a number of effects on consumer, producer, government and distribution
Quotas
- quantitative limitations on imports
Exchange Controls
- limits on taking foreign currency out of country
Export Taxes
Subsidies
Administrative Barriers
Procurement Policies
To protect declining industries
Non-economic arguments
- to preserve the production of a wide range of products in case of war
- refusal to trade with certain countries because of political disagreements
- to preserve a traditional way of life
- to maintain as diverse a society as possible
Arguments in favour of restricting trade
The infant industry argument
- industries may need to be protected the enable them to grow sufficiently to achieve economies of
scale
To prevent "dumping" and other unfair trade practices
- dumping refers to below cost selling
To prevent the establishment of a foreign-based monopoly
To reduce reliance on goods with little dynamic potential
To spread the risks of fluctuating markets
To reduce the influence of trade on consumer tastes
To prevent the importation of harmful goods
To take account of externalities
The exploitation of monopoly power
To protect declining industries
Non-economic arguments
- to preserve the production of a wide range of products in case of war
- refusal to trade with certain countries because of political disagreements
- to preserve a traditional way of life
- to maintain as diverse a society as possible
Problem with protection
There may be better ways of helping industry
World multiplier effects
- as one country's imports represents another country's exports reducing imports ultimately reduces export opportunities
Retaliation
- generally when a country imposes restrictions it imposes retaliatory measures
Protection may encourage inefficiency with respect to production
Bureaucracy
- protectionism can lead to large administrative costs
Types of Trading Agreements
- where countries remove tariffs and quotas against each other but are free to restrict imports
- Free Trade Area
from non-member countries
- a free trade area where countries adopt a common external tariff (and quotas) with respect to
- Customs Union
non-members
- where member countries operate a single market, implying similar taxes, similar laws and
- Common Market
- regulations, free movement of labour capital and materials and common policies in different
economic areas
- fixed exchange rates leading to common currency
- Economic and Monetary Union (EMU)
- common Central Bank
- common macroeconomic policies
- common defence policy
- Economic and Political Union
- centralised decision-making
Direct Effects of Customs Union
• Trade Creation
- where consumption shifts from high cost to low cost producer
• Trade Diversion
- where consumption shifts from lower cost to high cost producer
• Advantages of Customs Union
- increased market size
- external economies of scale
- increased bargaining power of whole customs union
- increased competition between member countries
• Disadvantages of Customs Union
- loss of sovereignty
- possible diseconomies of scale
- increased bureaucracy
- uneven effects throughout union
• Examples of Customs Union
- EU, NAFTA, ASEAN etc
The European Union
No. of countries
- presently 15 members Germany, France, Britain, Ireland, Italy, Spain, The Netherlands, Belgium, Luxembourg, Portugal, Denmark, Greece, Sweden, Austria, Finland
Applicant countries
- to join May 2004; Poland, Hungary, The Czech Republic, Estonia, Latvia, Cyprus,
Malta, Slovakia, Slovenia, Lithuania
Applicant countries - to join 2007; Bulgaria and Romania (Turkey undecided)
From Customs Union to Common Market
Common Agricultural Policy
- artificial high prices set for farm food
Regional Policy
- EU regional policy provides grants to firms and local authorities in depressed regions of the union
Competition Policy
- EU controls restrictive policies and monopoly Harmonisation of Taxation
- this has been carried out with respect to VAT