International Trade: Commerce among Nations

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International Trade: Commerce among Nations

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• Authors: Brad McDonald
• Published: June 15, 2019

Why trade raises living standards

• Trade among nations generally makes the world better off by allowing consumers and firms to buy goods and services produced more cheaply or better abroad.
• When a firm or individual buys a foreign product that better fits needs or is cheaper, living standards in both countries increase: the buyer gains and the foreign producer benefits from larger sales and foreign exchange earnings.
• Though societies as a whole gain, some individuals and firms lose when domestic producers relinquish sales to cheaper foreign competitors.
• Except where production costs omit social costs (for example, pollution), the world is better off importing products produced more efficiently abroad.

Comparative advantage (illustrative example)

• Ricardo: trade is driven by comparative rather than absolute costs; countries export products in which their absolute advantage is greatest and import where it is comparatively less.
• Numerical example from the source:
  • Country A: One hour of labor can produce either three kilograms of steel or two shirts.
  • Country B: One hour of labor can produce either one kilogram of steel or one shirt.
  • Suppose Country B offers to sell Country A two shirts in exchange for 2.5 kilograms of steel.
  • To produce these additional two shirts, Country B diverts two hours of work from producing (two kilograms) steel.
  • Country A diverts one hour of work from producing (two) shirts and uses that hour to instead produce three additional kilograms of steel.
  • Overall outcome: the same number of shirts is produced, while steel production increases by one kilogram—the extra kilogram is the gain from trade.
• Comparative advantage extends to services (for example, writing computer code or providing financial products).

Determinants of trade patterns and gains

• Heckscher-Ohlin proposition: factor endowments (labor and capital) influence comparative advantage—countries export goods that intensively use their relatively abundant factor.
• Countries well endowed with capital should export capital-intensive products; those well endowed with labor should export labor-intensive products.
• Economists view factor endowments as important but acknowledge other influences on trade patterns.

Adjustment, product variety, and growth

• Trade opening leads to adjustment across and within industries: foreign competition pressures less efficient firms, enabling more efficient firms, new entry, and technology adoption.
• Trade enables greater selection across different types of goods and increases product variety (for example, the United States imports four times as many varieties as it did in the 1970s; the number of countries supplying each good has doubled).
• Access to a wider variety and quality of intermediate and capital inputs improves investment efficiency and facilitates innovation, contributing to sustained higher growth.
• Models that incorporate technology transfer and pro-competitive forces find benefits of trade reforms—such as reducing tariffs and other nontariff barriers—are much larger than suggested by conventional models, though such influences are harder to model and results are subject to greater uncertainty.

Why trade reform is difficult

• Trade shifts capital and labor toward more efficient industries, raising economic welfare, but also causes dislocation for firms and workers unable to adjust.
• Adversely affected firms and workers often lobby for protection (tariffs, quotas, export restrictions) while beneficiaries are diffuse and less likely to mobilize.
• Political economy dynamics make opponents effective in trade debates; Thomas B. Macaulay noted that “Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular.”

Trade policies and the WTO

• Reforms since World War II have substantially reduced government-imposed trade barriers, but protection varies by sector and country group (tariffs higher in agriculture and clothing and among less developed countries).
• Services frequently face substantial barriers in areas such as transportation, communications, and often the financial sector.
• Examples of tariff incidence:
  • The United States is reported to collect about 15 cents in tariff revenue for each $1 of imports from Bangladesh.
  • The United States collects one cent for each $1 of imports from some major western European countries.
  • World Bank economists calculated that exporters from low-income countries face barriers on average half again greater than those faced by the exports of major industrialized countries.
• The World Trade Organization (WTO) and its predecessor have crafted agreements since 1948 to promote nondiscrimination and liberalization across tariffs, subsidies, customs valuation and procedures, trade and investment in service sectors, and intellectual property.
• The WTO’s dispute settlement process enforces commitments; under the rules-based system centered in the WTO, trade policies have become more stable, transparent, and open.
• The WTO is cited as a key reason the global financial crisis did not spark widespread protectionism, but challenges remain (for example, the Doha Round) and restrictive and discriminatory trade policies persist.
• Addressing remaining barriers could yield hundreds of billions of dollars in annual global benefits.

Policy implications and recommendations

• Further multilateral trade liberalization can deliver large global gains, especially if reforms reduce tariffs and nontariff barriers while accounting for technology transfer and pro-competitive effects.
• To make trade reform politically feasible:
  • Focus on the greater good and communicate diffuse benefits of trade.
  • Provide targeted assistance to the relatively few who may be adversely affected by trade (for example, policies to help workers and firms adjust).
  • Pursue continued multilateral engagement through the WTO and other fora to reduce restrictive and discriminatory policies.

F&D Magazine — International Trade: Commerce among Nations; Brad McDonald; Back to Basics