ECN202: Macroeconomics

Trade

To trade or not to tradeThis is a question societies must answer and history provides many examples of the battle between those promoting and those discouraging trade. Here we look at the spice trade that played an important role in world history. We will also look at the arguments for and against trade, which you can see in the headlines that follow, and the policy options available to manage trade. In the arguments for trade we use the production possibility curve to make the case and describe the concept of comparative advantage – a key concept in economics.

In the news: Trade is good1. “Industry in India helps open a door to the world”

2. “If it doesn’t kill you, financial globalization will make you stronger”

3. “The case for globalization”

4. “Globalization: The moral imperative”

5. “Indians find they can go home again”

6. “The insourcing boom”

7. “An iPod has global value. Ask the (many) countries that make it”

8. “The new face of global competition”

9. “US is urged to lift ban on foreign scholars”

10.“The third age of globalization”

1. “Free trade on trial”

2. “The tyranny of free trade”

3. “Global roulette”

4. “Trade’s victims: In the shadow of prosperity”

5. “Where your jobs are going”

6. “Dark side of free trade”

7. “Will the nation-state survive globalization?”

8. “Nafta’s promise unfilled”

9. “Storm over globalization”

10.“Skilled workers mount opposition to free trade”

11.“Trade barriers rise as slump tightens grip”

In the news: Trade is bad

Early civilizations

3500 BC unification3200 BC Hieroglphs2500 BC Pyramids

2700 BC Mycenaean

3100 BC Sumerians2200 BC Assyrians1700 BC Hammurabi

7000 BC Mehrgarh2700 BC Harappan

5000 BC Yangshao3000 BC Longshan2100-1600 Xi Dynasty?

Do you see a pattern here?Answer it before moving on

They are all on river valleys – why?

If you missed it?

Spice Trade: The “Problem

Rancid meat

Spices

Do you see a solution?What role did Admiral Zheng and Prince Henry have in the shift the balance of world economic power to Europe by the 16th century?

Portugal - 1419

A“solution” is

Started a series of explorations that “changed Everything.” You can see it in the economic growth or the colonial empires

The “result” is

The “result” is

What can the modern world learn from the history of the spice trade?

OIL

USChina

Europe

We will look at trade with the help of Possibility Curves, so for those who need a refresher on Possibility curves, consider the following Primer.

Possibility Curves & Trade

Possibility Curves

Economics is based on the premise that scarcity exists and this requires society to come up with a system to allocate scarce resources. Scarcity is just as real for decision makers – individuals, businesses, and government – and here we look at a graphical representation of choice situations. For example:1.How would a wharf allocate space between fishing and pleasure boats?2.How would you allocate your time to get better grades?3.How would a firm allocate ad money between print and internet ads?4.How would a government allocate funds between military and domestic spending?

Allocation of wharf space

Let’s look at a wharf in Newport that has 1,200 linear feet of space and each fishing boat is 80 feet and each please boat averages 40 feet. How many boats can be accommodated on the wharf? What is the wharf possibility curve?

This is a scarcity problem because the outcomes / goals are the boats to be docked and the resource/input is dock space. We want to create a graph that shows us the possible outcomes.

Wharf Possibility Curve

P

F

The first thing to do is create the graph by specifying the axes as I have done here. On the vertical axis I measure space committed to pleasure boats (P) and the horizontal axes measures the number of fishing boats (F). It does not matter which variable you put on which axis.

Now we need to draw the possibility curves and it is best to start with the two end points – with the an allocation that give all of the space to fishing boats and one that gives all of the space to pleasure boats.

Next

Wharf Possibility Curve

P

F

If we allocate all of the space to fishing boats then it is a simple math problem – 1,200 feet of space with each fishing boat averaging 80 feet. This allows us to accommodate 15 boats

Max #fishing boats = 1,200/80 = 15 boats

On the graph try to locate the allocation of all space to fishing boats

Next

Wharf Possibility Curve

P

F

We are looking for 15 fishing boats and 0 pleasure since we used up all of the space with the fishing boats.

Here is that allocation

Now what if we used all of the space for pleasure boats?

Next

15

Wharf Possibility Curve

P

F15

If we allocate all of the space to pleasure boats then it is a simple math problem – 1,200 feet of space with each fishing boat averaging 40 feet. This allows us to accommodate 30 boats

Max #pleasure boats = 1,200/40 = 30 boats

On the graph try to locate the allocation of all space to pleasure boats

Next

30

Wharf Possibility Curve

P

F15

Now we just look at all of the other possibilities and this is easy here since all we need to do is draw a line between the two points. We can attain anything on the line (B) if we use all of the space – anything inside the line(A) means we are not using all of the space – and anything outside of the line (C) is impossible.

Next

30

A

B C

Wharf Possibility Curve

P

F15

So what happens if some of the facts change? For example, what happens if 400 feet of docks space is added? Now there is 1,600 feet so we simply redo the math looking at the two end points

Max pleasure = 1,600 /40 = 40 andMax fishing = 1600/80 = 20

Next

30

A

B C

Wharf Possibility Curve

P

F15

The dashed line is the new possibility curve and this I what happens when have additional resources. You can now accommodate more boats on the wharf.

Next30

A

B C

Wharf Possibility Curve

P

F15

What happens if the average fishing boat rises to 100 feet?

To answer this simply redo the math

Next30

Wharf Possibility Curve

P

F15

Max pleasure boat is unchanged = 1,200/40 = 30

Max fishing boat = 1,200/100 = 12

So now plot the new end points

Next30

Wharf Possibility Curve

P

F15

Max pleasure boat is unchanged = 1,200/40 = 30

Max fishing boat = 1,200/100 = 12

So now plot the new end points and connect them and you get the new possibility curve. The possibility curve is inside of the original one because with the bigger fishing boats you can’t accommodate as many boats.

30

12

For some practice create the PPP curve and answer the following questions. Assume Countries X and Y have 100 units of labor that can be used to produce Food and Shelter.•Country X produces 8 Food or 4 shelter with 1 labor.•Country Y produces 1 Food or 2 shelter with 1 labor.

1.Draw the production possibility curves2.Would these countries trade if they could, and what would be the nature of the trade? 3.Who would benefit and who would lose from the decision to trade?

Here is the graph you should use. Try before moving on.

Possibility Curve and Trade

Units of Food

Units ofShelter

Possibility Curve: Country X

Units of Food

Units ofShelter

Possibility Curve: Country Y

Some help

If you are having trouble calculate the end points / intercepts. What would be the production possibility if there was complete specialization in shelter? What would it be if there was complete specialization in food? Then connect the points and you have it/

Assume Countries X and Y have 100 units of labor that can be used to produce Food and Shelter.•Country X produces 8 Food or 4 shelter with 1 labor.

• Specialize in food = 100*8 = 800• Specialize in shelter = 100*4 = 400

•Country Y produces 1 Food or 2 shelter with 1 labor.

• You do this one

Possibility Curve

Units of Food

Units ofShelter

Possibility Curve: Country X

800

400

Units of Food

Units ofShelter

Possibility Curve: Country Y

1. Would these countries trade if they could, and what would be the nature of the trade?

2. Who would benefit and who would lose from the decision to trade?

Look at the graphs below and see if you can see a trade – and to get you going see if you can determine the prices in the countries before trade.

Possibility Curve

Units of Food

Units ofShelter

Possibility Curve: Original

800

400

Units of Food

Units ofShelter

100

200

What is the price of shelter in terms of lost food in the two countries?

Now we will take a break and look at the question: Is trade good?

Make a list of the reasons trade is good and the reasons trade is not good – kind of like one of those lists you are advised to make when making important choices like deciding where to live or what job to take or what person to date. Once you have made that list, check it out against the following lists.

Arguments against trade

1. Unfairness of trade: 2. Economic growth: 3. Infant industry: 4. Loss of diversity:5. Increasing inequality:6. National security: 7. Race to the bottom: 8. Self interest:

The international trade “debate:” The bad

1. "When we buy the manufactured goods abroad, we get the goods and the foreigners get the money. When we buy the manufactured goods at home, we get both the goods and the money." Abraham Lincoln

2. “Will the Nation-state Survive Globalization,” Martin Wolfe, Foreign Affairs J/F 2001

3. “So far globalization has failed the world’s poor.” Tina Rosenberg

GDP per capita: (Nation/ World Average)Increasing inequity

Colonial EmpiresIncreasing inequity

Arguments for trade

1. Economic growth.

2. Power of competition.

3. National security.

The international trade “debate:” The good1. “The greatest improvement in the productive powers

of labour, and the greater part of the skill, dexterity and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour.” … As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market." Adam Smith, The Wealth of Nations

2. “Another set of arguments is political —having to do with the claim that economic integration engenders greater political stability and reduced potential for conflict.”

Economic Growth

Question

How can lower trade barriers be an alternative to higher defense spending as a national security policy – or can trade make the world a safer place?

To answer this think about a country that supplies food and shelter to its people and that a government stays in power if it manages to increase the possibilities for the people. In the possibilities diagram below that is similar to what you already did, the task for the government is to move from A to B. So how do they do it? How does the country expand the possibility curve?

The possibilities: How to get to B?

A

B

Option 1: Resource acquisition (take it)Alexander the Great did

So did the Romans

So did Suleiman the Magnificent

Option 1: Resource Acquisition

B

A

Expand resources = parallel shift in the curve

But…."wealth is usually needed to underpin military power, and military power is usually needed to acquire and protect wealth. If, however, too large a portion of the state’s resources is diverted from wealth creation and instead allocated to military purposes, then that is likely to lead to a weakening of national power over the longer term."  Paul Kennedy, The Rise and Fall of the Great Powers,

Option 2: Production Efficiency

B

Expand productivity in food = shift in the curve (steeper)

Question

How can lower trade barriers be an alternative to higher defense spending as a national security policy – or can trade make the world a safer place?

What is the theory of comparative advantage and why has it been so important in the debate over trade?

More bang for the buck….

"The same energy of character which renders a man a daring villain would have rendered him useful to society, had that society been well organized." Mary Wollstonecraft  1796 (in Canterbery - The Literate Economist

Economic system makes a difference as you can see in the Korea map – and look at China after it changed

Option 3: International Trade

International Trade: Country X

20

40

Production possibility curve

What is the price of food in terms of shelter?

Shelter is twice as expensive as food

International Trade: Country Y

Production possibility curve

What is the price of food in terms of shelter?

5

10

Food is twice as expensive as shelter

International Trade?

20

40

5

10

Would they trade at a 1-1 price? What would they do if this offer was presented to them?

International Trade: Country X

20

40

Production possibility curve

40

Consumption possibility curve at 1-1 price if specialize in Food (because shelter is cheaper through trade) and trade along dotted line

A

International Trade: Country X

20

40

40

Country X shuts down shelter and expands food production – so it moves from A to B – and then it trades at 1-1 along dotted line to reach C – and this is better than A – except for those who lost their jobs

A

B

C

International Trade: Country Y

20

40

Production possibility curve

40

Consumption possibility curve at 1-1 price if specialize in Shelter (because food is cheaper through trade) and trade along dotted line

10

10

International Trade: Country Y

20

40

40

Country Y shuts down food and expands shelter production – so it moves from A to B – and then it trades at 1-1 along dotted line to reach C – and this is better than A – except for those who lost their jobs

10

10

BAC

5

10 20

40

Country X has Comparative Advantage in foodCountry X has Absolute Advantage in food & shelterCountry Y has Comparative Advantage in shelter

Country X

Country Y

The reality: No free lunch - again

"the benefits of international economic integration comes with 'strings' attached: the 'price' of free trade in goods, services, and capital is that international markets get greater say about the way national economies are managed and their wealth is distributed."

Determinants of Trade

1. Technology

2. Public Policies

TechnologyFriedman “Smaller and smaller”

Globalization 1.0 (1800-WWI) – falling transport costs

TechnologyFriedman “Smaller and smaller”

Globalization 2.0 (1980s-2000) - falling telecomm costs

TechnologyFriedman “Smaller and smaller”

Globalization 3.0 – 2000+ underwater fibre-optic cable, diffusion of PCs around world, convergence of software

US Public Policies

• People

– Immigration policies

• Goods

– Trade policies• Tariffs• Non tariff policies

US Public Policies: Immigration

• 1875 Page Act – restrict “undesirables” (Asian forced labor, Asian prostitutes, convicts)

• 1921 Emergency Quota Act – numerical limit of 3% based on 1910 US census

• 1924 Immigration Act – numerical limit of 2% based on 1890 population (restrict E&S Europeans, Middle East, East Asians, Indians)

US Public Policies: International Trade

• 1790 Report on Manufactures (Hamilton / Federalists)

• 1807 Embargo Act (Jefferson / Republican)

• 1816 1st protective tariff

• 1828 Tariff of Abominations

• 1861-1864 Merrill & War tariffs

• 1890 McKinley tariff

• 1930 Smoot Hawley tariff

Krugman

Impact of policiesWhat do you see here? Write it down before reading on.

Globalization – the rise and fall and rise and …

• US < open than Europe before WW II• Japan rapid globalization after opening up in

1854 and during industrialization leading to WW II

• World trade drops after 1929 as result of policies and Great Depression

And then Great Depression

WW II

Post WW II: The Options were

Option #1•Export-led growth

– Build up export industries (textiles…)

•US led– Germany– Japan– Asian Tigers

Option #2•Import-substitution

– Build up domestic industries (steel…)

•USSR led– USSR– China

•Former colonies– India

US policies

Reduce immigration barriers

Tariff Rates in the United States Since 1820

Reduce trade barriers

World Exports, Manufacturing Exports and World GDP 360

200

8

Trade “explodes”

China closes itself off from the world

China opens up and begins to trade

The results are impressive