Lecture 7(iii)
Announcements
Start thinking about policy proposals for Global Issue 2: International Trade for next week’s platform debate.
Can look at the web page for global issue 2 for ideas.
Lecture
1 More on trade based on comparative advantage.
2. Trade based on increasing returns.
3. Application to trade between nations?
4. Trade between China and the U.S.
Comparative Advantage
Robinson PPF
Op. Cost 1 Fish = 1/3 Coconuts
Produce / ConsumeAutarky / 12 F, 4 C / 12F, 4 C
Trade / 24F, 0 C / 12F, 12 C
as a Basis for Trade
Friday PPF
Op. Cost 1 Fish = 3 Coconuts
Produce / ConsumeAutarky / 4 F, 12C / 4 F, 12 C
Trade / 0 F, 24 C / 12F, 12C
Robinson/Friday Trade
Trade Based on Comparative Advantage
David Ricardo: 1772-1823
Low skill country: specialize in labor intensive,assemble sneakers
High skill, high capital country: do
design, marketing, engineering
Comparative Advantage Trade
Actual Economy
Warm Climate Temperate
Climate
Low Skill High Skill
2. Increasing Returns and Gains from Trade
Suppose ppf looks like:
Opportunity cost one more fish falls as fish production increases
(One reason: learning by doing)
Can specialize and make:
24 fish, 0 coconuts
or
0 fish 24 coconuts
Or try to do both and make
7 fish and 7 coconuts
“Jack of all trades but master of none”
With autarky might still might do both even if not particularly good at either task without specialization.
Robinson in autarky
Perhaps produce and consume 7 coconuts and 7 fish.
Now suppose Robinson can trade with clones of himself? What do we expect to happen?
Specialization!
Robinson 1:
Produces ____ Fish ____Coconuts
Robinson Clone:
Produces ____ Fish ____Coconuts
Each consumers
____ Fish ____Coconuts
Increasing Returns
Robinson 1 PPF
Produce / ConsumeAutarky / 7 F, 7 C / 7F, 7 C
Trade / 24F, 0 C / 12F, 12 C
as a Basis for Trade
Robinson 2 (clone) PPF
Produce / ConsumeAutarky / 7 F, 7C / 7 F, 7 C
Trade / 0 F, 24 C / 12F, 12C
Robinson 1/Robinson 2 Trade
Trade Based on Increasing Returns
We can enjoy increasing returns and more product variety.
Paul Krugman Adam Smith
-
Trade Based on Increasing Returns
Actual Economy
Rich Country 1 Rich Country 2
Trade Based on Increasing Returns
Interest in the theory driven by the empirical observation that much trade is between similar countries
U.S. and Canada,
U.S. and Europe
U.S. and Japan
all high skill countries.
With increasing returns, through trade possible for:
(1) have large production volumes of any given product
(2) consumers have a large variety
Suppose Minnesota were a country
Suppose autarky. (No trade with other states or countries)
Car: Ranger Pickup
Movies:
Music:
Other Stuff
With trade, we can enjoy more variety than this
Discussion of Policy
Robinson/Friday Trade
(Comparative Advantage Trade)
· Example, trade sugar for corn
· The analysis of tariffs and quotas from last class applies and protectionist policies like tariffs or quotas lower total surplus, though they do benefit suppliers
Robinson1 Robinson2 trade
(Increasing Returns Trade)
· General analysis of policy much more complex (can’t do it with Econ 1101 tools, need more advanced tools.)
· We do have enough tools to see that protectionist polices have the potential to screw things up. (Building a wall to separate Robinson 1 from Robinson 2 will hurt both.
· But it is also to possible to write down models strategic trade policies can potentially be advantageous for a country.
· In this models, typically scale economies are very important, and they may be only room in the world for one of two players in a strategic industry. (For example, some economists would argue these considerations apply for a market like the jumbo set such as the Airbus A380)
· IMPORTANT CAVEATS
o Politicians can be tempted to use these arguments for a political cover when they don’t apply (For example, they might try to make a “strategic trade argument’’ to justify sugar quotas which would be ridiculous
o Even if the strategic trade arguments are applicable, it may not be possible for the government to do a good job “picking winners and losers.”
“Infant Industry” Argument?
Something like an increasing returns argument. Industry needs to get to a certain size to be successful. Can government help out to can get the ball rolling.
U.S. had high tariffs in 19th century (Alexander Hamilton)
Again: Have to be careful with arguments like this. Can make a theoretical case that this might work in principle, but the government might be bad at picking winners and losers. (And subsidies and trade protection might just go to good lobbyists))
That said, let’s look at the successful developing economies, How are they doing it?
Export led growth
Original “Asian Tigers
(Korea, Taiwan, Singapore, H.K.)
Now China (manufacturing)
and India (services, some manufacturing)
Different than the earlier failed policies of “import substitution” to set high tariffs to lock up domestic markets. (1950s-to 1980s)
(India’s economy was terrible during this earlier period.)
Comparative Advantage Trade
Robinson/Friday
Comparative Advantage Trade
China US
But what at about? Tech design?
Solar Panels?
Wind Turbines?
Increasing Returns likely plays role.
U.S. Debt
Issues for the U.S.
· Seems to have a comparative advantage in consumption. (Not such a great thing for future success!)
· Great in idea creation. A problem here is that China often just imitates and takes the ideas for free. (China plays off European and American firms against each other to get knowledge transfer. China won’t buy stuff without it.)
· China subsidizes exports
o Directly
o Indirectly through currency policy, China is effectively subsidizing exports and taxing consumption (Buys $ at rate of $billion a day to keep dollars expensive and the Chinese currency cheap.
o Through these subsidies, China makes more widgets than it otherwise would.
In the issue of trade between the U.S. and China, an important point is that the trade is based on a combination of Robinson/Friday trade (comparative advantage)
and
Robinson 1/Robinson 2 trade (increasing returns)
China is enjoying massive scale economies as it begins to dominate many industries.
If pure Robinson/Friday trade, then free trade is always beneficial (overall). When Robinson 1/Robinson 2 trade is mixed in, things get tricky and the best course not always clear.
Probably a good idea to be wary of becoming totally dependent on China for basic needs. The recent controversy about rare earth elements is a good example. Rare earths are used in many high-tech applications like the battery powering a Prius and in Tomahawk missles. As recently as 1995, the U.S. was the leading producer. China now has 97% of the market and is beginning to exploit this monopoly power (export taxes and controls to keep the price high).
(See Paul Krugman’s article in this week’s New York Times. The link will be the Global Issue 2 Link Page at Moodle)