poli 12d: international relations sections 1,...

POLI 12D: International RelationsSections 1, 6

Spring 2017TA: Clara Suong

Chapter 7International Trade

Plan for Today

§ Today’s office Hours in SSB 353 (not SSB 364)§ Quiz 5§ Review

• What Explains Trade Patterns?• Heckscher-‐Ohlin theory

• Which domestic group does (not) want free trade?• The Stolper-‐Samuelson theorem• The Ricardo-‐Viner theorem

§ Group discussion on the Trans-‐Pacific Partnership (TPP)

INTERNATIONAL TRADE7

The Central Puzzle About International Trade

§ Why do some countries hardly restrict trade while others come close to prohibiting it?

International Trade

§ Today, international trade is largely free.• However, trade policies often differ between industries

§ Trade stands at the intersection of international and domestic politics.• Foreign trade impacts domestic producers and consumers

§ Both domestic and international institutions shape trade policies.

§ To facilitate trade bargaining, a network of global and regional institutions has evolved.

Core of the Analysis

§ Barriers to trade hurt economic growth overall.

§ But trade liberalization creates winners and losers – thus, opponents and proponents.

§ International institutions can help make cooperation on trade policy possible.

What’s So Good About Trade?§ Actors engage in foreign trade to realize the benefits of specialization.

• Division of labor allows society to focus on different economic activities

§ Specialization increases productivity.• However, it requires access to large markets

§ The core concept of the economics of trade is comparative advantage. • A nation gains by specializing in producing and exporting what it produces most

efficiently • C.f. Absolute advantage: the ability to do something better than others.

§ Free trade allows a country to follow its comparative advantage. • Importing goods that we cannot make very well allows us to focus on more

efficient industries

§ Economic logic suggests that imports represent gains from trade.• Protection is costly to consumers

Special Topic: Comparative Advantage and the Political Economy of Trade

§ Absolute advantage:• Producing a good more efficiently than any other country

§ Comparative advantage:• Producing a good at a lower opportunity cost than any other country

• Opportunity cost: what a country forgoes in order to produce a particular good


§ All countries have a comparative advantage in something.• Comparative advantage implies that all countries benefit from trade by specializing

• Countries should focus on the goods they can produce most efficiently

Special Topic: Comparative Advantage and the Political Economy of Trade§ Assume there are two countries, Portugal and England. They can produce cloth or wine.• Assume that the only factor of production is labor; we thus measure production cost in man-‐hours

§ England takes 15 man-‐hours to produce a bolt of cloth and 30 man-‐hours to produce a barrel of wine. Portugal takes 10 man-‐hours for cloth, and 15 man-‐hours for a barrel of wine.


§ England must forgo 2 bolts of cloth to make a barrel of wine (30÷15).

§ Portugal must forgo 1½ bolts of cloth to produce a barrel of wine, or it can give up ⅔ of a barrel of wine to produce a bolt of cloth.


§ The opportunity cost of producing cloth is lower in England, and the opportunity cost of producing wine is lower in Portugal.• What if the two countries specialize, and then trade?

§ International trade increases aggregate welfare: there will be more cloth and wine to go around.

Special Topic: Distributional and Welfare Effects of Trade

§ Consider a country in a state of autarky; there is no international trade. • Prices are determined by the intersection of domestic supply and domestic demand.

§ The supply line is upward-‐sloping and the demand line is downward-‐sloping.

Demand, Supply, and Price in an Autarky


§ The world price is determined by the intersection of global, not domestic, supply and demand.

§ After the country moves from autarky to international trade, the domestic price declines to the lower world price.• The consumer surplus also increases considerably

§ Implications:• Opening trade redistributes income from producers to consumers

• Opening trade makes society as a whole better off

Demand, Supply, and Price in Free Trade


§ A tariff increases the domestic price of a good, quantity demanded falls, and consumer surplus falls. • But producer surplus increases

§ There is also a new region known as the deadweight loss.• This represents the efficiency losses to society from protectionism

§ The artificially high price of the protected good causes consumers to reallocate consumption toward goods that they would normally not buy.

§ Economists as a whole generally agree that tariffs make society as a whole worse off.

Demand, Supply, and Price in Tariffs

What Explains Trade Patterns?

§ Swedish economists Heckscher and Ohlin tried to explain national comparative advantage.

§ Heckscher-‐Ohlin trade theory• Characterizes states in terms of national factor endowments – the material and human resources they possess

§ Basic factors of production:• Land (essential for agricultural production)• Labor (unskilled labor)• Capital for investment (machinery, equipment and financial assets)

• Human capital (skilled labor)

§ Relative endowments determine comparative advantage.


§ The Heckscher-‐Ohlin trade theory argues:• A country will export goods that make intensive use of the resources the country has in abundance

• A country will import goods that make intensive use of the resources in which the country is scarce

§ The pattern of specialization explains trade patterns.


§ Industrial countries are rich in capital and skilled labor.• Therefore, they export goods that make intensive use of these endowments

§ Developing countries are rich in land, raw materials or unskilled labor.• So they export agricultural products, minerals, and labor-‐intensive products like textiles


§ Other economic links such as shared currencies encourage trade.

§ Noneconomic factors such as diplomatic relations also influence trade patterns:• Trade between hostile nations is riskier than trade with friendly nations

• Governments often pursue economic ties with their allies


§ National trade policies are the most important noneconomic source of international trade patterns.

§ Governments attempt to address the interests of corporations, consumers, farmers, and bankers.


Trade Restrictions are the Rule, Not the Exception

§ Protectionism: the use of specific measures to shield domestic producers from imports.• Nearly all governments restrict at least some imports

§ Trade barriers: impediments to the import of foreign goods.


§ Forms of barriers…• Tariff: A tax on imports levied at the border and paid by the importer

• Quota: limits the quantity of a foreign good that can be sold domestically

• Nontariff barriers to trade: regulations targeted at foreign goods


§ In the 1850s, Britain and other leading industrial countries moved towards trade liberalization.

§ Most of the world’s major economies were open and world trade grew rapidly.

§ In 1914, with the start of WWI, international trade relations entered 30 years of crisis.• Trade liberalization restarted after 1945 under American leadership

§ This led to further liberalization, which led to globalization after 1980.

Why Do Governments Restrict Trade?

§ Trade barriers often reflect domestic concerns.• Trade barriers assist national producers, even as they cost consumers more

§ The most direct cost of protection is to consumers of the protected good.

§ Redistributive effect: income is redistributed from domestic consumers to the protected domestic industry.

§ Protectionism also reduces the ability of society to use its resources most effectively.

Winners and Losers in International Trade§ Protection creates returns above the normal rate of profit by artificially restricting competition and supply.

§ Yet, 3 groups lose from trade protection:• Consumers of the imported good• Exporters• Politicians who may be punished by citizens due to the costs that protection imposes on them

Economic Interests and Trade Policy

§ There are two leading theories of trade-‐policy interests.• The Stolper-‐Samuelson approach• The Ricardo-‐Viner (specific-‐factors) approach

§ Stolper-‐Samuelson theorem:

• Protectionism benefits the scarce factor of production but hurts the abundant factor

• Trade benefits owners of factors of production used to produce exported goods.• Heckscher and Ohlin suggest that this will be the abundant factor

• Artificially restricting trade thus hurts owners of abundant factors.

The Stolper-‐Samuelson Approach

The Stolper-‐Samuelson Approach

§ E.g., the US • Abundant capital but scarce unskilled labor (thus, importing labor-‐

intensive goods)• Protection restricts importation of these products and raises domestic

demand for unskilled labor• This helps American unskilled workers (who “own” the scarce factor).

§ We would expect:• owners of scarce factors of production to favor protectionism.• owners of abundant factors to favor trade

§ Criticism of the Stolper-‐Samuelson theorem:• The theorem refers to very broad groups, but most demands for

protection come from specific industries (e.g., farmers or the steel industry)

The Ricardo-‐Viner Approach

§ The Ricardo-‐Viner theorem asks why whole industries often act together.• The answer: some factors of production are specific to particular industries

§ In this model, a worker’s interests flow from her sector of the economy (rather than the factor she owns).

Domestic Institutions and Trade Policy

§ Trade protection helps some groups.• But it harms the economy as a whole

§ Policy institutions that are responsive to more concentrated groups will be more favorable to protection.• Institutions that respond to broad national pressures will be more favorable to trade

§ The logic of collective action implies that small groups are more effective than large ones• Small groups make free-‐riding difficult

§ This tends to favor supporters of protection.• E.g., sugar subsidies benefit sugar farmers (small group) at the expense of American sugar consumers (large group)

§ More cohesive and powerful interests are likely to get more government support.• E.g., farms are well organized while consumers are rarely organized at all


§ Political institutions that are closely tied to narrow interests are more likely to favor protection.• One branch of government may be more sensitive to local pressures than another branch

§ Partisan features of government can also affect trade policy.


Case: Protecting the American Sugar Industry§ The US provides subsidies to sugar growers, guaranteeing

them a high price.• Subsidies come at the expense of American taxpayers

§ The cost to the economy: $640 million a year.

§ One study showed that every $1,000 given to a member of Congress by sugar producers increased the probability that the politician would vote for sugar subsidies by 4-‐7%.

§ Few Americans realize they are paying so much more for sugar.

Case: Protecting the American Sugar Industry

Costs, Benefits, and Compensation in National Trade Policies§ Trade puts unskilled American workers in direct competition with unskilled workers in poor countries with lower wages.

§ Trade will tend to make wages and profits similar across countries.• This is known as factor price equalization• Prices of factors of production tend to become more equal

Costs, Benefits, and Compensation in National Trade Policies

§ While trade liberalization benefits the economy as a whole better, it can seriously harm groups within the country.

§ The government can arrange compensation for people who lose from trade liberalization.• Such a policy would represent a movement toward the “Pareto frontier,” making some better off and nobody worse off

Strategic Interaction in International Trade Relations§ Governments also consider other states’ likely responses when making trade policy.

§ International trade bargaining problems can resemble a Prisoner’s Dilemma.• Both sides would be better off reducing trade barriers

• But concerns about cheating cause both sides to act noncooperatively

Strategic Interaction in International Trade Relations

§ Governments prefer not to remove trade barriers unilaterally.

§ An inability to ensure compliance can make mutually-‐beneficial trade agreements difficult to strike.

Strategic Interaction in International Trade Relations

§ Trade disputes can impede cooperation.• For instance: disputes often involve accusations that one country’s exporters are dumping goods

§ Dumping implies selling goods below the true cost of production in order to drive out competitors and gain market share.

Overcoming Problems of Strategic Interaction

§ Several factors help facilitate cooperation and coordination:• Small numbers• Information• Repeated interaction • Linkage politics

§ These all affect international trade relations.


§ Small numbers make it easy for governments to monitor others’ behavior.

§ Hegemonic stability can ensure cooperation when numbers are large.• The existence of one very powerful nation helps solve collective action and free riding problems


§ Information is crucial in trade negotiations.• Failures of trade cooperation are often due to fears about unseen behavior

§ Repeated interaction between governments provides incentives to avoid cheating.


§ Linking issues allows governments to “trade” cooperative policies.• If you cooperate on my issue, I’ll cooperate on yours

§ International institutions can help overcome collective action and other strategic problems.• Examples: World Trade Organization (WTO), North American Free Trade Agreement (NAFTA)

Institutions in International Trade

§ Institutions can:• Set standards of behavior• Monitor and enforce compliance• Reduce transaction costs

§ Institutional arrangements facilitate trade.• These are often based on the principle of reciprocity: concessions granted by one government must be matched by another

§ Most favored nation (MFN) status:• Countries that grant MFN status agree to extend the same concessions that they provide to all other nations

§ The World Trade Organization (WTO) succeeded the General Agreement on Tariffs and Trade (GATT) in 1995.• Both have been enormously successful in reducing barriers to trade among nations


§ All members in WTO have an equal vote.• But negotiations are generally

dominated by the largest trading states

§ The WTO encourages cooperation by collecting information about trade policies and monitoring national compliance.

§ Countries can file complaints with the WTO.• Complaints are sent to a Dispute

Settlement Body.• The panel investigates and issues a

report that becomes a ruling within 60 days.

• It not overturned, the ruling becomes binding


§ Similar institutions exist at regional levels:

• The European Union started in 1958 with six members; it now holds 27 in a single market

• The North American Free Trade Agreement (NAFTA) includes the US, Canada and Mexico

• Mercosur (the Southern Common Market) contains Argentina, Brazil, Paraguay and Uruguay


Creation of a Single European Market§ Plans for a common European market go back

to the 1920s. What made it possible?• The jolt of World War II• The infusion of foreign capital• A series of international agreements

§ The European Common Market was established in 1957 with six members.

§ Today, citizens of European Union nations can move freely to any other member country to live, work or study.• 15 EU members have adopted the Euro as a

common currency

§ Despite challenges, a single European market has finally won the day.

§ Some praise regional agreements, while others believe they restrict trade with nonmembers.

§ Antiglobalization critics complain that the WTO privileges international corporations above other interests.


Why Have National Trade Policies Varied Over Time?

§ The US was protectionist in the 1920s, but in the late 1940s moved towards trade liberalization.

§ Interests may alter and national political institutions may change.

§ Explanations for the American shift to trade:• The destruction of foreign economies after WWII• The desire to form a pro-‐American Western alliance during the Cold War

• The rise of powerful American manufacturing industries • Institutional changes that gave the president greater influence

Why Do Some Countries Have Higher Trade Barriers Than Others?

§ Interests may differ: differences among nations may be driven by different factor endowments or sectoral features.

§ National institutions also differ.

Why Has the World Trading Order Varied Over Time?

§ Three main causes of open trade relations:• International economic conditions• The role of one or a very few countries• The creation of international institutions

Conclusion

§ Trade policies are controversial not only within a country but also among countries.

§ National trade policies are determined by economic interests, political institutions and interactions with other nations.

Trans-‐Pacific Partnership (TPP)

§ http://www.cnn.com/2017/01/23/politics/trans-‐pacific-‐partnership-‐trade-‐deal-‐withdrawal-‐trumps-‐first-‐executive-‐action-‐monday-‐sources-‐say/

§ http://edition.cnn.com/videos/politics/2015/04/29/tpp-‐tpa-‐trans-‐pacific-‐partnership-‐explainer-‐origwx-‐js.cnn/video/playlists/obama-‐trade-‐deal/

Questions for Group Discussion1. Who are the key actors and what are their interests in

this controversy? 2. What are the relevant institutions/norms?3. Why did the Obama administration initially agree on

the TPP?4. Why did President Trump and other presidential

candidates oppose the TPP?5. Which theory explains the public attitudes toward the

TPP best?• The Stolper-‐Samuelson approach• The Ricardo-‐Viner approach

poli 12d: international relations sections 1,...

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