MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 2 nd

MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 2 nd edition International Trade 1

8 -2 Key Concepts n Comparative Advantage n Terms of trade n Opportunity Cost n New Trade Theory 2

8 -3 Patterns of World Trade Growth rate in world output and volume of world trade Trade Volume World GDP 3

8 -4 Comparative Advantage n Focus on activities in which disadvantage is least n Produce good/service with lowest opportunity cost n Trade for good with highest opportunity cost n Trade benefits all countries n Key assumptions n Competitive markets n Labor and capital can easily be reallocated n Stable rate of unemployment n Costless transportation n China-U. S. example 4

8 -5 Comparative Advantage n ALL countries benefit from free trade n However, not all countries will be equally well off Gains may not be equal between countries n Depends on terms of trade n n Not all citizens benefit n Country is richer as a whole, but some citizens are worse off n Should these problems stop trade? 5

8 -6 Terms of Trade n Ratio of the price of a country’s exports to the price of a country’s imports n Gains from trade rise with terms of trade n Example: oil-exporters have recently experienced a strong increase in their terms of trade n Application: Prebisch-Singer hypothesis n Hypothesis that agricultural prices, fall in value over time… n Rising productivity in agriculture n low elasticity of demand for agricultural products fall in agricultural prices relative to overall prices and decline in terms of trade n Countries should promote non-agriculture sector or fall behind 6

8 -7 Factor Price Equalization n Factor price equalization Theorem n As trade grows, input prices (wages and the cost of capital) should converge n Both within and across countries § Assumes identical inputs § Productivity-adjusted wages different 7

8 -8 Wages, US $, 2000 Source: BLS 8

8 -9 National Competitiveness: Classical Trade Theory n Trade is not a zero-sum game n Competitiveness concerns imply zero-sum game n Focus on comparative advantage, not competitiveness n Countries do not go bankrupt n Instead of bankruptcy, a country undergoes restructuring of economy n Reallocate labor and capital to new industry n Trade is not adversarial n Caveat: shortrun vs. longrun n Example: Mexico’s competitiveness concerns 9

8 -10 International Trade Theory: New Trade Theory n Economies of scale are important to some industries n Commercial airlines, auto dealers n Economies of scale require large production run, and in turn a large market to sell goods n If no large market, then… n No production of certain goods n Less variety n What’s one way to increase market size for a good? n International Trade 10

8 -11 International Trade Theory: New Trade Theory n Example: n Suppose two countries with annual market for 1 million autos n Before trade: 1 million auto market n After trade: 2 million auto market n Produce more, at lower cost, and greater variety 11

8 -12 International Trade Theory: New Trade Theory n First Mover Advantage n If economies of scale is important (i. e. need a large market) and there has been a first mover, then subsequent competitors will face a barrier to entry n Not enough market demand left for them to operate at level of economy of scale => cost disadvantage n Example: Airbus is spending $14 billion to develop 550 seat commercial plane § Needs to sale 350 planes for venture to be profitable § Demand over next 20 years is for 400 to 600 planes § Room for only one profitable player 12

8 -13 National Competitiveness: New Trade Theory n Don’t necessarily need productivity or factor endowment advantage to benefit from trade…if you are the first mover n Comparative advantage can be created n n Carpet industry, Dalton, Georgia Silicon Valley, California n Comparative advantage should not be accepted as is n Countries should actively promote strategic trade policies n Example: Aircraft industry n Imperfect competition n Increasing returns to scale n U. S. vs. Europe: Boeing vs. Airbus 13

8 -14 Strategic New Trade Theory Airbus Enter Boeing Enter Don’t enter Don’t Enter -$100 m $500 m 0 0 0 • If both firms enter, neither reap lower costs from increasing returns to scale (IRS) • $500 million earning potential…if IRS fully used • Best strategy is consider what the other firm is going to do 14

8 -15 Strategic New Trade Theory Airbus Enter Boeing Enter Don’t enter Don’t Enter $-100 m $500 m 0 $700 m 0 0 0 • Suppose European government promises $200 million subsidy if Airbus produces planes • Regardless of Boeing’s decision, Airbus will now produce…positive earning regardless • Boeing either looses $100 million or withdraws at no lost…easy choice • $200 million subsidy gave Airbus monopoly profits of $500 million and will help 15 create an European comparative advantage

8 -16 Strategic New Trade Theory Airbus Enter Boeing Enter $100 m Don’t enter 0 Don’t Enter $100 m $500 m 0 0 • If Europe and U. S. both subsidize $200 million, both firms will produce • However, profit includes subsidy • Europeans and Americans overpay for aircraft, foreigners benefit • Solutions: • Cartel: agree to set same prices • Move toward niche products • Raise the stakes: higher subsidies 16

8 -17 Strategic Trade Theory n Paul Krugman n Strategic trade policy is tantamount to “beggar thy neighbor” policy n Boost national income at expense of other country n Likely to provoke retaliation and trade ware n Result could be a costly subsidy race between two countries from which other countries benefit n What to do if competitor is subsidizing competing industry? n Better to establish “rules of the game” than to retaliate n WTO n Often government intervention is based on special interest rather than strategic trade theory (economies of scale) 17

8 -18 Arguments for Trade Restrictions n Political Arguments n National Security n Protecting Jobs and Industries n Retaliation n Consumer Protection (health, safety) n Furthering Foreign Policy Objectives n Economic Arguments n Infant Industry Protection n Strategic Trade Policy 18

8 -19 Summary n Trade is an increasing feature of the world economy n Comparative advantage and terms of trade n New trade theory n Arguments for Trade Restrictions 19