International Trade

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International Trade
2
Overview

• I What is International Trade?
• II Theory of Comparative (Absolute)
  Advantage
• III Why do countries trade?
• (Gains and Disadvantages from trade)
• IV Trade Patterns in Singapore

3
I International Trade

• Exchange of goods and services (buying and
  selling) between countries
• Includes all economic transactions that cross
  international boundaries
• Division of labour / specialization
• Openness of an economy ratio of countrys
  exports or imports to its GNP

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Why does trade occur?

• Assuming that I have 2 hours to spare and can
  produce 50 worth of economics lesson in an hour
  or clean 10 worth of rubbish in my room an hour.
  
• What am I supposed to do if need to do both items?

II Theory of Absolute Advantages
5
If I had 2 hours to spare
Cleaning room
Economics lesson
Country
10
50
ME
II Theory of Absolute Advantages
6
Why does trade occur?
II Theory of Absolute Advantages

• Assuming that I have 2 hours to spare and can
  produce 50 worth of economics lesson in an hour
  or clean 10 worth of rubbish in my room in an
  hour.
• What am I supposed to do if I need to do both
  items?
• What if now my neighbour can produce 20 worth of
  economics lesson an hour and clean 30 worth of
  rubbish in an hour?

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If we only had 2 hours to spare
II Theory of Absolute Advantages
Cleaning room
Economics lesson
Country
10
50
ME
30
20
Neighbour
40
70
Total
Any room for negotiations? Gains from trading?
Given the same resource time of 2 hours, what do
you think I am more efficient at doing? My
neighbour?
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If there was specialisation /division of labour
Cleaning room
Economics lesson
Country
0
100
ME
(50)
(10)
60
0
Neighbour
(20)
(30)
60
100
Total
(40)
(70)
Any change to total world output?
II Theory of Absolute Advantages
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For countries to gain, exchange must take place.
But what must be determined before exchange can
take place?
II Theory of Absolute Advantages
For ME, the opportunity cost of 1 Economics
lesson is to give up 0.2 worth of cleaning room
services. Therefore, I will not accept less than
0.2 cleaning room services for an Economics
lesson provided
Country Economics lesson Cleaning room
ME 50 10
Neighbour 20 30
Total 70 40
1 E 0.2 C
1 E 1.5 C
For Neighbour, the OC of 1 Economics lesson is
to give up 1.5 worth of cleaning room
services. Therefore, she will not offer more
than 1.5 cleaning room services for an Economics
lesson.
In the case, the rate of exchange must lie
between the domestic opportunity cost ratios for
the 2 parties.
In order to obtain the benefits of
specialisation, the country must trade. This
depends on the terms of trade
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If there was specialisation and then trade
Are both parties better off with trade?
Country Economics lesson Cleaning room
ME 100 0
Neighbour 0 60
Total 100 60
1 E 0.2 C
(75)
(25)
(25)
1 E 1.5 C
(35)
Terms of trade 1 Econs lesson 1 Cleaning
Room services
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II Theory of Absolute Advantage

• In my example, I have an absolute advantage in
  the production of economics lessons. My neighbour
  has absolute advantage in cleaning rooms.
• Obvious gains from specialisation and trade if I
  produce economics lessons and sell it to my
  neighbour that specialises in the production of
  other goods or services (cleaning rooms).

RECAP!!!!
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II Theory of Absolute Advantage

• A nation has an absolute advantage over another
  nation in the production of a commodity if the
  same amount of resources will produce more of the
  commodity (same amount of a good or service with
  fewer resources) in one nation than in another.
• (Adam Smith)

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Assumptions for AA theory

• 2 countries and 2 commodities
• Perfect competition
• Full employment
• No transportation costs
• Constant returns to scale / (Constant costs)
• Perfect factor mobility within industries but not
  across nations

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Why countries trade?
II Theory of Absolute Advantages
EX.1
Table - Before any trade or interaction
Country Electronics Spices
Europe 100 40
Asia 30 80
Total world 130 120
ELECTRONICS
SPICES
EUROPE
ASIA
Each country devotes HALF of its resources to
electronics production and the other half to
spices production
Qn. (i) Which country has absolute advantage in
which product. (ii) Which should
they specialize in? (iii) What are the
gains from trade after specialisation?
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Why countries trade.
II Theory of Absolute Advantages
EX.1
Both countries specialise in the production of
the commodity in which it has AA over the other.
Each country devotes ALL of its resources to
that production
Country Electronics Spices
Europe 100 40
Asia 30 80
Total world 130 120
(200)
(0)
(0)
(160)
(160)
(200)
What are the gains that can be seen?
After Specialisation
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Why countries trade?
II Theory of Absolute Advantages
Table after specialisation (but without trade)
Country Electronics Spices
Europe 200 0
Asia 0 160
Total world 200 160
1E 0.4S
1E 2.6S
What could be a fair trading price? Terms of
Trade?
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The Terms of Trade

• The Terms of Trade looks at the relationship
  between the price received for exports and the
  amount of imports we are able to buy with that
  money.

Average Price of Exports Terms of Trade
---------------------------------------- Averag
e Price of Imports
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Will all countries have an absolute advantage in
something?

• What happens if you and I were the parties
  involved?
• What happens when one party is superior in
  producing everything?
• Will trade between countries still take place?

II Theory of Comparative Advantages
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What is comparative advantage?

• Principle of Comparative Advantage
• Hence, gains from trade and specialisation
  depends on the pattern of comparative and not
  absolute advantage

Even if 1 of the 2 countries has an absolute
advantage in every commodity, specialisation and
trade can still benefit BOTH countries if each
country has a comparative advantage.
II Theory of Comparative Advantages
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What is comparative advantage?
II Theory of Comparative Advantage

• A country has a comparative advantage in the
  production of a good or service that it produces
  at a lower opportunity cost than its trading
  partners. (forgo less of other commodities in
  order to produce it.)
• Gains from specialisation trade depends on the
  pattern of CA, not AA.

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Theory of Comparative Advantage

• If now the comparison is made between a student
  and me.
• Assuming I can still teach 50 worth of economics
  and clean 10 of rubbish and a student can only
  teach 15 worth of economics and clean 4 worth
  of rubbish
• Is there still an opportunity for trade?

II Theory of Comparative Advantages
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Comparative Advantage
50 economics lesson 10 cleaning room For ME,
the OC of cleaning 1 more room is giving up 5
worth of economics lesson.
Country Economics lesson Cleaning room
ME 50 10
Student 15 5
Total 65 15
ECONOMICS LESSON
CLEANING ROOMS
ME
1C 5E
STUDENT
1C 3E
15 economics lesson 5 cleaning room For
student, the OC of cleaning 1 more room is
giving up 3 worth of economics lesson
Who has the CA in cleaning rooms? In giving
Economics Lesson?
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If there was specialisation /division of labour

• ME has a comparative advantage in the production
  of giving Economics lessons.
• ?Specialize in giving Econs Lesson
• Student has a comparative advantage in the
  production of cleaning rooms.
• ?Specialize in Cleaning Rooms

II Theory of Comparative Advantages
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Comparative Advantage

• David Ricardo (1772-1823), suggested that
  countries will specialise and trade in goods and
  services in which they have a comparative
  advantage.
• When countries have an absolute advantage there
  are clearly advantages to trade.
• However, even with absolute disadvantage in the
  production of all goods relative to their trading
  partners. They are inefficient in producing
  anything, relative to their trading partners.
  TRADE CAN STILL TAKE PLACE
• It is better for a country that is inefficient at
  producing goods or services to specialise in the
  production of that good it is least inefficient
  at, compared with producing other goods.

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Limitations to Specialisation Trade
Some Limitations to the Theory

• High Transport Cost
• Increasing Costs of Production
• Factor Immobility
• Trade Restrictions

II Theory of Comparative Advantage
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Recap Theory of Comparative Advantage
Mini Exercise 2
Mini Exercise 1
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III Why bother trading?

• Why do countries trade?
• Any disadvantages from trade?
• Case of Singapore?

GAINS FROM TRADE
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Gains from Trade
III Why Bother Trading ?

• Supply Side-Cost Factors
• Different endowments production capabilities.
• In Singapore, which of the following product
  would we be unable to enjoy without trade?
• Limited resources, knowledge expertise

WATER
FOOD
ELECTRICAL APPLIANCES
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Gains from Trade
III Why do countries trade?

• Demand Side Factors
• Greater amount and wider range of goods and
  services available
• Lower prices
• Foreign Exchange
• Higher employment
• Trade as an engine of growth
• Transmission of ideas
• Promotes Political Economic between countries
• Limited international mobility of resources

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More goods and services available

• Higher (better) consumption and more variety
• due to exchange, specialization trade
• Increased competition promotes innovative
  production methods, the use of new technology,
  marketing and distribution methods.

III Why do countries trade?
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Lower Prices

• Trading can improve the efficiency of allocation
  of resources.
• Lower costs of production can lead to lower
  prices
• International trade increases the size of a
  firms market. Bigger markets give rise to
  increase in the scale of production (bigger
  volume). Internal or external economies of scale.
  
• Increased competition from foreign imports.
  Foreign imports might be cheaper or would force
  local firms to be search for more efficient
  method of production.
• Prevent monopolies

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Graphical Illustration of benefits
LOWER PRICES
Before trade
Price
Sd
Dd
10
500
Qty
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Graphical Illustration of benefits
LOWER PRICES
After trade
Price
Sd
Dd
10
Sw
6
300
500
700
Qty
Imports 700 300 400
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Foreign Exchange

• Trading of goods and services enables the country
  to receive hard currency (earn foreign exchange
  from exports of abundant resources)
• Allows country to purchase imports it does not
  have or insufficient in supply.

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Higher Employment

• Employment will increase as more exports means
  that more output must be produced.
• Many jobs in Singapore, especially in
  manufacturing and service industries which are
  dependent on trade.

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Engine of growth

• Increase in Economic Growth
• increased volume of exports acts as an injection
  to stimulate AD
• allows countries to enjoy higher output and
  national income
• trade acts as a stimulus to economic development
  though the transfer of new technology and methods
  of production

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Promotes Political, Economic links between
countries

• Trade is used to promote ties with other
  countries
• Countries dependent on each other for trade or
  other activities are less likely to go to war
  with each other.
• Korea Sunshine policy

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Why countries prefer not to trade Disadvantages

• Unfavourable Foreign Competition
• Lack of Economic Diversification
• Economic Instability
• Environmental Problems
• Other Disadvantages

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Unfavourable foreign competition

• International markets are not a level playing
  field as countries with surpluses may dump them
  on the world markets below cost. Eg. Farmers
• Obstruct development of home industries. Some
  advantages are gained over time.
• Jobs might be lost
• structural unemployment may occur

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Lack of Economic Diversification

• Basics of trade is for country to specialise.
• hampers countries from developing
  self-sufficiency. Problems during crisis or wars
• Affected by problems faced by external parties.
  Dependent on the fortunes of a few goods. E.g.
  Recession and loss of essential products

However
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Economic Instability

• Increased domestic economic instability from
  international trade cycles, as economies became
  dependent on global markets.
• The Asian economic crisis in 1998 and economic
  slowdown in the global economy in 2001 illustrate
  this situation.

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Environmental Problems

• Exhaustion of essential resources
• Materials and minerals cannot be replaced
• Loss is even bigger if little benefit to country
• Trade can lead to pollution and environmental
  problems as companies fail to include these costs
  in the price of goods.

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Other Disadvantages

• Adverse Foreign Influences
• import of harmful commodities. Drugs, Alcohol
  etc..
• Exploitation of Workers and Growers
• Cheap Labour and underage/child workers
• Increase income inequality
• Increase in gap between the rich and the poor
• Rich people own more of the assets and benefit
  more from trade.

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IV Singapore Trade Patterns

• The Singapore Economy
• Changing Comparative Advantages and Singapore
• Singapore and FTAs

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Singapores Economy
External Trade 2003 2004 2005 2006
Total trade at current prices (m) Total trade at current prices (m) Total trade at current prices (m) Total trade at current prices (m) Total trade at current prices (m)
Total 515,894 628,952 715,722 810,483
Imports 237,316 293,337 333,190 378,924
Exports 278,577 335,615 382,532 431,559
GDP 160,890 181,539 194,241 209,990
Source MTI Annual Statistics 2006
IV Singapores Trade Patterns
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Singapores Economy
IV Singapores Trade Patterns
Top 5 Trading Partners
Growth
Country
Share


13.1
Malaysia
10.1
11.3
7.6
EU-25
11.1
United States
16.0
27.1
10.5
China
6.1
7.8
Indonesia
Source MTI Statistics 2006
What does Singapore trade?
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Singapore FTAs

• Singapores attitude toward free-trade
  agreements makes a sharp contrast with other
  countries in the region. Singapore only seems to
  become more eager with time when it comes to
  inking FTAs with the rest of the world.
• The city-state already has agreements with a
  host of nations, including the US, Chile, Japan,
  South Korea and New Zealand. Negotiations are
  under way with Jordan and the United Arab
  Emirates, and even with powerhouses India and
  China.

What can de deduced about the pattern of trade
between Singapore and ROW?
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Singapore and FTAs

• A champion for free trade agreements.
• FTAs contributed handsomely to Singapores
  economic growth over the past years esp. external
  trade volume the creation of jobs.
• To meet challenges from India and China, whose
  cheap goods and services can possibly threaten
  Singaporean enterprises
• Augment Singapores minuscule negotiating power
  in the world by associating the country with
  powerful trade partners

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Singapore FTAs
US-Singapore Free Trade Agreement (USSFTA) signed
on 6 May 2003 Include protection of intellectual
property, the inclusion of e-commerce and ICT
services
Singapore-Australia Free Trade Agreement (SAFTA)
signed on November 2002. Covers trade in goods,
trade in services, investment, telecommunication,
financial services,
ASEAN Free Trade Area (AFTA) was initiated in
1992. To reduce tariffs on gs to 0-5 over 15
years
Singapore Comprehensive Economic Cooperation
Agreement (CECA) launched on 27 May 2003
Japan and Singapore for a New-Age Economic
Partnership (JSEPA) launched in 22 Oct 2000.
October 2003, negotiations for the
Singapore-Jordan Free Trade Agreement (SJFTA)
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Singapore Case Study 1 Changing
Comparative Advantages

• With one of the highest per capita income
  levels in the world, Singapore hardly leaps to
  mind as a low-cost offshore location.  However,
  excellent education and infrastructure,
  intellectual property protection and aggressive
  government promotion of the IT and services
  sectors continue to reinforce Singapore's
  position as a favorite location for regional
  service functions.
• A.T. Kearney Study (2004)
• Qn. How does Singapore cope with changing CA
  with with the rise of low cost competitors such
  as China India?

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Singapore Case Study 1 Changing Comparative
Advantages

• With low cost competition faced from emerging
  China India, Singapore is losing its
  comparative advantage in terms of cheap labour
  costs and has reoriented it economy towards
  physical and human capital investment and in more
  recent years, towards an innovation driven one.
• Singapore-based facilities more focused on RD
  and product development, with a core of high-end
  manufacturing eg. Electronics.
• New efforts to restructure the economy to focus
  on knowledge-based industries other high valued
  financial services industries.

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Singapore Case Study 2 Changing Comparative
Advantages

• After enjoying decades of high economic
  growth, Singapores economic growth has slowed
  down. Together with falling fertility rates and a
  fast aging population, Singapore economy shows
  signs that it is maturing
• The Nanyang Economist (2005)
• Qn. With huge economies such as India and China
  growing rapidly, how can Singapore maintain her
  competitive edge and comparative advantage over
  these economies?

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Singapore Case Study 2 Changing Comparative
Advantages

• Increased economic competition from Singapores
  neighbours makes it imperative for Singapore to
  continually seek to remain competitive in the
  global market.
• Move towards capital intensive investment
• making investments in telecommunications,
  logistics, and business infrastructure to remain
  competitive
• create business friendly policies to create a
  compelling case for investment to come to the
  country.
• Continued development of its stock of human
  capital
• ? Ensure its small labour force retains its edge
  over rivals in the region