BerkeleyColumbia EMBA

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Berkeley-Columbia EMBA

• Briefing on International Trade
• Prof. John M. Veitch
• This file available at
• www.usfca.edu/economics/veitch/

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International Trade
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Trade The Big Picture

• Pattern of Trade
• Trade is based primarily on comparative advantage
  and specialization.
• Trade flows may arise from differences in
  technology, endowments, tastes, first-mover
  advantage, random.
• Gains from Trade
• Trade is not zero-sum, there are mutual gains to
  trade.
• But gains may be unequally distributed within a
  country.
• Result is pressure by concentrated groups for
  protectionism.
• Protectionism
• Attempts by government to shield economy from
  trade hurt welfare generally, but may improve
  welfare of sectors.

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Fundamentals of Trade

• Absolute vs. Comparative Advantage
• Gains from specializing in producing goods for
  which have a comparative, not absolute,
  advantage.
• Trade Specialization
• Nations specialize their production and trade for
  what they have a comparative disadvantage in.
• Relative Wages
• What matters for trade is relative cost versus
  relative productivities.
• Mutual Gains from Trade
• Increased range of consumption choices for each
  nation relative to no trade (autarky).

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Winners and Losers from Trade

• Trade specialization result in
• Lower prices and higher domestic consumption for
  imported products.
• Domestic Consumers benefit from lower prices and
  larger quantity and/or variety purchased.
• Large number of people each with small gains
• Collectively large gains to the economy.
• Domestic Producers hurt as firms suffer losses,
  leave industry and workers lose jobs.
• Small number of firms/people each with
  significant losses
• Collectively NOT a big loss to the economy.
• Ignores dynamic effect on economy as workers move
  from losing to winning industries our export
  firms.

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Instruments of Trade Policy

• Tariffs are taxes levied on imported goods.
• Specific Tariff levied as fixed amount on each
  unit of goods imported.
• Ad Valorem Tariff a tax levied as a fraction of
  the value of goods imported.
• Export Taxes or Subsidies levied on exported
  goods.
• Either as specific tax (subsidy)or as an Ad
  Valorem tax (subsidy) on exports.
• Non-Tariff Barriers (NTBs)
• Import Quotas Limitations on the quantity of
  imports.
• Export Restraints Limitations on quantity of
  exports (usually imposed by exporting country).
• Other NTBs

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Tariff for a Small Country
Price, P
2. Consumer surplus falls by areas
a b c d
SH
3. Producer surplus rises by area a
4. Government revenue rises by area c
5. Deadweight loss (cost of protection)
b d ( prodn loss consump loss)
DH
PW
D0
S0
Quantity, Q
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Other NTBs

• Government Procurement Provisions
• Restrict purchase of foreign goods by home govt
  agencies.
• Domestic Content Provisions
• Reserve some of value-added product sales to
  home producers.
• Administrative Classification
• Import duty depends on classification, gives
  leeway to customs.
• Restrictions on Services Trade
• Less visible. Restrict foreign provision of
  certain services.
• Health, Safety, or other Standards
• Some standards reflect not safety concerns but
  restrictions on imports.

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Industrial Policy as an NTB

• Two firms, one industry, new aircraft decision.
• Produce or Not Produce.
• Payoff Table at right.
• Payoffs to each given strategy choice of other.
• Assume particular structure.

• Features
• If both firms choose to produce new aircraft,
  both suffer losses.
• If either firm is sole producer, then they make
  substantial profits.
• Equilibrium
• Advantage to firm that moves first. First-mover
  captures entire market, no incentive for other
  firm to enter. No unique equilibrium.
• A firm could guarantee market if had a credible
  commitment to enter.

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Subsidies as an NTB

• Targeted Govt subsidy can provide a credible
  entry commitment.
• Assume EU guarantees Airbus a 25 mill. Subsidy
  to produce new aircraft.
• New Payoff Table at right.
• Payoffs to Airbus change.

• Features
• Profitable for Airbus to enter regardless of
  Boeing strategy.
• Boeing knows Airbus will enter, so Boeing will
  not to avoid loss.
• Equilibrium with Subsidy
• Subsidy ensures Airbus produces new aircraft
  Boeing does not enter.
• EU Subsidy acts as deterrent to U.S. firm, allows
  EU industry to capture industry.

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World Trade Organization (WTO)

• General Agreement on Tariffs and Trade, GATT
  (1947)
• Multi-lateral commitment to reducing trade
  barriers, sponsored
• Kennedy Round (1962 67)
• Tariffs reduced average 35 on 2/3 of
  manufactured goods.
• Tokyo Round (1974 79)
• Tariffs fall 1/3 on manufactures, restrict NTBs,
• Non-reciprocity principle for developing
  countries.
• Uruguay Round (1986 93)
• Tariffs fall 34 on manufactures, agricultural
  subsidies cut 36
• Textile quotas (MFA) phased out 2005, natl
  treatment for services under GATS, establish WTO
  to replace GATT.
• World Trade Organization, WTO (1995)
• Doha Development Round (1999 ongoing)
• Focus on tariff reductions for development,
  agriculture tariff reductions, trade-related
  intellectual property issues (TRIPs), other
  Singapore issues

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Issues in Trade Negotiations

• Doha Development Round (1999 ongoing)
• Tariff reductions for development
• G21 countries vs. G7
• Agriculture tariff reductions
• G21 Cairns Group vs. EU and US
• Trade-related intellectual property issues
  (TRIPs)
• Singapore issues
• Government Procurement programs
• Investment treatment
• Financial Service access
• Anti-Globalization (Seattle 1999)
• Anti-sweatshop campaigns, Child Labor opponents
• Fair trade advocates
• Trade and the environment, labor, women, etc.

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Other International Organizations

• International Monetary Fund (IMF)
• Established as central bank to support
  Bretton-Woods system of fixed exchange rates
• Now International Lender of Last Resort for
  countries with debt and/or currency crises
• World Bank
• Established as international bank to promote
  development for poor countries.
• Used to fund large infrastructure projects (dams,
  etc)
• Recent focus on sustainable development and
  addressing income inequality

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International Capital Mobility

• Foreign Direct Investment (FDI)
• Movement of capital that involves ownership and
  control.
• Generally involves foreign subsidiary of
  Multi-National corporation (MNC)
• Flow of real capital primarily affects nations
  production or income.
• Foreign Portfolio Investment (Hot Money)
• Capital flows that do not involve ownership or
  control.
• Flow of financial capital primarily affects
  nations Balance of payments or exchange rate.
• Considerable international capital mobility
  today.
• Capital should flow to areas where expectation of
  higher return.

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Reasons for FDI

• Firms invest abroad
• as response to large and growing international
  demand for their products.
• to secure access to mineral or raw material
  supplies.
• to access markets with high tariff or non-tariff
  barriers. EU Tariff factories to get behind
  the tariff wall.
• in countries with low relative wages.
• as defensive measure to protect market share.
• as means of risk diversification against economic
  or exchange rate fluctuations.
• Developed country firms invest in countries with
  similar per-capita incomes, and so similar
  demands for products.

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Regional Trade Blocs

• Free Trade Area
• All members of the bloc remove tariffs on each
  others products but retain independence in
  setting trade policy with non-members.
  Possibility of transshipments within FTA.
• Customs Unions
• All tariffs removed between members and common
  external trade policy for nonmembers common
  external tariff.
• Common Market
• All tariff barriers and all barriers to factor
  movement removed between members plus common
  external trade policy.
• Economic Union
• Common market plus unification of economic
  institutions and economic policies. If adopt
  common currency adopted then termed a monetary
  union..

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Trade Diversion or Creation?

• Trade Creation
• Regional trade bloc leads to shift in product
  origin from higher cost domestic producer to
  lower cost producer in member country.
• Similar effect to moving to free trade.
• Trade Diversion
• Regional trade bloc leads to shift in product
  origin from lower cost non-member producer
  (before tariff) to higher cost producer in member
  country.
• Opposite effect to moving to free trade.
• Regional Trade Arrangements desirable if Trade
  creation greater than trade diversion.

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The European Union
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The European Union

• Treaties of Rome, etc.
• 1951 establish European Steel and Coal Community
• 1957 European Economic Community established.
  Goal - Integrated market in goods, services,
  capital people.
• European Community (EC) expands from original 6
  to 15 members in 1973. Continues periodic
  expansion.
• 1968 eliminated tariffs on intra-EC trade
  adopts common external tariffs.
• High growth rates of members 1961-1970
• Disappointingly low growth 1970s-1980s
• 1986 Single European Act sets removal of all
  internal market restrictions for 1992. European
  Union
• Political implications of establishing
  supra-national institutions
• Cultural and social dimensions to economic
  liberalization

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The Euro,

• European Monetary System (EMS)
• 1979 creation of new monetary unit, ecu plus
• Exchange Rate Mechanism, ERM
• European currencies linked target exchange rates
  within tight bands supported by all European
  governments.
• European currencies as a whole float against ,
  yen, etc.
• Termed the snake.
• European Monetary Union (EMU)
• 1991 Maastricht Treaty established goal of
  common currency.
• 1999 11 of 15 EU countries fix exchange rates to
  begin.
• 2000 new currency, the euro, , begins to
  circulate, national currencies retired. Euro
  floats against all other currencies.
• Required new central bank, the ECB, and strict
  set of rules on national fiscal policy.

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Monetary and Fiscal Policies

• European Central Bank (ECB)
• Based on U.S. Fed Reserve model.
• Set monetary, interest rate exchange rate
  policies.
• Currently worries about high inflation, strong ,
  and slow economic growth.
• European Fiscal Policy
• High unemployment and social benefits.
• Future problems with state pension schemes.
• High budget deficits relative to Stability Pact
  level of 3 of GDP.
• Agricultural subsidies and enlargement.

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EU Accession

• May 1, 2004 saw enlargement of EU to include
• Poland, Czech Republic, Hungary, Slovak Republic,
  Slovenia, Lithuania, Cyprus, Latvia, Estonia, and
  Malta
• Features of these countries
• Majority were socialist until at least 1989
• All have much smaller economies and much lower
  per capita GDPs than existing EU members (except
  for Greece).
• Majority have increased trade with EU greatly in
  past 5 years.
• 2002 share of EU in exports - 63 up from 53 in
  1995
• Increase in foreign direct investment capital
  flows from EU to these countries in anticipation
  of accession.
• Many have large fiscal problems with mushrooming
  public debt, high levels of unemployment,
  potential political instability.
• Also migration, financial market stability, and
  infrastructure concerns.

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EU Trade Issues

• Agriculture
• Common Agricultural Policy (CAP), recent
  announcements, relation to enlargement.
• GMOs
• Soybeans, beef and hormones, Microsoft, finance
• Industrial Subsidies
• Airbus Boeing, National champions, Golden
  shares
• Labor and (non-) migration
• Lack of mobility across countries
• Problems with pensions and social benefits.

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Mercosur
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Mercosur

• Southern Cone Common Market (Mercosur)
• Established 1991 by Argentina, Brazil, Paraguay
  and Uruguay.
• Chile and Bolivia join later as associates.
• Combined population exceeding 200 million,
  combined GDP over 1 trillion.
• Customs Union
• No tariffs between members, common external
  tariff.
• Also agreement on capital no restriction on
  flows and protection against expropriation
• 1995 Intellectual property protections approved.
• Trade diversion
• Widely acknowledged that Mercosur has resulted in
  significant trade diversion, i.e. trade shifted
  into Mercosur and away from rest of world.

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Financial Currency Crises

• Argentina
• 1970 1991 Argentina experienced high rates of
  inflation and rapidly depreciating currency.
• Several monetary and currency reforms over period
• Peso to austral to new austral to new peso.
• 1991 - Currency board that fixes peso 11 to the
  US
• Gives up ability to conduct independent monetary
  policy.
• Stabilizes prices and exchange rate, increase
  exports
• 2002 - Currency board collapses
• Combination of
• Unsustainable fiscal deficits.
• Collapse of Brazilian real and appreciation of
  the US
• Leads to export decline and falls in real GDP

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International Debt Crises

• Argentina (2002)
• Declines in economy exports and rises in public
  debt lead to instability in financial markets.
• Suspends payments on its external debts in Dec
  2001
• Restricts withdrawals of deposits from banks.
• Abandons currency board on January 2002.
• Consequences
• Large depreciation in the peso, collapse of
  currency board to flexible exchange rate regime.
• Large increase in external debt burden (mostly in
  ).
• Decline in real wealth, instability in banking
  system, increases in unemployment, weak economic
  situation.

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Policies to Avoid Crises

• Chile
• Economic Policy
• Generally free market-oriented
• Private pension scheme, fiscal balance
• Property rights secure, political stability.
• Independent central bank.
• Trade
• Member of many bilateral trade agreements
  Mexico, Canada, Ecuador, US, Venezuela
• Member of APEC (Asian Pacific Economic Co-op)
• Uniform tariff of 6 on all goods from other
  nations.
• Capital Flows
• Had restrictions on capital flows INTO economy.
• No restriction on capital flows OUT OF economy.

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Current Fads In Trade
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The Twin Deficits

• Savings Investment in an open economy.
• Output Equilibrium Y C I G NX
• Rewrite as Y - C (-TT) - G
  S I NX
• (Y T C) (T-G) I NX
• Re-arrange as NFI S - I NX
• If Net Foreign Investment NFI negative, then
  inflow of foreign saving into domestic economy
  and trade deficit simultaneously.
• Balance of Payments 0 (under Flexible Exchange
  rates)
• Current Account Capital Account
• Current Account approx. equal NX Net Exports.
• Capital Account approx. equal -NFI -(Savings
  Investment)
• Now think about Japan versus the U.S. in terms of
  capital flows instead of trade flows.

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Intellectual Property (TRIPs)

• TRIPs
• Geographic name brand protection, also wines
  spirits
• TRIPs and Biodiversity
• TRIPs and Piracy
• Problems with widespread piracy in many countries
• Movies, albums, books, etc
• Luxury Brand Name retail goods
• Brand name manufactures auto parts, etc
• TRIPs and Public Health
• Patent medicine unavailable to poor countries at
  affordable price.
• Pressures to use unlicensed generics
• Widespread problem of copied drugs and unlicensed
  generics
• WTO agreement on compulsory licensing for health
  emergencies.

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Outsourcing

• Trade that occurs when services can be sourced
  more cheaply overseas i.e. jobs outside U.S.
• Potential Benefits
• Lower wages allow cost savings.
• Less regulation allow higher productivity.
• Flexibility and lower operating leverage.
• Potential Problems
• Communication and coordination.
• Reliability and productivity.
• Bureaucratic restrictions.
• Privacy, intellectual property, breeding
  competition.
• Rapid adjustments in wages and other input costs.
• Sweatshops, environment, human rights

Risk minimization of sourcing NOT price
minimization
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Responses to Outsourcing

• Maximize sourcing
• Generic components from China.
• Changing or just-in-time components from Mexico.
• Complex components final assembly in U.S.
• Bundling
• Meet customer needs by providing bundled
  components.
• Reduce customer assembly costs, improve quality,
  customize to customer needs.
• Improves pricing power and customer stickiness.
• Low volumes, high product mix
• Use higher skill labor to move between many small
  batches of custom products.
• Contract manufacturer or fab for high end, low
  volume items.
• Innovate in High Value or Tech industries
• Identify core competency as innovation and
  skilled labor/capital.
• Innovate and produce 1st generation in home
  market with skilled labor and high-tech
  production.
• Move 2nd generation products off-shore to low
  cost producers.

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China

• The Next Big Thing?
• Major demographic and macroeconomic problems
• GDP grows at 8 but needs 12-15 m new jobs each
  year.
• Population of 1.28 bn but average disposable
  income 545
• Well below 5000 level where discretionary
  spending takes off.
• Easy credit insolvent banking plus fixed
  exchange rate have led to an overheating economy.
• Major structural economic problems
• State-owned enterprises (SOEs) receive majority
  of credit but most essentially bankrupt - if
  there actually was bankruptcy.
• TVEs and private sectors small starved of
  investment.
• Rule of man not rule of law so concern about
  corruption, property rights, patronage,
  bureaucracy, etc.
• Leas t problems with intellectual property,
  technology licensing, long term investment,
  quality of investment, etc.