Slide1: Why Nations Trade REGIONAL INTEGRATION AND COOPERATION UEES LECTURE 1: Why Nations Trade Prepared by: Ignacio W Loor, MIBA – Economist


Slide2: Why do countries trade? Two Fundamentals The rise of middle-man Why do nations export? Why do nations import? Why do countries have different opportunity costs? Absolute and comparative advantage Governments regulation of trade Import restrictions Tariff and non-tariff barriers to trade Export subsidies Consequences of trade restrictions Why countries impose trade restrictions? Liberalization: The “deregulation” of international trade Regional trade liberalization Public concerns about trade Trade and international labor standards Trade and environmental standards Outline


Slide3: Why do countries trade? TWO FUNDAMENTALS: The great majority of international trade takes place between private individuals and private enterprises based in different countries International trade is not a modern invention THE RISE OF MIDDLE – MAN With the emergence of money, the exchange of goods and services became more efficient, but still among neighbors for many centuries Development in transportation and communications revolutionized economic exchanged A wide variety of market actors, individuals and firms, emerged to play supportive roles in commercial transactions – MIDDLE-MEN


Slide4: Why do countries trade? WHY DO NATIONS EXPORT: Countries have tended to sell things to other countries because: Individuals and firms have been able to produce more of certain goods and services than can be consumed at home They have been able to sell goods and services to other countries at prices higher than the prices they can obtain at home For many developing countries exports serve the purpose of earning foreign currency with which they can buy essential imports WHY DO NATIONS IMPORT: No nation today, including USA, can be totally self-sufficient at a cost that would be tolerable to its citizens. Then, countries import because: Goods or services that are either essential to economic well-being or that consumers desire are not available at home Goods or services that satisfy domestic needs or wants could be produced more inexpensively or efficiently by other countries


Slide5: Why do countries have different opportunity costs? Opportunity cost is the cost incurred (sacrifice) by choosing one option over the next best alternative Countries have different opportunity costs because they have different endowments of productive resources Country by country differences in the cost of producing goods and services have a major influence on the direction and content of trade Production inputs are: LABOR, CAPITAL (shorthand for equipment and technology), and LAND & NATURAL RESOURCES Goods and services that mainly require low-skilled labor can be produced at a lower cost in developing countries Goods and services whose production requires relatively large amounts of capital can be produced more cheaply in countries where capital is more abundant and less expensive


Slide6: Absolute and comparative advantage Countries have a mutual interest in specializing in the production of those goods and services that their particular combination of labor, capital, and land will allow them to provide most efficiently and cheaply When a country can produce more of a good with the same resources that another country can, it is said to have an absolute advantage in the production of that good Trade is usually beneficial to both countries even if one has an absolute advantage in the production of both goods that are to be traded Given any two products, a nation has a comparative advantage in the product with the lower opportunity cost The key to securing mutual gains from trade is for all countries to specialize as much as possible in the production of those products in which their efficiency and cost advantages relative to other countries are greatest Countries should devote as much of their national endowments as they can to those things they do best


Slide7: Government Regulations of trade Governments often try to manipulate trade in a wide variety of ways. They do this to achieve economic, political, and diplomatic objectives. There are two basic ways to manipulate trade: By restricting imports; and By encouraging exports IMPORT RESTRICTIONS: Generally take two forms: TARIFFS and QUANTITATIVE RESTRICTIONS TARIFFS and TARIFF RATE QUOTAS Tariffs are taxes on imports of a country or region Two economic purposes: They provide economic revenue to the government Provide economic returns to suppliers to domestic industry that face competition from imports A tariff-rate quota (TRQ) combines the idea of a tariff with that of a quota TRQ set a low tariff for imports of a fixed quantity and a higher tariff for any imports that exceed that initial quantity


Slide8: QUANTITATIVE RESTRICTIONS DOMESTIC CONTENT REQUIREMENTS Intent to stimulate the development of domestic industries by specifying the percentage of a product´s total value that must be produced domestically in order for the product to be sold in the domestic market IMPORT LICENSES Importers are required to obtain a license for each shipment they bring into the country IMPORT STATE TRADING ENTERPRISES STEs Government owned agencies that act as partial or pure single buyer importers in world markets. They also enjoy a domestic monopoly over the local sales TECHNICAL BARRIERS TO TRADE Technical rules about packaging, product definitions, labeling, etc. EXCHANGE RATE MANAGEMENT POLICIES Countries use exchange rate policies to discourage imports & encourage exports PRECAUTIONARY PRINCIPLE AND SANITARY AND PHYTOSANITARY BARRIERS Justification for government restrictions on trade in the context of environmental and health concerns, often regardless of cost or scientific evidence Government Regulations of trade


Slide9: Government Regulations of trade EXPORT SUBSIDIES: Governments regulate trade by providing support to export producers Export subsidies is the transfer of government funds to domestic firms to enable them to offer their products and services abroad at lower prices CONSEQUENCES OF TRADE RESTRICTIONS: According to some experts, the cost of protecting the jobs of workers in vulnerable industries far exceed the potential cost of retraining and finding new jobs for those workers Subsidizing exports can cost governments much more money than would programs designed to shift uncompetitive production into more efficient or internationally competitive sectors WHY COUNTRIES IMPOSE TRADE RESTRICTIONS? Tariffs provide a significance source of government revenues Tariffs protect industries in their earlier stages of development To protect domestic health or safety For political reasons, like the case of “embargo” with Cuba


Slide10: Liberalization: Deregulation Of international trade Following World War II, world´s largest industrial economies created GATT to promote trade liberalization, and the World Bank and International Monetary Fund to better coordinate global economic policy Every time a country suffers an economic downturn, it is always very tempting for political leaders to try to export their problems onto their trading partners by raising tariffs or devaluating their currencies Trade liberalization initiatives have been pursued at the country-to-country level (bilateral level), among groups of neighboring countries (regional level), and in the GATT REGIONAL TRADE LIBERALIZATION During the past two decades most countries that participated in GATT or WTO have joined with neighboring countries to form a regional trade agreement The objective is to increase trade and prosperity through the mutual reduction of barriers to the export of neighboring countries A key premise of regional trade arrangements is that neighboring countries, which sometimes share cultural and language ties, can expand trade more rapidly than can countries separated by great distances


Slide11: Liberalization: Deregulation Of international trade Member States of Selected Regional Trade Agreements Andean Trade Preference Bolivia, Colombia, Ecuador, Peru, Venezuela Arab Maghreb Union Algeria, Libya, Mauritania, Morocco, Tunisia ASEAN Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines Singapore, Thailand, Viet Nam MERCOSUR Argentina, Bolivia, Brazil, Chile, Paraguay, and Uruguay NAFTA Canada, Mexico, and United States


Slide12: Public concerns about trade TRADE AND INTERNATIONAL LABOR STANDARDS: Many labor unions and activists have argued that US should promote improved labor protections in any country with which it negotiates a new FTA The international labor organization of UN upholds a series of labor recommendations: Freedom of association and the effective recognition of collective bargaining Elimination of all forms of forced or compulsory labor Effective abolition of child labor Elimination of discrimination in respect to employment and occupation New FTA might include special provisions that permit restrictions if a country is found to be in violation of internationally accepted standards of labor protection TRADE AND ENVIROMENTAL STANDARDS: Environmentalist argue that increased trade can cause environmental damage They believe countries might do one of the following: Fail to enforce their own environmental protection to attract FDI Invalidate existing national regulations designed to protect the environment Undermine multilateral efforts when they conflict with the existing agreements


Slide13: CASE STUDY THE CASE OF AGRICULTURAL SUBSIDIES: For many years, the government of wealthy industrial countries, including the United States, Canada, Japan, and much of Europe, have subsidized exports of farm products. These subsidies were initially implemented to bolster domestic farmers in their competition with farmers from other wealthy countries, where agricultural production costs tend to be uniformly high. These subsidies have been a source of distress for developing countries that although they may have a comparative advantage in agricultural production, have difficulty competing on the world market against subsidized prices. Developing countries, therefore, have also subsidized their agricultural sectors, further distorting the market and creating the protectionist stand-off that has polarized negotiations on the issue. Reasons that countries may instate export subsidies in the agriculture sector include making sure that enough food is produced to meet the country´s needs; shielding farmers from the effects of the weather and swings in world prices; or preserving rural society. QUESTION: Do you consider fair for a country such as Ecuador to engage in a FTA with an industrialized country that subsidize its agricultural sector? What would it need to be done domestically to take an advantageous position in the event of a FTA with any industrialized country?