Modern International Trade and Globalisation - Essay Example

Essay A: International Trade Table of Content Table of Content 2 Introduction 3 This paper labors to discuss the conceptof international trade among trading countries and how such countries benefit from the Principle of absolute advantage and comparative advantage, intra-industry which arises when the country simultaneously imports and exports similar types of goods or services has also been highlighted. A detailed discussion of the trade policy analysis has been shown in this paper mainly on the impact of imposing and removal of trade tariffs on the welfare of producer, consumer, and the government, who benefits and who loses. 3 Principle of absolute advantage and comparative advantage 4 Intra Industry Trade 8 Types of Intra-Industry Trade 8 Horizontal Intra-Industry Trade 8 Vertical Intra-Industry Trade 9 Innovation and dynamic gains from trade 10 Trade Tariffs 11 Trade barriers are often focused on particular industries, and are often ‘cascading’: higher for finished goods than raw materials. Overall levels of trade barriers have declined in recent decades, largely due to international negotiations (Reinert 2012). 11 Types of Tariffs 11 Conclusion 14 Reference List 15 List of figures Figure 1: A Framework for Comparative Advantage …………………………… 6 Figure 2: The Production Possibilities Frontier…………………………………... 8 Figure 3: Tariff Diagram …………………...…………………………………….. 12 International Trade Introduction This paper labors to discuss the concept of international trade among trading countries and how such countries benefit from the Principle of absolute advantage and comparative advantage, intra-industry which arises when the country simultaneously imports and exports similar types of goods or services has also been highlighted. A detailed discussion of the trade policy analysis has been shown in this paper mainly on the impact of imposing and removal of trade tariffs on the welfare of producer, consumer, and the government, who benefits and who loses. International trade is a term used to refer to the exchange of goods and services among the countries of the world (Reinert 2012, P. 30). International trade does not only involve exchange of goods such as steel, automobiles among others it also include exchange of services for example financial services, and engineering services among other services. International trade in goods and services is playing contributes a lot in development of the world economy. International trade is one of the four realms of the world economies the other three include international production, international finance, and international development (Reinert 2012, p 30). Thus to develop the worlds economies and to improve welfare and living standards of everyone, students and professionals must have a good understanding of the international trade. According to Giddens (1999) globalization can be defined as conceptualized in social, cultural, and political, not just economy. Globalization is the integration of economy activities such as international trade, development in financial and currency system, and labor outsourcing, which were supported by technological changes (Valacich & Schneider 2009, p 56). International trade gives birth to a world economy whereby global events affect and are affected by demand and supply (Bhagwati 1964). Trading globally enables consumers and countries to access goods and services that are not available in their own countries or which could be otherwise expensive to produce in their own country. International trade and globalization enhances production efficiency, as developed countries are able to use their resources such as labor, technology and capital more efficiently. Because countries are endowed with different assets and natural resources, some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. Countries which cannot produce a commodity efficiently, can access the commodity by trading with another country that can produce the same commodity efficiently. This is known as specialization in international trade. Principle of absolute advantage and comparative advantage Adam Smith’s principle of absolute advantage and David Ricardo’s principle of comparative advantage, in general, are based on the technological superiority of one country over another country in producing a commodity. Absolute advantage refers to a country having higher (absolute) productivity or lower cost in producing a commodity compared to another country. However, absolute advantage in the production of a commodity is neither necessary nor sufficient for mutually beneficial trade. For example, a country may be experiencing absolute disadvantage in the production of all commodities compared to another country, yet the country may derive benefits by engaging in international trade with other countries, due to relative (comparative) advantage in the production of some commodities vis-à-vis other countries. Likewise, absolute advantage in the production of a commodity is not sufficient, since the country may not have relative (comparative) advantage in the production of that commodity. David Ricardo’s principle of comparative advantage does not require a higher absolute productivity but only a higher relative productivity (a weaker assumption) in producing a commodity. Pre-trade relative productivities/costs determine the pre-trade relative prices. Pre-trade relative prices in each country determine the range of possible terms of trade for the trading partners. Actual terms of trade within this range, in general, depend on demand patterns, which, in turn determines the gains from trade for each trading partner. International trade, through a better allocation of resources, increases incomes, saving, and investment, thus enabling a country to realize higher growth even in fully employed economies (Bhagwati 1964). In addition, for developing countries, trade can enable them to transform consumption goods and raw materials into capital goods as well as gain technological know how from technologically advanced countries. Trade can also provide demand stimulus to the lagging (excess capacity of some factors of production) economies. Furthermore, specialization through trade benefits not only the export industry, but all other industries (through increased demand for their products) related to the export industries. Lastly, by increasing the size of national market and thereby the size of production facilities, domestic firms can reap both external and internal economies of scale. International trade also implies more competitive pressures on domestic firms that stimulate research and development. Figure 1: A Framework for Comparative Advantage (Michael 1990, p.67) All these considerations yielding comparative advantage to the nation may be seen as a framework of a number of forces that can be portrayed in the form of a diamond shown in Figure 1 above, the firms specializing within the industries that have comparative advantage are on a much stronger footing to derive competitive advantage in producing standardized or differentiated products within that industry. In this framework, technology, resources, demand and the trade-enhancing policies are depicted as four forces influencing the comparative advantage of a nation in a commodity/service vis-à-vis other countries. Dynamic elements influencing comparative advantage are also included in these forces. In this essay I have considered Country X and Country Y both produce cotton sweaters and wine to explain how the concept of absolute advantage takes place in international trade. Country X produces ten sweaters and six bottles of wine every year while Country Y produces six sweaters and ten bottles of wine a year. Both can produce a total of sixteen units. Country X, however, takes three hours to produce the ten sweaters and two hours to produce the six bottles of wine. Country Y, on the other hand, takes one hour to produce 10 sweaters and three hours to produce six bottles of wine.  When these two countries realize that they could produce more by specializing on those products with which they have a comparative advantage. Country X then begins to produce only wine and Country Y produces only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products. We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and wine is 20 units of both products. Specialization reduces their opportunity cost and therefore maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease, thus giving an advantage to the end consumer as well. Note that in the example above, Country Y could produce both wine and cotton more efficiently than Country X. This is called an absolute advantage, and Country Y may have it because of a higher level of technology. However, according to the international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization. Figure 2: The Production Possibilities Frontier (Reinert 2012, p 42). In figure 2 above production possibilities frontier (PPF) diagram is showing economy which produces motorcycles and rice. Abbreviation QR and QM, respectively have been used to represent rice and motorcycle respectively. Supply side of this economy has been represented using a production possibilities frontier (PPF) diagram. The production possibilities frontier (PPF) diagram shows the blending of output of rice and motorcycles that the economy can produce given its available resources and technology. The PPF is shown in figure. 2, the PPF is shown as concave with respect to the origin in this figure. Given the available resources and technology, the economy can produce anywhere on or inside the PPF. Point A on the PPF itself is one such point. If the economy were at point A on the PPF, it would be producing QRA of rice and QMA of motorcycles. If the economy were to move from point A to point B, the output of rice would increase from QRA to QRB. However, the output of motorcycles would fall from QMA to QMB. The fall in motorcycles output is an example of a very general and very important concept in economics: opportunity cost. Opportunity cost is what must be forgone when a particular decision is made. If this economy chooses to move from point A to point B, then the decreased production of motorcycles is the opportunity cost of the increased production of rice. Point C is another production point in Figure 2. It is more desirable than either points A or B, because point C provides more of both rice and motorcycles compared with A and B. Point C, however, is not possible given the resources and technology of the economy. Point D, inside the PPF, is feasible. However, in contrast to points A and B, it gives less of both rice and motorcycles. Points A and B are said to be efficient in that, at these points, the economy is getting all it can from its scarce resources. This is false that at point D, and as a result, point D is not efficient (Reinert 2012, p 42-43). Intra Industry Trade Intra-industry trade arises if a country simultaneously imports and exports similar types of goods or services (Reinert 2012). Similarity is identified here by the goods or services being classified in the same “sector”. Suppose, for the sake of argument, that we focus on the sector “cars”. Intra-industry trade then occurs, for example, if Germany exports cars to France and simultaneously imports cars from Italy. On the one hand this raises the question why Germany is (at least partially) exporting cars in exchange for importing cars instead of focusing exclusively on so-called inter-industry trade, namely exporting cars in exchange for importing different types of goods (such as food or airplanes). On the other hand, this raises the question why different goods are lumped together in the same sector, as the exported Volkswagen Golfs differ from the imported Ferraris. Types of Intra-Industry Trade Horizontal Intra-Industry Trade Horizontal intra industry refers to the simultaneous exports and imports of goods classified in the same sector and at the same stage of processing (Reinert 2012). This is likely based on product differentiation, for example South Korea’s simultaneous import and export of mobile telephones in the final processing stage. As these mobile phones is produced using similar technology and provide similar functions they are classified in the same sector. Nonetheless, the exported Samsung telephones differ in appearance and product characteristics slightly from the imported Nokia telephones, catering to the desires of different types of consumers. Vertical Intra-Industry Trade Vertical intra-industry trade refers to the simultaneous exports and imports of goods classified in the same sector but at different stages of processing (Reinert 2012). This is likely based on the increasing ability to organize “fragmentation” of the production process into different stages, each performed at different locations by taking advantage of the local condition vertical intra-industry trade this refers to the simultaneous exports and imports of goods classified in the same sector but at different stages of processing. This is likely based on the increasing ability to organize “fragmentation” of the production process into different stages, each performed at different locations by taking advantage of the local conditions. Economists who studied comparative advantage were once puzzled by the trade between advanced European countries, like France and Germany, because the countries were not very different in terms of technology or resources.  Much of their trade is “intra-industry” trade.  For example, Germany exports Mercedes and BMW cars, but imports Peugeots and Renaults. The basis of this trade is that it enables consumers to have access to a broader variety of goods at lower prices, and enables producers to achieve economies of scale in production through having access to a larger market (Reinert 2012).  When the overall level of output rises, the fixed costs get distributed over a larger number of units, and, hence, the firm’s average costs of production decline.  The reason why, at the extreme, there is not only one firm producing a single type of product is that consumers prefer to choose from different varieties for each product they buy rather than buy the same one each time, i.e. they have a “love of variety”.  Taking the example of food, this means that consumers prefer a selection of different restaurants over one pizza restaurant. Over half of Germany’s trade with a number of European countries is of the “narrowly” defined intra-industry type. With developing countries, a large part of Germany’s trade is based on comparative advantage.  Countries share more intra-industry trade with each other the more similar they are in terms of economic size.  Theories of comparative advantage remain valid for certain sectors and trading partners, where country differences in technology and resources continue to play a role (James, 1821). Do firm or enterprise characteristics affect trade?  Until recently, trade literature has not focused much attention on the role of firms in international trade.  Mainly for simplification purposes, trade theorists typically used the concept of a representative firm, assuming that all firms in a given industry are identical (Reinert 2012). The evidence shows firm or enterprise characteristics do indeed matter.  In reality, most firms, even in traded-goods sectors, do not export at all.  Of those firms that export, only a few export a large fraction of their production.  At the same time, at least some firms export in every industry, with the share of exporting firms being a function of the industry’s comparative advantage (James, 1821). Most importantly, firms that export are different from non-exporters in a number of ways.  They are bigger, more productive, pay higher wages and are more capital and skilled labor intensive than non-exporters.  Further, trade liberalization raises industry productivity (Reinert 2012). Firms that import are more likely to export than non-importing firms, and firms that export are more likely to import than non-exporting firms.  When entry into new export markets is costly, exposure to trade offers new profit opportunities only to the more productive firms that can afford to cover the entry cost. Comparative advantage cannot explain why some firms export but many do not (Brakman &Garretsen 2006, p78). Innovation and dynamic gains from trade Trade can provide many dynamic benefits by provide incentives for firms to innovate. As trade increases the size of the market, it is easier to undertake R&D as these costs can be recoup over a bigger market (Curry & Kenney 2004, p. 92).  Imports embody technology and knowledge travels with the exchange of commodities and inputs.  Trade enlarges the scope of knowledge spillovers.  Trade can enhance competition in the local market.  These dynamic benefits are particularly important for developing countries because most innovations take place in a small number of advanced economies and are later transferred to the rest of the world.  Trade enriches the process of technology diffusion. But knowledge does not only travel North-South.  As the Economist argues, one of the strengths of Japanese manufacturing is the quality of its customers.  Good customers impose strict standards, forcing suppliers to raise their game.  But it is more than that.  The components, tools and materials in which Japanese firms excel are highly customised.  And it is only by working closely with clients over many years that suppliers gain insight into their future technical plans and are trusted to learn about thorny problems that a clever supplier might solve. Once firms become technology leaders, it is harder to unseat them.  All the more so, given that the knowledge about the technology is tacit, not formal (Curry & Kenney 2004). It cannot be transmitted by writing a manual or reading a patent application. Trade Tariffs Trade barriers are often focused on particular industries, and are often ‘cascading’: higher for finished goods than raw materials. Overall levels of trade barriers have declined in recent decades, largely due to international negotiations (Reinert 2012). Types of Tariffs The most common form of duty or tariff is the ad valorem: a tax assessed on merchandise value. In many countries, ad valorem taxes are applied to the value of merchandise, plus the cost of insurance and freight (Brakman &Garretsen 2006). Specific duties are those charged by weight, volume, length, or any other unit (e.g., charging 10 cents per square yard on fabric). Compound duties call for both an ad valorem and a specific duty on the same product. Alternative duties are those where the custom official calculates the ad valorem duty and the specific duty and applies whichever is higher. In addition, a processing fee and a value-added tax (VAT) may be assessed on top of the duties, plus an import processing fee, harbor tax and other taxes (Reinert 2012). Impacts of trade tariffs (who gains and who loses) A trade tariff on imports has the following welfare effects: consumers lose, producers gain, government gains revenue, the economy overall loses (deadweight loss), consumers overall lose much more than producers gain. Figure 3, Tariff Diagram (Reinert, 2012 p81) Figure 3 above shows a specific tariff on Japan’s imports of rice. Figure 3 have been used to show the effect of trade policy on welfare: consumers lose, producers gain, government gains revenue, the economy overall loses (deadweight loss), consumers overall lose much more than producers gain. From the figure 3 above consider Japans market for rice. The domestic Japanese rice supply curve is SJ, demand curve is D. The world price of rice is PW. A tariff of T per tonne of rice is imposed on imports. If the Japanese government imposes a tariff (tax) of T per tonne of rice, Japanese producers (suppliers) and consumers see a price of PW+T. At tariff price PW+T supply rises to Qs tariff demand falls to QD tariff Imports = excess demand = QD tariff – QS tariff = Zj tariff < ZJ. So the tariff implies fewer imports at a higher price. From figure 3 above, the domestic Japanese rice supply curve is SJ, demand curve is D. The world price of rice is PW. A tariff of T per tonne of rice is imposed on imports. With the tariff, T: Domestic producers are better off because they sell more: QS tariff > QS at a higher price PW+T > PW Consumers are worse off because they buy less QD tariff < QD at the higher price PW+T (Reinert, 2012 p.83). It can be derived from figure 3 that a small country’ case, where the importing country cannot influence the world price of the imported good PW is unchanged by the tariff In the large country case, if the importer buys a large fraction of world output, the drop in demand caused by a tariff may cause the world price to drop to: PW tariff < PW (Reinert, 2012 p.83). If the tariff causes a drop in world price from PW to PWtariff these cheaper imports are beneficial for the importing country. The size of this ‘terms of trade gain’ equals the quantity of imports with the tariff imposed multiplied by the drop in price = area E on diagram So for a large country with a terms of trade effect lowering the world price of imports, the net welfare effect of the tariff = -B - D + E Ambiguous – could be positive, negative or zero. In reality, the ambiguous net welfare effect for a large importing country = -B - D + E may often be positive. So - the tariff looks tempting but the fall in world price will harm the exporting country. Which may impose further tariffs in retaliation launching a ‘trade war’ with high trade barriers all round, making all countries worse off. Avoiding this is one of the main purposes of international trade negotiations (Reinert, 2012 p.83). Conclusion In conclusion international trade is the exchange of goods and services among the countries of the world. International trade enhances production efficiency, as developed countries are able to use their resources such as labor, technology and capital more efficiently. Because countries are endowed with different assets and natural resources, some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. Countries which cannot produce a commodity efficiently, can access the commodity by trading with another country that can produce the same commodity efficiently. This is known as specialization in international trade. Adam Smith’s principle of absolute advantage and David Ricardo’s principle of comparative advantage have been explained in details in this essay to show how countries with technological superiority over other countries benefit in producing the commodity. The two types of intra industry: vertical and horizontal intra industry has been discussed to show their impact on factors of production. Trade barriers have been discussed to show their impact on international trade, trade restrictions are shown as a major impediment to development efforts.  Developing countries are unable to sell their products abroad because of high tariffs and quotas. On the other hand Developing countries that do not have the fiscal resources to compete on subsidies will be affected negatively by international trade. Reference List Baldwin, R.E. 1960, "The Effects of Tariffs on International and Domestic Prices", Quarterly Journal of Economics, 74(1) 65-70.  Bergsten, C.F. 1975, "On the Non-Equivalence of Import Quotas and Voluntary Export Restraints", Lexington Books, Lexington MA.  Bhagwati, J. 1958, "Immiserizing Growth: A Geometric Note", Review of Economic Studies, 25, 201-205.  Bhagwati, Jagdish 1964, "The Pure Theory of International Trade", Economic Journal, 74, 1-78.  Brakman, S.,H.Garretsen,C. vanMarrewijk, andA. vanWitteloostuijn, 2006, Nations and Firms in the Global Economy: An Introduction to International Economics and Business, Cambridge University Press. Curry, J. and M. Kenney, 2004, “The Organization and Geographic Configuration of the Personal Computer Value Chain”, Stanford University Press, 113–141. Lipsey, R.G., and K Lancaster 1956, "The General Theory of the Second Best", Review of Economic Studies, 24, p. 11-32.  Lipsey, Richard 1960, "The Theory of Customs Unions: A General Survey", Economic Journal, 70, 496-513.  McIvor, R. 2005, “The Outsourcing Process: Strategies for Evaluation and Management”, Cambridge University Press. Reinert, Kenneth A, 2012, “An introduction to international economics”: new perspectives on the world economy, Cambridge University Press. Magee, S.P. 1973, "Factor-Market Distortions, Production and Trade: A Survey", Oxford Economic Papers, 25(1) 1-43.  Mayer, W. 1984, "Endogenous Tariff Formation", American Economic Review, 74(5) 970-985. (Also in Bhagwati Readings)  Melvin, James 1968, "Production and Trade with Two Factors and Three Goods", American Economic Review, 58(5) 1249-1268.  Metzler, L. 1949, "Tariffs, the Terms of Trade, and the Distribution of National Income", Journal of Political Economy, 57(1) 1-29.  Mill, James 1821, “Elements of Political Economy”, London, Baldwin, Cradock & Joy Read More