Trades between the Countries - Essay Example

Comparative Advantage and Short Term Protectionism Introduction The world is passing through a great economic crisis and recession with only few spared in the developing world. Countries such as U.S. and the most part of Europe are facing high unemployment rate for the last several quarters. Globalization accelerated the world trade manifold in the last decade exchanging the goods and services based on the basic tenets of Ricardo’s theory of comparative advantage; however, current high level of unemployment in many developed nations has made them rethink with the free trade policies that are in force since last several decades. How world trade progressed in the past 50 years can be seen from the following graph. World Exports, 1948–2008 (in Billions of U.S. Dollars) Source: http://www.flatworldknowledge.com/pub/international-trade-theory and/199668#web-199659 Below-mentioned graph shows world exports in terms of percentage of world gross domestic product for the year between 1970 and 2008. This indicates how flourishing has been the world trade in the last 40 years. World Exports, 1970–2008 (Percentage of World GDP) Source: http://www.flatworldknowledge.com/pub/international-trade-theory-and/199668#web-199659 To begin with, it would be prudent to know about the basic reasons for trades to take place between the nations. Suranovic (2010) mentions five basic reasons for any international trades to take place. Difference in Technological Ability Trades occur between the countries when they differ in their technological abilities to produce services and goods. The resources used are capital, labor, and land to deliver the output in terms of products and services. Each country will have varying ability to use the inputs in producing the given output. Difference in Resource Availability Again, each country will differ in their resource availability such as mines, minerals, water, and electricity. Heckscher-Ohlin model explains about the trades taking place due to difference in resource capabilities. Difference in Preferences Trades between the countries also occur due to difference in demands. Difference in demands may be rooted in their cultures, beliefs, customs or habits. There are the communities and countries who habitually consume more fish preparations compared to some who are pure vegetarians. Some make their houses using woods and some use more steel and cement while making their dwellings. These innate consuming habits tend to make the demand differences among the countries, which they would fulfill through exchange of goods and services. Economies of Scale in Manufacturing Economies of scale bring down the cost of production. Those who cannot operate at the level of economy of scale of production will be at disadvantageous situation. Global demand will rush to the country where the cost is lowest. Government Policy Regulations Subsidies and various government policy measures put the country either at advantage or disadvantage and as per the benefits trade exchange take place between the countries. The point is that the reason could be any one or many for the trade to take place; however, the theory of comparative advantage is in its root. There are long term benefits of free trade in goods and services to the consumers at large but still there are disputes and discontentment on the matter of free trades. Free trade does give boost to the country’s economy but inefficient domestic producers do not get benefitted from these trades and in the process they suffer most. Their inability to compete with the imported stuff could be for any reason; however, they feel that they need to be protected from the overseas marketers to safeguard the jobs of their workers. Before a tone for discussion on short term protectionism is initiated, it would be quite appropriate to recapitulate the basic tenets as proposed by Ricardo in his famous theory of comparative advantage. Theory of Comparative Advantage and Real World Ricardo put forward his theory of the comparative advantages before the world taking the example of two countries producing two goods; however, in reality many countries are involved in the trade of a single product. The labor was the only factor of production. He assumed goods to be identical across companies producing it. Labor can be reallocated between industries within a country without any bearing on cost. Labor is fully employed. He also assumed that labor and goods markets are perfectly competitive in countries transacting trades. The model assumes costless mobility of labor and full employment; all the labor force will get gainful employment immediately, which is not the case in reality. Labor skillful in a particular job may get full employment but on displacement they may not find themselves skillful in doing the new job. The theory certainly establishes one point that free trade raises aggregate world production efficiency and consumption efficiency but it has several pitfalls. Labor productivity is never a static thing and it changes over time. Full employment is never a reality due to complexity of the market. When labors move from one industry to another, their productivity will never be the same as found previously. (Suranovic, 2010, Ch.2) There seems to be several unrealistic assumptions and the real world scenarios are found much different than all theoretical considerations. All economic models simplify the situation to increase the understanding of the results and at times it becomes necessary also. It never means that the basic insights as proposed by the economic models should be discarded. Ricardian Model does give certain insights through its simplistic assumptions, which need to be extended further while working in a more complex world. (Suranovic, 2010, Ch.2) In order to maximize the total output in the world, the Ricardian Model states that the following conditions need to be fulfilled. a. All resources should be fully employed worldwide. b. Based on the comparative advantage, all the resources should be allocated within countries. c. Let the countries trade freely thereafter. This only implies that how things should be looked at to achieve maximum output and benefits. That is how the well-being of all individuals can be raised despite differences in their relative productivities. (Suranovic, 2010, Ch.2) As per this simplification, every worker and every individual is able to consume more goods after trade. It is somewhat a win-win situation for all. Unfortunately, assumptions made in the Ricardian Model are over simplification of the real world scenarios. Workers are never identical and they cannot move freely from one industry to another without any association of the cost. Once, we overlook these assumptions; it does not remain a win-win situation for all. In the absence of ideal conditions, when a trade between two countries take place, one group of workers gains in real income while another group loses on real income. In short, a free trade redistributes the income within the economy. There are some winners and some losers. In short, free trade benefits those who work in the industry related to export and harm those who work in the industry which is import-competing. (Suranovic, 2010, Ch.2) As an example, the U.S. government was compelled to impose tariffs on imported steel when it was essential to intervene and safeguard U.S. steel makers who were at huge disadvantage while competing with the imported stuff. In the event that U.S. steel makers close down due to their inability to ward off the competition, the displaced workers cannot move to other industries swiftly for various reasons without incurring any cost and acquiring new skillsets and that is where Ricardian Model of trade fails to respond. (Suranovic, 2010, Ch.2) There are proponents of protectionism and government takes various measures to control imports or trades between the countries in goods and services. They employ different means and ways. Some of them can be listed as per the following. Imposing Tariffs This is a kind of taxes levied on the import of goods and services. Tariffs are maneuvered in such a fashion that imports do not harm domestic producers. (Riley, 2006) Quota System Import allowed only in certain quantity is called import in quota system. The glaring example is found in the textile trades in which the U.S. has granted quotas to several countries limiting the imports from them. This is a kind of partial protection granted to their domestic industries. (Riley, 2006) Import Licensing Licenses are provided to importers with certain conditions imposed. Export Subsidies The export subsidies are granted to encourage and increase local production of the goods so that they become more affordable for exports. This is a kind of protection given to the domestic industries to increase and compete in international markets. (Riley, 2006) Exchange Rate Controls This is the most novel way of helping domestic producers by way of administered exchange rate mechanism. Currently, China does not have free floating currency exchange mechanism; all exchange takes place at administered price as per the regulation by the government. (Riley, 2006) Embargoes Embargo means a total ban imposed on imported goods. That happens mostly due to political reasons rather than any economic justifications. (Riley, 2006) Embargoes, quotas, exchange controls and export subsidies are all non-tariff based barriers to the trades between the countries. (Riley, 2006) Although the trades between the countries have benefitted the consumers to a large extent yet protectionists oppose the free trade simply because the large workforce in home country is thrown out of job because industries in which they work cannot compete with the imported stuff. Arguments proposed justifying short term protectionism are listed as per the following. Industries at Infant Stage Certain industries locally do have potential to grow and expand provided some sort of protectionism is provided to them for some minimum period and the argument has some validity. During the period of protectionism, infant industry is expected to come to the international level in terms of efficiency to effectively ward off the competition. After that the protection provided to them could be gradually relaxed so that they compete with international firms. (Riley 2006) Dumping This is another area when some countries try to offload the goods at much lesser price so as to disrupt the business of domestic firms completely. This is one of the major reasons for trade disputes between the countries. Dumping is a form of price discrimination and known as predatory pricing behavior. Usual complaint again dumping is that goods are sold below the cost of production. World Trade Organization considers dumping antitrade and illegal. But the nagging issue for the importer country is that how to prove dumping? It is a time-consuming process to prove that exporter country is dumping the goods below its cost of production. Developed countries give the examples of China, and India for dumping their textiles in their countries. But at the same time they forget that they provide large subsidies to their farmers to the tune of $1 billion a day (Oxfam 2011). After meeting domestic needs, surplus is sold to other countries including developing countries at much lower prices. Local producers of the goods then suffer heavily. Mozambique case is an eye opener when huge quantity of EU beet sugar was dumped to cripple their sugar industry. An example of cotton is worth to take note of how dumping disrupts the local farmers trade and their survival. U.S advocates the philosophy of free trade but provides subsidy to their farmers. Farmers across the world suffer due to this double policy of US. In 2001, U.S subsidies caused the loss of $0.30 billion to the sub-Saharan African countries. Americas cotton growers get richer and thrive on government subsidies at the cost of farmers in other parts of the world. (Oxfam 2011) Protection against Dumping Measures against dumping are taken through anti-dumping laws. When the cost of goods sold by exporting countries is found to be less than their normal value, the goods come under the definition of dumped goods. The normal value is decided based on the value of sale in the exporters home market. WTO definition can be used as a guideline for the countries to identify whether the goods sold in their countries can be called dumping or not. The World Trade Organization (WTO) tries to deal with rules of trades between countries and defining dumping is one of them. The WTO permits government of the suffering country to take action against dumping so as to safeguarded genuine domestic industry. Government needs to show that dumping is taking place. An anti-dumping measure is usually charging import duty on the particular good being dumped from a particular country so as to bring its price as close as possible to its normal value. (Anti-dumping 2011) Arguments against Protectionism Some of the arguments that are put forward by the critics of the protectionism can be described as per the following. Domestic Consumers are Biggest Sufferers Various kinds of measures are employed to protect the domestic industry but they work to the detriment of domestic consumers. The measures taken in the form of tariffs, quotas to restrict the imports hurt the domestic consumers, especially, the poor ones most. Trade restrictions in the form of duties or tariffs increase the prices and cover up the inefficiencies of the domestic producers. It lead to the inefficient allocation of resources in a resource starve nation. It has been estimated that the steel tariff imposed on imports of steel into the US increased the cost of car by $100. In a way, it is a cost borne by society at large. Higher prices mean less disposable income available to the consumers. (Riley, 2006) Protection Brings Laxity in Workforce and Industry Protection causes industries not to reinvent itself for the better utilization of resources. Even labor force becomes lax and do not hone up or improve their skill sets. World has reached to the current state of mass production only through the constant improvement in various processes reducing the use of resources and making the goods available at the minimal cost to the consumers. In ‘80s, Japan used to import the raw materials for most of the goods produced but through sheer innovation and efficiency, it could process these raw materials into finished products at unmatched price and quality. The consumer throughout the world benefitted from their inexpensive and quality products. In fact, it forced producers in other countries to imitate ‘just in time’ philosophy of production to bring down the cost of their products. Protection philosophy does not motivate industry and people to show excellence in their products. (Riley, 2006) There is consensus among economists that free trade policy does bring economic benefit to a large section of population; nevertheless, in a current world economic scenario, the free trade policy is found to be failing on many fronts, especially on the front of employment rate that is not improving in the U.S. since last several quarters. Short-term Protectionism as Viable Solution The U.S. government is spending a huge sum of money as a fiscal stimulus to bring the American economy out of crisis. The U.S. government has spent over $5 trillion either on bail out or as a pure stimulus package in the last 3 years; however, such a huge spending has failed to rejuvenate the American economy. The unemployment rate is still hovering at 9 percent and no sign of any improvement. This is definitely an extraordinary situation. (Stimulus Package… 2010) In such situations, Krugman (2009) argues that there is an economic case for short-term protectionism in favor of American industries, particularly when macro policy is not coordinated internationally. Krugmans argument stands on the different reasoning, which states that the world currently is in a liquidity trap and he is sure that any uncoordinated global attempt to resolve the current impasse would not be effective enough. He advocates ‘Buy-American’ approach, if true benefit of stimulus package has to reach American citizens and workers. The argument has merit in terms of economic sense, especially when U.S. government is coming through several stimulus packages in a row but without any real improvement on employment rate. He argues that there is a short-term case in favor of protectionism. Though he believes that protectionism is certainly a second best answer to the current problem that U.S. is facing; the first best solution to the issue is a global coordinated policy. He further argues that the responses to the current crisis from different countries would be largely uncoordinated one in terms of measure and timing; it will be better for each country to have indigenous solution suiting to their needs. The short term protectionism may make the U.S. much better off from the current economic peril that it is facing since the advent of subprime crisis. This does not, in any case, indicate that Krugman’s argument implies that he is going away from the basic thinking of free trade. He sees the philosophy of ‘Buy-American’ with short term protection extended to the certain group of American industries as a necessity to combat current critical economic situation. Miller Tim (1995) argues in the same line that factors of production are not perfectly mobile and full employment is not a valid assumption. Given the situations, the trade will result into structural unemployment and will not be economically advantageous. He argues protection is needed to protect the domestic industries from the dirty tricks played by exporting countries and dumping is one of them. Conclusion Economists world over are divided and there is a lot of controversy whether the free trade is a panacea for all ills. All theories appear lucrative on paper and to a certain extent in reality but none of them are workable in the most situations. The real world is quite complex and the players that play the game have only one motive in their mind and that is to increase their own welfare. That is why even most good looking theories and practices fail to bring the welfare for masses as usually anticipated. What is a remedy? Remedy lies in extending a short-term and selective protection to the certain group of industries from the onslaught of imported stuff in the manner appropriate to the situation and until the time when global economy turns the tide and starts moving swiftly full steam ahead. References 1. Riley, Geoff (2006), Protectionism, [Online] Available at http://tutor2u.net/economics/revision-notes/a2-macro-protectionism.html [Accessed 16 November 2011] 2. Suranovic, S. (2010), International Trade: Theory and Policy, [Online] Available at http://www.flatworldknowledge.com/pub/international-trade-theory-and/199668#web-199657 [Accessed 16 November 2011] 3. Oxfam (2011), Trade, [Online] Available at http://www.oxfam.org.uk/oxfam_in_action/issues/trade.html [Accessed 16 November 2011] 4. Anti-dumping (2011), World Trade Organization, [Online] Available at http://www.wto.org/english/tratop_e/adp_e/adp_e.htm [Accessed 16 November 2011] 5. Stimulus Package Details (2010), [Online] Available at http://www.stimuluspackagedetails.com/time.html [Accessed 16 November 2011] 6. Krugman, P. (2009), The conscience of a liberal, [Online] Available at http://krugman.blogs.nytimes.com/2009/02/01/protectionism-and-stimulus-wonkish/ [Accessed 16 November 2011] 7. Miller, T. (1995), Is Domestic Market Protection to the Advantage of Most People in the Country? [Online] Available at http://www.economic-truth.co.uk/alevel/marketprotection.pdf [Accessed 16 November 2011] Read More