UGBA 101B

Briefing on International Trade

Prof. John M. Veitch
Overview of International Trade
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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Dissimilar Nations and Trade
Countries will export goods that use their abundant
factors intensively and import those goods that use their
scarce resources intensively. (Hecksher-Ohlin Model)
Comparative advantage arises from having certain factors of
production in relative abundance.
Developed countries have relative abundance of skilled labor
while Developing countries have abundance of unskilled labor..

Effects of trade:
1. Trade results in mutual gains at national level.
2. Countries specialize in goods that use their abundant factors
intensively and trade these to ROW.
3. Abundant factor of prodn gains from the opening of trade, while
scarce factor of prodn loses from trade.
4. Predicts the proponents and foes to free trade agreements
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 Relative Factor Endowments
Estimates for 1966
Capital/Labor Capital/Land Labor/Land
Country ($ per worker) ($ per hectare) (workers per hectare)

Argentina $2,827.0 $101.7 .036

Australia 7,415.5 67.2 .009

Canada 10,583.1 198.0 .019

France 6,878.5 3,136.9 .456

Hong Kong 1,368.5 90,739.1 66.304

Japan 3,358.5 5,286.5 1.574

Mexico 1,684.8 122.9 .073

United Kingdom 4,359.6 5,169.8 1.186

United States 10,260.9 1,058.6 .103

Source: Bowen, Leamer, & Sveikauskaus, AER 1987

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 Convergence of Real Wages
Real Hourly Wage in Manufacturing
(as Percentage of U.S. Wage)

Country 1959 1970 1983 1990

Japan 11 24 51 108

Italy 23 42 62 100

France 27 41 62 101

U.K. 29 35 53 82

Germany 29 56 84 118

Average 24 40 62 102

U.S. 100 100 100 100

Source: IMF, OECD, and US BLS

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 Similar Nations and Trade
Trade between developed nations seems different than
trade between developed and less developed nations.
Much Intra-industry Trade in differentiated products
Often characterized by Imperfect competition or Increasing
Returns to Scale technologies
IRS = Average Cost per unit for output falls as output rises.
Several sources for gains from trade.
Expansion of IRS sector leads to pro-competitive gains:
Profit effect and decreasing average cost effect.
Gains from trade may be captured as increased product
diversity or lower average costs or both.
Pattern of trade may depend on historicval accidents or
strategic govt policies.
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 Sources of IRS
Internal Economies of Scale
When cost per unit for output depends on the size of the
individual firm but not necessarily on the size of the industry.
(Think Natural Monopoly)
Typically results in advantage to few, large firms acting in
imperfectly competitive manner. (Think Regulated Utilities,
Microsoft, etc)
External Economies to Scale
When cost per unit for output depends on size of the industry but
not on the size of any one firm. (Think knowledge spillovers.)
Typically results in industry of many small firms acting as perfect
competitors. (Think Silicon Valley, Multi-media Gulch, etc.)

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Sources of External Economies
External Economies to Scale occur at the level of the
industry, rather than the individual firm.
Sources of External Economies
Clustering of Specialized Suppliers.
Localized industrial cluster of firms collectively create market
large enough to support specialized equipment or support.
Pool of Specialized Labor.
Localized industrial cluster collectively create & support
market for specialized labor. Benefits both labor & firms.
Knowledge Spillovers.
Localized industrial cluster of firms create informal exchange
of ideas and knowledge for innovation.

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Product Cycle Model
Based on presumption that introduction of new product conveys
temporary monopoly in market.
New product requires highly skilled labor to produce
As product matures, it becomes standardized or can be imitated.
Comparative advantage shifts to nations with cheap labor.
Technological Gap model emphasizes time lag in imitation.
Product Cycle model emphasizes standardization process.
Stage I: New Product Phase Produced/consumed in innovating country only.
Stage II: Product Growth Phase Rising demand at home & abroad leads to
exports from innovating country.
Stage III: Product Maturity Phase Product standardized, prodn licensed to
others.
Stage IV: Imitation I Phase Imitating country undersells originator in ROW.
Stage V: Imitation II Phase Imitating country undersells in originators market.
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 Summary of IRS Models
1. Gains from IRS occur in addition to gains from
comparative advantage. Theories are thus
complementary to Standard Trade model results.
2. Pattern of specialization, and thus trade patterns,
inherently arbitrary. Possibly dependent on historical
factors, open to strategic interventions (first mover
advantage) to capture highest welfare effects.
3. IRS models offer more possibilities for gains from trade.
4. Empirical evidence indicates IRS important determinant
of trade flows for countries size of Canada or Western
European nations.
Primarily rationalization of manufacturing.

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Current Fads In Trade
Free enterprise made this country. Free trade will
destroy it. For five years, Ive been advocating a 20
percent tariff on all imports.
We can either do that, or our industrial base will erode to
the point where we cant build products to defend
ourselves in the event of war.
Our people will walk the streets because we are
exporting jobs and importing welfare.
June M. Collier, President,
National Industries, Inc., 1985
 I. - EU Trade Issues
Agriculture
Common Agricultural Policy (CAP), recent announcements, relation
to enlargement.
GMOs
Soybeans, beef and hormones
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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III. - 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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II. - 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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 II. - 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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IV. 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: Risk minimization of sourcing

Communication and coordination. NOT price minimization!
Reliability and productivity.
Bureaucratic restrictions.
Privacy, intellectual property, breeding competition.
Rapid adjustments in wages and other input costs.
Sweatshops, environment, human rights

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IV. - 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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