Comparative Advantages and International Trade Dynamics
Comparative Advantages and International Trade
Gains from Trade: Trade is based on comparative advantages, rather than absolute advantages.
World Development and Globalization
The world has been evolving towards a more liberalized global market, reducing protectionism and creating free trade areas. Tariffs and restrictions have been reduced, leading to the “vertical disintegration” of production. Nowadays, a product may be “produced” in several countries. For example, some parts may be made in China, others in India, assembled in Spain, but designed in Norway.
The idea of globalization, with few restrictions to the movement of goods and money, has been celebrated by some and criticized by others. For certain individuals within a country, trade can indeed make them worse off.
Consider farmers who produce vegetables. If vegetables can be imported at lower rates, what can they do? What are their legitimate expectations? The country is better off paying lower prices, but definitely not them.
Impact of Trade Restrictions
World trade without restrictions:
- Higher prices.
- Fewer consumer choices.
World trade with restrictions:
- Protects national defense and citizens’ health.
- Protects against dumping.
- Lower prices for consumers.
Trade barriers reduce the possible quantity of goods that can be consumed and produced within an economy. Prices will be higher, and there will be fewer choices with regards to consumer goods.
Arguments in Favor of Trade Restrictions
- National Defense – Foreign producers should not be relied upon for the production of defense goods, even if the goods can be produced at a lower cost abroad.
- Infant Industries – Start-up industries in a country may not be able to effectively compete against foreign producers because of their small size. An argument can be made that these industries should be protected until suitable economies of scale can be achieved. If the economies of scale are such that the domestic industry achieves a comparative advantage over foreign companies, the temporary protection will help to achieve better economic efficiency.
Anti-Dumping Measures
The term dumping is applied when foreign producers are thought to be selling goods at prices below their production costs, or below the prices charged in their home market. Retaliatory measures may include the imposition of tariffs, quotas, or fines against foreign producers. The fear is that this “unfair” practice will drive domestic producers out of business and that the foreign producers will then impose monopoly pricing. One argument against this fear is that when prices are raised at a later time, domestic producers can re-enter the market. Deliberately driving other producers out by selling at a loss usually does not work. Another argument against “anti-dumping” is that the country as a whole benefits when foreign-made goods are sold at lower prices than domestic ones.
Key Elements in World Trade
GATT (General Agreement on Tariffs and Trade): GATT was a multilateral agreement regulating international trade. According to its preamble, its purpose was the “substantial reduction of tariffs and other trade barriers and the elimination of preferences.”
WTO (World Trade Organization): The WTO is an intergovernmental organization that regulates international trade. The WTO deals with the regulation of trade between participating countries by providing a framework for negotiating trade agreements and a dispute resolution process aimed at enforcing participants’ adherence to WTO agreements, which are signed by representatives of member governments and ratified by their parliaments.