Theme 4 and 2

• Absolute advantage occurs when a country can produce a product using fewer factors of productions than another nation
• Comparative and absolute advantage assumes; Two countries, two goods, one factor input
• comparative advantage exists when a country is able to produce a good more cheaply relative to other goods produced domestically than another country
• theory of comparative advantage is that countries will find it mutually advantageous to trade, if opportunity cost of production of goods differ
• Countries trade to gain from specialisation and due to differences in factor endowment such as natural, human and physical leading to product differentiation and lower cost of production
• evaluations of comparative advantage

  No transport costs

  No external costs

  No tariffs or trade barriers

  Factors of product are perfectly mobile

  However there are constant costs with no economies of scale and only two economies are analysed which shows generalisation.
• Reasons for changing trade flows

  
  

  • Changes in absolute and comparative advantages
  • Development of emerging economies
  • Growth of trading blocs and bilateral trading agreements
  • Changes in relative exchange rate
• • Intra-regional trade - trade between countries in the same region. 
  • e.g. 27 members within EU. Countries trade the most with those in closest proximity – gravity theory
• Geographical Patterns of Trade

  • Other geographical factors that have also been studied.
  • Physical geography:
  • Shared borders, number of rivers, coastline, resources.
  • Human geography:
  • Shared culture, history, language, religion.
  • Common trading bloc.
  • Colonial origins.
• Commodity patterns of trade

  • The extent of a country’s dependence on primary, secondary and tertiary industries.
  • This helps us analyse the extent to which countries are overly dependent on extract industries
• • The EU is our biggest trading partner
  • 43% of UK exports go to EU - 2019
  • 52% of UK imports come from EU – 2019
  • The US is our largest trading partner country - export market worth £141 bil (16% of total X), 2nd to Germany £56 bil (10% of total X)
  • £30 bil worth of UK exports go to China (6th biggest export market) and 7% of UK imports come from China 
  • The Commonwealth makes up 9% of UK trade (India, Australia, Canada, Singapore and South Africa.)
• Terms of Trade: measures how the prices of a country’s export prices are changing compared to its import prices.

  Can be used as a measure of international competitiveness. 

  Index of export prices / index of import prices * 100
• If export prices rise relative to import prices, we say there has been an improvement in the terms of trade. One unit of exports buys relatively more imports. Generally, this leads to an improvement in living standards as imported goods appear cheaper to consumers.
• f import prices rise relative to export prices, we say there has been a deterioration in the terms of trade. Generally, this leads to a decline in living standards as foreign currency earnings are relatively less expensive and imported consumer goods more expensive.
• factors influencing the terms of trade

  • Changes in relative exchange rates
  • Changes in relative inflation rates
  • Changes in the demand for X/M
  • Changes in relative productivity
  • Changes commodity prices
• Why is an improvement in the Terms of Trade not always a good thing?

  • Ceteris paribus!
  • It depends on the PED of X and M.
  • It is possible for price of X to increase but value of X to decrease.
  • Leading to less export revenue and growth.
• • Why is a deterioration in the Terms of Trade not always a bad thing?
  • As a country becomes more competitive, their cost of exporting may decrease.
  • Lower export prices reduces a country’s Terms of Trade…
• Bilateral: an agreement between two parties.
• • Multi/Pluri-lateral: an agreement between three or more countries.
• • Static Benefits: the gains from specialisation. 

  Net welfare gain > Net welfare losses  
• Dynamic Benefits: the gains from increased competition and efficiency.
• • Custom Unions: members of a custom union not only remove trade restrictions between each other, but also agree to impose the same import restrictions (e.g. CET) on non-member countries. 
• • Common Markets: these not only have no import restrictions between member countries and a common external tariff, but also permit free movement of labour and capital between its members. 

  E.g. all 27 EU members
• • Economic Unions: takes integration a step further by introducing a single currency (monetary union), similar labour market policies and some degree of tax harmonisation (fiscal union).

     E.g. 19 of 27 EU countries who adopted Euro
• advantages of trade;

  Trade Creation – the welfare gain from joining a FTA.

  • Increased competition
  • Lower prices for consumers
  • Greater market size for exporters
  • Greater scope for FDI
• Advantages - Dynamic Gains if:

  • Economies of scale develop
  • Lessens international isolation of countries
  • Brings improvement in government rule of law and state
• Trade Diversion (disadvantages) – when imports shift from low-cost non-member countries to high-cost member countries.

  • Costs and prices may increase if trading blocs divert trade away from more efficient non-member countries.
  • Trading blocs are a “second best” solution. Following WTO principles of trade liberalisation are a “first best solution”. 
  • Gains from trade may be unequally distributed. 
  • Consumers, workers, firms (domestic & foreign).
  • Loss of sovereignty (MP) – Eurozone ECB controls interest rates
• • WTO founded in 1995 – Uruguay round 
  • Based in Geneva – 164 members
  • WTO membership accounts for 99.95% of world trade
  • Average tariffs on manufactured goods have fallen from 40% to 5% since 1979.
• Aim of the WTO;

  1. Reduce tariffs and quotas – trade liberalisation through negotiating agreements
  2. Ensure countries are active participants
• WTO aims

  1. Non-discrimination
  2. Free trade: gradually, through negotiation
  3. Predictability: through binding and transparency
  4. Promoting fair competition
  5. Encouraging development and economic reform 
• WTO - disputes

  Retaliation

  Where the country being hit by illegal tariffs or quotas is allowed to impose its own protectionist measures, up to an equivalent value, against the offending country.

  Aim: 

  • to reduce exports in the offending country
  • …thereby encouraging it to remove its illegal tariffs / quotas
  • …and to continue trading on the basis of Comparative Advantage
• WTO - Disputes

  
  

  Cross-retaliation

  Where a small country, which is being hit by illegal tariffs or quotas from a large country, is allowed to suspend its WTO obligations.

  
  

  Aim:

  • to inflict enough economic damage on the larger country
  • …such that the larger country removes its illegal tariffs / quotas, despite the unequal bargaining power
  • …and to continue trading on the basis of comparative advantage
• WTO - evaluation

  • May spark a trade war a vicious cycle of tariffs and quotas, retaliation, then counter-retaliation,
  • …comparative advantage is no longer the basis for trade - inefficient use of resources…
  • …leading to a fall in global output and living standards.
• WTO - Evaluation

  • Allows rich countries to exploit developing countries:
  • Low wages & poor working conditions.
  • Low prices as global competition increases.
  • Environmental degradation.
  • Erosion of local culture.
• Free Trade – international trade conducted without the existence of barriers to trade.
• • Protectionism – the use of economic policies to regulate trade between countries mainly to reduce imports.
• • Tariff – a tax on imported goods which causes domestic prices of imports to rise and reduces their demand.
• • Quota – a physical limit set on the quantity of an imported good.
• • Subsidy – a grant given to firms which lowers the price of their good, usually to increase production or consumption of those goods.
• • Dumping – the sale of goods at less than cost price by foreign producers in the domestic market.