ECON 201 Chapter 5 The U S

ECON 201 Chapter 5 The U. S. & the Global Economy

Learning Objectives • All about U. S. international trade! • Comparative advantage, specialization, and international trade. • How exchange rates are determined. • How and why (for God's sake!) government sometimes interferes with 'free' trade. • 'Free-trade zones' and the World Trade Organization.

We are linked with everyone Trade Flows Goods & Services United States Economy Resource Flows Capital & Labor Other Information & National Technology Flows Economies Information & Technology Financial Flows Money

Dependence • When you become engaged in international trade, over time, you become dependent on your trading partners and they become dependent on you. • We depend on bananas, coffee, raw silk, tin, diamonds, and natural rubber. • We provide semi-conductors, aircraft, chemicals, cars, etc.

Trade patterns • Trade deficit – when imports exceed exports – We have had a deficit in goods for many years. Everyone wants to sell here. Why? • Trade surplus – when exports exceed imports – We have had a surplus in services for many years. Everyone wants us to help them. Why?

Exports of Goods & Services – 2005 Selected Countries as a Percent of GDP Belgium Netherlands South Korea Germany Canada New Zealand Italy France United Kingdom Spain Japan United States 87% 71% 44% 40% 38% 27% 26% 25% 13% 11%

U. S. Trade as a Percentage of GDP Inflation Adjusted to Dollar Value in 2005 Exports Imports

Comparative Exports - 2004 Germany United States China Japan France Netherlands Italy United Kingdom Canada Belgium South Korea Mexico Russia Taiwan Singapore $593 $566 $912 $819 $449 $358 $349 $347 Billions of Dollars $317 $307 $254 $189 $184 $180

Financial linkages • How does a nation such as the US obtain more goods from others than it provides to them? We borrow money. • We are the world’s largest borrower of foreign funds.

What fueled rapid trade growth? • Transportation technology – the globe is shrinking! • Communications technology – duh • General decline in tariffs – everyone is slowly getting rid of tariffs so they can have more ‘free trade’. • Multinational corporations – doing business in several countries to ‘spread out’. • New participants - noone can argue that China and India haven’t had an effect on international trade.

Specialization • If someone else can produce the good better and cheaper than you, why not purchase it from them and put your now-available resources to work on something else? • Specialization increase the productivity of a nation’s resources. • Specialization results in greater overall output and income for everyone. • Examples: airplanes and bananas.

Comparative Advantage • Definition: we can make it better and cheaper than you. • Example in the book: CPAs vs House Painters. The CPA can hire the painter to paint his house because the CPA can better use his time to do people’s taxes…like the painter’s!

Why are they good? • Specialization based on comparative advantage improves global resource allocation • Through specialization and international trade, a nation can overcome the production constraints imposed by its domestic restraints

Exchange rates • Foreign Exchange markets – places where the currency of countries is exchanged. • When you buy a good from another country, they want to be paid in their currency. • Exchange rates can be deceiving…example: needing tickets to ride!

What can change the rates? • Example: if we buy cars from Japan, they want to be paid in Yen. So the more cars we buy, the more Yen we need to buy them. • When something is more in demand, the price of it goes up. • So we need more dollars to buy more Yen. That means the dollar has ‘depreciated’ in value…. a ‘weak’ dollar.

What can change the rates? . . . cont. • If, however, the Japanese want more American cars, then the demand for dollars goes up. • When something is more in demand, the price of it goes up. • So now the dollar is more valuable, so the dollar has ‘appreciated’… a ‘strong’ dollar.

How does the gov’t get involved? • Protective tariffs – shielding domestic producers from foreign competition • Import quotas – limiting how many items can be imported • Nontariff barriers – making it difficult to import… red tape!! • Export subsidies – payments to domestic producers to export…like farming!

A Misunderstanding • A commonly accepted myth is that the greatest benefit from international trade is increased domestic employment. • This suggests that exports are ‘good’ and imports are ‘bad’. • The true benefit is gaining the use of local resources and local output potential by using our resources for other things.

Politics is powerful • Trade may harm a domestic producer or industry which has a powerful ally in gov’t. • Sometimes they are small in number, but have much as stake, so they have a strong incentive to pursue political means. • It is very difficult for the American people as a whole to speak up and complain about footing the bill!

Costs to society • Tariffs and quotas are good for domestic producers, but bad for domestic consumers, who pay higher prices than they should. • Example: steel – Good for steel plant who won’t have to compete on a level field with foreign producers. But it is bad for the local construction company who now pays a higher price for steel than he would otherwise.

Trade Agreements • Smoot-Hawley Tariff Act – meant to reduce imports and stimulate domestic production. It is generally accepted it was a contributing factor in the Great Depression. • Reciprocal Trade Agreements Act – if a nation gains “most-favored nation’ status with the US, then they can benefit from reduced tariffs if we make agreements with others.

Trade Agreements…cont. • General Agreement on Tariffs and Trade (GATT) – tariffs on thousands of products were reduced or eliminated, and things like advertising, legal services, tourism, and financial services were liberalized. There are over 128 members of GATT.

World Trade Organization (WTO) • Succeeded GATT, there are over 149 member nations of WTO now. • Both GATT and WTO have succeeded in liberalizing trade around the world • WTO is criticized for pursuing too much ‘free trade’ that harm the environment, human rights, worker rights, etc.

European Union • This is an example of a ‘trade bloc’, where the member nations give each other advantages, like greater movement of capital and labor within the bloc, and a common currency. • The hope is that trade blocs raise the standard of living for everyone.

North American Free Trade Agreement • NAFTA was very controversial. It is another form of ‘trade bloc’ between US, Canada, and Mexico. • Many feared massive losses of jobs to Canada and Mexico, and to a small extent that did happen. • But overall, jobs have increased in all 3, and unemployment has gone down.

So is global competition and ‘free trade’ good for everyone?

End