Special supplementary slides on free trade

1
Special supplementary slides on free trade
trade theory
2

• Economists believe in free trade because free
  trade allows businesses and nations to find their
  comparative advantage
• If a country has comparative advantage in
  something, economists believe it should succeed
  without subsidies

3
Free trade means no barriers

• The principle You should have the same
  incentives when you consider a product from
  abroad as from your home country.

4

• An industry in which a nation has comparative
  advantage is an industry in which that country
  produces relatively efficiently (compared to
  other industries in that country).
• All nations have comparative advantage in
  something

5

• Your country has comparative advantage in the
  product or service where the ratio Resources
  required in your country . Resources
  required in the other country
• is low

6
Free trade theory is based on some basic
free-market economics

• Two fundamental principles
• The price for which sellers are willing to sell a
  product indicates what all the resources to
  produce (and sell) it are worth.
• The price for which buyers will buy indicates
  what the product is worth to the buyer
• So economists think anything that manipulates
  prices is dangerous

7

• Economists prefer income taxes or sales taxes (on
  everything) rather than tariffs (on particular
  imports)
• For any given amount of revenue raised, income
  and sales taxes disrupt the market less than
  tariffs

8
Most economists only make 1 or 2 exceptions

• Exception 1 tariffs to protect infant industries
• These are industries that lack comparative
  advantage, but could develop it soon
• Example Textile manufacturing in Vietnam in the
  1980s
• Because few Vietnamese were experienced in
  textile manufacturing, it was relatively less
  efficient than rice-growing
• But as Vietnamese got experienced, they soon
  learned to produce textiles efficiently

9

• Exception 2 strategic trade policy
• Sometimes when a brand new industry is invented,
  people can recognize
• It will have economies of scale (the people that
  produce most will produce cheapest)
• There will be big learning effects (the people
  who produce first will produce cheapest)
• So subsidies may be worthwhile
• Example flat-panel computer displays when they
  had just been invented

10
Smith, Ricardo and their successors
advocated free trade

• They believed that if people were left to trade
  on their own, they would naturally trade the
  goods in which their countries had comparative
  advantage
• Every individual seeks the most advantageous
  employment for his capital.
• Study of his own advantage necessarily leads him
  to prefer that employment most advantageous to
  society - Adam Smith, 1776

11
In the 19th century, free trade was widely
practiced

• In Europe, tariffs were low or non-existent
• But after WW I and especially in the early 30s,
  nations raised tariffs to protect their domestic
  economies
• A disastrous depression followed

12
GATT was created to prevent the mistakes of the
30s from repeating

• It provided a framework for negotiating
  reductions in tariffs and non-tariff barriers
• The WTO continued the process and provided an
  enforcement mechanism to prevent new barriers

13
So tariffs are not free trade

• The WTO (and almost all economists) discourage
  use of tariffs
• to raise funds
• to protect an industry that already has
  comparative advantage
• In the homework question, answers suggesting
  tariff protection for handmade blankets and wool
  would not get WTO support