MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT

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MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT
2nd edition

• International Trade

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Key Concepts

• Comparative Advantage
• Terms of trade
• Opportunity Cost
• New Trade Theory

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Patterns of World TradeGrowth rate in world
output and volume of world trade
Trade Volume
World GDP
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Comparative Advantage

• Focus on activities in which disadvantage is
  least
• Produce good/service with lowest opportunity cost
• Trade for good with highest opportunity cost
• Trade benefits all countries
• Key assumptions
• Competitive markets
• Labor and capital can easily be reallocated
• Stable rate of unemployment
• Costless transportation
• China-U.S. example

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Comparative Advantage

• ALL countries benefit from free trade
• However, not all countries will be equally well
  off
• Gains may not be equal between countries
• Depends on terms of trade
• Not all citizens benefit
• Country is richer as a whole, but some citizens
  are worse off
• Should these problems stop trade?

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Terms of Trade

• Ratio of the price of a countrys exports to the
  price of a countrys imports
• Gains from trade rise with terms of trade
• Example oil-exporters have recently experienced
  a strong increase in their terms of trade
• Application Prebisch-Singer hypothesis
• Hypothesis that agricultural prices, fall in
  value over time
• Rising productivity in agriculture
• low elasticity of demand for agricultural
  products
• fall in agricultural prices relative to
  overall prices and decline in terms of trade
• Countries should promote non-agriculture sector
  or fall behind

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Factor Price Equalization

• Factor price equalization Theorem
• As trade grows, input prices (wages and the cost
  of capital) should converge
• Both within and across countries
• Assumes identical inputs
• Productivity-adjusted wages different

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Wages, US , 2000 Source BLS
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National Competitiveness Classical Trade Theory

• Trade is not a zero-sum game
• Competitiveness concerns imply zero-sum game
• Focus on comparative advantage, not
  competitiveness
• Countries do not go bankrupt
• Instead of bankruptcy, a country undergoes
  restructuring of economy
• Reallocate labor and capital to new industry
• Trade is not adversarial
• Caveat shortrun vs. longrun
• Example Mexicos competitiveness concerns

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International Trade Theory New Trade Theory

• Economies of scale are important to some
  industries
• Commercial airlines, auto dealers
• Economies of scale require large production run,
  and in turn a large market to sell goods
• If no large market, then
• No production of certain goods
• Less variety
• Whats one way to increase market size for a
  good?
• International Trade

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International Trade Theory New Trade Theory

• Example
• Suppose two countries with annual market for 1
  million autos
• Before trade 1 million auto market
• After trade 2 million auto market
• Produce more, at lower cost, and greater variety

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International Trade Theory New Trade Theory

• First Mover Advantage
• If economies of scale is important (i.e. need a
  large market) and there has been a first mover,
  then subsequent competitors will face a barrier
  to entry
• Not enough market demand left for them to operate
  at level of economy of scale gt cost disadvantage
• Example Airbus is spending 14 billion to
  develop 550 seat commercial plane
• Needs to sale 350 planes for venture to be
  profitable
• Demand over next 20 years is for 400 to 600
  planes
• Room for only one profitable player

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National Competitiveness New Trade Theory

• Dont necessarily need productivity or factor
  endowment advantage to benefit from tradeif you
  are the first mover
• Comparative advantage can be created
• Carpet industry, Dalton, Georgia
• Silicon Valley, California
• Comparative advantage should not be accepted as
  is
• Countries should actively promote strategic trade
  policies
• Example Aircraft industry
• Imperfect competition
• Increasing returns to scale
• U.S. vs. Europe Boeing vs. Airbus

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Strategic New Trade Theory
Airbus Airbus Airbus Airbus
Enter Enter Dont Enter Dont Enter
Boeing Enter -100m -100m 500m 0
Boeing Dont enter 0 500m 0 0

• If both firms enter, neither reap lower costs
  from increasing returns to scale (IRS)
• 500 million earning potentialif IRS fully used
• Best strategy is consider what the other firm is
  going to do

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Strategic New Trade Theory
Airbus Airbus Airbus Airbus
Enter Enter Dont Enter Dont Enter
Boeing Enter -100m 100m 500m 0
Boeing Dont enter 0 700m 0 0

• Suppose European government promises 200 million
  subsidy if Airbus produces planes
• Regardless of Boeings decision, Airbus will now
  producepositive earning regardless
• Boeing either looses 100 million or withdraws at
  no losteasy choice
• 200 million subsidy gave Airbus monopoly profits
  of 500 million and will help create an European
  comparative advantage

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Strategic New Trade Theory
Airbus Airbus Airbus Airbus
Enter Enter Dont Enter Dont Enter
Boeing Enter 100m 100m 500m 0
Boeing Dont enter 0 500m 0 0

• If Europe and U.S. both subsidize 200 million,
  both firms will produce
• However, profit includes subsidy
• Europeans and Americans overpay for aircraft,
  foreigners benefit
• Solutions
• Cartel agree to set same prices
• Move toward niche products
• Raise the stakes higher subsidies

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Strategic Trade Theory

• Paul Krugman
• Strategic trade policy is tantamount to beggar
  thy neighbor policy
• Boost national income at expense of other country
• Likely to provoke retaliation and trade ware
• Result could be a costly subsidy race between two
  countries from which other countries benefit
• What to do if competitor is subsidizing competing
  industry?
• Better to establish rules of the game than to
  retaliate
• WTO
• Often government intervention is based on special
  interest rather than strategic trade theory
  (economies of scale)

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Arguments for Trade Restrictions

• Political Arguments
• National Security
• Protecting Jobs and Industries
• Retaliation
• Consumer Protection (health, safety)
• Furthering Foreign Policy Objectives
• Economic Arguments
• Infant Industry Protection
• Strategic Trade Policy

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Summary

• Trade is an increasing feature of the world
  economy
• Comparative advantage and terms of trade
• New trade theory
• Arguments for Trade Restrictions