The Export-Import Sector

Chapter 08

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

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Learning Objectives

After this chapter you should be able to:1. Explain and discuss the basis for international trade.

2. Demonstrate the relationship between specialization and exchange.

3. Summarize post-World War II trends in our imports and exports.

4. Distinguish between outsourcing and off-shoring.

5. Analyze the graphing of the C + I + G + Xn line.

6. Discuss the imports and exports of the world’s leading trading nations.

7. Summarize the world trade agreements and discuss free-trade zones.

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The Basis for International Trade

Start with trade between individuals.• Why do we (often, but not always) hire people to provide services for

us, such as building a deck, recovering our sofa, baking a wedding cake, or changing the oil in our cars?

• These activities have opportunity costs. The time it takes you to “Do It Yourself” could be used to do something else.

• The person you hire is probably a specialist who can do it better and more efficiently. – unless you really enjoy the DIY project or do not have the resources to hire someone.

This process is called specialization and exchange. What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. (Adam Smith, The Wealth of Nations, 1776)

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Specialization and Exchange Specialization and exchange increases an individual’s

productivity.• When families live relatively self-sufficiently, they lived on

farms where they grew their own food, wove their own cloth, built their own homes, made their own tools, clothes, and even pins, needles, and nails.

• By specializing, we get good at producing a good or service and can sell it for a relatively low price.

Nations can also increase their productivity by specializing and trading with countries that are more efficient at producing certain goods or services.

• Some nations have abundant fertile farm land; others do not.• Some nations have a labor force with specific skills; others

do not. • But self-sufficiency can also be a source of economic power.

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Examples of Specialization and Exchange

Production of Trains and Planes before Specialization

Table 1 Trains Planes

Algeria 5 10

Zaire 10 5

Production of Trains and Planes with Specialization

Table 2 Trains Planes

Algeria 0 20

Zaire 20 0

Consumption of Trains and Planes with Specialization

Table 3 Trains Planes

Algeria 10 10

Zaire 10 10

When each country When each country makes what it makes makes what it makes best and trades it, it best and trades it, it

expands its consumption expands its consumption possibilities.possibilities.

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U.S. Exports and Imports

We have been a major exporter of wheat, corn, cotton, and soybeans since colonial times.

• Initially, we had an abundance of land.• Eventually we came to have a tremendous stock of farm

equipment. During the 20th Century, the U.S. became a global

power in part because it was self-sufficient in agriculture and manufacturing.

• U.S. was the “arsenal of democracy.” • This self-sufficiency continued until well into the1970s, when

our relatively small export-import sector began to grow significantly.

• Positive balance of trade: Exports > Imports

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U.S. Exports and Imports (Continued)

The relationship between the U.S. and the global economy began to change in the 1970s.

• Negative balance of trade: Imports > Exports We used to be a major exporter of steel and textiles.

• Now other nations produce these more cheaply. After WWII, we produced more than 60% of the world’s oil

supply and exported much of this.• Now, we have exhausted most of our easily extractible reserves and

import more than 60% of our oil.. Today, the U.S. is a major exporter of:

• Computer software; entertainment goods and services; financial, legal, medical, construction and industrial engineering services; telecommunications; management and consulting; and travel services and tourism.

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U.S. Imports and Exports as percentage of GDP, 1970–2009

Source: Bureau of Economic Analysis. www.bea.gov .

Note the growing gap between imports and exports through 2005.

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U.S. Balance of Trade, 2009 (in billions of dollars)*

*Numbers may not add up due to rounding.Source: http://www.bea.gov.

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Questions for Thought and Discussion Can you think of an example of how specialization

results in trade?

How is trade among nations similar to trade among individual people? How is trade among nations different than trade among individual people?

Are there circumstances that would make specialization a bad idea for nations to specialize and trade? Are there certain industries that are important to maintain domestically? Why?

How do exchange rates affect the balance of trade?

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Outsourcing and Off-Shoring

Outsourcing: When a company in the U.S. contracts some of their jobs to other firms. These firms may be in the U.S. or overseas.

• Example: Wal-Mart hires company that specializes in janitorial services.

• Example: A school district hires a food services company to run the cafeteria.

• If the outsourcing is to a another firm in the U.S., there may no net job loss or job gain for the U.S. as a whole.

Individual workers may lose their jobs, but one American’s job loss is another American’s jobs gain.

However, if the outsourced firm is more efficient, there may be job losses.

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Outsourcing and Off-Shoring (continued)

Off-Shoring: When a company in the U.S. contracts some of their jobs to firms outside the U.S.

• Example: Company shuts down textile mill in South Carolina and replaces it with one in China.

• When jobs are transferred out of the U.S., the unemployment rates goes up.

Since 1970, at least 5 million relatively high paying jobs have been off-shored.

• Service sector jobs are now being sent abroad.• But many services are not vulnerable to offshoring.

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A Summing Up: C + I + G + Xn

Net Exports = Xn

• Xn = Exports – Imports

If balance of trade is positive, Xn is positive number.• The impact of Xn is to increase GDP.

If balance of trade is negative, Xn is negative number. • The impact of Xn is to decrease GDP.

Because the U.S. has a negative trade balance, we will draw the new line below the C + I + G line.

• We simplify the model by assuming Net Exports are independent of personal income.

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C + I + G +Xn = GDP

When exports are increased or imports decreased, GDP will grow.

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Questions for Thought and Discussion

How is outsourcing related to the principle of specialization and trade? Why do firms outsource work to other firms?

How is offshoring related to the principle of specialization and trade? How does offshoring affect each of the following: U.S. workers? U.S. consumers? U.S.-based businesses?

Explain the impact of exports and imports on an economy. Are exports good for GDP? Are imports good for GDP?

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World Trade Agreements and Free Trade Zones

Free trade zones:• North American Free Trade Agreement (NAFTA) • The Central American-Dominican Republic Free Trade

Agreement (CAFTA)• The European Union (EU)• China-Asean Free Trade Area• Mercosur

World Trade Agreements: • The General Agreement on Trade and Tariffs (GATT)• The World Trade Organization (WTO)

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NAFTA: The North American Free Trade Agreement

NAFTA was ratified by Congress in 1993. NAFTA created a free trade area that includes

Canada, the United States, and Mexico.• Trade barriers in industrial goods were dismantled.• Agreements on services, investment, intellectual property

rights, agriculture, and strengthening of trades rules were included.

• There were also side agreements on labor adjustment provisions, protection of environment, and import surges.

Impact on U.S. economy: • The threat of moving operations to Mexico has had a

depressing effect on American factory wages. • Furthermore, our trade deficits with both Mexico and Canada

have gone up substantially since the passage of NAFTA.

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U.S. Trade with Mexico and Canada, 1993 and 2009

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CAFTA, The Central American-Dominican Republic Free Trade Agreement

CAFTA includes the U.S., the Dominican Republic, Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.

CAFTA will eventually eliminate all tariffs among these seven nations.

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The European Union (EU)

This free trade association of 27 nations dates back to the 1950s but became a truly common market in 1992.

• Freight was now able to move anywhere within the EU without checkpoint delays and paperwork.

• So-called quality codes were ended.• Workers from any EU country could work in any other member

country.

In 1999, 11 EU countries formed the European Monetary Union, which established the euro as a common currency.

In 2002, new euro coins and paper money replaced each country’s own national currencies.

This common currency is expected to make trade easier to conduct among participating member nations.

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China-Asean Free Trade Area

Formed in 2010 by China and 10 other Asian nations.• Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the

Philippines, Singapore, Thailand, and Vietnam.

Third-largest free trade zone.

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Mercosur

Includes, Argentina, Brazil, Paraguay, and Uruguay and associate members Bolivia, Peru, and Chile.

It is the fourth largest market after NAFTA, the EU, and China-Asean.

It was formed in 1991. It has succeeded in eliminating all internal tariffs while

imposing a common external tariff on goods imported from countries outside the union.

However, some trade restrictions still exist, especially between Brazil and Argentina.

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Questions for Thought and Discussion

Is trade with Mexico, Canada, and China beneficial to the U.S.?

What have been the primary features of the different free trade agreements and how has this impacted the U.S. economy?

Is the development of the Euro a good thing for trade in the European Union? Why would a common currency be good for trade?

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World Trade Agreements

The General Agreement on Trade and Tariffs (GATT)• GATT was drafted in 1947 and has since been signed by more

than 146 nations. The latest version was ratified by Congress in 1994.

• GATT will Reduce tariffs worldwide by an average of 40%. Lower other barriers to trade such as quotas on certain

products. Provide patent protection for American software,

pharmaceuticals, and other industries.

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Protecting Intellectual Property and Opening Markets for Services

Will GATT help or hurt the United States?• For U.S. industries, the positive appears to outweigh the

negative. • On the average, foreign countries have more trade restrictions

and tariffs on U.S. goods than we have on theirs.• GATT will, for the first time, protect intellectual property rights like

patents, trademarks, and copyrights.• GATT will also open markets for service industries such as

accounting, advertising, computer services, and engineering. These are fields in which Americans excel.

• GATT brings agriculture under international trade rules for the first time.

European farm subsidies dwarf those paid to American farmers.

Proportionally, the Europeans will have to reduce their subsidies a lot more than the U.S., making American crop exports even more competitive.

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The World Trade Organization (WTO)

The WTO was set up in 1995 as a successor to GATT. The WTO is based on three major principles:

1. Liberalization of trade

2. Nondiscrimination–the most-favored-nation principle

3. No unfair encouragement of exports

The WTO has a Dispute Settlement Body to handle disagreements among member nations• Many politicians in the U.S. have very reluctantly accepted the

jurisdiction of the WTO. The U.S. has won almost all the more than two dozen cases in

which the U.S. was the complaining party. The U.S. has also lost some cases in which other governments

were the complaining parties.

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Liberalization of Trade

Trade barriers, which were reduced under GATT, should continue to be reduced.

• Trade barriers have been falling within free trade zones such as NAFTA and the European Union.

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Nondiscrimination: The Most-Favored-Nation Principle

Under the most-favored-nation principle, members of WTO must offer one member the same trade concessions as any other member.

• This is a lot like when the teacher says that if you bring candy to class, you must bring some for everyone.

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No Unfair Encouragement of Exports

No unfair encouragement of exports encompasses export subsidies, which are considered a form of unfair competition.

• American and European governments have long subsidized their farmers.

• This enables the producers to sell their crops well below cost.• This sets the price of agriculture staples so low that small

farmers in developing countries can’t compete.• These small farmers are eventually forced off their land by

subsidized imports and have no means to survive.

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Objections to WTO

Environmentalists argue that elitist trade and economics bodies make undemocratic decisions that undermine national sovereignty on environmental regulation.

Unions charge that unfettered trade allows unfair competition from countries that lack labor standards.

Human rights and student groups say the IMF and the World Bank prop up regimes that condone sweatshops and pursue policies that bail out foreign lenders at the expense of local economies.

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Summary

The debate is not just about “free trade” but also about “fair trade.”

• Many Americans, as well as citizens of other leading industrial nations, have strong reservations about ceding some national sovereignty to international organizations.

Especially the WTO• Much concern centers on the possible loss of jobs and the

reduction of wages in their countries if their workers were forced to compete with low-wage workers in the poorer countries.

Many earn just 1 or 2 dollars a day.• Is it fair to make American factories, which have relatively

high environmental standards, compete with Third World factories that are not similarly burdened?

• If the U.S. and other industrial countries are subject to the rules and regulations of the WTO, their own governments would be unable to prevent a flood of cheap imports.

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Questions for Thought and Discussion

Is your school sweatshirt sewn in a sweatshop? If it is, do school administrators and students bear any responsibility for the abysmal working conditions and measly pay of the workers making their college paraphernalia?

Can the environment be protected under the conditions of free trade? Are we in the race to the bottom in terms of wages, working conditions, and environmental quality because of globalization?