Midterm Reviewer

I. Standard Trade Theories

Absolute Advantage

For example, extracting oil in Saudi Arabia is

A country has an absolute advantage in
pretty much just a matter of “drilling a hole.”
producing a good over another country if it uses
Producing oil in other countries can require
fewer resources to produce that good. Absolute
considerable exploration and costly
advantage can be the result of a country’s natural
technologies for drilling and extraction—if
endowment.
indeed they have any oil at all.

Comparative Advantage

A country has a comparative advantage when a

good can be produced at a lower cost in terms of
other goods. The question each country or
company should be asking when it trades is this:
“What do we give up to produce this good?” It
should be no surprise that the concept of
comparative advantage is based on this idea of
opportunity cost from Choice in a World of
Scarcity.
For example, if Zambia focuses its resources on
producing copper, its labor, land and financial
resources cannot be used to produce other
goods such as corn. As a result, Zambia gives up
the opportunity to produce corn.

Competitive Advantage

A competitive advantage is an advantage over

competitors gained by offering consumers
greater value, either by means of lower prices or
by providing greater benefits and service that
justifies higher prices.
Porter suggested four "generic" business
strategies that could be adopted in order to gain
competitive advantage. The strategies relate to
the extent to which the scope of a business'
activities are narrow versus broad and the
extent to which a business seeks to differentiate
its products.
Great examples of a differentiation leadership
include global brands like Nike and Mercedes.
These brands achieve significant economies of
scale, but they do not rely on a cost leadership
strategy to compete. Their business and brands
are built on persuading customers to become
brand loyal and paying a premium for their
products.

*Quota Rent: Earnings from exporting an item

Standard Trade Model

- Increasing opportunity costs are faced by states (more realistic)
 Increasing amounts of one commodity that a nation must give up to release just enough
resources to produce additional unit of another commodity
 Reflected in a production frontier that is concave from the origin
 - Demand preferences are introduced through indifference curves
- Gains through specialization (comparative advantage)
- Problem of deindustrialization faced by advanced economies

Marginal Rate of Transformation

- Amount of one commodity that a nation must give up to produce each additional unit of another
commodity
- Another name for opportunity cost and is measured by the slope of the production frontier at the
point of production
- Assumptions why there are increases in MRT
 Factors of production are not homogenous
 Factors are not used in the same size proportion or intensity in the production of all
commodities
- As the supply and factors change over time, a nation’s production frontier also shifts

Equilibrium in Autarky
- Equilibrium relative commodity price in isolation: the relative commodity price at which a
nation is maximizing its welfare in isolation
- It is given by the slope of the common tangent to the nation’s production frontier and
indifference curve the autarky point of production and consumption

II. Hecksher-Ohlin Theory

 The country that is abundant in a factor exports the good whose production is intensive
in that factor.

 The H-O model assumes that the two countries (US and France) have identical
technologies, meaning they have the same production functions available to produce
steel and clothing. The model also assumes that the aggregate preferences are the same
across countries. The only difference that exists between the two countries in the model
is a difference in resource endowments.

 The H-O theorem states that a country will export that good that is intensive in the
country’s abundant factor.

 In the standard case, a country will produce more of its export good and less of its
import good but will continue to produce both. In other words, specialization does not
occur as it does in the Ricardian model.

 Trade is motivated by price differences. A capital-abundant (labor-abundant) country

exports the capital-intensive (labor-intensive) good because that product price is
initially higher in the labor-abundant (capital-abundant) country.

III. GATT and WTO

Basis for Comparison GATT
Meaning GATT can be described as a set
of rules, multilateral trade
agreement, that came into
force, to encourage
international trade and
WTO
WTO is an international
organization, that came into
existence to oversee and
liberalize trade between
countries.
 remove cross-country trade
barriers
Institution It does not have any
institutional existence, but
have a small secretariat.
Commitments Provisional
Application The rules of GATT are only for
trade in goods.
Agreement Its agreement are originally
multilateral, but plurilateral
agreement are added to it
later.
Domestic Legislation Allowed to continue
It has permanent institution
along with a secretariat.
Full and Permanent
The rules of WTO includes
services and aspects of
intellectual property along
with the goods.
Its agreements are purely
multilateral.
Not allowed to continue

IV. WTO case: Philippine Agriculture

For the past decades, the agricultural policies of most developed countries isolated their internal
markets for their own producers using quantitative import restrictions and providing them with price
supports. A vivid example of this is the protection accorded by Japan to its rice industry. These policies
have been actually costly and have led to over production of farm products. Surpluses from the US and
European countries in particular have found their way into world markets, causing the prices of major
agricultural goods to decline steadily. Agricultural producing countries like the Philippines have not
only faced declining world prices but have also absorbed fluctuations in the prices of farm products as
a result of production and trade distorting policies. The UR agreement on agriculture, therefore, is a
major step towards checking unfair trade practices through the imposition of a rules-based
agricultural trading system.

Uruguay Round (Dec. 1993)

- 8th round and most ambitious trade negotiations
- Goal: improve reverse proliferation of protectionism, bring services, agriculture and foreign
investments into the negotiation table, improve dispute settlement mechanism
- Tariffs, removed from pharmaceuticals, construction equipment, medical equipment, paper
products and steel
- Quotas on agricultural products to be replaced with less restrictive tariffs for agriculture, textile
and apparel
- Subsidiaries on agricultural exports to be reduced by 21% over a six-year perion. Government
subsidies for industrial research are limited to 50% of applied research cost
- Safeguards allow temporary raising of tariffs during import surge that severely harms a domestic
industry but health and safety standards are not allowed unless based on scientific evidence
- Intellectual property has 20-year protection of patents, trademarks and copyrights but allows a
10-year phase in period protection for pharma for developing countries
- Services, Us failed to secure markets in Japan, Korea, France and most of EU to lift restrictions on
American programs and films
- Other industry provisions, US and EU agreed to continue talking about limiting subsidies to
aircraft makers, telecoms, and steelmakers. With Japan, it is the computer chip market.
- Trade-related investment measures, phases out the requirement that foreign investors must buy
supplies locally or export as much as they import
 Outstanding Trade Problems after the Doha Round

1. There is still rising protectionism for jobs and domestic production especially during economic
crises
a. Issues/cases intellectual property and continued subsidizing of industries
i. US filed a case against China for subsidizing wind power equipment and
intellectual theft
ii. China imposed a stiff tariff on US poultry exports
iii. Brazil raised tariffs on American products igniting a trade war over cotton
subsidiaries
iv. Mexico imposed $2.4B tariffs on US products and Congress barred Mexican
trucks from working in US (despite NAFTA)
v. Russia raised tariffs on used car imports
vi. India banned Chinese toys
vii. US and EU are subsidizing embattled automakers
2. Subsidies and tariffs on agricultural products remain very high; antidumping measures and
safeguards are frequently abused which cause potential trade disputes
3. Tendency for the world to break up into three major trading blocs: NAFTA, EU, and Asian Bloc
4. Establishment of Labor and Environmental standards or “leveling off” and avoid “social
dumping”

V. Economic Integration
- Preferential trade agreements provide lower barriers among participating nations (British
Commonwealth Preference Scheme, the ACP)
- Free Trade Area where all barriers are removed on trade among members but each nation
retains its own barriers to trade with non-members (EFTA, NAFTA, MERCOSUR)
- Customs Union allows no tariffs or other barriers on trade among members (as in free trade
area) and in addition it harmonizes trade policies toward the rest of the world. (EU, 1957)
- Common Market goes beyond a CU by also allowing the free movement of labor and capital
among member nations (EU, 1993)
- Economic Union goes further by further harmonizing or even unifying monetary and fiscal
policies of member states – highest form (Benelux)

Preferential Trade Free Trade Area Customs Union Common Market Economic
Agreements Union
 A pact of trade, A free trade area A customs union is Is a customs union Is a common
formed between two is a grouping of a type of free trade policies on product market with a
or more countries, countries within agreement (FTA) regulation, and free common
allowing them to which tariffs and which involves the movement of currency and a
reduce the tariffs non-tariff trade removal of tariff goods, services, common
charged on specific barriers between barriers between capital, and labor. central-bank
goods during trade the members are members, together
with each other. generally with the
Even though the abolished but acceptance of a
tariffs aren’t with no common common (unified)
completely removed, trade policy external tariff
the amount charged toward non- (CET) against non-
is much lesser than members. members. A
that the amount customs union is a
charged from type of free trade
countries who are agreement (FTA)
not included within which involves the
the agreement. removal of tariff
barriers between
members, together
with the
acceptance of a
common (unified)
external tariff
(CET) against non-
members.
The North European Union Eurozone
American Free
Trade Area
(NAFTA) and the
European Free
Trade Association
(EFTA) are
examples of free
trade areas.

FREE TRADE AREAS

Advantages
1. Lower government spending Many governments subsidize local industry
segments. After the trade agreement removes
subsidies, those funds can be put to better use.
2. Foreign Direct Investment Investors will flock to the country. This adds capital
to expand local industries and boost domestic
businesses. It also brings in U.S. dollars to many
formerly isolated countries.
3. Technology transfer Local companies also receive access to the latest
technologies from their multinational partners. As
local economies grow, so do job opportunities.
Multi-national companies provide job training to
local employees.
Disadvantages
1. Increased Job Outsourcing Reducing tariffs on imports allows companies to
expand to other countries. Without tariffs, imports
 from countries with a low cost of living cost less. It
makes it difficult for U.S. companies in those same
industries to compete, so they may reduce their
workforce. Many U.S. manufacturing industries did,
in fact, lay off workers as a result of NAFTA.
2. Poor working conditions Multi-national companies may outsource jobs to
emerging market countries without adequate labor
protections. As a result, women and children are
often subjected to grueling factory jobs in sub-
standard conditions.
3. Theft of intellectual property any developing countries don't have laws to protect
patents, inventions, and new processes. The laws
they do have aren't always strictly enforced. As a
result, corporations often have their ideas stolen.
They must then compete with lower-priced
domestic knock-offs.

CUSTOMS UNION

Advantages
1. Increased trade flows
2. Trade Creation vs. Trade Trade creation, more efficient members can now sell more to
diversion less efficient (domestic) members

Trade diversion, more efficient non-members may now sell

fewer goods to members, creating an opportunity for less
efficient members to capitalize by selling more within the union
3. Solving the problem of Trade deflection occurs when non-members ship their goods to
deflection a low tariff FTA member (or set up a subsidiary in the low tariff
country) and then re-ship to a high tariff FTA member. Hence,
without a unified external tariff, trade flows would become
distorted
4. Closer integration and Customs union may pave the way for closer economic
cooperation integration and political collaboration, including the formation
of a single internal market, (common market) monetary union,
and fiscal union
Disadvantages
1. Loss of economic Members of a customs union are obliged to negotiate
sovereignty collectively with non-members, or organisations like the WTO,
as a single group (bloc) of countries. While this is essential to
maintain the customs union, it means that members are not free
to negotiate individual trade deals in their own national interest.
2. Allocation of tariff revenues Members who trade relatively more with countries outside the
union, such as the UK, may not get their 'fair share' of tariff
revenue
3. Complex tariff schedules, negotiations regarding the setting of common tariff levels can be
exceptions and ‘sensitive’ very complex and costly, both in terms of time and the use of
lists resources
4. Brexit

CUSTOMS UNION
Characteristics: All tariffs are removed between members and the group adopts a common external
commercial policy toward nonmembers. The group acts as one body in negotiation of trade
agreements with trade members (removes transshipment)

Potential concerns: Members give up their independence in setting tariff rates

Static Effects

- Although the goals is free trade, it can lead to the diversion of trade from a lower-cost
nonmember source to a member-country source
- This leads to trade creation and trade diversion
- Trade creation occurs when domestic production in a member of the customs union is replaced
by lower cost imports from another nation. This increases welfare
- Trade diversion occurs when lower cost imports from outside the union are replaced by higher
cost imports from another union member. By itself, this reduces welfare.
- This occurs because CUs are formed not only for economic reasons but for political
considerations and also depend on the geographic proximity of nations
- Structures and processes inside a country would have evolved differently had integration not
occurred
- Benefits are due to increased competition, economies of scale, stimulus to investment and better
utilization of economic resources
- Increased competition because producers are likely to grow sluggish and complacent behind
trade barriers. A CU will put pressure to be more efficient and meet the performance of
competitors
- Caveat: enforce anti-trust legislation...WHY?
- Economies of scale, although a CU is not a requirement in expanding beyond the domestic
market. What are some examples?
- Stimulus to investment, CU is likely to stir investor interest to take advantage of enlarged market
(tariff factories)
- Dynamic gains are believed to be greater than static gains and are the main reason why UK
joined