International Trade. Overview [I]What is International Trade? [II] Theory of Comparative & (Absolute) Advantage [III]Why do countries trade? (Gains and.

International Trade

Overview

[I] What is International Trade?

[II] Theory of Comparative & (Absolute) Advantage

[III] Why do countries trade? (Gains and Disadvantages from trade)

[IV] Trade Patterns in Singapore

[I] International Trade

• Exchange of goods and services (buying and selling) between countries

• Includes all economic transactions that cross international boundaries

• Division of labour / specialization

• Openness of an economy: ratio of country’s exports or imports to its GNP

Why does trade occur?

• Assuming that I have 2 hours to spare and can produce $50 worth of economics lesson in an hour or clean $10 worth of rubbish in my room an hour.

• What am I supposed to do if need to do both items?

[II] Theory of Absolute Advantages

If I had 2 hours to spare

$10$50ME

Cleaning roomEconomics

lessonCountry

[II] Theory of Absolute Advantages

Why does trade occur?

• Assuming that I have 2 hours to spare and can produce $50 worth of economics lesson in an hour or clean $10 worth of rubbish in my room in an hour.

• What am I supposed to do if I need to do both items?

• What if now my neighbourmy neighbour can produce $20 worth of economics lesson an hour and clean $30 worth of rubbish in an hour?

[II] Theory of Absolute Advantages

If we only had 2 hours to spare

$40$70Total

$30$20Neighbour

$10$50ME

Cleaning roomEconomics

lessonCountry

Any room for negotiations? Gains from trading?

Given the same resource: time of 2 hours, what do you think I am more efficient at doing? My neighbour?

[II] Theory of Absolute Advantages

If there was specialisation /division of labour…

$60$100 Total

$60$0Neighbour

$0$100ME

Cleaning room

Economics lesson

Country

(50)

(20)

(10)

(30)

(70) (40)

Any change to total world output?

[II] Theory of Absolute Advantages

For countries to gain, exchange must take place. But what must be determined before exchange can take place?

CountryEconomics

lessonCleaning room

ME $50 $10

Neighbour $20 $30

Total $70 $40

In order to obtain the benefits of specialisation, the country must trade. This depends on the terms of trade

For ME, the opportunity cost of 1$ Economics lesson is to give up 0.2$ worth of cleaning room services.

Therefore, I will not accept less than $0.2 cleaning room services for an Economics lesson provided

For Neighbour, the OC of 1 $ Economics lesson is to give up $1.5 worth of cleaning room services.

Therefore, she will not offer more than $1.5 cleaning room services for an Economics lesson.

1$ E: $0.2 C

1$ E: $1.5 C

In the case, the rate of exchange must lie between the domestic opportunity cost ratios for the 2 parties.

[II] Theory of Absolute Advantages

If there was specialisation and then trade…

CountryEconomics

lessonCleaning

room

ME $100 $0

Neighbour $0 $60

Total $100 $60

Terms of trade: 1$ Econs lesson: 1 $ Cleaning Room services

1$ E: $0.2 C

1$ E: $1.5 C

(75)

(25)

(25)

(35)

Are both parties better off with trade?

[II] Theory of Absolute Advantage• In my example, I have an absolute advantage in

the production of economics lessons. My neighbour has absolute advantage in cleaning rooms.

• Obvious gains from specialisation and trade if I produce economics lessons and sell it to my neighbour that specialises in the production of other goods or services (cleaning rooms).

RECAP!!!!

[II] Theory of Absolute Advantage

A nation has an absolute advantage over another nation in the production of a commodity if the same amount of resources will produce more of the commodity (same amount of a good or service with fewer resources) in one nation than in another.

(Adam Smith)

Assumptions for AA theory

• 2 countries and 2 commodities

• Perfect competition

• Full employment

• No transportation costs

• Constant returns to scale / (Constant costs)

• Perfect factor mobility within industries but not across nations

Why countries trade?

Country Electronics Spices

Europe 100 40

Asia 30 80

Total world 130 120

Table - BeforeBefore any trade or interaction

Qn. (i) Which country has absolute advantage in which product.

(ii) Which should they specialize in?

(iii) What are the gains from trade after specialisation?

[II] Theory of Absolute Advantages

Each country devotes HALF of its resources to electronics production and the other half to spices production

EX.1

ELECTRONICS

EUROPE

SPICES

ASIA

Why countries trade.

Country Electronics Spices

Europe 100 40

Asia 30 80

Total world 130 120

What are the gains that can be seen?

(160) (200)

[II] Theory of Absolute AdvantagesEX.1

Both countries specialise in the production of the commodity in which it has AA over the other. Each country devotes ALL of its resources to that production

(0) (160)

(200) (0)

After Specialisation

Why countries trade?

Country Electronics Spices

Europe 200 0

Asia 0 160

Total world 200 160

Table – after specialisation (but without trade)

What could be a fair trading price?

Terms of Trade?

[II] Theory of Absolute Advantages

1E: 0.4S

1E: 2.6S

The Terms of Trade

• The Terms of Trade looks at the relationship between the price received for exports and the amount of imports we are able to buy with that money.

Average Price of Exports

Terms of Trade = ----------------------------------------

Average Price of Imports

Will all countries have an absolute advantage in something?

• What happens if you and I were the parties involved?

• What happens when one party is superior in producing everything?

• Will trade between countries still take place?

[II] Theory of Comparative Advantages

What is comparative advantage?

Principle of Comparative Advantage

• Hence, gains from trade and specialisation depends on the pattern of comparativedepends on the pattern of comparative and not absolute advantage

Even if 1 of the 2 countries has an absolute advantage in every commodity, specialisation and trade can still benefit BOTH countries if each country has a comparative advantage.

[II] Theory of Comparative Advantages

What is comparative advantage?

• A country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners. (forgo less of other commodities in order to produce it.)

• Gains from specialisation & trade depends on the pattern of CA, not AA.

[II] Theory of Comparative Advantage

Theory of Comparative Advantage

• If now the comparison is made between a student and me.

• Assuming I can still teach $50 worth of economics and clean $10 of rubbish and a student can only teach $15 worth of economics and clean $4 worth of rubbish

• Is there still an opportunity for trade?

[II] Theory of Comparative Advantages

Comparative Advantage

CountryEconomics

lessonCleaning room

ME $50 $10

Student $15 $5

Total 65 $15$15 economics lesson: $ 5 cleaning room

For student, the OC of cleaning 1 $ more room is giving up $ 3 worth of economics lesson

$50 economics lesson: $10 cleaning room

For ME, the OC of cleaning 1 $ more room is giving up $ 5 worth of economics lesson.

1$C: $5E

1$C: $3E

Who has the CA in cleaning rooms? In giving Economics Lesson?

ME

ECONOMICS LESSON

STUDENT

CLEANING ROOMS

If there was specialisation /division of labour…

• ME has a comparative advantage in the production of giving Economics lessons.

Specialize in giving Econs Lesson

• Student has a comparative advantage in the production of cleaning rooms.

Specialize in Cleaning Rooms

[II] Theory of Comparative Advantages

Comparative Advantage

• David Ricardo (1772-1823), suggested that countries will specialise and trade in goods and services in which they have a comparative advantage.

• When countries have an absolute advantage there are clearly advantages to trade.

• However, even with absolute disadvantage in the production of all goods relative to their trading partners. They are inefficient in producing anything, relative to their trading partners. TRADE CAN STILL TAKE PLACE

• It is better for a country that is inefficient at producing goods or services to specialise in the production of that good it is least inefficient at, compared with producing other goods.

Limitations to Specialisation & Trade

• High Transport Cost

• Increasing Costs of Production

• Factor Immobility

• Trade Restrictions

Some Limitations to the Theory

[II] Theory of Comparative Advantage

Recap: Theory of Comparative Recap: Theory of Comparative AdvantageAdvantage

Mini Exercise 2Mini Exercise 1

[III] Why bother trading?

Why do countries trade?

Any disadvantages from trade?

Case of Singapore?

GAINS FROM TRADE

Gains from Trade

Supply Side-Cost Factors• Different endowments & production capabilities.

– In Singapore, which of the following product would we be unable to enjoy without trade?

• Limited resources, knowledge & expertise

[III] Why Bother Trading ?

FOOD WATER ELECTRICAL APPLIANCES

Gains from TradeDemand Side Factors• Greater amount and wider range of goods and

services available• Lower prices • Foreign Exchange• Higher employment• Trade as an engine of growth• Transmission of ideas• Promotes Political & Economic between

countries • Limited international mobility of resources

[III] Why do countries trade?

More goods and services available

• Higher (better) consumption and more variety

– due to exchange, specialization & trade

– Increased competition promotes innovative production methods, the use of new technology, marketing and distribution methods.

[III] Why do countries trade?

Lower Prices

• Trading can improve the efficiency of allocation of resources.

• Lower costs of production can lead to lower prices

– International trade increases the size of a firm’s market. Bigger markets give rise to increase in the scale of production (bigger volume). Internal or external economies of scale.

– Increased competition from foreign imports. Foreign imports might be cheaper or would force local firms to be search for more efficient method of production.

– Prevent monopolies

Graphical Illustration of benefits

SdDd

$10

Price

Qty500

Before trade

LOWER PRICES

Graphical Illustration of benefits

Sw

SdDd

$6

$10

Price

Qty300 500 700

Imports: 700 – 300 = 400

After trade LOWER PRICES

Foreign Exchange

• Trading of goods and services enables the country to receive hard currency (earn foreign exchange from exports of abundant resources)

• Allows country to purchase imports it does not have or insufficient in supply.

Higher Employment

• Employment will increase as more exports means that more output must be produced.

• Many jobs in Singapore, especially in manufacturing and service industries which are dependent on trade.

Engine of growth

• Increase in Economic Growth

– increased volume of exports acts as an injection to stimulate AD

– allows countries to enjoy higher output and national income

– trade acts as a stimulus to economic development though the transfer of new technology and methods of production

Promotes Political, Economic links between countries

• Trade is used to promote ties with other countries

• Countries dependent on each other for trade or other activities are less likely to go to war with each other.

• Korea Sunshine policy

Why countries prefer not to trade – Disadvantages

• Unfavourable Foreign Competition

• Lack of Economic Diversification

• Economic Instability

• Environmental Problems

• Other Disadvantages

Unfavourable foreign competition

• International markets are not a level playing field as countries with surpluses may dump them on the world markets below cost. Eg. Farmers

• Obstruct development of home industries. Some advantages are gained over time.

• Jobs might be lost– structural unemployment may occur

Lack of Economic Diversification

• Basics of trade is for country to specialise.

– hampers countries from developing self-sufficiency. Problems during crisis or wars

– Affected by problems faced by external parties. Dependent on the fortunes of a few goods. E.g. Recession and loss of essential products

However

Economic Instability

• Increased domestic economic instability from international trade cycles, as economies became dependent on global markets.

• The Asian economic crisis in 1998 and economic slowdown in the global economy in 2001 illustrate this situation.

Environmental Problems

• Exhaustion of essential resources– Materials and minerals cannot be replaced– Loss is even bigger if little benefit to

country

• Trade can lead to pollution and environmental problems as companies fail to include these costs in the price of goods.

Other Disadvantages

• Adverse Foreign Influences– import of harmful commodities. Drugs, Alcohol etc..

• Exploitation of Workers and Growers– Cheap Labour and underage/child workers

• Increase income inequality– Increase in gap between the rich and the poor– Rich people own more of the assets and benefit more

from trade.

[IV] Singapore Trade Patterns

The Singapore Economy

Changing Comparative Advantages and Singapore

Singapore and FTAs

Singapore’s Economy

External Trade

2003 2004 2005 2006

Total trade at current prices ($m)

Total 515,894 628,952 715,722 810,483

Imports 237,316 293,337 333,190 378,924

Exports 278,577 335,615 382,532 431,559

GDP 160,890 181,539 194,241 209,990

Source: MTI Annual Statistics 2006

[IV] Singapore’s Trade Patterns

Singapore’s Economy

What does Singapore trade?

6.17.8Indonesia

7.611.3EU-25

27.110.5China

16.011.1United States

10.113.1Malaysia

% Growth % ShareCountry

Top 5 Trading Partners

Source: MTI Statistics 2006

[IV] Singapore’s Trade Patterns

Singapore & FTAs“ Singapore’s attitude toward free-trade

agreements makes a sharp contrast with other countries in the region…. Singapore only seems to become more eager with time when it comes to inking FTAs with the rest of the world.

The city-state already has agreements with a host of nations, including the US, Chile, Japan, South Korea and New Zealand. Negotiations are under way with Jordan and the United Arab Emirates, and even with powerhouses India and China.” What can de deduced about the pattern of trade

between Singapore and ROW?

Singapore and FTAs

• A champion for free trade agreements.

~ FTAs contributed handsomely to Singapore’s economic growth over the past years esp. external trade volume & the creation of jobs.

• To meet challenges from India and China, whose cheap goods and services can possibly threaten Singaporean enterprises

• Augment Singapore’s minuscule negotiating power in the world by associating the country with powerful trade partners

Singapore FTAs

ASEAN Free Trade Area (AFTA) was initiated in 1992.

To reduce tariffs on g&s to 0-5% over 15 years

US-Singapore Free Trade Agreement (USSFTA) signed on 6 May 2003

Include protection of intellectual property, the inclusion of e-commerce and ICT services

Singapore-Australia Free Trade Agreement (SAFTA) signed on November 2002.

Covers trade in goods, trade in services, investment, telecommunication, financial services,

Singapore Comprehensive Economic Cooperation Agreement (CECA) launched on 27 May 2003

Japan and Singapore for a New-Age Economic Partnership (JSEPA) launched in 22 Oct 2000.

October 2003, negotiations for the Singapore-Jordan Free Trade Agreement (SJFTA)

Singapore Case Study 1 : Changing Comparative Advantages

“ With one of the highest per capita income levels in the world, Singapore hardly leaps to mind as a low-cost offshore location.  However, excellent education and infrastructure, intellectual property protection and aggressive government promotion of the IT and services sectors continue to reinforce Singapore's position as a favorite location for regional service functions.”

A.T. Kearney Study (2004)

Qn. How does Singapore cope with changing CA with with the rise of low cost competitors

such as China & India?

Singapore Case Study 1: Changing Comparative Advantages

• With low cost competition faced from emerging China & India, Singapore is losing its comparative advantage in terms of cheap labour costs and has reoriented it economy towards physical and human capital investment and in more recent years, towards an innovation driven one.

• Singapore-based facilities: more focused on R&D and product development, with a core of high-end manufacturing eg. Electronics.

• New efforts to restructure the economy to focus on knowledge-based industries & other high valued financial services industries.

Singapore Case Study 2: Changing Comparative Advantages

“ After enjoying decades of high economic growth, Singapore’s economic growth has slowed down. Together with falling fertility rates and a fast aging population, Singapore economy shows signs that it is maturing…”

The Nanyang Economist (2005)

Qn. With huge economies such as India and China growing rapidly, how can Singapore maintain her competitive edge and

comparative advantage over these economies?

Singapore Case Study 2: Changing Comparative Advantages

• Increased economic competition from Singapore’s neighbours makes it imperative for Singapore to continually seek to remain competitive in the global market.

• Move towards capital intensive investment: making investments in telecommunications, logistics, and

business infrastructure to remain competitivecreate business friendly policies to create a compelling

case for investment to come to the country.

• Continued development of its stock of human capital: Ensure its small labour force retains its edge over rivals in

the region