Trade

• The level of trade is the amount of exports of goods and services as a percentage of the GDP.

  • It measures how much of the country’s production it exports. It is also a measure of the country’s engagement with the global market.
  • It is influenced by (1) the size of the economy; (2) the Geography; and (3) the history of trade.
  • It is distinct from the balance of trade.

• The balance of trade is any gap between the monetary value of exports with imports.

  • Merchandise trade balance - trade balance tracked by the physical items transported between countries. This is outdated due to services exported by technology.

• Current Account Balance - includes other international flows of income and foreign aid on top of balance of trade.

  • A current account deficit implies the country is a net borrower from abroad.
  • A current account surplus implies that the country is a net lender to the rest of the world.

• From an economist’s perspective, A balance trade is a balance of payments

  • A trade deficit means the same thing as an inflow of financial capital.
  • Conversely, a trade surplus means the same thing as an outflow of financial capital.

• The national saving and investment identity is an equation showing the relation between money spent and money saved by an economy.

  • Domestic saving swill always appear as part of the supply of financial capital
  • Domestic investment will always appear as part of the demand for financial capital.
  • Government investment and trade balance can move from either supply or demand for as long as the identity is established.
  • A nation’s own levels of domestic saving and investment determine a nation’s balance of trade

• The equation can be rewritten as follows

  • - private savings
  • - imports
  • - exports
  • - private investments
  • - taxes
  • - government spending

• Consider the short-run effects of the economy on trade imbalance

  • In most cases, A recession tends (to make a trade deficit smaller or a trade surplus larger. The trade surplus is due to domestic prices being lower than foreign prices
  • In most cases, Strong economic growth tends to make a trade deficit larger or a trade surplus smaller. The deficit is due to foreign prices being lower than domestic prices which attracts foreign investors.

• Trade imbalance does not necessarily imply a successful economy nor does it imply an unsuccessful economy.

  • Trade deficits can be good if used to invest in jumpstarting infrastructure and sectors that boost productivity.

• Large trade surpluses or deficits can become an issues (i.e., recessions).

  • Running large deficits is bad when the country does not invest the incoming funds towards improving productivity.
  • When money rapidly flows in due to borrowing but at the same time rapidly flows out, the country may plunge into recession.
  • Trade surpluses may mean that financial capital is being “drained” out of the country, or that there is not enough investment within the country for the capital to go towards.
  • Countries that have trade imbalances are more vulnerable in the financial crisis since they are reliant on global supply (importers) and demand (exporters).

• The fundamental economic question is not whether a nation’s economy is borrowing or lending at all, but whether the particular borrowing or lending in the particular economic conditions of that country makes sense.

International Trade §

• International Trade tends to accompany economic growth.

• A country has an absolute advantage over another country in producing a good if it uses fewer resources to produce that good. This is influenced primarily by Geographical factors

• Trade occurs due to comparative advantage which means countries can produce a good at a lower cost relative to other goods.

  • Gains from trade happen when the trading price for a good (in terms of another good) is greater than the opportunity cost of obtaining that good through production.
  • Like firms, if each country specializes in its comparative advantage, it will benefit from trade, and total global output will increase

• Even when one country has an absolute advantage in all products, trade can still benefit both sides due to minimizing costs via specialization.

• Trade allows each country to take advantage of lower opportunity costs in the other country

• A high proportion of trade is intra-industry trade — the trade of goods within the same industry from one country to another.

  • In developing specific products, firms in certain countries develop unique and different skills and focus on refining the processes in one specific part of the value chain.
  • There is a trend in international trade of splitting up the value chain. This is due to easier infrastructure for information sharing and transportation.
  • Intra-industry trade also *facilitates economies of scale which drives down production costs.
  • It also facilitates competition which drives innovation and promotes market variety.

• Countries are not destined to have the same comparative advantage forever, but must instead be flexible in response to ongoing changes in comparative advantage.

• Tariff - taxes that governments place on imported goods.

  • Traditionally ,this is used to protect local industry.
  • Low-income countries benefit more from trade than high-income countries do.

Links §

• Shapiro, MacDonald and Greenlaw - Ch. 23, 33
• Macroeconomic Goals