Theory and Practice of International Trade

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Trade theory and policy

The correlation between trade and output is a complex one. Free trade may inhibit the growth of new industries in developing nations which causing them them to deflate and reduce output.

Macroeconomic context

Mundell says that tariffs will have adverse effects on output and employment but a fixed exchange rate will have the opposite in the absence of retaliatory tariffs.

Optimun tariffs

If a country is large enough to affect world prices then it may be in their interests to impose a tariffs. They get the benefit of stifling imports whilst only losing a few exports. It is also suggested that protectionism may offer a second best instrument for raising welfare by protecting jobs. Where protectionism is devised as a demand management tool under conditions of unemployment and slow growth then it is not necessary to identify strategic sectors just complementary imports v competitive imports. Protectionism need to be retaliatory where increased domestic demand still leads to increasing imports.

It is argued that protectionism may be a good policy compared to devaluation which raises the prices of all imports not just competitive ones. Protectionism can not deliver export led growth like devaluation which lowers export prices but by encouraging impot substitutes protection can stimulate demand at home. Again this may be a better tool than deflation, lower internal demand in order to bring payments in to equilibrium. If policy makers are concerned by minimizing the costs of unused resources then protectionism could be sed to help industries adjust to enable new competitive advantages.

Japans import levels are so much higher today because they protected their industries than it would have been otherwise under free trade. Coordinated use of fiscal and monetary policy would be required to avoid expansionary policies putting too much pressure on interest rates and exchange rates and the like.. It also needs the effective redistribution of winners and losers to avoid uneven development of economies. Improved regulation of financial institutions to prevent the gaming of the system. However in the medium term level of cooperation is unlikely, the rules of the game complex and there is no one country who can take center stage.

In the absence of a global policy them the alternative is to adopt expansionary policies at the country or regional level.

Trade and Growth

While the synchronization of national policies required under the gold standard conflicted at times...nonetheless policies aimed at sustaining and steadying effectiove demand would promote both internal stability and of exchange rates Ragnar Nurske 1944

The history of post war capitalism has been one of dominant powers in relative decline. The principal aim here is:

  • Relationship between the growth of world trade and world output since 1970
  • Evaluate the effectiveness of alternative international monetary regimes
  • Consider the trend in world trade and power that will shape the future.

Trade and growth: the mechanism

Stable international monetary systems in the post war increased trade but did not have universally positive effects. Increased reliance on trade can make countries more vulnerable to external shocks.

Trade and growth: some evidence

Between 1870 -1913 there was almost continual increase in world trade and there was a high interdependence between world trade and growth indicated by a high correlation. Growth was less volatile than anytime other than the Bretton Woods system

Trade and growth: the role of trade policies regimes

Pre-1913 world trade was founded on the Gold Standard. It provided stability via automatic adjustments via gold flows. Some have questioned the stability - Not all countries kept to the rules of the game. Rather than balancing through flows of gold, failing economies adjusted via deflation and migration. An additional mechanism was protectionism. This allowed countries to adjust without recourse to deflation or exchange rate realignment.

The interwar period saw reemergence of the Gold Standard but it failed becuase a beggar thy neighbour deflationary type policies and was replaced by the use of independent and uncoordinated trade policies. The growth of world rade was limited by the domestic policies of the surplus countries. For instance the BoE maintained its surplus and prevented the loss of gold. In Germany its persistent payments deficit made it reliant on loans raising the debt burden that undermined creditworthiness. Ultimately the needed to deflate.

Post war saw the Bretton Woods system. He also wanted the cost of adjustment shared between countries with trade surpluses and deficits, so that countries with big surpluses would have to revalue their currencies, as well as deficit countries being forced to devalue. Instead, the Bretton Woods system gave the US currency - which was linked to gold. But the system was asymmetrical in the adjustment was borne by weaker countries who deflated.

Regionalism and world trade

Chaos in the 1930 led to protectionism and the rise of trading blocs. These took tow forms. RTA Regional Trade Agreements - EEC, NAFTA, EU as well as ones organized around empires (UK, France etc). RTA's accounted for fouth fifths of the world trade in 1969; mostly Europe then NA then Asia. Globalization can counteract regionalization through extra-bloc trading. There is no evience according to Kitson that protectionism led to a collapse of multi-lateral trade but it is claimd (by GATT) then open trade would add $250bn a year to world trade although it is argued that would be skewed towards already industrialized states.

Lessons

One lesson is that regulatory frameworks needs to develop and adapt quickly and that IMF, World Bank etc need steamlining and stop using the tool of deflation as a condition of receiving aid. MF should stop the recommendation of privatization and accept that there are a variety of different social and industrial systems.

Commentary

Kitson and Michie make a strong argument (p42) in the text and online, that left to the free market and Ricardian theory, Japan would have developed a comparative advantage in rice growing and textiles. Instead, through the active use of economic policy they developed and protected their auto-mobile and electronics industries and were able to gain a competitive advantage in these industries and increase its GDP per capita. This provided Japan the income to increase the level of imports over what they would have otherwise been able to afford and thus increase the overall level of world trade. This model to some extent has been adopted by other developing nations to allow them to compete with the rest of the world.


One of the conclusions reached is that interventionist protection policies have not lead to a collapse in World Trade since WW2 and are a useful alternative to deflationary domestic policies. What I do not think was adequately discussed is how much state intervention is too much and under what circumstances it is necessary. State subsidies to Airbus for instance were probably warranted as a free market would not have produced a competitor to rival Boeing in the commercial aircraft industry and it balanced out the US military’s bias towards buying American. In a similar fashion the bail out of GM and Chrysler and the structured bankruptcy of GM probably allows for more choice and competition for consumers in the long run. It is unlikely that the free-market could have provided that outcome.


However, these should be considered well-thought through exceptions to the rule that markets can achieve equilibrium without direct interference in most forms of international trade provided that governments collaborate to provide regulation and access to markets through bodies such as WTO, IMF, etc

George Soros

speaking of George Soros he was at the WEF this week. In his interview with Bloomberg I noticed to that he argued that that free markets do not tend towards equilibrium. His thesis was that

  • The free markets do not tend to equilibrium but rather either boom or bust and therefore we should not look at economics in terms of a natural science. He also believes that not only are markets are imperfect but so are the regulators
  • He says that free markets eventually break down so regulation is required yet the evidence is that Europe (Basel3), US (Dodd/ Franks) and China are developing different standards in terms of regulation and this is likely to be harmful unless coordinated
  • The Euro is likely to stay but will/could develop in to two tier Europe with the creditor countries moving ahead and the debtors failing unless the debts are renegotiated.

His comments are more of a statement of the new economic reality than detailed solutions for the problems at hand but I guess that is not his role

Current World Economy

Today’s world economy shows the absence of:

- Accurate templates for forecasting the frequency, range and consequences of cycle segments, especially downturns (crisis, depressions);

- Clear guidelines for countries on how to successfully apply economic policies in order to amortize the cyclic movement of economic system caused by the market tendency to level itself;

- Fast adjustable protective mechanisms against aftermaths (bursting) of economic bubbles (especially speculative capital) which markets regularly tend to create;

- Distinctive rules of conduct for international financial institutions and measures of application.

Due to the listed deficiencies I support active economic policies and consider the possibility of:

A Formation of one new umbrella agency that would monitor and regulate international flow of capital;

B Introducing some form of global taxation.

It is also to be determined weather the current economic system has some fundamental flows, which in the long run can not be improved, no matter how the governments thrive with their fiscal and monetary activities. Mechanisms of supply and demand are not self correcting but they do tend to level themselves. The problem is that this osmotic process is not so smooth and regular at all. On the contrary, it creates a lot of bumps and turns on its way, which can cause severe consequences.

There is also the question weather some core corruption in these basic mechanisms had occurred during the natural evolution of the current economic system. Namely, advocates of the free market call for liberalisation from the government influence. They also forget the market is in fact increasingly affected by its own participants. Companies demand deregulation and fear from a planned economy, but they do some great amount of planning themselves.

When advertising emerged its role was to connect the supply and demand in the market. The inventive philosophy which basic principle was to answer the consumers need gradually become a policy of creating that need. So in fact, we have a newly formation of demand that would not originally exist and is in fact very much artificially created.

Concluding Remarks

The theoretical advantages of free trade are straightforward: each country can import goods that would be costly to produce domestically, while exporting goods that would be costly for other countries to produce. In principle then, each country can acquire a set a goods and services with fewer resources than if it tried to produce them all domestically. Under such reasoning, free trade is Pareto optimal —leaving no one worse off and at least some better off—and leads to the most efficient allocation of resources on a world scale. There are also a range of situations in which a country may benefit from a strategically chosen restrictive trade policy. In theory, free trade is the best policy for countries that exercise little to no control over world prices. Since they cannot affect prices to their own benefit, free trade allows them to achieve the maximum national consumption. However, if a country possesses some degree of monopoly power in exports, it can increase its own welfare through trade restrictions (i.e. OPEC). Most evidence suggests that domestic interests and political concerns are more often the source of protectionism than such “optimal tariff” considerations. One argument often made in favour of protection concerns infant industries (Paul has already mentioned the case of Airbus), or those that are deemed essential to the national interest, which may not be able to compete on an international level. Such protections are often associated with national fears of dependency on the international economy—above all, in such areas as agriculture and defence


Other sources

  • Transcript and video of government intervention in the automobile industry

http://www.cfr.org/business-and-foreign-policy/should-governments-drive-industry-change-lessons-learned-global-automotive-sector-video/p20807?breadcru%20mb=%2Fpublication%2Fby_type%2Fvideo

File:Globalization ambiguity.pdf

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