International Trade and Protectionism

This is Unit Seventeen of Principles of Macroeconomics, part one of two: international trade and protectionism. Unit sixteen ended by naming which failure an economy has. This part asks why two countries trade at all, and what they get from it. Carry one idea through. The concept that decides trade is not which country is better at making something, but which gives up less to make it — and almost every confused argument about trade comes from reading the first where the second is meant. Part two takes up the arguments for restricting trade, and the last entries here hand it the strongest premise it has. By the end you will find both kinds of advantage from an output table, show that specialising raises world output of both goods, find the trading ratios that leave both countries better off, say why very similar countries trade the same goods, and classify a form of protection.

Five entries on what trade is, the two kinds of advantage, and reading both off a table.

What trade actually is.

MAC 1601 Trade Is Mutually Beneficial Exchange

Trade between countries is exchange that both sides expect to gain from, not a contest with a winner and a loser. Two firms can be each other's largest supplier and largest competitor at once. Each does what it does best and buys the rest. The language of winning and losing is imported from sport, and it misleads here.

The first kind.

MAC 1602 Absolute Advantage

A country has an absolute advantage in a good when it can produce more of it from the same resources. That can come from more resources, from more productive ones, or from natural endowment: oil reserves, farmland, a climate that suits coffee, ore in the ground. Neither book's witness names this concept, so the definition here rests on the anchor alone.

The kind that decides trade.

MAC 1603 Comparative Advantage

A country has a comparative advantage in a good when it produces that good at a lower opportunity cost than its partner. The question is not what a country can make most of, but what it gives up to make it. This is unit one's opportunity cost, applied between countries. Comparative advantage, not absolute advantage, is what makes trade pay.

Reading both from a table.

MAC 1604 Finding Both from an Output Table

From output per worker, find each country's absolute advantage and each country's comparative advantage. Absolute advantage is read straight off by comparing the larger number in each row. Comparative advantage needs opportunity cost, which comes from setting the two outputs equal within one country and dividing. Take Northland and Southland. A Northland worker produces ten cloth or twenty grain a year; a Southland worker produces eight cloth or eight grain. Northland's numbers are larger in both goods, so Northland has the absolute advantage in both. Now the opportunity costs. In Northland, ten cloth and twenty grain take the same labour, so one cloth costs two grain. In Southland, eight cloth and eight grain take the same labour, so one cloth costs one grain. Southland gives up less grain per cloth, so Southland has the comparative advantage in cloth, and Northland has it in grain. Notice what happened: the country better at making everything has the comparative advantage in only one good. That is the whole point of the concept, and reading the table for absolute advantage alone gets the trade pattern exactly backwards.

Why the two costs lock together.

MAC 1605 The Reciprocal Rule

The opportunity cost of one good is the reciprocal of the other's. If one cloth costs two grain, then one grain costs half a cloth. So no country holds the comparative advantage in both goods. In Southland one cloth costs one grain, so one grain costs one cloth. State cost and slope consistently, because the anchor slips between them.

Three entries on what specialising actually gains, and on the ratios that share those gains out.

What specialising does.

MAC 1606 Gains from Specialisation

Show that moving each country toward its comparative advantage raises world output of both goods: compute world totals before trade from each country's own production, then recompute after each specialises, and compare. Each country has a hundred workers. Before trade, Northland puts thirty workers on cloth and seventy on grain, producing three hundred cloth and fourteen hundred grain. Southland splits evenly, producing four hundred cloth and four hundred grain. World output is seven hundred cloth and eighteen hundred grain. Now each specialises. Northland puts all hundred workers on grain, producing two thousand grain and no cloth. Southland puts all hundred on cloth, producing eight hundred cloth. World output is eight hundred cloth and two thousand grain. Both totals rose, from the same workers and the same skills. Nothing was invented and nobody worked harder. The extra hundred cloth and two hundred grain came only from each country doing what it gives up least to do.

Where the gains show up.

MAC 1607 Consuming Beyond the Frontier

Trade does not move a country's production possibilities frontier. It lets the country consume at a point outside it, by producing one thing and exchanging for the other. Production stays on the frontier; consumption moves beyond it. This is the single most exam-relevant sentence in the unit, and the two points are different points.

Which ratios work.

MAC 1608 The Range of Beneficial Ratios

Find the trading ratios that leave both countries better off, then show a consumption point beyond a frontier. The range is bounded by the two opportunity costs: any ratio strictly between them beats what each country could do alone, and outside that range one country would rather not trade. Northland's cost is two grain per cloth and Southland's is one, so beneficial ratios lie strictly between one and two grain per cloth. Take one and a half. Southland produces eight hundred cloth, keeps four hundred, and trades four hundred cloth for six hundred grain. Northland produces two thousand grain, keeps fourteen hundred, and trades six hundred grain for four hundred cloth. Northland now consumes four hundred cloth and fourteen hundred grain, against three hundred and fourteen hundred before: better by a hundred cloth. Southland consumes four hundred cloth and six hundred grain, against four hundred and four hundred before: better by two hundred grain. Both end outside their own frontier, which no domestic reallocation could achieve. Note also that the gains split unevenly, and where in the range the ratio settles decides the split — which is what trade negotiations are actually about.

Two entries on the cases that puzzle people most.

Better at everything.

MAC 1609 When One Country Is Better at Everything

A country can need fewer workers for every good and still gain from trade. Comparative advantage picks out the good where its advantage is relatively largest, and its partner's where its disadvantage is relatively smallest. Northland is better at both and still gains by leaving cloth to Southland. Total superiority cannot beat a time constraint, because every worker has the same hours.

How far it has to go.

MAC 1610 Partial Specialisation Is Enough

The gains do not require either country to abandon a good entirely. Shifting some workers toward the comparative advantage raises combined output, and the more that shifts, the larger the gain. A partial shift produces a partial gain, in the same direction. Full specialisation is the clean case in the arithmetic, not a requirement of the argument.

Two entries on trade the theory does not predict, and on advantage that can be built and lost.

The genuine puzzle.

MAC 1611 Why Similar Countries Trade the Same Goods

Here the unit's governing idea meets its hardest case. Comparative advantage predicts that trade happens between economies that are different from each other, and a large share of the world's trade is between economies that are very similar, often in the same industry — countries exporting and importing cars at the same time. That is a genuine puzzle for the model as stated, and the resolution is not that the model is wrong but that it is incomplete. Two further sources of gain operate alongside it. The first is specialisation and learning: goods are not homogeneous, and firms working on particular products develop particular skills, so one country exports one kind of machinery and imports another without either workforce being generally better. The second is economies of scale: average cost falls as output rises, up to a point, so a larger market supports lower costs. Neither requires the two countries to differ at all. Take a small economy and one product whose average cost keeps falling until a plant serves a market far larger than that country. Without trade, one or two plants could supply the whole domestic market at the lowest available cost — and consumers would then face almost no competition and almost no choice. Open it to trade and both problems dissolve at once: production runs at efficient scale, because the market is now the world rather than the country, and consumers face many producers instead of one or two. Scale and variety normally trade off against each other inside a closed economy, and trade is what lets an economy have both. The anchor credits foreign competition with much of the improvement in domestic car quality. Three cautions. First, economies of scale are not unlimited: the cost curve flattens beyond some output, so bigger is cheaper stops being true at some scale. Second, this changes what is traded — when the stages of making one good happen in different countries, design in one, components in another, assembly in a third, trade is increasingly in parts rather than finished goods, and where something was made stops having a single answer. Third, an advantage built from learning and scale can be built and can also be lost. Advantage grounded in climate or ore is fixed; advantage grounded in accumulated skill is not, which is the honest opening for the infant-industry argument in part two. All of this rests on the anchor alone.

Advantage that can be lost.

MAC 1612 Dynamic Comparative Advantage

Where advantage comes from learning, skill and scale rather than from climate or endowment, it can be created and it can be lost. Countries are not fixed in what they are good at, and an industry can be built up over a generation and overtaken in less. This is the strongest premise available to the infant-industry argument that part two takes up, and the anchor supplies it.

Three entries on where the trading rules came from, and on the three ways countries restrict trade.

Where the rules came from.

MAC 1613 The Rules and the Rounds

The General Agreement on Tariffs and Trade provided the trading system's rules from nineteen forty-eight, with reductions negotiated in successive rounds. The World Trade Organization began on the first of January nineteen ninety-five, after the Uruguay Round. The Doha round was launched at the fourth Ministerial Conference in November two thousand and one, and later Ministerials produced packages in twenty thirteen and twenty fifteen. Both books are stale here, so these dates come from the Organization itself.

Three ways to block imports.

MAC 1614 Three Forms of Protection

Protectionism blocks imports three ways. A tariff taxes them and raises their price. An import quota caps the quantity allowed in. A nontariff barrier uses rules, standards and paperwork to raise the cost of importing, so a safety standard can restrict trade as well as a tax can. The witness names only the first two; the third rests on the anchor alone.

Telling them apart.

MAC 1615 Classify the Barrier

From a description, name the form of protection and say how it raises the domestic price. The test is what the measure limits directly: a tax on the imported good is a tariff, a numerical ceiling is a quota, and anything that works by making importing harder or costlier without taxing or capping it is a nontariff barrier. A fifteen percent charge on every imported unit is a tariff, and it raises the price by raising the importer's cost directly. A rule admitting no more than forty thousand units a year is a quota, and it raises the price by restricting supply until the market clears higher. A requirement that each shipment be inspected at one designated port is a nontariff barrier, raising the price through delay and handling cost. A rule that a good may be labelled as made domestically only if its last substantial change happened there is also a nontariff measure, and producers respond by relocating the final stage to qualify. The three differ in who collects the difference. A tariff's revenue goes to the government. A quota's higher price goes to whoever holds the right to import, who may be a foreign producer. A nontariff barrier's cost is often pure waste, collected by nobody at all, which makes it the most expensive of the three per unit of protection delivered.

Look at what you can now do. You can find both kinds of advantage from an output table, and say why the country better at everything still has the comparative advantage in only one good. You can show that specialising raises world output of both goods from the same workers, and say that nothing was invented to make that happen. You can find the ratios that leave both countries better off, and say why where the ratio settles decides how the gains split. You can say why very similar countries trade the same goods, and name the two sources of gain that comparative advantage alone does not supply. And you can classify a form of protection and say who collects the difference it creates. Part two builds the model of protection and takes up the five arguments for it.