International Trade

Dr. Katie Sauer

Metropolitan State College of Denver

Presented at the “Discovering the European Union” Workshop

Sponsored by the Colorado Council for Economic EducationAnd the Colorado European Union Center of Excellence

August 4th, 2010 Denver, CO

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In 2008, world exports totaled $19,850 billion.(nearing $20 trillion)

merchandise: $16,070 billion services: $3,780 billion

International trade accounts for about one-third of the world economy.

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EU Merchandise Trade, 2008Exports Imports

share of world total 15.9% share of world total 18.4% composition composition

agriculture 6.6% agriculture 7.6%fuel/mining 8.7% fuel/mining 33.5%

manufactures 81.4% manufactures 56.4%Destination Source

United States 19.1% China 16.0%Russian Federation 8.0% United States 12.0%

Switzerland 7.6% Russian Federation 11.2%China 6.0% Norway 5.9%

Turkey 4.1% Switzerland 5.2%

Source: WTO trade profiles

Top 3 Exporters World Share: 1 Germany 9.1% 2 China 8.9% 3 US 8.0%

Top 3 Importers World Share: 1 US 13.2% 2 Germany 7.3% 3 China 6.9%

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EU Services Trade, 2008

Exports Imports

share of world total 26.8% share of world total 23.5%

composition composition

transportation 6.6% transportation 7.6%

travel 8.7% travel 33.5%

other 81.4% other 56.4%

Source: WTO trade profiles

Top 3 Exporters World Share: 1 US 13.8% 2 UK 7.5% 3 Germany 6.4%

Top 3 Importers World Share: 1 US 10.5% 2 Germany 8.1% 3 UK 5.6%

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I. Why do nations trade?A. General Reasons B. A little bit of Trade TheoryC. Trade in Theory and in PracticeD. Trade Pattern

II. The economic effects of international trade

III. Trade as a Policy ToolA. Types of Trade BarriersB. The EU and TradeC. The net effects of a tariff are negative

IV. Measures of Trade  A. The Relative Importance of Trade

B. The Trade Balance

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I. Why do nations trade?

A. General ReasonsWhy do nations export?

- individuals/firms produce more than can be consumedat home - sellers could receive a higher price in a foreign market- sellers may offer a product that doesn’t exist in the foreign market

Why do nations import?- some goods can’t be produced at home (or not enough)- some goods are produced at a lower cost or moreefficiently elsewhere- consumers like variety

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B. A little bit of Trade TheoryDue to differences in supply conditions, a country may be able to produce more of a good at a lower cost.

- superior technology- large factor (resource) endowments

Absolute advantage is the ability to produce a good at the lowest cost.

It implies a potential trade pattern.ex: tropical countries produce and export bananas coastal countries produce and export seafood

It gives an incentive to specialize in a good and export it.

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Absolute advantage alone is not sufficient to fully explain international trade.

- The opportunity cost of producing an item may exceed the cost of trading for it.

An opportunity cost is the value of everything that mustbe sacrificed in order to get something.

International trade is based on comparative advantage.

Comparative Advantage is the ability to produce at the lowest opportunity cost.

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Even if a nation has absolute advantage in nothing, it can have a comparative advantage.

When countries specialize in producing goods they have comparative advantage in, and then trade those goods, they can consume more goods and services than they could produce on their own.

In a nutshell, this is why economists have concluded that international trade is good and can be good for all countries involved.

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C. Trade in Theory and in Practice

In reality, specialization and trade don’t work exactly as the theories of absolute and comparative advantage suggest:

- no country specializes exclusively in the production and export of a single product

- countries produce at least some goods that could beproduced elsewhere more efficiently

- a lower income country may be able to produce morecheaply than a high income country but may not be ableto identify potential customers or to transport the itemcheaply or quick enough

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However, in general…

Countries with a relative abundance of low-skilled labor tend to specialize in and export items having low-skilled labor as a major cost component.

Countries with a relative abundance of capital tend to specialize in and export items having capital as a major cost component.

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D. Trade Pattern(what a country imports and exports and who its trading partners are)

GermanyExports: machinery, vehicles, chemicals, metals and manufactures, foodstuffs, textiles

France 10.2% UK 6.6%US 6.7% Italy 6.3% Netherlands 6.7%

Imports: machinery, vehicles, chemicals, foodstuffs, textiles, metalsNetherlands 8.5% US 5.9%China 8.2% Italy 5.9%France 8.2%

CIA World Factbook

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Cyprus

Exports: citrus, potatoes, pharmaceuticals, cement, clothingGreece 20%UK 10.8%Germany 6%

Imports: consumer goods, petroleum and lubricants, intermediate goods, machinery, transport equipment

Greece 16.9% Germany 8.3%, Italy 10.7% Israel 8.2%UK 8.7%

CIA World Factbook

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II. The economic effects of international trade

When a nation does not trade, the domestic supply and demand forces will determine the price and quantity sold.

When a nation opens up to international trade, then the world price will become relevant.

The world price is determined by:world supply (exports)world demand (imports)

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If the world price is higher than the domestic price:- domestic sellers will produce more to take advantage ofthe higher price

- domestic consumers will buy less because the price is now higher

- with sellers producing more and consumers buying less,there will be a surplus in the domestic market

- the surplus will be exported

Nutshell: good for domestic producers of this good, bad for domestic consumers of this good

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If the world price is lower than the domestic price:- domestic sellers will produce less because of the lowerprice

- domestic consumers will buy more because the price is now lower

- with sellers producing less and consumers buying more,there will be a shortage in the domestic market

- the goods will be imported to satisfy the shortage

Nutshell: good for domestic consumers of this good, bad for domestic producers of this good

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Trade is not a zero sum game… both importing and exporting nations can benefit at the same time.

Trade can make countries as a whole better off, but there are winners and losers among producers and consumers.

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The benefits of trade have been studied and quantified and proven time and time again.

- lower prices- more choice and variety- helps developing nations

- market access- technology transfer / human capital building

- access to foreign markets for domestic producers- cheaper inputs for domestic producers

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III. Trade as a Policy Tool

Trade is such a powerful economic tool that governments often manipulate trade to achieve various economic, political, and diplomatic objectives.

Sometimes this takes the form of erecting trade barriers.

Sometimes this take the form of eliminating trade barriers.

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A. Types of Trade Barriers

1) tariff : tax on imports- raise price of imports / decreases amount of imports- helps domestic producers- domestic government collects revenue

2) export subsidies : involves a transfer of funds from the government to an export producer

- encourages exports- helps domestic industry- government must spend money

3) non-tariff measures for restricting importsex: quotas or technical barriers

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B. The EU and Trade

Historically, each European country protected its domestic producers with tariffs and quotas:

- tariffs prevent the import of goods at prices lower than the domestic price

- quotas limit the volume of imports to be equal to domestic demand minus domestic production

Countries would basically only import the quantities of goods that are not normally supplied by domestic production.

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When domestic industries are protected from competition, they rarely make substantial efforts to

- reduce production costs- innovate/modernize

Consumers end up with limited choice and high prices for low quality goods.

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In the EC Treaty (1958), the European Community is based upon a customs union.

- prohibits customs duties on imports and exports betweenmembers

- prohibits all charges having an equivalent effect as dutiesbetween members

- adopt a common customs tariff for non-members

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Nations were given 12 years to eliminate trade barriers.January 1, 1958 – December 31, 1969

The tariff reductions were actually completed on 1 July 1968.- 18 months ahead of schedule - tariff dismantling did not cause major problems in themember states

- yes, some firms/industries were harmed- many new firms and industries chose to innovate

(Countries who joined the Community later were given 5 years to eliminate tariffs.)

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The economic impact was substantial.

Between 1958 and 1972:- trade between the EC and external countries tripled- intra EC trade was 9 times higher- the larger market stimulated business confidence and soinvestment increased- consumers enjoyed falling prices, rising quality and morevariety- standard of living increased dramatically in each of the EC nations

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Even though tariffs were eliminated, other trade barriers remained.

Many of those trade barriers were hidden in regulations, which varied across nations. (“technical barriers”)

- consumer or environmental protection standards

The elimination of non-tariff barriers proved to be much more difficult.

- completed in 1992

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Today, the members of the EU share a single market and a single trade policy.

In trade talks, there is one negotiator, the European Commission.

At the end of the negotiation process there is just one agreement instead of 27 different sets of trade rules.

The EU’s trade philosophy toward member nations:- free trade (goods and services can flow freely between nations without government imposed barriers like tariffs or quotas)

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The EU’s trade philosophy toward external nations:- open its market to trading partners who do likewise

- preferential treatment for developing countries

- maintain a “common external tariff” (same tariff is paid on products regardless of which EU country is the entry point to the EU market)

- after clearing customs, goods can be shipped throughout the EU without additional duties

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D. The net effects of a tariff are negative

The Benefits of Protectionism:1. The producers in the specific industry are helped (in the short run).

- firms face less competition- workers do not lose jobs

2. The government collects revenue (which presumably will be used for public projects and not “wasted”).

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The Costs of Protectionism1) other domestic industries and workers are harmed

- firms must pay more for inputs- workers lose jobs

2) consumers pay higher prices and enjoy less variety

3) resources are spent on lobbying activities

4) taxes are spent- “Buy Local” provisions are especially costly

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5) other nations view the EU as very hypocritical

6) the industry receiving protection is often weaker in the long run

- doesn’t keep costs down- doesn’t innovate

7) the tariff may violate existing trade agreements- end up in “court” at the World Trade Organization

(8. In the case of agricultural and commodities, developing nations are harmed)

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WTO Trade Disputes Involving the EU

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IV. Measures of Trade

A. The Relative Importance of TradeFor an individual country, the total trade value as a share of GDP is an indication of how important trade is in the country’s economy.

total trade value = exports value + imports value

trade value as a share of GDP = total trade value x 100 GDP

Let’s do an example:

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In which EU nation is Dr. Katie? 2 of the 7

towers of the Fisherman’s Bastion

Statue of Stephen I

Fisherman’s Bastion is built overlooking the bank of the Danube on the “Buda” side of the nation’s capital.

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Hungary 2009 GDP: € 93,086 millionExport value: € 72,480 millionImport value: € 65,954 million

total trade value: 72,480m + 65,954m =

138,434 million

trade value as a share of GDP:138,434m x 100 =

93,086m148.7%

(The total trade value as a share of GDP can be greater than 100%.)

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Let’s put this figure into perspective:

yeartrade value

% GDP1999 131.42000 147.92001 143.72002 128.22003 125.52004 129.72005 133.82006 154.92007 159.12008 161.72009 148.7

Hungary’s Trade Value Share

over time

Source: World Bank and eurostat

Greec

e

Franc

eIta

lySpa

in

United

King

dom

Roman

ia

Portu

gal

Poland

Finlan

d

Germ

any

Latv

ia

Sweden

Cypru

s

Denm

ark

Austri

a

Lithu

ania

Sloven

ia*

Bulgar

ia

Nethe

rland

s

Irelan

d*

Czech

Rep

ublic

Eston

ia

Hunga

ry

Slovak

ia

Belgium

Luxe

mbo

urg

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

Trade Value as share of GDPEU Nations, 2008

* Data from 2007Source: World Bank

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Sometimes it is useful to look at the export share and import share separately.

Hungary 2009 GDP: € 93,086 millionExport value: € 72,480 millionImport value: € 65,954 million

Export Share of GDP:72,480m x 100 = 93,086m

77.8%

Import Share of GDP:65,954m x 100 =93,086m

70.9%

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B. The Trade Balance

The trade balance is the difference between the value of a country’s exports and the value of its imports. It is also called net exports.

Trade Balance = export value – import value

If exports > imports, then there is a trade surplus.

If exports < imports, then there is a trade deficit.

Let’s do an example:

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In which EU nation is Dr. Katie?

Official residence of this nation’s sovereigns.

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UK 2009

Export value: €433,977m Import value: €469,920m

Trade Balance: €433,977m - €469,920m =

- €35,943m

The UK is running a trade deficit.

Franc

e

United

King

dom

Greec

eSpa

in

Portu

gal

Roman

iaIta

ly

Bulgar

ia

Cypru

s

Lithu

ania

Slovak

ia

Latv

ia

Eston

ia

Finlan

d

Hunga

ry

Czech

Rep

ublic

Denm

ark

Belgium

Austri

a

Luxe

mbo

urg

Sweden

Irelan

d

Nethe

rland

s

EU (15

coun

tries

)

Germ

any

EU (27

coun

tries

)

Euro

area

Euro

area

(16

coun

tries

)

Euro

area

(15

coun

tries

)

EU (25

coun

tries

)-60000

-40000

-20000

0

20000

40000

60000

80000

100000

120000

140000

Trade Balance EU Nations, 2009

(millions of euros)

Source: eurostat

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Factors that influence a country’s trade balance:

1) prices of goods produced domestically- if domestically produced goods are relatively expensive, then a country will import cheaper goods from abroad

2) exchange rates- if a country’s currency is strong against other currencies, then it is “cheap” to import while its exports are “expensive” to other countries

3) trade agreements- when a country signs a Free Trade Agreement, bothits exports and imports will likely increase

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4) trade barriers - if a country imposes tariffs on imports, then importsare reduced- if a country subsidizes exports, then exports will rise

5) the business cycle at home or abroad- in an expansion at home, consumer incomes are increasing, in general this will increase imports

- in an expansion abroad, consumer incomes elsewhereare increasing so the home country exports more

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Most economists don’t believe that trade deficits/surpluses are inherently good or bad.

The economic impact of a surplus or deficit depends on the specific circumstances surrounding it.

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Summary:The EU is a major player in international trade.

Nations engage in international trade for various reasons.

When the world price is higher than the domestic price, the nation will be an exporter. When the world price is lower than the domestic price, the nation will be an importer.

The EU has chosen to eliminate all trade barriers among members, with a very positive result.

The EU has a common set of trade barriers for external nations.

Trade as a share of GDP and the trade balance are two key measures of trade in an economy.