COURSE OVERVIEW: Explains why nations trade, the distribution effects of trade and the consequences of trade policy. Other topics include exchange rates, the balance of payments, interest rate and purchasing power parity and macroeconomic policies in an open economy.
Topics covered:
Patterns of Trade
Trade Policy
Part Two: Open-Economy Macroeconomics Exchange Rates
Balance of Payments
Solution
INTERNATIONAL TRADE
International Economics is primarily about international trade, which is based on Ricardian concepts and rationales. For instance, modern economists acknowledge that international trade is based on comparative advantage and comparative advantage is underlying principle of bilateral/regional trade; therefore, all trading countries benefit. It suggests that when economies produce goods and services that have less opportunity cost and trade them to other countries, both producer and consumer surplus increases. Also, because of optimal exploitation of scarce resources (due to low opportunity cost), economies perform efficiently (Krugman).
Classical and neo-classical economists assert that trade is highly beneficial for an economy and it facilitates countries/economies in realizing their political-economic and political-social objectives. In fact, they suggest that trade must be a major component of economic strategy and policy of a country/government. Such assertions influenced governments around the world and compelled them to amend their political-economic systems to 1) incorporate trade as a major component in economic strategy and 2) use it as an instrument to realize various kinds of economic objectives (adoption of the liberal-economic model).
As the economic policy changed and the size of trade increased (exponentially), various economic institutions appeared, with the objective to keep international trade (both bilateral and regional) transparent and fair. One of such institutions is World Trade Organizations, which facilitate international trade and strive to keep an international trade fair and transparent (Ospina and Roser). For Instance, World Trade Organization allows countries to take punitive actions (about trade) against those countries, which give subsidies to certain sectors or industries (countervailing measures). However, its policy regarding indirect measures to subsidize economy and its sectors/industries is flawed and incomprehensible (Donnan).
It is evident from the statistics, about trade, that economic perceptions and policies, of countries, have evidently changed; however, studies infer that trade has an ambiguous relation to economic growth. The skepticism, regarding trade and its alleged benefits, is not new, but rather quite old. In fact, Keynes and Keynesian economists are not great enthusiasts of trade, which is quite evident from the subtly opposition of international trade by them.
A SHORT OVERVIEW OF ECONOMY
The selected country is the United States, which has one of the largest economies in the world. In the year 2017, the size of its Gross Domestic Product was $18.57 trillion, and the unemployment rate was 4.1%, which was quite close to the natural rate of unemployment. The GDP growth rate, of the US, was 1.6%(United States Trade Representative).
The United States has an industrial economy; in which service sector dominates all other sectors, whereas the smallest of all sectors is an agriculture sector. Economists consider consumption of economic growth, as consumption intensifies economic activity in the United States.
TRADE POLICY
From the systematic analysis of Trade and Trade Policy, it is apparent that trade affects various aspects/sectors of the economy. The reason is that trade has become a very large and dominating economic factor and phenomenon in an economy. Therefore, it influences other aspects and sectors of the economy. However, it is also a fact that countries adopt trade and devise trade-related policies for its direct benefits, which include expansion of industry (because of growth in exports), increase in producer surplus (because of a better price in the international markets), increase in consumer surplus (because of inexpensive imports) and others.
Evidence reveals that when trade expands (assuming exports too), economic activity intensifies. This intensifying of economic activity expands 1) industry and 2) increases general employment level in a country. This expansion of the industry positively correlates with GDP growth, whereas the increase in the general employment levels directly associated with consumption, which is considered an engine of economic growth in both developed and developing economies (BS Reporter). Thus, both exports and consumption are important for economic growth (Choudhury).
As producers can sell in more lucrative markets, therefore, producer surplus increases, which benefits not only them but also an economy at large. Similarly, because of the competition, prices decrease in local markets, pushing firms to take extraordinary measures about it. It gives birth to corporate innovation, which is considered essential for the evolution of not only a firm but also the corporate/economic system, in which it functions (Ghidini).
There are also indirect benefits of trade. For instance, trade intensifies competition, which enforces innovation upon firms that are competing in the markets. Innovation is cherished in contemporary economic and corporate systems as it has numerous benefits in the long run, not only from a firm or an industry but also for the entire economy.
Another indirect advantage, of trade, is that it attracts Foreign Direct Investment, which economists consider essential for the expansion of the economy and its improvement (qualitative change in overall economy). In fact, some economists consider FDI inflows as an engine of growth and give an example of China and such other developing economies. Therefore, trade is an instrument and policy regarding it must be very potent (Krugman).
The United States is to ascertain that its trade policy must be such that facilitates economic growth (stimulating local and international investment). It should not adversely affect the economy.
It is plain that trade policy of developing country is always slightly different from the trade policy of developed countries. However, both types of countries emphasize on their competitive and comparative advantage, which also true for the United States. Therefore, the trade policy, of the United States, is based on both comparative and competitive edge.
The trade policy, of the United States, generally focuses on high-tech exports, whereas developing countries export manufacturing and agriculture-related products. Therefore, the targeted markets, of the United States, are different, from the markets targeted by developing countries, such as China, which is why their trade policy also differs (Caulfield).
The trade policy is influenced by various factors, such as the health of the world economy and prevailing perception regarding trade. Also, each country has its trade policy towards a particular country or region. For instance, the United States, Canada, and Mexico agreed to a tariff-free trade (North Atlantic Free Trade Agreement). Similarly, the United States gave China status of the Most Favorite Nation, which dramatically increased the size trade between the two countries ($648 billion in the year 2016) (United States Trade Representative). It implies that trade policy (tariffs/quotas/free-trade) directly influence the size of trade between the trading countries. The United States also exploit trade for strategic interests. For instance, by allowing countries to sell products and services in its lucrative markets, it develops leverage over them (Caulfield). China also does the same; however, in contrast to the United States, it offers its labor-intensive economy to foreign investors, where they can invest and from where they can trade with other countries (Leng).
TRADE PATTERN
The pattern of trade changes, as political-economic realities change. For instance, after the collapse of the Soviet Union, countries aggressively pursued economic goals by introducing economic reforms. It is true for the United States too. The reason for these changes, which the United States introduced gradually, was to bring more depth into its economy and to increase its capacity to realize the objectives and endure economic shocks.
Since the early 90s, political-economic structures have changed greatly, which have also changed trade pattern. For instance, liberal economic model encouraged trade and investment. It pushed governments to reduce tariffs and allow free-trade among countries. These developments also facilitated free movement of labor and capital to other countries, bringing enormous changes in the structure of the international or global economy. For instance, many United States firms and companies invested in Mexico and China after the 1990s; where they produced goods/products and sold in the US and other markets around the world (iPhone is an example). These developments evidently changed American economy and statistics related to it (Ospina and Roser).
A prime example of changes in the American economy, due to changes in the pattern of trade, is a flight of capital to labor-intensive economies. Many Americans firms invested in labor-intensive economies because the cost of production in such economies was low. The products or goods produced in these economies were then sold in lucrative markets around the world, which offered high returns. It allowed developing economies, like India, China, and Mexico to industrialize and grow at an impressive rate. These dramatic and positive changes in developing economies, due to trade, started to re-shape economic realities at the global level (BS Reporter).
However, it is also the fact that trade adversely affected the American economy causing deindustrialization and unemployment (trade imbalance). Evidence, regarding the deindustrialization, is enormous and it has caused a political reaction in the United States (Radwanski).
INTEREST RATES AND INFLATION
As trade impacts economic activity; therefore, it also influences inflation and interest rates. As we have established that deindustrialization has started to occur because of the United States’ trade policy; therefore, the pressure (downwards) is on interest rates. The US has employed an expansionary monetary policy to 1) stimulates investment, 2) increase consumption, 3) increase inflation and4) employment. Interest rates also affect currencies (exchange rate), which affect Purchasing Power Parity.
DATA
Trade % of GDP (USA)
Figure1. Trade % of GDP (USA) Graph from the World Bank Data. “Trade (% of GDP).” The World Bank. The World Bank,17 April 2018. Web. 18 April 2018.
| Series Name | Trade (% of GDP) |
| 1992 [YR1992] | 19.89274 |
| 1993 [YR1993] | 19.9859 |
| 1994 [YR1994] | 20.99351 |
| 1995 [YR1995] | 22.38218 |
| 1996 [YR1996] | 22.61124 |
| 1997 [YR1997] | 23.34412 |
| 1998 [YR1998] | 22.75974 |
| 1999 [YR1999] | 23.19303 |
| 2000 [YR2000] | 24.98318 |
| 2001 [YR2001] | 22.80314 |
| 2002 [YR2002] | 22.14966 |
| 2003 [YR2003] | 22.45059 |
| 2004 [YR2004] | 24.29492 |
| 2005 [YR2005] | 25.50066 |
| 2006 [YR2006] | 26.87362 |
| 2007 [YR2007] | 27.95893 |
| 2008 [YR2008] | 29.94141 |
| 2009 [YR2009] | 24.76583 |
| 2010 [YR2010] | 28.18245 |
| 2011 [YR2011] | 30.88516 |
| 2012 [YR2012] | 30.71463 |
| 2013 [YR2013] | 30.22626 |
| 2014 [YR2014] | 30.2235 |
| 2015 [YR2015] | 27.89004 |
| 2016 [YR2016] | 26.57992 |
In 1960, trade, as %of GDP, was only 8.7%; however, in the year 2016, it was 26.57% of total GDP, which is one of the largest GDPs of the world (The World Bank). It reveals that as American economy opened up and the influence of Keynesian economics dwindled, the size of trade started to increase at an incredible pace. In fact, in the year 2012 (post-recession period), Trade as Percentage of GDP was around 30.71%, which was extraordinarily high. However, in the subsequent years, it started to decline. For instance, in the year 2017, Trade as Percentage of GDP was 26.57%, which was less than the year preceding it. The fluctuation in trade is because of 1) World GDP and 2) Change in United States’ economic policy. The economic and trade policy has changed because the United States’ trade deficit has increased exponentially. Also, the flight of capital has also worried the United States, as it yielded long-term challenges (The World Bank Data).
| Country Name | United States | United States | United States |
| Country Code | USA | USA | USA |
| Series Name | CAB % GDP | CAB Current | Net Trade |
| 2003 [YR2003] | -4.50666208 | -5.2E+11 | -4.9E+11 |
| 2004 [YR2004] | -5.145366229 | -6.3E+11 | -6.1E+11 |
| 2005 [YR2005] | -5.691626662 | -7.5E+11 | -7.1E+11 |
| 2006 [YR2006] | -5.816747364 | -8.1E+11 | -7.6E+11 |
| 2007 [YR2007] | -4.911251043 | -7.1E+11 | -7.1E+11 |
| 2008 [YR2008] | -4.629460909 | -6.8E+11 | -7.1E+11 |
| 2009 [YR2009] | -2.583596249 | -3.7E+11 | -3.8E+11 |
| 2010 [YR2010] | -2.878182927 | -4.3E+11 | -4.9E+11 |
| 2011 [YR2011] | -2.865028484 | -4.4E+11 | -5.5E+11 |
| 2012 [YR2012] | -2.638132298 | -4.3E+11 | -5.4E+11 |
| 2013 [YR2013] | -2.094141593 | -3.5E+11 | -4.6E+11 |
| 2014 [YR2014] | -2.149104734 | -3.7E+11 | -4.9E+11 |
| 2015 [YR2015] | -2.398376797 | -4.3E+11 | -5E+11 |
| 2016 [YR2016] | -2.425260309 | -4.5E+11 | -5E+11 |
(Note: CAB is Current Balance)
EXPLANATION/INTERPRETATION OF DATA
The retrieved data aids us in understanding how US economy is affected by international trade and how the changes in US economy changes to trade policy and pattern. It is evident from the data that there is trade imbalance, which affects both industry and economy. It aids us in understanding the current outcome of American presidential elections, in which trade was a major subject. Recently United States imposed a tariff of $50 billion selected Chinese goods, which was, in fact, a passive strategy to address the United States’ trade imbalance with China (The World Bank).
CONCLUSION
In the end, it is concluded that United States’ trade is based on the rationale of comparative advantage, a Ricardian concept about the trade. In addition to that, the concept of competitive advantage to influence trade (size), trade policy and trade pattern. The United States adopted trade not just as an economic instrument, but also a strategic instrument (giving access to its lucrative markets). However, because of trade, United States economically and politically suffered. The Ricardian concept, on which United States’ trade is based is a flawed concept, as it ignores 1) flight of capital, 2) labor capacities and 3) taste. In the United States, trade has caused deindustrialization, which has both short and long-term implications for the United States’ economy. Government and financial/economic institutions are trying to address these issues at war footing; however, economists claim that it would require considerable time to address these issues. It is because investors are quite sensitive and they invest in the economy when they are confident regarding the dividends. Also, economic strategies and policies require time to produce desired results. It is because the size of the economy has become extraordinarily large and various factors influence economic outcomes.
Currently, Trump Administration is flirting with the protectionist policies, which may trigger a trade war with rival/trading countries. Such development will produce mix-results for the United States. One of the results could be re-industrialization, which will increase both employment and consumption. The other possible result could be decreased in consumer surplus and a slow-down of innovation.
Work Cited
BS Reporter. “Panagariya questions industrialists on avoiding labour-intensive sectors. “Business Standards. Business Standards, 8 April 2015. Web. 18 April 2018. http://www.business-standard.com/article/economy-policy/why-are-you-not-investing-in-labour-intensive-sectors-panagariya-asks-industrialists-115040700909_1.html.
Caulfield, Norman. NAFTA and Labor in North America. 1. University of Illinois Press, 2010.
Choudhury, Saheli Roy. “India could see its fastest growth rate in a year, driven by increased consumption.” CNBC. CNBC, 28 February 2018. Web. 23 April 2018. https://www.cnbc.com/2018/02/28/india-gdp-consumption-and-export-likely-aided-in-growth-recovery.html.
Donnan, Shawn. “Canada takes US to WTO over anti-dumping system.” The Financial Times. The Financial Times, 10 January 2018. Web. 23 April 2018. https://www.ft.com/content/5c25a546-f626-11e7-88f7-5465a6ce1a00.
Ghidini, Gustavo. Innovation, Competition and Consumer Welfare in Intellectual Property Law. Edward Elgar Publishing, 2010.
Krugman, Paul R. International Economics: Theory and Policy. 1. Pearson Education India, 2008.
Leng, Sidney. “China’s top economic officials put on a friendly face for foreign trade and investment.” South China Morning Post. South China Morning Post, 6 March 2018. Web.23 April 2018. http://www.scmp.com/news/china/economy/article/2135945/chinas-top-economic-officials-put-friendly-face-foreign-trade-and.
Ospina, Esteban Ortiz and Max Roser. “International Trade.” Our World in Data. Our World in Data,1 January 2018. Web. 18 April 2018. https://ourworldindata.org/international-trade.
Radwanski, Adam. “The long, slow decline of the nation’s industrial heartland.” The Globe and Mail. The Globe and Mail, 25 March 2017. Web. 23 April 2018. https://www.theglobeandmail.com/news/politics/after-the-gold-rush/article18923563/.
The World Bank Data. “Trade (% of GDP).” The World Bank. The World Bank,17 April 2018. Web. 18 April 2018. https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS.
The World Bank. “World Development Indicators. “The World Bank. The World Bank,1 April 2018. Web. 18 April 2018. http://databank.worldbank.org/data/reports.aspx?source=2&country=USA#.
United States Trade Representative. “U.S.-China Trade Facts.” Office of the United States Trade Representative. Office of the United States Trade Representative,1 January 2018. Web. 18 April 2018. https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china#.
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