IB Econ Study Guide Internationals - Sunny Hills High School

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Comparative advantage continued Factors determining the relative costs of production and thus Comparative advantage is a dynamic comparative concept advantage . Comparative . advantage is a dnamlc The quantity concept and quality as i1 of factors of production available can and does change (i.e. over time. Governments the can size and efficlency of the available labour force, d'ra ntsloflca y have promoted pol,cies the productivity tl"dt nelp to of the existing stock of capital and the create a comparative advantage in specific rate industries. of investment). A governrelt . could invest in education, Movements i.tcreasing in the exchange rate (the price of a currency Tne srocr< oi human cag!d-L4dlh"u:.&!4q.lgg9!r expressed in terms of another) can affect comDarative productivity and lowering average costs. advantage. lt could For create example, if the exchange rate rises favorable investment (appreciates) conditions for private firms by then exports from a : counTry lncrease rn ensuring price stability (low inflation), pnce. long-run This exchangeJ makes them less competitive in internationai rate equilibrium and more generally a conducive markets. business environment. . tt could also import technology Changes by in attracting the relative inflation rates affect export foreign direct investment in high-tech sectors. competltiveness. For example if average inflation in . An example of a country that did not rely on Country a static X is 4% while in Country B it is 8%, the interpretation of comparative goods advantage but instead and services produced by Country X wili become created a comparative advantage jn several relatively other areas more expensive over time. This worsens their is Korea. lf it had relied on its original comparative competlttveness and causes a loss in comparative advantage, it would stjll have been an exporter advantage. of rice. . Export subsidies can be used to create an artificial comparattve advantage for a country,s products: Us coton producers are a good example. . Non-price factors can lead to the creatjon or the loss of comparattve advantage (e.9. product design, reliability, quality of after-saies support). Export sales of German cars are not easily affected by an appreciation of the euro as their reputation is excellent in foreign markets. Protectionism ;o many and, ur I :ases, why do so manyl ' various degrees of I 'trade so common? i rrtjes involved gajn I vorse off. Free trade I ".' "..- ------"i the decrease in the producer surpius. The winnings of the winners are greater than the losses of the losers but there is no guarantee that the losers will be compensated. In addition, the winnings from free trade are spread over a very large number of people, each getting a small addition to his income while the resulting losses are spread over a much smaller number of individuals each suffering a significant cut in his income. lt follows that the losers have an incentive to put up a fight against free trade. To ensure that the adjustment costs for these individuals are small, governments often judge that some protectionism is necessary. ---------. .r-... --. --,: r.';:: .--a.- Non-economic arguments !!favour of proteclionism . To ensure that a country is self-sufficient in the oroduction of crucial goods in case ofir,,va-alis?hioic reasons). The weapons and aerospace inousrry aiweI as the food sector are often classified as beinq of strateoic importance. The vaIoiry of this argumenr is ooubiful at least for countries belonging to wide strategic and/or political alliances. . To restrict iTports ot illegar druqs and other har.nful subslances. Researchtlffia doubts as to the sJccess of such policies as drug use is widespread In manv countries. . To put pressure on and weaken politically unfriendly countries (embargoes). . To preserve a way of life or cultural identitv as oart of a broader socifiiratffi-- . To ensure thal certain safety and health standards are met. However, such standards may be a pretence throuqh wh.ch oomestic prooucers are protected. 99
100 Does it make sense? <strong>Econ</strong>omic arguments in favour of protectionism . To Drotect domestic iobs and declinino industries. falls to protect domesTic indJstries and workers against 'unfair' competition from 'cheap'foreign labour is perhaps the commonest argument heard in favour of protection. These calls must be carefully evaluated. Domestic wages could be higher because of higher labour productivity in which case labour costs per unit of output could be lower than abroad. lf the higher domeslic wages are not a reflection of higher productivity then the domestic industry has a comparative disadvantage. Theory then suggests that labour and other resources should be channelled to other, more efficient uses. Workers and owners of capital, and perhaps whole regions, will have to face real adjustment costs and will resist these changes. Instead of protection, which will reduce the incentive to restructure, other policies could be adopted to smoothen the transition. especially for displaced workers. In the case of developing countries shifting resources may be almost impossible without some government assistance which itself could be too costly to implement. In such a case trade liberalization should proceed gradually. To imorove a trade deficit. The idea is that prorectionrsm wi I'nake imports more expensive. 5pending on imports will thus decrease, shrinking the imbalance. There are several potential problems with this argument. First, it invites retaliation from trading partners as any improvement comes at their expense. Second, restricting foreign products into the country lowers foreign incomes and their ability to absorb our exports. Third and most important. such a poliry does not treat the root cause of a widening trade deficit problem. The ballooning trade deficit may be the result of domestic products being uncompetilive and thus unable to penetrate foreign markets (so that exports decrease) while domestic households find it cheaper to buy imports (imports rise). <strong>High</strong> inflation, structural rigidities, uncompetitive domestic markets as well as poor quality, reliability, delivery design or marketing may be the real reasons behind a growing trade imbalance, in which case protectionism will not prove helpfu but possibly detrimental. To assist certain industries in their initial staqes of deV€T-opment qrow and reaIze therr porentiai. Once !Frd.l*.t..,mey develop the necessary (now-how and achieve economies of scale they will be able to meet international competit on, at which point the pjl}+erh removed. This is the well-know argument. It too needs to be carefully eva{uated. The argument is sensible and the policy has been used by all developed economies n the past including the US and in varying degrees by all Asian export achievers. lt also suffers from potential major drawbacks. How does a government pick a 'winner'? lt may be difficult to determine which industry qualifies for such treatment. lf a mistake js made wjll it be possible for the government to withdraw its support? Removing the protection could be resisted by the industry stakeholders resulting in a 'perpetual infant'. There is an inherent risk of making the industry over-reliant on state suoport, sluggrsh and ine9e.iert-\ To help industries facinf dumping ffim abroad. Dumpinq exists iI a produc\s-sokrd6-road ar a price below average cost. lf dumping is proved then antidumping duties are permitted to ensure a 'evel playingfield'. However, dumping is not easy ro p.ove. Tl'e question arising is, which firm's average costs? lt could be that the foreign firms are much more efficient and thus have much lower unit costs of production. Or that the foreign firms are illegally subsidized by their governrnents, creating an artificial cost advantage. In the former case there is no case of dumping whereas in the atter there is. As antidumping duties are automatically imposed when dumping is suspected until the issue is investigated and a verdict is reached, many industries cry'dumping' to gain time in order to restructure and hopefully become more efficient. The strategic trade policy argument accordlng to which in a framework of international oligopolies (where few large firms dominate world markets) a government can tilt the balance and the profits away from foreign competitors by using trade policies. The government's assistance can be in the form of subsidies, grants or loans at below market interest rates and tariffs. The classic example is the aircraft manufacturing industry with Boeing and Airbus monopolizing the world market and where each side accuses the other of massive government assistance. In other cases, where there are'first mover advantages' (implying that firms that are first to succeed dominate the world industry), the assistance could take the form of setting industry standards in favour of domestic firms, as in the case of HDTV in the U5. The problem with strategic trade policy is that it carries the risk of destabilizino trade disoutes and retaliation as it is a 'beggar thy neighbour' policy. the risk of pro{ecting the wrong.indusffei In the case of tariffs, to provide a government with revenues. Tax systems in certain developing collect sufficient revenue to finance pro-development activities. lf this is the case then trade liberalization must be gradual to ensure that the provision of basic government services is not interrupted.
Page 1: International economics Free trade
Page 5 and 6: Voluntary Voluntary export restrain
Page 7 and 8: The bilateral/regional . The region
Page 9 and 10: The terms strictly refer to offlc,a
Page 11 and 12: Exchange rate This has two effeds:
Page 13 and 14: Why do Factors that may affect inve
Page 15 and 16: How does a fixed It will be maintai
Page 17 and 18: Current account The current account
Page 19 and 20: Current account Remember a current
Page 21 and 22: Terms of trade: causes and effects

IB Econ Study Guide Internationals - Sunny Hills High School

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