Jasper John D.

Estores

International Trade, Comparative Advantage, and Protectionism

Trade Surpluses and Deficits

All economies, regardless of their size, depend to some extent on other economies and
are affected by events outside their borders
Trade surplus: The situation when a country exports more than it imports
Trade Deficit: The situation when a country imports more than it exports

The Economic Basis for Trade: Comparative Advantage

Theory of comparative advantage: Ricardo’s theory that specialization and free trade will
benefit all trading partners (real wages will rise), even those that may be absolutely less
efficient producers
David Ricardo: one of the fathers of modern economics. A businessman, economist and
member of Parliament, his principal work, Principles of Political Economy was published
in 1817, two years before he entered Parliament. He used the theory of comparative
advantage to argue against the Corn Laws.
Corn Laws: The tariffs, subsidies, and restrictions enacted by the British Parliament in
the early nineteenth century to discourage imports and encourage exports of grain

Mercantilism and Theory of Absolute Advantage

Mercantilism: an economic doctrine that the government control of foreign trade is of

paramount importance for ensuring the prosperity and military security of the state.
Theory of Absolute Advantage: a concept coined by Adam Smith to counter mercantilist
ideas in his book An Inquiry into the Nature and Causes of the Wealth of Nations. It
refers to the ability of a party (an individual, or firm, or country) to produce more of a
good or service than competitors, using the same amount of resources.

Absolute Advantage versus Comparative Advantage

A country enjoys absolute advantage over another country in the production of a good if
it uses fewer resources to produce that good than the other country does
For example: Country A and Country B produce what wheat, but A’s climate is
more suited to wheat and its labor is more productive. Country A will produce more
wheat per acre than country B and use less labor in growing it and bringing it to market.
Country A enjoys an absolute advantage over country B in the production of wheat.
A country enjoys a comparative advantage in the production of a good if that good can be
produced at a lower cost in terms of other goods.
 For Example: Countries C and D both produce wheat and corn and C enjoys an absolute
advantage in the production of both-that is, C’s climate is better than D’s and fewer of
C’s resources are needed to produce a given quantity of both wheat and corn. Now C and
D must each choose
Trade enables countries to move beyond their previous resource and productivity
constraints. When countries specialize in producing those goods in which they have a
comparative advantage, they maximize their combined output and allocate their resources
more efficiently
When trade is free, patterns of trade and trade flows result from independent decisions of
thousands of importers and exporters and millions of private household and firms
Terms of trade: the ratio at which a country can trade domestic products for imported
products.
For any pair of countries, there is a range of exchange rates that will lead automatically to
both countries realizing the gains from specialization and comparative advantage. Within
that range, the exchange-rate will determine which country gains the most from trade.
This led us to conclude that exchange rates determine the terms of trade.
If exchange rates end up in the right range (that is, in a range that facilitates the flow of
goods between nations), the free market will drive each country to shift resources into
those sectors in which a country has a comparative advantage will be competitive in
world markets

The Sources of Comparative Advantage

The Heckser-Ohlin theorem looks to relative factor endowments to explain comparative

advantage and trade flows. According to the theorem, a country has a comparative
advantage in the production of a product if that country is relatively well endowed with
the inputs that are used intensively in that of the product.
A relatively short lists of inputs-natural resources, knowledge capital, physical capital,
land, and skilled and unskilled labor-explains a surprisingly large portion of world
patterns. However, the simple version of the theory of comparative advantage cannot
explain why many countries import and export the same good.
Some theories argue that comparative advantage can be acquired. Just as industries
within a country differentiate their products to capture a domestic market, they also
differentiate their products to please the wide variety of tastes that exists worldwide. This
theory is consistent with the theory of comparative advantage.

Trade Barriers: Tariff, Export, Subsidies, and Quotas

Trade barriers take many forms. The three most common are tariffs, export subsidies, and
quotas. All are forms of protection through which some sector of the economy is shielded
from foreign competition
Protection: the practice of shielding a sector of the economy from foreign competition.
Tariffs: tax on imports
Export subsidies: Government payments made to domestic firms to encourage exports.
 Dumping: a firm’s or an industry’s sale of production on the world market at prices
below its own cost of production
Quota: a limit on the quantity of imports.

Free Trade or Protection?

In one sense, the theory of comparative advantage is the case for free trade. Trade
barriers prevent a nation from reaping the benefits of specialization, push it to adopt
relatively inefficient production techniques, and force consumers to pay higher prices for
protected products than they would otherwise pay.
The case for protection rests on a number of propositions, one of which is that foreign
competition results in a loss of domestic jobs, but there is no reasons to believe that the
workers laid off in the contracting sectors will not be ultimately reemployed in other
expanding sectors. This adjustment process is far from costless however.
Other arguments for protection hold that cheap foreign labor makes competition unfair;
that some countries engage in unfair trade practices; that free trade might harm the
environment; and that protection safeguards the national security, discourage
dependency, and shields infant industries. Despite these arguments, most economies
favor free trades

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