Feenstra 5th Edition ch01 - Trade - Econ

Trade in the Global Economy
Chapter 1
© 2021 Worth Publishers

International Economics, 5e | Feenstra/Taylor 1
Trade in the Global Economy
• Questions to Consider
1. How does international trade today differ from trade
in the past?
2. How does the United States’ recent use of tariffs
compare with the past?
3. How does the movement of companies and people
around the world compare with the movement of
goods and services?

2
International Economics, 5e | Feenstra/Taylor
Introduction (1 of 2)
• In this book, we will study international trade in

goods and services.
• We will learn the economic forces that determine:

– What international trade looks like
– What products are traded
– Who trades them
– At what quantities and prices they are traded
– What the benefits and costs of trade are
• We will also learn about the policies that

governments use to shape trade patterns among
countries.

3
Introduction (2 of 2)
• The second international trade topic that we will

study is migration, the movement of people
across borders to live elsewhere.
– People entering a country to live are immigrants.
– People leaving a country to live elsewhere are emigrants.
– Some migrants are called refugees if their safety is
endangered in their home country.
• The third facet of international trade that we will

study is foreign direct investment (FDI), which
occurs when a firm in one country owns some or
all of a firm located in another country.

4
1) International Trade (part 1)
• The Basics of World Trade

– Countries buy and sell goods and services from one
another constantly.
• An export is a product sold from one country to another.
• An import is a product bought by one country from another.

5

– A country’s trade balance is the difference between
its total value of exports and its total value of imports
(usually including both goods and services).
– Countries that export more than they import, such as
China, run a trade surplus.
– Countries that import more than they export, such as
the United States, run a trade deficit.
– The bilateral trade balance is the difference between
exports and imports between two countries.

6
SIDE BAR
The Macroeconomics of the Trade Balance
• Y = C + I + G + EX – IM
• The difference between the value of exports and imports, EX – IM, is
the trade balance of the economy. If the value of exports exceeds the
value of imports, EX – IM > 0, the trade balance is in surplus; if the
value of exports is less than the value of imports, EX – IM < 0, the trade
balance is in deficit.
• What determines the trade balance for an economy? Rearrange terms:
• (Y – T – C) – I = G – T + EX – IM
• Sp = (Y – T – C )
• (Sp – I) + (T – G ) = EX – IM
• When both (Sp – I) < 0 and (T – G) < 0, the equations shows that EX –
IM < 0, so that the trade balance must be in deficit. That deficit reflects
the low saving in the economy, either by households (with Sp < I) or by
the government by running a deficit (with T < G). This result shows how
the trade balance of an economy is determined by the macroeconomic
saving behavior of the households and the government.

7

– The U.S. bilateral trade balance with China, for example,
has been a trade deficit of more than $200 billion every
year between 2005 and the present.
– In 2013, the iPhone 5 16GB was valued at about $227
when it was shipped from China to the United States, and
it sold for about $650 in the United States.
– However, only $8 of that amount reflects the value-added
by Chinese labor used in the assembly. The rest of the
$219 export value was very likely imported into China from
other countries.
– Nevertheless, the entire $227 is counted as an export from
China to the United States.

8
Application: Is Trade Today Different
from the Past? (part 1)
FIGURE 1-1 (a)
The Changing Face of U.S. Import Industries, 1925–2018 The

types of goods imported by the United States have changed
drastically over the past century. Foods, feeds, and beverages and
industrial supplies were 90% of imports in 1925, but represented
only 30% in 2018.
9
Application: Is Trade Today Different
from the Past? (part 2)
FIGURE 1-1 (b)
The Changing Face of U.S. Import Industries, 1925–2018 The types

of goods exported by the United States have also changed drastically
over the past century. Capital plus consumer goods plus automobiles
have increased from 20% of exports in 1925 to 60% of exports in 2018.

10
FIGURE 1-2
• Map of World Trade
World Trade in Goods, 2018 ($ billions) This figure shows trade in

merchandise goods between selected countries and regions of the world.

11

TABLE 1-1
Shares of World Trade, Accounted for by Selected Regions, 2018
Share of World Share of World

Trade (%) Trade (%)
Europe (internal trade) 21 Asia (exports) 29
Europe (internal) plus trade 26 Middle East and 9
with the United States Russia (exports)
Americas (internal trade) 8 Africa (exports) 2
Europe and the 49 Australia and New 2
Americas (exports) Zealand (exports)

12

• European and U.S. Trade
– The largest amount of trade shown in Figure 1-2 is the flow of
goods within Europe, $4.5 trillion, or 21%, of world trade.
– The European countries trade a great deal with one another
because there are many countries located near to each other, so
it is easy to ship from one country to another, and also because
import tariffs are low.
– There are also large trade flows between the United States and
Europe. The United States exported nearly $400 billion of goods
to Europe in 2018 and imported $565 billion from Europe.
– This shows that a large amount of world trade occurs between
countries that are similar in their levels of advanced
industrialization.

13

• Trade in the Americas
– There is also a large amount of trade recorded within the
Americas, that is, between North America, Central
America, South America, and the Caribbean.
– Trade within the Americas in 2018 was $1.7 trillion, about
8% of world trade.
– The vast majority of international trade within the Americas
is between Canada, the United States, and Mexico. The
three countries are part of a free-trade area as defined by
the United States–Mexico–Canada Agreement (USMCA),
which took effect in 2020.

14

• Trade with Asia
– Exports from Asia totaled about $6.1 trillion in 2018,
or nearly one-third (29%) of world trade, as shown in
Table 1-1.
– Remember that this total includes only trade in goods
and omits trade in services, which is becoming
increasingly important.
– India, for example, performs a wide range of services
such as accounting, customer support, computer
programming, and research and development tasks
for firms in the United States and Europe.

15

• Other Regions
– The exports of the Middle East and Russia combined
(together with countries around Russia such as Azerbaijan
and Kazakhstan) total $1.9 trillion, or another 9% of world
trade.
– And then there is Africa. Africa has the closest trade links
with the European nations, reflecting both its proximity to
Europe and the former colonial status of many African
countries.
– Adding up all its exports, the continent of Africa accounts
for only 2% of world trade, a very small number given that
Africa accounts for 20% of the Earth’s land mass and 17%
of its population.

16
• Trade Compared with GDP

– So far, we have discussed the dollar amounts of trade
crossing international borders.
• There is a second way that trade is often reported, as a ratio
of a country’s trade to its gross domestic product (GDP), the
value of all final goods produced in a year.
• For the United States, the average value of imports and
exports (for goods and services) expressed relative to GDP
was 16% in 2018.
• Most other countries have a higher ratio of trade to GDP.

17
• Trade Compared with GDP
TABLE 1-2 Country Trade/GDP (%) GDP ($ billions)
Hong Kong (China)
Singapore
188%
163
$332
377
Trade/GDP Ratio in 2018 This
Hungary 84 185
Malaysia 66 438 table shows the ratio of total
Thailand 62 507
Switzerland
Austria
59
53
771
511
trade to GDP for each country,
Denmark
Sweden
52
45
419
669 where trade is calculated as
Germany 44 4,524
Mexico 40 1,505 (Imports + Exports)/2, including
Greece 36 290
Norway
Spain
35
33
562
2,435
both merchandise goods and
Canada
France
33
32
2,186
3,359 services. Countries with the
United Kingdom 31 3,282
Italy
Turkey
31
30
2,456
1,421
highest ratios of trade to GDP
South Africa
Russian Federation
30
26
493
1,978
tend to be small in economic
India 22 3,269
Indonesia 22 1,317 size.
China 19 1,779
Japan 18 7,109
United States 16 20,494
Argentina 15 513
Brazil 15 2,653
Pakistan 14 292

18
• Barriers to Trade
FIGURE 1-3 Trade in Goods and Services Relative to GDP
This diagram shows total trade in

merchandise goods and services
for each country divided by GDP.
There was a considerable
increase in the ratio of trade to
GDP between 1890 and 1913.
This trend was ended by World
War I and the Great Depression.
Most of the industrial countries
shown did not reach the level of
trade prevailing in 1913 until the
1970s.
The term trade barriers refers to all factors that influence the amount
of goods and services shipped across international borders.

19
• “First Golden Age” of Trade

– The period from 1890 until World War I (1914–1918)
is sometimes referred to as a “golden age” of
international trade.
– Those years saw dramatic improvements in
transportation, such as the steamship and the
railroad, that allowed for a great increase in the
amount of international trade.

20
• Political Economy of Tariffs

– Explanations for tariffs that combine both economic and
political reasoning are referred to as political economy.
– In 1865 the United States had high tariffs to raise revenue
during the U.S. Civil War (1861–1865).
– U.S. tariffs fluctuated in the decades leading up to World
War I but remained much higher than in the rest of the
world.
– The Tariff Act of 1890 substantially raised tariffs to protect
U.S. industries that were mainly located in the North.
– Tariffs were raised again in 1897, not as an end in
themselves, but rather as a tool to negotiate an overall
lowering of tariffs with trade partners.

21

• Interwar Period
– Signed into law in June 1930, the Smoot–Hawley Tariff Act
raised tariffs to as high as 60% on some categories of
imports.
– These tariffs were meant to protect farmers and other
industries, but they backfired by causing other countries to
retaliate, a situation called a trade war.
– Canada retaliated by applying high tariffs of its own against
the United States.
– France used import quotas, a limitation on the quantity of
an imported good allowed into a country, to restrict imports
from the United States.

22

• Interwar Period FIGURE 1-4
Average Worldwide
Tariffs, 1860–2019
This diagram shows the
world average tariff for 35
countries. The average
tariff fluctuated around 15%
from 1860 to 1913. After
World War I, however, the
average tariff rose sharply
because of the Smoot–
Hawley Tariff Act in the
United States and the
reaction by other countries,
reaching 25% by 1933.
Since the end of World War
II, tariffs have fallen.

23
• “Second Golden Age of Trade”

– In addition to the end of World War II and tariff
reductions under the General Agreement on Tariffs
and Trade (GATT), lower transportation costs
contributed to the growth in trade.
– The shipping container, invented in 1956, allowed
goods to be moved by ship, rail, and truck more
cheaply than before.
– World trade grew steadily after 1950 in dollar terms
and as a ratio to GDP. For this reason, the period
after 1950 is called the “second golden age” of trade
and globalization.

24
• The U.S.–China Trade War

– In July 2018 President Trump applied import tariffs against
China that were very different from those imposed by other
modern U.S. presidents because the tariffs were applied
only against China and at high levels.
– By September 2019 the tariffs applied to nearly all U.S.
imports from China. China responded in kind by applying
tariffs against more imports from the United States.
– Figure 1-5 shows that the average U.S tariff against
imports from China rose from 3.1% in January 2018 to
21% in September 2019, and the average Chinese tariff on
U.S. imports rose from 8% to 21.8% over the same period.

25

26

– Why did President Trump impose these tariffs on China?
– He hoped to gain concessions from China in negotiating
with the Chinese over their own trade barriers.
– The United States would like China to reduce import tariffs
on products such as automobiles and other consumer
goods, increase its purchases of U.S. agricultural
products, be more open to the entry of foreign firms, and
more strongly enforce its protection for intellectual property
– American companies have already begun shifting
production away from China as a result of the trade war.

27
2) Migration and Foreign Direct
Investment (part 1)
• Map of Migration
FIGURE 1-6
Foreign-Born
Migrants, 2017
(millions) This figure
shows the number of
foreign-born migrants
living in selected
countries and regions
of the world for 2017
in millions of people.

28
Investment (part 2)
• Map of Migration
– In 2017 more than one-half (53%) of the foreign-born people
worldwide were living in the Organisation for Economic Co-
operation and Development (OECD) countries, while only less than
one-quarter (23%) of the OECD-born people were living in another
country.
– Most migration occurs from countries outside the OECD, with more
than one-half of migrants moving to countries within the OECD.
– Comparing the map of immigration in Figure 1-6 with that of
international trade in Figure 1-2, we see a big difference: while more
trade arrows point in both directions (countries both import from and
export to their trading partners), the immigration arrows often point
in one direction only, from lower-income to higher-income countries.
– International trade can act as a substitute for movements of labor or
capital across borders by raising the living standard of workers.

29
Investment (part 3)
• Political Economy of Migration
• Migration in the EU
– Prior to 2004 the European Union (EU) consisted of 15 countries
in western Europe, and labor mobility between them was very
open.
– After 10 more countries joined the EU on May 1, 2004, a large
difference in per capita income and wages in these countries
created a strong incentive for labor migration from low-wage to
high-wage countries within the EU.
– 26 countries in the EU created the Schengen Area of open
borders.
– Refugee migration from Africa and Asia since 2015 has created
a controversy in Europe over which countries should take them
in and whether they can move to other countries.
– This played a role in the 2016 vote in the United Kingdom to
leave the EU.

30
Investment (part 4)
• Political Economy of Migration
• Migration in the United States
– As shown in Figure 1-6, there were 26 million people from Latin
America living in the United States and Canada in 2017.
– The largest group of these migrants was composed of Mexicans
living in the United States. It is estimated that there are about 11
million Mexicans living in the United States, and slightly less than
one-half of these (5 million) are undocumented immigrants.
– The concern that immigration will drive down wages applies to
Mexican migration to the United States.
– Recent increases in persons attempting to cross the U.S.–
Mexico border come from citizens of Guatemala, Honduras, and
El Salvador who transit through Mexico.
– Immigration policy is a frequent topic of debate in the United
States.

31
Investment (part 5)
• Map of Foreign Direct Investment
FIGURE 1-7
Stock of Foreign
Direct Investment,
2018 ($ billions) This
figure shows the stock
of foreign direct
investment (FDI)
between selected
countries and regions
of the world for 2018 in
billions of dollars. The
largest stocks have the
heaviest lines.

32
Investment (part 6)
• The majority of world flows of foreign direct
investment occur between industrial countries.
– In 2018 the total value of foreign direct investment (FDI)
stocks worldwide was $32.3 trillion.
– The stocks that are both owned by and located in
European countries is $8.1 trillion (25% of the total world
stock of FDI).
– The flow of FDI stock into China and other Asian countries
is $7.4 trillion.
– Most of this FDI is from industrial countries, but Chinese
firms have begun to acquire land in Africa and Latin
America for agriculture and resource extraction.

33
Investment (part 7)
• Horizontal FDI
– The majority of foreign direct investment occurs between
industrial countries, when a firm from one industrial
country owns a company in another industrial country. We
refer to these flows between industrial countries as
horizontal FDI.
• Vertical FDI
– The other form of foreign direct investment occurs when a
firm from an industrial country owns a plant in a developing
country, which we call vertical FDI. Low wages are the
principal reason that firms shift production abroad to
developing countries.

34
Application: An American Factory
• In 2013 the Chinese Company Fuyao Glass

Industry Group purchased a shut-down
General Motors plant in Dayton, Ohio.
• How did the Chinese make it profitable?
– The American workers were paid much less than the
workers who worked at the GM plant.
– Production levels had to be high.
– Unionization failed.
– The Chinese also introduced robots to perform certain
manual tasks.

35
HEADLINES
• Don’t Think That All Chinese Factories Are like

the One in American Factory
– The author claims that many manufacturing companies
owned by U.S., Canadian, and European companies share
many of the worst traits displayed by Fuyao.
– BYD is a Chinese company that opened a plant in the
United States that builds environmentally friendly buses.
The new plant has delivered on its promise of jobs that are
beneficial not just to local workers but for all of us living on
a rapidly warming planet.
– When it comes to treatment of workers and the protection
of the environment, any company anywhere can choose to
be a good actor or a bad one.

36
Conclusions
• Globalization means many things: the flow of goods and

services across borders, the movement of people and firms,
the spread of culture and ideas among countries, and the tight
integration of financial markets around the world.
• Although it might seem as if such globalization is new,
international trade and the integration of financial markets
were also very strong in the period before World War I.
• Migration across countries is not as free as international
trade, and all countries have restrictions on immigration.
• FDI is largely unrestricted in its flows between high-income
countries but sometimes faces some restrictions in developing
countries.

37
KEY POINTS (part 1)
1. The trade balance of a country is the difference

between the value of its exports and the value of
its imports, and it is determined by
macroeconomic conditions in the country.

38
KEY POINTS (part 2)
2. The type of goods being traded between

countries has changed from the period before
World War I, when standardized goods (raw
materials and basic processed goods like steel)
were predominant. Today, the majority of trade
occurs in highly processed consumer and
capital goods, which might cross borders
several times during the manufacturing
process.

39
KEY POINTS (part 3)
3. A large portion of international trade takes

place between industrial countries. Trade within
Europe and trade between Europe and the
United States accounts for roughly one-quarter
of total world trade.

40
KEY POINTS (part 4)
4. Many of the trade models we study emphasize

the differences between countries, but it is also
possible to explain trade between countries that
are similar. Similar countries will trade different
varieties of goods with each other.

41
KEY POINTS (part 5)
5. Larger countries tend to have smaller shares of

trade relative to GDP because so much of their
trade occurs internally. Hong Kong (China) and
Singapore have ratios of trade to GDP that
exceed 100%, whereas the United States’ ratio
of trade to GDP is 16%.

42
KEY POINTS (part 6)
6. Trade wars occur when countries respond to

tariffs of one country by applying higher tariffs
themselves. There was a global trade war
during the Great Depression, and there was a
U.S.–China trade war in 2018–19.

43
KEY POINTS (part 7)
7. The majority of world migration comes from

developing countries, and, when possible, the
migrants prefer to enter wealthier, industrial
countries.

44
KEY POINTS (part 8)
8. International trade in goods and services acts

as a substitute for migration and allows workers
to improve their standard of living through
working in export industries, even when they
cannot migrate to earn higher incomes.

45
KEY POINTS (part 9)
9. There is even more FDI than international trade

between high-income countries like those in
Europe and the United States, and there is less
FDI than trade between high-income and
middle- or low-income countries.

46
KEY TERMS
international trade foreign direct investment trade embargo

export (FDI) gross domestic
trade balance product (GDP)
imports
trade surplus trade barriers
import tariffs
trade deficit political economy
export quota
bilateral trade import quotas
migration
balance trade war
immigrants
value-added horizontal FDI
emigrants
offshoring vertical FDI
refugees
free-trade area
sanctions

47
Clicker Question 1: The majority of trade today is
in:
a. basic processed goods like steel.

b. agricultural commodities.
c. raw materials.
d. highly processed consumer and capital goods.

48
Clicker Question 1: The majority of trade today is
in: (ANSWER)
a. basic processed goods like steel.

b. agricultural commodities.
c. raw materials.
d. highly processed consumer and capital
goods. (correct answer)

49
Clicker Question 2: The largest amount of world
trade (in U.S. dollars) is within:
a. Asia.
b. Europe.
c. the Americas.
d. Africa.

50
Clicker Question 2: The largest amount of world
trade (in U.S. dollars) is within: (ANSWER)
a. Asia.
b. Europe. (correct answer)
c. the Americas.
d. Africa.

51
Clicker Question 3: A(n) __________ is a tax on an
imported good, and a(n) __________ is a numerical limit
on an imported good.
a. tariff; export quota

b. import quota; export quota
c. tariff; import quota
d. import quota; tariff

52
Clicker Question 3: A(n) __________ is a tax on an
imported good, and a(n) __________ is a numerical limit
on an imported good. (ANSWER)
a. tariff; export quota

b. import quota; export quota
c. tariff; import quota (correct answer)
d. import quota; tariff

53
Clicker Question 4:Migrants typically choose
__________ countries to immigrate to.
a. low-income
b. middle-income
c. high-income
d. none of the above

54
Clicker Question 4:Migrants typically choose
__________ countries to immigrate to. (ANSWER)
a. low-income
b. middle-income
c. high-income (correct answer)
d. none of the above

55
Clicker Question 5: The majority of FDI occurs:
a. between industrial countries.

b. between high-income and low-income
countries.
c. between middle-income and low-income
countries.
d. between countries in Africa.

56
Clicker Question 5: The majority of FDI occurs:
(ANSWER)
a. between industrial countries. (correct

answer)
b. between high-income and low-income
countries.
c. between middle-income and low-income
countries.
d. between countries in Africa.

57
Discovering Data
• In this chapter we examined the flow of FDI stocks.

In theory FDI should flow from high-income to low-
income countries, but the data appear to show that
this is not the case. Go to the online OECD
database https://data.oecd.org/fdi/fdi-
stocks.htm#indicator-chart and download the data
for FDI stock.
a. Which five (5) countries had the largest FDI stock from
2015 to 2019?
b. For each country, research why they have been so
successful at attracting FDI. What are the top three (3)
reasons for each country?

58

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Trade in the Global Economy

© 2021 Worth Publishers

© 2021 Worth Publishers

• In this book, we will study international trade in

• We will learn the economic forces that determine:

• We will also learn about the policies that

© 2021 Worth Publishers

• The second international trade topic that we will

• The third facet of international trade that we will

© 2021 Worth Publishers

• The Basics of World Trade

© 2021 Worth Publishers

• The Basics of World Trade

© 2021 Worth Publishers

© 2021 Worth Publishers

• The Basics of World Trade

© 2021 Worth Publishers

The Changing Face of U.S. Import Industries, 1925–2018 The

The Changing Face of U.S. Import Industries, 1925–2018 The types

© 2021 Worth Publishers

World Trade in Goods, 2018 ($ billions) This figure shows trade in

© 2021 Worth Publishers

• Map of World Trade

Shares of World Trade, Accounted for by Selected Regions, 2018

Share of World Share of World

© 2021 Worth Publishers

• Map of World Trade

© 2021 Worth Publishers

• Map of World Trade

© 2021 Worth Publishers

• Map of World Trade

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• Map of World Trade

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• Trade Compared with GDP

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© 2021 Worth Publishers

This diagram shows total trade in

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• “First Golden Age” of Trade

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• Political Economy of Tariffs

© 2021 Worth Publishers

• Political Economy of Tariffs

© 2021 Worth Publishers

• Political Economy of Tariffs

© 2021 Worth Publishers

• “Second Golden Age of Trade”

© 2021 Worth Publishers

• The U.S.–China Trade War

© 2021 Worth Publishers

• The U.S.–China Trade War

© 2021 Worth Publishers

• The U.S.–China Trade War

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

© 2021 Worth Publishers

• In 2013 the Chinese Company Fuyao Glass