Adam Smith and David Ricardo gave economics the theory of International Trade by 1817 (Smith 1776) and what they said remains the basis of the reason economists favour free trade over protection.
The theory says that countries should specialise according to their comparative advantage and as a result overall production will rise and these gains in output will be redistributed through trade (i.e. swapping of goods and services).
To achieve specialisation a country must grow some industries while others shrink (those in which other countries specialise). The result will be more jobs in some industries and less in others.
The loss of jobs is regrettable and is referred to as an 'adjustment cost.' Economists are fully aware of this cost and could explain to those who are now unemployed the overall benefit of the process. It will not be a popular message with the unemployed.
The World Bank is reported to have written a report confirming Smith and Ricardo's conclusions. The growth of free trade (Globalization) has led to overall more jobs, but some have lost out. They estimate 20% of job losses in some areas, like the USA, are due to free trade.
The problem is that there is no guarantee that a country will gain as many jobs through their specialization as they lose. Portugal is a good example. They have lost many jobs to lower cost manufacturing nations (such as Eastern Europe and China), but don't have the comparative advantage in high tech and knowledge based industries they need to replace those jobs.
So the World Bank report is basically saying Smith and Ricardo were right.
Showing posts with label Comparative advantage. Show all posts
Showing posts with label Comparative advantage. Show all posts
Thursday, 6 October 2016
Thursday, 7 April 2016
The Australian exchange rate - it's complicated!
Prices are set by demand and supply in a free market and that applies to exchange rates - the price of one currency in terms of another. For exchange rates there are, however, many competing influences on demand and supply and government monetary policy has a significant impact.
The purpose of this post is not to say too much because The Guardian article linked below says a great deal you need to know.
The Australian dollar is presently experiencing a modest rise in value (from around 70 cents to 75 cents to the US$). This is spoiling the hoped for improved competitiveness of Australian non-mining exports which suffered from the very high value of the dollar caused by the mining investment boom.
The article is wide ranging, explaining some current influences on the exchange rate and the importance of monetary policy of both the home country and other countries on exchange rates.
The question I would want to consider is about if a country should really rely on devaluations (or depreciation's) to maintain competitiveness and so economic success? A fall in the exchange rate might provide a short term boost to exports (Marshall-Lerner conditions allowing) and so higher Aggregate Demand. However long term economic success is based on the level of productivity and comparative advantage.
The purpose of this post is not to say too much because The Guardian article linked below says a great deal you need to know.
The Australian dollar is presently experiencing a modest rise in value (from around 70 cents to 75 cents to the US$). This is spoiling the hoped for improved competitiveness of Australian non-mining exports which suffered from the very high value of the dollar caused by the mining investment boom.
The article is wide ranging, explaining some current influences on the exchange rate and the importance of monetary policy of both the home country and other countries on exchange rates.
The question I would want to consider is about if a country should really rely on devaluations (or depreciation's) to maintain competitiveness and so economic success? A fall in the exchange rate might provide a short term boost to exports (Marshall-Lerner conditions allowing) and so higher Aggregate Demand. However long term economic success is based on the level of productivity and comparative advantage.
This article is important for VCE and IB students. VCE students need to understand influences on Monetary Policy and the level of the exchange rate and how it can affect the economy. For IB students it is also important to understand how to evaluate the effects of a change in policy or the exchange rate. Looking at the long term vs. short term effects of a change offers one possible path to evaluation.
The A$ vs US$ over the last year
Sunday, 3 April 2016
Steel tariffs may hurt more than just the steel industry
The world is presently seeing a bout of 'economic nationalism' over
steel. The US and China are just two countries who are raising tariffs
on steel but this will have wide ranging implications for many.
A tariff is a tax on imports. The aim of raising the price of imports on the domestic market is to reduce demand for them. It is hoped that this will lead to import substitution, domestic consumers switch to domestically produced products. This will raise domestic output and employment and might reduce a current account deficit.
The diagram below shows the effects of the imposition of a tariff on steel by the Chinese on British made steel. (This is referred to in the BBC article linked below.)
Rather than analyse this standard graph today I want to look at the wider implications of the imposition of tariffs. Space will mean much of this article just suggests further investigation.
There are both gains and losses from using tariffs. When evaluating the imposition of a tariff we might look at the long-run and short-run implications, the effect on stakeholders, such as consumers, firms and governments and the advantages and disadvantages of the tariff.
A tariff is a tax on imports. The aim of raising the price of imports on the domestic market is to reduce demand for them. It is hoped that this will lead to import substitution, domestic consumers switch to domestically produced products. This will raise domestic output and employment and might reduce a current account deficit.
The diagram below shows the effects of the imposition of a tariff on steel by the Chinese on British made steel. (This is referred to in the BBC article linked below.)
There are both gains and losses from using tariffs. When evaluating the imposition of a tariff we might look at the long-run and short-run implications, the effect on stakeholders, such as consumers, firms and governments and the advantages and disadvantages of the tariff.
There are no long-run justifications for putting a tariff on trade because it prevents specalization and the exploitation of comparative advantage. We know from economic theory that in the long- run everyone gains from trade. However in the short-run this might not be true.
The article describes how China may be 'dumping' steel on the world market - that is selling steel below the cost of production. If this is the case then this is unfair and other countries steel industries will contract and jobs are lost. Even if the Chinese are not dumping (because they are able to produce steel more cheaply) another country might not want to see the sudden contraction of its steel industry with the resultant structural unemployment. Therefore in the short-run they protect their industry and manage its decline due to the loss of comparative advantage,
The stakeholders in the protected industry are often consumers. They lose out due to the imposition of tariffs because they pay higher prices and so lose consumer surplus. Another stakeholder is the government on the importing country. They gain tariff revenue and avoid paying greater unemployment benefits, both of which affect the government budget deficit. Notice here that the consumers who pay higher steel prices (by paying more for the goods made with steel) might be saved from higher taxes needed to pay unemployment benefits!
The static gains and loses represented by the diagram miss the dynamic gains and losses that can occur. The most obvious loss is that a trade war can result from placing tariffs on goods. This is evidenced in the article where one country imposing tariffs causes others to retaliate. The net effect is less overseas trade and slower economic growth worldwide.
There are always more questions to ask in economics and students should look to find the right questions to ask to reach a valid judgement on the effects of any policy measure.
This article is especially relevant to IB students who will find the tariff diagram is virtually always drawn at some point on Paper 2. However VCE and IB students need to practice evaluation - making a judgement based on economic theory and for that they need to ask wider questions about who is affected and how.
Sunday, 28 February 2016
Trade barriers in Africa are difficult to dismantle
The benefits of free trade are well known to economics students. When there is free trade production can be located where the law of comparative advantage dictates. Trade follows and in the long run everyone is better off.
The problem comes with the 'long run' part. Lots of people will be displaced from their current employment as comparative advantage does its work. They might be out of luck in moving into a country's expanding sector for its declining one. Politicians hate this as people who lose their job tend to blame governments.
Africa is one area where the benefits of free trade are yet to be fully realised. Despite a number of free trade and co-operative areas there are still significant barriers to trade. A favorite tactic is to replace lower tariff barriers with higher non-tariff barriers.
A non-tariff barrier is a regulation. For example a safety standard which means firms have to spend money to alter their product before it can be sold in the country. This raises the price and so favours local producers. There are many possible non-tariff barriers and bringing down one of them can lead to two more being set up.
The Economist covers moves to try to reduce Africa's trade barriers ans so encourage more intra-African trade. Presently Africa trades more with the rest of the world than it does internally. While this is partly down to poor infrastructure it is also due to high tariffs and other barriers to trade.
The problem comes with the 'long run' part. Lots of people will be displaced from their current employment as comparative advantage does its work. They might be out of luck in moving into a country's expanding sector for its declining one. Politicians hate this as people who lose their job tend to blame governments.
Africa is one area where the benefits of free trade are yet to be fully realised. Despite a number of free trade and co-operative areas there are still significant barriers to trade. A favorite tactic is to replace lower tariff barriers with higher non-tariff barriers.
A non-tariff barrier is a regulation. For example a safety standard which means firms have to spend money to alter their product before it can be sold in the country. This raises the price and so favours local producers. There are many possible non-tariff barriers and bringing down one of them can lead to two more being set up.
The Economist covers moves to try to reduce Africa's trade barriers ans so encourage more intra-African trade. Presently Africa trades more with the rest of the world than it does internally. While this is partly down to poor infrastructure it is also due to high tariffs and other barriers to trade.
The Economist article is here
This article is of most use to IB Economics students who study trade in some depth. However VCE students can benefit from the application of trade theory and policy and its link to the standard of living.
Thursday, 7 November 2013
The dangers of not competing
Qantas have announced they will stop maintaining aircraft at Avalon. Despite the protests of the engineers they have themselves to blame to some degree.
The decision will mean that part of the Qantas fleet will be maintained abroad where it is much cheaper to do so. While this is unfortunate, especially for Geelong who might welcome Australia's first nuclear power plant right now, it is an illustration of the benefits of trade.
As Qantas will be able to save money on maintenance by this move they will be able to charge lower fares. Those lower fares will benefit Qantas consumers directly and other passengers as it adds to competition in the market.
There is no point complaining about lower wages abroad or lower quality (first may be true but the second isn't). The fact is that countries should specialise in what they are comparatively best at and import the rest. In the long run nobody wins by subsidising uneconomic industries, the taxpayers and consumers pay more for a brief period of higher wages and employment for the inefficient.
The actual answer is to invest in human capital via education and training to make Australia competitive in the high tech, knowledge based industries that will allow Australians to maintain their standard of living. The alternative is to drop living standards to those of the bulk of the Asian Pacific region. There will be few takers for that.
The decision will mean that part of the Qantas fleet will be maintained abroad where it is much cheaper to do so. While this is unfortunate, especially for Geelong who might welcome Australia's first nuclear power plant right now, it is an illustration of the benefits of trade.
As Qantas will be able to save money on maintenance by this move they will be able to charge lower fares. Those lower fares will benefit Qantas consumers directly and other passengers as it adds to competition in the market.
There is no point complaining about lower wages abroad or lower quality (first may be true but the second isn't). The fact is that countries should specialise in what they are comparatively best at and import the rest. In the long run nobody wins by subsidising uneconomic industries, the taxpayers and consumers pay more for a brief period of higher wages and employment for the inefficient.
The actual answer is to invest in human capital via education and training to make Australia competitive in the high tech, knowledge based industries that will allow Australians to maintain their standard of living. The alternative is to drop living standards to those of the bulk of the Asian Pacific region. There will be few takers for that.
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