Myths About International Trade

This blog posting seeks to provide some starting points for discussion about the benefits and costs of international trade.  In this particular posting, I address aggregate national considerations and do not address either exchange rate effects or distributional effects within the U.S. or any other country. Those will be topics for future postings.

In order to make sense of the economics of international trade, it’s useful to define a number of key concepts.

  • Balance of Trade: the difference between what a country exports and imports in goods and services over a designated time period.
  • Balance of Payments: Balance of Trade plus net income from factor services (capital and labor) plus net income from international transfers. Also referred to as the Current Account.
  • Tariff: a tax on imports. Alternatively, as defined by Ambrose Bierce in The Devil’s Dictionary, “a scale of taxes on imports, designed to protect the domestic producer against the greed of his consumer.”
  • Zero-Sum Game: the gains made by one individual (or firm, state, or nation) are a result of and matched by the losses imposed on another.
  • Mercantilism: Economic nationalism for the purpose of building a wealthy and powerful state through restraining imports and encouraging exports.
  • Free Trade: The lack of any (tariff or non-tariff) barriers to the movement of goods or services between countries.
  • Comparative advantage: a person, firm, or country has a comparative advantage in producing a particular good or service if it foregoes less (has a lower opportunity cost) to do so than the entity it trades with.
  • Capital account: The flow of assets into and out of a country over a designated period. When countries run a Balance of Payments deficit, they will need to obtain the funds from abroad so capital will flow in.  Stated differently, foreign owners will purchase domestic assets, and thus provide the funds to close the gap, or they will receive asset transfers (such as gold) from a domestic entity. The balance in the capital account will, by definition, be exactly the negative of the balance in the payment account.

This posting addresses four myths about international trade.

  1. Trade between countries is a zero-sum game. 
    • If one country’s gains were losses to another country, they would not trade.  All trade should yield mutually beneficial outcomes, at least from the point of view of those doing the trading.
    • People (or countries) are made better off when they devote resources to that in which they have a comparative advantage; this allows those affected to generate more income and achieve a higher material standard of living.
    • Countries that engage in significant amounts of trade tend to grow faster than those countries that close doors to trade.
  2. A positive trade balance improves the economic welfare of a country (in terms of GDP), while a negative trade balance makes a country worse off.
    • A trade (or payments) deficit for many years in a row bears no relationship to a company that generates losses many years in a row.  In the former case, other countries have been willing to lend funds to enable such deficits to take place. These lenders view the return on their funds worth engaging in the financial transaction.  The same cannot be said for a company that continues to generate losses year after year.
    • The figure below shows that Japan ran current account surpluses from 1995 until 2011; yet, its economy stagnated.japan-trade-balance-vs-gdp-growth
    • The figure below shows that The United States has run current account deficits for every  year except 1991 since 1982 ; its economy has tended to grow at  modest rates.  Furthermore, periods of reduced trade deficits have coincided with periods of low economic growth. In short, as growth prospects in the U.S. have improved, US households and businesses buy more from abroad, and foreign capital owners choose to invest more in the United States.us-current-account-balance-and-gdp
    • Trade deficits are equivalent to domestic savings deficits; that is, when total national savings is less than total national investment, countries must obtain the requisite goods and services from abroad. Similarly, savings surpluses are coincident with trade surpluses; that is, if domestic savings exceed domestic investment then such savings will be exported and enable foreign purchasers to buy excess production of domestic goods and services.
  3. Expanded trade hurts workers (in the aggregate).
    • Expanded trade in both exports and imports helps to employ workers since countries that expand trade will be able to use their domestic resources more productively; thus, domestic purchasers will have both more income to purchase goods and services with and the prices of such will be lower than they would be if the country did not engage in trade.
    • As the figure below illustrates, for the U.S., periods with high trade deficits exhibit relatively low unemployment rates, and periods with low trade deficits exhibit relatively high unemployment rates. us-trade-balance-vs-unemployment-rate
  4. China is a mercantilist country; the United States is not.
    • China provides public support for much of what it produces and places barriers in front of both foreign investment and imports.
    • The United States provides support for some of what it produces (e.g., farm products), makes borrowing to purchase exports attractive (through the Export-Import Bank) and places barriers in front of some imports (e.g., sugar, cotton, solar panels) and in front of some exports (technology to certain countries.) For more specifics, go to U.S. Customs and Border Protection website.
    • Virtually all countries engage in some actions that give preference to some of their own products over competing foreign products; thus, virtually all countries engage to a degree in mercantilistic activity.
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