International Trade

• Overview of international trade

• International trade theories
– Main features of international trade after the
Second World War
• Strong growth
• Change g & s
• Change countries.
– What are the main causes of this growth?
• Liberalization of trade
– Multilateral (GATT / WTO)
– Regional (EU, NAFTA)
• Technology.
– Transport costs
– Control production
Volume of World Trade and World
Production, 1960-2010
Map of World Trade
FIGURE 1-2

World Trade in Goods, 2006 ($ billions) Trade in merchandise goods

between selected countries and regions of the world.
Map of World Trade
European and U.S. Trade
TABLE 1-1

Shares of World Trade, Accounted for by Selected Regions, 2006

.
• https://www.wto.org/english/res_e/statis_e/s
tatis_e.htm

• https://www.wto.org/english/res_e/publicatio
ns_e/publications_e.htm

• https://www.wto.org/english/res_e/statis_e/
wts2020_e/wts20_toc_e.htm
 International trade
• Explanations of international trade patterns.
– Why countries export/ import what they do

• The effects of international trade on countries and individuals

– Who wins
– Who loses
 International trade
• The effects of government policies on international trade

• International trade history

– Where WTO comes from
– International Trade Agreements
– Regional Trade Agreements

• Other things that happen in the economy and influence

international trade.
 International Trade vs Interregional
Trade
• The reason for interregional trade and international trade is
the same
– It makes little economic sense for a country to produce a
good that can be purchased from another country at a
lower price.
• There is a different perception
– A concern that buying from foreign sources may lead to a
loss of domestic jobs
• Differences between international trade and interregional
trade
– Boundaries
– Different currencies
 Do countries benefit from
international trade?
• A debate for several hundreds years.
• Back since Adam Smith economists try to show that
countries can benefit if each country specializes in
the production of those goods that it can produce
best and trade those goods for other goods
• Specialization and trade makes total output of
goods and services larger
Market size
 Countries can benefit from
international trade?
• International trade is not a zero-sum game
– The overall net effect is positive.
– But, it can be winners and loosers.

• The usual way to show the benefis of international

trade is to compare a situation with no trade with a
situations with free trade.
 Trade theories
• Trade based on Absolute Advantage (Adam Smith)
• Trade based on Comparative Advantage
– Ricardian model
– Heckscher-Ohlin
• New trade theories
 Trade Based on Absolute Advantage
“It is the maxim of every prudent
master of a family, never to attempt to
make at home what it will cost him
more to make than to buy. (…) What is
prudence in the conduct of every
private family, can scarce be folly in that
of a great kingdom. If a foreign country
can supply us with a commodity
cheaper than we can make it, better buy
it of them with some part of the
Adam Smith
(1723 - 1790)
produce of our own industry employed
in a way we have some advantage”
Adam Smith
 Trade Based on Absolute Advantage
• Absolute Advantage
– The ability of a country to produce a good using
fewer resources than another country

• Adam Smith´s concept of cost is based on the labor

theory of value
– The cost of a good is determined solely by the
amount of labor used to produce it
 Absolute advantage
PORTUGAL England
1 un. cloth = 90 h. Labor 1 un cloth = 70 h. Labor

1 un. wine = 80 h. Labor 1 un wine = 120 h. Labor

Which country has absolute advantage in producing cloth?

Which country has absolute advantage in producing wine?

Comparative advantage. David Ricardo
PORTUGAL England
1 un. cloth = 90 h. Labor 1 un cloth = 100 h. Labor

1 un. wine = 80 h. Labor 1 un wine = 120 h. Labor

Which country has absolute advantage?

Portugal, can produce both goods at a lower cost.

Would it be beneficial for Portugal to trade with England?

Trade Based on Comparative Advantage

“Comparative advantage is one of the few things

in economics that is true, but not obvious”
Paul Samuelson (1915 –2009)

David Ricardo (1772-1823 )

Krugman “Ricardo’s idea is truly, madly, deeply difficult. But it is also utterly true,
immensely sophisticated – and extremely relevant to the modern world”.
Comparative advantage. David Ricardo
• Comparative cost. Quantity of one good that can be
obtained in exchange of 1 unit of the other good
• A country has comparative advantage in the
production of one good if it can be produced at a
lower cost in terms of the other good
 Comparative advantage. David Ricardo.
PORTUGAL ENGLAND

Absolute costs Absolute costs

1 un. cloth = 90 h. Labor 1 un. wine = 100 h. Labor

1 un. wine = 80 h. Labor 1 un. wine = 120 h. Labor

Comparative costs Comparative costs

1 u. cloth= 90/80= 1,125 u. wine 1 u. cloth = 100/120 = 0,83 u. wine

1 u. wine = 80/90 = 0,88 u. cloth 1 u. wine = 120/10 = 1,2 u. cloth

Portugal comparative advantage wine

England comparative advantage cloth

 Comparative advantage. David Ricardo.
PORTUGAL ENGLAND

Absolute costs Absolute costs

1 un. cloth = 90 h. Labor 1 un. wine = 100 h. Labor

1 un. wine = 80 h. Labor 1 un. wine = 120 h. Labor

Comparative costs Comparative costs

1 u. cloth= 90/80= 1,125 u. wine 1 u. cloth = 100/120 = 0,83 u. wine

1 u. wine = 80/90 = 0,88 u. cloth 1 u. wine = 120/10 = 1,2 u. cloth
 Comparative advantage. David Ricardo.
NO TRADE
PORTUGAL ENGLAND
1 un. cloth = 90 h. labor 1 un. cloth = 100 h. labor
1 un. wine = 80h. labor 1 un. wine = 120 h. labor

NO TRADE 2 units of wine and 2 units of cloth

TRADE

PORTUGAL ENGLAND
TOTAL = 170 h. labor TOTAL = 220 h. labor
170h/80 = 2,125 un of wine 220h/100 = 2,2 un of cloth

TRADE 2,125 of wine and 2,2 of cloth

 Ricardo´s assumptions
1. Two countries
2. Two goods
3. Only on factor of production. Labor
– Labor is fully employed
– The supply of labor in each country is fixed
– Labor productivity in each country and in each
industry is constant but differs between industries
and between countries (marginal product of labor
is constant)
 Ricardo´s assumptions
4. Labor mobility
– Labor is mobile between industries within a
country
– Labor is completely inmobile between countries
5. Perfect competition
6. No transportation costs
 Trade Based on Comparative
Advantage
• The relative cost of a good is determined by the cost
to produce it in terms of the other good.

• Comparative advantage is the ability of a country to

produce a good at a lower opportunity cost than
another country.

• If both countries specialize according to their

comparative advantage, they both gain from this
specialization and trade
 Comparative advantage and opportunity
cost
• Countries have a comparative advantage in the
production of goods where the opportunity cost of
producing those goods is lower
• Comparative advantage is used to explain the world
pattern of trade.
 Dynamics gains from trade
• There are also dynamic gains from trade (appart
from the static gains from trade)
– Faster economic growth
– Increasing returns to scale
– An increase in the quality of the goods we
consume
– An increase in competition within the domestic
market.
 Neoclasical model. Heckscher-Ohlin
• 2 countries
• 2 goods
• 2 factors of production
 Neoclasical model. Heckscher-Ohlin
• A country's comparative advantage is determined
by the relative endowments of the factors of
production
• A country has comparative advantages in those
goods for which the required factors of
production are relatively abundant in the country.
• Goods that require inputs that are locally
abundant will be cheaper to produce than those
goods that require inputs that are locally scarce
 Relative
endowments
Comparative Trade pattern
of the factors Specialization
advantage
of
production
Country Export good X
A Labour Good X Good X
Import good Y

Country Export good Y

B Capital Good Y Good Y
Import good X

Country A Relative abundant in labor

Country B Relative abundant in capital

Good X The production requires more labor

relative to capital
Good Y The production requires more capital
relative to labor
Intraindustry Trade
 Intraindustry Trade (IIT)
• Intraindustrial trade vs interindustrial trade
• How to measure IIT
• Explanations
• Horizontally vs vertically differentiated IIT
 Introduction
• What we have seen so far:
• Trade ocurs because of differences in the prices
of goods between countries
• Prices are different because the differences in the
opportunity cost of producing different goods
• Opportunity costs are different because the
factor proportion in different countries are
different
 Introduction
• This explains trade between different countries that
trade different goods.

• But similar countries trade similar goods

• A large share of international trade cannot be
explained based on comparative advantage that
results from different factor endowments

• We need to explain this kind of trade

 Intraindustry trade vs Interindustry
trade
• Interindustry trade occurs when a country either
exports or imports goods in different industries
• Intraindustry trade occurs when countries trade
essentially the same goods with one another
– The trade of autos and auto parts between Spain and
France
– Intraindustry trade implies that a country has a
comparative advantage and disadvantage in the same
good
 Intraindustry trade vs Interindustry
trade
• Before the integration process in Europe.
• The widely accepted neoclassical theory predicted
that a process of reduction in trade barriers will lead
to the specialisation of every country according to its
factor endowment.
• The integration process would lead to an increase of
inter industrial trade as a proportion of total trade.
 Intraindustry trade vs Interindustry
trade
• After the integration process in Europe.
• Empirical studies of the effects of the EEC integration
process showed that the reduction or elimination of
trade barriers actually increased Intra Industrial
Trade (IIT)
• Search for a theoretical explanation for IIT
 Intra Industrial Trade (ITT)
• Intra industrial Trade is trade within the same
industry
• The simultaneous exports and imports within
industries between countries of similar
development levels.

41
 DEFINING INTRAINDUSTRY TRADE

• The intraindustry trade index

X−M
Intraindustry trade index = 1 −
X+M

Where for a particular industry or product group

X = the value of exports

M = the value of imports
 DEFINING INTRAINDUSTRY TRADE

• Consider the case when the U.S. exports

$50,000 of food to India and imports $50,000
of food from India
0
Intraindustry trade index = 1 − =1
$100,000

• This indicates that 100% of the trade in the food

industry is intraindustry trade

The closer the index is to 1, the more intraindustry

trade there is relative to interindustry trade
 DEFINING INTRAINDUSTRY TRADE

• The major shortcoming to this index is that

results vary depending on how an industry or
industry group is defined
– The more broadly a group is defined, the more
likely we are to find intraindustry trade and the
higher the intraindustry trade index will be
– The more narrowly a group is defined, the less likely
we are to find intraindustry trade and the lower the
intraindustry trade index will be
 DEFINING INTRAINDUSTRY TRADE

• Suppose the U.S. imports $100,000 of men’s

pants and export $100,000 of ladies pants
– All pants in one group
0
Intraindustry trade index = 1 − =1
$200,000
• Men’s and women’s pants in different groups
$100,000
Intraindustry trade index Men's Pants = 1− =0
$100,000
$100,000
Intraindustry trade index Women's Pants = 1 − =0
$100,000
 Intraindustrial trade. Explanations
Inter industrial and intra industrial trade have
different explanation.
• Intra industrial trade can be explained by a
monopolistic competition model.
• Because of product differentiation, each country
produces different types of the same good (eg.
Vehicles)
• Because of economies of scale, large markets are
desirable: the foreign country exports some vehicles
and the domestic country exports some vehicles. 46
The relative importance of intra-industry trade
depend on how similar countries are.
– Countries with similar relative amounts of factors
of production are predicted to have intra-
industry trade.
– Countries with different relative amounts of
factors of production are predicted to have inter-
industry trade.

47
 Distinction between horizontally and
vertically differentiated IIT
• Horizontal IIT deals with the exchange of goods with
different characteristics rather than different levels
of quality
• Vertical IIT deals with the exchange of similar kinds
of goods with different levels of quality.
• This distinction is revealing since both, the
determinants and the consequences of the two
different types of IIT, differ.
THE WELFARE IMPLICATION OF INTRAINDUSTRY
TRADE

• It is easier for resources to reallocate among

industries participating in intraindustry trade
– Industries have similar factor intensities
– Both the contracting and expanding industries are
either skilled-labor intensive or capital intensive

• The gains from intraindustry trade may be

larger and the adjustment costs lower than for
interindustry trade