Question

Globalization has impacts on the performance of the economies of countries due to various reasons. Consider the case of international trade. It has been argued that the gains from trade are based on comparative advantages, which reflect the relative opportunity costs of production. When countries specialize in producing goods and services for which they have comparative advantages, total production in the global economy rises. Trade advocates argue that this increase in the size of the economic pie can be used to make all trading countries better off through international trade. Economists also use the principle of comparative advantage to advocate free trade among countries as a better policy.

There is also an issue of trade balance. A balance of trade is the difference between the monetary value of exports and imports of a country. Trade balance can be positive (favorable) when the value of exports is greater than the value of imports. The positive trade balance is also called trade surplus. On the contrary, if the value of imports is greater than the value of exports, the trade balance indicates trade deficit (negative net export).

Based on the above summary and the detailed descriptions of the international trade issues in the textbook, thoroughly discuss the following questions.

a. Does free trade contribute to the improvement of economic well-being in the U.S. economy? How does trade stimulate long-term economic growth? Explain. How do the gains compare to the losses? Explain using examples. What is the impact of free trade on domestic job creation policy? Elaborate with examples.

b. Do you think the U.S. exports and imports of goods and services are based on the principle of comparative advantage of trade? Explain. Why do countries impose trade restrictions on goods and services they import from other countries? What are the pros and cons of trade protectionism like tariffs on the U.S. economy?

c. What are the impacts of currency devaluation and revaluation on the international trade? What is currency (exchange rate) war? How does it affect trade between countries? What are the impacts of currency manipulations on the U.S. trade?

Answer 1

a.

Free Trade

Free trade is a trade policy that does not limit imports or exports. Under a free trade policy, goods and services can be bought and sold across international limits with little or no government tariffs, quotas, subsidies, or prohibitions to constrain their exchange. In government, free trade is mostly advocated by political parties that hold liberal economic positions.

Most nations are today members of the World Trade Organization multilateral trade agreements. Free trade was best demonstrated by the unilateral attitude of Great Britain who reduced regulations and duties on imports and exports from the mid-nineteenth century to the 1920s. Most governments still impose some protective policies that are intended to support local employment, such as applying tariffs to imports or subsidies to exports. Governments may also limit free trade to limit exports of natural resources. Other obstacles that may hinder trade include import quotas, taxes and non-tariff barriers, such as regulatory legislation.

Factually, openness to free trade substantially increased from 1815 to the outbreak of World War I. Trade openness increased again during the 1920s, but misshapen (in particular in Europe and North America) during the Great Depression. Trade openness increased considerably again from the 1950s onwards (albeit with a slowdown during the oil crisis of the 1970s). Economists and economic historians struggle that current levels of trade openness are the highest they have ever been.

There is a broad harmony among economists that protectionism has a negative effect on economic growth and economic welfare while free trade and the reduction of trade barriers have a positive effect on economic growth and economic constancy. Though, liberalization of trade can cause important and unequally distributed losses, and the economic dislocation of workers in import-competing sectors.

Features

Free trade policies may promote the following features.

· Trade of goods without taxes (including tariffs) or obstacles (e.g. quotas on imports or subsidies for producers).

· Trade in services without taxes or other trade obstacles.

· The absence of trade misrepresenting policies (such as taxes, subsidies, regulations, or laws) that gives some firms, households, or factors of production an advantage over others.

· Unregulated entree to markets.

· Unregulated entree to market information.

· Inability of firms to misrepresent markets through government-imposed monopoly or oligopoly power.

· Trade agreements which inspire free trade.

Free trade increases richness for Americans and the citizens of all participating nations by allowing consumers to buy more, better-quality products at lower costs. It energies economic growth, enhanced efficiency, increased innovation, and the greater fairness that escorts a rules based system. These benefits increase as general trade exports and imports increases.

Free trade increases entree to higher-quality, lower-priced goods. Inexpensive imports, particularly from countries such as China and Mexico, have eased inflationary pressure in the United States. Prices are held down by more than 2 percent for every 1 percent share in the market by imports from low income countries like China, which leaves more income for Americans to spend on other products. Free trade incomes more growth. At least half of US imports are not customer goods; they are inputs for US based producers, according to economists from the Bureau of Economic Analysis. Freeing trade decreases imported-input costs, thus reducing businesses’ production costs and promoting economic growth. Free trade improves efficiency and novelty. Over time, free trade works with other market procedures to shift workers and resources to more productive uses, allowing more efficient industries to thrive. The results are higher wages, investment in such things as infrastructure, and a more dynamic economy that continues to create new jobs and opportunities. Free trade drives competitiveness. Free trade does require American businesses and workers to familiarize to the shifting demands of the worldwide marketplace. These adjustments are critical to remaining competitive, and competition is what fuels long term growth. Free trade promotes equality. When everyone follows the same rules-based system, there is less chance for cronyism, or the ability of participating nations to skew trade advantages toward favored parties. In the absence of such a system, bigger and better connected industries can more easily obtain unfair advantages, such as tax and regulatory loopholes, which shield them from competition.

Without free trade agreements, countries often are protected by their domestic industries and businesses. This protection often made them still and non-competitive on the global market. With the protection removed, they became inspired to become true global competitors. Many governments fund local industries. After the trade agreement eliminates subsidies, those funds can be put to better use. Investors will drove to the country. This adds capital to expand local industries and increase domestic businesses. It also brings in U.S. dollars to many previously isolated countries. ​Global companies have more know-how than domestic companies to develop local resources. That is especially true in mining, oil drilling, and manufacturing. Free trade agreements permit global firms access to these business opportunities. When multinationals partner with local firms to develop the resources, they train them on the best practices. That gives local firms entree to these new methods. Local companies also receive access to the latest technologies from their multinational partners. As local economies grow, so do job opportunities. Multi-national companies offer job training to local employees.

Countries that are open to international trade incline to grow faster, innovate, improve productivity and provide higher income and more opportunities to their people. Open trade also aids lower-income households by offering consumers more affordable goods and services. Mixing with the world economy through trade and global value chains helps drive economic growth and reduce poverty—locally and globally.

Free trade does not create more jobs, but neither does protection. Free trade may decrease jobs in inefficient industries, but it frees up resources to create jobs in efficient industries, boosting overall wages and improving living standards. Protectionism, in contrast, efforts to protect jobs that the market will not sustain, it does so at the expenditure of more innovative industries. Much of the change in the labor force is not the consequence of free trade but of innovation. New technology, such as apps on mobile devices, has exiled a staggering variety of products, including radios, cameras, alarm clocks, calculators, compact discs, DVDs, carpenters’ levels, tape-measures, tape recorders, blood-pressure monitors, cardiographs, flashlights, and file cabinets. Using protectionist policies to save a job comes at enormous cost, as opportunities shrink and input costs decrease for industries downstream. The only beneficiaries of trade restrictions are the inefficient firms and special interests that secure these protections upon competition. In spite of receiving protection from foreign competition for many decades, large firms have gradually left the US steel industry due to high fixed costs and competition from smaller firms. Tariffs on steel upsurge costs in steel-consuming industries, which employ 12 million Americans, compared to the 190,000 Americans employed in the steel-making industry. The United States’ recent burden of tariffs on Chinese-made solar panels resulted in China imposing tariffs on Americans raising the cost of solar equipment and reducing employment opportunities in both nations. US trade shortfalls generally are good for Americans. The trade deficit is not a debt. A rising trade deficit, despite its misleading name, is good for the economy. It is typically a sign that global investors are confident in America’s economic future. The US trade shortfall might be larger than it would otherwise be if a trading partner chooses to keep the price of its currency artificially low, but this practice harms the trading partner, not the United States.

b.

Comparative advantage is an economy's capability to produce a particular good or service at a lower opportunity cost than its trading partners. A comparative advantage gives a company the ability to sell goods and services at a lower price than its contestants and realize stronger sales margins. The theory of comparative advantage familiarizes opportunity cost as a factor for analysis in choosing between different options for production. Comparative advantage suggests that countries will engage in trade with one another, transferring the goods that they have a relative advantage in. Absolute advantage refers to the unconcealed superiority of a country to produce a particular good better. The United States’ comparative advantage is in specialized, capital-intensive labor. American workers produce classy goods or investment opportunities at lower opportunity costs. Specializing and trading along these lines benefit each.

Comparative advantage motivates people to trade. Because comparative advantage comes from variances in relative prices, it means that characteristics of both supply and demand matter. Thus comparative advantage for a country results from a multilayered combination of the characteristics that are difficult to change , characteristics of the overall country that change relatively slowly (such as the share of production and consumption of services relative to the share    of manufacturing, agriculture, and mining), characteristics of production technology that in some cases can change relatively quickly (such as through turnkey production technology), and characteristics of individual preferences (such as for a particular kind or quality of products, services, or financial assets).

Some examples of comparative advantage come from trade in commodities, where resource benefactions are quite important. For example, the United States imports coffee and tea because people desire to drink these beverages, but the North American climate is not suitable for the plants that produce the beans and leaves. Likewise, the United States buys oil on international markets because it can import it at a price lower than the cost of extracting it from US oil wells—current production technology combined with resource endowments and the substantial US use imports polyester windbreakers (which are cheaper to produce abroad) and exports Polartec anoraks (which are produced in the United States using special production inputs and techniques). Supercomputers and desktop models are both computers, but their functionality is different. Both types of computers are produced in the United States as well as abroad, with different specifications. Since some consumers and businesses in the United States and abroad need supercomputers and some need desktop models, the United States exports and imports both.

Trade restrictions are classically undertaken in an effort to protect companies and workers in the home economy from competition by foreign firms. A protectionist policy is one in which a country limits the importation of goods and services produced in foreign countries. The slowdown in the U.S. economy late in 2007 and in 2008 has produced a new round of protectionist sentimentality—one that became a factor in the 2008 U.S. presidential campaign.

The United States, for example, uses protectionist policies to restrict the quantity of foreign produced sugar coming into the United States. The effect of this policy is to decrease the supply of sugar in the U.S. market and increase the price of sugar in the United States. The 2008 U.S. Farm Bill sugared things for sugar growers even more. It raised the price they are certain to receive and limited imports of foreign sugar so that American growers will always have at least 85% of the domestic market. The bill for the first time set an income limit—only growers whose incomes fall below $1.5 million per year (for couples) or $750,000 for individuals will receive direct subsidies (“Who Wants to Be a Millionaire?” The Wall Street Journal, May 14, 2008, p. A20).

The U.S. price of sugar is almost triple the world price of sugar, thus dropping the quantity consumed in the United States. The program benefits growers of sugar beets and sugar cane at the expenditure of consumers.

Barriers to Trade

Tariffs

A tariff refers to a tax on imported goods and services. The average tariff on dutiable imports in the United States (that is, those imports on which a tariff is imposed) is about 0.4%. Some imports have much advanced tariffs. A tariff raises the cost of selling imported goods. It thus shifts the supply curve for goods to the left, as in Figure 17.7 “The Impact of Protectionist Policies.” The price of the protected good rises and the quantity available to consumers falls.

Antidumping Proceedings

One of the most common protectionist measures now in use is the antidumping proceeding. A domestic firm, faced with competition by a foreign competitor, files charges with its government that the foreign firm is dumping, or charging an unfair price. Under rules spelled out in international negotiations that preceded approval of the World Trade Organization, an unfair price was defined as a price below production cost or below the price the foreign firm charges for the same good in its own country.

The practice of a foreign firm charging a price in the United States that is below the price it charges in its home country is common. The U.S. market may be more competitive, or the foreign firm may simply be trying to make its product attractive to U.S. buyers that are not yet accustomed to its product. In any event, such price discrimination behavior is not unusual and is not necessarily “unfair.”

In the United States, once the Department of Justice has determined that a foreign firm is embarrassed of charging an unfair price, the U.S. International Trade Commission must determine that the foreign firm has done material harm to the U.S. firm. If a U.S. firm has agonized a reduction in sales and thus in employment it will typically be found to have suffered material harm, and punitive duties will be imposed.

Quotas

A quota is a direct constraint on the total quantity of a good or service that may be imported during a specified period. Quotas limit total supply and therefore increase the domestic price of the good or service on which they are imposed. Quotas generally specify that an exporting country’s share of a domestic market may not exceed a certain limit.

In some cases, quotas are set to raise the domestic price to a particular level. Congress requires the Department of Agriculture, for example, to impose quotas on imported sugar to keep the wholesale price in the United States above 22 cents per pound. The world price is typically less than 10 cents per pound.

A quota restricting the quantity of a particular good imported into an economy shifts the supply curve to the left, as in Figure 17.7 “The Impact of Protectionist Policies.” It raises price and reduces quantity.

An important distinction between quotas and tariffs is that quotas do not increase costs to foreign producers; tariffs do. In the short run, a tariff will reduce the profits of foreign exporters of a good or service. A quota, however, raises price but not costs of production and thus may increase profits. Because the quota imposes a limit on quantity, any profits it creates in other countries will not induce the entry of new firms that ordinarily eliminates profits in perfect competition. By definition, entry of new foreign firms to earn the profits available in the United States is blocked by the quota.

Voluntary Export Restrictions

Voluntary export restrictions are a form of trade barrier by which foreign firms agree to limit the quantity of goods exported to a particular country. They became prominent in the United States in the 1980s, when the U.S. government persuaded foreign exporters of automobiles and steel to agree to limit their exports to the United States.

Although such restrictions are called voluntary, they typically are agreed to only after pressure is applied by the country whose industries they protect. The United States, for example, has succeeded in pressuring many other countries to accept quotas limiting their exports of goods ranging from sweaters to steel.

A voluntary export restriction works precisely like an ordinary quota. It raises prices for the domestic product and reduces the quantity consumed of the good or service affected by the quota. It can also increase the profits of the firms that agree to the quota because it raises the price they receive for their products.

Other Barriers

In addition to tariffs and quotas, measures such as safety standards, labeling requirements, pollution controls, and quality restrictions all may have the effect of restricting imports.

Many restrictions aimed at protecting consumers in the domestic market create barriers as a purely unintended, and probably desirable, side effect. For example, limitations on insecticide levels in foods are often more stringent in the United States than in other countries. These standards tend to discourage the import of foreign goods, but their primary purpose appears to be to protect consumers from harmful chemicals, not to restrict trade. But other nontariff barriers seem to serve no purpose other than to keep foreign goods out. Tomatoes produced in Mexico, for example, compete with those produced in the United States. But Mexican tomatoes tend to be smaller than U.S. tomatoes. The United States once imposed size restrictions to “protect” U.S. consumers from small tomatoes. The result was a highly effective trade barrier that protected U.S. producers and raised U.S. tomato prices. Those restrictions were abolished under terms of the North American Free Trade Agreement, which has led to a large increase in U.S. imports of Mexican tomatoes and a reduction in U.S. tomato production.

c.

The terms currency devaluation and currency revaluation refer to large changes in the value of a country’s currency comparative to other currencies under a fixed exchange rate regime. These changes are made by the countrys government or monetary authority. If a country has a floating exchange rate regime, or if the changes in the exchange rate under a fixed exchange rate regime are slight (within the boundaries allowed by the government), the changes in the exchange rate induced by market fluctuations are referred to as currency depreciation and appreciation.

When a government demeanors a devaluation, or devalues its currency, it changes the fixed exchange rate in a way that makes its currency worth less. When a government conducts a revaluation, or revalues its currency, it changes the fixed exchange rate in a way that makes its currency worth more. Since the exchange rates are usually bilateral, an increase in the value of one currency corresponds to a decline in the value of another currency. The convention is to use the term that describes the origin of the policy change.

Devaluation

There are two consequences of devaluation. First, devaluation makes the country's exports comparatively less expensive for foreigners. Second, the devaluation makes foreign products comparatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country's exports and decrease imports, and may therefore help to reduce the current account deficit.

There are other policy issues that influence lead a country to change its fixed exchange rate. For example, rather than implementing unpopular fiscal spending policies, a government might try to use devaluation to boost aggregate demand in the economy in an effort to fight unemployment. Revaluation, which makes a currency more expensive, might be undertaken in an effort to reduce a current account surplus, where exports exceed imports, or to attempt to contain inflationary pressures.

Effects of Devaluation

A important danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, the government may have to raise interest rates to regulate inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be risked. Thus, devaluation may diminish investor confidence in the country's economy and hurt the country's ability to secure foreign investment.

Another possible consequence is a round of consecutive devaluations. For instance, trading partners may become concerned that a devaluation might destructively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partner's devaluation.   Since the 1930s, various international organizations such as the International Monetary Fund (IMF) have been established to help nations manage their trade and foreign exchange policies and thereby avoid successive rounds of devaluation and retaliation. The 1976 revision of Article IV of the IMF charter encourages policymakers to avoid manipulating exchange rates to gain an unfair competitive advantage over other members. With this revision, the IMF also set forth each member nation's right to freely choose an exchange rate system.

Currency Revaluation

Revaluation is a substantial rise in a countys official exchange rates in relation to a foreign currency. The procedure of revaluation can only be done by the central bank of the revaluing country.

For example, if a countries currency trades at 10 units to 1 US dollar, to revalue it, the said country can change to using 5 units of its currency to be equivalent to 1 dollar in order to make it twice expensive compared to the dollar.

Causes of Currency Revaluation

Changes in interest rates of various countries could cause a country to opt for currency revaluation so as to maintain its profitability and economic competitiveness.

Countries can also revalue their currency for hypothetical purposes. For example, prior to the 2016 Brexit by Britain, a lot of other countries’ currencies fluctuated because of speculative reasons and need to remain profitable despite any outcome of the vote.

International Monetary Fund

The issue of currency revaluation and devaluation led to the establishment of the International Monetary Fund (IMF), a body that controls the frequent devaluation and revaluation that are used by different countries to unfairly gain a competitive advantage over others. The IMF has also given each member a right to choose an exchange rate to use. These policies have helped the misguided motives of devaluation and revaluation.

Currency Manipulation

Currency manipulation is the practice of insincerely setting exchange rates by the central bank of one country in order to gain an unfair advantage. Classically currency manipulation occurs when a country fixes the exchange rate of its currency relative to the currency of another country. It can include a requirement for a fixed exchange rate or the compulsory use of a country’s central bank for foreign exchange sales.

Article IV of the International Monetary Fund (IMF) Agreement states that a member should “avoid manipulating exchange rates in order to gain an unfair advantage over other members,” and related surveillance provision defines manipulation to include “protracted large scale intervention in one direction in the exchange market.” In other words if an India trading partner makes large scale purchasing of INR and other currencies that leads to lower than market based exchange rate, there is an evidence of currency manipulation to gain unfair competitive advantage according to IMF Agreement  .

There are two ways the price of a currency can be persistent against another. A fixed, or pegged, rate is a rate the government (central bank) sets and upholds as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged.

When governments intervene in currency markets to subsidize their exports, they violate the principles of free trade and force the market to ignore normal pressures of supply and demand. ... Government intervention in currency markets distorts trade flows and undermines free trade agreements.

Manipulating currency to gain an unfair competitive advantage is already prohibited for members of the IMF and WTO, but the prohibitions lack teeth. The solution is simple: strong and enforceable currency rules must be included in all future trade agreements.

If these rules are included, any country found to be in violation would lose the benefits of the trade agreement. This will strongly discourage currency cheating and protect free trade and free market principles.