Question

Discuss in detail the factors that contribute to imperfect specialization in international trade.

Answer 1

Impact of Inflation:

If a country’s inflation rate increases relative to the countries with which it trades, its current account will be expected to decrease, other things being equal. Consumers and corporations in that country will most likely purchase more goods overseas (due to high local inflations), while the country’s exports to other countries will decline.

Impact of National Income:

If a country’s income level (national income) increases by a higher percentage than those of other countries, its current account is expected to decrease, other things being equal. As the real income level (adjusted for inflation) rises, so does consumption of goods. A percentage of that increase in consumption will most likely reflect an increased demand for foreign goods.

Impact of Government Policies:

A country’s government can have a major effect on its balance of trade due to its policies on subsidizing exporters, restrictions on imports, or lack of enforcement on piracy.

Subsidies for Exporters:

Some governments offer subsidies to their domestic firms, so that those firms can produce products at a lower cost than their global competitors. Thus, the demand for the exports produced by those firms is higher as a result of subsidies.

Many firms in China commonly receive free loans or free land from the government. These firms incur a lower cost of operations and are able to price their products lower as a result, which enables them to capture a larger share of the global market.

Restrictions on Imports:

If a country’s government imposes a tax on imported goods (often referred to as a tariff), the prices of foreign goods to consumers are effectively increased. Tariffs imposed by the U.S. government are on average lower than those imposed by other governments. Some industries, however, are more highly protected by tariffs than others. American apparel products and farm products have historically received more protection against foreign competition through high tariffs on related imports.

In addition to tariffs, a government can reduce its country’s imports by enforcing a quota, or a maximum limit that can be imported. Quotas have been commonly applied to a variety of goods imported by the United States and other countries.

Lack of Restrictions on Piracy:

In some cases, a government can affect international trade flows by its lack of restrictions on piracy. In China, piracy is very common; individuals (called pirates) manufacture CDs and DVDs that look almost exactly like the original product produced in the United States and other countries. They sell the CDs and DVDs on the street at a price that is lower than the original product. They even sell the CDs and DVDs to retail stores. It has been estimated that U.S. producers of film, music, and software lose $2 billion in sales per year due to piracy in China.

As a result of piracy, China’s demand for imports is lower. Piracy is one reason why the United States has a large balance-of-trade deficit with China. However, even if piracy were eliminated, the U.S. trade deficit with China would still be large.

Impact of Exchange Rates:

Each country’s currency is valued in terms of other currencies through the use of exchange rates, so that currencies can be exchanged to facilitate international transactions.
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