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Table of Contents

Principles of Microeconomics, v. 1.0

by Libby Rittenberg and Timothy Tregarthen

Chapter 17 International Trade

Start Up: Trade Winds

Rapid increases in the flow of goods and services between vastly different nations and cultures have changed what people eat, how they dress, and even how they communicate with one another. For you, increased trade has meant greater choice of what to buy and often lower prices.

Look through your room. Chances are it is full of items from all around the world. The relatively free trade that exists today provides you with expanded choices. No one forced you to buy that shirt from India or that CD player from Japan. Presumably you bought them because you preferred them to other shirts and CD players you might have bought, perhaps because they had certain characteristics—style, color, perceived quality, or price—that you favored.

Your gains are being experienced worldwide because the winds of international trade have blown generally freer in the past decades. Nations all over the world have dramatically lowered the barriers they impose on the products of other countries.

One region that was once closed to virtually all trade but is now open is Eastern Europe and the countries that made up the former Soviet Union. A key part of these countries’ attempts to create market capitalist economic systems has been the opening of their borders to international trade.

In Western Europe, the members of the European Union (EU) have eliminated virtually every restriction on the free flow of goods and services among them. A truckload of electronic equipment from Italy now passes through France on its way to Spain with no more restrictions than would be encountered by a truck delivering goods from Michigan to Illinois. The purchase of the equipment can even be arranged using a new currency, the euro, which has been adopted by most EU nations.

Canada, Mexico, and the United States, while not adopting a common currency, have created a similar free trade area, the North American Free Trade Area (NAFTA). In addition, the 18 member nations of the Asian-Pacific Economic Cooperation organization (APEC) agreed in 1994 to forge a free trade area among industrialized nations such as the United States and Japan by 2010. Other member nations such as Mexico and China agreed to participate by 2020.

NAFTA has resulted in a dramatic increase in trade between Canada, the United States, and Mexico. Since NAFTA’s creation in 1994, employment in all three countries has risen substantially. Those increases in employment cannot necessarily be attributed to NAFTA, but the fact that they have occurred flies in the face of the arguments when NAFTA was first proposed that it would lead to a reduction in U.S. employment.

President Bush proposed and Congress passed in 2005 the creation of a Central American Free Trade Association (CAFTA) that would create a free trade area south of Mexico and linked to the United States. It abolishes most tariff restrictions between the United States and the countries of Central America—Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua. The six countries make up the second-largest export market for the United States in Latin America, behind Mexico. President Bush has also proposed extending the free trade zone throughout the Western Hemisphere.

And, in 1995, the World Trade Organization (WTO) was established to “help trade flow smoothly, freely, fairly and predictably” among member nations. In 2008, it had 153 member countries. Since World War II, the General Agreement on Tariffs and Trade (GATT)—WTO’s predecessor—and WTO have generated a series of agreements that slashed trade restraints among members. These agreements have helped propel international trade, which in 2006 was more than 35 times its level in 1950, but the negotiations leading to these agreements have always been protracted and tumultuous and issues of nationalism and patriotism are often not far from the surface. The current and ninth round of trade talks are referred to as the Doha Round, because they were officially launched in Doha, Qatar, in 2001. In mid-2008, talks were still mired in controversy over the removal of agricultural export subsidies and lowering of trade barriers of various kinds.

Why have so many countries moved to make trade freer? What are the effects of free trade? Why do efforts to eliminate trade restrictions meet with resistance? Why do many nations continue to impose barriers against some foreign goods and services? How do such barriers affect the economy? How do such barriers affect you?

This chapter will answer these questions by developing a model of international trade based on the idea of comparative advantage, introduced in an earlier chapter. The model predicts that free international trade will benefit the countries that participate in it. Free trade does not benefit every individual, however. Most people benefit from free trade, but some are hurt. We will then look at the phenomenon of two-way trade, in which countries both import and export the same goods. The last part of the chapter examines the effects of trade restrictions and evaluates the arguments made for such restrictions. Economists tend to be skeptical of their validity.