Free trade by huangyuarong


									Special supplementary slides
on free trade & trade theory
o Economists believe in free trade
  because free trade allows
  businesses and nations to find
  their comparative advantage
  n If a country has comparative advantage
    in something, economists believe it
    should succeed without subsidies
“Free trade” means no barriers
o The principle: You should have the
  same incentives when you consider a
  product from abroad as from your
  home country.
o An industry in which a nation has
  comparative advantage is an
  industry in which that country
  produces relatively efficiently
  (compared to other industries in that
  n All nations have comparative advantage
    in something
o Your country has comparative advantage in the
  product or service where the ratio
     Resources required in your country .
     Resources required in the other country

  is low
Free trade theory is based on some
basic free-market economics
o Two fundamental principles
  1. The price for which sellers are willing to
     sell a product indicates what all the
     resources to produce (and sell) it are
  2. The price for which buyers will buy
     indicates what the product is worth to
     the buyer
o So economists think anything that
  manipulates prices is dangerous
o Economists prefer income taxes or
  sales taxes (on everything) rather than
  tariffs (on particular imports)
  n For any given amount of revenue raised,
    income and sales taxes disrupt the
    market less than tariffs
Most economists only make
1 or 2 exceptions
o Exception 1: tariffs to protect infant
o These are industries that lack
  comparative advantage, but could
  develop it soon
  n Example: Textile manufacturing in
    Vietnam in the 1980s
    o Because few Vietnamese were experienced
      in textile manufacturing, it was relatively
      less efficient than rice-growing
    o But as Vietnamese got experienced, they
      soon learned to produce textiles efficiently
o Exception 2: strategic trade policy
  n Sometimes when a brand new industry is
    invented, people can recognize
    o It will have economies of scale (the
      people that produce most will produce
    o There will be big learning effects (the
      people who produce first will produce
  n So subsidies may be worthwhile
    o Example: flat-panel computer displays
      when they had just been invented
     Smith, Ricardo and their
successors advocated free trade

o They believed that if people were left to
  trade on their own, they would naturally
  trade the goods in which their countries
  had comparative advantage
  n “Every individual seeks the most advantageous
    employment for his capital….
  n “Study of his own advantage necessarily leads
    him to prefer that employment most
    advantageous to society”
              - Adam Smith, 1776
In the 19th century, free trade
was widely practiced
o In Europe, tariffs were low or
o But after WW I and especially in the
  early 30s, nations raised tariffs to
  protect their domestic economies
o A disastrous depression followed
GATT was created to prevent the
mistakes of the 30s from repeating
o It provided a framework for
  negotiating reductions in tariffs
  and non-tariff barriers
o The WTO continued the process and
  provided an enforcement mechanism
  to prevent new barriers
So – tariffs are not
free trade
o The WTO (and almost all economists)
  discourage use of tariffs
  n to raise funds
  n to protect an industry that already has
    comparative advantage
    o In the homework question, answers
      suggesting tariff protection for handmade
      blankets and wool would not get WTO

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