International Trade and its Applications

MBAC 600 The Theory of Competitive AdvantageIt is hard, if not impossible, to argue that a group of people can produce more if each specializesand produces what they are best at producing relative to other people or groups they caninteract with. If a region or nation can clearly produce more output at less resource cost ofinputs, then it has an absolute advantage. Free trade theory argues that each nation shouldproduce where they have an absolute advantage and trade with other nations who are alsoproducing where they have an absolute advantage. By doing this we are all producing more atleast cost and the global society benefits.Comparative advantage takes this concept one step further and says that even if a nation doesnot have an absolute advantage, they should produce where they are most efficient relative toother nations. For example, say Mexico and the U.S.A. only have two items to trade Manufactured Goods and Banking. Let’s say the U.S.A. can produce both items at a lower costper unit due to high knowledge content in Banking and highly automated Manufacturingprocesses. The theory of Comparative Advantage states that even though the U.S.A. istechnically more efficient in both (absolute advantage), it should focus its limited resources moretowards Banking if Mexico’s efficiency in Manufacturing is more comparable to the U.S.A. thanits efficiency in Banking. Hence, the two nations come out ahead if the U.S.A. produces all theBanking and both nations produce Manufacturing, thereby utilizing all the resources at hand.The historical data tends to support the notion that those nations that engage more in free tradetend to grow more economically as long as they are both exporting and importing. Despite this,free trade is very difficult to achieve primarily due to political realities and the difference betweenthe short-term and long-term. While it is very difficult to argue that in the long-term more freetrade is better for overall societies and the world (or any economic unit engaging in free trade)the political realities center on who specifically benefits in the short-term and the hardshipscreated when free trade is pursued. As John Maynard Keynes once said, “In the long-term,we’re all dead”. He was referring to the benefit derived from short-term policy intervention toimprove economic conditions.These shorter-term realities lead to extensive tariff and non-tariff forms of trade barriers. In fact,barriers to trade versus free trade is more like a pendulum which swings back and forth basedupon specific macro-economic and industry level micro-economic conditions. In general, theconsumption side of the equation generally benefits more from free-trade while the productionside (employment and returns on capital investment) tend to suffer more. Pizur, Anthony (2013) MBAC 600Exchange rates and balance of payments also come into play in regulating the flows of tradebetween nations. Most currencies of the world have little value. The currencies fail a major testfor good “money”, i.e. the currency does not store value very well. Money is only as good aswhat you can do with it. Hence, most currencies have to be pegged to other currencies toestablish their exchange rate and then the countries with those fixed currencies must not seetheir national balance of payments (between them and the rest of the world) be constantlynegative unless they have extensive reserves to fund the negative balance of payments. In thissense, the national balance of payments is like household or company checking and savingsaccounts. One can only run in the red as long as there are adequate reserves.Managing this process is less of a problem with floating exchange rates. When the relativevalue of a currency fluctuates based upon market supply and demand factors, then running apersistent negative balance of payments will generally cause the value of the currency todecline relative to other currencies. This will in turn make importing more expensive andexporting easier which will might turn the balance of payments situation around. Other factorssuch as capital flows (investments) and the flow of services and wages earned in one nationversus another can also impact the balance of payments.Sometimes barriers to trade are established to promote economic development objectives.Governments will limit imports in certain sectors so the industry can have more sales while theydevelop the logistics, R&D, and other business processes necessary to compete effectively.This happens in both old industries like steel in the U.S. and emerging industries like autos fromS. Korea. Governments will also use trade barriers to support geo-political agendas. They willimpose sanctions in an attempt to exert political pressure and will allow tariff free imports fromnations they support.The World Trade Organization (WTO) is a relatively new organization which supplanted theGeneral Agreement on Tariffs & Trade (GATT). The WTO exists to enforce trade agreementsand to support the expansion of free trade worldwide. Because of the sensitive role of thisorganization, the WTO often is a political hotbed that becomes a forum for the developed anddeveloping world to debate a wide range of issues such as the distribution of wealth betweenrich and poor nations. Environmental groups also frequent these forums to highlight dangers tothe environment which result from an emphasis on globalism.Two global financial institutions include the World Bank and the International Monetary Fund(IMF). The former funds longer term economic development projects in developing economies.It was an outgrowth of the redevelopment efforts of post World War II. The IMF tends to focusmore on monetary flows, exchange rates, and balance of payment issues. In this sense theWorld Bank is a long-term lender while the IMF is a short-term lender. Both advise on financialissues and advocate for prudence in monetary and national banking issues worldwide.The above represent the primary aspects of international economics. They also play criticalroles in the international trend towards globalism. While globalism encompasses these aspects,it is not the outgrowth of any one aspect. In fact globalism refers to the greater economicintegration and interdependence of national and regional economies on a worldwide basis. Thistrend is primarily related to technological advancements in transportation and communication,the growing sophistication of international capital and money markets, the emergence of multinational business and non-governmental organizations around the world, and geo-politicalposturing of national governments and coalitions of governments. While the movement towards Pizur, Anthony (2013) MBAC 600globalism appears inevitable on the surface, it requires non-binding cooperation to continue itsdevelopment unless an international enforcer or world government with the power ofenforcement emerges. Equal to the forces of globalism are forces encouraging regionalism, orthe promotion of freer trade and factor mobility within geographic regions such as Europe, theAmericas, or the Pacific Rim. Trade patterns are much more regional (as opposed to global) asa general rule and there is an inherent sensibility to cooperating more regionally than globallyfrom an economic perspective. Pizur, Anthony (2013)