The Global Economy & International Trade

Globalization is a process of interaction and integration among the people, companies, and governments of different nations – a process driven by international trade and investment and aided by technology.

This process has effects on the environment, on culture, on political systems, on economic development and prosperity, and on human physical well-being in societies around the world.

Absolute advantage refers to the ability of a country to produce a good more efficiently than other countries.

It arises when fewer resources are needed to produce the same amount of goods.

In other words, a country that has an absolute advantage can produce a good with lower marginal cost (fewer materials, cheaper materials, in less time, with fewer workers, with cheaper labor etc.).

However, having an absolute advantage doesn’t necessarily mean that an economy should produce that good. This requires a country to have a comparative advantage.

Imagine that Economy A can produce 5 widgets per hour with 3 workers and Economy B can produce 10 widgets per hour with 3 workers.

Assuming that the workers of both economies are paid equally, Economy B has an absolute advantage over Economy A in producing widgets per hour. This is because Economy B can produce twice as many widgets as Economy A with the same number of workers.

Let’s say England employs 10 units of labor to produce 1 unit of cloth and 12 units of labour to produce 1 unit of wine, while Portugal employs 14 units of labor to produce 1 unit of cloth and 8 units of labor to produce 1 unit of wine.

As you can see in the figure below, England has an absolute advantage in the production of cloth, while Portugal has an absolute advantage in the production of wine. Therefore, England will produce cloth and trade it with Portugal’s wine.

In this example, two countries, the UK and India produce textiles and books.

– For the UK to produce 1 unit of textiles, it has an opportunity cost of 4 books.
– For India to produce 1 unit of textiles, it has an opportunity cost of 1.5 books (3/2).

Therefore India has a comparative advantage in producing textiles because it has a lower opportunity cost.

– If the UK produces a book, the opportunity cost is 1/4 (0.25).
– If India produces a book, the opportunity cost is 2/3 (0.66).

Therefore, the UK has a comparative advantage in producing books (because it has a lower opportunity cost of 0.25 compared to India’s 0.66).

– Environmentalists are concerned that as countries specialize, production will concentrate in countries that have fewer regulations to protect the environment from pollution and habitat destruction.

– Labor unions oppose it on the grounds that production will shift toward low-wage countries that have little or no union representation.

– Human rights activists oppose free trade as production shifts toward countries where working conditions are often inhumane, and where workers are not afforded the same rights as in industrialized nations.

– Politicians sometimes oppose trade agreements as they argue that decisions are being made by an international body not directly subject to the people.

Sometimes, countries seek to tax, limit, or even ban international trade. Why do they do this?

Even though voluntary trade is mutually beneficial, the benefits are spread out over society, and the costs are sometimes borne directly by a specific group.

People might have a strong interest in preserving their industry, raising tax revenue, saving the environment, or even creating social change. At times, a country might limit trade in order to punish another country.

Tariffs, quotas, and embargoes are a few of the tools that a country uses in order to accomplish these other interests.

A tariff is a tax on trade. It can be used to raise revenue for the government or in order to benefit a certain segment of the economy. The government can also be pressured to enact a tariff if your country is subject to foreign competition.

For example, in 2007, India proposed a tariff on rice exports in order to prevent food shortages.

Quotas are limits on trade.

Instead of a tax on imports, you might use a quota to limit the number of imported goods coming into your country.

– They do not generate tax revenue for the government, but do create more responsibility.

– They provide an incentive to smuggle goods illegally in order to avoid the quota, thus creating black markets.

– Quotas may be manipulated by foreign firms to limit competition from other foreign firms. For example, if there is a quota on German cars imported into the US, then the German firm that first fills the quota has effectively blocked other German firms from competing in the American market.

An embargo is a ban on trade with another country. The purpose of an embargo is usually to punish a country for some offense.