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Let s suppose that Illinois economy is block from the rest of the world. And people that are working in Illinois are corn farmers or oil producers. Also, let s suppose there are two hundred labor hours. And lastly, there is only labor and it takes one hour to produce a barrel of oil or a bushel of corn. If people in Illinois will take all two hundred hours to produce oil, they will have only two hundred barrels of oil and zero bushels of corn. And if they will switch their goods production, they will have two hundred bushels of corn and zero barrels of oil. There is one more possibility; if producers will divide their time into the half then everyone wins, corn farmers will have one hundred bushels of corn and oil producers will have one hundred barrels of oil. Now, what if they want to trade Illinois workers can trade on this condition: one bushel for one barrel. Now, let s look on Oklahoma and let s suppose they are under the same conditions as Illinois have, that is, they have two hundred hours and they are sealed off from the rest of the world. Also, they are producers of oil and corn. And let s suppose there is one difference between Illinois and Oklahoma: the prices are different. It will take four hours to produce barrel of oil, and only twenty minutes to produce bushel of corn. Now, if oil producers will devote all two hundred hours to produce oil, they will get only fifth barrels of oil and zero bushels of corn. And if corn farmers will produce only corn for two hundred hours, they will get six hundred bushels of corn and zero barrels of oil. On other hand, if they will divide their time as Illinois workers did, their results will look like that, in one hundred hours there would be twenty five barrels of oil and three hundred bushels of corn. In that point they would trade one barrel of oil for twelve bushels of corn. Then, let s imagine that Illinois is trading with Oklahoma, and there is oil producer which want to trade for corn. He can stay at Illinois and trade one barrel of oil for one bushel of corn, or he can trade with Oklahoma. At that point he will have twelve bushels of corn, which have been traded for one barrel of oil. The same deal is with Oklahoma corn farmers. Instead of getting 1/12 of barrel of oil in Oklahoma, he can get one barrel of oil for his bushel of corn in Illinois. In other words, there would be free trade between states. And if something like that would happen Illinois would be in big trouble because Oklahoma would be able to make twelve bushels of corn, and in Illinois they are able to make one bushel of corn during one hour. And what about Oklahoma oil producers? If we would look from this perspective than Oklahoma oil producers would not have a chance to compete with Illinois oil producers, because by the time they would have one barrel of oil the Illinois would have four. Under geographic specialization aspect, everybody benefits, that is oil is produce in Illinois and corn is produce in Oklahoma. After two hundred hours of labor, Illinois workers produce two hundred barrels of oil, and Oklahoma workers produce six hundred bushels of corn. Let s imagine the price is three bushels for one barrel. In Oklahoma people produce six hundred bushels of corn, from which they consume three hundred, and the rest is sold to Illinois for one hundred barrels of oil. That way everybody wins. What would happen if Oklahoma farmers would start to produce corn in Illinois Than people from Illinois wouldn’ t be glad, because they wouldn t have
any chance with other competition. Because of that, they can always put all their energy into production of oil. That s why we have protective tariffs. If free trade is allowed between states, then it is not a problem to allow free trade between countries. For example, in Mexico it takes only ten minutes to produce a bushel of corn. That is half the time of work that workers in Oklahoma have to perform. Also, let s suppose it take one hour to produce one barrel of oil. Now, United States can trade with Mexico. Both countries will have more corn and oil. Before free trade Mexico divided their four hundred hours into the half and United States did the same. That way, oil producers had two hundred hours and corn farmers had two hundred hours, also. And, during free trade, United States producers can get three bushels of corn for their barrel of oil. And, if they are trading with Mexico, they can get six barrels of oil for one bushel of corn. This way, Mexican will be more advance. So, why do that The answer is easy; if the Mexican will exchange with United States, then their quantity of oil is doubled. What happen if both countries decide to specialize in their productions Then both countries will gain.
All countries or states, even cities have absolute advantage, which means that some countries have advantage in producing goods using less labor than others. Looking at the example, Illinois has an absolute advantage in producing oil, and Oklahoma has an absolute advantage in growing corn. Sometimes absolute advantage is not used when countries are trading, and the perfect example for that is United States and Mexico. Then what they can do is to use comparative advantage, which means that country can produce a good at lower cost than the country with which is trading. Then, Mexico uses only ten minutes to produce bushel of corn, where United States needs twenty minutes to produce the same thing, but both countries produce barrel of oil at the same time. So, why to trade Because Mexican are giving twelve bushels of corn for one barrel of oil, and American are giving three bushels of corn for barrel of oil. In that case, United States has a comparative advantage. Let s suppose that the price is four bushels for barrel. Mexico, which is specializing in producing corn is keeping 1600 and trades with remanding eight hundred bushels with United States for oil. So they end up with two hundred barrels of oil. But then, the price was hired; it went up from four to five. So the United States will export half of what have they made to Mexico for one thousand bushels of corn. In that case, United States will gain more from Mexico. And if the price would increase from five to six and United States would gain even more, and then Mexico would lose.
During the era of European colonialism in the 17th through 19th centuries, lopsided gains were commonplace. Trade between colonies and the Europeans exclusive rights to markets and at prices designed to shift most of the gains to them. Many less developed countries (LDCs) like Africa, Asia, and Latin America are behind in agriculture, if looked from imports or exports side. Something like that is happening because market is competitive. On the contrary, LDCs are rising because of manufacturing. Imagine that Japanese motorcycles are traded for Bolivian tin. And now, let s suppose that demand and supply, of motorcycles, are increase, so the
price went up from 7000 to 8500. In that point, the price of tin is decrease; it went off from 7000 to 6000. So, it takes 1.9 tons of tin to buy the motorcycle. Equation that can be used to resolve the specific amount is: index of export prices / index of import prices x 100, it is also known as terms of trade. There are a lot of countries that are getting worst and worst from year to year. For example, in the Central African Republic a unit in 2000 buys less than 40 percent of the imports it was able to buy in 1980. In Pakistan, unit of its exports in 2000 buys a little less than 90 percent of what was sold in 1980. In Nigeria its 55 percent, in Uganda its 25%, Zambia its 49%, Columbia its 88%, Egypt its 47%, Algeria its 59%, Jamaica its 73%, and lastly Burundi its 43%. Also some countries have high volatility. For example, Uganda s terms of trade bounced from 74.1 in 1990 to 61.5 in 1992 to 66.9 in 1994 to 80.1 in 1996 to 78.2 in 1998. United States are involved in exchanging a lot of goods. We can find shoes from Italy, shirts from China, tin from Bolivia, coffee from Brazil, cheese from Switzerland, sweaters from Scotland, television sets from Japan, and Food processors from France on our market. They are also exchange in other countries, also, but United States is the main country for trades. More and more countries are joining into market network. In 2003, more than 15% of the world’s GDP made its way onto the international market in the form of exports. That compares to less than 3% of the world’s GDP in 1970. Because all the time new technologies are coming out, we should expect that export and import in 21st century would be even higher. Observations had shown that big countries are trading with one each other and little ones want to trade, also. About two thirds of world exports in 2001 were exported to the industrially developed countries, and only one third were exported to less developed countries. Individually developed countries take 71.8 percent of export, and they absorbed 57.0 percent of LDC exports. United States is on the top if it is looked under import and export aspect. Their trade value is 1,909.9 billion. Right under them is Germany, and their trade value is 1,056.8 billion. And other countries like: Japan, France, Britain, Canada, Italy, The Netherlands, Belgium, and Korea. Not all people know that Japan is third country that trades with United States. First country that United States trades with is Canada, and then right under them is Mexico. Trade between United States and Canada is the largest one from the world. Goods that are exported from United States to Canada are over 163.7 billion, and goods that are imported are over 220.1 billion. United States exports to Canada and Mexico were bigger than the combined United States exports to all other countries. Canadians, under this aspect, are very important to United States, but we are even more important for them. The United States bought about 88.1 percent of Canadian exports in 2001. And let s not forget about Mexico; United States bought exports from them around 88.5 percent. Also United States imported to Canada about 63.6 percent in 2001, and to Mexico about 67.6 percent. People that are against free trade know what benefits do we have. United States oil producers are losing because we are trading with Mexico. And that s why people don t pay a lot for the oil. What happens if, for example, one country is producing goods at the lower price Should we stop producing our own goods and relay completely on other country The
answer is no. Let s suppose that France s Mirage is at lower price and more effective than United States F-16. At that point, we could relay completely on them, and both countries would gain; but country has to think about national survival. Most of the major industrial economies of the world produce their own security systems, even though most understand that they forfeit the gains that would result from international specialization. There are some products, which should be produce at our own country, like weapons, munitions, missiles, tanks, submarines, aircraft carriers, cannons, and radar equipment. That s why in 1815; the British Parliament put tariffs on grain, which came from ordaining a lot of laws. And now Europeans are not to happy trading with them with the food supplies, even though Britain wanted to be protected from the cheaper grains. Now, all the countries are taking example from them because of the national security. Some industries don t have as much of an experience as other industries, which were longer time trading. That’s why young industries need more time. Countries like that need protection from foreign countries, because without that, they won’t be able to start. There is no point to trade, in the short run, because country wants to gain from greater efficiency at smaller price. And because of that it’s better to be in long run. Log run protection for the beginning country can take a lot of years. There is no specific number, every country develops differently. Many, having run the learning curve many times over, are still as inefficient as they were the day protection was granted. Others remain protected under new guises. For example, United States industry of steel is still protected as an infant. There is a battle between countries regarding indiscriminate free trade, that is, some countries employ cheaper labor. United States textile industry hires people, which have high pay, so, now, how U.S. can compete with countries like Mexico, Jamaica, China, Brazil, The Philippines, and Malaysia, where their wages are extremely low comparing to United States wages. Some people argue that United States can’t compete with them, and that s why wages are declining. Those countries ignore United States higher level of productivity, and the reality is that employees are paid at the same wage as other. Another example is raincoats, which are produced at China at the lower price than in New York. If United States would take advantage of that then consumers would be able to live better life. But, what about producers A lot of them would lose, people would lose jobs, stockholders would lose their investments, etc. And in some cases, they won’t be able to get up . Some economies are doing extremely well in one or two production so most of the time they are exporting. For example, Honduras and their bananas, if their prices are high then the demands are also high, but if the prices fall then whole economy suffers. For some economies, if the prices are unstable than, also, they are unpredictable. That’s why it is a good reason to diversify industrial production, and for that is protection. Many less developed countries want that kind of protection. United States and Western Europe are already sufficiently diversified. Some countries doesn t need protection against absolute or comparative advantage, they need protection against dumping. Foreign competitors would lower their prices of goods below the cost and what that makes is that others are not
able to keep up with them, so they are eliminated. And when that happens, then the prices are raised even higher than they were before. United States Congress thought about that and made dumping illegal. There is another problem with the comparison of goods exported from foreign countries. To do that, there have to be comparison between exported prices with the prices they are charging in their market. Other countries have free access to United States market, but U.S. don t have the same privilege, and that is, because of the conditions that we established with foreign countries. The most annoying thing for United States is the partnership with Japan. They are protection their market before United States, even though we have been trading for the long time. And what the are saying is, that if they are not allowing United States free access, then we should do the same. And since we are a major market for their exports, the retaliation may encourage them to rethink their protection strategies. If that would happen then export and import would increase, and both countries would benefit from that. United States can restrict import by tariffs and quotas. A tariff is a government-imposed tax on imports. It can be used as percentage of the import s value or as a specific tax per unit of import. Like other taxes, it belongs to the government. Even through importers are paying tariffs, some part of it goes to costumers. Tariff is invisible for the costumers. For example, bikes that are made at the United States are a lot more expensive than in Germany. Let s suppose that their price for the bike is 200.00 and United States price is 450 on the U.S. market. And if Congress would not put the tariffs on bikes, then manufacturers at United States would be at trouble. But let s suppose that Congress put one hundred percent tariff on their bikes because of the protectionist argument. And let s suppose that German producers are willing to pay that price. For a minute let’s think what would happen if the market would be insulated from the rest of the world Then United States producers would be busy producing, let’s say, three million bikes and selling them at a price of 450. And what will happen if German producers are willing to sell the bikes at U.S. market at a price of 200 At that price, United States consumers rate increase from three to five million bikes. And United States firms would lose some amount of money. And if the tariff will be on German Bikes, than the demand will drop. There are times where government prefers to give quota instead of tariff. What is the difference between them tariffs are import taxes added to prices, and quotas limit the amount of a good that is allowed into the country at any time. Even if it may seem that end results would be the same, the truth is that they are different. For example, United States government is not placing one hundred percent tariff on German bikes, but instead is limiting the number of imports to 500,000 units. And the price for German bike is 200.00. At that point the demand for German bikes would go up on United States market, but after a while they would increase their price up to 420. It’s not a big difference at prices between United States and German bikes. Now, a lot of people won’t buy theirs bikes. The protection options with the quota are almost countless. Each specific quota yields a unique U.S. production and market price. As with the tariff, there’s no magic number that defines every quota.
It could be any number, depending on the objectives of the government and U.S. producers. At United States, tariffs and quotas are not the only barriers that can be used to reduce imports. The government can, also, pass the law that specifies highly restrictive health and safety standards that imports must meet. Let s suppose that government insist on inspection of all German bikes, and that may cost, let’s say, 75. And after that inspection bikes should guarantee safety. Some foreign countries are doing that voluntary. When they are importing goods they don t want the higher tariffs or lower quotas. Whatever tariff is establish between two countries, then the same tariff should apply to other countries, also. For example, if United States and France agreed to reduce tariff, let’s say, from forty to twenty five percent, on wine imports, than another country, Portugal should have the same tariff for imports of wine. If that would not happen, then it would be a discrimination. Something like that calls reciprocity. It becomes affective after World War 2. The General Agreement on Tariffs and Trade (GATT) served as a framework for this multilateral trade objective and nations came together under its auspices to negotiate trade policies. After World War 2 it was organized, which was including twenty-two nations, and right now it is including one hundred nations, and also it is representing eighty percent of them. GATT argument was to reduce tariffs on the world. United States was interested at lower world trade. GATT record three success rounds of negotiations: The Kennedy Round (1962-1967), which reduced tariffs by forty percent; the Tokyo Round (1973-1979), which cut tariffs by an additional thirty percent; and the Uruguay Round (1986-1993), which cut them again by forty percent. There were some countries that were unhappy with that reduction, and those countries were less developed nations. They needed tariff to start industrialization. At that point, nations agreed that less developed countries can have tariffs. GATT let to World Trade Organization (WTO), in 1995. and it starts to exist because of Uruguay Round. The most important differences between GATT and WTO are dispute settlement procedures. First WTO let GATT to rule with them but the affect were disappointing, and then they become aggressive in the face of GATT. Its record at being effective is incredible, settling more trade related disputes in its first year than GATT did in fifty. In 1958, the six Western European countries like, France, Germany, Italy, Holland, Belgium, and Luxembourg established a custom union, in other words,the European Economic Community (EEC), which arranged between themselves free trade within the union and a tariff against whole world. Then, in 1970s, Denmark, England, and Ireland joined them. In the 1980s, Greece, Spain, and Portugal did the same. In the 1992 Treaty of Maastricht changed the name from the EEC to the European Union (E.U.), which included not only economic aspects but also political. In the 1990s, Iceland, Finland, Sweden, and Austria joined the E.U. In the 2004, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Cyprus, and Malta followed other. And lastly, Bulgaria and Romania are expected to join this year. Now that E. U. is present, the WTO is thinking, should they lower their tariffs. And if United States will do that to one country from E.U., then it has to do the same to other countries, also.
The customs union has the free trade area. And what does that mean is, that the free trade area is, only, permitted among them, but each country is allowed to establish their own rights regarding tariffs for countries that are nonmembers. To this day, the most important trade agreement that United States has is with Canada and Mexico. In 1989, the United States Congress and Canadian House of Commons concluded the North Free Trade Agreement (NAFTA). And in 1993, Mexico joined them. It is the biggest free trade in the world, even E.U. can’t compete with them, if you will look under production of goods and services. NAFTA established, around ten years ago, that there will be no tariffs, quotas, and other trade barriers. Even though seventy five percent of trades between United States and Canada were without tariffs, it is very significant for both countries. Right now United States and Canada are gaining more, than before where they had to face the tariffs. Arguments regarding NAFTA took place at United States, but it was major political problem at Canada. Canadian were scared that is might influence production in United States, and they would be even more powerful. When Mexico entered in to the NAFTA United States and Canada thought that it will help them. All the decisions were made by United States or Canada. The problem that was discuss, it was low wage in Mexico. Without tariffs, United States and Canada now are worried that low wage labor in Mexico will be attractive to theirs countries. Because of NAFTA, Mexico can develop, it will provide markets for Canada and United States, and also employment. NAFTA can help Mexican people from illegal immigration. And the jobs, that are low paid, will lose only United States and Canada. NAFTA should be able to reemploy those people who lost jobs at better pay. Whatever our view is on tariffs, it is know that they dropped dramatically during last fifty years. In early years, our international trade policy was protectionist. During the period 1870 to 1900, the average tariff rate on imports was over twenty five percent. The skyrocketing of rates during 1920s and early 1930s appears as an exception, the direct result of the highly protectionist Fordney - McCumber Tariff Act of 1922 and the Smoot- Hawley Tariff Act of 1930. the Reciprocal Trade Agreement Act of 1934 reversed the upward movement in rates, and by 1950, rates were back to pre-1920 levels. Since 1970, the rates have fallen below ten percent and continue to decline. The average United States tariff, 1990-1993, was 5.9 percent, which compares to Canada s 10.5 percent, Australia s 9.8 percent, Japan s 6.3 percent, and E.U. s 6.7 percent. The discussion that is presented at the United States, now, is regarding NAFTA and the job losses. Congress voted for NAFTA because they thought about people and the employment, which was the primary reason. They thought that NAFTA would help economy to grow.