S ECTORES Y ACTIVIDADES ECONÓMICAS CON MEJORES PERSPECTIVAS DE EMPLEO

1 Gains from trade

International trade occurs when firms in different countries specialise and trade with one another. Two theories help to explain why this trade occurs:

• Theory of absolute advantage. • Theory of comparative advantage.

1.1 Theory of absolute advantage. The theory of absolute advantage states that if two countries are each more efficient in a product than another, then each country should specialise in producing the product they are better at and they should trade. Why do countries have absolute advantages in products?

All countries are limited to the amount and type of products they can produce. This is because, e.g.:

• Some countries have supplies of certain natural resources, while others don’t, e.g. UK has oil, Japan doesn’t.

• Some countries have climatic advantages, e.g. Spain can grow oranges, the UK can’t.

• Some countries have workers with skills and know-how.

To overcome these problems, countries specialise and trade with each other, exchanging those goods in which they have an

absolute advantage.

1.2 Theory of comparative advantage. The theory of comparative advantage states that:

‘Even when a country has an absolute advantage in all products, it will benefit it to specialise in those products in which its

‘Even when a country has an absolute disadvantage in all products it should specialise in the product in which its disadvantage is least.’

For example, if UK producers are ten times better than Malaysian producers at producing computers and two times better at producing TVs it would be to the advantage of both countries for UK producers to specialise in computers and for Malaysian

producers to specialise in TVs. Note that the UK has an absolute advantage in both computers and TVs but a comparative advantage in computers. Comparative advantage means the advantage which a country has in one product compared with its advantage in another. In this example the UK’s advantage in computers is greater than its advantage in TV’s. Malaysia has an absolute

disadvantage in both products but a comparative advantage in TVs, i.e. its disadvantage in TVs is not so bad as its disadvantage in computers.

You will find in textbooks that comparative advantage is sometimes measured in opportunity costs.

Example

Output per week:

Computers TVs

UK producer 100 200

Malaysian producer 10 100

• The opportunity cost per computer is lower in the UK (2 TVs compared to 10 in Malaysia).

• The opportunity cost per TV is lower in Malaysia (0.1 computer compared to 0.5 in the UK).

The theory states that production should take place in the country where opportunity cost is lower and that the two countries should trade.

1.3 These two theories explain why countries specialise and trade. The gains from international free trade include:

• efficient use of world resources – goods will be produced where it is most efficient to produce them

• the gains from specialisation and economies of scale, i.e. more efficient use of resources, reduced unit costs, greater output and better quality

• increased competition for producers leading to increased efficiency

• increased choice of goods for consumers. • lower prices for consumers

• closer political links between countries, e.g. this is how the EU began.

2 Trade restrictions

2.1 Despite the advantages of specialisation and trade, countries may find reasons to impose restrictions on the free movement of goods and services. Those who support trade restriction see it as a way of: • protecting employment in industries affected by foreign

competition

• protecting employment in new or ‘infant’ industries, which have not yet grown to a size big enough to allow them to compete • maintaining industries which are considered strategic, e.g. food

supplies, defence supplies, energy supplies

• reducing imports in order to improve a weak balance-of- payments position

• retaliating against those countries which protect their industries and markets

• preventing dumping; dumping is the selling of goods, by foreign producers, at prices below the cost of production; this may be done to gain a foothold in new markets or to get rid of

surpluses

• helping the environment, e.g. banning the import of hardwoods from tropical rain forests; products from rare animals, e.g. rhino horn, furs.

• protecting consumers from harmful products, e.g. illegal drugs, dangerous animals

• exerting political pressure, e.g. the UN embargo on Iraq. 2.2 Methods of protection

• Tariffs – taxes on imported goods or services which raise their price and reduce their competitiveness.

• Quota restrictions on the quantity of an import allowed in. A variation of the quota is voluntary export restraint, i.e. agreement between two countries to limit exports, e.g. until recently Japan had agreed to limit exports of cars and videos to

• Embargoes – complete ban on certain goods or imports from

certain sources or exports to certain destinations.

• Subsidies to domestic producers which allow them to compete more strongly in their home and in foreign markets.

• Soft loans – governments may give loans at low rates of interest

to foreign buyers or guarantee credit offered by exporters in order to boost exports.

• Favouring home producers with government contracts even when there are cheaper foreign suppliers.

• Imposing strict health and safety standards on imported goods. To meet these standards might involve extra cost for the producer, which increases the price.

3 Effects of restrictions

Trade restrictions may help an economy in the short run but in the long run they lead to problems:

• Restricting imports often results in retaliatory action being taken against a country’s exports.

• Protection reduces competition, which allows inefficiency among domestic producers leading to rising costs and rising prices for consumers.

• Consumer choice is reduced.

• The volume of trade is reduced, which leads to unemployment in industries dependent on exporting their output.

• Political ill-will arises between countries.

4 Removing trade barriers

4.1 The EU. There are a number of free-trade areas in the world where

barriers to trade are being removed. The most relevant example for us is the European Union (EU) which is now described as a single market. This means that restrictions on the free movement of goods and services between member countries have been removed. The EU has, however, maintained trade restrictions on goods coming from countries outside the EU. But the EU is a member of the World Trade Organisation (WTO) which is in the process of reducing restrictions on trade throughout the world economy. For more detail on the EU see Topic 2 of Unit 3, The

4.2 World Trade Organisation (WTO). The WTO consists of about 120 countries. The WTO was formed in 1995 and replaced GATT

(General Agreement on Tariffs and Trade), but with much stronger powers of enforcement. It exists to negotiate reductions and removal of trade barriers between member countries. A country can complain to the WTO about unfair restrictions taken against it by another country, and if the complaint is justified the WTO can order the offender to change their policy or offer compensation.