POLS1005 Study Guide - Final Guide: Collective Action, International Political Economy, Comparative Advantage
Ch. 7
International Trade
Why do countries trade?
• In the modern world, international trade has been one of the two most important economic relationships
among countries → dramatic reductions in trade barriers and dramatic increases in international trade itself
are a major component of the globalization of the contemporary world economy
Comparative Advantage
• Comparative advantage - an ability of country to produce a specific good/service more efficiently than all
other goods/services (compared to efficiency of other economic activities of the country, not other countries)
• Absolute advantage – an ability of country to produce more of particular good/service than other countries
using same amount of resources and efforts
Therefore, the principle of free trade is that each country is better off at producing and exporting what it
does best and importing other goods that it is not as good at producing
The economic argument for free trade is counterintuitive:
• It is argued that exports are good because they create jobs, imports are bad because they take away jobs,
government should stimulate the national economy by restricting imports and encouraging exports
• The conflicting argument is that imports are the gains from trade while exports are its costs. A country
imports goods that it cannot make very well itself allowing the nation to focus its productive energies on
making the goods that it produces best
Why do countries trade what they do?
Heckscher-Ohlin Trade Theory:
• Heckscher-Ohlin trade theory: the theory that a country will export goods that make intensive use of the
factors or production in which it is well endowed. Thus, a labor rich country will export goods that make
intensive use labor
• Factors of production are:
- Land
- Labor (unskilled)
- Human capital (skilled labor)
- Capital (technology, equipment, finances)
• So if a country has a lot of farmland it will likely to have a comparative advantage in agriculture
• Developed countries are usually rich in capital and skilled labor, while developing countries have
abundance of land, raw resources and unskilled labor
• Noneconomic factors also affect both with and whom countries trade:
- Countries that are geographically close together trade more since transports costs are lower
- Diplomatic and military relations between nations also influence their trade patterns
• E.g. During the Cold War, the U.S. and its allies purposely limited their economic ties with
the Soviet Union, just as they encouraged ties among themselves
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Protectionism
• Protectionism – the imposition of barriers to restrict imports
Types of barriers:
1) Tariff – a tax imposed on imports raising the domestic price of imported good, may be applied to
protect domestic producers from competition
2) Nontariff barriers to trade – obstacles to imports other than tariffs such as quotas (limited placed on
amount of a particular good allowed to be imported), regulations that favour domestic products over
imported ones, and other measures that discriminate against foreign goods and services
- E.g. restrictions on the number of products that can be imported (quantitative restrictions, or
quotas), regulations that favor domestic over imported products
• Quantitative restriction (quota): limit placed on the amount of a particular good that is allowed to be
imported
Why do governments restrict trade? The Domestic Political Economy of Protection
• In order to understand domestic politics of trade, it is necessary to look at interests, institutions that
represent these interests, and how competing interests interact with each other
• Benefits of protectionism typically go to national producers
• While costs are shared by consumers (increase in prices) and the national economy in general (ability of
society to use its resources most effectively is compromised). So there is a redistributive effect – consumers
lose and producers gain from protectionism
Winners and Losers in International Trade
• Domestic industries protected by trade barriers receive clear and concentrated benefits:
- Protection creates returns above the normal rate of profit by artificially restricting competition and
supply
- However at least three groups of actors stand to lose from trade protection:
1. Consumers of the imported goods – i.e. consuming industries
2. Exporters – they worry that their country’s protective barriers might provoke retaliation in
foreign markets
3. Citizens – in general may be willing and able to punish politicians for the cost that protection
imposes on them, especially if the connection is clear and the issue is prominent
Interests: Who will support/oppose protectionism?
1. The first approach is derived from HO theorem and is called Stolper-Samuelson theorem that
protectionism benefits scarce factors of production, while free trade benefits factors that are in abundance.
The implication is that in developed countries rich in capital and skilled labor, capitalists and skilled
workers would favour free trade, while unskilled labor would favour protectionism
2. However, sometimes interests are aggregated not on the basis of factor of production but base don the
specific industry. The second approach is Ricardo-Viner model that is different from HO theorem and
where the sector/industry in which factors of production are employed is main consideration. A worker and
manager in industry that faces competition is likely to be protectionist, while employees of exporting
industry would support free trade.
Institutions: Organization and Representation of Interests
• Organizations of interests can be challenging because of collective action problem among both supporters
and opponents of free trade. Typically there are few producers and large number of consumers so producers
are more effective at lobbying their interests.
• Winners of free trade: exporting companies and consumers. Losers: companies that have to compete with
imports
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• In terms of institutions, democracies are in general more likely to liberalize trade than non-democracies.
Differences in partisan, electoral, and legislative institutions are likely to result in different trade policies.
In general, politicians with local constituencies are more responsive to local interests
How do countries get what they want? The International Political Economy of Trade
Strategic Interaction in International Trade Relations
• When governments make national trade policies, they take into account what other governments are likely
to do in response
- E.g. A government that raises tariffs dramatically, might find other countries retaliating with even
higher barriers to its exports – so that the benefits to domestic producers sheltered from imports
might be canceled out by costs to exporters frozen out of foreign markets
• In trade negotiations states face same old cooperation problem rising from prisoner’s dilemma: both states
are better off cooperating to reduce trade barriers but each is worried other side would cheat which results
in non-cooperation
• However, problem of cooperation can be overcome with:
a) Small numbers (small group of countries): makes it easier for governments to monitor each others’
behaviour, there is likely to be less free riding among small groups of countries than in the world at
large
- An extreme version of this observation is the theory of hegemonic stability, which argues that the
existence of a single very powerful nation facilitates the solution of problems of collective action
and free riding the hegemonic power is large and strong enough to be both willing and able to
solve these problems for the world as a whole
b) Information
- Many failures of cooperation are due to fears of hidden actions – such as the fear that one
government might use its superior knowledge of its own domestic conditions to take advantage of
other governments
c) Iteration (repeated interaction) – between governments on a continuing basis provides a reason to
avoid cheating, or even the appearance of cheating
- The possibility that the collapse of a current deal might sour future deals can impose a powerful
discipline on government behaviour and can encourage greater efforts to cooperate
d) Linkages (concessions in one arena linked to concessions in another) – e.g. a government would
otherwise be uninterested in negotiating lower barriers in steel if they are willing to exchange
concessions in steel if its partner gives it concessions in some other industry
International Institutions in International Trade
• Institutions set standard of behavior, verify compliance, provide information, reduce costs, ensure iteration
Institutional arrangements in trade negotiations:
• Reciprocity: in international trade relations, a mutual agreement to lower tariffs and other barriers to trade.
Reciprocity involves an implicit or explicit arrangement for one government to exchange trade-policy
concessions with another
• Most-favored nation (MFN) status: a status established by most modern trade agreements guaranteeing
that the signatories will extent to each other any favorable trading terms offered in agreements with third
parties
World Trade Organisation
• General Agreement on Tariffs and Trade (GATT): an international institution created in 1947 in which
member countries committed to reduce barriers to trade and to provide similar trading conditions to all
other members. In 1995, the GATT was replaced by the WTO
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