The advantages and disadvantages of international trade

Author: Simona Zlatkova

The purpose of this article is to analyze the publication " Indirect Damages " ( note), published in the magazine " The Economist" in July last year, and by comparing it with the information provided by the US Chamber of Commerce a few months later, to build an argumentative structure that allows everyone to give their own answer to the decades-long discussion "for" or "against" international trade.

Theory of comparative advantage

Before we begin the analysis of the article "Indirect Damages", let us first present a brief explanation of the theory of comparative advantage for those who have no knowledge of economics or who have forgotten over the years the first lectures of courses such as "Principles of Microeconomics" or "Introduction to Economics".

Let us assume that there are only two goods—computers and televisions—and one productive resource consisting of land, labor, and capital. Imagine that producing 200 computers requires 4 units of productive resource in the United States and 8 units in Bulgaria, and producing 2,000 televisions requires 6 units of productive resource in the United States and 8 units in Bulgaria. Thus:

According to the information provided, Americans have an absolute advantage in producing both computers and televisions. Thus, it is very easy to make the erroneous conclusion that Americans cannot gain from potential trade with Bulgaria and therefore should produce both computers and televisions. This conclusion, however, fails to note that it costs more to produce televisions in the United States than in Bulgaria, because the cost of producing televisions effectively represents the foregone production of more computers.

Imagine that the United States decides to specialize in the production of televisions. Using 6 units of production resources to produce 2,000 televisions in the United States would sacrifice the production of 300 computers, whereas if Bulgaria decides to specialize in the production of televisions, only 200 computers would be sacrificed. For this reason, the Bulgarians have a comparative advantage in the production of televisions, while the Americans have an absolute advantage. Thus, if the two countries decide to trade with each other, they should take advantage of their comparative advantage and specialize in the industry associated with lower costs.

Indirect damages – fact or myth?

The article “Indirect Damages” aims to present the direct and indirect damage of international trade on local production, when the benefits of the so-called “comparative advantage” are improperly absorbed by countries such as China or Vietnam. The author places at the center of his analysis the discussion about the advantages and disadvantages arising from economic collaboration between countries through trade. It is this discussion that is at the heart of the schism dividing economists and politicians into two opposing camps these days. While supporters of the idea of free trade believe that it leads to an overall growth in world production, members of the opposition camp encourage the construction of barriers to trade, believing that this will stimulate the development of the local economy. This idea is also supported by the author of the publication in the magazine “The Economist”, according to whom international trade increases unemployment in local production.

His thesis, however, is refuted by a study by the US Chamber of Commerce, according to which it is not the growth in international trade that is at the root of the increase in unemployment among the workforce employed in manufacturing, but the increasingly intensive introduction of modern technologies and automation in production processes. In addition, according to information provided by the US Department of Commerce, "exports of manufactured goods directly support approximately 6 million jobs in the country - about half of all manufacturing employment". This argument directly attacks the claim that international trade, or more precisely the import of cheap goods from countries rich in cheap labor, is detrimental to the manufacturing sector.

The data does not support the thesis that free trade causes harm

The author of “Indirect Damages” does not deny that trade leads to lower prices for imported goods, but he criticizes that the losses for industries deprived of a comparative advantage are too visible but ignored. As a result, workers employed in these sectors receive lower wages and spend a long time outside the labor market. Furthermore, the article in the magazine “The Economist” argues that government programs that are supposed to compensate for the unequal distribution of the gains from trade by providing additional training for retraining or additional social benefits for the unemployed are not sufficiently subsidized or, in many cases, the funds sink into the gray sector after a bunch of unclear transactions.

A few months after this article was published, the U.S. Chamber of Commerce released data designed to highlight the benefits of trade for manufacturing industries. Data provided by the Federal Reserve Bank of St. Louis shows that over the past 25 years, real U.S. manufacturing capacity has increased by approximately 80 percent. In addition, U.S. value-added production has grown eightfold in real terms since 1947. Applying the theory of comparative advantage to service sectors such as banking and telecommunications has resulted in revenues of $716 billion in 2015 and a services trade surplus of $227 billion, according to data provided by the U.S. Department of Commerce.

While both sides of the debate agree that international trade not only leads to a wider range of choices for consumers but also to an increase in per capita purchasing power due to lower prices for imported goods, the article “Indirect Damages” focuses particularly on the uneven distribution of the positives of trade and the failure of “active” policies to alleviate the negative effects on the labor market. The information provided by the US Chamber of Commerce fails to present the fact that the manufacturing industry may benefit from international trade as a whole, but at the same time global competition may lead to losses for some of its members, or rather, members deprived of a comparative advantage.

Problem Analysis

Let us now analyze the problem of indirect damage caused by international trade in the following way. According to many, economic collaboration between countries through trade creates a so-called win-win situation in which there are no losers. However, it should be noted that this win-win situation applies only to countries and their economies as a whole, not to individual industries. A manufacturing industry benefits from international trade only when it becomes an exporter, which means that it has a specific advantage over the same industry in the partner country.

To make the example clearer, let's imagine that Abakariya is a real country, whose economic potential is comparable to that of countries such as the United States and Germany. The workforce in Abakariya is divided into two groups: workers providing manual labor, and specialists whose skills add additional value to production. The economy of our fictional country has only two manufacturing sectors, producing textiles and computers, respectively. Furthermore, it is relatively easy for workers in Abakariya to switch from one manufacturing sector to the other. It should be mentioned that the production of textiles requires more labor than the production of computers.

Now let us assume that the government of Abakariya decides to remove the tariff imposed on textile imports, as a result of which the price of imported textiles has fallen dramatically. In order to compete with foreign producers, firms in Abakariya must reduce the price of their output. Due to the reduced income, fewer producers in Abakariya are willing to supply the market with textiles. As a result, textile imports increase to fill the gap created by the decline in domestic production.

However, the question arises here, what happens to the manufacturers who abandon the production of textiles. Looking for more profitable investment opportunities, they redirect their funds to the computer industry, which leads to an increase in the export of computers. In turn, the growth of the computer industry leads to an increase in the number of workers employed in it, which means that part of the labor force that is no longer needed in the textile industry will be needed in computer production. But why do we talk about only “part” of the labor force?

Let us recall that earlier in our hypothetical scenario we mentioned that textile production initially requires more labor than computer production. For this reason, some of the labor force that is no longer needed in the textile industry will not be hired in the computer industry and will remain outside the labor market. It is the consequences of this scenario that are not considered in the information provided to us by the US Chamber of Commerce.

Participation in international trade is beneficial for countries because it reduces the price of many goods and services, which increases the purchasing power of the population, but unsuccessful policies aimed at mitigating the negative consequences of free trade and the structural unemployment created become a powerful weapon in the hands of political demagogues, who usually use it before elections to control the ill-informed masses, shaping public opinion against international trade.

Further analysis

Further research in this direction should focus on the fact that structural unemployment can arise not only as a result of international trade, but also due to changes in consumer tastes and preferences. In this case, if the country's economy is closed, those workers left outside the labor market are unlikely to be employed in another industry.

Sources used

Federation, American Farm Bureau. "Social." Fast Facts About Agriculture. N.p., n.d. Web. 09 Oct. 2016.

"Manufacturing Sector: Real Output." - FRED. N.p., n.d. Web. 09 Oct. 2016.

"The Benefits of International Trade." U.S. Chamber of Commerce. N.p., n.d. Web. 09 Oct. 2016.

Did you like it? Take a minute to support the EKIP on Patreon!