Transcript Slide 1

IDEAS & THEORIES
ON INTERNATIONAL TRADE
ANCIENT CHINESE TRADE
The light/heavy theory
Guan Zhong
and the book
Guan Zi
(725-645 BC)
Guan Zhong argued that when a good was abundant, it became
light, and its price would fall--- when the good was “locked away”,
it became heavy, and the good’s price would rise
There are movements of goods into and out of markets based on
their lightness and heaviness, with a tendency toward one price–
equilibrium --- hence a statement of the law of supply & demand
The movement “IN and OUT” of markets was trade
A TRANSELATED QUOTE
Guan Zhong
“INDEED, IT IS THE NATURE OF MEN THAT WHENEVER THEY SEE PROFIT, THEY
CANNOT HELP CHASING AFTER IT, AND WHENEVER THEY SEE HARM, THEY
CANNOT HELP RUNNING AWAY. WHEN THE MERCHANT ENGAGES IN TRADE AND
TRAVELS TWICE THE ORDINARY DISTANCE IN A DAY, USES THE NIGHT TO EXTEND
THE DAY, AND COVERS A THOUSAND LI WITHOUT CONSIDERING IT TOO FAR, IT IS
BECAUSE PROFIT LIES AHEAD. WHEN THE FISHERMAN PUTS OUT TO SEA, THE
SEA MAY BE TEN THOUSAND-REN DEEP, AND WHEN HE HEADS INTO ITS WAVES
AND STRUGGLES AGAINST ITS TIDES, RAISES HIS SMALL MAST AND SAILS OUT A
HUNDRED LI, NEVER LEAVING THE WATER FROM MORNING TO NIGHT, IT IS
BECAUSE PROFIT LIES IN THE WATER. THUS, WHEREVER PROFIT LIES, EVEN
THOUGH IT BE ATOP A THOUSAND-REN PEAK, THERE IS NO PLACE PEOPLE WILL
NOT CLIMB. EVEN THOUGH IT IS AT THE BOTTOM OF THE DEEPEST DEPTHS,
THERE IS NO PLACE PEOPLE WILL NOT ENTER.
INDEED, THOSE WHO ARE SKILLED IN GOVERNMENT
CONTROL THE PRESENCE OF WEALTH SO THAT THE
PEOPLE ARE NATURALLY CONTENT. WITHOUT PUSHING
THEM, THEY GO; WITHOUT PULLING THEM, THEY COME.
WITHOUT TROUBLE OR WORRY, THE PEOPLE ENRICH
THEMSELVES. IT IS LIKE A BIRD SITTING ON ITS EGGS;
THERE IS NEITHER SHAPE NOR SOUND, BUT THE YOUNG
SUDDENLY APPEAR QUITE COMPLETE”
GUAN ZHONG, GUAN ZI, VOL. II, TRANSELATED BY W.
ALLYN RICKETT (PRINCETON, N.J.: PRINCETON
UNIVERSITY PRESS, 1998), pp. 219-220.
MERCANTILISM
THE RISE OF THE MERCHANTS IN ECONOMIC AND SOCIAL LIFE
THE TENETS OF MERCANTILISM:
BULLIONISM – INCREASE GOLD (PRECIOUS METALS), HENCE
INCREASE WEALTH OF A NATION VIA INTERNATIONAL TRADE
KEEP EXPORTS > IMPORTS – BRING IN SPECIES
INTERNATIONAL TRADE IDEAS – RESTRICTIONS ON OUTWARD
MOVEMENT OF RAW GOODS
KEEP DOMESTIC PRICES LOW
KEEP PRICES LOW ON INBOUND RAW INPUTS AND GOODS
COLONIZATION- MONOPOLIZE COLONIAL TRADE
KEEP COLONIES DEPENDENT ON MOTHER LAND
RESTRICT COLONY MANUFACTURING
THIS IS THE IMPACT OF THE EARLY
NAVIGATION ACT BARRIERS IN THE EARLY AMERICAN
COLONIES – BRITISH SHIP MONOPOLY
MORE ON MERCANTILISM
STRONG CENTRAL GOVERNMENT – MONARCHY
LANDED CLASS (LORDS), MERCHANTS BECOME RENT SEEKERS
THE “ROYAL MANUFACTURERS” THE ONLY EXPORTERS
A GRANT TO SHIPPING MONOPOLY GRANTED BY THE KING
THE KING IS A LORD WHICH KEEPS THE ARMY AND NAVY
TAXES PAID BY THE OTHER LORDS TO KEEP THE MILITARY
AND THE KING IN COMFORTABLE POSITION
NEED A LARGE HARD WORKING POPULATION –
HENRY VIII DECREE ON NO IDLENESS NOR BEGGING
LOW PAY TO KEEP WORKERS ENGAGED IN PRODUCTION
(A SLUTSKY SUBSTITUTION EFFECT NOTION– THE INCOME
EFFECT DOMINATES THE SUBSTITUTION EFFECT
OF A WAGE CHANGE--- IF PAY INCREASES, THEN
WORKERS PURCHASE MORE LEISURE--- CAN’T HAVE
THAT BEHAVIOR – IT IS BACKWARD BENDING
SUPPY CURVE OF LABOR IDEA
WHO BENEFITED?
MERCHANT CAPITALISTS --- THEY BECOME PART OF SOCIETY--- THEY ARE
ACCEPTED NOW
THE MONARCHY – GOVERNMENT OFFICIALS
THE RENT SEEKERS --- PARTICULARLY IN FRENCH MERCANTILISM
THE FRENCH HAD STRONG FEUDAL FLAVOR TO MERCANTILISM
THERE IS A LASTING IMPACT
--RENT SEEKING BEHAVIOR AND ORGANIZATION OF GOVERNMENT SUPPLY
OF GOODS AND SERVICES
--INTERNATIONAL TRADE – ONE OF THE MAIN THEORIES OF
INTERNATIONAL TRADE DEVELOPS
AND THE DEBATE GOES ON
MERCANTILISM – CONNECTION TO MODERN POLICY
A STATEMENT BY ROBERT E. LUCAS, JR. (UNIVERSITY OF CHICAGO)
(NOBEL LAUREATE IN ECONOMICS)
ON THE OCCASION OF BEING INTERVIEWED BY REASON MAGAZINE
ABOUT THE IMPACTS OF THE NEW ADMINISTRATION COMING TO POWER
IN 1993 IN THE U.S.
THE QUESTION BY REASON – WHAT WILL BE THE ECONOMIC IMPACT OF
THE NEW CLINTON ADMINISTRATION?
LUCAS – “IN ECONOMIC POLICY, THE FRONTIER NEVER CHANGES.
THE ISSUE IS ALWAYS MERCANTILISM AND GOVERNMENT
INTERVENTION VS. LAISSEZ FAIRE AND FREE MARKETS.
AND THAT’S EXACTLY WHAT’S ON THE FRONTIER RIGHT NOW WITH
WITH THE NEW ADMINISTRATION. HOW MERCANTILIST ARE THEY
GOING TO BE?
WE DON’T KNOW”
-This could be said of any incoming administration
-This debate could apply to any government formation/operation
What do you think?
Adam Smith
--attack on Mercantilism-
In 1776, Adam Smith published the first modern
statement of economic theory, An Inquiry into the
Nature and Causes of the Wealth of Nations
• The Wealth of Nations attacked mercantilism—the system of
nationalistic economics that dominated economic thought in
the 1700s
• Smith proved wrong the belief that trade was a zero sum
game—that the gain of one nation from trade was the loss of
another
• Trade is a positive sum game—both nations gain
THE MERCANTILIST BELIEVED THAT WHAT YOU GOT IN
TRADE, SOME OTHER NATION DID NOT GET ---- ASSUMED
THE ZERO-SUM GAME --- ONE NATION HAS DIABOLICALLY
OPPOSED PREFERENCES FROM ANOTHER NATION
SPAIN
STRATEGY
FRANCE
A
B
C
I
1, -1
6, -6
0, 0
II
2, 2
0, 0
3, - 3
III
3, - 3
2, - 2
4. -4
PAYOFFS SUM TO ZERO IN A ZERO-SUM GAME FOR ANY SET OF PAYOFFS
THE SOLUTION IS A MIXED STRATEGY --- AN ATTEMPT TO
MASK THE STRATEGIES ON THE PART OF THE PARTICIPANTS
FRANCE CHOOSES I (1/6 PROBABILITY), II ( DOES NOT
CHOOSE) , III (5/6 PROBABILITY)
SPAIN CHOOSES A (2/3 PROBABILITY), B (1/3
PROBABILITY), C (DOES NOT CHOOSE)
A Bit of Game
Theory here
CONSTANT SUM GAME PAYOFFS SUM TO SOME CONSTANT k, BUT k COULD BE 0
What was Smith implying
here?

Access to foreign markets helps create wealth
• In the extreme, If no nation imports, every company
will be limited by the size of its home country
market
• Imports enable a country to obtain goods that it
cannot make itself or can make only at very high
costs --- consumers have a variety of choices of
goods --- consumer economic welfare increases
• Trade barriers decrease the size of the potential
market, hampering the prospects of specialization,
technological progress, mutually beneficial
exchange, and, ultimately, wealth creation
DAVID HUME – PHILOSOPHER – ECONOMIST
ONE-SIDED TRADE SOLUTION IS A DILEMMA
MORE GAME THEORY ----NASH EQUILIBRIUM --- DO THE BEST YOU CAN THOUGH IT MAY NOT BE
AN OPTIMUM POSITION– NO PLAYER HAS INCENTIVE TO MOVE FROM THE NASH EQUILIBRIUM
DOMINANT STRATEGY– ONE PLAYER PLAYS A STRATEGY IRRESPECTIVE OF THE STRATEGY CHOICE
OF THEIR COMPETITOR PLAYER
STRATEGIES
Free Trade
Restricted
trade
Free Trade
50, 50
20, 60
Restricted trade
60, 20
27, 27
PAYOFFS
DAVID HUME SUGGESTED RESTRICTED TRADE IS A ZERO-SUM
GAME OR LEADS TO A PRISONER’S DILEMMA IN MODERN NASH
GAME THEORY ANALYSIS
The Solution is a restricted trade strategy-restricted trade strategy
What is this game theory bit??
What is a Nash equilibrium?
A Nash equilibrium is an action exercised from which there is no
incentive to move --- in a game there are players (firms, consumers,
etc), say player A, B, C, etc, actions taken by the players, say a = (a1, .
. an) and payoffs given by π = f(a1, . . an), where, f( . . . ) means
“function of”
A Nash equilibrium exists in actions if:
π = f(a1, ., ai-1, ai*, . . an) >= π = f(a1, ., ai-1, ai, . . an) , that is, the
payoff to a player, πA = f(a1, ., ai-1, ai*, . . an) of all actions including
action ai* is greater than the payoff with out action ai* for player A as
π = f(a1, ., ai-1, ai, . . an)
This position may not be an optimum such as maximum profit or
maximum economic welfare, but there is no incentive to move from
this position --- if this occurs for all players, then a Nash equilibrium
exists
One can also find a similar “resting point” if a player chooses action set (a1, ., ai1, ai*, . . an) irrespective of what other players choose – This is the property of
arriving at a solution by dominance in action strategies --- the set
(a1, ., ai-1, ai*, . . an) is dominant over other play action
ABSOLUTE ADVANTAGE &
COMPARATIVE ADVANTAGE

A nation has Absolute productivity advantage if it
produces more of a certain good per hour worked
than another (other inputs could be used in the
example in addition to labor) -- Adam Smith

A nation has Comparative productivity advantage (or
comparative advantage) if it has lower opportunity
costs of producing a good than its trading partners
– David Ricardo

Comparative advantage allows a country that lacks
absolute advantage to sell its products abroad
Let Output = Q, Input = X,
PQ = price of Q, W = cost of input

Absolute advantage:
• Greatest Q/X of trading nations, or greatest
average product
• Or lowest X/Q ---- lowest input per unit
of output

Comparative advantage:
• Lowest opportunity cost of trading nations
• Or PQ =(X/Q)(W) is lowest, or lowest pretrade price of trading nations, PQ=(X/Q)(W)

Notice that comparative advantage also
incorporates absolute advantage
• PQ= (X/Q)(W), since input per unit of
output, (X/Q), is contained within the idea
of comparative advantage
Notice also that these ideas are mainly
based on production efficiency
 A nation may not have any absolute
advantage, but may have a sector that
has least disadvantage and can trade

The idea of absolute advantage
NATION
PRODUCT
SOYBEANS
A
B
LABOR
REQUIRED
12 UNITS
3 UNITS PER
PER UNIT
UNIT OF
OF OUTPUT
OUTPUT
TEXTILES 6 UNITS PER 4 UNITS PER
UNIT OF
OUTPUT
UNIT OF
OUTPUT
Which nation
has absolute
advantage in
soybeans?
Which nation
has absolute
advantage in
textiles?
Nation A has absolute advantage in soybean
production, while nation B has absolute advantage
in textile production (lowest labor employed per
unit of each output)
NATION A HAS ABSOLUTE ADVANTAGE IN SOYBEANS
NATION B HAS ABSOLUTE ADVANTAGE IN TEXTILES
SO THE NATIONS SHOULD SPECIALIZE IN THE PRODUCT
THAT HAS ABSOLUTE ADVANTAGE
HOW? MOVE 6 UNITS OF LABOR FROM TEXTILES IN
NATION A TO BE USED IN THE PRODUCTION OF
SOYBEANS --- SO THIS NATION LOSES 1 UNIT OF
TEXTILES (6 UNITS OF LABOR PER 1 UNIT OF TEXTILES),
BUT GAINS 2 UNITS OF SOYBEANS (3 UNITS OF LABOR
TO PRODUCE 1 UNIT OF SOYBEAN OUTPUT)
WHAT THEN IS THE GAIN IN NATION A? – 1 OF TEXTILES
AND + 2 OF SOYBEANS FOR AN OVERALL GAIN OF +1
WHAT ABOUT NATION B?
MOVE LABOR FROM SOYBEANS (12 UNITS OF LABOR PER
1 UNIT OF OUTPUT) INTO PRODUCING TEXTILES
NATION B, IN THIS CASE WOULD LOSE 1 UNIT OF
SOYBEANS, BUT GAIN 3 UNITS OF TEXTILES
PRODUCTION (4 UNITS OF LABOR PER 1 UNIT OF
OUTPUT)
SO NATION B LOSES 1 UNIT OF SOYBEANS BUT GAINS 3
UNITS OF TEXTILES--- THE NET GAIN IS + 2
THERE IS A COMPLETE SPECIALIZATION
DEMAND FOR TEXTILES IN A FALLS, BECAUSE NATION A
CAN GET THE TEXTILES CHEAPER FROM NATION B
PRODUCERS OF TEXTILES
WORKERS LEAVE TEXTILES AND GO TO THE SOYBEAN
SECTOR IN NATION A
THE OPPOSITE HAPPENS IN NATION B --- WORKERS
MOVE TO THE TEXTILE INDUSTRY---- TEXTILE DEMAND
HAS RISEN BECAUSE NATION A WANTS THE TEXTILES -- SOYBEAN PRODUCTION FALLS BECAUSE LABOR HAS
MOVED TO TEXTILES
NOTICE --- THIS WORKS IF THE LABOR IS MOBILE --- THE
PROBLEM THAT ARISES IS IN THE CASE WHERE LABOR
IS IMMODILE EITHER BECAUSE OF LACK OF SKILLS OR
THE IMPOSITION OF RESTRICTIONS ON LABOR
MOBILITY BETWEEN SECTOR AND NATIONS
WHAT IS GOING
ON HERE?
NATION
PRODUCT
SOYBEANS
SHOES
BRAZIL
MEXICO
LABOR
REQUIRED
12 UNITS
3 UNITS PER
PER UNIT
UNIT OF
OF OUTPUT
OUTPUT
6 UNITS PER 8 UNITS PER
UNIT OF
UNIT OF
OUTPUT
OUTPUT
IT APPEARS THAT
BRAZIL HAS
ABSOLUTE
ADVANTAGE IN
BOTH SOYBEANS
& SHOES
WHAT NOW?
This is where
comparative
advantage takes
hold
MEXICO DOES HAVE LEAST DISADVANTAGE IN PRODUCING
SHOES AND COULD TRADE IN SHOES SINCE BRAZIL WOULD
WANT TO CONCENTRATE ON THE BIG ADVANTAGE THEY HAVE
IN PRODUCING SOYBEANS --- BOTH CAN TRADE WITH EACH
OTHER AND OTHER NATIONS (THE LATTER ACTION
DEPENDING ON COMPARATIVE ADVANTAGE AS WELL)
SUPPOSE AN ANOTHER EXAMPLE:
THERE ARE TWO NATIONS, MARYDOM AND HEYBIA, AND TWO
PRODUCTS, DAIRY PRODUCTS AND COMPUTER CHIPS. THE AVERAGE
PRODUCTS OF LABOR FOR THE TWO PRODUCTS IN EACH NATION ARE
GIVEN IN THE TABLE BELOW
FANTASTIC
NIGHT LIFE IN
THIS HAVEN
NATION
MARYDOM
HEYBIA
3
2.4
4
2
PRODUCT
DAIRY
PRODUCTS
COMPUTER
CHIPS
IN WHICH PRODUCT DOES EACH NATION HAVE COMPARATIVE ADVANTAGE?
WHICH NATION ACCORDING TO COMPARATIVE ADVANTAGE SHOULD HAVE THE
HIGHER WAGE?? Look again --- we are now in average product terms here
NATION
MARYDOM
HEYBIA
3
2.4
4
2
PRODUCT
DAIRY PRODUCTS
COMPUTER CHIPS
MARYDOM APPEARS TO HAVE ABSOLUTE ADVANTAGE IN BOTH
INDUSTRIES --- BUT MARYDOM HAS COMPARATIVE ADVANTAGE IN
PRODUCING COMPUTER CHIPS --- HEYBIA HAS COMPARATIVE
ADVANTAGE IN PRODUCING DAIRY PRODUCTS
MARYDOM SHOULD HAVE THE HIGHER WAGE --- THE LOWER LIMIT
ON THE RELATIVE HIGHER WAGE WOULD BE 3 / 2.4 = 1.25, OR THE
WAGE IN MARYDOM SHOULD BE NOT LESS THAN 1.25 TIMES THE
WAGE ( OR 25% HIGHER) IN HEYBIA--- BUT THE WAGE IN
MARYDOM COULD BE UPWARD TO 4 / 2 = 2 TIMES HIGHER THAN
THE WAGE IN HEYBIA, BUT NOT MORE THAN THAT AS JUSTIFIED
BY THE PRODUCTIVITY DIFFERENCE IN MARYDOM RELATIVE TO
HEYBIA