International Trade Theory free essay sample

Industry snowcapped volcanoes that rise to more than 20,000 feet. The bushes are protected by 20-foot-high canopies of plastic sheeting. The combination of intense sunlight, fertile volcanic soil, an equatorial location, and high altitude makes for ideal growing conditions, allowing roses to flower almost year-round. Ecuador apparently has a comparative advantage in the production of roses. Ecuadors rose industry started some 20 years ago and has been expanding rapidly since. Ecuador is noW the worlds fourth largest producer of roses. Roses are the nations fifth largest export, with customers allover the world. Rose farms generate $240 million in sales and support tens of thousands of jobs. In Cayambe, the population has increased in 10 years from 10,000 to 70,000, primarily as a result of the rose industry. The revenues and taxes from rose growers have helped to sophisticated pave roads, build schools, and construct irrigation systems. Maria works Monday to Saturday, and earns $210 a month, which she says is an average wage in Ecuador and substantially above the countrys $120 a month It is 6:20 AM, February 7, in the Ecuadorian town of Cayambe, and Maria Pacheco has just been dropped off for work by the company bus. She pulls on thick rubber gloves, wraps an apron over her white, traditional embroidered dress, and grabs her clippers, ready for another long day. Any other time of year, Maria would work until 2 PM, but its a week before Valentines Day, and Maria along with her 84 coworkers at the farm are likely to be busy until 5 PM. By then, Maria will have cut more than 1,000 rose stems. A few days later, after they have been refrigerated and shipped via aircraft, the roses Maria cut will be selling for premium prices in stores from New York to London. Ecuadorian roses are quickly becoming the Rolls Royce of roses. They have huge heads and unusually vibrant colors, including 10 different reds, from bleeding heart crimson to a rosy lovers blush. Most of Ecuadors 460 or so rose farms are located in the Cayambe and Cotopaxi regions, 10,000 feet up in the Andes about an hours drive from the capital, Quito. The rose bushes are planted in huge flat fields at the foot. Understand the important implications holds for business practice. that international trade theory minimum wage. The farm also provides her with health care and a pension. By employing women such as Maria, the industry has fostered a social revolution in which mothers and wives have more control over their familys spending, especially on schooling for their children. For all of the benefits that roses have bought to Ecuador, where the gross national income per capita is only $1,080 a year, the industry has come under fire from environmentalists. Large growers have been accused of misusing a toxic mixture of pesticides, fungicides, and fumigants to grow and export unblemished pest-free flowers. Reports claim that workers often fumigate roses in street clothes without protective equipment. Some doctors and scientists claim that many of the industrys 50,000 employees have serious health problems as a result of exposure to toxic chemicals. A study by the International Labor Organization claimed that women in the industry had more miscarriages than average and that some 60 percent of all workers suffered from headaches, nausea, blurred vision, and fatigue. Still, the critics acknowledge that their studies have been hindered by a lack of access to the farms, and they do not know what the true situation is. The International Labor Organization has also claimed that some rose growers in Ecuador use child labor, a claim that has been strenuously rejected by both the growers and Ecuadorian government agencies. In Europe, consumer groups have urged the European Union to press for improved environmental safeguards. In response, some Ecuadorian growers have joined a voluntary program aimed at helping customers identify responsible growers. The certification signifies that the grower has distributed protective gear, trained workers in using chemicals, and hired doctors to visit workers at least weekly. Other environmental groups have pushed for stronger sanctions, including trade sanctions, against Ecuadorian rose growers that are not environmentally certified by a reputable agency. On February 14, however, most consumers are oblivious to these issues; they simply want to show their appreciation to their wives and girlfriends with a perfect bunch of roses. 167 168 Part 3 The Global Trade and Investment EnVlfonment Introduction The Ecuadorian rose industry is a striking example of the benefits of free trade and globalization. Lower barriers to trade have allowed Ecuador to exploit its comparative advantage in the growing of roses and enabled the country to emerge as one of the largest exporters of roses in the world. This benefits Ecuador, where economic growth and personal incomes have been bolstered by the emergence of the rose growing industry. It also benefits consumers in developed nations, who now have access to affordable high-quality roses from Ecuador. February is not exactly the best time for growing roses in New York state, but thanks to free trade, a New Yorker can now buy a bunch of fresh roses for his beloved on February 14 that were picked in Ecuador only 24 hours earlier. It also benefits foreigners who export goods and services to Ecuador, for a stronger Ecuadorian economy can purchase more of those goods and services. If there are losers in this process, they are high-cost rose producers in places like Florida, who have lost business to the Ecuadorians. In the world of international trade, there are always winners and losers, but as economists have long argued, the benefits to the winners outweigh the costs borne by the losers, resulting in a net gain to society. Moreover, economists argue that in the long run free trade stimulates economic growth and raises living standards across the board. The economic arguments surrounding the benefits and costs of free trade in goods and services are not abstract academic ones. International trade theory has shaped the economic policy of many nations for the past 50 years. It was the driver behind the formation of the World Trade Organization and regional trade blocs such as the European Union and the North American Free Trade Agreement (NAFTA). The 1990s, in particular, saw a global move. toward greater free trade. It is crucially important to understand, therefore, what these theories are and why they have been so successful in shaping the economic policy of so many nations and the competitive environment in which international businesses compete. This chapter has two goals that go to the heart of the debate over the benefits and costs of free trade. The first is to review a number of theories that explain why it is beneficial for a country to engage in international trade. The second goal is to explain the pattern of international trade that we observe in the world economy. With regard to the pattern of trade, we will be primarily concerned with explaining the pattern of exports and imports of goods and services between countries. We will not be concerned with the pattern of foreign direct investment between countries; that is discussed in Chapter 7. An Overview of Trade Theory We open this chapter with a discussion of mercantilism. Propagated in the 16th and 17th centuries, mercantilism advocated that countries should simultaneously encourage exports and discourage imports. Although mercantilism is an old and largely discredited doctrine, its echoes remain in modern political debate and in the trade policies of many countries. Next we will look at Adam Smiths theory of absolute advantage. Proposed in 1776, Smiths theory was the first to explain why unrestricted free trade is beneficial to a country. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. Smith argued that the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports. His arguments imply that such a laissez-faire stance toward trade was in the best interests of a country. Building on Smiths work are twO additional theories that we shall review. One is the theory of comparative advantage, advanced by the 19th-century English economist David Ricardo. This theory is the intellectual basis of the modern argument for unrestricted free trade. In the 20th century, Ricardos work was refined by two Swedish economists, Eli Heckscher and Bertil Ohlin, whose theory is known as the Heckscher-Ohlin theory. InternatIonal Trade Theory Chapter 5 169 THE BEf\IEFITS OF TRADE The great strength of the theories of Smith, Ricardo, and Heckscher-Ohlin is that they identify with precision the specific benefits of international trade. Common sense suggests that some international trade is beneficial. For example, nobody would suggest that Iceland should grow its own oranges. Iceland can benefit from trade by exchanging some of the products that it can produce at a low cost (fish) for some products that it cannot produce at all (oranges). Thus, by engaging in international trade, Icelanders are able to add oranges to their diet of fish. The theories of Smith, Ricardo, and Heckscher-Ohlin go beyond this commonsense notion, however, to show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. This is a difficult concept for people to grasp. For example, many people in the United States believe that American consumers should buy products made in the United States by American companies whenever possible to help save American jobs from foreign competition. The same kind of nationalistic sentiments can be observed in many other countries. However, the theories of Smith, Ricardo, and Heckscher-Ohlin tell us that a countrys economy may gain if its citizens buy certain products from other nations that could be produced at home. The gains arise because international trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries. Thus it may make sense for the United States to specialize in the production and export of commercial jet aircraft since the efficient production of commercial jet aircraft requires resources that are abundant in the United States, such as a highly skilled labor force and cutting-edge technological know-how. On the other hand, it may make sense for the United States to import textiles from China since the efficient production of textiles requires a relatively cheap labor force-and cheap labor is not abundant in the United States. Of course, this economic argument is often difficult for segments of a countrys population to accept. With their future threatened by imports, U. S. textile companies and their employees have tried hard to persuade the government to limit the importation of textiles by demanding quotas and tariffs. Although such import controls may benefit particular groups, such as textile businesses and their employees, the theories of Smith, Ricardo, and Heckscher-Ohlin suggest that such action hurts the economy as a whole. Limits on imports are often in the interests of domestic producers, but not domestic consumers. PATTERN OF INTERNATIONAL TRADE The theories of Smith, Ricardo, and Heckscher-Ohlin help to explain the pattern of international trade that we observe in the world economy. Some aspects of the pattern are easy to understand. Climate and natural resource endowments explain why Ghana exports cocoa, Brazil exports coffee, Saudi Arabia exports oil, and China exports crawfish. However, much of the observed pattern of international trade is more difficult to explain. For example, why does Japan export automobiles, consumer electronics, and machine tools? Why does Switzerland export chemicals, pharmaceuticals, watches, and jewelry? David Ricardos theory of comparative advantage offers an explanation in terms of international differences in labor productivity. The more sophisticated Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the factors of production (such as land, labor, and capital) are available in different countries and the proportions in which they are needed for producing particular goods. This explanation rests on the assumption that countries have varying endowments of the various factors of production. Tests of this theory, however, suggest that it is a less powerful explanation of realworld trade patterns than once thought.