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Introduction to Business 2e

3.2 Why Nations Trade

Introduction to Business 2e3.2 Why Nations Trade

3.2 Why Nations Trade

  1. Why do nations trade?

One might argue that the best way to protect workers and the domestic economy is to stop trade with other nations. Then the whole circular flow of inputs and outputs would stay within our borders. But if we decided to do that, how would we get resources like cobalt and coffee beans? The United States simply can’t produce some things, and it can’t manufacture some products, such as steel and some clothing, at the low costs we’re used to. The fact is that nations—like people—are good at producing different things: you may be better at financial services than developing an app. In that case, you benefit by “exporting” your financial services and “importing” the app development you need from a skilled programmer. Economists refer to specialization like this as advantage.

Absolute Advantage

A country has an absolute advantage when it can produce and sell a product at a lower cost than any other country or when it is the only country that can provide a product. The United States, for example, has an absolute advantage in high-tech sectors.

Suppose that the United States has an absolute advantage in air traffic control systems for busy airports and that Brazil has an absolute advantage in coffee. The United States does not have the proper climate for growing coffee, and Brazil lacks the technology to develop air traffic control systems. Both countries would gain by exchanging air traffic control systems for coffee.

Comparative Advantage

Even if the United States had an absolute advantage in both coffee and air traffic control systems, it should still specialize and engage in trade. Why? The reason is the principle of comparative advantage, which says that each country should specialize in the products that it can produce most readily and cheaply and trade those products for goods that foreign countries can produce most readily and cheaply. This specialization ensures greater product availability and lower prices.

For example, India and Vietnam have a comparative advantage in producing clothing because of lower labor costs. Japan has long held a comparative advantage in consumer electronics because of technological expertise. The United States has an advantage in computer software, airplanes, some agricultural products, heavy machinery, and jet engines.

Thus, comparative advantage acts as a stimulus to trade. When nations allow their citizens to trade whatever goods and services they choose without government regulation, free trade exists. Free trade is the policy of permitting the people and businesses of a country to buy and sell where they please without restrictions. The opposite of free trade is protectionism, in which a nation protects its home industries from outside competition by establishing artificial barriers such as tariffs and quotas. In the next section, we’ll look at the various barriers, some natural and some created by governments, that restrict free trade.

Concerns about Trade and Globalization

Protests at meetings of groups such as the World Trade Organization, World Bank, and the International Monetary Fund (the organizations are discussed later in the chapter) provide some evidence that there is concern about world trade and globalization. What are the concerns? The negatives of global trade are as follows:

  • It has been reported that millions of Americans have lost jobs due to imports or production operations shifting abroad. Many can find new positions but sometimes not at the same pay they previously earned.
  • Millions of others fear losing their jobs, especially at those companies operating under competitive pressure.
  • Employees fear that firms will export their jobs if they do not work for lower wages or agree to pay cuts.
  • Service-industry jobs such as IT and customer service are increasingly vulnerable to operations moving offshore.

Sending domestic jobs to another country is called outsourcing, a topic you can explore in more depth. Many U.S. companies, such as JPMorgan Chase, Comcast, and Verizon have set up call centers in India, the Philippines, and other countries. Now even engineering and research and development jobs are being outsourced. Outsourcing, the trade deficit, and the labor market are highly debated issues that are often the topic of political debates. Additionally, U.S. jobs and trade are frequently significant components of both state and national elections. Through government interventions, in some cases jobs can be retained in the United States. There are many factors that are considered by firms when deciding to move jobs or functions overseas. It is important to remember that the economic factors work in conjunction with the firms' needs. In some cases, the business needs push the company to globalize.15

Exhibit 3.3 Anti-globalization groups oppose America’s free-trade stance, arguing that corporate interests are hurting the U.S. economy and usurping the power of the American people. The 2017 protests at the G20 meetings in Hamburg, Germany, expressed anti-free-trade sentiment, supporting the idea that multinational corporations wield too much power. Are fears expressed by anti-globalization activists and nationalists justified? Why or why not? (Credit: fiction of reality/ Flickr/ Attribution 2.0 Generic (CC BY 2.0))

So is outsourcing good or bad? If you happen to lose your job, it’s obviously bad for you. However, some economists say it leads to cheaper goods and services for U.S. consumers because costs are lower. Also, it should stimulate exports to fast-growing countries. No one knows how many jobs will be lost to outsourcing in coming years. According to estimates, over 4 million U.S. jobs were outsourced in 2025.16

Benefits of Globalization

A closer look reveals that globalization has been the engine that creates jobs and wealth. Benefits of global trade include the following:

  • Productivity grows more quickly when countries produce goods and services in which they have a comparative advantage. Living standards can increase faster. One problem is that big G20 countries have added nearly 2,300 restrictive export and import measures since 2008.
  • Global competition and cheap imports keep prices down, so inflation is less likely to stop economic growth. However, in some cases this is not working because countries manipulate their currency to get a price advantage.
  • An open economy spurs innovation with fresh ideas from abroad.
  • Through infusion of foreign capital and technology, global trade provides lower-income countries with the chance to develop economically by spreading prosperity.
  • More information is shared between two trading partners that may not have much in common initially, including insight into local cultures and customs, which may help the two nations expand their collective knowledge and learn ways to compete globally.17

Concept Check

  1. Describe the policy of free trade and its relationship to comparative advantage.
  2. Why do people fear globalization?
  3. What are the benefits of globalization?
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