Free Trade

Nations trade for the same reasons that individuals do - because they believe that the products they receive are worth more than the products they give up. In many cases, trade occurs because countries lack goods at home. This is especially true when it comes to various crops, and also essential raw materials needed to produce US goods. Goods exchanged among countries are identified as imports and exports. Imports are the goods and services that a nation buys from other nations. Exports then are the goods and services that a nations sells to other nations. A country can put itself into a trade deficit whenever the value of the products it imports exceeds the value of the products it exports. It then has a trade surplus whenever the value of its exports exceeds the value of its imports. Each is dependent on the international value of its currency.

Trade works best when countries focus on those products that they can produce best. It may be cheaper for a country to import a product than to manufacture it. This is seen clearly through the difference between absolute and comparative advantage. A country has absolute advantage when it can produce more of a given product than another country can produce. For example, China and other Asian economies are able to export low-cost manufactured goods, which take advantage of their much lower unit labor costs. This is why Apple transferred their production of the iPhone to Foxconn in China.

With comparative advantage, a country has the ability to produce a given product relatively more efficiently than another country by doing it at a lower opportunity cost. A country has a comparative advantage when it is better than any other country in producing something, AND it doesn't give up as much by producing it. For example, oil-producing nations have a comparative advantage in chemicals. That's because the oil provides a cheap source of material for the chemicals when compared to countries without it. As a result, Saudi Arabia, Kuwait, and Mexico are competing with U.S. chemical production firms. Their opportunity cost is low. They don't have to give up much to produce chemicals. That's because a lot of the raw ingredients are produced in the oil distillery process.

While free markets and international trade can bring many benefits, some people still object, because trade can displace selected industries and groups of workers. When people object to trade, they look for ways to prevent it, or to at least slow the rate of growth. Each country has their own set of trade rules and regulations, and when wanting to conduct trade internationally, companies have to comply. Not only do they need to ensure that they are not breaking international trade laws, but also domestic ones as well.

In history, there have been two major ways to restrict trade. One way is through a tariff, which is a tax placed on imports to increase their price in the domestic market. The other is a quota, which limits the quantities of a product that can be imported. However, there are other restrictions such as the health inspections on imported foods, which tends to be very rigorous. Other methods include requiring a license to import, or charging a large fee to carry an import license. Many European countries use health issues in that they refuse to import foods that have been genetically altered.

There are two types of tariffs use: a protective tariff and a revenue tariff. A protective tariff is a tariff that is high enough to protect less-efficient domestic industries. For example, if it costs $1 to produce a mechanical pencil in the US, while the same product can be imported for 35 cents from another country, the government may place a 95 cent tariff on each imported pencil. This would this raise the cost per imported pencil to $1.30, and the domestic industry is protected form being undersold by a foreign one.

A revenue tariff is a tariff that is high enough to generate revenue for the government without actually prohibiting imports. It is a tax placed imported goods to raise revenue. With the same example as before with the pencil, if the tariff was only 40 cents, the price of import would only by 75 cents per pencil. This would still put it 25 cents less than the domestic pencil, and if the products are identical then the consumer would prefer to purchase the imported product. The purpose of this tariff would then be to simply raise revenue rather than protect domestic producers from foreign competition.

Foreign goods sometimes cost so little that even a high tariff on them might not protect the domestic market. The government would then use a quota to keep foreign goods out of the country. Quotas can even be set as low as zero to keep a product from ever entering the country. More often though, quotas are used to to reduce the total supply of a product to keep prices high for domestic producers.

In order to eliminate or smooth out trade disagreements, the World Trade Organization(WTO) will meet regularly to discuss trade issues. The WTO is an international agency that administers trade agreements, settles trade disputes between governments, organizes trade negotiations, and provides technical assistance and training for developing countries. With the development of the WTO, international trade has been flourishing, and has allowed stores to offer a wide variety of industrial and consumer goods from all over the world. In 1993, the North American Free Trade Agreement (NAFTA) was signed to reduce tariffs and increase trade among the United States, Canada and Mexico. It was originally proposed by President George H.W. Bush and was concluded by the Clinton administration in 1993.

Student Activity

Read the articles linked below and answer the questions on the notes handout.

Trump, Trade diverges from Free Trade Republicans

Impact of US Steel Tariffs

The latest on steel imports

US companies can apply for exemptions

Sources