International Trade: Why We Don't Have More of It

By Ostapik, Edith; Yi, Kei-Mu | Business Review (Federal Reserve Bank of Philadelphia), Fall 2007 | Go to article overview

International Trade: Why We Don't Have More of It


Ostapik, Edith, Yi, Kei-Mu, Business Review (Federal Reserve Bank of Philadelphia)


Globalization has many facets. One of the most important is the enormous increase in international trade. Over the past 40 years, world exports as a share of output have doubled to almost 25 percent of world output. (1) However, despite globalization and the increasing share of output that is exported and imported internationally, economic evidence suggests that significant barriers to international trade still exist. (2) We will summarize the latest developments in the measurement of international trade barriers, drawing mainly from a recent comprehensive survey on the subject by James Anderson and Eric van Wincoop. In their survey, these authors report estimates of the magnitudes of different categories of international trade costs. They find that, on average, international trade costs almost double the price of goods in developed countries.(3)

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The primary policy implication of the existing research is that globalization still has a long way to go, so that there is still plenty of room for trade to grow. Growth in trade will likely occur primarily through technological changes that reduce transportation or communication costs or from long-run policy choices, such as a national currency or language. Reduction in policy-related barriers, such as tariffs, will also play a role.

WHY AND HOW TRADE COSTS REDUCE TRADE

The core idea underlying the benefits of international trade goes back to Adam Smith and his famous pin factory parable. According to Smith, when each worker specializes in doing only those tasks he is best suited to do, a factory achieves its maximum economic efficiency. Smith and later economists extended this argument from firms to countries. Economic efficiency occurs when each country specializes in making and exporting only those goods it is relatively efficient at producing. In turn, each country imports those goods other countries produce relatively efficiently. (4)

In other words, international trade enhances a society's economic well-being because it facilitates specialization in production. With trade, prices consumers pay for goods are lower than those they would pay without trade. According to Smith and later economists, when trade is free and unfettered, a society maximizes its economic well-being.

Barriers to international trade prevent the efficient outcome described above from occurring. For example, because these barriers raise the costs of purchasing imported goods, U.S. consumers would buy fewer foreign goods, and foreign consumers would buy fewer U.S. goods. To satisfy the demand for products that previously had been imported under free trade, each country would now be making more goods it is not relatively efficient at producing. In the presence of international trade barriers, there would be less specialization, prices would be higher, and, overall, consumers in all countries would be worse off.

THE TWO MAIN TYPES OF TRADE COSTS

In 19th-century England, economist David Ricardo used these core ideas of the benefits to international trade to argue against a pressing political barrier to trade: the Corn Laws, which protected British agriculture and kept domestic food prices high. Since then, economists have studied many other barriers to trade. We will describe these barriers in terms of costs, following the convention used by Anderson and van Wincoop. (5)

Broadly, trade costs are all costs incurred from the time a good leaves the factory or its place of production to the time it is purchased by the end-user. Such costs can he incurred internationally (for example, at the border) or domestically (that is, within a country). In the case of consumer goods such as automobiles, televisions, clothing, and food, trade costs are the difference between the price at the "factory gate" and the retail price. (6)

International trade costs can be broadly divided into two main categories: border-related costs and international transportation costs.

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