CHAPTER 8:
TRADE, TARIFFS
AND GROWTH
COMPARATIVE ADVANTAGE
• David Ricardo (1772-1823): countries trade to gain from their comparative advantages
• Countries only differ by labour productivity, should export good they are relatively efficient at producing
• countries should trade even if they don’t have an absolute advantage in production
• Due to opportunity costs
• Trade greater extent of the market specialization
growth
HECKSHER & OHLIN AND WINNERS AND LOSERS FROM TRADE
• Comparative advantage based on relative abundance of factors of production
– E.g. land-abundant countries will export land-intensive goods, agricultural produce
• Stolper-Samuelson: Trade increases (decreases) return to owners of the abundant (scarce) resources
– E.g. owners of land will gain from exporting agricultural produce from land-abundant country
• Winners and losers from trade trade policy important!
TRADE IN THE 19
THCENTURY
• H-O based their model on 19th century trade: largely intersectoral: goods traded between countries from different sectors and industries
– E.g. land-abundant US exported agricultural produce, capital- abundant UK exported manufactures
• Exceptions to H-O model such as US due to trade policy
– E.g. US protected industrial production
MERCHANDISE TRADE PATTERNS IN THE UK
AND THE US 1880-1913
TRADE IN THE 20
THCENTURY
• Trade became increasingly intrasectoral: countries exported similar goods to those they imported
• Paul Krugman’s New Trade Theory, monopolistic
competition: economies of scale at the level of the firm
competition between varieties of goods
• Free trade gives both cheaper goods and more variety
• But comparative advantage is still relevant, especially for trade between industrial and lesser developed
countries
MERCHANDISE TRADE PATTERNS IN
WESTERN EUROPE 1963-1999
TRADE AND GROWTH
• Trade implies a one-off welfare improvement as resources allocated more efficiently through
specialization
• Also impacts on growth through technological change
– Technological knowledge is embedded in capital equipment – N.B. Non-rival nature of knowledge
• Caveat: More competition with trade implies less profit, so less for firms to invest in R&D!
AN ARGUMENT FOR PROTECTION
• Infant industry protection, e.g. in the US of industry
• Might pay to protect until an industry is of a sufficient size to compete internationally
– If technological progress aided by learning by doing and dynamic economies of scale
• Problems:
– How to identify industries with potential
– Protection might make industries less competitive
– Might be politically difficult to remove protection again!
THE INFANT-INDUSTRY ARGUMENT
FOR PROTECTION
MERCANTILISM
• Mercantilism until the beginning of the 19th century
• International reserves needed in risky environment protectionism, export > import
• Problem: not every country can have a current account surplus!
• Trade was mostly in non-competing goods
– Sugar and cotton from the colonies
• Gradual increase in world trade
MOVEMENT TO FREE TRADE
• Liberal critique of mercantilist policies in France and Britain by end of 18th century
– But land-owners had power, and land was scarce in Europe – Tariffs important source of government revenue
• Ricardo motivated by the British Corn Laws: protection of grains
• Corn Laws repealed in 1846, 1860 Cobden-Chevalier Treaty and gradual movement to free trade in Europe
THE FIRST FREE TRADE ERA IN EUROPE
PROTECTIONIST BACKLASH
• Many European nations eventually returned to protection
• Cheap grain imports from US caused landowners to campaign for protection
• Germany: more general reaction: ‘iron and rye’ alliance
• US did not share movement to free trade
– Protection for government revenue
– Northern states won civil war, wanted infant industry protection (in contrast to agricultural south)
THE DISINTEGRATION OF WORLD TRADE IN THE INTERWAR PERIOD
• Free trade until the 1920s, but Great Depression of the 1930s led to fall in trade
– Gold Standard countries were more protectionist
– Devaluing countries actually increased trade in the 1930s No beggar-thy-neighbour
• US Smoot-Hawley tariffs increased already high tariffs
• Other countries had no choice but to retaliate, since could not finance trade deficits after financial collapse
• The world divided into trade blocs
AVERAGE PROTECTION (%) FOR 23
COUNTRIES 1865-2000
RESTORATION OF FREE TRADE
• After Second World War, countries recognized the
dangers of trade wars General Agreement on Tariffs and Trade (GATT) rounds from 1947
– Agriculture left out of GATT negotiations, remains protected in US and Europe
– Customs unions such as the European Union permitted
• World Trade Organization (WTO) from 1987
• No protectionist backlash after 2007/8 crisis
– Because no worldwide fixed exchange rate system?
THE VOLUME OF WORLD TRADE AFTER
TWO GREAT SHOCKS
TARIFFS AND GROWTH
• Difficult to test relationship between tariffs and growth
– How to measure protection?
• Mixed empirical evidence
– ‘Tariff-growth paradox’: tariffs good for growth before WW2, bad afterwards!
• Reason: depends on how tariffs are used!
– Which sectors are protected? E.g. industrial protection might foster industrialization
– History, politics, etc. matter
SUMMARY
• Theory is ambiguous about impact of protectionism on growth
– Gains from trade by specialization and technology transfer – But short run protection might be useful
• Historical evidence suggests a little protection is not bad, and might even be helpful, but extreme protection is
disastrous
