Why Countries Trade

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of advantage. The Heckscher-Ohlin proposition maintains domestic industries vary. Tariffs are much higher in certain that countries tend to export goods whose production makes sectors (such as agriculture and clothing manufacturing) intensive use of relatively abundant factors of production. and among certain country groups (such as less-developed Countries rich in capital—such as factories and machinery— countries). Many countries have substantial barriers to trade export capital-intensive products, while those rich in labor in services in areas such as transportation, communications, export labor-intensive products. Economists today think and the financial sector; others have policies that welcome that although factor endowments matter, there are also other foreign competition. important influences on trade patterns (Baldwin, 2008). Moreover, trade barriers affect some countries more Recent research shows that when trade opens up, it is fol- than others. Often hardest hit are less-developed countries lowed by adjustment not only across industries, but within whose exports are primarily low-skilled, labor-intensive them as well. Increased competition from foreign firms products that industrialized countries often protect. The puts pressure on profits, forcing less-efficient firms to con- United States, for example, is reported to collect about tract, making room for more efficient firms. Expansion and 15 cents in tariff revenue for each $1 worth of imports from new entry introduce better technologies and new product Bangladesh (Elliott, 2009), compared with 1 cent for each varieties. Likely most important, trade enables greater selec- $1 worth of imports from some major western European tion across different types of goods (say refrigerators). This countries—even though imports of a particular prod- explains the prevalence of intra-industry trade (for example, uct from Bangladesh face the same or a lower tariff than a countries that export household refrigerators may import similarly classified product imported from western Europe. industrial coolers), which the factor endowment approach World Bank economists calculated that exporters from low- does not encompass. income countries face barriers on average 50 percent higher There are clear efficiency benefits from trade that result than those of major industrialized countries (Kee, Nicita, in more products—not only more of the same products, but and Olarreaga, 2006). greater product variety. For example, the United States imports Members of the World Trade Organization, which ref- four times as many varieties (say different types of cars) as it did erees international trade, are engaged in a complex effort in the 1970s, while the number of countries supplying each good to reduce and level out government-imposed obstacles to has doubled. An even greater benefit may be the more efficient trade in a round of negotiations begun in Doha, Qatar, in investment spending that results from firms’ access to a wider 2001. The talks cover a wide range of issues, many of them variety and quality of intermediate and capital inputs (think politically sensitive, including elimination of remaining optical lenses rather than cars). farm export subsidies, limiting domestic farm subsidies, Economic models used to assess the impact of trade typi- and sharply cutting advanced economies’ tariffs on farm cally neglect technology transfer and pro-competitive forces and industrial products. Doha also seeks to address other such as the expansion of product varieties. This is because crucial issues such as barriers to trade and investment in these influences are difficult to model, and results that do services, trade rules in areas such as fishery subsidies and incorporate them are subject to greater uncertainty. Where antidumping, and customs and trade facilitation. this has been done, however, researchers have concluded that If successful, the Doha Round could yield hundreds of bil- the benefits of trade reforms—such as reducing tariffs and lions of dollars in annual global benefits. But some groups other nontariff barriers to trade—are much larger than sug- have sought to delay and to dilute the deal. A focus on the gested by conventional models. greater good, together with ways to help the relatively few that may be adversely affected, can help deliver a fairer and Why trade reform is difficult economically more sensible trading system. n Trade contributes to global efficiency. When a country opens up to trade, capital and labor shift toward industries Brad McDonald is a Deputy Division Chief in the IMF’s in which they are used more efficiently. Societies derive a Strategy, Policy, and Review Department. higher level of economic welfare. But these effects are only part of the story. Trade also brings dislocation to firms and industries that References: cannot cut it. Such firms often lobby against trade. So do their Baldwin, Robert E., 2008, The Development and Testing of workers. They often seek barriers such as import taxes (called Heckscher-Ohlin Trade Models: A Review (Cambridge, Massachusetts: tariffs) and quotas to raise the price or limit the availability of MIT Press). imports. Processors may try to restrict exports of raw mate- Elliott, Kimberly Ann, 2009, “Opening Markets for Poor Countries: rials to artificially depress the price of their own inputs. By Are We There Yet?” Center for Global Development Working Paper 184 contrast, the benefits of trade are diffuse, and its beneficiaries (Washington). often do not recognize how trade benefits them. Irwin, Douglas A., 2009, Free Trade Under Fire (Princeton, New Jersey: Princeton University Press, 3rd ed.). Trade policies Kee, Hiau Looi, Alessandro Nicita, and Marcelo Olarreaga, 2006, Reforms since World War II have substantially reduced gov- “Estimating Trade Restrictiveness Indices,” World Bank Policy Research ernment-imposed trade barriers. But policies to protect Working Paper 3840 (Washington).