Principles of Microeconomics Scarcity and Social PChapter 28 The Economics of Globalization and Trade A Pluralistic Approach

CHAPTER 28 . THE ECONOMICS OF GLOBALIZATION AND TRADE A PLURALISTIC APPROACH INTRODUCTION TO GLOBALIZATION AND TRADE FROM A PLURALISTIC PERSPECTIVE CHAPTER In this chapter , you will learn about Review the Orthodox Economics Comparative Advantage and Trade Story . Examine Critiques of Orthodox Free Trade Story . Identify an Alternative Approach for Evaluating the Impact of International Trade . 11 Chapter 27 Globalization and Protectionism several concerns associated with free trade are tackled and , presumably , debunked . In International Trade and Its Effects on jobs , Wages , and Working Conditions , three issues are raised . Trade and Wages . Labor Standards and Working Conditions In Arguments in Support of Restricting Imports , another five issues are tackled . Infant Industry Argument Environmental Protection Low Foreign Wages National Interest Argument . But , are these issues really ?

Does orthodox economics effectively minimize the above outlined issues ?

From the standpoint of heterodox economists , the answer to both of these questions is no . There is a significant body of research available , within the context of a more pluralistic in economics , that point to other interpretations of international trade in which the standard orthodox economic free trade story has very real weaknesses . The intention of this section is to provide a to that of the orthodox comparative advantage story . The critique is directed toward the orthodox presentation of its theoretical ideas , specifically how orthodox theory promotes the merits and benefits of free trade . The critique will take two forms . The first and primary criticism will focus on the wide array of ways in the orthodox theoretical story fails as both a technical and functional theoretical presentation . The second element

PRINCIPLES OF ECONOMICS 803 of criticism will , in periodic instances , include references to history as well as empirical evidence to document instances in which the orthodox comparative advantage story appears to not fulfill its claims .

THE ORTHODOX STORY OF TRADE A SYNOPSIS LEARNING OBJECTIVES By the end of this section , you will be able to Define the term comparative advantage . Explain the terms and conditions of trade from an orthodox economic perspective . ever there was a sacrosanct idea within orthodox economic thought , it is the belief , faith even , that orthodox economists have regarding the merits and benefits of economic actors being free to trade . The basis for the orthodox economists faith has much to do with the theoretical tion orthodox economists utilize to explain how trade works and why it is beneficial . Consider the ideas presented in the chapter entitled International Trade . As presented , orthodox economics organizes its free trade story around several assumptions . The assumptions are designed to constrain the scope of the analysis so as to simplify the story . In the ical introductory textbook presentation , orthodox economists utilize production possibilities tiers to depict their story . In support of the production possibilities frontier presentation , orthodox economists apply eight assumptions . The following represents the eight , most common , assumptions . Two producers Two products Fixed resources . Fixed technology . Full resource utilization . Zero transactions costs No external costs or benefits Autarky . Lets take a moment to upon these assumptions and what they mean . For starters , it is typically to assume that the two producers in the model will be countries . Within the two countries , only two products will be produced . Each country will have a fixed number of resources available to produce those products . Limited resources will subsequently limit the amount of production of the two that is possible within the two countries . Additionally , the fixed technology assumption further limits the extent of possible production . Given the limits to production , all resources and technology are assumed to be used , fully utilized , meaning that production will take place at some point on the

PRINCIPLES or ECONOMICS 805 production possibilities frontier . Once products are produced , if the two countries seek to trade with one another , there will be no transactions costs associated with trade . Transactions costs are costs such as the legal costs of creating contracts or the transportation costs associated with shipping a product from one part of the world to another . In addition to no transactions costs , external costs or benefits are assumed to be absent . As a reminder , external costs or benefits are the possible spillover effects that occur as a result of economic activity such as production or consumption . As one can imagine , because trade requires transportation , the social costs associated with the wastes generated by transportation are very real . However , for the sake of simplicity , the model assumes the costs or benefits of are zero . Finally , autarky means that each producer is . sufficient producers do not require trade in order to survive . If trade is a luxury rather than a , then when trade occurs it is voluntary trade and only to the benefit of the trading partners . Given the models assumptions , the orthodox free trade story then showcases three essential to the trade story . First , the initial step in facilitating trade is for producers to identify their comparative advantage . Recall , comparative advantage means that producers are capable of ing some product ( at a lower opportunity cost than another producer is capable of producing the same product ( As a producer , regardless of whether the producer is an individual , firm , or nation , as long as the producer is producing the product at a lower opportunity cost than the other producer , the producer with the lower opportunity cost has a comparative advantage . The second step in the trade story is the specialization of production . Upon identifying its comparative advantage , orthodox economics argues that a producer should specialize in the production of the product that which it has a comparative advantage . Specialization means that a producer should direct their available resources toward the production of a specific product . The third component of the trade story is , trade . producers , producing a product of which they have a comparative advantage , should now seek to identify trading partners that are also specialized producers of desirable products . Producer Producer Specializes in Trade with Identifies its the Production other Producers Comparative of the Comparatively of other Advantage Advantageous Product Products THE BENEFITS OF TRADE Orthodox economics sees the outcomes of trade as having predominantly positive impacts for the economic of those people participating in the trade . Trade is deemed beneficial for several reasons . Orthodox economics concludes that trade will not only stimulate economic growth , increase efficiency , and enhance economic development , but that trade is also the best path toward pursuing those goals . The story of growth is relatively straightforward . The economic growth , when examined more specifically , such as in the case of international trade as producers get access to consumers beyond their domestic borders , the number of available consumers should grow . In the face of a larger

806 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER consumer market place , domestic producers will seek to expand their productive capacities , known as growth , in order to produce more in an effort to take advantage of having more potential consumers . The story of efficiency is less obvious , but is still relatively straightforward , particularly if viewed through the lens of international trade . In an international trade environment , producers that may have otherwise been subject to their own country domestic competition , are now confronted by international competition . Given more competition , producers are forced to seek ever more efficient ways to produce products or risk being driven out of business . More trade equates to more tion and , through the eyes of an orthodox economist , Finally , in the case of the economic development story , the relationship between trade and ment is a bit murky but still evident . By focusing on the specialized production product ( that are comparatively good at producing , the total amount of available products should grow . As two or more parties trade , each producer relative abundance of production becomes available to more people to be consumed . Essentially , with the growth of products comes an increased ability to meet people wants . As more wants are met , facilitated by trade , the sum total of utility grows for all and everyone is made better off . In this case , economic development is being defined as raised living standards by virtue of access to consumer products .

A CRITICAL EXAMINATION OF THE ORTHODOX DEPICTION OF FREE TRADE LEARNING By the end of this section , you will be able to Explain ways in which the Orthodox Economic Trade story is limited as a technique for analyzing trade . Define the different types of technical critiques of the orthodox free trade model Explain that critiques of the orthodox free trade model are of differing severity . Analyze applied examples of the limitations of the orthodox economic model . the discipline of economics not all economists agree with the rather rosy picture by orthodox economists in their defense of free trade . Critiques of the orthodox free trade story tend to focus on two areas . Some heterodox economists emphasize what they see as the theoretical failures of the orthodox story , namely its disassociation with the real Other heterodox economists focus their criticisms toward the orthodoxy depiction of the outcomes of trade , particularly the orthodoxy conclusion that trade stimulates economic growth and nomic development Upon examination it can be argued that both paths of criticism really represent the two different sides of the same coin . For example , if the theoretical model presented by orthodox economics is , in fact , inaccurate because it is in some way divorced of real world context , then the theoretical drawn by the theory will likely also be . Looked at the other way , if real world evidence points to outcomes different from the outcomes predicted or perceived by orthodox economics , then it stands to reason that the theoretical model utilized to predict outcomes is failing in some capacity . In the following each of the two critical paths will be explored . The careful reader will note that the two paths frequently intersect . TECHNICAL CRITIQUES THE ORTHODOX MODEL IS POORLY CONSTRUCTED In this section of the chapter we will explore the model imperfections approach to critiquing the orthodox presentation of free trade . The model imperfections critique is , essentially , a failure of the techniques employed by orthodox economists . There are two main types of model imperfections . Type One Mild . Type Two More Severe to Very Severe

303 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER For Type I critics of the orthodox economic free trade story , the shortcomings associated with the orthodox economic presentation of free trade is strictly the result of a failure of technique , but not necessarily a failure of the overall theory . In other words , the theory does generalize to the real world , but due to model imperfections such as the models choice of assumptions being overly , the model is unable to fully capture actual real world circumstances . The degree of seriousness associated with these critiques can be classified as mild . For Type II critics , the model imperfections critique represents a much more serious indictment of the standard orthodox free trade story . In this case , comparative advantage , specialization , and trade does not actually generalize well to the real world . The socially positive results that are depicted in the orthodox theoretical presentation , when these imperfections are accounted for , will not emerge . In other words , because the real world will , and does , contain imperfections that do not conform to the orthodox economic model , the orthodox theoretical presentation will often deviate from actual events in the real world causing the model to blatantly misrepresent the benefits of trade . with modifications designed to correct the imperfections , the model can be corrected enough so as to reflect conditions in the real world . A NOTE ON THE FAILURE OF TECHNIQUE A failure of technique means that by making alterations to the choice of assumptions , the comparative advantage story can be modified to present theoretical outcomes that are more accurate to the real world . As a general rule the changes in assumptions are applied on an ad hoc basis , meaning that assumptions are altered from situation to situation . The goal becomes to modify assumptions in order to reflect phenomena experienced in the actual global economy . The tion of assumptions suggests that there are limits to the usefulness of the techniques utilized within orthodox economic theory to explain . TYPE I MODEL IMPERFECTIONS The following represent examples of instances in which the restrictive features of the assumptions do not provide a real world depiction , but also do not fundamentally undermine the free trade story . EXCLUSION OF TRANSACTIONS COSTS In constructing their theoretical presentation of international trade , orthodox economics excludes transactions costs . Transactions costs include factors such as transportation , legal , and costs . As one can imagine , in the actual world in which we live the trade of products will always include significant transaction costs . When transactions costs are included some trades that would have otherwise been beneficial will not be worthwhile as the costs associated with making the trade become too high to justify the trade . While this critique certainly does point to instances in which some trades will not happen as would be the case in the standard orthodox trade story , the critique is not a deal breaker as most of the orthodox trade story remains intact . PRODUCTION POSSIBILITIES FRONTIERS Production possibilities curves are not linear ( straight line ) but rather concave ( bowed outward ) A bowed outward the principle of increasing opportunity cost . Increasing opportunity cost implies that as a nation moves closer and closer to specializing in the production of one good or one type of good , the opportunity cost of specialization will rise . For example , for countries producing

PRINCIPLES or ECONOMICS 809 agricultural commodities , there tend to be land or ecology limits on their productive capacity . As a result , to specialize in an agricultural product and then expanding production in an agricultural sector may cause there to be an increase in the average cost of production due to declining productivity associated with the of scale that accompanies introduction of less and less fertile land . Since the free trade story is told on the basis of comparative advantage such that a nation produces those goods that require a low opportunity cost of production , if opportunity costs are changing ( specifically , rising ) then production of a good that may have a low opportunity cost at one point , may have a significantly higher opportunity cost after specialization . The following table illustrates this point . CANADA SILVER ( OUNCES ) LUMBER ( MEXICO SILVER ( OUNCES ) LUMBER ( BOARD FEET ) 088 The ratios in red illustrate the lowest opportunity costs of production for both Canada and Mexico . For Canada , the numbers indicate that they have a comparative advantage in producing lumber because they can produce unit of lumber at the expense of only units of silver . Canada advantage outcome emerges when Canadian production changes from lumber and silver to lumber and silver . For Mexico , the numbers indicate that they have a advantage in producing silver because they are capable of producing unit of silver for units of lumber . Mexico comparative advantage emerges when Mexican production changes from silver and lumber to silver and lumber . According to the logic of orthodox economic theory , now that the Canadian and Mexican advantages have been identified , with Canada having the advantage in lumber and Mexico the advantage in silver , Mexico and Canada should then specialize and trade . Specialization means that Canada should now only produce lumber , moving their production outcome to silver and lumber while Mexico should now only produce silver , moving their production to lumber and silver . It is at this point that a problem appears . Once each country specializes , what was a comparative advantage dissolves into a comparative disadvantage . Examining the table , as a result of the principle of increasing opportunity cost , the opportunity cost in silver of specializing in lumber increases as Canada moves to maximum lumber production

810 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER ing a lumber to silver ratio . Mexico experiences as similar problem except theirs is the problem of a rising opportunity cost associated with forgone lumber . For Mexico the ratio changes to silver for lumber ( which is also lumber for silver ) In fact , as is demonstrated by this table , once the country specialize , each country now has a comparative advantage in the opposite product from what it previously had a comparative advantage . Mexico is now capable of lumber at a lower opportunity cost than Canada and Canada is now able to produce silver at a lower opportunity cost than Mexico . Clearly the orthodox economic story does not fit this stance . This is not to say that free trade necessarily breaks down as a result of this scenario , but it does demonstrate that in a more realistic setting , specialization and trade are not appropriate . In fact , one thing the table clearly demonstrates is that both countries are better off producing a combination , a diversity , of products . At this point , based on a diversity of products produced , if the countries trade , then trade will allow both countries to acquire even more of the respective product that they do not have a comparative advantage in producing . TYPE II MODEL IMPERFECTIONS The following examples provide an overview of some of the Type II imperfections that appear to a divide between real , actual , world circumstances and the orthodox economic trade story . Each imperfection represents a more fundamental challenge to the orthodox model of trade than did the Type I imperfections . As such , the imperfections are presented from least significant to most cant in terms of their implications for the orthodox model . SPECIALIZATION AND ECONOMIC VULNERABILITY Any time production becomes highly specialized , the producer confronts potential risks . Here are two potential risks associated with specialization . Any country that chooses to completely specialize in the production of one product runs the risk of a decline in the market for the specialized good . For example , consider a circumstance in which consumers lose interest in the product . In this case market demand declines and the country specializing in the production of this product will necessarily suffers significant economic damage . Any country that specializes in the production of an agricultural good , beyond losses in consumer demand also face production risks . A change in weather or a natural disaster has the potential to completely undermine the economy of the nation ( producing the single agricultural product and devastate an economy . In either of the above stated situations , the orthodox economic advice of specialization and trade has the potential to cause negative , not positive effects , for the participants . Clearly there are potentially economically devastating risks associated with a program of rigid specialization . Although the issue of risks does present a more pressing critique of the standard orthodox free trade story , because potential risks are not definite risks , absent the emergence of these events , the free trade story is still applicable . Additionally , if the above stated risks are a concern , one can argue that the orthodox model can alter its assumptions to acknowledge heightened risks and , advocate for more diversified economies . Diversified economies can still trade and , within the orthodox economic story , these economies would still be encouraged to open their borders to the free flow of products .

PRINCIPLES or ECONOMICS 811 SPECIALIZATION AND LESS THAN FULL EMPLOYMENT While the orthodox economic free trade story presents the idea that trade may produce increases in available goods and services to the trading partners , as a nation or nations specializes the industries suffering from a comparative disadvantage will , ultimately , displace laborers . Because the losses in one industry may not be fully compensated in another industry or industries , more laborers may be displaced than necessarily employed , thus causing unemployment . An example of the above situation , consider the trading situation of two countries where one country has an abundance of labor and the other country has an abundance of capital ( tools , equipment , machinery ) In the country that tends to have an abundance of labor the firms within that country would tend to use a lot of labor , and less capital , for their production . In the country that tends to have an abundance of capital , the firms within the capital intensive country will tend to use a lot of capital , rather than labor , in their production processes . According to orthodox economic theory , in identifying their respective comparative advantages , the labor intensive country would determine that it has a comparative advantage in producing products that require a lot of labor while the capital intensive country would find that it has an advantage in producing products that require a lot of tools , equipment and machinery . The challenge that emerges in this situation is that not all firms in the capital intensive country will be capital intensive producers , some will be labor intensive producers . The labor intensive firms in the capital intensive country will discover that they are at a comparative disadvantage against labor intensive producers from the labor intensive country . The resulting outcome will be that the labor intensive firms , with an abundance of labor , from the capital intensive country , will begin laying off workers . At the same time , while the capital intensive firms in the capital intensive country will likely grow and expand with trade , thus hiring more laborers , it is likely that their hiring will be less than the number of layoffs from the labor intensive firms . In summary , because the firm using a lot of machines tends to use capital rather than labor for its production the number of laborers it absorbs will likely be less than the number of ers the labor intensive firm fires . The overall outcome would be a rise in unemployment in the capital intensive country . In this instance , the increase in unemployment being described would imply that trading countries will frequently not be operating at their maximum point of productive possibilities . The notion of less than full employment is a concept that is , more often than not , the case across the entire global economy . The evidence of less than full employment is overwhelming . For example , over the last three decades ( as global free trade policies and agreements have expanded , not contracted ) ment rates across countries identified as economically advanced and developed ( countries such as the United States , Canada , japan , Germany , France , the United Kingdom , Australia , Sweden , and others ) unemployment rates have ranged from between a low of to as high as 25 . Additionally , in the rest of world , where the majority of the global population resides the absolute number of unemployed or laborers exceeds billion people . Clearly less than full employment is the norm , not the exception . A less than full employment outcome undermines the standard orthodox free trade story because countries at less than full employment can produce more of any two products while opportunity costs are zero . In the case of less than full employment , determine a comparative advantage is impossible because both products the lowest possible opportunity cost , zero . In a circumstance such as this , the orthodox free trade story is not capable of explaining the very real world situation of trade under conditions of less than full employment . Correcting the model to account for this imperfection

812 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER would require that the model assume that an action will be taken to push the economy back to full employment . Such actions could include government ( public ) policy measures designed to alleviate the unemployment that emerges as a result of trade . Even for many orthodox economists edging the less than full employment scenario is a justification for government action to mitigate the negative consequences associated with trade .

CHALLENGING FUNCTIONALITY A MORE PENETRATING CRITIQUE LEARNING By the end of this section , you will be able to Identify different radical of critiques of the orthodox free trade model Define the phrase factor endowments . Define the concept of an growth model . Explain that critiques of the orthodox free trade model are not only technical but also functional . Analyze ways in which the orthodox economic trade does not explain the real world . the model imperfections critiques often cite the idea that the orthodox theory , while too simple , still provides an approximation of the real world . More radical critiques of the orthodox free trade story argue that not only does the orthodox story not generalize to the actual world in which we live , but that the model also can not be modified to explain certain events or phenomena . For many more radical economists the usefulness of any economic model is how well it can explain the basic functioning of the economy . Failure to account for the actual functional of the economy can not be corrected by ad hoc assumptions . Instead , what is required , is an gether different theoretical structure . The following critiques reflect functional limitations associated with the orthodox trade story . limitations imply the failure of theory to adequately explain events relevant to the real world . Perhaps the theory is simply too narrow in scope and fails to account for other important economic considerations , such as economic growth or economic development . For example , the whole point of the orthodox comparative advantage story is to demonstrate trade between two countries improves the overall economic plight of both countries . Paradoxically , even as the immediate exchange benefits appear , the same theory can be utilized to also explain why the long term economic growth within both economies may be harmed as a result of free trade . In other words , trade is shown to make tries both better off and worse off ?

How is this possible ?

The answer is that it is probably not ble , therefore the functional usefulness of the orthodox economic trade story is called into question . THREE COUNTIES AND THREE PRODUCTS Perhaps no example of the limits to the applicability of the orthodox free trade story is more direct than the curious situation of three countries and three products . Given three countries and three commodities , it is not obvious that each country will have a clear lowest opportunity cost product to

814 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER produce . Absent a clear comparative advantage , what does a country do ?

If a country doesnt have a comparative advantage does it produce nothing ?

Does it produce all three products ?

Can the country without a comparative advantage refuse to engage in trade ?

Should the country just export its entire population , put up a border wall , and stop functioning ?

The orthodox presentation of the trade story can not answer any of these questions . The absence of comparative advantage is the absence of a explanation . Clearly this issue of three countries and three products is not the exception , but rather the rule . In the actual world where we there are over 200 hundred countries in the world and , potentially , millions of products . The comparative advantage story is not at all relevant to the actual world , and this proves to be a drastic failure of the orthodox economic model . Consider the table below COLOMBIA SCOTLAND PERU COFFEE 100 10 30 WOOL 50 40 30 SOYBEAN 60 20 30 The table represents a scenario in which there are three countries and three products . In the above table , one country will not have a comparative advantage in producing any of the products . The and letters highlighted in red indicate the comparison between two products and the point of lowest opportunity cost production which , recall , is the basis for comparative advantage . For ple , as can be seen above , Colombia has a comparative advantage in producing coffee relative to both wool and soybeans . In the case of coffee to wool , every unit of coffee produced requires that producing unit of wool . In the case of coffee to soybeans , for every unit of coffee produced of a unit of soybeans are foregone . No other producer of coffee can produce coffee at such a low opportunity cost . The reader should note , Colombia also has a comparative advantage in producing soybeans relative to wool , while Scotland has a comparative advantage in producing wool to soybeans and wool to coffee as well as soybeans to coffee . At no point does Peru ever have a advantage . So what should Peru do ?

The answers really are not remotely obvious with solutions becoming increasingly complex . Consider just one possible scenario . In one scenario , it can be argued that the only viable product that Peru could specialize in producing is soybeans . After all , because Colombia has a comparative advantage in coffee to wool and coffee to soybeans , and its coffee to wool ratio is better than its soybeans to wool ratio , Colombia may find it desirable to specialize in coffee production . Additionally , because Scotland has a comparative

PRINCIPLES or ECONOMICS 815 in wool to coffee and wool to soybeans , and its wool to coffee ratio is better than its wool to beans ratio , Scotland may find it desirable to specialize in wool production . In this case , Peru could , theoretically specialize in soybean production as neither Colombia nor Scotland are producing beans but the residents of those countries may want to consume soybeans so Colombia and land could then trade for soybeans and , as Peru is the only soybean producer , Colombia and Scotland would be forced to trade with Peru . The trouble with the Peru specializing in soybeans scenario is that it wouldn take Colombia and Scotland too long to realize that they are each better off producing some soybeans for themselves , because each can produce soybeans at a lower opportunity cost than can Peru . For example , if produced coffee and traded with Peru for Soybeans , the minimum price that Peru could charge Colombia for the soybeans would be unit of soybeans for unit of coffee . If Scotland decided to produce some soybeans to trade with Colombia for coffee , the minimum price Scotland could charge Colombia for soybeans is unit of soybeans for a unit of coffee . In this case Peru would simply not be able to compete with Scotland price . The same circumstance emerges with Scotland trading wool for soybeans with Peru . The lowest price Peru can charge Scotland for unit of soybeans is unit of wool . If Colombia decided to produce some soybeans to trade with Scotland for wool , the lowest price Colombia could charge is soybean for wool . Peru is , once again , not price competitive and Scotland and Colombia are better off trading with one another for soybeans than they would be ing with Peru for soybeans . COMPARATIVE ADVANTAGE AND CONSTANT RETURNS TO SCALE The comparative advantage story is based on an assumption of constant returns to scale . As a reminder , constant returns to scale implies that as a productive process grows , the returns in total output generated grows proportionally to the expansion of the productive process . In other words , if a production process doubles in size , then the amount of productive output will also double . The constant returns to scale concept is closely tied to the linear production possibilities frontier concept discussed above . After all , if a production possibilities frontier is linear , and all productive inputs ble , then the production possibilities frontier will shift outward proportionally , remaining parallel to the previous production possibilities frontier . The essential point to be grasped here is this , constant returns to scale imply that as production of one product increases The challenge associated with the concept of constant returns to scale is , what happens if returns to scale are not constant for producers ?

Orthodox economic theory provides a theoretical foundation for the idea that sometimes production processes experience increasing returns to scale . As a reminder , increasing returns to scale implies that as a production process expands , the associated increase in production expands by more than the growth of the production process . In other words , as a production process doubles its size it will more than double its output yielding a declining average total cost for the output as more output is produced . Under conditions of increasing returns to scale in production , the country that is the first to produce a commodity will develop a comparative advantage in the production of the commodity . The reason why the first producer of the product will have the comparative advantage is because as that country increases its production of the product , its costs of doing so will decline making it difficult for another country to compete with the first country to produce the product . In other words , one country will have a head start that other countries will not be able to competitively overcome . Presumably , where increasing returns to scale hold for production processes , the first producer of any product will have

816 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER a competitive advantage over all producers . In this situation , one country could come to dominate production throughout many industries leaving other countries to produce a limited range of other products . Of course , where increasing returns to scale applies the thought that one country can dominate duction may not be acceptable to other countries , particularly for countries attempting to develop economically . The implication is that countries need to protect their industries until those industries have increased their production to the point of increasing returns to scale and , thus , declining average costs of production emerge . Only when a producer has achieved low enough average total costs will it be able to compete effectively in global markets . ABSOLUTE COSTS ARE MORE IMPORTANT FACTOR EN One theme that emerged above when describing model imperfections is the notion that due to factor endowments , some countries are going to be more prone to a greater loss of employment from and trade than would other countries . The basis for the less than full employment ment was a byproduct of the concept of factor endowments . The concept of factor endowments is an idea that argues a country comparative advantage may be by which factors of tion the country has an abundance of and which are relatively scarce . A country is said to be factor endowed when it has a relative abundance of a given factor of production . When a country has an abundance of a factor of production , orthodox economics argues that the country will tend to products whose production processes are organized to require a lot of the factor of which the country has an abundance . Due to the relative low cost of the abundant factor , the country will likely have a comparative advantage in producing the product that which they have an abundance of the factor of production . So , for example , a country with an abundance of land will likely produce cultural products as land is the relatively low cost factor of production that the country is more endowed . Taken further , the factor endowment story goes so far as to argue that production processes will be modified to adjust to a country factor abundance and factor scarcity . For orthodox economics what this means is that if a country has an abundance of capital , then the products it produces will utilize an abundance of capital even if the same product can be produced elsewhere with an abundance of labor . Should labor be the factor of production that a country is relatively well endowed , then duction processes will be modified to include more labor and less capital , and so on , and so forth . Certainly , for some types of production , the factor endowment story will be relevant , which also makes the idea of a less than fully employed economy , as argued in the above , also vant . However , what happens when the product and the production process are inextricably linked ?

It is not at all uncommon for a production process to require the same combination of land , labor , and capital , regardless of where production takes place . So even if a country has a large supply of labor , and relatively cheap labor , this does not mean that firms will suddenly change their tion processes to take advantage of the cheap factor endowment . An example of this concept can be seen with a company like Boeing . Boeing produces commercial and military aircraft . The tion processes require a significant amount of technological how , with capital and labor being very specialized and highly skilled . Furthermore , the capital and technology employed in the tion of an airplane are very expensive . It is also a known fact that Boeing produces airplanes in the United States and China . In comparison to , the United States has an abundance of capital and China has an abundance of labor . If factor endowments were relevant , Boeing would

PRINCIPLES or ECONOMICS 817 produce its aircraft differently in China than in the United States . In China , Boeing would use more labor and in the United States Boeing would use more capital . In fact , Boeing uses the same tion of capital and labor in its production processes regardless of location of production . The to producing in China is , then , some reductions in absolute labor costs . In this scenario , absolute costs are far more important than some vague notion of opportunity cost . Furthermore , the labor cost reduction is not , however , necessarily significant because the overall costs of producing airplanes tend to be more closely tied to capital , due to the advanced capital and technology used in production , as opposed to overall labor costs . As such , if all of the other costs , such as transportation costs , are not favorable , then it may not be cost effective to produce airplanes in China as opposed to the United States . Either way , absolute costs , not opportunity costs , are oftentimes the most important nant of what is produced and where it will be produced . MARKETS ARE NOT STATIC So much of the orthodox free trade story seems to be built on a model that yields a surprising lack of choices for producers . After all a country is deemed to be endowed with an allotment of land , labor , and capital , and among those three factors of production the choice of what is produced is determined by which products can be produced at the lowest opportunity cost of production . In this scenario , the country does not choose its initial endowments of factors of production nor , at that point , is the try really making a choice as to what products to produce as the opportunity cost of production will depend on the country endowment of factors of production relatively to all other countries of factors of production . In essence , any country is relegated to being at the mercy of global circumstances and global markets . Being at the mercy of the market is an awfully risky proposition for many countries . A country better hope that what it specializes to produce and then trade will always be a desirable commodity . for many countries , the reality of global markets , where new technologies and changes in tastes and preferences arise on a regular basis , often times causes countries to suffer significant nomic hardship and economic development setbacks . But , are countries and their economies really at the mercy of a global market ?

If history is a guide , the answer to this question appears to be unequivocally , no . Many students evaluating the factor ment story outlined above might , for example , question why a given country would accept its factor endowment position ?

After all , factor endowments such as labor and capital are not , over time , static . Given time , populations tend to grow and countries will find that their allotment of capital stock will also tend to grow . It is not as though the United States was endowed with capital stock from some divine being and , as a result , is a capital intensive country . Any country could , presumably , develop a capital intensive economy . If so desired , countries have the power to where capital stock accumulates and toward what end that capital stock can and should be used . Under conditions such as this it appears as though countries have the power to direct their place in the global economy . Among advanced developed economies there are countless examples of industrial planning and trade protections , essentially market manipulations , being utilized to promote domestic economic and steer a country economic place in the global economy . In the and centuries countries such as Great Britain and the United States both utilized trade restrictions in an effort to support the development of domestic , high value added , industries , particularly manufacturing . Into and throughout the century , the United States as well as countries such as Germany , Japan , and South Korea have all also utilized trade restrictions and industrial planning policies . In the case of

813 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER War and Germany , trade restrictions and planning policies were utilized to allow domestic industries that had been destroyed during the war to themselves in their tive domestic markets . By the , the protective policies utilized by japan and Germany allowed both countries to engage in international export of products such as automobiles and electronics , stimulating an growth model . An growth model is the idea that a country can use trade surpluses , exporting more products than they import , to boost domestic economic ity , generate economic development , and improve the country international competitiveness in the global economy . Not to be left out , other countries , particularly in Asia , also recognized the benefit of nomic growth . South Korea , as one of the Asian Tigers , used trade protections to bolster and create a domestic electronics and automobile industry . Over time South Korean producers such as sung in electronics as well as and Kia in the automobile industry have become ally competitive and internationally recognizable producers . Another example is China . The Chinese economy , through use of targeted industrial planning , trade restrictions , and currency adjustments , has utilized an growth model . China has run consistent trade surpluses with the countries within the European Union as well as the United States . The results , since China Great Opening Up in 1978 , which began under then Chinese leader Deng Xiaoping , have been an economic boon for China . In the nearly forty years since 1978 , China has experienced consistent growth rates of 10 . A NOTE ON CHINA INCLUSION IN THE WORLD TRADE ORGANIZATION As of December 11 , 2001 , China has been a member of the World Trade Organization ( As noted by the policy think tank , the Economic Policy Institute ( EPI ) China inclusion in the has not been benign in terms of economic sequences . An EPI study suggests that 2001 and 2013 , China growth model and subsequent trade surpluses with the United States ( or US . trade deficits with China ) has caused the United States to lose million jobs , including million job losses in the manufacturing sector . GLOSSARY factor endowments a country comparative advantage may be by which factors of production the country has an abundance of and which are relatively scarce growth model the idea that a country can use trade surpluses , exporting more products than they import , to boost domestic economic activity , generate economic development , and improve the country international competitiveness in the global economy

AN ALTERNATIVE PRESENTATION OF INTERNATIONAL TRADE PATH DEPENDENCY LEARNING By the end of this section , you will be able to Define the term path dependence . Explain how a path dependency analysis of trade is different from the comparative advantage approach . Define the phrase factor endowments . Define the concept of an growth model . Analyze different real world examples that support the path dependency approach to understanding international trade . the critiques outlined above , many progressive and radical ( heterodox ) economists believe that the orthodox economic free trade theory is chronically incapable of addressing important , real world , concerns . Because of its failure to explain real world conditions , the orthodox model is also incapable of suggesting policy approaches that may be helpful in correcting many of the problems that emerge when trade between countries expands and grows . For example , in the orthodox world of free trade , any , and all , trade protections are perceived as inefficient and costly . As a result , if the real world provides evidence of the effectiveness of trade restrictions , a story built on the benefits of free trade can not and will not be functionally applicable . Using the free trade story in this regard would generate inaccurate analyses , failing to recognize that trade protections have had historic usefulness toward assisting an economy economic development . In this instance , the free trade story is of no functional use . What is needed , instead , is a different theory of how trade works . A sound theory of regarding trade should be able to demonstrate how trade may stimulate more economic growth or improve a country economic development prospects . Because theorists outside of the orthodoxy view the orthodox economic trade story as being limited in its real world applications , heterodox economists generally begin their trade story from a different perspective . For many heterodox economists , in the real world , specialization and trade are path dependent . Path dependence means that history matters . A given country productive is the byproduct of past circumstances , past decision making ( with respect to domestic nomic choices as well as the country place in the global economy ) Further a country economic development , its future productive possibilities and future economic position in the global economy , depends on the choices it makes in the present .

820 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER To follow the logic of comparative advantage , a country identifies its comparative advantage , and then trades . So if agricultural products are the only products that a country has a tive advantage producing , then the country will specialize in the production of agricultural products only and then trade for the other products that are desired . In response to this scenario , heterodox economists ask , for how long does a country only produce agricultural ?

After all , from an economic development standpoint it is well known that there is not a advanced developed economy that only produces agricultural products . In fact , the production of products in all advanced developed economies are overwhelming diverse . ECONOMIC DEVELOPMENT AND THE CASE FOR CONSCIOUS DIVERSIFICATION The United States is widely recognized for having one of the most diverse economies in the world . based firms produce agricultural products , light and heavy manufactured products , industrial products , pharmaceutical products , and so on and so forth . Aside from no longer being due to weather volatility or changes in consumer tastes and preferences , a diversified economy can better endure overall market volatility because some sectors may grow when others contract . as markets change , as new technologies emerge , a diversified economy is better apt to be able to find uses for new technologies and integrate those technologies into their economy . As a result , in the , diversification , rather than simple specialization and trade , is encouraged because diversification is an economic development strategy . as is noted by the critiques provided above , diversification can not be achieved by comparative advantage and a free trade environment . By evaluating trade through a lens of path dependency , heterodox economists are able to correct for some of real world limitations associated with the orthodox free trade story . For example , the very nature of path dependency requires strategic thinking and public policy planning on the part of tries and their governments . Countries will often target industries for protection from international competition because they see an industry as generating a added , high income , and employment outcome for their economy . The automobile industry is an example of industry where countries have been apt to enact policies to encourage both domestic production as well as foreign direct investment into the production of automobiles . Countries such as , Egypt , and Malaysia all have developing internal domestic automobile producers . Additionally , China is the worlds largest producer and consumer of automobiles with production being generated by a large number of foreign firms such as Volkswagen and General Motors as well as the domestic Chinese producer , The benefit of having a viable domestic automobile industry is that mobiles are one of the highest value added products in the world . If a country can produce automobiles to meet even just some of its internal consumer demand for automobiles , then the country will be retaining valuable domestic expenditures in the form of valuable domestic income . Finally , a path dependency approach to examining trade between countries empowers the heterodox economist to understand why some countries have had more relative success than others with respect to economic development . By thinking of trade as a result of path dependency , the role of trade restrictions , industrial planning , and targeted competition can reveal to the theorist tactics and approaches that have successful enhanced economic development or , alternatively economic development . As a result , the fact that advanced developed economies have a history of managed trade , rather than free trade , can be understood as strategic decision making . Undoubtedly , advanced developed economies owe some of their economic position to the strategic trade choices that they made in the past . Furthermore , the recent success of a country like China can also be explained as

PRINCIPLES OF ECONOMICS 821 being related to the strategic , State planned and managed , trade decisions that the Chinese ment has implemented . Finally , the path dependency approach can also be utilized to explain why persistent free trade policies have also been use to undermine the economic development of many countries , exacerbating persistent inequalities between countries .