International Trade

A textbook example: in Mankiw, the rancher produces everything faster than the farmer. But for one ounce of potatoes, the farmer gives up a quarter of an ounce of meat, the rancher half an ounce. So the farmer grows the potatoes and the rancher mostly raises the meat; both gain if they trade at a price between these two opportunity costs, for example a third of an ounce of meat per ounce of potatoes. The idea goes back to David Ricardo, in 1817, with the example of English cloth and Portuguese wine.

The exchange rate matters: a falling currency can make exports cheaper for foreigners and imports more expensive; the balance can then improve if quantities respond enough, sometimes after first deteriorating (the J-curve). But much of world trade is invoiced in dollars: in the short run, for many countries, it is mainly the dollar exchange rate that matters (Gopinath et al., 2020).

A deficit is not a loss in itself: in the textbook model, where saving is calculated from output, a deficit in trade in goods and services equals the gap between what the country saves and what it invests (NX = S − I). The country then borrows from abroad or sells foreigners financial assets (shares, bonds, companies), which can finance useful investment. In this model, in the long run, it is this gap, not the exchange rate, that sets the balance: the exchange rate adjusts until the balance equals this gap.

A tariff has a price: it protects a sector, but makes products more expensive for buyers, including firms that buy parts abroad, and can trigger retaliation.

Countries also trade similar products: France both sells and buys cars. Between countries with similar costs, such as France and Germany, comparative advantage explains this trade poorly. Krugman's model (Nobel Prize 2008) rests on two assumptions. First, designing a car model and equipping a factory is expensive: the more a carmaker builds, the less each car costs it (economies of scale). It therefore pays to produce few models, in long production runs, rather than a little of everything. Second, buyers do not all have the same tastes: some French buyers prefer a German model, some German buyers a French one (taste for variety). Each country thus sells its models abroad and buys those of others. The gain is not Ricardo's: buyers have more choice, and each model, sold in a larger market, can cost less to produce. Between developed countries, a large share of trade is of this kind.

The country can gain without every region gaining: the model assumes that workers and machines move easily from one activity to another. In the United States, competition from Chinese imports is estimated to have cost 2 to 2.4 million jobs from 1999 to 2011, across the whole economy (Acemoglu et al., 2016); in 2019, nearly a decade after the peak of this competition, the affected regions were still feeling its effects (Autor, Dorn and Hanson, 2021).

Foreigners do not always pay the tariff: according to one study, the 2018 US tariffs were fully passed through to the prices paid by US importers (Amiti, Redding and Weinstein, 2019). As a result, tariffs are partly passed on indirectly to consumers. These tariffs then raise the price level once: prices rise faster for a while, without this necessarily turning into lasting inflation.

A deficit does not always weaken the currency: in 2022, the US deficit in trade in goods and services reached about $900 billion, a record at the time, and the dollar its highest level against major currencies since the early 2000s. The two go together: capital drawn by rising US interest rates and by safe assets pushed up the dollar, and these capital inflows are, by construction, the counterpart of the current account deficit, most of which is the deficit in trade in goods and services.