Many other nations have lower labor costs than the United States, which
allows them to export goods that require a lot of labor, such as shoes,
clothing, and textiles. But even in trading with other industrialized
countries—whose workers are similarly well educated, trained, and highly
paid—the United States finds it advantageous to export some high-tech
products or professional services and to import others. For example, the
United States both imports and exports commercial airplanes, automobiles,
and various kinds of computer products. These trading patterns arise
because within these categories of goods, production is further
specialized into particular kinds of airplanes, automobiles, and computer
products. For example, automobile manufacturers in one nation may focus
production primarily on trucks and utility vehicles, while the automobile
industries in other countries may focus on sport cars or compact
vehicles.
Greater specialization allows producers to take full advantage of
economies of scale. Manufacturers can build large factories geared toward
production of specialized inventories, rather than spending extra
resources on factory equipment needed to produce a wide variety of goods.
Also, by selling more of their products to a greater number of consumers
in global markets, manufacturers can produce enough to make
specialization profitable.
The United States enjoyed a special advantage in the availability of
factories, machinery, and other capital goods after World War II ended in
1945. During the following decade or two, many of the other industrial
nations were recovering from the devastation of the war. But that
situation has largely disappeared, and the quality of the U.S. labor
force and the level of technological innovation in U.S. industry have
become more important in determining trade patterns and other
characteristics of the U.S. economy. A skilled labor force and the
ability of businesses to develop or adapt new technologies are the key to
high standards of living in modern global economies, particularly in
highly industrialized nations. Workers with low levels of education and
training will find it increasingly difficult to earn high wages and
salaries in any part of the world, including the United States.
B Barriers to Trade Despite the mutual advantages of global trade, governments often adopt policies that reduce or eliminate international trade in some markets. Historically, the most important trade barriers have been tariffs (taxes on imports) and quotas (limits on the number of products that can be imported into a country). In recent decades, however, many countries have used product safety standards or legal standards controlling the production or distribution of goods and services to make it difficult for foreign businesses to sell in their markets. For example, Russia recently used health standards to limit imports of frozen chicken from the United States, and the United States has frequently charged Japan with using legal restrictions and allowing exclusive trade agreements among Japanese companies. These exclusive agreements make it very difficult for U.S. banks and other firms to operate or sell products in Japan.
While there are special reasons for limiting imports or exports of
certain kinds of products—such as products that are vital to a nation’s
national defense—economists generally view trade barriers as hurting both
importing and exporting nations. Although the trade barriers protect
workers and firms in industries competing with foreign firms, the costs
of this protection to consumers and other businesses are typically much
higher than the benefits to the protected workers and firms. And in the
long run it usually becomes prohibitively expensive to continue this kind
of protection. Instead it often makes more sense to end the trade barrier
and help workers in industries that are hurt by the increased imports to
relocate or retrain for jobs with firms that are competitive. In the
United States, trade adjustment assistance payments were provided to
steelworkers and autoworkers in the late 1970s, instead of imposing trade
barriers on imported cars. Since then, these direct cash payments have
been largely phased out in favor of retraining programs.
During recessions, when national unemployment rates are high or rising,
workers and firms facing competition from foreign companies usually want
the government to adopt trade barriers to protect their industries. But
again, historical experience with such policies shows that they do not
work. Perhaps the most famous example of these policies occurred during
the Great Depression of the 1930s. The United States raised its tariffs
and other trade barriers in legislation such as the Smoot-Hawley Act of
1930. Other nations imposed similar kinds of trade barriers, and the
overall result was to make the Great Depression even worse by reducing
world trade.
C World Trade Organization (WTO) and Its Predecessors
As World War II drew to a close, leaders in the United States and other
Western nations began working to promote freer trade for the post-war
world. They set up the International Monetary Fund (IMF) in 1944 to
stabilize exchange rates across member nations. The Marshall Plan,
developed by U.S. general and economist George Marshall, promoted free
trade. It gave U.S. aid to European nations rebuilding after the war,
provided those nations reduced tariffs and other trade barriers.
In 1947 the United States and many of its allies signed the General
Agreement on Tariffs and Trade (GATT), which was especially successful in
reducing tariffs over the next five decades. In 1995 the member nations
of the GATT founded the World Trade Organization (WTO), which set even
greater obligations on member countries to follow the rules established
under GATT. It also established procedures and organizations to deal with
disputes among member nations about the trading policies adopted by
individual nations.
In 1992 the United States also signed the North American Free Trade
Agreement (NAFTA) with its closest neighbors and major trading partners,
Canada and Mexico. The provisions of this agreement took effect in 1994.
Since then, studies by economists have found that NAFTA has benefited all
three nations, although greater competition has resulted in some
factories closing. As a percentage of national income, the benefits from
NAFTA have been greater in Canada and Mexico than in the United States,
because international trade represents a larger part of those economies.
While the United States is the largest trading nation in the world, it
has a very large and prosperous domestic economy; therefore international
trade is a much smaller percentage of the U.S. economy than it is in many
countries with much smaller domestic economies.
D Exchange Rates and the Balance of Payments
Currencies from different nations are traded in the foreign exchange
market, where the price of the U.S. dollar, for instance, rises and falls
against other currencies with changes in supply and demand. When firms in
the United States want to buy goods and services made in France, or when
U.S. tourists visit France, they have to trade dollars for French francs.
That creates a demand for French francs and a supply of dollars in the
foreign exchange market. When people or firms in France want to buy goods
and services made in the United States they supply French francs to the
foreign exchange market and create a demand for U.S. dollars.
Changes in people’s preferences for goods and services from other countries result in changes in the supply and demand for different national currencies. Other factors also affect the supply and demand for a national currency. These include the prices of goods and services in a country, the country’s national inflation rate, its interest rates, and its investment opportunities. If people in other countries want to make investments in the United States, they will demand more dollars. When the demand for dollars increases faster than the supply of dollars on the exchange markets, the price of the dollar will rise against other national currencies. The dollar will fall, or depreciate, against other currencies when the supply of dollars on the exchange market increases faster than the demand.
All international transactions made by U.S. citizens, firms, and the
government are recorded in the U.S. annual balance of payments account.
This account has two basic sections. The first is the current account,
which records transactions involving the purchase (imports) and sale
(exports) of goods and services, interest payments paid to and received
from people and firms in other nations, and net transfers (gifts and aid)
paid to other nations. The second section is the capital account, which
records investments in the United States made by people and firms from
other countries, and investments that U.S. citizens and firms make in
other nations.
These two accounts must balance. When the United States runs a deficit on
its current account, often because it imports more that it exports, that
deficit must be offset by a surplus on its capital account. If foreign
investments in the United States do not create a large enough surplus to
cover the deficit on the current account, the U.S. government must
transfer currency and other financial reserves to the governments of the
countries that have the current account surplus. In recent decades, the
United States has usually had annual deficits in its current account,
with most of that deficit offset by a surplus of foreign investments in
the U.S. economy.
Economists offer divergent views on the persistent surpluses in the U.S.
capital account. Some analysts view these surpluses as evidence that the
United States must borrow from foreigners to pay for importing more than
it exports. Other analysts attribute the surpluses to a strong desire by
foreigners to invest their funds in the U.S. economy. Both
interpretations have some validity. But either way, it is clear that
foreign investors have a claim on future production and income generated
in the U.S. economy. Whether that situation is good or bad depends how
the foreign funds are used. If they are used mainly to finance current
consumption, they will prove detrimental to the long-term health of the
U.S. economy. On the other hand, their effect will be positive if they
are used primarily to fund investments that increase future levels of
U.S. output and income.
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