PAGE ONE Economics TEACHER EDITION. Does International Trade Create Winners and Losers?

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1 TEACHER EDITION Page One Economics is an informative accessible essay on timely economic issues. The Teacher Edition provides the essay; student questions with answers; and additional lesson ideas for classroom, extra credit, or make-up assignments. The Student Edition includes the essay and student questions; National Common Core State Standards (see pages 8-9) November 2017 Does International Trade Create Winners and Losers? Scott A. Wolla, Ph.D., Senior Economic Education Specialist Anna Esenther, Economic Education Intern

2 Does International Trade Create Winners and Losers? Scott A. Wolla, Ph.D., Senior Economic Education Specialist Anna Esenther, Economic Education Intern GLOSSARY Domestic: Inside a particular country. Economies of scale: Factors that cause a producer s average cost per unit to fall as output rises. Exports: Goods or services that are produced domestically but sold abroad. Imports: Goods or services that are produced abroad but sold domestically. Productivity: The ratio of output per worker per unit of time. Services: Actions that can satisfy people s wants. Standard of living: A measure of the goods and services available to each person in a country; a measure of economic wellbeing. Also known as per capita real GDP (gross domestic product). It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry. Adam Smith, The Wealth of Nations Is trade good for Americans? People seem largely divided on the issue. A 2017 poll found that only 52 percent of Americans feel that trade agreements between the United States and other countries are good for the United States. 1 However, unlike the general population, economists are overwhelmingly supportive of trade. A 2014 poll found that 93 percent of economists agree that past major trade deals have benefited most Americans. 2 Given the consensus among economists, why is international trade, and the free-trade agreements that make it possible, so controversial? Many people suspect that international trade operates as a zero-sum game. That is, they think it is like a sporting event a competition with rules that ends with a winner and a loser. Specifically, people sometimes think that if our trading partners are gaining through international trade, the United States must be losing. In this view, exported goods represent a win for the economy and imported goods represent a loss for the economy. This idea is nothing new; it dominated economic and political thought from the sixteenth to eighteenth centuries. Known then as mercantilism, it led to government policies that encouraged exports and discouraged imports. One of Adam Smith s purposes in writing The Wealth of Nations (which helped establish economics as a distinct academic discipline) was to dispel the zero-sum game myth behind mercantilism. The Costs and Benefits of Trade In spite of people s apprehension about trade, both imports and exports are at all-time highs (see the figure). As such, it s important to understand why economists believe trade is good. Think back to the thriving trade in your elementary school cafeteria. Perhaps a friend across the table offered November 2017 Federal Reserve Bank of St. Louis research.stlouisfed.org

3 Federal Reserve Bank of St. Louis research.stlouisfed.org 2 Imports and Exports on the Rise SOURCE: FRED, Federal Reserve Bank of St. Louis; accessed September 9, to trade her bag of grapes for your stack of crackers. You considered the costs and benefits of the transaction: The cost of the trade was the stack of crackers you would give up, and the benefit of the trade was the bag of grapes you would gain. Of course, you traded only if the perceived benefits (grapes gained) outweighed the perceived costs (crackers lost). And your friend agreed only if the perceived benefits (crackers gained) outweighed the perceived costs (grapes lost). Here is the economic lesson: For trade to occur, it must make both parties better off. This is a positive-sum game, not a zero-sum game, because both sides gain. However, this does not mean that everyone is better off. The costs and benefits of trade extend beyond the actual buyer and seller in the transaction. And, once third parties are included, it is clear that trade can create winners and losers. The Winners Just as the cafeteria trade demonstrated, both buyers and sellers benefit from trading. With international trade, the winners include consumers (buyers) and domestic companies that export goods (sellers). First, let s discuss the benefits to buyers. Consumers see the benefits of trade in terms of variety and price. International trade ensures that consumers have access to a larger variety of goods and services. Think about some of the imported goods and brands that you buy on a regular basis. If imports were not available, your options would be more limited than they are now. In addition, many people buy imported goods and services when the prices of those imports are lower than the prices of domestic goods and services. This often occurs when producers in foreign countries can produce these goods and services at a lower cost than domestic producers. These lower costs often translate into lower prices, which benefit consumers by stretching their purchasing power. In addition, the competition provided by imported goods provides incentives for domestic producers to keep improving the quality of their goods while keeping prices low. Domestic sellers also benefit from trade. Domestic companies that export have the world as their marketplace, not just the domestic economy. Producing for this larger market gives them the opportunity to grow and produce on a larger scale. These economies of scale enable them to take advantage of efficiencies and produce goods at a lower average cost. The lower production costs help make the companies more competitive and can result in lower prices for consumers. Benefits of trade extend beyond the immediate buyers and sellers. Countries that engage in international trade benefit from economic growth and a rising standard of living. This occurs in two ways. First, trade gives countries access to physical capital (technology, tools, and equipment) that they might not produce domestically. This physical capital often results in increased productivity,

4 Federal Reserve Bank of St. Louis research.stlouisfed.org 3 which is a key driver of economic growth and a rising standard of living within a country. 3 Second, access to global markets also increases export opportunities for developing economies. For example, China has become a manufacturing powerhouse 4 and India has become a leader in exporting services. 5 Both countries have experienced growth and development that might not have happened without access to global markets. Economists suggest that trade provides an avenue for the poorest nations to escape poverty. Recent research suggests that the removal of trade barriers could close the income gap between rich and poor countries by 50 percent. 6 The Losers At its core, international trade is similar to the cafeteria exchange both buyers and sellers trade because both benefit from the transactions. Third parties, however, need to be taken into account because some are worse off from international trade. The most obvious third-party losers are companies that sell products that cannot compete in a global marketplace. These companies must find ways to make their products competitive or produce other products, or they risk going out of business. When businesses shut down, people lose jobs. This is painful for workers because many of them must learn new job skills to find new employment. Net Benefits of Trade Economists find that after taking both the winners and losers into account trade has net benefits for society. In other words, the benefits outweigh the costs. This does not seem obvious to many people because the costs are often more visible than the benefits. For example, it is relatively easy to identify businesses or industries that have shut down because of trade. Likewise, it is relatively easy to identify people who have lost jobs in those industries. Perhaps you know someone who has lost a job in this way. However, it is more difficult for consumers to identify how much cheaper their car, clothing, and food are because of international trade. In addition, the lower prices paid by consumers and businesses mean they have more money to spend on other goods and services. As a result, there are businesses that have experienced more growth as a result of that spending, which would not have happened without trade. But, again, those gains can be difficult to identify. Policy Solutions Those who suspect that trade might be hurting the economy sometimes propose protectionist measures, which are policies designed to protect workers from foreign competition (see the boxed insert). While these measures might save some jobs and industries, when trade volume is reduced, so are the benefits of trade. Economists often suggest policies that preserve the benefits of trade while addressing the costs, by compensating those who lose from trade. For example, many economists suggest that international trade should be left largely unregulated but that government should subsidize job-skills training programs for workers who have lost their jobs because of trade. The Trade Adjustment Assistance Program administered by the U.S. Department of Labor operates on this idea. 7 In this way, the benefits of trade are preserved, but policy addresses the needs of those negatively affected by trade. Conclusion Types of Trade Barriers Trade barriers, as the name might imply, are policies designed to make it more difficult to conduct international trade. These are often referred to as protectionist policies because they are intended to protect workers in industries that are threatened by imported goods. Tariff refers to a tax imposed by a nation on an imported good. This tax increases the price of the imported good and can give the competing domestic good a relative price advantage. Import quota refers to a limit imposed by a nation on the quantity (or total value) of a good that may be imported during a given period of time. Because this quota limits the number of imported goods, it reduces the potential damage to threatened domestic industries. Export subsidy refers to a government payment to a domestic producer that reduces production costs, which enables domestic producers to charge a lower price (and sell more exports) in world markets. Voluntary export restriction refers to self-imposed limitations on the number of products shipped to a particular country. Nations voluntarily impose these limits on themselves to reduce the chances of other countries setting up trade barriers that might be more damaging. People trade because it will make them better off. This is true in school cafeterias as well as in the global marketplace. Trade enables countries to experience economic

5 Federal Reserve Bank of St. Louis research.stlouisfed.org 4 growth and a rising standard of living by increasing access to physical capital and export markets. However, not everyone is better off as a result of international trade. Some domestic businesses and industries fail in the face of foreign competition, which results in job losses for workers. Economists suggest, however, that policy solutions that impose trade barriers are harmful to the economy. Rather, they propose policies such as those that provide job training programs to assist those displaced by trade. n Notes 1 Jones, Bradley. Support for Free Trade Agreements Rebounds Modestly, But Wide Partisan Differences Remain. Pew Research Center, April 25, 2017; 2 Responses are weighted by each expert s confidence. See IGM Forum. Fast- Track Authority. November 11, 2014; 3 Santacreu, Ana Maria. Convergence in Productivity, R&D Intensity, and Technology Adoption. Federal Reserve Bank of St. Louis Economic Synopses, 2017, No. 11; 4 Wen, Yi and Fortier, George E. The Visible Hand: The Role of Government in China s Long-Awaited Industrial Revolution. Federal Reserve Bank of St. Louis Review, Third Quarter 2016, 98(3), pp ; 5 Kapur, Devesh and Ramamurti, Ravi. India s Emerging Competitive Advantage in Services. Academy of Management Perspectives, May 2001, 15(2), pp Mutreja, Piyusha; Ravikumar, B. and Sposi, Michael J. Capital Goods Trade and Economic Development. Working Paper No , Federal Reserve Bank of St. Louis, February 2016; 7 U.S. Department of Labor Employment and Training Administration. Trade Adjustment Assistance Program for Workers Program, Fiscal Year accessed September 9, Please visit our website and archives for more information and resources. 2017, Federal Reserve Bank of St. Louis. Views expressed do not necessarily reflect official positions of the Federal Reserve System.

6 Federal Reserve Bank of St. Louis research.stlouisfed.org 5 Name Period Federal Reserve Bank of St. Louis Page One Economics : Does International Trade Create Winners and Losers? After reading the article, complete the following: 1. Explain why international trade is not a zero-sum game. 2. International trade does not necessarily make everyone better off there are winners and losers. a. Who are winners from international trade? b. How can the benefits of international trade extend beyond the buyers and sellers in trade transactions and benefit a whole country? c. Who are losers from international trade? 3. Why is it easier to identify the costs than the benefits of international trade? 4. Trade barriers are often suggested as a method of protecting workers from foreign competition. a. Why do economists generally advise against using trade barriers? b. What is one way the government helps those who are harmed by international trade?

7 Federal Reserve Bank of St. Louis research.stlouisfed.org 6 Teacher s Guide Federal Reserve Bank of St. Louis Page One Economics : Does International Trade Create Winners and Losers? After reading the article, complete the following: 1. Explain why international trade is not a zero-sum game. Because trade makes both parties better off, it is a positive-sum game, not a zero-sum game. 2. International trade does not necessarily make everyone better off there are winners and losers. a. Who are winners from international trade? Consumers are winners if it allows them to pay lower prices and choose from a greater variety of goods and services. Domestic companies are also winners if it provides them a larger market to sell to, which would allow them to benefit from economies of scale. b. How can the benefits of international trade extend beyond the buyers and sellers in trade transactions and benefit a whole country? Countries that engage in international trade benefit from economic growth and a rising standard of living. First, it gives countries access to physical capital that they might not produce domestically. Second, it provides access to global markets. c. Who are losers from international trade? Domestic companies are losers if their products can t compete in the global marketplace. Employees can be losers, too, if these companies shut down and their jobs are lost. 3. Why is it easier to identify the costs than the benefits of international trade? The costs are often more visible than the benefits. For example, it is relatively easy to identify businesses or industries that have shut down and people who have lost jobs due to international trade. It is more difficult, however, to identify how much cheaper goods and services are and how much more economic activity has occurred because of international trade. 4. Trade barriers are often suggested as a method of protecting workers from foreign competition. a. Why do economists generally advise against using trade barriers? While trade barriers might save some jobs and industries, when trade volume is reduced, so are the benefits of trade. b. What is one way the government helps those who are harmed by international trade? It subsidizes job-skills training programs through the Trade Adjustment Assistance Program.

8 Federal Reserve Bank of St. Louis research.stlouisfed.org 7 Additional Resources Econ Lowdown of the Federal Reserve Bank of St. Louis provides numerous economic education resources for teachers to use with their students. These include lesson plans, online modules, interactive whiteboard lessons, podcasts, and videos. These free resources are available at Use the Econ Lowdown classroom resources listed below to help teach about topics related to this issue of Page One Economics. To register your students for the online course, on the Econ Lowdown website (linked above), click the TEACHERS button to create or access your account and visit the Instructor Management Panel. International Trade: Making Sense of the Trade Deficit (Page One Economics Teacher and Student Editions) As Adam Smith said, everyone lives by exchanging. They exchange buy and sell to make themselves better off. Does the same principle apply to international trade? Do nations benefit from importing and exporting? This Page One Economics explains the basics of international trade and its importance to the economy. Comparative Advantage Online Course for Teachers and Students In this course, you will meet Jack Of All Trades, a most awesome superhero. In all tasks, Jack can do everything better and faster (he has absolute advantage), but does that mean he must do everything while the rest of the people stand around helplessly? Find out if justice is served when a formerly idle citizen, Andy, wades through the depths of opportunity cost and the benefits of comparative advantage. The Global Economy: It s a Small World After All (Page One Economics Classroom Edition) To understand why people trade, suppose you were limited to consuming only items you could find within walking distance of your house. Or, perhaps even worse, only items you could produce yourself. For most of us, this restriction would severely diminish the variety of goods and services we enjoy on a daily basis. This Page One Economics explains that the simple reason people (or entire countries) trade is to enjoy a wider variety of goods. Why Are Some Countries Rich and Others Poor? (Page One Economics Teacher and Student Editions) Over 200 years ago, Adam Smith attempted to explain why some nations are wealthier than others. Today, the gap between rich and poor countries is even larger. This Page One Economics describes how total factor productivity contributes to economic growth and how growth leads to a rising standard of living.

9 Federal Reserve Bank of St. Louis research.stlouisfed.org 8 National Standards Common Core State Standards English Language Arts Standards Reading Informational Text Key Ideas and Details RI : Determine a central idea of a text and analyze its development over the course of the text, including how it emerges and is shaped and refined by specific details; provide an objective summary of the text. RI : Cite strong and thorough textual evidence to support analysis of what the text says explicitly as well as inferences drawn from the text, including determining where the text leaves matters uncertain. Grades 6-12 Literacy in History/Social Studies, Science, and Technical Subjects History/Social Studies Key Ideas and Details RH : Cite specific textual evidence to support analysis of primary and secondary sources, connecting insights gained from specific details to an understanding of the text as a whole. RH : Determine the central ideas or information of a primary or secondary source; provide an accurate summary that makes clear the relationships among the key details and ideas. Integration of Knowledge and Ideas Writing RH : Integrate and evaluate multiple sources of information presented in diverse formats and media (e.g., visually, quantitatively, as well as in words) in order to address a question or solve a problem. Research to Build and Present Knowledge WHST : Conduct short as well as more sustained research projects to answer a question (including a self-generated question) or solve a problem; narrow or broaden the inquiry when appropriate; synthesize multiple sources on the subject, demonstrating understanding of the subject under investigation. Voluntary National Content Standards Standard 5: Trade Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation, and among individuals or organizations in different nations. Benchmarks: Grade 8 1. When people buy something, they value it more than it costs them; when people sell something, they value it less than the payment they receive. 2. Free trade increases worldwide material standards of living. 4. Despite the mutual benefits from trade among people in different countries, many nations employ trade barriers to restrict free trade for national defense reasons, to protect key industries, or because some companies and workers are hurt by free trade. 5. Imports are foreign goods and services that are purchased from sellers in other nations. 6. Exports are domestic goods and services that are sold to buyers in other nations. 7. Voluntary exchange among people or organizations gives people a broader range of choices in buying goods and services.

10 Federal Reserve Bank of St. Louis research.stlouisfed.org 9 Benchmark: Grade When imports are restricted by public policies, consumers pay higher prices and job opportunities and profits in exporting firms may decrease. Standard 15: Economic Growth Investment in factories, machinery, new technology, and in the health, education, and training of people stimulates economic growth and can raise future standards of living. Benchmarks: Grade 8 1. Standards of living increase as the productivity of labor improves. 4. Increases in productivity can result from advances in technology or increases in physical or human capital. Benchmarks: Grade Economic growth is a sustained rise in a nation s production of goods and services. Long-term growth in output results from improvements in labor productivity and increases in employment. It varies across countries because of differences in investments in human and physical capital, research and development, technological change, and from alternative institutional arrangements and incentives. 2. Historically, economic growth that raises per capita output has been a vehicle for alleviating poverty and raising standards of living.