Comparing the advantages in international trade
In March 1990, Associate Dean Alan V. Deardorff shivered in a cold passenger jet on a runway in Alpena, MI. He was seated with his son and his son's friend, in the midst of a plane full of people anxious to escape. They were all waiting for the signal that it was OK to slide down the inflatable emergency chute to the tarmac.
Deardorff, professor of economics and public policy and the John W. Sweetland Professor of International Economics, lived to tell the tale. He says once was enough, though: "It was cold! We had to wait for a long time before we were told to go down the slide. And we were all in our stocking feet so that our shoes wouldn't rip the slide! I don't think I'd do it again!
"My son might, though."
It wasn't a near-death experience. It was the filming of a sequence for the movie Die Hard 2: Die Harder. The Deardorffs were extras and their motivation was the younger Deardorff's interest in movie making. The reason some scenes were filmed in Alpena might be described by trade economist Deardorff as the airport's "comparative advantage"—snow and frigid temperatures.
Deardorff and trade economists tend to believe that international free trade will sort itself out based on comparative advantage. Americans produce goods that we're efficient at making, due to our natural resources, human resources, capital, knowledge, etc. Other countries will produce a different set of goods, and we'll trade with one another.
For example, the United States produces lots of automotive parts. Country X produces apparel. We sell our car parts to country X because we have more than we need and we produce them at a low enough cost that we can sell for a profit. Country X is in a similar position vis-à-vis apparel.
Alpena's advantage in March 1990 was in comparison to Moses Lake, WA, where Die Hard 2's airport scenes were originally going to be filmed. That year, Moses Lake had rain. Alpena had snow.
There are always winners and losers in trade. "Free trade provides the stuff we want, goods and services, at low cost. The goods can be obtained more cheaply and therefore we can get more of them," says Deardorff. "But no responsible economist would say that there aren't losers."
According to the Alpena Chamber of Commerce in 1990, the Die Hard 2 production pumped $1 million into the local economy. That's $1 million that didn't go to the Moses Lake economy. Winner: Alpena. Loser: Moses Lake.
The North American Free Trade Agreement (NAFTA), signed by the United States, Canada, and Mexico in 1994, provides an international example. Corn is a traditional mainstay of the Mexican diet. Before NAFTA, Mexico's corn farmers struggled to meet the demand, often growing corn in small plots and in difficult-to-farm terrains.
After NAFTA, U.S. corn, grown in the endless fields of the Midwest and planted and harvested by giant machines, was available at a lower cost to Mexico than their domestic corn. Corn prices dropped in Mexico, meaning that the relatively poor Mexican farmer had to lower the prices of the corn he raised and sold, or leave the land for the city.
International free trade, by itself, is beneficial, says Deardorff. "This doesn't mean it won't hurt someone. We argue that a trade policy is desirable if it benefits the winners so much that they could, in principle, compensate the losers and still be better off. In that sense, we recommend policies if they stand to increase the aggregate welfare of an economy."
But there are inevitable complications. The example of our corn trade with Mexico, for instance, is not as simple as it initially appears. The relatively low price of our corn is somewhat artificial, in that it depends on agriculture subsidies from the federal government.
These subsidies also relate to one of the obstacles preventing successful negotiation of the latest World Trade Organization's (WTO) multilateral trade agreement. The WTO's predecessor, the General Agreement on Tariffs and Trade (GATT), has successfully negotiated eight sets of agreements since World War II. The agreements provide fundamental terms for trade among the 159 WTO-member countries.
The Doha Development Round (so named because the meetings were initiated in Doha, Qatar) began in 2001 and was intended to focus on improving the trading prospects of developing countries. Among the issues that have resisted resolution is agricultural trade. Deardorff says that part of the problem is that developing countries are intimidated by our tremendous and government-subsidized agricultural productivity and fear how their domestic interests would compete with U.S. and European agriculture if trade barriers were reduced. And yet the United States and Europe are unwilling to eliminate their subsidies.
Deardorff, who made an international name for himself early in his career by developing, with Robert M. Stern, a model to predict the effects of trade changes due to the Tokyo Round of Multilateral Trade Negotiations in the 1970s, is not optimistic about a successful negotiation of the Doha Round. However, he says, the smaller, more local trade agreements like NAFTA, are thriving. "So many countries are negotiating free trade agreements with other countries—there are hundreds of them— that we're moving in a direction where we may end up with every country having an agreement with every other country. That's pretty close to the idea of multilateral free trade."
Recently, Deardorff has been examining one of the ways in which free trade agreements (FTAs) differ from global free trade. An FTA eliminates tariffs among the countries signing the agreement, however tariffs against other countries remain. "If countries participating in a free trade agreement have different tariffs, this is a problem," says Deardorff.
For example, the U.S. tariff on light trucks is normally 25 percent—a truck from Japan would be subject to this tariff, but because of our FTA, a truck from Mexico would not. If Mexico's light-truck tariff is smaller than ours, what's to stop canny traders from shipping Japanese trucks through Mexico to evade the U.S. tariff?
The answer is something called Rules of Origin. These define where a product originates and stipulate the specific tariff policy. This is not a simple process as most products are constructed of parts from numerous countries. While the basics of an FTA may be brief, the agreements pertaining to Rules of Origin can be hundreds of pages in length. Deardorff has been examining these negotiated agreements to see how they interact with one another and what happens when countries are in overlapping trade agreements.
Below is a formatted version of this article from State & Hill, the magazine of the Ford School. View the entire Spring 2013 State & Hill here.