Pat Buchanan is currently campaigning to become the Republican representative in the next U.S. Presidential election. He is credited with striking a chord amongst the main stream, blue collar sector of the country. This is because he has based his economic platform on common myths about free trade and how it is the cause of the economic problems in the U.S. His theme is that layoffs and the closing of American plants are the result of foreign companies and countries taking advantage of easy access into U.S. markets which, in his opinion, is not being reciprocated abroad. This is how he accounts for the current trade deficit that the U.S. is running with countries like Japan. Pat’s economic platform regarding trade policy can be summarized as follows: * Impose a 10% tariff on Japanese imports and a 20% tariff on Chinese imports. This would generate, in his opinion, $20 billion in government revenue and reduce the trade deficit which could be reinvested into the American economy and help create tax cuts for small businesses. * Impose a social tariff on Third World manufactured goods to protect U.S. workers’ wage rates from the foreign laborers who are paid a fraction of what their U.S.
counterparts earn. He also resents that foreign companies do not have to adhere to the strict environmental, safety, and health standards that American firms do yet get free access to the U.S. market via GATT and NAFTA. It is evident that Pat Buchanan believes that trade deficits and trade with Third World countries are at the heart of what he perceives to be America’s economic problems. He feels that through tariffs the burden of income taxes paid by U.S. workers and small businesses can be shifted onto consumers who purchase foreign goods. His underlying sentiment about his trade restrictive policies is, “This is our land; America is our country; the U.S. our market. We decide who enters here and who does not.” The basis of international trade is that their are gains to be had from partaking in it. This was proven by David Ricardo, an economist in the early 19th century, who introduced the concept of comparative advantage. His theory stated that a country’s “absolute advantage (overall productivity differences between countries) should be reflected in differences in income, whereas comparative advantage (variations in productivity differences by sector) will determine the pattern of international trade.” A common misconception about free trade is that it is based on absolute advantage.
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Comparative advantage always is applicable when applied to international trade so it stands to reason that there will always be gains from trade. The existence of low wages in a country is not by itself a reason for the U.S. to fear trading with them. For one thing, wages generally reflect the productivity levels of workers. If low wages meant low costs then world trade would be dominated by Th! ird World countries and the U.S. would never export. The fact is that differences in technology cause labor productivity variances between countries which affects unit labor costs. A firm will tend to hire more workers until the value of the product that the last worker produces is equal to the cost of that worker. In the less developed countries low productivity, as a result of low levels of technology, is reflected in wages. The significant measure to determine which sectors a country has a comparative advantage is not wages, but unit labor costs. A country can have a comparative advantage in a sector even if it is more inefficient than any other country. This is because comparative advantage is based not on who is the best, but rather on where a country’s “margin of superiority is greater, or its margin of inferiority smaller”.
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As long as a poor country specializes in sectors where it is the least inefficient compared to a rich country then it will gain from trade. The Ricardian Model, based on differences in labor productivity, is best explained using a simple situation based on the following assumptions: two countries, one called Wealthy, the other Poor; two goods, jeans and sneakers; and labor is the only factor of production. Both countries have 40 hours of labor available but Wealthy has more advanced technology which gives it an absolute advantage in the production of both goods. These countries will benefit from trade because pre-trade relative prices differ. For this example assume that sneakers and jeans are traded in world equilibrium on a 1 for 1 basis and that there are constant returns to scale. Amount of labor JEANS SNEAKERS JEANS/SNEAKERS WEALTHY hours required to 1 2 1/2 POOR produce one unit 5 2.5 2 In analyzing the production possibility frontiers of each country it becomes apparent that Wealthy can produce only 1/2 a pair of sneakers in an hour. However, in that same hour, they could make one pair of jeans and trade with Poor for one pair of sneakers.
Thus, they will gain from trade with their less technologically advanced partner by specializing in the production of jeans. Poor can make 1/5 of a pair of jeans in an hour or produce 1/2.5 of a pair of sneakers which can be traded for 1/2.5 of pair of jeans on the world market. Therefore, through trade both countries are using their labor twice as efficiently than when they had closed economies. This results in gains being realized from trade. The U.S. signed NAFTA and became trading partners with Mexico much to the chagrin of Pat Buchanan. His opinion, and it is a common one, is that U.S. companies will relocate to Mexico where wages and employee benefits are a fraction of what American workers earn and environmental regulations are quite lax. It is for this reason that he feels it is impossible to compete with Third World countries and a tariff must be imposed on them for their social injustices. Buchanan should be asking himself what causes American firms to relocate in Third World countries and is it really a problem worth addressing. From a humanitarian perspective it is concerning that some countries are attracting companies due to the lack of regulation in their manufacturing industry.
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It is not an appealing thought to think that a country’s comparative advantage is sweatshop labor and unregulated pollution. However, it is a misconception to think that trade is only beneficial if both countries receive ! high wages. Whether these companies relocate because of low wages or higher productivity is irrelevant. The reality is that it is cheaper for America in terms of its own labor to trade for these goods than produce them. The root of the low-skilled job migration problem lies in the fact that America has a highly skilled labor force. Most politicians and economists would say that this is an enviable position to be in because the global economy has a scarcity of skilled labor. This translates into high wages since there is more demand than supply in the world for high-skilled labor. However, some sectors of the American economy are based on labor intensive, low-skilled labor. In the U.S. there is a relative shortage of low-skilled workers so they receive a relatively higher wage than the world wage for low-skilled labor. It is therefore more efficient for companies who use low-skilled labor to move their operations to countries that have an abundance so that they can reduce their labor cost per unit.
Labor productivity is the real reason behind why firms are relocating. Buchanan should recognize that by trying to preserve jobs that Third World countries can perform more efficiently, he is! actually weakening the very country he is trying to strengthen. Every country has a comparative advantage in producing certain goods. If a Third World country has a comparative advantage in certain labor intensive industries due to their low wages then America should not focus their efforts in these sectors. It is important to take into account the productivity of foreign workers when analyzing wage rate discrepancies between countries. The Ricardian model has shown that there is a correlation between labor productivity and comparative advantage. All countries have limited resources which limits the amount that they can produce. Therefore, the U.S. must decide where to allocate its factors of production and it faces a trade-off in that when it produces more of one good it will produce less of others. In choosing which goods to produce the U.S. will have to take into consideration what its products can be traded for on international markets. This results in them choosing to produce goods that have a relatively high value in world mar! kets and abandoning the production of goods that consequently have a relatively low trading value.
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The U.S. should be specializing in the production of goods whose relative price exceeds the opportunity cost foregone by not producing alternative goods. It is currently accomplishing this by letting various sectors of its economy, like the textile industry, migrate to Third World countries like Mexico. The relative labor productivity between the U.S. and Mexico across industries will lead to them specializing in the production of different goods. A country like the U.S. has an absolute advantage in production of all goods and yet the Ricardian model proves that it still gains from trade because of comparative advantage. It is neither efficient nor economical for the U.S. to try and protect industries that can be done relatively less expensively in other countries. It is cheaper for the U.S. in relation to its labor force to produce high value goods and trade for lower valu! e goods than to try and produce them both. The free market will guide private enterprise toward industries where the returns are higher and with higher returns comes higher wages. Focusing on industries that produce goods with a relatively high trading value allows individuals to maximize their earnings, and this is consequently reflected in their wage rate.
This is the second argument against protectionism, especially in low wage, low-skill sectors of industry where Third World countries are attracting U.S. companies. The Stolper-Samuelson theory states that trade affects relative prices and that the real return to the factor used intensively in the production of a good (labor) will increase accordingly and the return of the other factor which is used scarcely will decrease. According to this model trade has a significant impact on income distribution within the countries involved. This can be seen in the U.S. where the low skill, low wage jobs are being lost to Third World countries who have an abundance of these workers. At the same time the U.S. has an abundance of high-skill, high-wage jobs and this is resulting in a serious gap between the up! per and lower classes of American society. Pat Buchanan has gained favor with the lower classes because he wants to apply tariffs to Third World countries and try and protect American jobs from being relocated to other countries. There are serious long term ramifications to a country who holds onto industries that are no longer competitive in the global economy. It is a painful process when layoffs occur and jobs move south of the border where most Third World countries are situated but it is necessary for the further development of the American Economy.
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Imports and foreign competition have taken a lot of jobs from U.S. workers but this economic change is also creating millions of jobs at the same time. These new jobs are in small businesses, not the highly visible sectors of the economy like steel mills or auto plants. None-the-less they are where the future lies and they offer higher wages and require new skills. Trade has shifted industry from the assembly lines into complex products with specialized designs a! nd relatively short life cycles which require skilled workers. Through importing, competition has increased and this “forces firms to be more productive, and that desperate drive for productivity makes the entire economy more dynamic.” . A dynamic economy has lower inflation due to intense competition and gives consumers more variety to choose from in stores. Furthermore, since low-wage workers spend a higher percentage of their income at the store than the high-wage workers they see a greater proportion of their earnings being saved as less is going towards necessities like food. Buchanan should focus his attention on the real problem at hand which is the retraining of those workers who currently find themselves in low skill jobs.
The Stolper Samuelson effect has shown that low skilled labor is earning less while statistics show that skilled labor wages have risen. The next logical move is to try and close the gap by retraining workers for the demands required of them i! n today’s work environment America’s current account deficit with Japan has received a lot of press coverage and been the subject of political debate in numerous congressional elections. The general conception that the lay person is told through the media and politicians is that by running this current account deficit it costs Americans jobs and indebts them to foreign nations. Pat Buchanan stated in a speech, “our merchandise trade deficit is a $166 billion. As this vast transfer of U.S. wealth and technology was taking place….our share of world GDP had fallen …..and the real income of Americans who work with their hands, tools and machines has fallen 20 percent , in 20 years.” However, without questioning the source of Buchanan’s statistics, it is important to review his underlying premise. The current account deficit that the U.S. is currently running is the reason for the blue collar workers’ problems.
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Furthermore, he has stated that the gains from trading with these countries are minimal. Why should it matter where America’s imports are being made as long as it is relatively cheaper in terms of factors of production for foreigners to make them.? Buchanan is concerned that Japan is not practicing fair trade and this is reflected in the trade deficit the U.S. currently has with them. Yet Japan is a member of GATT and as such is subject to the same rules of trade as the U.S. Furthermore, they have never asked the U.S. for voluntary export restraints and did not complain when it was asked of them. However, while visible trade barriers are in line with other developed countries Japan is accused of abusing the use of non-tariff or intangible trade barriers. It is perceived as difficult to export manufactured goods to Japan due to their “product standards and testing procedures, the wholesale and resale distribution systems, and government procurement.” A common them in the U.S. is that the current account deficit signifies that exports are being restricted as a result of non-tariff trade barriers in other countries much like the aforementioned Japan case.
Before analyzing the current account deficit it is important to clarify what it is composed of. The current account consists mainly of imports and exports of goods (visible trade balance), the flow of “services (such as transport and banking); interest or dividend payments to foreign investors (and receipts on overseas investments);private transfers from workers…and official transfers (such as foreign aid).” When a country is running a current account deficit they are actually becoming indebted to foreigners. Subsequently, the reasons for taking on this debt should be the main concern of politicians like Buchanan, not the existence of the debt itself. If the U.S. was using this debt to finance consumption rather than increasing production capabilities then there wou! ld indeed be cause for concern. The increase in ability to produce goods and services through investment is what gives a country the capability to service and eventually pay off their debt. Another aspect of the current account is that it is affected by domestic fiscal policy. This is because the majority of government expenditure is on transfers and subsidies. Consumption spending of this sort can be dangerous because it does not help to generate the necessary resources to repay the debt.
Tariffs on Japanese and Chinese goods will have numerous effects on the U.S. economy. The main goal will be to raise the price received by domestic producers of that good and reduce imports . By raising the prices of imports, U.S. consumers will experience a consumer welfare loss. They will be paying more for goods that they have incorporated into their lifestyle and will see a decrease in selection. Substituting domestic goods for foreign ones could result in a further loss by consumers if they receive less value, variety, or substandard products for their money. Competition breeds competitiveness and if Buchanan makes it harder for foreigners to gain access to the U.S. market then he is creating an uncompetitive environment. If a tariff were put into place it would raise the price of the applicable goods in the U.S. and create an incentive for domestic producers to increase production. However, consumers will demand less and look for substitute goods. Imports will de! cline because Japan and China will have to lower their domestic prices which will lead to less producers and an increase in demand. The end result is that the U.S. current account deficit will decrease and might even become a surplus.
However, this is the most inefficient way to accomplish such a goal. Increasing savings or reducing the government deficit is the first-best policy to reduce the current account deficit. Unambiguously the terms of trade gain will always be outweighed by the efficiency loss that results from a tariff. Economies of scale cannot be achieved because tariffs fragment world markets and attract too many firms to enter the protected industries as a result of reduced foreign competition and increased profits. Buchanan feels that through tariffs (which he labels a foreign consumption tax) import substitution will stimulate growth in the American economy. The main problem with this mode of thinking is that tariffs allow an industry to survive but the! y do not promote efficiency. If Buchanan feels that America needs jobs and has lost its dominant role in the world economy he should focus on promoting exports. The very countries that he is condemning for the downfall of the American economy all have followed “industrialization oriented primarily toward export rather than domestic markets.” However, the solution that he should be looking at for the current account deficit is staring himself in the mirror every morning.
Politicians must act fiscally responsible and reduce government spending because it is the deficit that causes the problem. As the deficit goes, so goes America’s current account balance. Pat Buchanan feels that protectionism is the answer to re-establishing the U.S. as the world’s dominant industrial nation. Through analyzing his policies it becomes evident that though his vision is shared by many his means of achieving it are economically fallible. If he implemented his policies he would accomplish the very result which he is condemning. Buchanan’s economic platform is pandering to the notions of ill-informed people. If we think of the U.S. as a boat, he is trying to patch a leak, and in doing so, has created two new ones. Lets just hope that level heads prevail and he is not elected or we might just have to bail water to prevent the mighty U.S. from sinking. BIBLIOGRAPHY Buchanan, Pat, “An American Economy for Americans” Buchanan, Pat, “Time for Economic Nationalism” “In Praise of Free Trade”, Newsweek, July 12, 1993 King, Philip, International Economics and International Economic Policy: A Reader. Singapore: McGraw-Hill Book Co., 1990 “Not so absolutely fabulous”, The Economist, November 4, 1995 Paul Krugman and Maurice Obstfeld, International Economics. New York: HarperCollins College Publishers, 1994 The abuse of economics: Common economic fallacies, UK: The Economist, 1996