Why Nations Trade

One might argue that the best way to protect workers and the domestic economy is to stop trading with other nations. Then the whole circular flow of inputs and outputs would stay within our borders. But if we decided to do that, how would we get resources like coffee beans? Most countries simply cannot produce everything they need, and they cannot manufacture some products, such as steel and most clothing, at the low costs to which they have become accustomed. The fact is, that nations—like people—are good at producing different things: you may be better at programming a computer than repairing a car. In that case, you benefit by “exporting” your computer skills and “importing” the car repairs you need from a good mechanic. Economists refer to specialization like this as advantage.


Absolute Advantage

A country has an absolute advantage when it can produce and sell a product at a lower cost than any other country or when it is the only country that can provide a product. China is known for having an absolute advantage in most manufacturing. The United States, for example, has an absolute advantage in reusable spacecraft and other high-tech items.

Suppose that the United States has an absolute advantage in air traffic control systems for busy airports and that Brazil has an absolute advantage in coffee. The United States does not have the proper climate for growing coffee, and Brazil lacks the technology to develop air traffic control systems. Both countries would gain by exchanging air traffic control systems for coffee.


Comparative Advantage

Even if the United States had an absolute advantage in both coffee and air traffic control systems, it should still specialize and engage in trade. Why? The reason is the principle of comparative advantage, which says that each country should specialize. When they do, they can focus on things they can produce inexpensively or easily and import the other products. This specialization ensures more things will be produced globally and at lower prices.

For example, India and Vietnam have a comparative advantage in producing clothing because of lower labour costs. Japan has long held a comparative advantage in consumer electronics because of technological expertise. The United States has an advantage in computer software, airplanes, some agricultural products, heavy machinery, and jet engines.

Thus, comparative advantage acts as a stimulus to trade. When nations allow their citizens to trade whatever goods and services, they choose without government regulation, free trade exists. Free trade is the policy of permitting the people and businesses of a country to buy and sell where they please without restrictions. The opposite of free trade is protectionism. This is when a nation protects its home industries from outside competition by establishing tariffs and import limits. In the next section, we will look at the various barriers, some natural and some created by governments, that restrict free trade.


The Fear of Trade and Globalization

The continued protests during meetings of the World Trade Organization show that many people fear world trade and globalization. What do they fear? Some of the negatives of global trade are as follows:

Millions have lost jobs due to imports or to production shifting abroad. Most find new jobs, but often those jobs pay less.
Millions of others fear losing their jobs, especially at those companies operating under competitive pressure.
Employers often threaten to export jobs if workers do not accept pay cuts.
Service and office jobs are increasingly vulnerable to operations moving abroad.
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