Explain the gains from trade and the implications for trade negotiations Trade is the transfer of goods and services from one person or entity to another in return for something in exchange from the buyer. The fundamental force that drives trade is David Ricardo’s law of comparative advantage; that is, the ability of an individual or group to carry out a particular economic activity (such as making a specific product) more efficiently than another activity.
One country cannot have a comparative advantage in all goods, as having a comparative advantage in one good automatically means that the country will have a comparative disadvantage in another. International trade allows countries to develop comparative advantages that they have created, which will have been largely determined by underlying resources and capabilities. The first gain in trade is the greater variety of available goods for consumption.
Without trade, an economy can consume only what it produces – its consumption possibilities frontier (CPF – the limit to what a country’s citizens can consume) is the same as its production possibilities frontier (PPF – the representation of an outcome or production combination that can be produced with a given amount of resources). Trade brings in different varieties of particular products from different destinations. This gives consumers wider arrays of choices which will satisfy the tremendous diversity in tastes in the marketplace.
Secondly, there will be more efficient allocation and better utilization of resources since countries tend to produce goods in which they have a comparative advantage. When countries produce through comparative advantage, and import goods in which they only have a comparative disadvantage, wasteful duplication of resources is prevented; thus reducing pollution and concentrating on creating goods which are the most valuable to them.
Furthermore, trade promotes efficiency in production as countries will try to adopt better methods of manufacture to keep costs down in order to remain competitive (an example of which would be the exploitation of economies of scale, the output per unit of input may rise, so that, costs per unit of output may fall). Countries that can produce a product at the lowest possible cost will be able to gain a larger share in the market. Therefore an incentive to produce efficiently arises. This will help standards of the product to increase and consumers will have a good quality product to consume at the most competitive price possible.
On top of this, trade speeds up the pace of technical innovation and progress. The establishment of newer industries to cater for the demands of various countries creates the need to overcome scientific barriers and challenges. Without the demand, these advances would not be achieved. However, Not forgetting, if a country repeatedly produces a particular good, given time, dynamic comparative advantage should be gained; whereby a country (or person or firm) possesses as a result of having specialized in a particular activity and, as a result of learning by doing, becomes the producer with the lowest opportunity cost.
Therefore, simply by practicing and perfecting the process of production, a country can become even more efficient, increasing output and offering the best possible price to the customer. A Trade negotiation is an intervention between pairs of governments, or among groups of governments, exchanging commitments to alter their trade policies, usually involving reductions in tariffs and sometimes nontariff barriers. Governments restrict international trade to protect domestic industries from foreign competition.
The first tool that governments use to protect their domestic markets are tariffs. A tariff is a tax that is imposed by the importing country when an imported good crosses its international boundary. The money raised through tariffs often goes towards paying a subsidy, which is a payment made by a government to a domestic producer based on the quantity produced. In the European Union, buyers of agricultural products face prices that, on the average, are 40% above world prices.
These higher prices result from the Common Agricultural Policy (CAP), which is a price support programme for farmers that acts as a tariff on non-EU agricultural products. This scheme is highly beneficial to producers, ‘in total, during the ten years to 2009, taxpayers and consumers in the EU have transferred nearly €1 trillion to agricultural producers …, which represents a high level of support and keeps production and exports higher, and imports lower, than would otherwise be the case. (Agritrade, 2012). Therefore, it is the general public of the E. U who are paying the real price of this tariff; agricultural products that are consumed in Europe are significantly more expensive than they would be if free, international trade were practiced. Furthermore, the CAP represents 40% of the E. U budget expenditure and is the most expensive of the E. U policies, however many people argue that it is not sustainable to for farmers to rely completely on their subsidies that they receive.
In some cases, it would be more profitable for a farmer to do absolutely nothing on his land and to still gain the CAP payment, than to work all year managing the land, which is not only viewed as unethical, but also allows room for inefficiency, whereas if the subsidy did not exist, farmers would not have this safeguard. In New Zealand, the government adopted in the 1970s a deficiency payment subsidy scheme to its beef, sheep and dairy producers. However, in 1984, when a new Labour government were elected, import controls were removed and tariffs were reduced.
Although the short term repercussions were painful for farmers, (e. g. immediate fall in real incomes, land prices down), those who withstood the grief prospered in the end, as they embraced new techniques and technology to boost farm productivity and Total Factor Productivity for the country increased. Despite New Zealand having a clear comparative advantage in creating agricultural products due its climate and other resources, it is argued that it is not dissimilar to the UK and other parts of Europe, in which case, perhaps the UK could survive without its CAP payment.
This would cut out the implications of such heavy tariffs on food,( which would help lower the cost of living for the public,) would allow the precious E. U budget to be spent elsewhere and would make production more efficient. In conclusion, there are several gains from trade, including greater variety of goods for consumption, greater efficiency and allocation of resources, faster innovation and progress and will gain dynamic comparative advantage.
All of these benefits are driven behind the law of comparative advantage; it is vital to achieve the optimum profitably and efficiency that countries specialise is goods which they are successful in producing. A true example of this would be the case of New Zealand, which has learnt how to manage its resources and embrace new technologies competently, so as it is not reliant on the subsidies it gains from its governments. Although tariffs have been used as a source of government revenue for centuries and it is a simple way to protect home markets, industries, particularly agriculture would be more proficient if they could run without it.