How do countries conduct trade in the global economy?
As Figure 15.2 shows, international trade has grown dramatically since the end of World War II. Over the past half-century, the worldwide trade in merchandise, which includes all types of goods, has expanded more than 120 times, or by 12,000 percent. A number of developments have combined to make this increase in global trade possible.
First, advances in transportation have had a major impact on cross-border trade. It is easier to move goods around the world than ever before. Ships are far larger today than they were 50 years ago, enabling them to carry more goods at a lower cost per unit. Container ports have facilitated shipping by allowing the loading and unloading of whole containers of goods. The development of wide-body, long-distance jet planes has made air transport cheaper and faster. As a result, perishable goods such as fresh fruits and vegetables can be shipped thousands of miles without spoiling.
Improved communications have also fueled the growth of global trade. Satellite systems now link computers and telephones around the world, making it possible to communicate almost instantly across great distances. A company in one country can serve its customers in another almost as easily as if they were in the same city. Global business can be transacted, and money can be exchanged, with just a few keystrokes.
A shift in the types of goods being produced and traded has further promoted global commerce. At one time, much of the trade between countries was in bulk commodities, such as grains, coal, and steel. These items were heavy and relatively hard to ship. Today a large share of global trade is in lighter manufactured goods, such as computers and other electronic devices, which are easier to transport and which sell for much higher prices.
Countries trade with each other for the same reason individuals do: to get the goods and services they value at the lowest cost. Most countries lack either efficiently than other countries can. Such an advantage might come from a country having access to a scarce resource or having the ability to produce something more cheaply than other countries can. For example, South Africa’s rich diamond deposits give it an absolute advantage in diamond production.
A country has a comparative advantage in trade when it can produce a good or service at a lower opportunity cost than its competitors can. For example, the United States and Canada are both capable of producing jet airplanes and wood products. But the opportunity cost of producing timber is lower for Canada than it is for the United States. And the opportunity cost of producing jet airplanes is lower for the United States than it is for Canada. So it makes sense for the United States to trade its relatively cheaper airplanes for Canada’s relatively cheaper timber. By specializing, both countries get the goods they want at a lower cost than if they tried to produce both goods for themselves.
One country’s comparative advantage over another might stem from any of several differences between them. Three of the most important are differences in climate, factors of production, and technology.
Differences in climate. Many countries have a comparative advantage in the production of certain crops based on climate. Tropical countries export warm-weather crops like mangos, bananas, and coffee. Countries with temperate climates trade grains like wheat and corn. Seasonal variations between the Northern and Southern hemispheres can also play a part. For example, during the winter months the United States and Europe buy fruits and vegetables from southern countries such as New Zealand and Chile, which are then in their summer growing season.
Differences in factors of production. Countries with an abundance of a particular factor of production – land, labor, or capital – may have a comparative advantage in the production of goods derived from that resource. Canada, for example, with its extensive forestland, has a comparative advantage in timber products. China, with its huge population, has an advantage in the production of goods like clothing that require large amounts of low-cost labor. Japan, with its high national savings rate, is able to specialize in industries that require a lot of investment capital, like automobile manufacturing.
Differences in technology. Countries that have developed high levels of technology also enjoy a comparative advantage in producing high-value goods. Japan’s advantage in auto production is in large part a result of advances in engineering and production methods. Similar advances in the software and pharmaceutical industries have given the United States and Europe a comparative advantage in those fields.
Global trade is not solely a matter of absolute or comparative advantage. After all, many countries are equally efficient at producing all kinds of goods – cars, foods, movies, clothing. They don’t have a particular advantage in the production of such goods, and yet they trade them nonetheless.
The reason is simple. Consumers enjoy the variety created by differentiated products. Differentiated products are products that are essentially the same, but are distinguished from each other by variations in style, materials, or taste.
Consider a commonplace food like cheese. All cheese is basically the same – a product made of cultured milk. Looked at that way, one type of cheese is pretty much the same as another. But consumers who buy cheese don’t look at it that way. Cheese is a differentiated product. The unique tastes and textures of the many varieties are strong selling points for consumers. Shoppers tend to seek out specific cheeses – French brie, Greek feta, Italian parmesan – to suit their particular tastes and menus. This demand drives the international trade in cheeses.
The same principle applies to other products and countries. Consumers may seek out leather shoes and handbags from Italy, popular music from Great Britain, or animated movies from Japan. Economists note that differentiated products like these are an increasingly important factor in global trade.
