Category Archives: Trade

AS Economics – Economic Integration

Although in the CIE syllabus only three stages of economic integration are mentioned there are actually six stages between nations, ranging from the relatively weak to more complex and stronger associations.

1. Preferential Trading Area – weakest form of integration. Nations agree to give preferential access to certain products from overseas countries. The EU (European Union) and countries of the ACP (African, Caribbean and Pacific) have formed Preferential Trading Area.

2. Free Trade Area – most common type of integration. Nations permit an agreed list of products to be traded tariff free. However those nations can set their own tariffs between themselves and nations outside the agreement. EG. NAFTA, EEA and APEC

3. Customs Union – same as FTA but all member nations agree a set of standard tariff levels between themselves and outside nations. This is known as the Common External Tariff (CET).

4. Common Market – same as Customs Union but is more complex in that it involves the establishment of common laws relating to the economy, trade, and employment and a common form of taxation between member nations.

5. Economic and Monetary Union – one trade barrier that a Common Market does not eradicate is the presence of different currencies although Economic and Monetary Union does not necessarily involve a single currency. It is where member nations irrevocably fix their exchange rates to one another.

6. Complete Economic Integration – all of the above but also includes considerable political integration as well. Nations embark on harmonization of economic policies and there tends to be the development of a supranational state making decisions on behalf of member nation’s governments.

Economic integration has the potential to benefit all parties involved and create additional economic welfare. It also brings nations together politically and culturally which again, can be a positive.

Examples of Regional Trade Agreements (RTAs):

  • The number of RTAs has risen from around 70 in 1990 to over 300 today
  • The European Union (EU) – a customs union, a single market and now with a single currency
  • The European Free Trade Area (EFTA)
  • The North American Free Trade Agreement (NAFTA) – created in 1994
  • Mercosur – a customs union between Brazil, Argentina, Uruguay, Paraguay and Venezuela
  • Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
  • Common Market of Eastern and Southern Africa (COMESA)
  • South Asian Free Trade Area (SAFTA) created in January 2006 and containing countries such as India and Pakistan

Record Terms of Trade for New Zealand – Q2 2020

New Zealand’s terms of trade rose by 2.5 percent in the June quarter, reaching a new record high.

Terms of Trade – Q2 2020

  • Export prices rose by 2.4 percent – forestry product prices rising by 11.1%, and dairy product prices by 4.1%.
  • Import prices fell by 0.1 percent in the quarter, driven by lower petroleum and petroleum product prices. This is despite higher prices for cellphones, televisions and laptops.

NZ’s high Terms of Trade highlights how NZ’s role as a food exporter will likely provide the NZ economy with some buffer as the global economy is rocked by the COVID-19 pandemic.

What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another.

Formula: Terms of Trade (TOT) =

Export Price Index (Px)           x   1000 (base year)
Import Price Index (Pm)

  • An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
  • A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”

A “favourable” (increase) in the TOT may come about because the average:

– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster

The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.

Limitations of the Terms of Trade

Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Evaluation

  • A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports.
  • The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
  • Some Less Developed Countries (LDCs) have seen an improvement in terms of trade because of rising price of commodities and food post 2008. It is not always LDCs who see a decline in the terms of trade.
  • It is important to distinguish between a short term decline in terms of trade and a long term decline. A long term decline is more serious for reflecting a fall in living standards.



Do imports slow GDP growth?

A book published this year ‘Fully Grown: Why a Stagnant Economy Is a Sign of Success’ Dietrich Vollrath addresses the issue – is growth the best way to measure economic success — and does a slowdown indicate problems in an economy?

He discusses that the slowdown (Pre-Covid) is an indicator of economic prosperity. The economy has already provided much of what we need in life – comfort, security and luxury – that we have turned to new forms of production and consumption that enhance our well-being but do not contribute to growth in GDP. One chapter looks at the increase in imports from China and how it doesn’t necessarily have any connection with the level of GDP or growth rate. It is commonly portrayed in the media that imports from China have a negative effect on US GDP and you can say that they do impact on employment levels in certain sectors – e.g. manufacturing industry. This can lead to a slowdown in growth if workers didn’t find alternative employment. According to Vollrath the size of imports from China looks too small to account for the growth slowdown.

There is an assumption that imports lower GDP but most introductory economics courses refer to GDP with the following:

Y = C + I + G + (X-M)

Y = GDP, C = Consumption, I = Investment, G = Government spending, (X-M) = Exports – Imports
With this equation if imports are higher, it must be that GDP is lower. The right hand side of the equation is just a way of accounting for GDP; it does not determine the size of GDP. Vollrath now puts imports on the other side of the equation so you have:

Y + M = C + I + G + X

The above equation helps given the common way that people understand the relationship if they imagine that M goes up, they’ll jump to the conclusion that one of the items on the right (C + I + G + X) must have gone up as well.

Y + M is the total goods and services available in a given year which we can purchase. The other side of the equation represents the purchasing of these goods and services whether it is consumption goods, capital good, government purchases and foreign purchases. An increase in imports means that there are more goods and services to purchase. But there is no necessary mechanical effect of having more imports on the size of our own production, GDP.

Domestic tourists needed to bolster GDP in NZ

Although in New Zealand the containment of the Covid-19 has so far been successful, with no international visitors the tourism sector has seen a sharp downturn. Those that have suffered most are the smaller operators and bars, restaurants, accommodation providers. Even with the wage subsidy a lot of these firms have been forced out of business. Domestic tourism will be essentially for the survival of a lot of the tourist spots around the country. The return of overseas visitors is some way off and even when restrictions are lifted visitor numbers are likely to be limited.

Visitor arrivals in New Zealand

Source: Westpac Economic Overview – May 2020

Before Covid-19, Tourism was New Zealand’s largest export industry in terms of foreign exchange earnings. It directly employed 8.4 per cent of the New Zealand workforce. For the year ended March 2019:

  • the indirect value added of industries supporting tourism generated an additional $11.2 billion, or 4.0 percent of GDP.
  • tourism as whole generated a direct contribution to gross domestic product (GDP) of $16.2 billion, or 5.8 percent of GDP.
  • international tourism expenditure increased 5.2 percent ($843 million) to $17.2 billion, and contributed 20.4 percent to New Zealand’s total exports of goods and services.

As the economy struggles along people will be concerned about job security and look to be a lot more cautious with spending. However having been restricted during the lockdown there is the hope that New Zealanders will want to travel domestically.

Source: Tourism New Zealand

NZ Farmers seek anti-dumping tariff on potatoes

This is a very good example of barriers to trade – CIE AS Level Unit 4 and NCEA Level 2. There has been a lot of publicity about potatoes being imported from Holland and Belgium at a price below that of New Zealand farmers. Pw represents the price which dumped items are imported into a domestic economy which is below the domestic market price.

Source: Tutor2u

European farmers have traditionally been receiving subsidies from their governments which means they can drive down export prices. Dumping margins are currently between 95 to 151%.

(Domestic value − Export Price) ÷ Export Price x 100 = % Margin of Dumping

Domestic value: The normal value is generally the selling price of the good in the country where it was produced.

Export price: The export price is generally the exporter’s selling price reduced by any export charges that are included in the price, such as freight and insurance.

These margins are expected to increase with price undercutting for the NZ industry of between 18% and 38%.

The absence of a tariff will see NZ potato processors being forced to cut production and demand for potatoes from NZ growers would drop leading to higher unemployment in the industry. The imposition of an anti-dumping duty on dumped imports of frozen potato products, would help to maintain demand for New Zealand grown potatoes, and ensure the continuity of employment and business in the growing sector.  A duty would mean that the potato growers would experience the same market conditions, including competition between themselves and fluctuations in market prices, as they did before the dumping occurred. 

The value of exports of potatoes and potato products from New Zealand grew from $93 million in the year to March 2010 to $128 million in 2020; an increase of 38 percent. During the same period, the value of imports of these products increased from $47 million to $60 million; an increase of 28 percent.

Effects on consumers
It should be noted that there is no guarantee that the benefit of lower prices will be passed on to consumers.  It is probable that any advantage of low prices to consumers will not endure.  Dumping occurs because overseas producers have a glut of produce or a collapse in demand in their own markets, and both these conditions are unlikely to be sustained.  Accordingly, a longer term consequence for consumers is that they could face higher prices if New Zealand based processors and growers are forced out of business by the dumping.

Effects on employment
At the national level, potato growing and processing is a relatively small industry, but it still directly and indirectly provides employment for almost 5,000 people.  Potatoes are one of the few crops grown outside, produced in most regions of New Zealand and harvested all year round.  The industry is therefore an important provider of widely distributed and stable employment.

Barriers to trade not the answer during the pandemic

The WTO has warned that the reduction in global trade could be bigger than that following the GFC in 2008 – see graph below. For countries to start reducing the volume of imports because export volumes have been decreasing is not seen as the right way forward. With countries dependent on the global supply chain for PPE and pharmaceuticals, it would be wrong to focus on being self-sufficient in these essential products.

Source: WTO

As Martin Wolf of the FT pointed out the issue is not with trade but a lack of supply. Export restrictions merely relocate the shortages, by shifting them to countries with the least capacity. The natural response might be to become more self-sufficient in every product but free trade and globalisation does have its advantages:

The Paradox of Aid – dumping in developing countries.

Although a few years old now the video below is a good example of dumping – where the exporting country is able to lower its prices below that of the domestic price in the market it is selling into. Useful to show when teaching barriers to trade.

The U.S. spends approximately $37 billion dollars a year on foreign aid – just under 1% of our federal budget. “The Foreign Aid Paradox” zeroes in on food aid to Haiti and how it affects American farming and shipping interests as well as Haiti’s own agricultural markets. The fact that the US dump rice exports on the Haitian market below the equilibrium price severely affects the revenue of local farmers. Should there be a trade-not-aid strategy for developing countries? Below is a very good video from wetheeconomy

The trade-not-aid strategy is based on the idea that if developing countries were able to trade more freely with wealthy countries, they would have more reliable incomes and they would be much less dependent on external aid to carry out development projects. International trade would raise incomes and living standards as poor countries would be able to export their way to economic development by selling their products to rich countries eager to buy their goods.

Source: http://www.globalization101.org/trade-not-aid/

New Zealand Tourism will take a hit.

Tourism accounts for approximately 10% of GDP but the forecast doesn’t look good even with the success of eliminating Covid-19. NZ growth totalled $40.9bn last year of which $16.2bn – 5.8% GDP – came from tourism – see graph below. Tourism also helped the retail and hospitality sectors to the tune of $11.2bn – 4% GDP. But there are a number industries which have been hit hard by the lack of tourism due to Covid-19. The food and beverage industry relies on tourism and it accounts for 24% of the total food and beverage serving services.

Of visitors to New Zealand the three main ones are:

  • Australia – 23%
  • China -13%
  • Rest of Asia – 13%

New Zealand is more exposed to tourism than a lot of other countries; we rely more heavily on this sector for employment, income and GDP. In 2019, 229,566 people were directly employed in tourism (8.4% of the labour force). This is a significant portion of the labour market and is considerably higher than many other countries. It has estimated that 100,000 jobs could be lost in the tourism sector as a result COVID-19 – that is 40% of those employed in the sector. On 22nd April 2020 visitor numbers fell to zero – see graph below – as a result of the border closures. However the lockdown has given the tourism sector the chance to restructure the sector into a more sustainable model and be less reliant on overseas visitors. But the future is very fragile.

Arrivals to New Zealand

Source: ANZ Research – New Zealand Weekly Focus – 25th May 2020